Keep limit on alternative investments: O'Connor Juanas

Key Concepts

• Earnings Season: The period when publicly traded companies release their financial results.
• EPS Growth (Earnings Per Share Growth): An increase in a company's profit allocated to each outstanding share of common stock.
• Guidance: A company's forecast of its future financial performance.
• Capex (Capital Expenditures): Funds used by a company to acquire, upgrade, and maintain physical assets such as property, buildings, and equipment.
• Trade Truce: An agreement between countries to temporarily suspend or reduce trade barriers.
• S&P 500: A stock market index representing 500 of the largest companies listed on stock exchanges in the United States.
• Multiples: Valuation ratios, such as the price-to-earnings (P/E) ratio, used to compare the value of different companies.
• Emerging Markets: Countries with developing economies that are in the process of industrialization and modernization.
• Developed Markets: Countries with advanced economies that have high per capita income and well-developed financial markets.
• Tactical Trade: A short-term investment strategy aimed at profiting from anticipated price movements.
• Alternative Investments: Investments outside of traditional asset classes like stocks, bonds, and cash.
• Private Credit: Loans made by non-bank lenders to companies.
• Infrastructure: The basic physical and organizational structures and facilities needed for the operation of a society or enterprise.
• Quantitative Tightening (QT): A monetary policy tool where a central bank reduces the size of its balance sheet by selling assets or allowing them to mature without reinvestment.
• Fixed Income: Investments that pay a fixed rate of interest, such as bonds.
• Cash Allocation: The portion of an investment portfolio held in cash or cash equivalents.

Earnings Season and Market Performance

Brenda Okconor, Senior VP and Financial Advisor at UBS, discusses the current earnings season, noting that while 30% of the S&P 500 has reported, overall results are "relatively good." Key points include:

• EPS Growth: Current EPS growth stands at 9.2%.
• Guidance Beat: 87% of companies have beaten their guidance, following a strong Q2 where 80% also beat expectations.
• UBS Upgrade: UBS has upgraded its EPS growth forecast for the current year to 10% and for next year to 7%.
• Market Support: This positive earnings environment, coupled with the Federal Reserve cutting rates and the potential tailwind from the "big beautiful bill" (likely referring to a stimulus package or significant legislation), supports a target of 7,300 for the S&P 500 next year.
• Solid Guidance and Minimal Revisions: A key takeaway is the solidity of company guidance and the minimal nature of revisions, indicating a stable outlook.

Investment Themes: Beyond US Equities

Despite a positive view on the US market, Okconor highlights that "better ideas" are likely to be found outside the US, and potentially not even in equities.

• US Market Valuation: The US market is considered "pretty fully valued" at 22-23 times earnings.
• Emerging Markets Opportunity: Emerging markets are trading at a significant discount, at 14 times earnings, which is below both developed markets and their own historical averages.
• Focus on Asia and Chinese Tech: Within emerging markets, UBS favors Asia, specifically China and Chinese tech stocks.
  • Thesis: Chinese tech companies often possess strong balance sheets, post solid earnings, and have business models comparable to their US counterparts but trade at "half the multiples."
  • Tactical Approach: Okconor suggests these Chinese tech names are more of a "tactical trade over six months" rather than a long-term structural addition to portfolios.
  • Sectors of Interest: The focus is on e-commerce, cloud, and digital infrastructure, with potential for outperformance leading up to 2026.

Alternative Investments: Private Markets

The discussion shifts to alternative investments, which are typically non-publicly traded assets and can be challenging to value.

• Suitability and Allocation: While suitable for some investors, Okconor recommends limiting allocations to private assets.
  • Target Allocation: An average target allocation of 20-25% to private markets is suggested.
• Reasoning for Private Market Allocation:
  • Brought-Forward Returns: The strong performance of public markets over the past two years has "brought forward returns," making it harder to find yield and income in public markets going forward.
  • Yield and Income Search: Investors are seeking where to generate yield, income, and returns through 2026, especially as public market returns have been accelerated.
• Specific Private Market Opportunities:
  • Private Credit: Despite recent negative headlines, private credit can still generate 9-12% returns. The strategy involves sticking to "big blue chip funds" lending to their portfolio companies, with generally low default rates.
  • Infrastructure: Retail investors are often underallocated to infrastructure. This asset class offers an interesting risk-return profile, with bond-like risk and high single-digit expected returns.
    • AI Theme Play: Infrastructure can also be a way to play the AI theme, as the bottleneck in AI is often delivering capacity and power to data centers. This theme is also being played through public market power and energy companies.

Central Bank Policy and Interest Rates

The conversation touches upon central bank policy, specifically the Federal Reserve's stance on interest rates.

• Fed's Stance: While Jerome Powell, the Fed Chair, appears cautious about cutting rates in December, Okconor believes the market has a clearer picture of his intentions.
• Rate Cut Path: The Fed is on a path to cut rates, and the focus is on determining the pace.
• Market Expectations: The market is pricing in a 70% chance of a December cut, and UBS anticipates two additional cuts in the coming months.
• Quantitative Tightening (QT): UBS expects quantitative tightening to potentially accelerate at the end of the year or beginning of next year.
• Impact on Investors:
  • Public Markets: Rate cuts are expected to be a tailwind for public markets.
  • Cash Allocation: Clients have been over-allocated to cash, which has served as a good store of wealth. However, with expected 3.75% tenure in the coming months, this presents an opportunity to allocate to quality fixed income in anticipation of further cuts.

Conclusion

Brenda Okconor's analysis suggests a nuanced investment approach. While US equities have performed well and continue to show positive earnings, the market is considered fully valued. Investors are advised to look for better opportunities in emerging markets, particularly Chinese tech stocks, as a tactical trade. Furthermore, a strategic allocation to alternative investments, such as private credit and infrastructure, is recommended to capture yield and returns, especially in light of brought-forward returns in public markets and the ongoing AI boom. The Federal Reserve's path towards rate cuts is seen as a positive for public markets, but also presents an opportunity to reallocate from cash into quality fixed income.