AI drops 5% masking improvement in breadth, UBS (UBS.US): Probability of correlated rise underestimated

According to Woofun AI, UBS (UBS.US) revealed in its Global Equity Strategy Report released on October 19, 2026, that although the AI sector experienced a significant 5% pullback last week, there is a structural divergence within the market characterized by accelerating de-risking and improving breadth. Excluding AI, as many as 400 stocks recorded gains of 2.5%, and all components of the equal-weighted S&P 500 index—other than technology stocks—achieved gains. UBS (UBS.US) believes that the current implied market correlation is at a very low level. If pressures from interest rates and oil prices ease, U.S. midterm election risks do not materialize, AI demand continues to provide support, earnings reports exceed expectations, and buyback activity picks up, the probability of a synchronized rally between tech and non-tech sectors is being severely underestimated by the market.

On the macro level, surging yields and valuation resets have become the dominant logic. Although bond yields have fallen back somewhat, CPI data remains warm, and WTI crude oil rose 10% due to heightened tensions in Iran, further fueling market volatility. Machine learning models show that Fed policy expectations have become more important in explaining returns, with AI still the top factor but off its peak. Since early September, the surge in yields has been driven more by position unwinding than by pure repricing of growth—S&P 500 forward P/E has declined about 20% since the end of last year, with the valuation reset now complete.

It is noteworthy that interest rate-sensitive sectors such as capital goods, utilities, durable consumer goods, real estate, and banks have underperformed by more than what macro variables would imply, while transportation and retail have also lagged due to sensitivity to oil prices. Over the past year, the U.S. 10-year yield has risen above its 1-year average by 1.5 standard deviations for the seventh time, and historically, it does not significantly decline in the following two months. UBS (UBS.US) points out that if the Fed raises rates by less than 100 basis points within a year of yield surges, the MSCI Global Index and S&P 500 rise an average of 8%-10% over the next 6 months, and 15%-18% over the next year; conversely, if the aggressive rate hike cycles of 1994, 1999, or 2022 are repeated, markets may deliver flat or negative returns over the following year. The rise in yields partly reflects the government’s debt burden but also faster productivity growth, deregulation, and stronger nominal growth—higher hurdle rates are seen as reflecting a more dynamic economy.

According to data compiled by Woofun AI, yield volatility has exceeded equity volatility, and the risk of further tightening in rate expectations needs to be hedged.

In-depth AI fundamental analysis shows that accelerating cloud revenue and capital expenditure are key supports. Cloud revenue for hyperscalers is expected to grow 60% year-over-year in Q3, well above 50% in Q2. Over the next four quarters, cloud revenue is expected to reach $574 billion—about 15% above consensus, with about 73% year-over-year growth. UBS (UBS.US) believes that accelerating cloud revenue could drive up estimates for 2027 cloud sales, serving as a circuit breaker for AI sell-offs.

Despite the surge in CoreWeave (CRWV.US) CDS, which triggered sector-wide selling and concerns around financing costs and structure weighing on capex commitments, new cloud providers’ 2027 capex share stands at about 7% with enterprise value around $130 billion—compute demand far exceeds supply, and capital concerns will not alter the overall AI buildout trend. UBS (UBS.US) emphasizes that hyperscalers’ operational cash flow and borrowing capacity are sufficient to sustain AI demand.

Moreover, second-quarter earnings thresholds are low, with nearly 70% of companies expecting EPS growth below Q2 levels, and the median stock has declined more than 7% since Q2 earnings reports started. However, earnings revisions remain strong—overall up 1.8%, tech up 3.6%, non-tech up 0.8%—the combination of low thresholds and strong revisions favors upside earnings surprises.

Key catalysts and options strategies are focused on election risks and hedging. Over the next two-plus weeks, catalysts include the October 28 Fed meeting, employment and wage data, inflation data, oil prices, the November 3 midterm election, tech earnings, and buyback windows—these variables will decide the trajectory for equities into 2027. History shows the S&P 500 typically rises 6% from the end of September to the end of December in midterm election years, and gains 14% by the following March. UBS (UBS.US) suggests buying S&P 500 December out-of-the-money call options to participate in potential synchronized rallies while keeping downside protection.

While implied options volatility is elevated, the cost of index protection is high and dispersion suppresses index volatility. To hedge risk, UBS (UBS.US) also recommends buying downside protection on HYG (HYG.US) to guard against the double whammy of rising rates and high yield spreads. Credit spreads have remained calm amid rising rate volatility, but a surprise tightening cycle could first hit low-quality high-yield debt and leveraged loans.

Additionally, selling utility sector put options can be used to fund S&P 500 puts, optimizing the cost structure.

Global asset allocation recommendations point to sector rotation and regional comparisons. U.S. utility P/E is around 15, near a decade low, compared to about 25 for consumer staples. Utility earnings yield plus EPS compound growth is near 16%, for consumer staples about 11%, and utilities are less crowded than consumer staples. UBS (UBS.US) suggests selling consumer staples calls and buying industrials calls.

In Europe, renewable energy valuations are below macro-model-implied levels; the negative impact from rising bond yields outweighs the positive impact of higher natural gas prices; EU industrial earnings revisions are accelerating, with AI capex shifting from product vendors to capacity-building industrials—long EU industrials over consumer cyclicals, and go long EU renewables. Regionally, the S&P 500 trades at a roughly 15% discount to the FTSE 100 on valuation, but with 22% stronger earnings growth; the FTSE 100 has a high weighting to defensives, which lack earnings growth to offset the high real yield.

KOSPI has the strongest two-year EPS outlook with a P/E below India, Korea’s current account surplus is 5%-6% of GDP, and India’s current account deficit is about 2%. UBS (UBS.US) recommends going long S&P 500 vs. FTSE 100, and KOSPI vs. NIFTY 50. Energy has rallied over 50% this year—high oil prices could dampen demand, operating cash flow has grown about 25% year-on-year, but ex-hyperscalers, capex/operating cash flow is at decade lows. Begin to reduce energy exposure—rotate some risk into industrials, as AI-related industrial demand remains robust when rates rise, with capex spreading from AI and data centers to manufacturing recovery.