Cyclical stocks are expected to explode? UBS: The expectation of economic overheating is triggering a broad expansion in the market. Stagnant sectors are likely to usher in a rally.

UBS Group AG analysts pointed out that the market has started to price in the possibility of the economy overheating, with the probability currently at 12% and rising. Sean Simonds, stock strategist at UBS Group AG, stated that this trend could push cyclical stocks higher and further expand market breadth across various industries. Simonds said, "This may lead to continued outperformance of cyclical sectors over the broader market, as the automotive and parts, durable consumer goods and apparel, and diversified financial sectors are the most sensitive industry groups to the 'overheating probability' we calculated." The best-performing industry sectors in the current S&P 500 index include software, media and entertainment, semiconductors, and equipment and banks; while sectors like household and personal care products, chemicals, and packaging containers are in the worst-performing category. UBS Group AG analysts stated that the ranking of these sectors is mainly based on the "R.E.V.S. scoring system," which considers economic cycles, company earnings, valuation levels, and market sentiment. The scoring results show that the market is exhibiting a signal of "breadth expansion," with 26 out of 27 industry sectors receiving positive scores, suggesting that market breadth will further expand and stagnant sectors are expected to see a rally. Simonds pointed out that according to market expectations, the profit growth gap between the "tech+" sector companies and other components of the S&P 500 index is expected to converge by 2026. He further explained, "By 2026, the profit gap between the 'Big Six Tech+' companies - NVIDIA Corporation, Microsoft Corporation, Apple Inc., Alphabet Inc. Class C, Amazon.com, Inc., and Meta - and other components of the S&P 500 index will return to normal, narrowing the overall market profit differentiation." He added that the market still expects semiconductor, pharmaceutical, and media industry companies to achieve strong growth of over 15%. Currently, the forward price-to-earnings ratio of the S&P 500 index is above 22 times; excluding the "tech+" sector, this valuation level is 18.6 times. UBS Group AG analysts believe that this valuation level falls in the category of "overvalued." However, Simonds pointed out, "Modern market structure factors such as stock buybacks and stable fund inflows from global pension savings plans have collectively fueled the 'momentum effect' supporting current valuations. While valuation concerns objectively exist, these concerns will only have a significant impact when corporate profit expectations begin to be revised downward; in the short term, the continued improvement in corporate profits and the widening scope of improvement should offset the pressure from overvaluation." In terms of market sentiment, the market sentiment for the communication services, technology, and finance sectors remains particularly strong. Simonds' analysis of "portfolio beta coefficients" shows that the size of balanced fund holdings is increasing again, pushing the comprehensive beta holdings index back to average levels; while hedge fund holdings data suggests that funds are withdrawing from the banking, food and beverage, and tobacco sectors and flowing into the pharmaceutical sector. Lastly, Simonds stated that the UBS Group AG's "Hot Theme Indicator" shows that the market crowding of the stocks of the "Big Seven" and the investment theme of artificial intelligence is at an extreme level, but this phenomenon "still makes sense - as they display relative resilience in terms of corporate profit expectations revision and market leadership advantages." Stocks with the highest scores in the "R.E.V.S. scoring system" include: Hasbro, Inc., Dayforce, Qualys, Inc., STERIS plc, and MongoDB.