U.S. stocks see overheating probability rising as breadth widens: UBS

Investing.com -- U.S. stocks are showing signs of overheating as market breadth improves, according to UBS.

The bank’s market-implied economic regime probabilities suggest that while overheating risk is still relatively low at 12%, “it does look like it may be inflecting and could lead cyclicals higher,” strategists led by Sean Simonds said in a Monday note.

Sector-weighted PMIs for the S&P 500 remain firmly in expansion territory, and 26 of 27 industry groups now hold positive scores in UBS’s REVS framework, the bank’s model that combines regime, earnings, valuation, and sentiment (REVS) indicators to gauge relative performance.

That broadening is helping areas such as autos, consumer durables, and financials, which the bank said are among the most sensitive to rising overheating probabilities.

Software, media and entertainment, semiconductors, and banks ranked as the strongest industry groups this month, while personal products, chemicals, and packaging lagged.

Earnings revisions have been largely stable following the latest reporting season, with semiconductors seeing upgrades. Strategists said the gap between technology-heavy groups and the rest of the S&P 500 is expected to normalize into 2026, reducing earnings dispersion.

Pharma and media companies, however, remain among the leaders, with the market expecting “very strong (>15%) growth” in those segments.

Valuations remain elevated, with the S&P 500 trading at over 22 times forward earnings and 18.6 times for the S&P ex-Tech+, UBS’s measure that strips out its defined group of large technology and technology-adjacent stocks such as the “Magnificent 7.”

Strategists acknowledged that the index looks expensive, but argued that buybacks, global pension flows, and resilient earnings revisions support the current backdrop.

“If hard data/jobs begin to weaken faster negative earnings revisions could lead to increased volatility and more sellers, but there are strong arguments that this market structure continues to offset valuation downside in the U.S.,” they wrote.

Investor sentiment is strongest in communication services, technology, and financials, the strategists note.

Hedge funds have rotated out of banks, food, beverage and tobacco, and health care equipment into pharmaceuticals, while crowding in the “Magnificent 7” and AI-related names remains high.

The bank’s thematic scorecards continue to favor AI-linked groups, financials, and health care, while tariff-exposed sectors such as personal products and autos appear vulnerable.