22 February 2024, 4:05PM UTC
Chief Investment Office GWM
Investment Research
US equity sectors
CIO View
David Lefkowitz, CFA, CIO Head of US Equities, UBS Financial Services Inc. (UBS FS)
Nadia Lovell, CIO Senior Equity Strategist, US Equities, UBS Financial Services Inc. (UBS FS)
Matthew Tormey, CIO Equity Strategist, US Equities, UBS Financial Services Inc. (UBS FS)
• Despite recent mixed economic signals, we think the backdrop for
US equities remains supportive, driven by healthy economic growth,
moderating inflation, a Fed that's pivoting to rate cuts, and a strong
surge in AI investment. Although some sentiment and positioning
measures look elevated, any modest pullback in the coming months
could offer investors a better opportunity to add to equity positions.
• This month, we upgrade healthcare and industrials from neutral to Source: gettyimages
most preferred. We downgrade consumer staples and energy from
most preferred to neutral. Our most preferred sectors are healthcare,
industrials, and information technology. Our least preferred sectors Fig. 1: Remain balanced, but shifting
are real estate and utilities (Fig. 1).
exposures
Tactical preferences from benchmark (S&P 500)
CIO six-month tactical view
We are most preferred on the healthcare, industrials, and information
technology sectors. Healthcare is our preferred defensive sector due to
faster earnings growth relative to other defensives. Industrials should
benefit from resilient economic growth, an improvement in manufacturing
business sentiment, and a bottoming in cyclical areas such as transport.
Tech should benefit from its higher quality bias, AI-driven growth, and a
pickup in key end-markets
We are least preferred on the real estate and utilities sectors. For real estate,
Source: UBS, as of 22 February 2024
growth in adjusted funds from operations this year will likely lag S&P 500
profit growth. Resilient economic data may lead to underperformance for
the utilities sector.
Most preferred
Healthcare (upgrade from neutral): This is our preferred defensive sector
due to faster earnings growth relative to the other defensives (Fig. 2) and
the potential for certain segments—managed care and life sciences tools
—to benefit from a pickup in earnings growth as the year progresses.
Drugmakers are facing patent expirations on several large products, but
promising new drug therapies in large untapped end-markets, such as
Alzheimer's and obesity, offer an offset.
Industrials (upgrade from neutral): The sector should benefit from resilient
economic growth, an improvement in manufacturing business sentiment,
This report has been prepared by UBS Financial Services Inc. (UBS FS). Please see important disclaimers and disclosures
that begin on page 4.
US equity sectors
a bottoming in cyclical areas such as transports, multiyear growth in Fig. 2: Healthcare earnings growth
infrastructure, reindustrialization of the US economy in certain areas, and should outpace other defensives in
aerospace demand. Investments in energy supply (fossil and renewable)
2024
should provide further support for the sector. Finally, the defense segment
Annual EPS growth, y/y in %
should benefit from the current geopolitical environment, although many
of these companies are contending with burdensome fixed price contracts
with the government.
Information technology: AI infrastructure spending remains robust as
businesses across many industries experiment with use cases for this new
functionality. Key components will likely remain supply-constrained into
next year. It is still early in the rollout of AI applications, but so far the
uptake has been encouraging. In addition, the sector should benefit from
a bottoming in PC and smartphone end-markets. As a result, earnings Source: FactSet, UBS, as of 21 February 2024
revisions are faring better relative to the broader market (Fig. 3). Investors
will likely continue to gravitate to high-quality companies that have good
secular growth. That all being said, the sector has performed well recently
and valuations have expanded, which could prompt some periodic profit-
taking.
Fig. 3: Tech relative earnings revisions
have improved
Neutral US IT sector relative net earnings revisions, 3-month
Communication services: The sector has been one of the best performers average
over the past year due to a better tone regarding digital advertising,
investor enthusiasm about opportunities in AI, and aggressive cost-cutting
at some mega-caps. However, the integration of AI into internet search
queries will likely usher in a heavier investment cycle for incumbents and
could lead to competitive threats and margin pressure. Competition in
broadband poses risks for this segment. Investors should be aware that
the market-cap-weighted version of the sector is highly concentrated, with
Alphabet and Meta accounting for nearly 70% of the total.
Source: DataStream, UBS, as of 21 February 2024
Consumer discretionary: The sector has been a strong performer over
the past year largely due to investor enthusiasm about AI and mega-cap
growth companies. While valuations look elevated for auto manufacturers,
other segments look more reasonably priced and could benefit from an
eventual recovery in goods consumption, especially if headwinds in the
housing market continue to diminish. Investors should be aware that the
market-cap-weighted version of the sector is highly concentrated, with
Amazon and Tesla accounting for more than 45% of the total.
Consumer staples (downgrade from most preferred): We shift our
preference within defensives from consumer staples to healthcare. Pricing
power is eroding as inflation cools, and companies will likely be more reliant
on a pickup in volumes to drive revenue growth. In our view, higher-quality
companies within the sector appear pretty fully valued.
Energy (downgrade from most preferred): Oil prices have recovered since
the start of the year and are now near our commodity team's year-
end forecast. Although we continue to see the oil market as slightly
undersupplied in 2024, higher-than-expected production growth remains
a risk. The sector should act as a cheap hedge for any unexpected increase
in inflation or geopolitical tensions. However, we prefer to take cyclical
exposure through industrials.
Financials: Regulation is tightening but uncertainty has diminished,
providing better clarity on the path for capital return to shareholders.
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US equity sectors
Although higher funding costs remain a fundamental headwind, we think Fig. 4: Real estate AFFO growth likely
there may be potential upside to earnings due to lower loan-loss provisions to lag S&P 500 profit growth this
and green shoots in capital markets in a soft-landing scenario. The higher
year
likelihood of Fed rate cuts in the coming months is an upside catalyst.
S&P 500 Real Estate and S&P 500 EPS y/y growth,
actuals and consensus estimates
Materials: Inventory destocking in chemicals is advanced, and we don't
see as much downside risk to profit forecasts in the context of a soft
landing. However, the timing of any increase in demand remains uncertain,
especially considering that it may take time for the property market in
China to regain its footing.
Least preferred
Real estate: The sector looks slightly expensive relative to real interest AFFO = Adjusted funds from operations
rates, which are a key driver of sector valuations. Estimates are still high in Source: FactSet, UBS, as of 21 February 2024
some areas that over-earned during the pandemic. Furthermore, growth in
adjusted funds from operations will likely lag S&P 500 profit growth (Fig.
4). Note that our view is on the publicly-traded real estate sector relative
to the S&P 500 and does not reflect a view on privately-owned real estate.
Utilities: In the near term, increased regulatory risks and resilient economic
data may continue to weigh on relative sector performance. Excess
demand for labor should keep the job market strong, and the risk of a hard
landing seems less likely. We prefer to have defensive exposure through
the healthcare sector, which offers better earnings growth and exposure
to some secular growth drivers.
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US equity sectors
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US equity sectors
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