EFTA01089722.pdf

For marketing purposes only UBS CIO WM Global Investment Office External Version CIO monthly video For smartphone users: scan the code with an app like "scan" UBS CIO Monthly Extended July 2012 Published Please see important disclaimer and disclosures at the end of the document. The content of this publication reflects the view of UBS Wealth Management & Swiss Bank's Chief Investment Office (ao). The relative asset 29 June 2012 class preferences in this publication refer to an investment horizon of 6 months following the publication date - if not indicated differently - and will be updated on a monthly basis. The preferred investment themes have a time frame of either 3-12 months or >12 months since inception, as indicated. The information does not constitute UBS financial research and therefore may not reflect or be fully aligned with the views of UBS Research expressed in other publications. The statutory regulations regarding the independence of financial research are not applicable to this publication. Investments may be subject to jurisdictional and regulatory restrictions and may therefore not be available - please discuss the availability and appropriateness of specific investments with your client adviser. EFTA01089722 Table of Contents Section 1 Base slides 3 Section 2 Asset class views 12 2.A Equities 13 2.B Fixed income 23 2.0 Foreign exchange 30 2.D NTAC: Commodities, Listed real estate, Hedge funds and Private equity 34 t EFTA01089723 Section 1 Base slides *UBS EFTA01089724 Summary "With the global • Economy The successful formation of a Greek government after the June 17 elections has reduced economy the risk of an imminent Greek exit from the Eurozone. However, the Euro debt crisis continuing to persists, and further reform and consolidation efforts in Spain and Italy are needed. In the US, economic data weakened recently, but it remains in line with our forecast of moderate muddle through, growth of around 2% in 2012. The Fed extended "Operation Twist" until the end of the year and is ready to do more if the economic situation deteriorates materially. Meanwhile, we believe that Chinese activity data is showing signs of stabilization and inflation remains low. We expect US corporate the Chinese economy to gradually pick up in the second half of 2012. bonds offer the • Equities Despite our relatively positive outlook for US and Chinese economic growth, ongoing best risk return." Eurozone issues keep us neutral on global equities. We think US companies are better positioned than their European peers, and thus keep our longer-standing preference for US equities. US earnings are relatively robust and the recovery of the domestic economy continues to support revenues. Furthermore, we keep a moderate overweight in emerging market (EM) equities as valuations are attractive and we expect growth to accelerate in the second half of the year. In the near term EM currency weakness remains a risk factor. • Fixed Income High grade government bond yields remain extremely low due to ultra-expansive monetary policy and ongoing investor concerns over global growth. While we expect yields to only rise very gradually in the near term, we continue to see better investment opportunities in other fixed income segments. US high yield remains our favorite asset class, given attractive valuations and a favorable default outlook. We also keep our overweight recommendations on investment grade and EM bonds. • Commodities We avoid broad commodity exposure as we see further price weakness ahead. While the worst of the oil sell-off is likely behind us, we see no reason for higher prices in the near term and expect roll costs to weigh on positions. • Foreign Exchange In light of the ongoing Eurozone troubles, we continue to prefer the US dollar over the euro. We also prefer the Canadian dollar, given its relatively good growth dynamics, a possible rate hike, and relatively high short rates. UBS 3 Please see important disclaimer and disclosures at the end of the document. EFTA01089725 Cross-asset preferences Most preferred Least preferred Portfolio weights • US • Europe Commodities 3% Liquidity Real Estate 10% • Western winners from EM Hedge Funds/ 5% High Grade Bondf growth private Equity 10% 6% • High quality dividend yields My Grade Equities • Event-driven and relative value Corp0rateS seitrihta USA Bonds 9% hedge funds 10% High Yield • Natural gas growth gainers Bonds 6% Emerging Markets Bonds Levities 6% Europe • US high yield • Developed market 20% EmMa Equities Equities Other 9% • Global investment grade credit government bonds 6% Fixed income • Event-driven and relative value hedge funds Note: Portfolio weights are for an advisory • EM corporate bonds client with a "EUR moderate" profile. For portfolio weights related to other risk profiles • USD • CHF please contact your client advisor. • GBP • EUR • CAD • Agriculture Commodities • Energy $ Recent upgrades ta Recent downgrades UBS 4 Please see important disclaimer and disclosures at the end of the document. EFTA01089726 Reference portfolio Tactical asset allocation deviations from benchmark* Currency allocation underweight neutral overweight underweight neutral overweight Cash USD Equities total EUR US GBP Eurozone JP‘f UK 3 CHF cr Japan Switzerland SEK EM NOK Other CAD NZD Government bonds -a AUD c Corporate bonds (IG) High yield bonds • new old EM bonds (USD) Commodities total Precious metals Energy * Please note that the bar charts show total portfolio preferences and thus can Base metals be interpreted as the recommended deviation from the relevant portfolio Agricultural benchmark for any given asset class and sub asset class. Listed Real Estate Also note that the implementation in advisory or discretionary products might slightly deviate from the 'unconstrained' asset allocation shown above, ■ new old depending on benchmarks, currency positions and for other implementation Source: UBS CIO considerations 4re UBS Please see important disclaimer and disclosures at the end of the document. EFTA01089727 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 models Developed world government bonds offer a comparatively small cushion that pay sustainable dividends offer an attractive income stream in a against future interest rate hikes and many face increasing credit risk. We low yield world. Historically, dividends have made a substantial expect select bonds of supranational or national agencies, sub-national contribution to total returns, and we expect this to remain the case in governments, multinational corporates, and covered bonds to the current environment. outperform 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 Asian economies are also well positioned to continue to outpace their balance sheets provide support to US high yield corporate bonds. Current Western peers in the years ahead. We have identified companies from a yield spreads of roughly 660 basis points still price in a much more dire variety of sectors in Europe, the US and Japan which have significant economic outcome than we expect. Historically, US high yield bonds have exposure to the rapidly growing emerging regions. We believe a delivered similar returns to US equities with lower volatility. We continue diversified portfolio of these companies will reward investors seeking to believe that US high yield corporate bonds represent a more favorable to profit from the robust demand growth in emerging economies. risk/return potential than equities and expect total returns of • Natural gas growth gainers approximately 7% over the next 6 months. 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 Recent economic data has shown signs of improvement, but growth in long term. We have examined the dynamics of the global market and most developed markets remains muted. In this environment, less the various components of the gas value chain, and identified the areas directional hedge fund strategies, such as relative value and event driven, we see as the most significant beneficiaries currently. These include should offer above average returns. producers in Europe and Asia, suppliers of infrastructure, services and related machinery, and Master Limited Partnerships (MLPs) in the US, • EM corporates: a growing asset class (sourced from global that offer both attractive yields and growth. government bonds - CIO UW) Given our relatively constructive current view on risk, we regard EM corporate debt as more attractive than EM sovereign debt due to its higher overall yield. Over a 6-month horizon, we expect EM corporate bonds to outperform US Treasuries and deliver total returns of close to 8% p.a. cat UBS 6 Please see important disclaimer and disclosures at the end of the document. EFTA01089728 Global economic outlook - Summary Key questions Global growth expected at just under • Can emerging markets (EM) continue to offset developed market (DM) weakness to buoy global 3% in 2012 growth? Kest GDP growth in '- 2011 20121 2013F 2011 20121 20131 • What are the risks of near-term faltering of the US economic recovery? America US 1.7 2.1 2.6 3.1 21 1.7 • When is the European economy likely to return to sustainable economic expansion? Canada 2.4 2.1 2.4 2.9 2.1 23 wan 2.7 2.0 9.8 65 52 65 Allaolractik Japan 2.5 2.0 -0.3 0.2 05 CIO View (Probability: 60%*) alraI 2.1 3.7 3.5 3.4 1.6 25 Dina 92 8.2 0.5 5.4 3.0 4.0 • Global economic activity remains moderate; the growth impulse stems largely (some 80%) from the EM bide 6.5 6.0 7.0 7.8 69 7.0 region. As expected, China started to ease monetary policy. The country is better placed than other EM Europe Eundone 1.5 -0.4 0.4 2.7 2.3 2-0 Gonnany 3.1 IA 1.1 2.5 1.7 IS and particularly DM countries to counter growth weakness with further monetary and fiscal stimuli. Thus, Nate 1.7 0.3 0.4 2.1 2.5 22 we expect EM growth to stabilize soon and pick up in 2H 2012. tatr 0.5 •18 0.2 2.9 3.4 3.9 Spain 0.7 -1.6 -1.3 3.1 1.9 1.9 • US economic indicators have on balance been disappointing recently, especially data related to business UK 0.7 02 1.3 9.5 2.8 1.9 fixed investment and employment growth. Thus, we lowered our 2Q 2012 real GDP growth forecast to an Switzerland 2.1 1.3 1.7 0.2 -0.4 t.4 Rum 43 3.8 3.7 8.5 9.5 69 annualized rate of 1.5% from 2%. We still expect growth slightly above 2% in 2H 2012. We think that the World 32 2A 3.3 3.9 3.0 3.0 risk that the Fed will take measures in addition to the extension of "Operation Twist" is still significant. Source: UBS CIO, as of 28 June 2012 • Large parts of Western Europe are in recession or stagnation. We expect the economies of the Eurozone In developing the OO economic forecast. CIO economists and the UK to show mild improvement in 2H 2012. Still, economic activity is likely to remain very sluggish worked in collaboration with economist employed by UBS Investment Research. Forecasts and estimates are current despite support from lower oil prices and less rigorous fiscal austerity. The Bank of England may support only as of the date of this publication and may change the UK economy by increasing its amount of bond purchases soon. The probability that the ECB will take without notice. further action to support the economy has risen significantly. Global economic momentum is X Positive scenario (Probability: 15%*) deteriorating (UBS GDP tracker) • The Eurozone crisis abates. Financial market conditions recover, mitigating the drag from fiscal austerity. 14 95 12 • Growth in Western Europe is marginally positive (Eurozone stagnates) in 2012 and the US economy May 10 grows moderately above trend. 8 6.3% Negative scenario (Probability: 25%*) 6 4 • There are three key downside risks to the global economy: 1. a significant escalation of the Eurozone 3.1% 2 debt crisis; 2. a sharp fiscal contraction in the US, and 3. a sharp deceleration of the Chinese economy. Each 0 1.0% one of these risks could precipitate a significant downturn of the global economy. .2Jan Jan Jan Jan Jan Jan Jan Jan .4 OS 06 07 08 10 11 12 13 Key dates •6 —Global —DM — EM• 2 July USA: ISM manufacturing PMI for June Source: Bloomberg, UBS ao, as of 22 June 2012 5 July Eurozone: ECB press conference • DM= developed markets, EM = emerging markets 24 July Eurozone: purchasing managers indices (PMI), July estimates Note: Past performance is not an indication of future returns. 22-25 July China: HSBC flash manufacturing purchasing managers index (Jul) ••scenario probabilities are based on qualitative assessment. UBS For further information please contact CIO economist Dirk Faltin, 7 Please see important disclaimer and disclosures at the end of the document. EFTA01089729 Key financial market driver 1- Eurozone crisis Key questions Bottoming in Eurozone leading • What is the way forward for Eurozone banks? indicators (PMI) in June? • What is the most likely course of events in Spain, Italy and Portugal? 65 • In what direction will the economy and the ECB go? 60 CIO View (Probability: 65%•) Austerity and weak growth 55 • Support for the banking sector is a major political agenda item, and the request for external support for 50 Spanish banks can be seen as the starting point for greater European support and oversight for banks, to 45 be discussed at the upcoming European Council. 40 • Greece's debt remains unsustainable, but the risk of a euro exit over the next six months has diminished 35 after the 17 June elections, which have produced a viable government coalition. The Troika may only 30 accept moderate adjustments to the second Greek package. Portugal is likely to receive an increased 06 07 08 09 10 11 12 bailout package and is unlikely to default in 2012. Progress on reforms and consolidation in Spain and Italy — Manufacturing —Services —Composite is most crucial for the near-term development of the crisis. Risk premiums would rise strongly on any failure to meet deficit targets; we expect bond risk premiums to remain elevated for Spain and Italy over Source: Bloomberg, UBS CIO, as of 21 June 2012 (estimates) the next six months. • Following stagnation in 1Q 2012, economic surveys are commensurate with a quarterly GDP contraction of around 0.3% at present. Business survey evidence points to a general wait and see mode. The risk to the outlook for a stabilization of economic growth in the second half of 2012 is skewed to the downside. The ECB remains on hold, but the bar to support the economy and markets has been lowered substantially. We Yield of Spanish and Italian 10-year see a significant probability of policy action in early July, including the possibility of a rate reduction. bonds over German Bunds (in bps) Despite all the talk about political measures to support growth and increased tolerance for budget 6C0 slippages, there is practically no leeway for fiscal stimuli. The near-term growth impact of any fiscal measure will at best be marginal, in our view. SW 7f Positive scenario (Probability: 15%•) Return to macro stability 41:0 • Bond yields are contained, as peripheral countries' budgets stay on track and economic activity recovers 3120 faster than expected. Greece fully complies with the austerity plans and receives further support. Market confidence is restored, and economic growth stagnates in 2012. 240 11 Negative scenario (Probability: 20%•) Major shock ico • Major shocks could include Spain being pushed into a full IMF/EU program, possibly by a rating cut to junk, enhancing pressure also on Italy; serious political disagreement in core countries (for instance after 0 Dutch elections, etc.); a possible Portuguese default; a Greek euro exit or a major external growth shock. 01/2011 04/2011 07/2011 10/2011 01/2012 0402012 — Italy — Spain Key dates Source: 1)85 CIO, Bloomberg, as of 18 June 2012 5 July ECB press conference Note: Past performance is not an indication of future returns. 9-10 July Eurogroup/ECOFIN-Meeting Scenario probabilities are based on qualitative assessment. 24 July Eurozone purchasing manager indices (PMI), July estimates UBS For further information please contact CIO analyst Thomas Wacker, CIO economist Ricardo Garcia, and 8 Please see important disclaimer and disclosures at the end of the document. EFTA01089730 Key financial market driver 2 - US policy Key questions US moderate growth to continue • Will the economic outlook deteriorate? Will QE3 become necessary? US real GDP and its components, quarter-over-quarter annualized in % • How will the election outcome change fiscal policy deliberations? • Can politicians find an agreement to avoid sharp fiscal contraction in early 2013 ("fiscal cliff")? 8% 6% CIO View (Probability: 65%*) No QE3, political gridlock and some fiscal tightening 4% • The economy stays on a moderate growth path, coupled with stable core PCE inflation close to the Fed's 2% target of 2%. UBS forecasts real GDP growth of 1.5% in 2Q 2012 (consensus: 2.1%) and 2.3% in 3Q 2012 0% 2% (consensus: 2.4%), with some downside risk due to rising uncertainty. The Fed has decided to extend so -4% called "Operation Twist' until the end of the year. More near-term monetary easing is still possible, but it -6% is currently not our central scenario. -8% • In the elections, Republicans will likely lose seats in the House overall, but retain a majority; we also -10% 12% expect them to win a narrow majority in the Senate. Obama will likely retain the White House. Such an Q12036 QI 2007 Q12008 QI 2009 QI 2010 Q12011 QI 2012 electoral outcome would confirm the existing gridlock between Republicans and Democrats. =Consumption • Gemmemai real estate investment =Capitalexpenstoures =Residential investment • Against the backdrop of ongoing political gridlock, we expect only moderate fiscal tightening of about hventonts =Net Exports • Government — Real GDP Mel annual1444) 0.9% of GDP in 2013. The government will likely let unemployment benefits and the payroll tax cut expire, but postpone income tax hikes and sequestration spending. Source: Thomson Datastream, UBS OO, as of 20 June 2012 $ Positive scenario (Probability: 10%*) No QE3, Democratic sweep and more fiscal tightening • Propelled by ultra-expansive monetary policy and improved confidence, cyclical forces surmount the structural hindrances and thus growth accelerates. More rapid growth leads to higher inflation, and the Fed responds by tightening monetary policy sooner. US fiscal cliff at year-end 2012 • The improved economic outlook raises the odds for an Obama re-election and makes it harder for Fiscal effects of change in provisions under current law, USD billion annualized Republicans to win a majority in the Senate. US fiscal consolidation efforts are facilitated by faster rising tax collections. A Democratic stronghold leads to some tax hikes and limited spending cuts. Fiscal policy 1Q13 2Q13 3Q13 4Q13 GYZ013 tightens by about 1.2% of GDP in 2013. -60 -68 -76 -76 -70 N Negative scenario (Probability: 25%*) QE3, political dysfunction and huge fiscal tightening -16 -16 -16 -17 -16 • Structural hindrances dominate and weigh on the cyclical recovery, thus growth weakens or turns -38 -58 -58 -65 -55 negative. The Fed embarks on QE3, most likely in the form of agency MBS and Treasury purchases. -164 -156 -137 -172 -157 • Weaker economic conditions raise the odds for a larger Republican majority in Congress, but Obama 0 -374 -125 -29 -132 remains President. The debt limit is reached earlier and the Treasury runs out of money before year-end. -94 -114 -114 -114 -109 The political gridlock becomes dysfunctional, thus fiscal policy tightens by USD 600 billion (3.7% of UBS -34 -34 -34 -34 -34 estimate of 2013 GDP) in 2013 ("fiscal cliff"). The US credit rating is downgraded. -27 -27 -27 -27 -27 - - 34 40O Key dates Source: Goldman Sachs, UBS OO, as of 20 June 2012 2 July ISM manufacturing PMI for June Scenario probabilities are based on qualitative assessment. 6 July Nonfarm payrolls and unemployment rate for June Note: Past performance is not an indication of future returns. 6 Nov US Presidential and Congressional elections UBS For further information please contact US economist Thomas Berner, 9 Please see important disclaimer and disclosures at the end of the document. EFTA01089731 Key financial market driver 3 - China growth outlook Key questions First interest rate cut since 2008 • When will the economy bottom out? • What economic policy responses can we expect to support the economy ahead? • How significant is the contagion risk from a possible downturn in the Eurozone? CIO View (Probability: 70%*) Modest policy easing to support growth in 2H12 • The latest economic data suggest that economic activity is showing signs of stabilization, albeit at a comparatively low level. However, we have yet to see meaningful pick-up in activity. We think that policy measures to support the economy should have more visible effect on activity in the second half of the 3 year. • To this effect, the People's Bank of China (PBoC) has recently cut interest rates by 25bps - the first such move since late 2008. With investment demand still sluggish, we don't expect the measure to have a significant near-term effect on growth. Still, the cut confirms the leadership's commitment to support the 0 2 3 8 r. co o o economy. Importantly, with the rate cut, measures were announced to increase the banks' ability to set e o • $ k e interest rates, which should bolster private household spending power in the future. .a 5 5 i .a 2 — 1-year lending rate — I -year deposit rate • The rate reduction took place against a backdrop of falling price inflation. Thus, inflation is no obstacle for further measures to ease monetary policy. However, at this point we don't expect further rate cuts this Source: Bloomberg, UBS CIO, as of 18 Jun 2012 year; especially since increased interest rate flexibility should contribute to an easing of monetary conditions ahead. If anything, we think the PBoC may implement more reductions in banks' reserve requirement rates to ensure sufficient liquidity provisions. Thus, we think the real focus has to be on the Pick-up in infrastructure investment fiscal policy measures now, including possibly an acceleration of infrastructure investments, measures to 6: support consumer spending and selective relaxation in the property market (while keeping home-purchase restrictions intact). 50 7; Positive scenario (Probability: 20%*) Higher-than-expected growth 40 Year.on.yeat %, • Chinese GDP grows above 8.5% in 2012. For this we would probably need to see stronger-than-expected 30 fiscal and monetary policy support from the government. A speedy improvement in the Eurozone debt 2C crisis could also lead to this positive scenario. 11 Negative scenario (Probability: 1O%*) Hard landing 10 • Chinese GDP growth 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. Other risks include a sharp decline in Chinese residential property prices —which would slow investment growth, a large-scale default of local 1C government debt, or a surge in inflation that forces the PBoC to significantly tighten monetary policy. 05 06 07 08 09 10 11 12 F xed asset investment —Infrastructure Key dates -Peal estate development -Manu'actv 1 Jul Manufacturing purchasing managers index (Jun) 13 Jul Fixed asset investment, industrial production (Jun), 2Q12 GDP Source: Bloomberg, UBS CIO, as of 18 Jun 2012 11-15 Jul New bank lending, M2 (Jun) Note: Past performance is not an indication of future returns. • Scenario probabilities are based on qualitative assessment. 22-25 Jul HSBC flash manufacturing purchasing managers index (Jul) cat UBS For further information please contact CO analyst Gary Tsang, Glenda Yu, S Patrick Ho, Please see important disclaimer and disclosures at the end of the document. EFTA01089732 Section 2 Asset class views 4 UBS EFTA01089733 Section 2.A Asset class views Equities 4 uss EFTA01089734 Equities overview Preferences (6 months) Global equity markets - Key points • We keep an overall neutral allocation to equities (see summary on slide 3). • The US remains our preferr