EFTA01089619.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 May 2013 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 April 2013 The market prices provided are closing prices on the respective principal stock exchange. This applies to all performance charts and tables in this publication. EFTA01089619 Table of Contents Section 1 Base slides 3 Section 2 Asset class views 13 2.A Equities 14 2.B Fixed income 24 2.0 Foreign exchange 32 2.D NTAC: Commodities, listed real estate, hedge funds and private equity 36 EFTA01089620 Section 1 Base slides SUBS EFTA01089621 Summary "We stick to a • Economy Recent US growth indicators have weakened, with the ISM, non-farm-payrolls, and retail sales disappointing in March. moderate However, we believe the weakness can partly be attributed to tax hikes and sequester spending cuts, which are expected to fade. As such we believe it is likely to prove temporary. Meanwhile, we expect the Fed to taper, but not halt, QE asset overweight in purchases in 4Q13. Despite some better-than-expected economic data points in the Eurozone, such as February industrial production, recent forward-looking PMIs suggest that the Eurozone economy remains on a weak footing, and we expect equities and US the ECB to cut its refinancing rate in May. The Bank of Japan (BoJ) recently surprised with more monetary stimulus than previously expected. We foresee economic growth rising on higher government and private consumption, and core high yield. We shift inflation climbing slowly toward positive territory. Recent regulatory measures in China are likely to weigh on sentiment in the short term but will not derail economic growth, which we expect to come in around 8% in 2013. our overweight EM • Equities equities to Japan We are sticking to our moderate overweight in equities, and remain overweight in the US, where we believe the weakness in data is likely to prove temporary. We are replacing our overweight position in emerging markets with an and go long USD overweight position in Japan. Uncertainties over global growth, Chinese policy, and commodity prices could weigh on EM, while the Bank of Japan's aggressive easing policies should help support the Japanese economy and drive earnings and CAD." upgrades. • Fixed Income We expect a tapering in QE from Q4 to push global yields somewhat higher. German and Japanese yields are close to historical lows, and we expect them to rise moderately along with inflation in the coming year. Within fixed income, the best investment opportunities are to be found in corporate bonds. Investment grade bonds offer a yield pickup over government bonds and low volatility, although absolute returns will likely be only modest. High yield and emerging market corporate bonds still offer potential for tighter spreads, making them attractive from a risk-return perspective. We remain overweight credit. • Commodities Precious metals have come under severe pressure recently. Gold is down 14% since the beginning of April, and silver is down 18%. The Fed signaling that it is considering tapering QE later this year, together with speculation over potential gold sales by the Bank of Cyprus, triggered the negative sentiment. We are sticking to a neutral view on commodities, given the high volatility on the asset class. • Foreign Exchange We continue to favor GBP against EUR. This week's announcement of an extension to the Funding for Lending scheme could see some MPC members back away from calls for more QE, and concerns over a change in Bank of England policy should continue to recede following March's budget. We are also overweighting USD, using CHF for funding. The US has a clear advantage in economic momentum over the Eurozone. Furthermore, we are upgrading CAD to overweight against an underweight in AUD. Recent economic indicators suggest that Canadian growth is likely to improve while we expect more economic disappointments in Australia. Furthermore, the AUD remains highly overvalued based on Purchasing Power Parity. 3 Please see important disclaimer and disclosures at the end of the document. EFTA01089622 Cross-asset preferences Most preferred Least preferred Portfolio weightings Commodities Liquidt, Real Estate 5% • US • Canada 5% 9% High Grade Bonds • Japan (X) • European telecoms Hedge Funds, 5% Mr Grade Private Equity Corporates • US mid caps 10% Bonds 9% • US housing High Yield Bonds • Japanese exporters Equities US 3% 11% EM Sov. Bonds Equities • Western winners from EM 3% EM Corp. growth Bonds 3% • Water-linked investments (A) Equities Other • Relative value and equity Equities Europe 11% 23% Equities EM long/short hedge funds 3% Note: Portfolio weightings are for an advisory client with a "EUR moderate" profile. For • Too expensive government portfolio weights related to other risk profiles • US high yield or currencies please contact your client bonds • Global investment grade credit advisor. • EM corporate bonds • Corporate hybrids • Relative value hedge funds • Emerging markets • EUR Foreign • GBP • CHF (V) exchange • CAD (a) • AUD (V) • USD (X) Commodities Recent Recent upgrades a downgrades Please see important disclaimer and disclosures at the end of the document EFTA01089623 Recommended tactical asset allocation Tactical asset allocation deviations from benchmark* Currency allocation underweight neut al overweight underweight neutral overweight Cash Equities total l l USD US EUR Eurozone 0 GBP cu UK a = JPv cr Japan Switzerland CHF EM SEK Other Bonds total NOK High grade bonds CAD ,,, Corporate bonds (IG) -o c NZD o co High yield bonds EM sovereign bonds (USD) AUD EM corporate bonds (USD) ■ new old Commodities total 0 Precious metals * Please note that the bar charts show total portfolio preferences and thus can cu a be interpreted as the recommended deviation from the relevant portfolio -o Energy o benchmark for any given asset class and sub asset class. E Base metals E The UBS Investment House view is largely reflected in the majority of UBS V Agricultural Discretionary Mandates and forms the basis of UBS Advisory Mandates. Note Listed Real Estate that the implementation in Discretionary or Advisory Mandates might deviate slightly from the "unconstrained' asset allocation shown above, depending on • new old benchmarks, currency positions and other implementation considerations. Source: U8S CIO WM Global Investment Office - as of 25.04.2013 Please see important disclaimer and disclosures at the end of the document. EFTA01089624 CIO preferred investment themes (1/2) Liquidity & Foreign Exchange • Emerging market currencies: An underappreciated asset class Emerging market corporates: A growing asset class The currencies of EM countries, collectively as an asset class and measured Within EM hard currency debt, we prefer corporate to sovereign due to its using total returns (i.e. including interest received), have the potential to more attractive valuation and higher overall yield. Moreover, our relatively contribute positively to the longer term returns of a well-diversified portfolio. constructive current view on risk is another reason to prefer EM corporate We believe that this is especially relevant now that the developed world is over sovereign debt. Over a six-month horizon, we expect EM corporate bonds settling into an extended period of very low interest rates. to deliver total returns of more than 3.5%. • GBP - the best of the majors Government bonds too expensive The pound had come under pressure after speculation earlier in the year over Improving economic data has already led to an increase in government bond potential changes to monetary policy targets. This week's announcement of yields in most major markets. While tight fiscal budgets and high debt an extension to the Funding for tending scheme could see some MPC burdens in the US and Europe are unlikely to allow for a large increase in members back away from calls for more QE, and concerns over a change in interest rates, even a small further rise would lead to negative total returns on Bank of England policy should continue to recede following March's budget benchmark government bonds, and we believe that the risk-reward in the statement. As a result, the pound is our preferred major currency. bonds of most weaker countries is currently poor. We therefore recommend switching out of the affected bonds, which are identified in this theme. Fixed Income Yield pickup with corporate hybrids Equities The corporate hybrid segment is a lesser known segment of the investment • REMOVED: Emerging market equities grade credit world that has lagged the broad-based spread recovery. As a On a tactical basis we are downgrading emerging market equities to neutral, consequence, we see attractive opportunities for investors with a suitable risk and so removing them from ao preferred themes. With near-term tolerance or a trading orientation. We expect mid to high single-digit returns uncertainties over global growth, the future of Chinese policy, and the on selected instruments over a 12-month period. outlook for commodities, we foresee no catalyst to help emerging markets realize their significant longer term valuation potential. US high yield corporate bonds Positive economic growth, robust corporate earnings, and healthy balance sheets provide support to US high yield (HY) corporate bonds. Current yield spreads of -478 basis points still price in a more dire economic outcome than • Water thirst for investments The demand for clean water should increase with a growing global population. However, the supply of clean water is constrained by the lack of 4 we expect. Historically, US high yield bonds have delivered similar returns to water infrastructure in emerging markets. Climate change, urbanization and US equities with lower volatility. We continue to believe that US high yield emerging markets' stronger focus on the industrial sector are also damaging corporate bonds have a favorable risk/return and expect mid-single-digit the water supply. Furthermore, we have identified three short-term trends returns over the next six months. Senior loans are exposed to similar positive that should add earnings power for water-exposed companies - ship ballast fundamentals and offer an attractive, floating rate alternative to US HY. water treatment US shale development and desalination. The CIO preferred investment themes represent the CIO's highest conviction, thematic investment ideas. We aim to recommend ideas that are attractive on a risk-reward basis and expected to deliver positive absolute returns. It will include the best investment themes for each of our TAA overweights, further aligning the asset allocation and themes recommendations, along with a range of other short, medium and long-term, as well as SRI, themes. 6 Please see important disclaimer and disclosures at the end of the document. EFTA01089625 CIO preferred investment themes (2/2) Equities • US mid caps: The sweet spot • No turnaround for European telecoms US economic data has begun to stabilize and forecasts now show an We expect further relative downside in European telecoms in the coming acceleration of growth in 2013. The greater domestic sales exposure of US months. Operating results, free cash flows, and dividends will likely stay under mid caps, and their more cyclical sector make-up, give greater leverage to the pressure, and further adjustments to consensus forecasts are required, in our US recovery. For these reasons we believe that mid-cap companies will view. Share price developments are likely to remain erratic and we recommend outperform large caps in the US over the next 6-12 months. continuing to avoid the sector. • REMOVED: Swiss high-quality dividends • US housing: The long grind higher With the 2013 Swiss dividend payment season largely behind us, we are US housing activity has been recovering for about a year. We believe that the removing this theme from CIO preferred. In particular, the attraction of high recovery is sustainable and will not be hampered by the negative forces arising dividend yielders will fade for the next few months, although high-quality from fiscal austerity and sequestration. We are also slightly more optimistic companies with strong cash flows and steadily rising dividends remain than consensus regarding the speed of recovery. A sustainable US housing attractive. recovery provides opportunities for equity investments in companies with high exposure to the housing market that are still valued attractively. . Japanese exporters supported by a weaker yen We believe that the impact of an approximately 10% weaker yen over the first quarter should start emerging in earnings results, supporting exporters' Hedge Funds & Private Equity outperformance until the national election in July. Given the recent • The place to be in hedge funds underperformance of Japanese exporters vs. domestic companies, we believe The favorable conditions for relative value remain unchanged in 2013. A the theme of Japanese exporters is now even more attractive in a Japanese continued improvement in global growth and the supportive monetary policy context. backdrop support spread products such as corporate bonds and securitized • Western winners from emerging market growth loans. Moreover, the decline in the number of market participants due to the Despite recent concerns, emerging economies continue to grow faster than Volcker rule should provide more opportunities for strategies such as fixed developed economies. With little need to deleverage and repair their balance income arbitrage. We also like equity long short which should benefit from sheets, Asian economies are also well positioned to continue outpacing their stronger equity markets. The associated lower stock correlations should Western peers in the years ahead. We have identified companies from a enable managers picking under- and overvalued stocks to perform well. variety of sectors in Europe, the US and Japan with significant exposure to the Commodities rapidly growing emerging regions. We believe a diversified portfolio of them will reward investors seeking to profit from the robust demand growth in • REMOVED: Platinum: Attractively valued emerging economies. Platinum remains our most preferred precious metal. The lack of supply growth and an improving economy in 2H13 should enable platinum prices to move higher later this year. That said, volatility could remain elevated in the near term given platinum's exposure to gold's sell-off and the ongoing uncertainty regarding gold's investment demand. We are removing it from our CIO preferred themes due to changed risk/return characteristics. = New investment theme 7 Please see important disclaimer and disclosures at the end of the document EFTA01089626 Global economic outlook - Summary Key points Global growth expected to be 2.9% in 2013 • We expect moderate US growth over the next six months after a dismal 4Q12 performance and 1Q13 rebound. 1255=Thill • In the Eurozone we think that economic activity is slowly recovering. Antonin 05 JOI31 2) 25I.II 2) X641 10 200 21 20IY• I) 2014$ 13 • In the emerging markets we expect real GDP growth of around 5% in 2013, with moderately rising inflation to 2H13. Canada 30 20 21 16 19 2s Prato 09 33 3a SO 6) 6 13 AllaiPaCIIIC oDWI 20 10 In 00 01 III CIO view (Probability: 70%*) Sluggish expansion antInDs 36 10 10 III )a 14 China /II •0 50 ) 7 15 a0 • We expect US growth to stay moderate over the next six months after a dismal 4Q12 performance followed by Aga S0 65 /0 05 /4 70 growth acceleration in 1Q13. Stronger private sector demand and reaccelerating inventory accumulation will be offset Kam. tannen• 4Aimand 0% 09 04 07 07 II 15 II I7 1! I 6 16 by fiscal tightening and fiscal policy uncertainty. In conjunction with the debt ceiling debate in July/August and the fora 00 03 07 20 10 I3 Pay .21 d2 03 33 IP I0 expected passage of the FY2014 budget by September, we expect further budget agreements to add more flexibility !pan I 4 .I7 00 1. 3. I5 to the implementation of the sequester spending cuts, but we don't expect any additional cuts. We estimate the 2013 Of 02 07 I I 20 31 32 swerenand 10 09 13 07 00 OH fiscal drag at 1.5%, with a 1.2% GDP impact as households can lower their savings to buffer the drop in after-tax Rutiall 34 30 40 51 65 56 Wald 26 29 34 29 28 3.2 income. We expect the Fed's open-ended QE3 program to last until mid-2014 with some tapering off in 4Q13. Total purchases will likely amount to USD 1.3tn, bloating the Fed's balance sheet to USD 4tn at year-end 2013. Source: UBS, as of 23 April 2013 • Latest economic data in the Eurozone points to a modest weakening of quarter-on-quarter economic growth in the In developing the CIO economic forecasts, CIO economists second quarter. This dynamic is mainly driven by lower business surveys following the Italian elections and the Cyprus worked in collaboration with economists employed by UBS Investment Research. Forecasts and estimates are current crisis. It remains to be seen how strong the impact will be. Our base case of a stabilizing economy in 1H remains intact only as of the date of this publication and may change (in line with consensus) given economic data so far. The ECB is hesitant to cut rates and wants first to see more without notice. evidence of weakening growth in the second quarter and thus remains in wait-and-see mode for now. Due to the weakening of the business surveys, the risk of a rate cut in the second quarter has increased substantially though. • We cut our GDP growth forecast for Brazil to 3.3% (from 4% previously) for 2013 and to 3.4% for 2014 (from 3.6%) due to a less benign external environment and weaker household consumption. In China, we expect growth of around Global purchasing manager indices 8% in coming quarters, with slightly better sequential growth in 2Q13. Inflation will gradually rise in 2H13 and could consolidating at expansionary levels trigger a more neutral policy stance. Modest headwinds may come from real estate, credit, and liquidity policies. Global PMIs Indian inflation is on a slowing trend and we expect some more rate cuts in the coming months. We see growth of around 6% over the next 12-18 months. In Russia, growth is slowing, but lower inflation provides room for some 65 monetary policy support in the coming months. We expect Russian growth of 3.5% in 2013. 60 55 71 Positive scenario (Probability: 15%1 Return to long-term trend 50 • The Eurozone crisis abates. Financial market conditions recover, mitigating the drag from fiscal austerity. 45 • Growth in Western Europe accelerates and the US economy grows above its 2.5% trend. 40 11 Negative scenario (Probability: 15%*) Recession • There are three key downside risks to the global economy: 1) a significant escalation of the Eurozone debt crisis; 2) a 35 protracted government shutdown and a sharper fiscal contraction in the US; and 3) a sharp deceleration of the Chinese 30 economy. Each of these risks could precipitate a significant downturn in the global economy. 15 07 08 09 10 II 11 I) Key dates —service — moroauvog —corroove mxionoe len 1 May US: FOMC monetary policy decision 2 May Eurozone: ECB press conference Source: JP Morgan, Bloomberg, UBS; as of April 2013 3 May US: Nonfarm payrolls and unemployment rate for April Note: Past performance is not an indication of future returns. 10-15 May *Scenario probabilities are based on qualitative assessment. China: New bank loans, total social financing, money supply (April) 22 May Eurozone: EU Council For further information please contact CIO economist Ricardo Garcia, Please see important disclaimer and disclosures at the end of the document. EFTA01089627 Key financial market driver 1- Eurozone crisis Key points Purchasing managers' indices still signal • We expect the Eurozone to gradually emerge from recession. Fiscal policy will be less restrictive than in 2012. economic weakness • The ECB provides a credible backstop to contain debt crisis-related break-up risk. The rate cut probability has 65 increased. 60 • We think that Spain is at risk of needing external support and Italy will likely call early elections in late 2013 or early 2014. 55 50 CIO view (Probability: 70%*) Austerity and weak growth 45 • Economic data so far suggests that the recession in the Eurozone has eased since the beginning of 2013, with France 40 a key exception, though business surveys weakened following the Italian elections and the Cyprus crisis. Real activity 35 data so far supported our base case of a stabilizing economy in the first half of the year (in line with consensus), but 30 the impact on business confidence has created downside risks for the second quarter and could delay the fragile 25 recovery. The ECB prefers to keep its policy rate unchanged despite a fall in consumer price inflation to 1.7% in March. 2007 ZOOS 2009 2010 2011 2012 2013 The risk of a rate cut in the second quarter has increased substantially though following the weaker business surveys. No-cAvnge Ime — manufactunng —service composite • We believe that the risk of Spain requiring a support program in 1H13 remains high. The continuing recession, a much higher than initially planned budget deficit of 5.5-6%, and record-high funding needs of more than EUR 130bn Source: Bloomberg, UBS; as of 23 April 2013 are contributing to the risk. We see an about even chance of Moody's downgrading the country's credit rating to junk over the next three months, which may impair the country's access to funding at affordable rates. • Italian bond yields remain vulnerable to contagion from other peripheral countries due to the uncertainty over the Spreads of Spanish and Italian 5-year timing and outcome of early elections. With a pro-reform government, Italy should remain investment grade rated. bonds In • Ireland and Portugal continue to recover gradually, but are highly indebted. A failure to fully return to the bond markets later this year may lead to the need for a second support program. We think that Greece requires a large 70D further debt haircut and exit risks will increase if the current government loses its majority over additional austerity 600 demands from the IMF, possibly in 2H13. We expect France to deliver negative headlines in 1H13 because of rising 500 concerns about its fiscal slippage on the back of economic weakness. 400 • Even with OMT support, longer term peripheral yields should stay sensitive to countries' debt trajectories as debt 300 levels remain very high. Banking supervision at the ECB will likely be operational by 2014, but a banking union is 200 unlikely to be formed in the next few years, with the most controversial aspect being joint deposit insurance. 100 0 71 Positive scenario (Probability: 15%•) Growth and fiscal stabilization 032011 082011 012012 062012 11,2012 042013 • Bond yields converge further as peripheral countries consolidate their budgets and economic activity recovers faster than expected. Italy forms a government that continues the reform path. Note: Past performance is not an indication of future returns. la Negative scenario (Probability: 15%*) Major shock • Scenario probabilities are based on qualitative assessment. • Major shocks include Spain and Italy being cut off from bond markets, i.e. requiring all new funding through ESM/IMF loans, with European rescue funds only able to cover them until the end of 2013; resistance from core countries against further support; a near-term Portuguese debt restructuring; a Greek euro exit in 1H13; massive fiscal slippage in France; or a major external shock. Key dates 2 May ECB press conference 22 May EU Council 23 May PMI Composite for May (flash) For further information please contact OO analyst Thomas Wacker, and CIO economist Ricardo Garcia, 9 Please see important disclaimer and disclosures at the end of the document. EFTA01089628 Key financial market driver 2 - US economic outlook Key points US growth to rebound after 4Q12 slump • US growth should remain moderate, with accelerating private sector growth partially offset by fiscal tightening. US real GDP and its components, quarter-over-quarter • Inflation is expected to stay slightly below the Fed's target of 2% over the next six months. annualized in % • The Fed's open-ended QE3 has dampened the risk to growth but has not dramatically boosted activity. 8% 6% CIO view (Probability: 70%*) Moderate expansion 4% • We expect the economy to stay on a moderate growth path and the unemployment rate to come down gradually 2% over the next six months. UBS forecasts real GDP growth of an annualized 3.0% in 1Q13 (consensus: 2.9%) and 2.9% in 0% 2% 2Q13 (consensus: 1.6%), as private sector demand remains solid and very lean inventories give way to faster inventory 4% accumulation. Inflation should stay slightly below the Fed's target of 2%. 6% • Relative to 2012 policy, Congress has raised taxes and is cutting spending. We estimate the total federal budget 8% 10% effect to be 1.5% of GDP in 2013. However, the 2013 GDP growth impact will likely be more muted as households can 12% lower their savings to offset the drop in after-tax income caused by higher tax rates. We estimate a real GDP growth QI QI 01 01 Of Q1 Q1 QI impact of 1.2% in 2013. So far the impact from higher taxes has been negligible as households significantly lowered 2006 2007 2008 2009 2010 2011 2012 2013 - Consumption •Commercial real estate investment their savings rates, which we expect to be increased moderately in the future. • Capital expend lures - Residential investment • We think the sequester spending cuts will remain in place but that new budget negotiations related to a necessary la Inventories • Net Exports Gcmemment Real GOP (Wq annuelaedl increase in the debt ceiling in July/August will provide more flexibility in implementing them. The possible political rift Source: Thomson Datastream, UBS; as of 23 April 2013 and insufficient cuts to stabilize the medium-term debt-to-GDP ratio will likely lead to another US sovereign rating downgrade. • The Fed's open-ended QE3 program linked to labor market conditions - USD 85bn in Treasury and agency MBS purchases per month - mitigates risks to growth, but has not dramatically boosted growth