EFTA01089678.pdf

UBS CIO WM Global Investment Office CIO monthly video For smartphone users: scan the code with an app like "scan" UBS CIO Monthly Extended November 2012 Published This report has been prepared by UBS AG. Please see important disclaimers and disclosures at the end of the document. Past performance is no indication of future performance. 25 October 2012 The market prices provided are closing prices on the respective principal stock exchange. This applies to all performance charts and tables in this publication. EFTA01089678 Table of Contents Section 1 Base slides 2 Section 2 Asset class views 11 2.A Equities 12 2.B Fixed income 22 2.0 Foreign exchange 29 2.D NTAC: Commodities, Listed real estate, Hedge funds and Private equity 33 EFTA01089679 Section 1 Base slides *UBS EFTA01089680 Summary • Economy "Global growth Global growth is showing broad-based signs of improvement, supported by decisive is showing monetary policy from the world's major central banks. In the US, the housing market recovery continues and the labor market remains on a modest uptrend. This has helped broad-based improve the sentiment of US consumers, and consumption remains the most important contributor to US GDP growth. Growth has also begun to pick up in key areas of the signs of emerging markets, including China and Brazil. While the Eurozone economy remains weak, we expect Q3 2012 to mark the bottom, and that growth will begin to get "less bad" from improvement." Q4 2012. • Equities Equity markets have been supported by central bank action and the recent improvements in economic data. Our preferred markets remain the US and Emerging Markets (EM). Investor funds have started to flow back into EM, as economic data is improving and inflation remains under control. Canada and Australia remain our least favored regions due to falling earnings. • Fixed Income US high yield bonds remain supported by strong corporate fundamentals, modest economic growth, and the broad demand for yield-generating assets. Given this, we see potential for further spread tightening. Meanwhile, benchmark rates are expected to rise gradually on better economic data, while short rates remain ultra-low. While investment grade corporate bond spreads are approximately fair value, we continue to view their absolute yields as attractive. • Commodities We keep a neutral stance on commodities. Increased global liquidity has pushed prices up over the last few months, however, for a more sustained price increase we likely need to see further evidence of an acceleration in global growth. • Foreign Exchange We remain underweight the Japanese yen. The Japanese economy continues to weaken against its peers, leading to rising pressure for the Bank of Japan to engage in further quantitative easing. We have closed our preference for the Canadian dollar following its recent strength, and therefore close our offsetting short CHF position. UBS 3 Please see important disclaimer and disclosures at the end of the document. EFTA01089681 Cross-asset preferences Most preferred Least preferred Portfolio weights • US • Canada Commodities Liquidity • Western winners from EM • Australia Real Estate 5% 10% High Grade 5% Bonds growth Hedge Funds Private Equity 7% Equities • High quality dividend yields 10% Inv Grade • Event-driven and relative value Corporates Bonds Equities USA hedge funds 10% 9% High Yield • Natural gas growth gainers Bonds 6% Emerging Market; Bonds • US high yield • Developed market Equities 3% Equities Other • Global investment grade credit government bonds Europe 21% EmMa Equities 6% 6% Fixed income • EM corporate bonds • Event-driven and relative value Note: Portfolio weights are for an advisory hedge funds client with a "EUR moderate" profile. For portfolio weights related to other risk profiles please contact your client advisor. • GBP • JPY • Emerging markets (7I) Foreign exchange Commodities $ Recent upgrades y Recent downgrades UBS Please see important disclaimer and disclosures at the end of the document. EFTA01089682 Recommended tactical asset allocation Tactical asset allocation deviations from benchmark* Currency allocation underweight neutral overweight underweight neutral overweight Cash USD Equities total EUR US Eurozone GBP vl a UK JPY = W a Japan CHF EM SEK Other NOK Bonds total CAD Government bonds N c Corporate bonds (IG) NZD o co High yield bonds AUD EM bonds (USD) ■ new old Commodities total N Precious metals * Please note that the bar charts show total portfolio preferences and thus can ao be interpreted as the recommended deviation from the relevant portfolio -0 Energy o benchmark for any given asset class and sub asset class. E Base metals o The UBS Investment House view is largely reflected in the majority of UBS L.) Agricultural Discretionary Mandates and forms the basis of UBS Advisory Mandates. Note Listed Real Estate that the implementation in Discretionary or Advisory Mandates might slightly deviate from the "unconstrained' asset allocation shown above, depending on ■ new old benchmarks, currency positions and for other implementation considerations. Source: UBS CIO WM Global Investment Office - as of 25.10.2012 UBS Please see important disclaimer and disclosures at the end of the document. EFTA01089683 Preferred themes • High quality dividend yields (sourced from existing European • Government bond alternatives (sourced from government bonds - and UK equities) CIO UW) High quality companies with geographically diversified business Developed world government bonds offer a comparatively small cushion models that pay sustainable dividends offer an attractive income against future interest rate hikes and many face increasing credit risk. We stream in a low yield world. Historically, dividends have made a expect selected bonds of supranational or national agencies, sub-national substantial contribution to total returns, and we expect this to remain governments, multinational corporates, and covered bonds to outperform the case in the current environment. government bonds. We recommend switching out of government bonds into these alternatives. • Western winners from emerging market growth (sourced from existing equity holdings) • US high yield corporate bonds (sourced from government bonds — Emerging economies continue to grow faster than developed CIO UW) economies. With little need to deleverage and repair balance sheets, Positive economic growth, robust corporate earnings and healthy balance Asian economies are also well positioned to continue to outpace their sheets provide support to US high yield corporate bonds. Current yield Western peers in the years ahead. We have identified companies from spreads of 540 basis points still price in a more dire economic outcome a variety of sectors in Europe, the US and Japan which have significant than we expect. Historically, US high yield bonds have delivered similar exposure to the rapidly growing emerging regions. We believe a returns as US equities with lower volatility. We continue to believe that diversified portfolio of these companies will reward investors seeking US high yield corporate bonds represent a more favorable risk/return to profit from the robust demand growth in emerging economies. potential than equities and expect mid single digit returns over the next 6 months. Senior loans are exposed to similar positive fundamentals, and • Natural gas growth gainers (sourced from existing equity offer an attractive, floating rate alternative to US high yield. holdings) Natural gas is a relatively clean source of energy, and we think it will • The place to be in Hedge Funds benefit from continued substitution for other energy sources over the Growth in most developed markets remains muted. In this environment, long term. We have examined the dynamics of the global market and less directional hedge fund strategies, such as relative value and event the various components of the gas value chain, and identified the driven, should offer above average returns. areas we see as the most significant beneficiaries currently. These • EM currencies: An underappreciated asset class (sourced from include producers in Europe and Asia, suppliers of infrastructure, government bonds - CIO UW) services and related machinery, and Master Limited Partnerships (MLPs) The currencies of emerging countries, collectively as an asset class and in the US, that offer both attractive yields and growth. measured using total returns (i.e. including interest received), have the • EM corporates: a growing asset class (sourced from global potential to contribute positively to the longer-term returns of a well- government bonds - CIO UW) diversified portfolio. We believe that this is especially relevant now that Given our relatively constructive current view on risk, we regard EM the developed world is settling into an extended period of very low corporate debt as more attractive than EM sovereign debt due to its interest rates. higher overall yield. Over a 6-month horizon, we expect EM corporate bonds to outperform US Treasuries and deliver total returns of close to 4%. = New theme UBS 6 Please see important disclaimer and disclosures at the end of the document. EFTA01089684 Global economic outlook - Summary Key questions Global growth expected to be around 3% in • What are the prospects for the global economy in 4Q 2012 and 1Q 2013? 2012 and 2013 • What are the risks that the US economic recovery will falter in the near term? • When is the European economy likely to emerge from contraction? 00si GOP rowth • What is the near-term outlook for the Chinese economy? 20n 2011F 2013E 2011 2012F 2013E Anialkas US 1.a 2.1 1_3 3.1 2.1 1.7 Canada 2.0 2.0 1_3 2.9 2.0 23 Waal 2.7 IS 03 6.5 5.4 63 CIO View (Probability: 75%) Sluggish expansion Asla/PactfIc Aryan MASSY 09 2.1 23 33 2.0 12 03 3.0 00 1.7 0.3 23 • Global economic activity has shown signs of improvement over the last month - albeit from a low base. Importantly, Chna 9.3 7.5 72 5.4 25 16 nth) 65 5.5 6.5 60 7.5 7.0 the .IPM global composite PMI (a survey measuring economic activity) rose significantly to 52.5 in September from 50.9 (wog. EurOZOOe 1.5 .0.1 0.2 2.7 2.1 1.9 in August. The increase was driven by improvements in both manufacturing and service sector activity. Thus, the GOMW9 3.1 0.9 1.1 25 1.7 1.5 Force 1.7 02 01 2.1 2.0 1.3 global manufacturing PMI rose marginally to 48.9 from 48.1, while the services PMI jumped two index points to 54. nor 0.5 -2.1 42 29 33 2.7 • Geographically, improvements were concentrated in the emerging markets and the US. Indeed, we think that Span UK OA 0.9 •1a .0-3 1.0 3.1 AS 25 2.7 2.7 2.3 downside risks in the US have diminished lately and we expect the moderate recovery to continue ahead. Chinese data Sxtualvd 1.9 1.1 La 0.2 0.5 1.2 RUSS. 0.3 3.11 3.7 05 5.1 &II are still mixed, but we think that an improvement in the economic momentum is in the cards in 4Q. In the EMU and World 3.2 2.7 3.1 3.9 2.9 3.0 UK, recent PMI surveys deteriorated but we still expect the EMU to improve gradually in coming quarters. Overall, we expect the moderate improvement in global economic activity to continue ahead. A key driver here is the latest wave Source: UBS CO, as of 24 October 2012 of ultra-expansionary monetary policy. Downside risks have diminished somewhat in recent months. We expect Greece In developing the CIO economic forecasts, CIO economists to stay in the euro this year and sign a new memorandum in November. In the US modest fiscal tightening is expected worked in collaboration with economists employed by UBS with the Fed mitigating downside growth risks. The risk of an idiosyncratic slowdown in Asia has declined as the latest Investment Research. Forecasts and estimates are current Chinese data confirms that the economy has bottomed." only as of the date of this publication and may change • Global consumer price inflation peaked in summer 2011 and has since fallen gradually. Base effects and rising without notice. commodity prices since June may push up the global headline rate of inflation in coming months. 76 Positive scenario (Probability: 10%•) Services and manufacturing diverging Return to long-term trend • The Eurozone crisis abates. Financial market conditions recover, mitigating the drag from fiscal austerity. (Global PMis, 3-month moving averages) • Growth in Western Europe turns decisively positive by early 2013 and the US economy grows above trend. 65 & Negative scenario (Probability: 1S%*) Recession 60 • There are three key downside risks to the global economy: 1) a significant escalation of the Eurozone debt crisis; 2) a 55 sharp fiscal contraction in the US, and 3) a sharp deceleration of the Chinese economy. Each of these risks could so precipitate a significant downturn of the global economy. 45 —Manufacturing —Services 40 — Composite — No-change line Key dates TBA Troika report on Greece 35 2 Nov Nonfarm payrolls and unemployment rate for October 08 09 10 11 12 6 Nov US presidential and congressional elections Source: Bloomberg, UBS CIO, as of September 2012 8 Nov The 18th National Congress of the Communist Party of China Note: Past performance is not an indication of future returns. 22-23 Nov European Council •Scenario probabilities are based on qualitative assessment. UBS For further information please contact CIO economist Dirk Faltin, and CIO economist Ricardo Garcia, 7 Please see important disclaimer and disclosures at the end of the document. EFTA01089685 Key financial market driver 1- Eurozone crisis Key questions Purchasing managers indices point to • What do we expect from the economy and EC8 policy? ongoing contraction in 3Q • Can Spain and Italy continue to tap the primary market if they ask for a support program? • How much more support will Greece receive and will it be able to stay in the Eurozone next year? 65 60 CO View (Probability: 70%*) Austerity and weak growth 55 50 • We think the Eurozone economy troughed in 3Q. We expect flattish growth in 4Q 2012 and 1Q 2013 (in line with 45 consensus). Beyond this, uncertainties regarding the debt crisis and continuing fiscal austerity efforts will likely keep 40 the pace of recovery subdued. The ECB is still in easing mode but after announcing a conditional bond purchasing 35 program, it would take a marked worsening of the debt crisis and/or a worsening of economic data to trigger any 30 further policy action. 25 • There is political pressure on Spain to apply for official financial support (OMT by the ECB and direct support from 07 08 09 10 11 12 the EFSF/ESM). However, the government may hesitate until market pressure rises and/or clear political benefits are on — Manufacturing —Services offer. We think that Italy will have to apply for an aid package similar to Spain's. We see a high probability of Spain —Composite — No-change line being downgraded to junk by at least one rating agency. Source: Bloomberg, UBS, as of October 2012 • OMT bond purchases in the secondary market will focus on maturities of up to three years and countries will be expected to maintain their funding profiles by also issuing longer-dated bonds. Hence, longer yields should stay elevated as bondholders remain concerned about countries' ability and willingness to implement necessary reforms, and about the de-facto subordination to ECB holdings and official loans. The central banking supervision at the ECB is Yield of Spanish and Italian 10-year bonds unlikely to be ready by January 2013, meaning that direct bank recapitalization through the ESM remains unavailable. over German Bunds (in bps) • We think Greece will not exit the euro in 2012 but will sign a new memorandum by November, although further delay is possible. We think that Greece's failure to meet targets may trigger a cut-off from funding by early 2013 and 700 a possible gradual exit later. Portugal and Ireland should remain on track with their bailout packages, Cyprus will 600 likely get a new package and Slovenia may ask for help soon. 500 $ Positive scenario (Probability: 15%•) Return to macro stability • Bond yields are contained as peripheral countries' budgets stay on track and economic activity recovers faster than 400 expected. Greece complies with the new austerity plans and market confidence is restored. 300 N Negative scenario (Probability: 15%*) Major shock • Major shocks include Spain and Italy being fully cut off from bond markets, i.e. requiring all new funding through 200 EFSF/ESM/IMF loans, with European rescue funds only able to cover them until the end of 2013; resistance from core 100 countries against the ECB program and further support; a Portuguese default; a Greek euro exit before the end of 2012; or a major external shock. 0 03.2011 0612011 092011 122011 03/2012 062012 09/2012 Key dates —Italy —Spain TBD Troika report on Greece 8 Nov ECB press conference Source: UBS, Bloomberg, as of 16 October 2012 12 Nov Eurogroup meeting Note: Past performance is not an indication of future returns. 15 Nov Eurozone GDP 3Q: first estimate • Scenario probabilities are based on qualitative assessment. 22 Nov Eurozone composite purchasing managers index 22-23 Nov European Council UBS For further information please contact CIO analyst Thomas Wacker, CIO economist Ricardo Garcia, and Please see important disclaimer and disclosures at the end of the document. EFTA01089686 Key financial market driver 2 - US economic outlook Key questions US growth to pick up throughout 2013 • Is the nascent growth recovery sustainable? Will the Fed stimulus boost growth? US real GDP and its components, quarter-over-quarter • How will the election result change fiscal policy deliberations? annualized in % • Can politicians find an agreement to avoid a sharp fiscal contraction in early 2013 (i.e. the "fiscal cliff')? 8% grqamutikeed CCO View (Probability: 70%*) Moderate expansion 4% • The economy stays on a moderate growth path but the unemployment rate comes down only very gradually - the 2% September report exaggerated the pace of improvement. Core personal consumption expenditure (PCE) inflation stays 096 -2% 11J- slightly below or close to the Federal Reserve's target of 2%. UBS forecasts real GDP growth of 2.0% in 3Q 2012 (consensus: 1.8%) and 1.6% in 4Q 2012 (consensus: 1.9%). The Fed has added considerable stimulus: it extended -6% Operation Twist and its interest rate forward guidance, indicated that it will stay highly accommodative even after the 8% recovery strengthens, launched an open-ended agency mortgage-backed securities (MBS) purchase program of USD 10% 12% 40bn per month, and shows a strong easing bias tied to the state of the labor market. The Fed actions effectively QI QI QI Q1 QI Q1 01 Q1 mitigate downside growth risks, but they are unlikely to dramatically boost growth. 2006 2007 2008 2009 2010 2011 2012 2013 • In the elections, Republicans will likely lose seats in the House on a net basis but retain a majority; we expect them Consumption 0Cormierciel real estate imestment • Capitalexpemitures 0Residential investment to be even with Democrats in the Senate. Obama will likely retain the White House. Such an electoral outcome would Inventories Net Exports • Gerrerivrent — Real GDP (gAi ant1":0940 prolong the existing gridlock between Republicans and Democrats. • Due to the ongoing political gridlock, we expect modest fiscal tightening. The government will likely let Source: Thomson Datastream, UBS, as of 15 October 2012 unemployment benefits phase out and payroll tax cuts expire, but postpone income tax hikes and sequester spending cuts. Such a decision would lower the federal deficit by 0.7% of GDP, with a likely lower real GDP growth impact as households could buffer the income loss with lower savings. Budget impact of US fiscal cliff in 2013 Cumulative budget effects of fiscal cliff components, in % of 71 Positive scenario (Probability: 10%*) Strong expansion UBS estimate of 2013 GDP • Propelled by expansive monetary policy and a fading Eurozone crisis, growth accelerates persistently above 3.0%. This leads to higher inflation and the Fed responds by halting QE3 and raising rates sooner. • The better economic outlook raises the odds of an Obama reelection and makes it harder for Republicans to gain seats in Congress. Faster-rising tax collection and a Democratic stronghold leads to some tax hikes and limited spending cuts. Fiscal policy tightens by about 1.2% of GDP in 2013. Negative scenario (Probability: 20%*) Growth recession • US fiscal deleveraging and an escalating Eurozone crisis weigh on the cyclical recovery. Falling profit margins weigh on business capital expenditures. Real GDP growth deteriorates much further. The Fed massively purchases agency MBS and Treasuries under its QE3 program. $ e $ .$5 ‘tb e t • The debt limit is reached earlier and the Treasury runs out of money before year-end. Political gridlock becomes c seif e ,c,* 4p.c.F.s4` elit i .1 xpe- dysfunctional, thus sending the country over the 'fiscal cliff," with fiscal policy tightening by e o- USD 607 billion (32% of UBS estimate of 2013 GDP) in 2013. The US credit rating is downgraded. i Fat * A .) Key dates Note: AMT = Alternative Minimum Tax, ACA = Affordable Care 30 Oct Conference Board consumer confidence Act 1 Nov ISM manufacturing purchasing managers index for October Source: CBO, UBS, as of 9 October 2012 2 Nov Nonfarm payrolls and unemployment rate for October " Scenario probabilities are based on qualitative assessment. 6 Nov US presidential and Congressional elections Note: Past performance is not an indication of future returns. UBS For further information please contact US economist Thomas Berner, 9 Please see important disclaimer and disclosures at the end of the document. EFTA01089687 Key financial market driver 3 - China growth outlook Key questions Nascent rebound in domestic commodity • What are the drivers for a modest sequential growth recovery? prices • What is our policy expectation? • How strongly will the recently announced infrastructure projects boost growth? CIO View (Probability: 70%*) Stabilization in economic momentum • We continue to expect a sequential recovery in the growth momentum in the current quarter. Inventory reductions should be less of a drag on growth and the government is rolling out more investment plans. At the same time, political uncertainty should diminish after the power handover in November. We think that real GDP will grow 7% y/y in 4Q (consensus: 7.7%) before improving mildly to 7.3% in 1Q 2013 (consensus: 7.9%). • Indicators measuring inventory levels have fallen recently, showing that the destocking cycle is well advanced. In addition, domestic prices for some major raw materials appear to have bottomed out, which should support a mild rebound in production activity in the coming months. However, this may not be sustainable without a genuine recovery in final demand. • While the government has recently announced trillions of infrastructure investment projects, the spending will span Atte-10 Oen10 Aott11 Oct.1t AD8.12 Oet.12 several years and the source of funding remains unclear. In addition, real estate investment growth is likely to stabilize —Ste* —Cement —Coal but not rebound strongly in the months ahead. We therefore do not expect a sharp rise in investment growth. Fiscal Source: CEIC, Wind, UBS, as of 15 October 2012 support measures should help to stabilize economic growth, but are unlikely to result in a strong growth boost. • The 18th National Congress of the Communist Party of China will be held on 8 November, which is exactly the same date as in the previous leadership handover in 2002. With the transition of the senior Communist Party leadership Investment staying supportive to growth taking place in this meeting, political uncertainties should be reduced. Execution of policy easing measures could improve, although a substantial new stimulus is unlikely in the near term. In terms of monetary policy, we do not 60 expect any interest rate cut for the rest of the year, but a reserve requirement cut is still possible to manage liquidity. 50 Growth rate lac. ley 3foiriai 71 Positive scenario (Probability: 20%*) Higher-than-expected growth 40 • Chinese GDP grows above 7.7% in 2012. This would require more effective fiscal and monetary policy support from the government and possibly also a fast improvement in the Eurozone debt crisis. 30 Negative scenario (Probability: 10%*) Hard landing 20 • Chinese GDP grows below 6%, i.e. a hard landing of the economy. This could be triggered by a global financial crisis/recession, causing a slump in Chinese exports, or domestic policy staying adrift during the leadership transition 10 period. Other risks include a sharp movement in residential property prices, or a surge in inflation that forces the PBoC 0 to significantly tighten monetary policy. (10) Key dates 2006 2007 2006 2009 2010 2011 2012 1 Nov Manufacturing purchasing managers inde