From the studio

Podcast: Signal over Noise with Ulrike Hoffmann-Burchardi (8 mins)
Video: The AI Show | Correction in the software industry and how to position next (5 mins)
Video: Deep Dive | US Financials: Earnings and the deregulation tailwind for 2026 (6 mins)
Video: UBS Explains | Warsh nominated as Fed Chair, what's next? (4 mins)

Thought of the day

What happened?

Tech stocks continued to recover on Monday after a week of mixed investor reactions to higher AI capex spending as well as fears that advances in AI would disrupt the software sector. The main worry has been that an upgrade to coding tools by Anthropic—a private company that offers the Claude chatbot—could disrupt the business models of some software firms. A second major theme was a more selective approach to tech stocks, with investors looking for strong earnings and monetization potential to justify heavy AI capital spending. Finally, there was also a rotation away from tech toward other parts of the market.

What do we expect?

After a 6% rally in the S&P 500 information technology sector over the past two trading sessions, we downgrade the sector to Neutral from Attractive for three reasons:

A likely deceleration in hyperscaler capex growth. Based on guidance from hyperscalers, capex could reach USD 700bn this year—a more than fourfold increase over three years. This level of capex will consume almost 100% of hyperscalers’ cash flow from operations compared with a 10-year average of 40%. Investor concerns about the sustainability of capex growth could be an overhang, and we note that spending is now increasingly being funded by external debt or equity financing.

In our view, capex growth is likely to moderate from these levels, which could improve investor perceptions of those doing the spending, but is a potential negative for some companies in the enabling layer. Depending on the speed of progress in monetization, we continue to expect higher levels of capex over the longer term to support growth of agentic and physical AI, to the benefit of companies in both the enabling and application layers.

Software uncertainty could linger. AI could have a meaningful impact on the software industry, making it easier for competitors to encroach on incumbent software providers. The threat of increased competition makes it difficult for investors to have conviction in the growth rate and profitability of firms in the software industry, and we believe uncertainty about the outlook could linger for some time.

At the same time, the disruption in software could be seen as a validation of the monetization potential for AI, which ultimately should benefit both the intelligence and application layers. More recently, the sell-off in software has also been relatively swift and broad, meaning that some individual stocks that have suffered recently may ultimately offer appealing longer-term value.

Tech hardware valuations look full. Tech hardware is the final segment of the IT sector and is heavily dominated by smartphone manufacturers. This segment has been performing well due to the recent strong growth in smartphone units, which seems to be partly driven by an aging installed base of phones. However, current tech hardware valuations appear full, with a 12-month forward price-to-earnings ratio of 27.7x compared with a 10-year average of 20x and five-year average of 24x. There is also potential for smartphone growth to cool as replacement demand is satisfied.

How do we invest?

We recommend that investors maintain strategic exposure to broad technology, AI, and the US market as a whole.

Moving the US IT sector to Neutral is also not a negative view on technology as a whole, and it is important to recognize that there is more to the AI opportunity than this sector. The S&P 500 IT sector comprises only 24% of our AI Transformational Investment Opportunity (TRIO), and we retain our Attractive view on AI.

The US economy is also benefiting from both fiscal and monetary stimulus. We expect a further two rate cuts of 25bps from the Federal Reserve this year, and financial conditions are already loose. Solid economic growth, in part supported by productivity gains, is fueling corporate earnings, which we believe are on track to grow 14% in the ongoing fourth-quarter earnings season. We expect 12% earnings growth for full-year 2026. We maintain our June 2026 and December 2026 S&P 500 price targets of 7,300 and 7,700, respectively.

Nevertheless, we do think investors should review current exposures to US technology or diversify exposures that are above benchmark levels. For reference, MSCI USA IT comprises 21% of the MSCI AC World index. In light of rising competitive risks, investors should also review concentrated exposures to individual software firms, particularly those “pure-play” companies that do not have diversified business models.

To navigate potential risks and to benefit from what we expect to be a broadening market rally, we think investors with excess exposure to US IT should consider diversifying toward other preferred areas of the market, including banks, health care, utilities, communication services, and consumer discretionary.

We like US financials for their improving profitability and increased capital market activity, with upward-sloping yield curves and stronger net interest margins also providing a potential boost. Health care should benefit from innovative new therapies. Longer term, both sectors are also well positioned to deploy AI to improve efficiency and business outcomes, in our view. Meanwhile, the utilities sector should continue to benefit from increased power demand.