UBS Downgrades US Stocks: Weaker Dollar Plus High Valuations and Policy Disruptions, Capital May Continue to Flow Overseas

TradingKey - Against the backdrop of structural downside risks for the U.S. dollar, high valuations in U.S. equities, and an uncertainty premium fueled by shifting White House policies, Wall Street's long-standing confidence in the "structural outperformance" of U.S. stocks is beginning to waver.

UBS Andrew Garthwaite, Head of Global Equity Strategy, recently downgraded U.S. stocks to "Neutral" within global equity portfolios, marking a return to a neutral stance from a previous relative overweight, while maintaining an overweight position on emerging market equities.

In UBS's view, the U.S. dollar is currently the most critical variable. The bank expects EUR/USD to rise to 1.22 by the end of the first quarter and emphasizes that the dollar faces "asymmetric structural downside risks."

Market performance year-to-date already reflects signs of this rotation. The MSCI World ex-USA Index has gained approximately 8%, the Nikkei 225 is up about 17%, and the Stoxx Europe 600 has risen roughly 7%, while the S&P 500 has essentially remained flat. Fund flows further confirm this trend change. UBS's communications with North American clients indicate that some institutions are shifting new allocations to overseas markets, and ETF flow data also shows a significant proportion of capital flowing into regions outside the U.S. recently.

While a weaker dollar should theoretically boost the translated earnings of U.S. companies' overseas revenue, UBS noted that the positive impact of dollar depreciation on corporate earnings in the most recent quarter was significantly weaker than in previous cycles, undermining the traditional logic that a "weak dollar favors U.S. equities."

At the same time, the timing of returns from the AI investment boom remains a subject of debate, and with recurring domestic inflationary pressures in the U.S., risk assets as a whole are under pressure.

On the other hand, corporate buybacks are also weakening at the margin. UBS pointed out that U.S. stock buyback yields are now roughly on par with global peers and even lower than in some markets. For over a decade, buybacks have been a major force driving earnings per share (EPS) growth and valuation expansion; today, this advantage is no longer prominent.

Valuation pressures are equally apparent. UBS estimates that, after adjusting for sector composition, the P/E ratio for U.S. stocks reflects a premium of approximately 35% over international markets, compared to an average premium of only about 4% since 2010. About 60% of industry sectors are trading not only above their global peers' valuations but also above their own historical premium levels.

Policy uncertainty has added to the risk premium. UBS cited frequent policy adjustments this year regarding tariffs, proposed credit card interest rate caps, restrictions on private equity involvement in the housing market, reviews of drug pricing, and suggestions to limit dividends and buybacks for defense contractors. These shifting policy directions challenge the stability of corporate capital expenditures and earnings expectations.

However, UBS has not turned entirely bearish.

Garthwaite noted that in the early stages of a potential bubble, the U.S. economy and stock market tend to benefit more. The U.S. maintains a leading edge in the advancement of AI applications, and earnings growth in related sectors is likely to be faster than in most other regions, providing some support for valuations.

Strategist Sean Simonds maintains a year-end target of 7,500 for the S&P 500, which, while lower than some peer forecasts, is not significantly pessimistic.

From a macro perspective, UBS expects global GDP growth to be around 3.4% in 2026. Historical data shows that when global economic growth accelerates beyond 3.5%, U.S. stocks often underperform relative to global markets. Furthermore, the U.S. market accounts for more than 70% of the MSCI World Index; even maintaining a "benchmark" allocation leaves absolute holdings at a substantial scale.

Overall, UBS's rating downgrade is not a loss of confidence in U.S. equity fundamentals, but rather a comprehensive rebalancing based on valuation, currency, and policy risks. If the dollar continues to weaken alongside the valuation advantages of overseas markets, the pressure on the relative performance of U.S. stocks may persist. For global asset allocation investors, this means the risks of making unilateral bets on the U.S. market will be magnified by multiple factors.