House Call: Talking Equity Markets with UBS Asset Management

Jeremy Zirin · UBS Asset Management

US bull market stays volatile but should continue while corporate earnings and the economy hold up.

The S&P 500 gained only 2.3% in Q3, but gains were narrow: seven of 11 sectors fell, the equal-weight index hit a multi-decade low relative to cap-weight, and 42% of S&P 500 companies were more than 20% below their 52-week highs. Despite that, Zirin still sees a volatile bull market likely to persist for the foreseeable future. The case rests on strong corporate earnings and a resilient economy; as long as those hold, which is his expectation, the bull market should continue. Volatility sources include higher rates, index concentration, Middle East and European geopolitics, and high expectations for AI-driven earnings.

“I still contend we're in a volatile bull market and likely to remain in a volatile bull market for the foreseeable future. Corporate earnings remain strong and the economy has been resilient.”at 2:57

Jeremy Zirin · UBS Asset Management

S&P 500 valuation has eased to about its 10-year average as earnings grew faster than prices.

The S&P 500 forward P/E has fallen from about 22x at the start of the year to roughly 19x, close to its 10-year average. The compression happened because earnings estimates rose considerably faster than index prices. Zirin concludes the market is not an indiscriminate risk-on rally but one increasingly focused on companies with strong, sustainable profit growth. Valuation is therefore a smaller concern this year than it was at the start of the year.

“The S and P five hundred's forward PE multiple has contracted from 22 times at the beginning of the year to roughly 19 times earnings or close to its ten year average. That's because earnings estimates have risen considerably faster than the price gains that we've seen in the index so far this year.”at 3:36

Jeremy Zirin · UBS Asset Management

Index concentration is high, so a broad market-cap index no longer offers the diversification it once did.

By late September the ten largest S&P 500 companies made up about 40% of index market capitalization and 37% of forward earnings. That creates two-sided risk: if the largest companies keep delivering, the index can stay resilient, but if a few heavily weighted names disappoint, the index-level effect can be significant. For investors, this means that owning a market-cap-weighted index of the whole US market no longer provides the same diversification it once did.

“The 10 largest S and P 500 companies represented approximately 40% of its market capitalization and 37% of forward earnings. ... this means that investing in an index representing the entire US equity market by market cap no longer provides the same level of diversification that it once did.”at 10:13

Jeremy Zirin · UBS Asset Management

High-quality growth stocks look attractive after lagging value, with growth at a nine-year relative valuation low.

Growth stocks extended their year-to-date underperformance versus value to more than 10 percentage points in Q3, even though large-cap growth has stronger trailing earnings growth and earnings revisions than large-cap value. As a result, the Russell 1000 Growth trades at a nine-year low relative to the Russell 1000 Value on forward P/E. Zirin also argues that growth companies tend to become more valuable as the economic cycle matures, because investors pay more for firms that can generate their own growth when aggregate growth is scarcer. That makes high-quality growth one of the most attractive opportunity sets.

“The relative underperformance has resulted in more Russell one thousand growth index trading at a nine year low relative to the Russell one thousand value index on a forward price to earnings basis.”at 14:16

Jeremy Zirin · UBS Asset Management

Fundamentally sound laggards could re-rate within 6-12 months if rates calm and earnings breadth improves.

Many stocks are well below their 52-week highs while the index sits near a record, which Zirin sees as an opportunity. The re-rating depends on two conditions: rates becoming less volatile and earnings participation broadening beyond a small group of large companies. If both occur, several fundamentally sound laggards could re-rate over the next six to twelve months.

“So if rates become less volatile and earnings participation broadens, there certainly is several fundamentally sound laggards that could re rate over the next six to twelve months.”at 16:42

Jeremy Zirin · UBS Asset Management

Quality stocks are particularly attractive now as the cycle matures and higher rates reward strong balance sheets.

Zirin argues that quality matters more when the margin for error narrows, which he sees now. Early in a recovery, weaker, cyclical businesses often outperform because investors overlook weak balance sheets, but as the cycle matures capital becomes more expensive and markets punish missed expectations. He looks for high return on equity, consistent margins and strong balance sheets. With rates higher, the ability to self-fund growth matters more, and strong balance sheets let companies keep investing, make opportunistic acquisitions, or return capital when weaker rivals retrench. Quality portfolios have lagged in this early-bull phase but should help later in the cycle and limit downside.

“So our view is that the timing for quality stocks is particularly attractive right now, as you mentioned, as the economic and market cycle matures.”at 18:39

Jeremy Zirin · UBS Asset Management

Returns like the past three years' 20% annual pace are unlikely to repeat over the next 3-5 years.

The S&P 500 has compounded at about 20% a year over the past three years, more than double its long-term average annual return. Zirin notes that early bull-market phases tend to be led by high-beta and momentum stocks, while quality-disciplined portfolios can lag, as they have for several quarters. Given the magnitude of recent returns, he thinks it is highly unlikely the market repeats that level of bullishness over the next three to five years. This is a qualitative call, not a numerical target.

“And just given the magnitude of returns over the last three years, it's highly unlikely that we're going to have a repeat of that type of bullishness over the next three to five years.”at 19:19

Jeremy Zirin · UBS Asset Management

Main AI capex risk is returns: capacity, competition and depreciation may undercut earnings, not an AI bubble burst.

Zirin still sees AI as a genuine secular opportunity, but says the investment implications are evolving. The first phase rewarded companies supplying scarce infrastructure, and the next phase will increasingly require proof that customers can monetize the spending. He does not see an AI bubble bursting as the main risk. Instead, capacity growth, competition, and high depreciation expense for AI capex spenders could cause earnings and cash flow growth to fall short of already-high expectations. The shift in focus is toward return on investment to gauge the sustainability of AI infrastructure capex.

“the next phase will increasingly demand proof that customers can monetize that investment. And to me, the risk isn't that AI... that an AI bubble burst, it's more that capacity growth, competition and high depreciation expense for the AI... CapEx spenders causes earnings and cash flow growth to potentially fall short of relatively high expectations.”at 9:41

Jeremy Zirin · UBS Asset Management

Prefers companies supplying AI infrastructure, such as cloud, networking and leading-edge chips, over AI-narrative names.

Zirin says technology remains an important part of the high-quality growth opportunity set, and he continues to like companies providing critical AI infrastructure: cloud computing platforms, sophisticated networking equipment and leading-edge semiconductors. He cautions that the best opportunities are not necessarily the companies with the most exciting AI narrative. He prefers businesses with long-term, sensible competitive positions, genuine customer demand, and a credible line of sight from today's investment to sustainable positive free cash flow.

“Technology continues to remain an important component of that opportunity set and we continue to like companies providing critical infrastructure for AI, such as cloud computing platforms, sophisticated networking equipment and leading edge semiconductors.”at 14:43

Jeremy Zirin · UBS Asset Management

Overall US consumer spending is healthy, but lower-income households are under pressure from prices and financing costs.

Early bank results suggest overall consumer spending remains healthy, which Zirin names as one of the items he is watching most closely this earnings season. He qualifies that by noting that higher prices and higher financing costs continue to pressure household budgets, particularly for lower-income consumers. The consumer is one of the three things he is watching as the earnings season unfolds, alongside margins and AI spending.

“Early results from the [banks] suggest that overall consumer spending is healthy, but higher prices and financing costs continue to pressure household budgets, particularly for lower income consumers.”at 5:40

Jeremy Zirin · UBS Asset Management

Headline earnings are strong and growth should stay healthy into 2027, with breadth improving beyond AI.

Q3 earnings season started well: 78% of the roughly 80 early reporters beat estimates, by about 5% on average, and consensus Q3 estimates rose 1.5% during the quarter, the opposite of the usual pattern. All 11 sectors are projected to grow revenue, and several sectors outside tech and AI are expected to post double-digit earnings growth. Zirin sees this broadening as healthier for the index because it reduces reliance on a small group of AI beneficiaries. He therefore expects earnings growth to remain healthy heading into 2027, which underpins his constructive view on US equities.

“And all 11 [sectors] entering the third quarter earnings season are projected to have positive revenue growth. And several sectors outside of tech and AI are expected to produce double digit earnings growth.”at 6:53

Jeremy Zirin · UBS Asset Management

Rising yields are the most immediate equity risk, especially if the increase is fast or inflation- or fiscal-driven.

Zirin calls interest rates the most immediate concern for equities. Stocks can usually absorb gradually rising rates, especially when the rise reflects stronger growth, which he believes is happening now. The problem is speed and source: in late September the 10-year Treasury yield rose more than half a percentage point, and stocks have historically struggled to advance during moves that fast. Rates driven by inflation or fiscal concerns are also more damaging than rates rising on growth.

“interest rates are probably the most immediate concern. Equities can often absorb gradually rising interest rates and rates are moving higher for a good reason, such as stronger economic growth.”at 8:02

Jeremy Zirin · UBS Asset Management

Unresolved Middle East tensions could keep energy prices high, sticking inflation and prompting more Fed hikes.

Zirin lists the path of economic growth as the second key variable. If geopolitical tensions in the Middle East do not de-escalate, energy prices may stay higher for longer. That would make inflation stickier and could trigger further Fed rate hikes. The reverse is also true: if oil and especially diesel prices normalize, core inflation pressures should ease. That could trigger a strong equity rally, especially in areas of the market that have lagged this year.

“If geopolitical tensions in The Middle East do not de escalate, energy prices may stay higher for longer, leading to stickier inflation and potentially triggering even more rate hikes by the Fed.”at 8:51

Jeremy Zirin · UBS Asset Management

Midterms likely produce modest sector and company winners and losers, not a result that overwhelms markets.

Zirin argues elections matter for future policy but are rarely a good standalone timing tool, since fundamentals such as earnings, growth, inflation and rates matter more. The election matters more beneath the surface for themes like AI, where a Republican-held Senate would likely favor faster permitting, power generation and data center buildout, while a Democratic chamber could bring more scrutiny of electricity costs, privacy and environmental impact. The most likely outcome is a narrow Senate majority and divided government, which makes sweeping legislation difficult and limits outsized sector effects. Healthcare, energy and financials may see more volatility near the midterms.

“So my bottom line is the midterms could create some modest winners and losers at an industry or a company level, but I don't think that the result by itself is likely to overwhelm the broader earnings and macroeconomic backdrop.”at 13:15

Jeremy Zirin · UBS Asset Management

Healthcare is a compelling growth area: durable demographic demand, attractive margins and defensive, low cyclicality.

Zirin sees healthcare as another area with compelling growth. Longer-term demographics suggest durable demand for the sector's products and services. Most healthcare stocks offer attractive margins, and the sector acts defensively because of its below-average sensitivity to the economic cycle, which makes it a good hedge against economic weakness. Healthcare also contains innovation-driven companies whose company-specific execution matters more than the direction of GDP.

“And most stocks of the sector offer attractive margins and the sector generally acts defensively given its below average sensitivity to the economic cycle.”at 15:29

Jeremy Zirin · UBS Asset Management

Rising rates with a healthy economy favor banks; loan growth, credit trends and pipelines look solid.

Zirin argues that rising rates alongside a healthy economy are generally a winning formula for banks and capital-markets-sensitive stocks. Early Q3 earnings-season results support this: core financial sector fundamentals look solid, loan growth remains strong, credit trends are positive, and banking pipelines remain robust. He therefore highlights financials as one of the areas with attractive fundamentals.

“Rising rates in concert with a healthy economy is generally a winning formula for banks and capital market sensitive stocks. And from what we've heard during earnings season so far, core financial sector fundamentals look solid, loan growth remain strong, credit trends are positive, and banking pipelines remain robust.”at 16:10