UBS

Global Equity Strategy

Risks vs fundamentals: where are the asymmetries?

Keith Parker · Gerry Fowler · Marc el Koussa · Maxwell Grinacoff, CFA · Shreyas Guntur · Sunil Tirumalai · Sean Simonds · Sutanya Chedda · Jack Fu · Artour Danilov · Bhanu Baweja下载原始 PDF

De-risking accelerated but signs of resilience waiting for circuit breakers

Market internals showed signs of accelerated de-risking with large relative moves in defensives>cyclicals, high quality>low and low momentum>high, Europe>US, among others. The AI 100 was down 5% last week as Coreweave's CDS surged but the ex-AI 400 was up 2.5% with every equal weighted S&P sector up except Tech as bond yields fell even though CPI was "hot" and WTI oil was up 10% on Iran escalation fears.

Risk premiums vs fundamentals: using our frameworks to find asymmetries

We see rising odds of both a correlated rally and selloff with key catalysts the next 2+ weeks (earnings, FOMC, US midterms) determining the path for stocks into 2027, and Iran an increasing overhang. Implied correlations are too low if Tech and ex-Tech / rate sensitive segments can rally or fall at the same time. After the rate spike, the beta of risk premia to moves in rates seems to be higher now as highlighted by CRWV CDS. Amid now higher risk premia and lower P/Es, we look for relative asymmetries to position amid uncertainty using a number of our frameworks including: 1) ML model to identify what overshot macro moves, 2) REVS scores vs rates betas, 3) PEG ratios vs EPS momentum.

We highlight the following trade ideas with more detail in the note:

  • Upside: SPX OTM calls for year-end rally if 1) AI demand/narrative are supportive, 2) rates/oil pressures abate, 3) earnings beat low bar after derating, 4) US midterm risks do not realize, and 5) buybacks jump post blackout after the OCF surge.
  • Hedges: SPX vs XLU put switches for growth/AI hit with Utilities P/Es near 10+year lows, HYG downside for higher yield+spread "double whammy".
  • Regions: S&P 500 over FTSE 100, Korea over India.
  • Sectors: US Utilities and Industrials over US Staples (buy XLI calls funded with XLP calls), EU Industrials over Consumer cyclicals. Start reducing Energy exposure.
  • Baskets: US higher growth+CFROI at a Discount (UBEQHGCD) over Expensive Fundamentals (UBEQEXFN), Long EU Renewables (UBXXERNEW).

Circuit breakers: AI demand, Fed path, oil/Iran, midterms, buybacks

AI demand remains the first principal driver of equities though Fed rates have jumped in explaining returns based on our ML model. A local peak in yields and rates vol is key for stocks. Last week's fall in the US 10y and Dec '27 Fed pricing without rates vol rising despite higher CPI and oil is a good sign into FOMC and the thick of earnings.

  • Hyperscaler cloud beats. Hyperscaler results need to show accelerating AI demand and OCF, to drive CDS spreads lower like 3mo ago (META Oct 21 with MSFT, GOOG, AMZN Oct 28-29). UBS analyst forecasts are ~15% above consensus on US cloud sales the next 4 quarters, so upgrades can fuel another leg up in AI trades and the market. Comments about diversification of backlogs as well as AI monetization in ecosystems will be key as ROI debates need addressing.
  • FOMC path. When the Fed hiked <100bp within a year of 10y spikes, ACWI and SPX rallied 8-10% on avg the next 6mo and 15-18% the next year versus weak equities returns on larger Fed hiking cycles. No Fed hike next week combined with less hawkish rhetoric should see rates vol lower, which is positive for stocks.
  • Iran and oil. Escalation concerns are rising as US midterms approach. Higher oil prices can hit future demand, lowering the upside value in owning Energy stocks.
  • Buybacks. Micron can buy back stock starting Dec 9, with MU+NVDA quarterly buybacks of $70bn over 25% of total SPX LTM buybacks. Broad OCF growth at $825bn y/y though points to even larger buyback increases.

This report has been prepared by UBS Securities LLC. ANALYST CERTIFICATION AND REQUIRED DISCLOSURES, INCLUDING INFORMATION ON THE QUANTITATIVE RESEARCH REVIEW PUBLISHED BY UBS, BEGIN ON PAGE 31.

Contents

  • Trade ideas 4
  • Rates driving equities: what next? 6
  • AI demand key amid AI capex risk on higher rates 7
  • Benign hiking cycle points to further rally 8
  • Rising odds of a correlated rally 9
  • Hedges for tightening tail, growth/AI spillovers 11
  • Sectors and industries: where are the asymmetries? 13
  • ML model: rate sensitive sectors overshot 13
  • REVS and rates betas: pair subindustries on relative fundamental trends 15
  • Own low PEG industries with positive revisions 16
  • Oil at a fulcrum: demand destruction at higher prices 18
  • Trade ideas 19
  • Regions and countries: looking for underpriced growth 25
  • Look for low PEG ratios, strong revisions amid rate sensitivity 25
  • Trade ideas 27
  • Equities have greater asymmetry to lower rates (vs higher) 29
  • Appendix 31

Trade ideas

  • US: Rates spike and equities: what's next?
  • Europe part 1: Bond yield effects in European Equities
  • Europe part 2: Bond yields: the growth offset
  • EM: Higher yields, hawkish Fed and higher oil
  • Equity volatility not the only game in town

Trades for market exposures - Buying cheap growth and hedges

Buy SPX December OTM calls: Helps position for a broader rally if rates/oil pressures ease, midterm-election risk passes without a major shock, AI demand remains strong and earnings and buybacks provide additional supports - without pretending the macro downside has disappeared. The S&P 500 has historically rallied by an average of 6% from end-September to end-December in midterm-election years and by 14% through the following March. OTM calls add upside exposure while keeping downside limited amid still-elevated macro risks.

Buy HYG downside for the yield-plus-spread 'double whammy': We prefer using HYG downside structures to hedge the tail risk that Treasury yields and high-yield spreads rise together. Credit spreads have remained unusually calm despite higher rates volatility, but an unexpected tightening cycle could expose lower-quality high yield and leveraged loans first.

Buy SPX puts, funded by selling XLU puts: Index protection remains expensive to carry as high levels of dispersion continue to mute index-level moves. Utilities have already underperformed by more than expected by our macro model implies at a time where power demand remains supported by the AI build-out. XLU downside volatility is relatively rich versus SPX, and hence selling XLU puts to fund SPX puts therefore provides protection against a broader growth or AI disappointment.

Short KOSPI2/SMH/SOXX puts to buy SXXP calls: Take downside risk in Korea (and primarily Korean semis), where strong pricing, cash flow and buybacks are underwritten by DRAM undersupply through 2028 and a multiple already discounting considerable margin mean reversion that we don't expect. Use the rich implied vol to buy more than two times the notional of upside in Europe, where most industry groups are growing earnings above 10% and those expectations are still rising.

Long SPX vs FTSE 100: SPX has derated ~15% relative to the FTSE despite delivering 22% stronger relative earnings growth during the same period. US equities offer superior exposure to Technology and Industrials, the areas with the strongest growth and revision support, while the FTSE's defensive mix lacks the earnings growth offset required in a high real yield environment.

Long KOSPI versus NIFTY 50: Korea offers stronger two-year earnings growth and a lower valuation than India. The position also has appeal across rate scenarios: both markets are rate sensitive, but Korea's current-account surplus provides a buffer if rates and/or oil increase further, whereas India is more reliant on foreign capital and is more exposed to slowing IT services.

Trades for risks stabilizing/reversing - Buying asymmetric recovery potential

Buy XLI calls, funded by selling XLP calls: Consumer pockets (e.g. XLP, XRT) have rallied aggressively amidst the yield retracement despite oil remaining elevated — upside convexity to yields + oil falling in tandem now appears reduced. We would favor selling XLP upside to fund XLI upside. Fundamentally, Industrials are more attractive amid stronger revision momentum. Investors may consider XLI Dec vs. XLP Dec 25-delta ratio call switches for flat premium, which rewards a scenario in which rates pressure eases and the industrial part of the market recovers alongside an already aggressive Staples recovery.

US Utilities over US Staples. As rates have risen, Utilities P/E has fallen toward 15x, near 10+ year lows, despite rising medium-term EPS growth expectations on increased capex and power demand. Staples P/E is a lofty ~25x, despite falling EPS growth potential. Utilities earnings yields plus EPS CAGR is nearly 16%, compared to just ~11% for Staples. Both are rates sensitive, but Utilities are also less crowded than Staples. In the case of rate pressure abating, we see investors reallocating back to Utilities given its higher growth is now at a substantial discount.

Long EU renewables (UBXERNEW): Positive revisions, light crowding and a valuation held back by real yields. Renewables trade below our Narrative Radar fair value having underperformed their macro-sensitivities where bond yields going up is negative but gas prices going up is positive but under-priced currently.

Long US Industrials and Capex Broadening (UBEQCPXB). We believe AI related industrial demand will remain robust amid higher rates. On the other side, capex had been turning up beyond AI/data centers as mfg recovered from a ~3yr recession, while operating cash flow is up ~$825bn y/y (+25%) and capex to OCF is near historic lows ex hyperscalers. The correction provides an attractive entry point to a secular story related to AI, combined with the potential for a cyclical recovery in other segments.

Long EU Industrials (SXNP) vs Consumer (UBXECCYC): AI capex in Europe is moving from product suppliers to the industrials that build capacity. Revisions for these 'industrial capacity beneficiaries' are now as strong as for the 'AI Capex beneficiaries', from cheaper valuations and lighter positioning. Industrials lead European sector revisions while EU Consumer Cyclicals are being cut.

Rates driving equities: what next?

Our machine learning (ML) model assesses the key drivers of equities on an absolute and relative basis (see Tactical Dashboard). Our model currently shows that Fed policy expectations have increased in importance in explaining returns, with AI still at the top but down from the highs. While there have been many drivers of the 10yr rise, the shift from expectations of Fed cuts last fall to now pricing more Fed hikes has been the main driver. The first phase of the bond selloff was fundamental driven by the repricing of growth while the "spike" since early Sep has been exacerbated by positioning unwinds.

Investors have been asking what level of US 10y yield breaks the market/cycle. While equities were relatively resilient to the rise in yields given such strong earnings, the SPX P/E is down ~20% since late last year and risk premium more broadly have been repriced across sectors and factors with the spikes in France and Coreweave spreads the most visible casualties of the rates spike.

An orderly rise in yields/spreads on stronger growth became excessively volatile on positioning stress in September. As bond volatility subsides, we think bond yields/spreads retrace a little toward fundamentals and lower bond volatility allows equity risk-premia to recover.

AI demand key amid AI capex risk on higher rates

AI demand remains the first principal driver of equities. CDS spreads fell sharply on Q2 cloud beats amid the momentum unwind. Again, hyperscaler beats and commentary are the needed circuit breaker to refocus on accelerating AI demand and OCF.

Meta's results are Wed Oct 21 with MSFT, GOOG and AMZN next Wed-Thu.

UBS ~15% above consensus for N4Q cloud revenue. UBS analysts expect US hyperscaler cloud revenue to grow 60% y/y in 3Q, accelerating from 50% in 2Q and ahead of consensus. More important, over the next 4 quarters, UBS expects cloud revenue to reach $574bn, ~15% above consensus and ~73% growth versus prior. Thus, we see the potential for notable upgrades to 2027 cloud sales through Q3 reporting and into next year, which can hopefully act as a circuit breaker for the AI selloffs and reignite interest in the AI infrastructure theme as investors get more confidence in the sustainability of spending amid accelerating OCF.

Comments about diversification of backlogs/cloud revenue as well as AI monetization in ecosystems will be key as the ROI debate needs to be addressed.

Neocloud 2027 capex share is ~7%. The spike in Coreweave's bond yield further fueled a selloff in the AI complex on worries about financing costs and structure weighing on the ability to fund capex commitments. Though neoclouds are a bigger share of GPU demand, they account for 7% of AI capex in 2027 and neocloud enterprise value is ~$130bn. Compute demand far exceeds supply, so compute will get allocated in the event capital is an issue, with low risk to the broad AI build out in our view if AI demand is there given core hyperscaler OCF and borrowing capacity.

Low bar for Q2 reporting after derating. We see a low bar for Q2 earnings with nearly 70% of companies expected to deliver slower EPS growth than in 2Q and the median stock having derated 7%+ since the start of 2Q reporting. Revisions remain strong, with estimates up 1.8%, including 3.6% for Tech+ and 0.8% for ex-Tech+.

UBS estimates for cloud revenue growth are well above consensus for the next four quarters (~15% above), pointing to higher odds of consensus forecast upgrades.

Benign hiking cycle points to further rally

The US 10yr has risen +1.5 stdev above its 1yr moving average only seven times in 40 years. Many catalysts will affect the path of rates (oil, employment, inflation, midterms), but 10y yields did not meaningfully decline for 2+ months post this stage of 10yr spikes, and yields increased further in full Fed hiking cycles (Rates spike & equities).

  • Fed hikes moderate -> equities rallied. When the Fed hiked <100bp within a year of rate spikes in the 2013, 2016, 2021 and 2023 episodes, the US 10yr yield settled at elevated levels for ~2mo on avg before falling. After treading water those ~2mo, ACWI and SPX rallied 8-10% on avg the next 6mo and 15-18% the next year. We see a case for the 10y to return toward 5% if data/catalysts fall the right way and rates vol falling further fueling a rebound in rate sensitive equities.
  • Fed hiking cycles -> equities weak. When the Fed hiked by 100+bp within a year of the 10y surge in 1994, 1999 and 2022, ACWI and SPX returns were negative or flat over the following year. The 10y also took 100 trading days on avg to reach the peak after crossing the +1 stdev threshold (vs 43 for other cases), and took much longer to get back to the moving average (288 days versus 197).

Our baseline is a benign hiking cycle of <100bp of hikes given inflation expectations are elevated but contained and employment trends are not overly strong.

Rising odds of a correlated rally

After the rates spike, bond yields are likely to stay elevated near-term and we had highlighted SPX 1x2 call spreads to play for a slow grind through US midterms. However, from late October on, we see rising odds of a more correlated rally in equities if 1) rates/oil pressures abate, 2) US midterm election risks do not realize, 3) AI narratives/demand are supportive, 4) earnings beats provide a tailwind, and 5) corporate buyback activity +announcements pick up after the OCF surge. In a scenario of these drivers becoming tailwinds around the same time, we see implied correlations as too low if Tech and ex-Tech / rate sensitive segments can rally at the same time, and like OTM index options for the theme.

The key catalysts to monitor include:

  • Fed (FOMC meeting 28th Oct)
  • Employment/wages (Q3 ECI 30th Oct, Sep JOLTS 3rd Nov, Oct NFP 6th Nov)
  • Inflation data (Sep PCE 29th Oct, Oct CPI 10th Nov)
  • Energy prices (especially refined products (Middle East and Ukraine conflict, inventory data)
  • US midterm elections (polls close on 3rd of November but results could be confirmed in following days/weeks)
  • Tech earnings (MSFT 27/10/2026, GOOGL 27/10/2026, META 21/10/2026, AMZN 28/10/2026)
  • Buyback calendar (blackouts end, announcements to pickup in Q3 reporting, MU buyback can start 9th Dec)

Trade idea: SPX Dec OTM calls

We like SPX OTM calls for Dec to position for a more correlated rally and add delta exposure amid still elevated risks. SPX has historically rallied an avg of 6% from end Sep to end Dec in midterm election years, and an avg of 14% from end Sep to end Mar. We see rising odds of a broadening in the equity market rally if the above catalysts turn out largely positive. Rising equity markets associated with rising correlations has historically resulted in stronger returns.

Trade idea: Short KOSPI2/SMH/SOXX puts to buy 2x SXXP calls

Take downside risk in Korea (and primarily Korean semis), where strong pricing, cash flow and buybacks are underwritten by DRAM undersupply through 2028 and a multiple already discounting considerable margin mean reversion that we don't expect. Use the rich implied vol to buy more than two times the notional of upside in Europe, where most industry groups are growing earnings above 10% and those expectations are still rising.

Europe has lagged even though PMI new orders, sales and earnings have all been rising across the largest sectors (financials, industrials, tech and pharma). Scarcity has emerged in key areas of industrial capacity. Many European industrials that lagged the first wave of scarcity in data-centre capital goods, are now outperforming as those companies need to build new industrial capacity. In Europe growth is financed by bank lending that has risen to over 4% yoy - supporting ongoing positive banking sector earnings revisions.

Hedges for tightening tail, growth/AI spillovers

We discussed in previous sections how non-benign tightening cycles have historically been a large headwind for equities. The three main mechanisms which rates affect equities are higher real rates, weaker growth, and higher credit spreads, to which every major market has a very large negative beta. An aggressive tightening cycle is not our base case. We also think equities are likely to stay more resilient than rates because of the growth offset and suppressed correlations.

Rising rate hike probabilities into early 2027 have driven sharp moves across the yield curve. Our Rates Strategists see these moves as difficult to fade as yields remain highly sensitive to oil, the Fed is giving energy prices unusual weight, and the geopolitical backdrop is unlikely to resolve quickly. History further suggests rates stay elevated for at least a few months after similar yield spikes recently witnessed. Rate volatility has already risen notably to reflect this, in line with our view.

Our credit strategists suggest that spreads have remained unusually complacent, as the link between rate volatility and spreads has historically strengthened during tightening cycles. They see an unexpected tightening cycle as the main downside risk for credit, with stress emerging first in lower-quality HY and leveraged loans. We have already seen early signs of this with yield vs. HY spread correlation just off all-time highs, a 'double whammy' we think is not being fully priced into HYG volatility.

Trade idea: HYG downside for yield + spread 'double whammy'

We continue to favor HYG downside structures to hedge an environment in which Treasury yields and HY spreads rise in tandem. Rate risks are more pronounced for companies with debt and will come through in credit spreads more quickly than equity markets skewed heavily toward profitability rather than leverage. Investors may consider HYG 1x1.5 put ratios to position for further downside, exploiting recently higher skew amidst the initial drawdown.

Trade idea: SPX vs. XLU put switches for growth/AI downside

Index volatility continues to be very difficult to carry as high levels of dispersion continue to mute index-level moves. This dynamic is typically exacerbated through earnings reporting seasons. We would therefore look to fund any SPX downside protection with protection on sectors in which we fundamentally believe downside could be limited in the near-term. Defensive sectors like Utilities (XLU) appear fundamentally more attractive to sell downside puts as power demand has been rising on the back of prior capex amidst the AI buildout. Additionally, Utilities underperformance the last 3mo has been far greater than the underperformance implied by our ML model. A correlated rate-driven selloff could also see defensives more buffered despite higher yields (similar to 2022). Investors may consider selling XLU puts to fund SPX puts for flat.

Sectors and industries: where are the asymmetries?

We have leveraged a number of our frameworks and models to assess the backdrop for sectors and industries amid the rate shock.

  • ML model residuals. To get an understanding of the tactical setup, we leverage our ML model to look at how industry performance compares to that implied by moves in rates and other macro variables (see Tactical Dashboard). Rate and oil sensitive industry underperformance looks to have overshot implied returns based on macro variable moves.
  • REVS scores vs rates betas. Amid elevated rates, we like sectors and subindustries that currently score high on REVS given stronger fundamentals over those that score low on REVS with weaker trends. This reduces exposure to rates vol, and in the event of rates normalizing, investors should be more willing to buy rate-sensitive industries with better fundamentals.
  • PEG ratios and revisions. The logic when looking at sectors and styles is the same as regions and countries. We want to own industries cheaper on growth with stronger earnings momentum.

In general, we are looking for sectors and industries where the growth offset is the greatest with strong revisions, that includes parts of traditional growth but also parts of cyclical value which are exposed to the 'right' growth. PEG ratios are a good metric as pointed out above, and our REVS framework incorporates earnings and growth momentum together with valuation and positioning. Our ML model gives a read of what areas may have overshot the macro moves.

Positive sectors/industries. Putting the three approaches together, the following sectors and industries stand out on the positive side:

  • In the US, Capital Goods and Transports are positive across all three while Banks, Utilities, Insurance and pockets of Consumer Services (Hotels, Leisure, etc) look good on 2 of 3 while Consumer Durables and to a lesser extent Retail look like potential catch up trades on rates/oil relief.
  • In Europe, Utilities/Renewables score well across all three.

Negative sectors/industries. The following sectors and industries stand out on the negative side:

  • In the US, Staples, US Telecom and Materials ex Metals score negatively across all three while Energy and Software & Svcs have both outperformed model implied and look weaker on PEG and REVS, respectively.
  • In Europe, Chemicals and Software have outperformed model implied and look weak on PEG/revisions.

ML model: rate sensitive sectors overshot

Figure 20 and Figure 15 show actual industry group relative performance over the past three months compared with the performance expected by the ML model based on key top down drivers. Most of the industries that have underperformed ML model expectations in the US are the rate sensitive ones led by Cap Goods, Utilities, Consumer Durables, Real Estate and Banks. Oil sensitive industries have also lagged by more than implied led by Transports and Retail. In Europe, Consumer Durables & Apparel, Food, Beverage & Tobacco and Utilities have underperformed the most relative to ML model implied.

REVS and rates betas: pair subindustries on relative fundamental trends

Comparing our Composite REVS scores to rates betas, top ranking subindustries Semis, Pharma, Refining and Div Banks remain attractive and appear less exposed to rates, in our view. We like pairing positive REVS subindustries with higher rates betas against low scoring rate sensitive industries:

  • High REVS and negative rates beta: Biotech, Building Products, Consumer Finance, Trading Companies & Distributors, Hotels & Leisure and Regional Banks. Homebuilders have the highest rates beta and neutral REVS, though Building Products offers housing exposure, but scores well ahead on fundamentals.
  • Low REVS with negative rates beta: Renewables, Automobiles, Construction Materials and Healthcare Facilities, alongside Auto Retail, Restaurants, Media and Application Software.

This US read on REVS vs rates beta shows a relatively supportive fundamental picture for European renewables amid high yield sensitivity, even though US renewables score weaker on REVS. European renewables score high on REVS and are up ~20% year to date against down over 10% for US renewables. The rates sensitivity is a valuation issue, not an earnings one for EU renewables, so a peak in yields matters more for them than for most.

Own low PEG industries with positive revisions

Buying earnings growth at a reasonable valuation is a proven strategy in this environment. Growth alone has not been enough to offset higher yields when the starting valuation is demanding. Our European team shows that earnings have helped parts of cyclical value, while expensive growth can remain sensitive to the price paid and defensives lack a comparable growth offset. The story in EM is similar. Our team shows that the best performing factors when US real yields rise from high levels are high growth, dividend yield and high ROE while the worse ones are high PE and high leverage.

European Semis, Cap Goods and Transport offer both earnings growth at a discount and very strong earnings revisions. Telecoms and Banks also offer an attractive mix of strong revisions and revisions. It is similar in the US with Semis, Mining and Tech Hardware offering the best mix of revisions and PEG. Pharma and Software also look attractive.

Secondly, buy positive earnings revisions. Europe stocks with positive CFROI revisions of zero to +0.10 percentage points returned 0.0% at the median, against +5.8% once revisions exceeded +0.10 points. The +0.25 to +0.50-point group returned +9.8%. The result persisted within sectors: 15 of 17 showed a positive within-sector spread at the +0.10-point hurdle. The revision signal is therefore more than a sector allocation.

The largest upgrades are not automatically the best investments because of valuation. Returns plateaued above +0.50 points in Europe and some highly valued stocks were not rewarded despite substantial upgrades. Valuation is therefore a constraint on the revisions trade.

Oil at a fulcrum: demand destruction at higher prices

The Energy sector has typically tracked medium- and long-term oil expectations embedded in the forward curve rather than moves in spot prices. But spot and forward oil recently diverged, with forward prices basically flat as front month rose from <$90 in Aug to >$105 in early Sep while forward prices rose as oil price pressures alleviated some. This could potentially reflect demand-destruction concerns, as well as future supply/demand dynamics. More notably, Energy equities have also rallied more than forward oil prices, suggesting more is being priced unlike the early summer when Energy equities lagged oil futures moves.

Time to start reducing Energy exposures. Our US REVS framework showed Energy at the top across sectors heading into Sep as the regime was shifting. Energy has notably outperformed of late, and is up over 50% YTD. With the potential to see demand destruction on even higher oil prices, particularly with less refining capacity globally pushing up product prices, we see less attractive risk reward in the sector and would be paring exposure and reallocating elsewhere. After Energy outperformance of Cap Goods and Transports as oil has jumped, we like reallocating some of that Energy risk to the Industrials.

Trade ideas

Based on the analysis above as well as our frameworks and prior work, we would highlight a few trade ideas:

1. Sell US Staples (XLP) upside to fund US Industrials (XLI).

We favor selling US Consumer Staples (XLP) calls to fund upside elsewhere (XLI), as Staples have rallied substantially (up >8% since 30-Sep) amidst the sharp yield retracement. Fundamentally, Industrials are in a better relative position than other cyclicals with the AI buildout and the potential for recovery in investment outside of Tech, making XLI upside calls attractive. We think this trade could work in an environment where yields and oil come off in tandem, which could spur upside in Industrials — while this move has already been priced in consumer-related pockets like Staples (XLP) and Retail (XRT). Investors may consider XLI vs. XLP call switches — we would favor selling XLP upside on a Dec expiry (~0.8 XLI:XLP ratio, indicatively). We would also opportunistically look to sell XOP upside to fund other upside given even higher oil.

2. Add Industrials and Cap Goods exposure.

US industrials have strong fundamental momentum despite ~10% correction. Strong investment activity, led by AI, was a primary reason for the repricing of rates. We believe AI related industrial demand will remain robust amid the higher rates. On the other side, capex had been turning up beyond AI/data centers as mfg recovered from a ~3yr recession, while operating cash flow (OCF) is up ~$825bn y/y (+25%) and capex to OCF is near historical lows ex hyperscalers. Higher rates should be a headwind to some activity, but we see the selloff as providing an attractive entry point to a secular story related to AI, combined with the potential for a cyclical recovery in other industrial segments.

  • Cap Goods over Energy. As mentioned above, we specifically like reallocating some Energy exposure back to US Cap Goods, as relative performance is now back to 2yr lows despite cap goods new order growth remaining strong and the surge in OCF providing further fuel for corporate capex growth.
  • Capex broadening basket (UBEQCPXB) over equal wt SPX. The basket of 48 stocks leveraged to capex broadening with less AI exposure is weighted by fundamental momentum relative to what's priced. The basket's EPS revisions have climbed toward 2020-21 highs while its earnings score jumped through Q2 reporting. Yet the relative P/E premium has come down notably and crowding is much lower for the basket than the avg stock.

European industrials are where revisions are accelerating as AI capex is moving down the chain. 'Data-centre capex' beneficiaries such as Munters and Siemens Energy are capacity-constrained and now spending capex themselves, which becomes the orders of broader 'industrial capacity' beneficiaries. Until late 2025 positive surprises were concentrated in the AI capex beneficiaries. In 2026 they have been as strong and accelerating for those building 'industrial capacity', and European companies have among the most positive revisions. European names are also less crowded. European defense (UBXESPND) and German fiscal spending (UBXEGFXD) add additional fuel to the theme.

Long EU Industrials (SXNP) vs EU Consumer Cyclicals (UBXECCYC). EU Industrials have nascent positive earnings revisions, lighter crowding and the multiple drivers of this momentum. EU Consumer Cyclicals have negative revisions and depend on consumers getting real wage relief.

3. Add Utilities/Renewables exposure.

US Utilities over US Staples (and Telecom). After correcting 15% from the Jul highs to the Sep lows, Utilities have had a small bounce in Oct. As rates have risen, Utilities P/E has fallen toward 15x, near 10+ year lows, despite rising medium-term EPS growth expectations on increased capex and power demand. While higher bond yields raise interest costs for Utilities on new financings for capex and existing bonds, they can usually recapture the increased interest cost in the allowed rate base. On the other side, Staples P/E is a lofty ~25x, despite falling EPS growth potential. Telecom also screens near the bottom on REVS and has outperformed the ML implied moves, making it an attractive source of funds for Utilities as well. Utilities earnings yields plus EPS CAGR is nearly 16%, compared to just ~11% for Staples. Both are rates sensitive, but Utilities are also less crowded than Staples. In the case of bond yields normalizing some, we see investors reallocating back to Utilities given its higher growth is now at a big discount.

Long EU renewables (UBXERNEW). European renewables tell the same story. Our Narrative Radar macro model puts them 7% below the level implied by moves in yields and other macro drivers over the last 3 months. They have been impacted negatively by rising bond yields more than they have benefitted from rising gas prices (revenue link). A retracement in bond yields should unlock the fundamental momentum in our view.

4. Higher Growth+CFROI at a Discount vs Expensive Fundamentals

There is considerable dispersion in growth and CFROI trends with the top 20-40% of companies in terms of forward sales CAGR and CFROI seeing growth and profitability gaps widen vs weaker cohorts. However, there are many higher growth +CFROI companies that are trading well below levels implied by their stronger fundamentals based on our valuation framework. On the other side, there are many stocks trading at elevated multiples relative to their sales CAGR and profitability.

We recommend pairing our Higher Growth and CFROI at a Discount basket (UBEQHGCD) versus our Expensive Fundamentals basket (UBEQEXFN) to take advantage of these multiple gaps as it relates to relative growth and CFROI.

  • Growth+CFROI at a Discount trades at a ~30% discount on P/E relative to Expensive Fundamentals and yet has a forward sales CAGR that is ~10pp higher and CFROI that is ~28pp higher.
  • Growth+CFROI at a Discount trades at 1.1x PEG ratio based on sales CAGR vs 4.6x for Expensive Fundamentals, despite also much higher FCF yields.
  • The fundamental gap is widening: growth, CFROI and sales revisions are improving for Higher Growth and CFROI at a Discount, while trends for Expensive Fundamentals remain flat or deteriorating.

Regions and countries: looking for underpriced growth

As discussed earlier, we want to be positioned in the near-term for rates staying elevated while avoiding short duration exposure as there is a good chance rates eventually normalise. We have highlighted that the market is pricing in lower growth and/or lower profitability for many areas of the market relative to consensus expectations in the US and globally.

Look for low PEG ratios, strong revisions amid rate sensitivity

We compare P/E to 2yr forward EPS growth PEG ratios to 3mo earnings momentum for regions and countries. The US, the Netherlands, Taiwan and Korea offer an attractive mix of growth at a discount and relatively strong positive earnings revisions. The UK, Sweden, Canada, India and France are the least attractive market with high PEGs and weaker revisions. Switzerland and Japan have relatively strong earnings revisions but do not look cheap while China and Germany have an attractive PEG but subdued earnings revisions. India and Korea are also both the most negatively exposed to higher yields on our REVS yield beta which makes the pair trade particularly attractive as it would perform well in a normalised yield environment.

Our view is that:

  • A higher discount rate is not necessarily a headwind for equities when it comes with higher earnings growth. Given the rates shock is mainly a real rates shock, it is likely caused by stronger growth expectations, not only energy prices.
  • We like regions and indices where the growth offset is the greatest. Higher real rates raise the earnings hurdle for owning stocks.
  • We want to own growth at reasonable price and which is being revised up. Higher real rates hurt expensive stocks the most via derating and earnings revisions are the key cushion against higher discount rates.
  • We want exposure to the "right growth". We expect the main earnings growth engine to be AI and the broadening in capex. These areas should also outperform even if rate pressures abate.
  • Some emerging markets are increasingly interesting in this environment. Many EMs face less of a bond problem than developed markets. EM equities appear less sensitive to moves in US rates than in previous cycles, allowing fundamentals and earnings revisions to play a larger role in performance.

We like the following expressions of the view:

  1. Go long in general of regions and countries with low PEG and strong revisions vs high PEG and weak revisions. We like pairing indices with negative yield beta in particular to get convexity to a yield normalisation scenario.
  2. Long SPX vs FTSE 100. S&P has much stronger fundamentals and revisions, yet it has still derated by ~10% relative to the FTSE ytd.
  3. Long KOSPI vs NIFTY 50. Korea offers the strongest two-year EPS outlook out of all major markets at a P/E discount to India, whose flattish estimates and slowing IT services put it on the wrong side of the AI trade.

Trade ideas

Long SPX vs FTSE 100

The S&P 500 has de-rated by roughly 15% relative to the FTSE 100 over the past two years, despite delivering around 22% stronger relative earnings growth over the same period. As discussed earlier, we think the S&P is quite cheap relative to its fundamentals. The FTSE remains skewed towards defensive sectors that lack the earnings-growth offset needed to absorb higher real yields, while its underweight of Tech and Industrials leaves it underexposed in the strongest parts of the growth cycle. We expect it to underperform even if rates pressure abates.

Historically, the FTSE has also tended to underperform the S&P 500 during rate-shock episodes, even benign hiking cycles. We believe it will be the same this time as the current environment remains more supportive for US equities where stronger earnings growth continues to offset a higher discount rate.

Long KOSPI vs NIFTY 50

Korea offers the strongest two-year EPS outlook out of all Emerging markets, with memory stocks FCF worth 80%+ of market cap over the next two years. EPS has been revised up by 15% over the last three months vs 4% for India. India is on the wrong side of the AI trade with its heavy IT services exposures while Korea is at the forefront. Our EM team is overweight Korea and underweight India.

We also like the trade because we think it does well in both a yields normalisation and yield sell off scenario. Both have the most negative betas to yields so the trade should still perform if yields normalise. In the event of yields selling off even more, Korea's current account surplus at roughly 5-6% of GDP creates a powerful buffer for both the won and equities, while India's c2% of GDP current account deficit leaves it more dependent on foreign capital inflows and vulnerable to energy shocks.

Equities have greater asymmetry to lower rates (vs higher)

Across the UBS Global Equity Strategy team, we have highlighted a number of reasons why equities are more resilient to higher bond yields now than in the past, and have greater asymmetry to a decline in rates. Some of the key points from our work are summarized below.

1. Valuation reset has largely happened (Parker)

The SPX derating is already large. The 10yr is up about ~100bp YTD to 5.1%, and the S&P 500 NTM P/E is down ~20% since November. That matches 1994 and is close to the 20% to 30% deratings seen around recessions. Moreover, the SPX P/E is below fair value and pricing in either weaker growth or higher rates. Stronger forward sales growth and CFROI put the model-implied P/E above 24x, against <20x now. The residual is near 2020 and 2011-12 levels.

2. Earnings growth and revisions from AI and the broadening in capex should more than offset higher discount rates

The main engines for earnings growth in this cycle are AI and broadening capex. The AI spend cycle is over two years into what prior IT cycles suggest is a ten-year run at ~20% real growth. The next leg has barely started with only 8% of enterprises having deployed AI agents at scale, against ex-Tech OCF up $436bn y/y to fund more. Delivering the data-centre build out requires power, grids, electrical equipment, cooling, construction, transportation, etc. - capacity that doesn't yet exist. Security and resilience pending compounds it.

3. Yields are partly rising for the right reasons with the broadening capex cycle and rising money velocity, which should be less rate sensitive than recent cycles (Fowler)

Defence, AI equipment, infrastructure and power are expanding together, the first cycle like this in a generation. Industrial spend has higher money velocity than services spend. Of the ~130bp rise in the 10yr from end February to 5.00%, 120bp came from real yields, partly reflecting stronger growth expectations. Moreover, Capex is locked in for years. Grid, defence, fab and power projects are not deferred because policy rates move 50bp, so committed capital keeps being spent.

4. EM is not the blanket long US duration trade it used to be (Tirumalai)

US rates are less of a headwind than in the past due to changed nature of EM stocks and EM investor base. Importantly, local rates are becoming more important. It has also some room to absorb higher rates as it is the fastest growing major region due to it exposure to tech and has attractive valuations. At an aggregate level, EM equity valuation spread over bonds are now near longer term averages (unlike US which is tighter).

Appendix

What time-varying betas say about the impact of yields on equities

We have built a weekly Kalman-filter model in which equity sensitivities are allowed to change over time as new information arrives. Four US macro factors are estimated together: real rates, inflation breakevens, credit spreads and growth. Each coefficient is therefore a partial beta, holding the other factors constant. Absolute betas translate an actual factor move into an equity sensitivity; standardized betas put returns and factors on comparable volatility-adjusted scales.

Valuation Method and Risk Statement

Investing in global equities poses currency, country, industry, and company-specific risks. Valuations can be impacted by company-specific factors, investor risk appetite, as well as changes in the macroeconomic landscape and financial market stability. Equity market returns are influenced by corporate earnings, interest rates, risk premia, as well as other variables influenced by the business cycle. The outlook for any and all of these variables is subject to change. Risks of multi-asset investing include but are not limited to market risk, credit risk, interest rate risk, and foreign exchange risk. Correlations of returns among different asset classes may deviate from historical patterns. Geopolitical events and policy shocks pose risks that can reduce asset returns. Valuations may be adversely affected during times of high market volatility, thin liquidity, and economic dislocation.

Risks include macroeconomic variables (such as GDP growth rates and inflation), economic slowdown, a weakening currency, global economic events, and government policy changes. Our quantitative models rely on reported financial statement information, consensus earnings forecasts and stock prices. Errors in these numbers are sometimes impossible to prevent (as when an item is mis-stated by a company). Also, the models employ historical data to estimate the efficacy of stock selection strategies and the relationships among strategies, which may change in the future. Additionally, unusual company-specific events could overwhelm the systematic influence of the strategies used to rank and score stocks. Past performance is not a guarantee of future performance.

Options, structured derivative products and futures (including OTC derivatives) are not suitable for all investors. Trading in these instruments is considered risky and may be appropriate only for sophisticated investors. Prior to buying or selling an option, and for the complete risks relating to options, you must receive a copy of "The Characteristics and Risks of Standardized Options." You may read the document at https://www.theocc.com/publications/risks/riskchap1.jsp or ask your salesperson for a copy. Various theoretical explanations of the risks associated with these instruments have been published. Supporting documentation for any claims, comparisons, recommendations, statistics or other technical data will be supplied upon request. Past performance is not necessarily indicative of future results. Transaction costs may be significant in option strategies calling for multiple purchases and sales of options, such as spreads and straddles. All foreign options discussed in this note are over-the-counter. The securities and futures products described herein may not be eligible for sale in all jurisdictions or to certain categories of investors.

The HOLT methodology does not assign ratings or a target price to a security. It is an analytical tool that involves use of a set of proprietary quantitative algorithms and warranted value calculations, collectively called the HOLT valuation model, that are consistently applied to all the companies included in its database. The HOLT valuation model is a discounted cash flow model. Third-party data (including consensus earnings estimates) are systematically translated into a number of default variables and incorporated into the algorithms available in the HOLT valuation model. The source financial statement, pricing, and earnings data provided by outside data vendors are subject to quality control and may also be adjusted to more closely measure the underlying economics of firm performance. These adjustments provide consistency when analyzing a single company across time, or analyzing multiple companies across industries or national borders. The default scenario that is produced by the HOLT valuation model establishes a warranted price that represents the expected mean value for a security based upon empirically derived fade algorithms that forecast a firm's future return on capital and growth rates over an extended period of time. As the third-party data are updated, the warranted price updates automatically. A company's future achieved return on capital or growth rate may differ from HOLT default forecast. Additional information about the HOLT methodology is available upon request. CFROI, CFROE, HOLT, HOLT Lens, HOLTfolio and "Powered by HOLT" are trademarks or registered trademarks of UBS in the United States and other countries. HOLT is a corporate performance and valuation service of UBS.

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UBS Global Research: Global Equity Rating Definitions

12-Month RatingDefinitionCoverageIB Services
BuyFSR is > 6% above the MRA.55%24%
NeutralFSR is between -6% and 6% of the MRA.39%20%
SellFSR is > 6% below the MRA.6%21%

Source: UBS. Rating allocations are as of 30 September 2026. 1: Percentage of companies under coverage globally within the 12-month rating category. 2: Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided within the past 12 months. KEY DEFINITIONS: Forecast Stock Return (FSR) is expected percentage price appreciation plus gross dividend yield over the next 12 months. In some cases, this yield may be based on accrued dividends. Market Return Assumption (MRA) is the one-year local market interest rate plus 5% (a proxy for, and not a forecast of, the equity risk premium). Under Review (UR) Stocks may be flagged by the analyst to indicate that the stock's price target and/or rating may change in the near term, usually in response to an event that may affect the investment case or valuation. Equity Price Targets have a 12-month investment horizon. EXCEPTIONS AND SPECIAL CASES: UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance record and discount; Neutral: Neutral on factors such as structure, management, performance record and discount; Sell: Negative on factors such as structure, management, performance record and discount. Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment Review Consultation (IRC). Factors considered by the IRC include the stock's volatility and the credit spread of the respective company's debt. As a result, stocks deemed very high or low risk may be subject to higher or lower bands for rating purposes. Where such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece.

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Report date 19 October 2026. Source material supplied as a 35-page PDF.

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