Top of the Morning: CIO Equity Pulse - Monthly performance update & outlook

David Lefkowitz · UBS Chief Investment Office (UBS Financial Services Inc.)

Leveraged neocloud data-center operators are under pressure while hyperscalers hold up better.

Higher interest rates hurt companies that rely on external capital and carry a lot of leverage. Young neocloud startups in the data-center buildout fall into that group, and their shares are under heavy pressure. Hyperscalers, which have large data-center businesses and have raised or are still raising capital, are reacting much less. The gap in reactions shows the market is becoming more selective about debt-funded AI infrastructure.

“you can really see this by looking at sort of the different reaction that we're seeing from some... of the neo clouds. These are kind of startups... And those are becoming under a lot of pressure versus some of the more... hyperscalers, which have massive data center businesses”at 2:53

David Lefkowitz · UBS Chief Investment Office (UBS Financial Services Inc.)

AI compute remains scarce; rising GPU rental prices show demand still outstrips supply.

The demand story has not changed. GPU rental prices, which show what it costs to rent an AI chip, are still rising. Rising rental prices mean the industry is still short of compute and supply and demand remain mismatched. This is the main reason the speaker stays constructive on AI demand despite recent volatility.

“I think the story with demand really hasn't changed. ... when you look at the price it costs to rent an AI semiconductor. These are the GPU rental prices. ... we still see that these prices are going up. And so that to us means we are still very short compute”at 3:38

David Lefkowitz · UBS Chief Investment Office (UBS Financial Services Inc.)

Enterprise AI app revenue growth slowed on safety-driven agent caution; expects reacceleration within months and quarters.

Private AI lab revenue growth has slowed. Some of that comes from one-time factors that have been widely reported. The main ongoing cause is a safety focus that makes enterprises reluctant to commit fully to AI agents until the risks are understood. Leading labs are also holding back on releasing higher-capability models. The speaker expects these issues to be sorted out with better controls, so AI application revenue growth could reaccelerate in the coming months and quarters.

“this whole focus on safety is also leading to some pullback in terms of demand from enterprises because they don't want to go all in on agents until they really understand what are the risks around that. ... I wouldn't be surprised if we do, in the coming months and quarters, see a reacceleration in the revenue growth for the AI applications.”at 5:13

David Lefkowitz · UBS Chief Investment Office (UBS Financial Services Inc.)

Constructive on AI as a market driver, but later in the cycle and reliant on external capital; favor quality.

The speaker is not bearish and still sees AI as an important market driver with strong end demand. He also says the sector is later in its cycle and now depends much more on external capital. For that reason he advises moving up in quality within the AI complex and avoiding too much concentration in the market winners of the past three or four years. Broad exposure and an application-side focus are also recommended.

“So we're not bearish. We're still constructive on AI as an important market driver. ... We wanna recognize that we are later in this cycle, and we're now much more reliant on external capital”at 6:11

David Lefkowitz · UBS Chief Investment Office (UBS Financial Services Inc.)

AI is not a dot-com replica; companies must earn returns, but a plausible path to returns exists.

The speaker rejects a like-for-like comparison with the 1999-2000 dot-com bubble. He agrees that AI companies will have to earn a return on their investment for the spending to pay off. He argues there are plausible and reasonable assumptions that give a clear line of sight to those returns. He acknowledges that this line of sight has become murkier in the very near term because of AI safety concerns.

“It's not an apples to apples situation... Ultimately, these companies are gonna have to earn a return on this investment, for all this to work out... we think there are plausible and reasonable assumptions that one can make to see a line of sight to earning a return.”at 7:15

David Lefkowitz · UBS Chief Investment Office (UBS Financial Services Inc.)

Each 100bp Fed hike trims GDP about 40bp; expects about 30bp drag and little corporate profit impact.

The speaker uses a rule of thumb that every one-percentage-point rise in the Fed funds rate trims GDP growth by a little under half a percent, about 40 basis points. He expects a smaller drag of about 30 basis points. He does not think the impact on corporate profits will be very noticeable. Higher rates are less good for corporate profits and cause some valuation compression. The US economy is also less rate sensitive than it was historically, which limits the damage.

“rule of thumb is that 100 basis points of our, so one percentage point increase in the Fed funds rate. You typically wanna trim your GDP growth by... A little bit less than half a percent, so 40 basis points. And so we're not even looking for four. Right? We're looking for three.”at 8:46

David Lefkowitz · UBS Chief Investment Office (UBS Financial Services Inc.)

Fed needs only modest further hikes, not restrictive policy; oil-driven inflation and a non-inflationary labor market limit it.

The speaker's firm raised its expected number of Fed hikes, but it does not think the Fed has to hike much more. The inflation the Fed is trying to fight is oil-driven, and the Fed cannot produce more oil or diesel, so tighter policy cannot fix the underlying cause. The labor market is not a source of inflation, unlike in 2022, when businesses struggled to find workers and wage growth was a concern. Together these mean the Fed does not need to move into a restrictive stance.

“we don't think the Fed has to hike a lot because the inflation that the Fed is trying to fight is this oil inflation, which they can't... They can't make more barrels of oil... And also, the labor market is not a source of inflation at the moment.”at 9:25

David Lefkowitz · UBS Chief Investment Office (UBS Financial Services Inc.)

Housing is most rate-sensitive but already depressed by affordability, so little downside from higher mortgage rates.

Housing remains the most rate-sensitive part of the economy. However, housing activity has already been depressed because affordability is so poor. Because activity was already operating at a low level, higher mortgage rates have limited further downside to corporate profits and the broader economy. The speaker had earlier said 30-year mortgage rates above 7% act like a wet blanket on buyer enthusiasm.

“Now housing is still the most rate sensitive, but housing activity has been pretty depressed because affordability is so bad. So there's not much downside from higher mortgage rates”at 10:38

David Lefkowitz · UBS Chief Investment Office (UBS Financial Services Inc.)

Middle East war is a big, unpredictable risk, but Trump's sensitivity to market pain should cap a 20% drawdown.

The conflict is a big risk. It has lasted longer than the consensus expected, and wars are inherently unpredictable, so investors should be prepared for volatility. The speaker thinks that if the conflict caused real pain in financial markets, Trump would respond, acting as a circuit breaker. That gives comfort that it will not lead to a 20% equity drawdown. A pullback from conflict-driven volatility would likely be a reasonable buying opportunity.

“This is a big risk. ... This has lasted longer than any of us thought. ... I think that still is a circuit breaker for Trump. So that gives me some comfort that this isn't gonna lead to, you know, a 20% drawdown in equities.”at 12:32

David Lefkowitz · UBS Chief Investment Office (UBS Financial Services Inc.)

Q3 beats were solid and 2026 S&P 500 earnings growth is seen at 25%; growth is decelerating but still strong.

With about a quarter of S&P 500 market cap reported, Q3 numbers have been decent, with solid magnitude and breadth of earnings beats. Q3 earnings growth is expected to be around 28%. Q4 guidance is a bit weaker than recent quarters, so earnings are decelerating, but momentum remains strong. Analysts are not revising estimates down, and the firm expects 25% earnings growth this year and 14% in 2027, which could even be low. This keeps the earnings backdrop supportive for equities.

“the numbers have been, you know, pretty decent... the magnitude and breadth of earnings beats have both been... solid... We're looking for 25% earnings growth this year.”at 13:57

David Lefkowitz · UBS Chief Investment Office (UBS Financial Services Inc.)

Oil-driven cost increases are a real but not dramatic earnings headwind for travel, freight and industrials.

Energy and oil are the one headwind visible in the early Q3 earnings season. Higher costs, mostly from oil prices, are clearly hurting companies in travel and freight, with impacts now showing up in industrials and consumer names too. The effect is not dramatic, but earnings momentum is more dented and is decelerating, with the Q4 guidance slightly weaker.

“this whole discussion on energy and oil, that clearly is a headwind for some companies... It's having an impact. It's not dramatic”at 14:22

David Lefkowitz · UBS Chief Investment Office (UBS Financial Services Inc.)

Midterms bring no major policy change while Trump holds the White House; any election volatility should be short-lived.

The election is unlikely to be a major market event. With Trump still in the White House, legislation is unlikely to pass, and Democrats will not have 60 Senate seats. Trump still leads regulatory, foreign policy and trade decisions. Congress could flip, but the outcome is not expected to change policy much. Any negative reaction in sectors like health care or financials on fears about 2028 policy would be an overreaction and a buying opportunity. Market volatility from the election should be short-lived.

“I don't think it's gonna really be the market event. I mean, we're we're not looking for any, really, any policy changes as a result of the election outcome.”at 16:58

David Lefkowitz · UBS Chief Investment Office (UBS Financial Services Inc.)

Stays constructive on US equities; S&P 500 target of 8,400 by June 2027 is unchanged.

The outlook rests on a three-legged stool of growth, the Fed and AI. Growth may decelerate somewhat because of Fed hikes, but analysts are not expected to mark down earnings. The Fed is less accommodative but is not expected to become a headwind, since inflation is not pervasive and not in the labor market. AI end demand remains strong, and any growing pains around safety could improve. The market is forward-looking and may already anticipate the end of Fed hikes, so the firm sees no reason to change its June 2027 S&P 500 target of 8,400.

“we still don't see a reason to change our June 2027 price target, which we have at 8,400 for the S and P.”at 20:44