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UBS CIO Monthly Extended
July 2012
Published
29 June 2012
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 (CIO). The relative asset
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.
Table of Contents
Section 1 Base slides 3
Section 2 Asset class views 12
2.A Equities 13
2.B Fixed income 23
2.C Foreign exchange 30
2.D NTAC: Commodities, Listed real estate, Hedge funds and
Private equity 34
1
Section 1
Base slides
Summary
"With the global
economy
continuing to
muddle through,
we believe that
US corporate
bonds offer the
best risk return."
• Economy
The successful formation of a Greek government after the June 17 elections has reduced
the risk of an imminent Greek exit from the Eurozone. However, the Euro debt crisis
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
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,
Chinese activity data is showing signs of stabilization and inflation remains low. We expect
the Chinese economy to gradually pick up in the second half of 2012.
• Equities
Despite our relatively positive outlook for US and Chinese economic growth, ongoing
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.
3
Please see important disclaimer and disclosures at the end of the document.
Cross-asset preferences
Most preferred
Least preferred
Portfolio weights
Equities
• US
• Western winners from EM
growth
• High quality dividend yields
• Event-driven and relative value
hedge funds
• Natural gas growth gainers
• Europe
Commodities
3%
Real Estate
5%
Hedge Funds /
Private Equity
10%
Equities USA
10%
Liquidity
10%
High Grade
Bonds
6%
Inv Grade
Corporates
Bonds
9%
High Yield
Bonds
6%
Fixed income
Foreign
exchange
• US high yield
• Global investment grade credit
• Event-driven and relative value
hedge funds
• EM corporate bonds
• USD
• GBP
• CAD
• Developed market
government bonds
• CHF
• EUR
Equities
Europe
20%
EmMa Equities
6%
Equities Other
9%
Emerging
Markets Bonds
6%
Note: Portfolio weights are for an advisory
client with a "EUR moderate" profile. For
portfolio weights related to other risk profiles
please contact your client advisor.
Commodities
• Agriculture
• Energy
� Recent upgrades �
Recent downgrades
4
Please see important disclaimer and disclosures at the end of the document.
Reference portfolio
Tactical asset allocation deviations from benchmark*
Currency allocation
underweight
neutral
overweight
underweight
neutral
overweight
Cash
USD
Equities total
EUR
Equities
US
Eurozone
UK
Japan
GBP
JPY
CHF
Switzerland
SEK
EM
NOK
Other
CAD
Bonds
Bonds total
Government bonds
Corporate bonds (IG)
High yield bonds
NZD
AUD
new
old
EM bonds (USD)
Commodities total
Commodities
Precious metals
Energy
Base metals
Agricultural
* Please note that the bar charts show total portfolio preferences and thus can
be interpreted as the recommended deviation from the relevant portfolio
benchmark for any given asset class and sub asset class.
Listed Real Estate
Source: UBS CIO
new
old
Also note that the implementation in advisory or discretionary products might
slightly deviate from the "unconstrained" asset allocation shown above,
depending on benchmarks, currency positions and for other implementation
considerations
5
Please see important disclaimer and disclosures at the end of the document.
Preferred themes
• High quality dividend yields (sourced from existing European
and UK equities)
High quality companies with geographically diversified business models
that pay sustainable dividends offer an attractive income stream in a
low yield world. Historically, dividends have made a substantial
contribution to total returns, and we expect this to remain the case in
the current environment.
• Western winners from emerging market growth (sourced from
existing equity holdings)
Emerging economies continue to grow faster than developed
economies. With little need to deleverage and repair balance sheets,
Asian economies are also well positioned to continue to outpace their
Western peers in the years ahead. We have identified companies from a
variety of sectors in Europe, the US and Japan which have significant
exposure to the rapidly growing emerging regions. We believe a
diversified portfolio of these companies will reward investors seeking
to profit from the robust demand growth in emerging economies.
• Natural gas growth gainers
Natural gas is a relatively clean source of energy, and we think it will
benefit from continued substitution for other energy sources over the
long term. We have examined the dynamics of the global market and
the various components of the gas value chain, and identified the areas
we see as the most significant beneficiaries currently. These include
producers in Europe and Asia, suppliers of infrastructure, services and
related machinery, and Master Limited Partnerships (MLPs) in the US,
that offer both attractive yields and growth.
• Government bond alternatives (sourced from government bonds
–CIO UW)
Developed world government bonds offer a comparatively small cushion
against future interest rate hikes and many face increasing credit risk. We
expect select bonds of supranational or national agencies, sub-national
governments, multinational corporates, and covered bonds to
outperform government bonds. We recommend switching out of
government bonds into these alternatives.
• US high yield corporate bonds (sourced from government bonds –
CIO UW)
Positive economic growth, robust corporate earnings and healthy
balance sheets provide support to US high yield corporate bonds. Current
yield spreads of roughly 660 basis points still price in a much more dire
economic outcome than we expect. Historically, US high yield bonds have
delivered similar returns to US equities with lower volatility. We continue
to believe that US high yield corporate bonds represent a more favorable
risk/return potential than equities and expect total returns of
approximately 7% over the next 6 months.
• The place to be in Hedge Funds
Recent economic data has shown signs of improvement, but growth in
most developed markets remains muted. In this environment, less
directional hedge fund strategies, such as relative value and event driven,
should offer above average returns.
• EM corporates: a growing asset class (sourced from global
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.
6
Please see important disclaimer and disclosures at the end of the document.
Global economic outlook
–
Summary
Key questions
• Can emerging markets (EM) continue to offset developed market (DM) weakness to buoy global
growth?
• What are the risks of near-term faltering of the US economic recovery?
• When is the European economy likely to return to sustainable economic expansion?
CIO View (Probability: 60%*)
• Global economic activity remains moderate; the growth impulse stems largely (some 80%) from the EM
region. As expected, China started to ease monetary policy. The country is better placed than other EM
and particularly DM countries to counter growth weakness with further monetary and fiscal stimuli. Thus,
we expect EM growth to stabilize soon and pick up in 2H 2012.
• US economic indicators have on balance been disappointing recently, especially data related to business
fixed investment and employment growth. Thus, we lowered our 2Q 2012 real GDP growth forecast to an
annualized rate of 1.5% from 2%. We still expect growth slightly above 2% in 2H 2012. We think that the
risk that the Fed will take measures in addition to the extension of "Operation Twist" is still significant.
• Large parts of Western Europe are in recession or stagnation. We expect the economies of the Eurozone
and the UK to show mild improvement in 2H 2012. Still, economic activity is likely to remain very sluggish
despite support from lower oil prices and less rigorous fiscal austerity. The Bank of England may support
the UK economy by increasing its amount of bond purchases soon. The probability that the ECB will take
further action to support the economy has risen significantly.
� Positive scenario (Probability: 15%*)
• The Eurozone crisis abates. Financial market conditions recover, mitigating the drag from fiscal austerity.
• Growth in Western Europe is marginally positive (Eurozone stagnates) in 2012 and the US economy
grows moderately above trend.
� Negative scenario (Probability: 25%*)
• There are three key downside risks to the global economy: 1. a significant escalation of the Eurozone
debt crisis; 2. a sharp fiscal contraction in the US, and 3. a sharp deceleration of the Chinese economy. Each
one of these risks could precipitate a significant downturn of the global economy.
Key dates
2 July USA: ISM manufacturing PMI for June
5 July Eurozone: ECB press conference
24 July Eurozone: purchasing managers indices (PMI), July estimates
22–25 July China: HSBC flash manufacturing purchasing managers index (Jul)
Global growth expected at just under
3% in 2012
Source: UBS CIO, as of 28 June 2012
Global economic momentum is
deteriorating (UBS GDP tracker)
14
%
12
10
8
6
4
2
0
-2Jan
-4 05
-6
Jan
06
Jan
07
Real GDP growth in % Inflation in %
Jan
08
Jan
09
Global DM EM*
2011 2012F 2013F 2011 2012F 2013F
Americas US 1.7 2.1 2.6 3.1 2.1 1.7
Canada 2.4 2.1 2.4 2.9 2.1 2.3
Brazil 2.7 2.0 4.8 6.5 5.2 6.5
Asia/Pacific Japan -0.7 2.5 2.0 -0.3 0.2 0.5
Australia 2.1 3.7 3.5 3.4 1.6 2.5
China 9.2 8.2 8.5 5.4 3.0 4.0
India 6.5 6.0 7.0 7.8 6.9 7.0
Europe Eurozone 1.5 -0.4 0.4 2.7 2.3 2.0
Germany 3.1 1.0 1.1 2.5 1.7 1.5
France 1.7 0.3 0.4 2.1 2.5 2.2
Italy 0.5 -1.8 0.2 2.9 3.4 3.9
Spain 0.7 -1.6 -1.3 3.1 1.9 1.9
UK 0.7 0.2 1.3 4.5 2.8 1.9
Switzerland 2.1 1.3 1.7 0.2 -0.4 1.4
Russia 4.3 3.8 3.7 8.5 4.9 6.9
World 3.2 2.8 3.3 3.9 3.0 3.0
In developing the CIO economic forecasts, CIO economists
worked in collaboration with economists employed by UBS
Investment Research. Forecasts and estimates are current
only as of the date of this publication and may change
without notice.
Jan
10
Jan
11
Jan
12
May
6.3%
3.1%
1.0%
Jan
13
Source: Bloomberg, UBS CIO, as of 22 June 2012
* DM= developed markets, EM = emerging markets
Note: Past performance is not an indication of future returns.
**Scenario probabilities are based on qualitative assessment.
7
For further information please contact CIO economist Dirk Faltin, dirk.faltin@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Key financial market driver 1 –
Eurozone crisis
Key questions
• What is the way forward for Eurozone banks?
• What is the most likely course of events in Spain, Italy and Portugal?
• In what direction will the economy and the ECB go?
CIO View (Probability: 65%*)
Austerity and weak growth
• Support for the banking sector is a major political agenda item, and the request for external support for
Spanish banks can be seen as the starting point for greater European support and oversight for banks, to
be discussed at the upcoming European Council.
• Greece's debt remains unsustainable, but the risk of a euro exit over the next six months has diminished
after the 17 June elections, which have produced a viable government coalition. The Troika may only
accept moderate adjustments to the second Greek package. Portugal is likely to receive an increased
bailout package and is unlikely to default in 2012. Progress on reforms and consolidation in Spain and Italy
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
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
see a significant probability of policy action in early July, including the possibility of a rate reduction.
Despite all the talk about political measures to support growth and increased tolerance for budget
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.
� 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 expected. Greece fully complies with the austerity plans and receives further support. Market
confidence is restored, and economic growth stagnates in 2012.
� Negative scenario (Probability: 20%*) Major shock
• 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
Dutch elections, etc.); a possible Portuguese default; a Greek euro exit; or a major external growth shock.
Key dates
5 July ECB press conference
9–10 July Eurogroup/ECOFIN-Meeting
24 July Eurozone purchasing manager indices (PMI), July estimates
Bottoming in Eurozone leading
indicators (PMI) in June?
65
60
55
50
45
40
35
30
Source: Bloomberg, UBS CIO, as of 21 June 2012 (estimates)
Yield of Spanish and Italian 10-year
bonds over German Bunds (in bps)
600
500
400
300
200
100
06 07 08 09 10 11 12
Manufacturing Services Composite
0
01/2011 04/2011 07/2011 10/2011 01/2012 04/2012
Italy Spain
Source: UBS CIO, Bloomberg, as of 18 June 2012
Note: Past performance is not an indication of future returns.
* Scenario probabilities are based on qualitative assessment.
For further information please contact CIO analyst Thomas Wacker, thomas.wacker@ubs.com and
CIO economist Ricardo Garcia, ricardo-za.garcia@ubs.com
Please see important disclaimer and disclosures at the end of the document.
8
Key financial market driver 2 –
US policy
Key questions
• Will the economic outlook deteriorate? Will QE3 become necessary?
• How will the election outcome change fiscal policy deliberations?
• Can politicians find an agreement to avoid sharp fiscal contraction in early 2013 ("fiscal cliff")?
CIO View (Probability: 65%*)
No QE3, political gridlock and some fiscal tightening
• The economy stays on a moderate growth path, coupled with stable core PCE inflation close to the Fed’s
target of 2%. UBS forecasts real GDP growth of 1.5% in 2Q 2012 (consensus: 2.1%) and 2.3% in 3Q 2012
(consensus: 2.4%), with some downside risk due to rising uncertainty. The Fed has decided to extend so
called "Operation Twist" until the end of the year. More near-term monetary easing is still possible, but it
is currently not our central scenario.
• In the elections, Republicans will likely lose seats in the House overall, but retain a majority; we also
expect them to win a narrow majority in the Senate. Obama will likely retain the White House. Such an
electoral outcome would confirm the existing gridlock between Republicans and Democrats.
• Against the backdrop of ongoing political gridlock, we expect only moderate fiscal tightening of about
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.
� 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.
• The improved economic outlook raises the odds for an Obama re-election and makes it harder for
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
tightens by about 1.2% of GDP in 2013.
� Negative scenario (Probability: 25%*) QE3, political dysfunction and huge fiscal tightening
• Structural hindrances dominate and weigh on the cyclical recovery, thus growth weakens or turns
negative. The Fed embarks on QE3, most likely in the form of agency MBS and Treasury purchases.
• Weaker economic conditions raise the odds for a larger Republican majority in Congress, but Obama
remains President. The debt limit is reached earlier and the Treasury runs out of money before year-end.
The political gridlock becomes dysfunctional, thus fiscal policy tightens by USD 600 billion (3.7% of UBS
estimate of 2013 GDP) in 2013 (“fiscal cliff”). The US credit rating is downgraded.
Key dates
2 July ISM manufacturing PMI for June
6 July Nonfarm payrolls and unemployment rate for June
6 Nov US Presidential and Congressional elections
US moderate growth to continue
US real GDP and its components, quarter-over-quarter
annualized in %
8%
q/q annualized
6%
4%
2%
0%
-2%
-4%
-6%
-8%
-10%
-12%
Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011 Q1 2012
Consumption
Capital expenditures
Inventories
Government
Source: Thomson Datastream, UBS CIO, as of 20 June 2012
US fiscal cliff at year-end 2012
Commercial real estate investment
Residential investment
Net Exports
Real GDP (q/q annualized)
Fiscal effects of change in provisions under current law, USD
billion annualized
UBS CIO
forecasts
1Q13 2Q13 3Q13 4Q13 CY2013
Sequester automatic cuts
(discretionary spending) -60 -68 -76 -76 -70
Sequester automatic cuts (mandatory
spending) -16 -16 -16 -17 -16
2001/2003 tax cuts (250k+ incomes,
estate tax) -38 -58 -58 -65 -55
2001/2003 tax cuts (middle incomes) -164 -156 -137 -172 -157
Alternative Minimum Tax (incl.
interaction with tax cuts) 0 -374 -125 -29 -132
Payroll tax cut -94 -114 -114 -114 -109
Emergency Unemployment
Compensation -34 -34 -34 -34 -34
Affordable Care Act (3.8%/0.9% tax
on passive/wage income 250k+) -27 -27 -27 -27 -27
Total (all provisions) -433 -847 -587 -534 -600
Source: Goldman Sachs, UBS CIO, as of 20 June 2012
* Scenario probabilities are based on qualitative assessment.
Note: Past performance is not an indication of future returns.
9
For further information please contact US economist Thomas Berner, thomas.berner@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Key financial market driver 3 –
China growth outlook
Key questions
• 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
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
economy. Importantly, with the rate cut, measures were announced to increase the banks' ability to set
interest rates, which should bolster private household spending power in the future.
• 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
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
fiscal policy measures now, including possibly an acceleration of infrastructure investments, measures to
support consumer spending and selective relaxation in the property market (while keeping home-purchase
restrictions intact).
� Positive scenario (Probability: 20%*) Higher-than-expected growth
• Chinese GDP grows above 8.5% in 2012. For this we would probably need to see stronger-than-expected
fiscal and monetary policy support from the government. A speedy improvement in the Eurozone debt
crisis could also lead to this positive scenario.
� Negative scenario (Probability: 10%*) Hard landing
• 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
government debt, or a surge in inflation that forces the PBoC to significantly tighten monetary policy.
Key dates
1 Jul Manufacturing purchasing managers index (Jun)
13 Jul Fixed asset investment, industrial production (Jun), 2Q12 GDP
11–15 Jul New bank lending, M2 (Jun)
22–25 Jul HSBC flash manufacturing purchasing managers index (Jul)
First interest rate cut since 2008
Source: Bloomberg, UBS CIO, as of 18 Jun 2012
Pick-up in infrastructure investment
Source: Bloomberg, UBS CIO, as of 18 Jun 2012
Note: Past performance is not an indication of future returns.
* Scenario probabilities are based on qualitative assessment.
10
For further information please contact CIO analyst Gary Tsang, gary.tsang@ubs.com, Glenda Yu, glenda.yu@ubs.com, Patrick Ho, patrick-ww.ho@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Section 2
Asset class views
Section 2.A
Asset class views
Equities
Equities overview
Global equity markets – Key points
• We keep an overall neutral allocation to equities (see summary on slide 3).
• The US remains our preferred developed market. The domestic economy is expected to continue to
grow. This should underpin earnings growth for US companies. With labour costs in check, profit margins
should stay around the current high levels.
• We keep our overweight position on EM equities. Monetary easing in key countries continues, and
relatively attractive valuations remain key supporting factors. However, near-term economic and currency
weakness remains a major concern for investors – especially those domiciled in hard currency regions (e.g.
USD, EUR). Until year-end, we expect some growth acceleration and therefore stay overweight.
• The UK remains a preferred market. It offers a solid earnings outlook compared to other European
markets. Moreover, the valuation is attractive at a trailing P/E ratio close to 10.
• We keep our negative stance on Eurozone equities. The economy remains very weak affecting
earnings growth negatively. The sovereign debt crisis remains a major risk (see page 8).
• We remain cautious on Australian equities. The earnings prospects are still being revised down by
analysts. The domestic economy is moving at two speeds with the strong part getting its impulse from the
mining sector. We maintain a small underweight.
• We keep a moderate underweight in Swiss equities, as valuation looks expensive relative to world
equities. The negative earnings impact of the strong Swiss franc should ease further in coming quarters.
Global equity sectors – Key points
• Consumer Staples and Healthcare remain preferred among defensive sectors, as their long-term
earnings prospects are very solid. Both sectors also offer strong balance sheets, exposure to favorable
demographic trends and emerging markets.
• We keep our negative view on Telecom and Utilities. Both sectors suffer from weak revenue growth
as well as margin pressure.
• Within cyclical sectors, we keep our preference for IT due to a solid earnings outlook and strong
corporate balance sheets. Moreover, we reiterate our neutral allocation to Industrials.
• Valuations are high and earnings expectations are optimistic for Consumer Discretionary. However,
we reduce our Underweight as we become more positive on the sector in the US.
• Following the latest oil price decline and a good relative performance, we have reduced our
overweight on Energy. However, the earnings outlook remains solid and valuation is very attractive.
While Materials are not expensive, we are neutral, as margins remain under pressure.
• The earnings outlook for US and Asian Financials is solid, which leads us to be neutral on Financials
from a global perspective. However, we maintain our underweight on Eurozone Financials, where
sovereign indebtedness and bank capitalization remain major concerns.
Preferences (6 months)
North
America
Europe
APAC
EM
US
Canada
EMU
UK
Switzerland
Sweden
Australia
Hong Kong
Japan
Singapore
Global EM
Note: Preference in hedged terms (excl. currencies)
Consumer Discretionary
Consumer Staples
Energy
Financials
Healthcare
Industrials
IT
Materials
Telecom
Utilities
-- neutral
++
new
-- neutral ++
new
old
old
Source: UBS CIO, as of 28 June 2012
13
For further information please contact CIO asset class specialists Markus Irngartinger, markus.irngartinger@ubs.com, or Carsten Schlufter carsten.schlufter@ubs.com.
Please see important disclaimer and disclosures at the end of the document.
US equities Preference: overweight
S&P 500 (27 June): 1,332 (last month: 1,319)
UBS View S&P 500 (6-month target): 1,430
• US firms on average show more resilient earnings than their global and especially European peers.
Modest domestic economic growth supports US companies' revenue and thereby earnings growth. About
two thirds of revenues are generated in the US.
• While profit margins are slightly higher than their average over the last 30 years, we expect them to hold
up in coming quarters. Pressure from rising wages on margins is rather muted. So company earnings are
forecast to develop in line with revenues.
• In the next six months, we forecast the price-to-earnings ratio (P/E) of the S&P 500 to rise to about 14.0x
realized earnings from slightly above 13.0x currently.
• The combination of expected moderate earnings growth and an expansion of the valuation multiples
make the US one of our preferred equity markets.
� Positive scenario S&P 500 (6-month target): 1,580
• An accelerating US and global economy reduces risks to company earnings. Investors begin to shift funds
into more cyclical sectors such as Industrials and Materials in light of better growth prospects. In this
scenario, we would expect earnings to grow by around 10% in the next 12 months, and the trailing P/E
multiple to expand to around 15x.
� Negative scenario S&P 500 (6-month target): 1,115
• The US slides into a recession and corporate earnings fall by around 15% over the coming 12 months.
Coupled with an escalation in the Eurozone debt crisis, we would expect the P/E multiple to contract
towards 12.0x trailing earnings.
Note: Scenarios refer to global economic scenarios (see slide 7)
What we're watching Why it matters
Business sentiment The ISM is a leading indicator for US manufacturing and services. Key dates: 2
July, ISM manufacturing; 5 July, ISM non-manufacturing
The Fed
The direction of monetary policy and hints on further quantitative easing can
influence equities. Key date: 11 July, minutes from June FOMC meeting
Labor market
Improvement in the labor market is key for domestic consumption. Key date: 6
July, US labor market report for June
Earnings reports Earnings season in the US, with 60% of the S&P 500 companies reporting in July.
Key date: 9 July, Alcoa, first major earnings report in July
Recommendations
Tactical (6 months)
• We have adopted a neutral allocation
between defensive and cyclical sectors.
• Among defensives, we still like Consumer
Staples, while IT is a preferred cyclical
sectors. We also like Energy.
• We are cautious on Materials, where we
expect margin pressure to continue, as
well as Telecom and Utilities, due to high
valuations.
Strategic (1 to 2 years)
• We like medium-sized US companies,
which should benefit from robust
earnings growth in the long term (see
also slide 21).
Our sector stance in the US
Sectors
Consumer Discretionary
Consumer Staples
Energy
Financials
Healthcare
Industrials
IT
Materials
Telecom
Utilities
US
�
�
�
�
�
�
�
�
�
�
Source: UBS CIO, as of 28 June 2012
Note: Past performance is not an indication of future returns.
14
For further information please contact CIO asset class specialist Markus Irngartinger, markus.irngartinger@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Eurozone equities Preference: underweight
Euro Stoxx (27 June): 217 (last month: 215)
UBS View Euro Stoxx (6-month target): 223
• The crisis in the Eurozone will remain the main driver in the coming months. After the elections in
Greece, progress on the reform program will be closely monitored. Spain and Italy will also remain in the
spotlight with levels of government bond yields too high for being sustainable.
• With the sovereign debt crisis dragging on we expect the Eurozone market to stay highly volatile in
coming months.
• Economies in peripheral countries increasingly feel the burden of austerity. The economic weakness
affects company earnings negatively. Analysts' earnings growth forecasts (consensus) for 2012 have come
down to about 3% for this year, but we see this as still too high against the weak economic backdrop.
• All in all, the ongoing risks stemming from the sovereign debt crisis lead us to the view that Eurozone
equities will underperform other major markets.
� Positive scenario Euro Stoxx (6-month target): 275
• Global economic growth reaccelerates and Eurozone growth shows clear signs of bottoming out,
enabling 2–4% earnings growth over the rest of the year. The trailing P/E ratio could re-rate to 12x from
the current reading close to 10x.
� Negative scenario Euro Stoxx (6-month target): 165
• Europe slides into a deep recession, and the debt crisis leads to severe pressure on Spain and Italy. In a
major crisis, earnings could fall by 10% to 15% from current levels until year-end, and the trailing P/E ratio
could drop to 8.5x by the end of 2012.
Note: Scenarios refer to global economic scenarios (see slide 7)
What we're watching Why it matters
Growth indicators Economic growth indicators provide information on the development of a
potential Eurozone recession. Key dates: 2 July, Final PMI manufacturing
Eurozone, Germany, France for June; 24 July, Flash PMI Eurozone,
Germany, France for July; 25 July, IFO business climate Germany
Policy action
Decisions by European politicians and the ECB affect the course of the debt crisis.
Key dates: 5 July, ECB meeting
Earnings season Earnings reports of the Euro Stoxx companies. Key dates: Mid July until mid
August
Recommendations
Tactical (6 months)
• We continue to recommend defensive
sectors. We like Consumer Staples and
Healthcare.
• We also like the Energy sector, where the
valuation is very attractive.
• Because of risks stemming from the
sovereign debt crisis, we keep a cautious
stance on Financials – especially Banks
and diversified Financials.
Strategic (1 to 2 years)
• For investors with a multiyear horizon,
we believe there are attractively valued
opportunities in core Europe (see also
slide 21).
Our sector stance in the Eurozone
Sectors
Consumer Discretionary
Consumer Staples
Energy
Financials
Healthcare
Industrials
IT
Materials
Telecom
Utilities
Eurozone
�
�
�
�
�
�
�
�
�
�
Source: UBS CIO, as of 28 June 2012
Note: Past performance is not an indication of future returns.
15
For further information please contact CIO's asset class specialist Markus Irngartinger, markus.irngartinger@ubs.com
Please see important disclaimer and disclosures at the end of the document.
UK equities Preference:
overweight
FTSE 100 (27 June): 5,524 (last month: 5,266)
UBS View FTSE 100 (6-month target): 5,785
• We continue to like UK equities relative to global ones. An expected improvement in the global economy
over the coming quarters should support UK companies as 70% of revenues are generated abroad.
• Energy is the largest sector of the UK market. While the oil price eased sharply over the past months, we
expect it to stabilize in the second half of 2012. An attractive valuation of the energy sector at 6.5x trailing
earnings provides some buffer for earnings volatility going forward.
• Profitability of UK banks is reasonable. They are less affected by the sovereign debt crisis than their
Eurozone peers. While the recent easing of collateral requirements by the Bank of England is supportive in
the short-term, the profitability of the domestic operations could be negatively affected by the
implementation of the ring-fencing bank reform by 2015.
• UK equities’ P/E, at about 10.0x trailing, indicates attractive value relative to global equities. Based on our
12-month forward earnings growth estimate of about 5% and the P/E multiple slightly expanding to 10.3x,
we expect UK equities to show good returns over the next six months.
� Positive scenario FTSE 100 (6-month target): 6,650
• Continued global growth and strong demand from emerging markets should support demand for
commodities, helping the Materials and Energy sectors to lead the market higher. The market could re-rate
to a P/E multiple of close to 12.0x, and we would expect earnings growth of 5–8% over 12 months.
� Negative scenario FTSE 100 (6-month target): 4,400
• A global recession drags UK earnings down by 15–20%. The market's defensive characteristics would only
partly offset its strong exposure to commodity-related sectors. We would expect the trailing P/E multiple to
drop towards slightly below 9x.
Note: Scenarios refer to global economic scenarios (see slide 7)
Recommendations
Tactical (6 months)
• We like the Energy sector due to
attractive valuations; Consumer Staples
is another preferred sector Because of
its defensive qualities.
• Approaching the end of the patent cliff
should remove some uncertainty on the
Healthcare sector and enable a rerating.
Strategic (1 to 2 years)
• As commodity-related sectors, Energy
and Materials should benefit from
robust demand in emerging markets.
• The UK market's 4% dividend yield
provides a good income stream.
UK market trades at a P/E-discount
(based on realized earnings)
35
30
25
20
What we're watching
Growth indicators
Commodity prices
Policy action
Why it matters
Business survey indicators provide information on the economic development in
the UK. Key date: 2 July, PMI manufacturing for June; 4 July, PMI services
for June;
Energy and Materials together are about 30% of the UK market by market
capitalization. Developments in commodity prices affect earnings estimates.
Loose monetary policy by the Bank of England (BoE) supports equities. Key date:
05 July, Bank of England policy meeting
15
10
5
0
01.90 01.92 01.94 01.96 01.98 01.00 01.02 01.04 01.06 01.08 01.10 01.12
FTSE 100 realized P/E World realized P/E
Source: Thomson Reuters, UBS CIO, as of 21 June 2012
Note: Past performance is not an indication of future returns.
16
For further information please contact CIO asset class specialist Markus Irngartinger, markus.irngartinger@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Swiss equities Preference: underweight
SMI (27 June): 5,997 (last month: 5,818)
UBS View SMI (6-month target): 6,200
• Swiss listed companies generate a high share of profits in economies outside Switzerland. Consequently,
the Swiss equity market is affected by the recent weakening in global growth.
• Swiss companies try to mitigate concerns on the global economic prospects by maintaining tight cost
controls. This should allow to maintain relatively robust operating margins in 2012.
• While the Swiss franc remains overvalued, we expect the currency impact to gradually become less of a
drag. In fact, at current exchange rates, Swiss companies' earnings would show some positive currency
translation effects by end 2012, compared to the previous year.
• Still, the PE-ratio of the market is relatively high compared to the global average, indicating less
attractive value. The SMI is trading at about 12.8x realized earnings. We are thus more cautious on the
ability of the market to deliver further multiple expansion in a challenging market environment. As a
result, we maintain a small underweight stance on Swiss equities.
� Positive scenario SMI (6-month target): 6,900
• Eurozone economic growth reaccelerates meaningfully, providing relief to Swiss financials as well as
Swiss exporters. Defensive sectors would likely be left behind in a relief rally. In this scenario, we would
expect the equity market P/E to re-rate to 14x and earnings to grow by 5% over the next six months.
� Negative scenario SMI (6-month target): 5,075
• The sovereign debt crisis re-escalates, leading to further downside for Swiss financials and the exportfocused
Industrials and Materials sectors. In this scenario, corporate earnings could drop by 5–10% over
the next six months and we would expect the P/E to contract significantly, toward 11.5x.
Note: Scenarios refer to global economic scenarios (see slide 7)
Recommendations
Tactical (6 months)
• We favor companies with a strong and
broad foothold in emerging markets, as
well as innovative companies able to
market their products and services
efficiently and globally.
• We continue to favor large caps.
Strategic (1 to 2 years)
• We like stocks paying high and
sustainable dividends.
• Moreover, we favor leaders in regards
to the two key Swiss success factors:
innovation and globalization.
Swiss market trades at a P/E-premium
(based on realized earnings)
42
35
28
What we're watching
Economic indicators
Monetary and economic
policy
Corporate results
Why it matters
Key announcement dates of domestic economic indicators: 2 July, PMI
manufacturing; 27 July, KOF Swiss leading indicator
Key Swiss/European monetary policy dates that can impact Swiss equities: 2 July,
SNB meeting; 5 July, ECB Governing Council meeting
Key corporate announcement dates that could move the market: 5 July, Barry
Callebaut; 12 July, Partners Group; 16 July, Kühne+Nagel; 17 July, Georg
Fischer & SGS; 19 July, Actelion; 20 July, Sulzer; 25 July, Rieter & Lonza; 26
July, ABB, CS Group, Logitech & Sika
21
14
7
2003 2005 2007 2009 2011
MSCI Switzerland: realized P/E MSCI World: realized P/E
Source: Thomson Reuters, UBS CIO, as of 25 June 2012
Note: Past performance is not an indication of future returns.
17
For further information please contact CIO's asset class specialist Stefan Meyer, stefan-r.meyer@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Japanese equities Preference: neutral
Topix (27 June): 745 (last month: 721)
UBS View Topix (6-month target): 780
• We expect earnings growth of about 45% over the coming 12 months. This exceptional high growth is
mainly due to the two natural disasters last year, as well as tax regulation changes which caused a
number of one-time losses to be booked in the fiscal year that ended in March 2012.
• In our base case scenario, we see only limited scope for an additional earnings boost from the local
economic recovery, given the slowing in export markets. Japanese companies are expected to continue
their cost reduction efforts to counter the impact of a strong yen.
• The Japanese government has started implementing its JPY 18tn recovery budget in 4Q 2011, and we
expect the budget to boost Japanese GDP by 1–1.5% in FY2012.
• Mainly due to the earnings rebound, we expect the TOPIX trailing P/E to drop from around 16.5x to 14x
– 14.5x by year end; still the earnings rebound should provide some room for moderate price increases.
� Positive scenario Topix (6-month target): 900
• Stronger global demand and stabilizing European markets provide an additional boost to earnings, and
also lead to improved risk taking. Falling risk aversion is likely to lead to a weaker yen, providing further
upside to earnings. TOPIX target is based on 16.0x trailing P/E.
� Negative scenario Topix (6-month target): 600
• Faltering global growth leads to weak exports, triggering negative earnings surprises. A strengthening
USDJPY below 75 in response to rising risk aversion might provide an additional drag on the economy and
earnings. We would then expect the P/E ratio to contract to 13.5x, even if earnings show no recovery.
What we're watching
Why it matters
Note: Scenarios refer to global economic scenarios (see slide 7)
JPY and exports The exchange rate is an important factor for the Japanese equity market, and
central bank intervention is a key swing factor. Japan’s trade balance could be in
deficit and may impact USDJPY rates. Key date: 09 July, Japanese trade
balance
BoJ’s monetary policy
board meeting
The Bank of Japan’s (BoJ) additional commitment to its asset purchase program,
which is currently JPY 65tn in size, would lead to a weaker yen, in our view. Key
date: 12 July, BoJ policy meeting
Recommendations
Tactical (6 months)
• The earthquake in Japan and recent
floods in Thailand have impacted
Japanese earnings negatively. A recovery
from these disasters should benefit auto
and industrial stocks in particular.
• We prefer companies that continue cost
reduction initiatives to maintain price
competitiveness during the period of yen
strength.
Strategic (1 to 2 years)
• A weaker USDJPY may drive Japanese
companies’ earnings recovery beyond a
technical recovery from natural disasters.
• A rapidly aging population and the lack
of a powerful and stable government
remain negative for the country's longerterm
economic prospects.
Japanese realized earnings likely to
recover going forward
95
85
75
65
55
45
35
25
15
5
(5)
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Topix: 12m realized earnings per share
Source: Thomson Reuters, UBS CIO, as of 21 June 2012
Note: Past performance is not an indication of future returns.
18
For further information please contact CIO asset class specialist Toru Ibayashi, toru.ibayashi@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Emerging market equities Preference: overweight
MSCI EM (27 June): 913 (last month: 907)
UBS View MSCI EM 6-month target: 1,000
• Currency weakness hurt emerging market (EM) equity performance in US-dollar terms year-to-date. We
expect EM FX to appreciate against the USD from current levels over a six-month horizon.
• As expected, China has started to ease monetary policy. We believe there is also room to do more on the
fiscal side, helping to support China's economic growth outlook for the second half of 2012 and into 2013.
The 2Q GDP numbers are expected to represent the low point in the current cycle.
• Given the above, in our base case, we see scope for some multiple expansion for the MSCI EM Index,
from the current 10.3x realized price-to-earnings ratio to closer to 11x over the next six months. We expect
earnings growth of around 10% over the next 12 months.
• Within EM, we believe that Asia is best positioned for economic growth in the second half of 2012. In
emerging Asia, we prefer China. In Latin America, we prefer Brazil and Mexico. Central and Eastern
Europe remains the most vulnerable region, and we remain neutral on Russia.
� Positive scenario MSCI EM (6-month target): 1,190
• The outlook for the global economy improves, boosting EM's ability to grow more strongly in 2013.
Stronger economic growth leads to earnings growth of 15%. Investor confidence improves, leading to a
better P/E multiple of 12.5x trailing earnings. More cyclical Korea and Taiwan would benefit.
� Negative scenario MSCI EM (6-month target): 730
• Serious negative developments (e.g. a further deterioration of the Eurozone crisis, the US fiscal cliff, or a
Chinese hard landing) hit trade and thus the economic prospects of emerging markets. In this case, we
would expect a 25% decline in earnings. More defensive Malaysia would do better, whereas more cyclical
Korea and Taiwan would underperform. We assume, however, that the market would also be expecting
some recovery in earnings for 2013, helping the P/E multiple to recover to 9.5x trailing earnings.
Note: Scenarios refer to global economic scenarios (see slide 7)
What we're watching Why it matters
Emerging market Investors are trying to figure out which emerging market central banks still have
monetary policy room to ease monetary policy and where rates may be heading up. Inflation
data due for Russia (4–9 July), Brazil (7 July), China (9 July), Mexico (9
July), India (13 July), South Africa (18 July).
Oil prices & EM FX Recent declines in oil prices are helping to reverse some of the inflationary impact
of earlier rises, but the exchange rate matters, too.
Recommendations
Tactical (6 months)
• In Asia, we expect Chinese equities to
benefit as the Chinese economy avoids a
hard landing. In Latin America, we prefer
Brazil and Mexico.
Strategic (1 to 2 years)
• Structural factors (e.g. stronger fiscal
position, more favorable demographics)
should continue to support stronger
economic growth than in the developed
economies.
• Strategically, we would advise a tilt in EM
portfolios toward cash-rich and fastergrowing
Asia.
Emerging market country preferences
Current most
preferred markets
Brazil
China
Mexico
Current least
preferred markets
Hungary
Indonesia
Poland
We currently have a neutral view on the
remaining emerging equity markets in the
MSCI EM index.
19
For further information please contact CIO asset class specialist Costa Vayenas, costa.vayenas@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Asian equities (ex-Japan) Preference: overweight
MSCI Asia ex-Japan (27 June): 469 (last month: 466)
UBS View MSCI Asia ex-Japan (6-month target): 515
• The region continued to show high volatility last month, with its P/BV temporarily close to 2008 lows.
• Hong Kong and Singapore markets' domestic fundamentals remain solid. Hong Kong should benefit
from China's gradual recovery in 2H 2012, while Singapore's economy is rebounding and corporate
balance sheets and earnings remain solid. After the rate cut early June, we expect China to have more
policies to support growth in 2H 2012. China is our most preferred market, while Indonesia is least
preferred in the region. We are more concerned about Indonesia's fiscal deficit, since the fuel price hike
did not happen. Domestic problems for Indonesia include current account deficits, potential capital
outflows, bottomed-out inflation and hiccups in economic and market reforms, in our view.
• We expect 10% earnings-per-share growth over 12 months for the MSCI Asia ex-Japan, which trades on
11.6x 12-month trailing earnings. We expect this multiple to expand slightly in the next six months, as the
current earnings downgrade cycle is approaching its end. Nevertheless, MSCI Asia ex-Japan is likely to see
further volatility in the near term due to global macro risk factors.
� Positive scenario MSCI Asia ex-Japan (6-month target): 610
• More supportive monetary and fiscal policy, stable inflation, sustained domestic demand growth, and an
improved global growth outlook should lead to a better earnings outlook. We would expect earnings
growth of 15% and a P/E based on realized earnings of 14x.
� Negative scenario MSCI APAC ex-Japan (6-month target): 380
• A hard landing in China with a global recession leads to negative earnings revisions for 2012. In this
scenario, earnings could fall 20% over 12 months and the P/E could fall to about 10.5x.
Note: Scenarios refer to global economic scenarios (see slide 7)
What we're watching
Growth
Why it matters
Both HK and Singapore's GDP growth disappointed, raising concerns about the
growth momentum in the region. Investors should focus on whether growth
will re-accelerate in the near term. Key dates: 3 July, HK retail sales; 13
July, SG retail sales; 17 July, SG exports
Policy responses Some other countries in the region have structural issues due to fuel subsidies
(e.g. Indonesia) and fiscal deficits (e.g. India). Policy responses often come on an
ad hoc base.
Recommendations
Tactical (6 months)
• We prefer Hong Kong banks, Singapore
high-dividend stocks and Chinese
insurance and consumer plays.
• We are concerned about India's inflation
pressure, but we see opportunities in the
power and banking sectors.
Strategic (1 to 2 years)
• Rising consumption is the long-term trend
in Asia ex-Japan that we expect will
continue to play out.
• In China, sectors that contribute to
improved labor productivity or deliver
goods and services for the elderly should
benefit from demographic changes
(ageing population and decelerating
population growth).
Asia ex-Japan country preferences
Current most
preferred markets
China
Current least
preferred markets
Indonesia
We currently have a neutral view on the
remaining emerging equity markets in the
MSCI Asia ex-Japan index.
20
For further information please contact CIO asset class specialist Patrick Ho, patrick-ww.ho@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Equity styles
UBS View
Prefer value and large caps in Europe, mid caps in US
• We recommend that investors look for value opportunities in Europe: The cheapest stocks within each
sector are at extreme relative valuations, which should begin to normalize. Within Financials, however,
investors should limit their direct exposure to the Eurozone debt crisis. We assess the cheapness of a stock
by looking at its price-to-earnings and price-to-book ratios relative to its peers.
• We believe US mid caps will outperform large caps. US economic data is forecast to stabilize and GDP
growth should be resilient in the second half of 2012. Greater domestic sales exposure reduces earnings
risk coming from Europe. In Europe, we prefer large over small caps in the current very challenging
economic environment.
• High quality dividend paying stocks provide a real and stable income stream to investors during the
current low yield environment. Furthermore, they give exposure to the long term potential of equity
markets while also providing some support in declining markets.
� Positive scenario Prefer value, low quality and small caps
• Leading indicators continue to move higher, and risks related to the Eurozone debt crisis subside. In this
case, add deep cyclical value (cheap price/book, price/earnings) regardless of sector, with high beta and
high leverage. In such an environment, small- and mid-cap stocks should also perform well, but a dividend
strategy would be too defensive to outperform the market.
� Negative scenario Prefer quality and large caps
• The global economic picture deteriorates markedly. In this case, buy high-quality growth companies and
large caps. Do not look for value opportunities, but be as defensive as possible with your equity exposure.
Look to high-quality, dividend-paying stocks for yield.
Note: Scenarios refer to global economic scenarios (see slide 7).
What we're watching
Earnings revisions – see
chart
(3-month moving
average upgrades vs.
downgrades)
US and Eurozone PMIs
Why it matters
Watch for signs of continued improvement in earnings revisions (aggregated
from stock level). An improved earnings outlook would cause investors to add
more risk, allowing multiples to expand and triggering the outperformance of
value stocks.
If PMIs stabilize or improve, value stocks should outperform as there is no longer
justification to pay the high price for earnings stability (quality). Key dates: 2
July, PMI Manufacturing Eurozone; 2 July, US ISM Manufacturing
Regional differentiation
• Within Europe, look for value
opportunities within each sector, but be
aware of the higher-risk Financials.
• In the US, there are opportunities in value
names that also show strong growth.
• Within Europe, avoid small caps and
instead rotate into large caps.
• In the US, prefer mid caps to large caps
while GDP growth is above 2%.
Strategic (1 to 2 years)
• We expect value strategies to outperform
the market significantly over the long
term.
• Mid-cap stocks provide attractive
opportunities over the longer term.
European earnings revisions fell hard
last year, but the down cycle might be
be ending (net revisions, in %; MSCI
Europe)
30%
20%
10%
0%
-10%
-20%
-30%
-40%
-50%
-60%
Jun.05 Jun.06 Jun.07 Jun.08 Jun.09 Jun.10 Jun.11 Jun.12
Source: FactSet, UBS CIO, as of 27 June 2012
Note: Past performance is no indication for future returns.
For further information please contact CIO's asset class specialist Christopher Wright, christopher-zb.wright@ubs.com 21
Please see important disclaimer and disclosures at the end of the document.
Section 2.B
Asset class views
Fixed income
Bonds overview
Government bonds – Key points
• Government bond yields of major developed markets started to rise from their historical lows ahead of
Greek elections, in particular with hopes of more Eurozone integration (e.g. Eurobonds or a European
bank deposit guarantee). The new Greek government has at least eased concerns of an imminent and
disorderly Greek exit helping yields in their short term rise. However, further central bank easing,
including the extension of Operation Twist (OT) until end of 2012 by the Fed limited the further upside
potential in yields over the coming months.
• Our expectations for bond yields over the coming 6 months remain a marginal rise. Despite recent
setbacks in global growth, the world economy remains in expansion mode. However, OT will keep longer
yields low for longer. Also short-term downside risks to bond yields cannot be excluded; Spain has
returned to the spotlight, and challenges in Italy's adjustment programs remain. Given current division
among European leaders, the mutualization of debt is unlikely to be resolved soon.
• On a relative basis, we prefer German and Swiss bonds, over those in the US and UK, where bond yields
could rise faster due to a sounder economic outlook. In particularly in the US, the cyclical recovery looks
comparatively more robust.
• Declining growth momentum, extension of Operation Twist by the Fed and a rising likelihood of a rate
cut by the ECB, are likely to keep yields on extraordinary low levels, for the time being. Thus we suggest a
neutral duration position at this stage.
Preferences (6 months)
short duration neutral
USD
EUR (DE)
GBP
JPY
CHF
CAD
AUD
new old
underweight neutral
long duration
overweight
Corporate and emerging market bonds – Key points
• We maintain our preference for corporate credit (both investment grade and high yield) as well as
emerging market bonds, keeping overweight positions in all three segments.
• Investment grade (IG) corporate bonds showed remarkable resilience in the latest downturn. The asset
class is likely to outperform government bonds in the coming six months, with higher liquidity and lower
volatility than HY bonds. We see the highest return potential in the lower-rated IG segment (BBB and A).
• US corporate bonds of lower credit quality (high yield, HY) remain fundamentally supported by solid
balance sheets and a benign US growth outlook. Given the low risk of default losses, valuations are
attractive at an effective yield of 7.5%. For US HY, we expect high single-digit total returns in the next six
months. US senior loans are an attractive alternative to traditional fixed income assets.
• Emerging market bonds should continue to benefit from better fundamentals than those of developed
markets over the medium term. Valuations remain attractive, and the potential for spreads to trend lower
should more than offset the gradual increase in US Treasury yields in the quarters ahead. We continue to
prefer increasing exposure to corporate bonds while keeping existing investments in sovereign bonds.
Bonds total
Government
bonds
Investment
grade
corporate
bonds
High yield
bonds
Emerging
market
bonds
Source: UBS CIO, as of June 19 th 2012
new
old
For further information please contact CIO's asset class specialist Achim Peijan, achim.peijan@ubs.com and CIO's asset class specialist Daniela Steinbrink Mattei,
23
daniela.steinbrinkmattei@ubs.com
Please see important disclaimer and disclosures at the end of the document.
US rates Duration preference: neutral
US 10-year (29 June): 1.6% (last month: 1.7%)
UBS View US 10-year (6-month forecast): 1.8%
• US 10-year yields have recovered slightly from their June 1 st 2012 lows after a reduction of political risks
in the Eurozone. However, Treasury yields remain near historical lows due to the extension of Operation
Twist (OT) coupled with recent setbacks of domestic economic data.
• We expect a marginal rise in yields since the US economy remains on a moderate cyclical growth path
with the housing market having bottomed out. Additionally the diminished near-term risk of a Greek exit
from the Eurozone following elections supports a gradual rise in Treasury yields.
• However, over a six-month horizon, the extension of Operation Twist (OT) until the end of 2012 by the
Federal Reserve (Fed) will limit the upside potential in yields. As of late, the probability of even more
stimulus in the form of quantitative easing from the Fed has risen substantially and markets have pushed
out the first rate hike expectation into 2015. Additionally, structural obstacles from the pending US fiscal
consolidation will also limit the upside potential for yields. Further, the US economy seems more vulnerable
to possible spillover effects of increased political uncertainties in the Eurozone.
� Positive scenario for US bonds US 10-year (6-month range): 1.5–1.7%
• The European debt crisis further re-escalates. The resulting contagion would intensify the current flight to
quality, with Italian and Spanish spreads above 550 basis points to the Bund (our base case).
• With the increased likelihood of further quantitative easing, the risk is that yields would stay low or fall
lower.
� Negative scenario for US bonds US 10-year (6-month range): 2.3–2.9%
• If the EU leaders indicate serious commitment towards more fiscal integration, and US growth proves
more sustainable with a rapidly improving labor market, then yields could rise.
• Recently, market expectations regarding future rate hikes by the Fed have pushed out a first rate hike
into 2Q 2015. Any re-pricing into 2014 or 2013 will result in higher yields.
Note: Scenarios refer to global economic scenarios (see slide 7)
What we're watching Why it matters
Fed policy The Fed's assessment of the labour market determines it's stance on quantitative
easing and is key for yields. Key dates: 31 July, Federal Open Market
Committee meeting
Labor market
Key focus of the Fed, judged in part based on estimates of the non-accelerating
inflation rate of employment. Key date: 6 July, US non-farm payrolls
Inflation expectations Current yields reflect low real interest rates, but rather normal inflation
expectations. If inflation expectations decline, the risk of a deflationary spiral
would exist, leading to more downside risk for long maturity yields.
US presidential election The US presidential election will guide fiscal spending for the coming years.
Recommendations
Tactical (6 months)
• Declining growth momentum, extension
of Operation Twist by the Fed and a rising
likelihood of a rate cut by the ECB, are
likely to keep yields on extraordinary low
levels, for the time being. Thus we
suggest a neutral duration position
tactically.
Strategic (1 to 2 years)
• Yields have significant upside potential
over the next couple of years given the
current extraordinarily low levels – of real
interest rates in particular. Thus clients
with a longer time horizon should focus
on bonds with short and medium
maturities
USD 10-year yields and forecasts
5%
4%
3%
2%
1%
0%
Jun-09 Jun-10 Jun-11 Jun-12 Jun-13
forecasts
Source: Bloomberg, UBS CIO, as of June 18 th 2012
US 10Y
Note: Past performance is not an indication of future returns.
24
For further information please contact CIO's asset class specialist Daniela Steinbrink Mattei, daniela.steinbrinkmattei@ubs.com
Please see important disclaimer and disclosures at the end of the document.
European rates Duration preference: neutral
EUR (DE) 10-year (29 June): 1.6% (last month: 1.4%)
UBS View EUR (DE) 10-year (6-month forecast): 1.7%
• We believe the reasons for the recent rise in Bund yields are numerous: First, signs of more Eurozone
integration (e.g. European bank deposit guarantee) combined with the recapitalization of Spanish banks.
Second, the firm commitment of central banks to act if downside risks materialize (possible quantitative
easing by the BoE and a higher probability of a ECB rate cut) and finally, Greek election results met
expectations. However, this rise was muted given the extension of Operation Twist, weak global / German
data and Spain's return to the spotlight.
• Over a three- to six-month horizon, we expect growth momentum to remain subdued but still in positive
territory; we should have more information on how Spain and Italy are handling their adjustment
programs. Also, the new pro-memorandum Greek government should limit safe haven inflows, and thus
limit short-term downside risks to yields.
• In the UK, economic data continues to be mixed as the recovery continues but is prone to external shocks.
The recent liquidity provision announcement by the BoE has confirmed these concerns.
• In Switzerland, yields have traded range bound owing to conflicting economic data. The SNB stressed
increased downside risks to the economy and stands ready to act. However, we believe Swiss yields will
gradually normalize.
� Positive scenario for German bonds 10-year Bund yield (6-month range) 1.1–1.3%
• The European debt crisis re-escalates. The resulting contagion would intensify the current flight to
quality.
• The economic recovery fails to gain momentum in the second half of the year. Credit demand fails to
improve further as some of the recent European Central Bank (ECB) data indicates. The ECB cuts rates.
• Further quantitative easing by the Fed would be supportive for Bunds and speaks for lower yields.
� Negative scenario for German bonds 10-year Bund yield (6-month range) 1.9–2.3%
• A moderate Eurozone economic recovery kicks in, supporting debt-burdened Eurozone countries in their
efforts to fulfill austerity commitments and thus reducing the demand for safe-haven assets. Alternatively,
Germany gives additional guarantees and the Eurozone moves towards a transfer union.
Note: Scenarios refer to global economic scenarios (see slide 7)
What we're watching
Elections/EU fiscal
consolidation
Central banks
Economic variables
Eurozone yield spreads
Why it matters
The EU Summit will show if newly elected governments will change the dynamics
in the Eurozone.
The revival of the SMP program by the ECB would reduce the yields in the
periphery. Their assessments of the current economic situation can give hints of
further rate cuts or quantitative easing measures. Key dates: 5 July, ECB rate
decision; 31 July, Fed FOMC meeting
Credit conditions (ECB bank lending survey). Key date: 14 August, Eurozone
GDP Q2
The level of yield spreads to German bonds influences the level of German Bund
yields due to safe-haven flows.
Recommendations
Tactical (6 months)
• Long term Bund yields would fall lower,
in case of rising Euro zone break up
probability. In contrast if Germany would
need to support the periphery further,
Bund yields would rise. We expect the
market to oscillate between these two
cases and recommend to stay neutral on
duration tactically.
Strategic (1 to 2 years)
• Yields have significant upside potential
over the next couple of years. Thus clients
with a long time horizon should focus on
bonds with short and medium maturities.
EU 10-year yields and forecasts
5%
4%
3%
2%
1%
0%
Jun-09 Jun-10 Jun-11 Jun-12 Jun-13
forecasts
UK 10Y
Germany 10Y
Switzerland 10Y
Source: Bloomberg, UBS CIO, as of June 18 th 2012
Note: Past performance is not an indication of future returns.
For further information please contact CIO's asset class specialist Daniela Steinbrink Mattei, daniela.steinbrinkmattei@ubs.com or Sebastian Vogel, sebastian.vogel@ubs.com
25
or Nina Gotthelf, nina.gotthelf@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Investment grade corporate bonds Preference: overweight
Current global spread (26 June): 225bps (last month: 225bps)
UBS View Spread target (6-month): 170bps
• We expect investment grade (IG) corporate bonds to achieve a total return of around 3% over the next
six months. Our spread target of 170bps is based on our benign economic outlook, ongoing investor
appetite for income-generating assets and expected negative net issuance. This target spread is still above
its 15-year average of 130bps.
• Non-financial corporates: While total yields are at record lows, the pickup over government bonds and
money market rates is attractive. Aggressive re-leveraging by companies looks unlikely in the current
environment. Credit quality should remain good and non-financials continue to deliver a stable income.
• Financial corporates: Due to regulatory challenges, spreads are expected to remain above past averages.
Total returns could outpace non-financials, but volatility will be considerably higher.
• Overall, IG corporate bonds remain a preferred asset class, providing an attractive yield pickup. The asset
class offers relatively low volatility and a benign total return outlook. We expect lower-rated issuers (BBB
and A) to outperform higher-rated ones.
� Positive scenario Spread target (6-month): 140bps
• Global growth accelerates more forcefully than expected. This could compress spreads to closer to precrisis
levels. Spreads for Financials are likely to remain elevated due to regulatory challenges. However, in
this positive case, rising benchmark yields would limit total returns to 1–2% over six months.
� Negative scenario Spread target (6-month): 400bps
• Even if US economic growth falters, and the European recession turns out to be worse than currently
expected, we believe we would be unlikely to see the spread levels reached in 2009, given companies’
superior balance sheet positions. European financial issuers would be most at risk in this scenario.
Note: Scenarios refer to global economic scenarios (see slide 7)
What we're watching
Why it matters
Recommendations
Tactical (6 months)
• We still see room for tighter yield spreads;
the return outlook compares very
favorably to government bonds.
• Internationally diversified companies from
non-financial sectors offer a stable and
relatively safe income stream for
conservative investors.
• We recommend bonds from the lower IG
rating segments (BBB and A) over higherrated
issuers.
Strategic (1 to 2 years)
• We prefer corporate over sovereign assets
given companies' robustness compared to
the structural weakness of public finance
in many countries.
Yield spreads
700
600
500
400
300
200
bps
Core market yields
Corporate fundamentals
New issuance
Developed market sovereign yields are only expected to increase gradually. A
sudden rise and high volatility would hurt IG credit. Key dates: 1 August,
Federal Open Market Committee meeting
Good corporate earnings and low leverage on corporate balance sheets should
help prevent defaults.
As companies continue to deleverage, net negative supply on the IG market
should support higher prices.
100
0
2005 2006 2007 2008 2009 2010 2011 2012
EUR Investment Grade
USD Investment Grade
Source: Bloomberg, UBS CIO, as of 26.June 2012
Note: Past performance is not an indication of future returns.
26
For further information please contact CIO’s asset class specialist Philipp Schöttler, philipp.schoettler@ubs.com
Please see important disclaimer and disclosures at the end of the document.
High yield corporate bonds Preference: overweight
UBS View
Spread USD HY (26 June): 660bps (last month: 660bps)
USD HY spread target (6-month): 525bps
• US high yield (HY) bonds continue to offer attractive value; we expect high single-digit total returns over
the next six months. We stick to our spread forecast of 525bps based on an ongoing recovery of the US
economy, robust company balance sheets, rising earnings, and ongoing investor appetite for higheryielding
assets. US HY bonds remain our preferred asset class.
• Fundamental factors remain supportive. Despite the recent uptick in defaults, in the absence of a
renewed US recession only a very gradual increase is to be expected. We forecast a modest rise in the
trailing default rate to 3.5% at the end of the year from 3.1% in May. A heavy load of new issuance in the
first three months of the year means that HY companies will be faced with a lower risk of failed
refinancing going forward (e.g. in case of an unexpected economic slump).
• We acknowledge that ongoing risk aversion could still cause spreads to widen somewhat in the short run.
Investors who are able and willing to hold on to their HY position will likely benefit over 6 months.
� Positive scenario USD HY spread target (6-month): 450bps
• In the positive economic scenario, a rally in high yield bonds and a return to pre-crisis spreads of about
400bps is likely. Benchmark yields would also rise, limiting HY returns to around 10%. European HY
outperforms the US.
� Negative scenario USD HY spread target (6-month): 1,200bps
• A global recession is a major risk for high yield bonds. Based on the more robust state of the corporate
sector, we would not expect spreads to widen to 2008/09 peak levels above 2,000bps. Although short-term
spikes are likely, due to liquidity suddenly drying up, we would expect a quick return to the "usual"
recession-level spread of around 1,200bps.
Note: Scenarios refer to global economic scenarios (see slide 7)
What we're watching
Credit quality/
default cycle
New issuance
Bank lending standards
Why it matters
As long as corporate earnings increase and balance sheets remain backed by high
cash levels and low debt ratios, the default rate will remain below its 5% longterm
average.
For now, favorable conditions in the primary market have mainly been used for
refinancing. More aggressive issuance activities should be monitored.
Bank lending provides an important source of funding. US banks relaxed
standards slightly in 2Q. Key dates: early-July, ECB bank lending survey;
late-July, Fed Senior Loan Officer Survey
Recommendations
Tactical (6 months)
• US high yield corporate bonds offer an
attractive return outlook and should be
overweighted.
• We prefer US over European issuers given
the poorer economic outlook in Europe
and the increasing proportion of
peripheral and financial issuers in the
European HY universe.
• Inflows into HY mutual funds have been
strong so far in 2012, but new issuance has
cooled down a bit in April and May.
Strategic (1 to 2 years)
• We expect US defaults to remain at belowaverage
levels for longer. Significant releveraging
is unlikely in the medium term.
• We believe US high yield corporate bonds
will provide good returns for absolute
return-oriented investors, as well as
relative to other fixed income segments.
Yield spreads
27
For further information please contact CIO’s asset class specialist Philipp Schöttler, philipp.schoettler@ubs.com
Please see important disclaimer and disclosures at the end of the document.
2,500
2,000
1,500
1,000
500
0
bps
2005 2006 2007 2008 2009 2010 2011 2012
EUR High Yield
USD High Yield
Source: Bloomberg, UBS CIO, as of 26 June 2012
Note: Past performance is not an indication of future returns.
Emerging market bonds Preference: overweight
EMBI Global / CEMBI spread (27 June): 388bps / 430bps (last month: 410bps / 440bps)
UBS View EMBI Global / CEMBI spread target (6-month): 340bps / 350bps
• Emerging market (EM) bond spreads are currently higher than implied by fundamentals, and we think
they offer attractive returns even against a more challenging global backdrop.
• The probability remains significant, though, that negative headlines out of the Eurozone or a weakening
global growth outlook will put short-term pressure on EM bond prices. However, given EM sovereigns'
better average fundamentals, and EM corporates' solid profit growth outlook and low leverage ratios, we
think that periods of price weakness should offer attractive entry points.
• Although we revised our spread targets (to 340bps from 300bps for sovereigns, and to 350bps from
310bps for corporates), we continue to expect spreads to trend gradually lower over the next six months,
more than offsetting the moderate rise in US Treasury yields we expect in the quarters ahead.
� Positive scenario EMBI Global / CEMBI spread target (6-month): 290bps / 290bps
• Yield stability in Europe's core markets and higher-than-expected growth in the US would provide a
favorable backdrop for EM fixed income spreads. In such an environment, issuers of lower credit quality
would likely fare better. Average spreads could tighten to below 300bps in such an environment.
� Negative scenario EMBI Global / CEMBI spread target (6-month): 525bps / 700bps
• An environment of escalating risk aversion in Europe, deteriorating EM funding markets, weakening
global growth prospects, and lower commodity prices could impact EM credit negatively. Liquidity in
emerging market bonds could dry up and spreads could spike.
Note: Scenarios refer to global economic scenarios (see slide 7)
What we're watching Why it matters
Core market yields The direction of US Treasury and German Bund yields are important for EM fixed
income spreads, especially for USD- and EUR-denominated bonds.
Key dates: 1 August, US ISM & FOMC rate decision
Capital flows The European debt crisis may lead to further periods of outflows and weaker
prices, which could offer attractive entry levels for investors.
Monetary policy cycles Monetary policy easing remains a key topic for local currency bonds. We look for
central bank policy announcements in key markets such as Brazil, Indonesia,
Malaysia, Mexico, Poland, South Africa, and Turkey. Key policy rate
announcement dates: 29 June, Colombia; 4 July, Poland; 5 July,
Malaysia; 11 July, Brazil; 12 July, Indonesia; 19 July, Turkey
Recommendations
Tactical (6 months)
• EM corporate bonds are particularly
attractive due to favorable valuation,
solid fundamentals, and their relatively
short duration. We advise clients to focus
on investment grade bonds in the current
environment. We continue to like
selected sovereign bonds.
• Please refer to our EM bond list for
specific guidance.
Strategic (1 to 2 years)
• EM bonds are attractive for longer-term
investors looking for higher yields.
• Local markets in Asia offer interesting
opportunities for longer-term investors
because of a supportive currency outlook.
Room for tightening
Spreads of EM bonds over US Treasuries (in bps)
600
500
400
300
200
100
0
Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11
Emerging market sovereign bonds (EMBI Global)
Emerging market corporate bonds (CEMBI Broad)
Source: JP Morgan, UBS CIO, as of 27 June 2012
Note: Past performance is not an indication of future returns.
28
For further information please contact CIO's asset class specialist Michael Bolliger, michael.bolliger@ubs.com and Kilian Reber, kilian.reber@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Section 2.C
Asset class views
Foreign exchange
Foreign exchange overview
Foreign exchange – Key points
• EUR: Greek election results reduce the near-term euro break-up risk. Now starts a difficult period with
re-negotiation of the Greek austerity program. Also Spanish yields, which have reached hard to sustain
highs, need to be addressed. As the crisis carries on and hurts growth prospects for Europe well into 2013
we recommend to keep euro short positions. The risk for either an ECB rate cut or an extension of bond
purchase program by ECB as well as the increasing risks to the banking system are weighing on the euro.
• The extension of Operation Twist in response to weakening growth outlook in the US has its pros and
cons for the USD. Global risk aversion and search for alternatives to the euro is supporting the greenback
currently. The clear commitment of the Fed to respond with more stimulus to European contagion and
the approaching fiscal cliff is limiting the upside potential for the USD.
• The CAD has increased in attractiveness recently due to weaker spot rates, while good growth dynamics
in Canada still lead to rate hike expectations. We continue to recommend an overweight.
• We keep the overweight position in the GBP. The BoE eased monetary conditions for the banking
system to protect the UK financial market against contagion effects spilling over from the continent.
Apart from this, we think the pound remains well supported, because valuation is cheap and investors are
seeking liquid alternatives to the euro.
• EURCHF is currently trading at the low end of our expected range of 1.20–1.25, and we therefore keep
an underweight position in the CHF. The 1.20 EURCHF floor prevents any CHF appreciation and the SNB
has clearly shown in May that it is willing and can protect the floor; we expect the SNB to continue in this.
• Sweden and Norway stand out for their lower debt-to-GDP ratios and current account surpluses. The
NOK appreciated recently, due to safe haven inflows. We stay neutral as the appreciation potential is now
limited. The SEK is very sentiment-driven and should profit in the medium term.
• Longer-term debt issues and weak competitiveness of major exporters are hurting the Japanese
economy. Therefore the Bank of Japan and Ministry of Finance will maintain an expansive policy and
continue to try weaken the JPY. However, current positive growth dynamics are supportive of the JPY.
• For commodity currencies, the AUD and NZD weakened within ranges from March to May. We expect
another bout of weakness over the next three months together with increasing European troubles.
• We expect the CNY to appreciate 3% against the USD, moving towards 6.15 over the coming 12 months.
Internationally marketable instruments (such as CNH, the offshore version of the Chinese currency traded
in Hong Kong) have similar appreciation potential. Our most preferred emerging market currencies are
currently MXN, ZAR, PLN, ZAR, KRW and CNY.
Preferences (6 months)
underweight
neutral
USD
EUR
GBP
JPY
CHF
SEK
NOK
CAD
NZD
AUD
new old
Source: UBS CIO, as of 22.06.2012
overweight
30
For further information please contact CIO 's asset class specialist Thomas Flury, thomas.flury@ubs.com
Please see important disclaimer and disclosures at the end of the document.
G10 currencies
UBS View see UBS FX forecasts, below-right
• The negative momentum on the EUR is likely to persist. The growth outlook has deteriorated in the last
couple of months to a point, which challenges the fiscal austerity efforts seriously.
• The USD profits from European troubles, but the upside remains limited by expansive fed policy
• The GBP is resuming its uptrend despite stimulus measures by the Bank of England. The main reason is
the need for diversification of the EUR and better current economic indicators.
•The AUD seems to have found a bottom, and should recover on the back of better risk sentiment. We
believe the CAD remains one of the most attractive currencies.
• The SNB has shown that it will defend the CHF-floor. EURCHF will remain in the 1.20-1.25 range.
� Positive scenario FX targets: EURUSD >1.35 / EURJPY 120
• Eurozone economies avoid a material contraction and financial market conditions recover. EURUSD
should trade above 1.40 in this case. Yen weakness could develop, since hopes for global growth would
make the carry-trade role of the yen more prominent.
� Negative scenario FX targets: EURUSD <1.20 / EURJPY 100
• European growth outlook deteriorates further with continued recession in 2013. The euro could rapidly
fall below 1.20. A European debt default cascade is a tail risk for the single currency. Risk aversion would
lead to an extended USD and JPY rally.
Note: Scenarios refer to global economic scenarios (see slide 7)
Recommendations
Tactical (6 months)
• Long USD, GBP and CAD
• Short EUR, and CHF
Strategic (1 to 2 years)
• We recommend investors diversify from
large USD and EUR exposures into minor
currencies. Structural financing issues
weigh on each of the major currencies.
• The best diversifiers based on long-term
macroeconomic fundamentals are the
CAD and the SEK. The AUD, NOK and CHF
should only be added at better entry
levels.
UBS CIO FX forecasts
What we're
watching
Why it matters
Chinese growth We expect Chinese growth to land softly and then recover. Should China disappoint us
with a hard landing, then we have a problem. Risk unwinding will support USD and JPY
versus risk takers currencies.
European
sovereign crisis,
ECB policy
US growth and
Fed policy
response
With Greek elections out of the way, the main focus lies on Spain and on potential ECB
rate cuts. Any improvement in Spain should support the euro, a rate cut would probably
hurt it. Key dates: ECB Meetings on 5 July and 2 August
Will the Fed add QE to current Operation Twist programs? How will presidential
elections change political powers in Washington? Keys to address long-term financing
issues. Key dates: 1 August, FOMC meeting; 6 November, US Presidential
elections
Source: Thomson Reuters, UBS CIO, as of 25.06.2012
Note: Past performance is not an indication of future returns.
31
For further information please contact CIO's asset class specialist Thomas Flury, thomas.flury@ubs.com
Please see important disclaimer and disclosures at the end of the document.
EM currencies
UBS View For current exchange rates and CIO forecasts see table
• With the risk of a Greek Eurozone exit subsiding, we think selected emerging market (EM) currencies
look attractive over the medium term against the USD and JPY and some even against the EUR.
• Global growth prospects remain intact, also due to recent policy easing in China, and the risk of a
broader European crisis remains contained, in our view. Over the medium term, this will likely support EM
currencies. However, further bouts of volatility remain likely in the months ahead, since negative headlines
from Europe will likely continue to weigh on investor sentiment.
• Our tactical and strategic recommendations list our preferred currencies. For now, we remain cautious on
the Brazilian real, Hungarian forint, Indian rupee, and Turkish lira.
� Positive scenario > 7% outperformance of EM FX against G4 currencies over a 6-month horizon
• Macroeconomic data comes in stronger than expected and contagion risks in Europe subside further. EM
exchange rates could appreciate swiftly against G4 currencies (USD, EUR, JPY, GBP).
� Negative scenario > 4% depreciation of EM FX across regions against USD over a 6-month horizon
• Global growth prospects suffer a prolonged deterioration and the European debt crisis intensifies
further. EM exchange rates could see a significant, although likely temporary, sell-off across regions.
Should growth concerns return to the fore, we expect export-oriented EM countries (e.g. most Asian
economies) to welcome currency weakness in order to cushion economic growth.
Note: Scenarios refer to global economic scenarios (see slide 7)
What we're watching Why it matters
Inflation dynamics
in EM
European sovereign
crisis
US growth
Inflation dynamics are important to forecast central bank policy rate decisions.
Monetary easing typically weighs on EM currencies, while rate hikes tend to be
supportive. Key policy rate announcement dates: 29 June, Colombia; 4 July
Poland; 5 July, Malaysia; 11 July, Brazil; 12 July, Indonesia; 19 July, Turkey
Setbacks in sentiment will likely lead to bouts of EM currency depreciation and
elevated volatility across regions, providing attractive entry points for investors.
Growth in the US is key for risk sentiment, growth prospects in EM, and US
monetary policy decisions. Positive surprises tend to support EM currencies. Key
dates: 1 August, US ISM & FOMC rate decision
Recommendations
Tactical (6 months)
• Several EM currencies look attractive at
current levels; we advise investors to
gradually increase their exposure to our
preferred EM currencies, using the yen
and the USD as funding currencies. Our
preferred EM currencies are CNY, IDR,
KRW, SGD, MXN, ZAR, CZK, and PLN.
Strategic (1 to 2 years)
• We recommend EM currencies backed by
stable fundamentals as a strategy to
diversify currency exposure.
• Our favorites include the Chilean peso,
Czech koruna, Polish zloty, Chinese
renminbi, Korean won, Malaysian ringgit
and Singapore dollar.
UBS CIO EM FX forecasts
27.06.2012 3-month 6-month 12-month
Americas
USDBRL 2.07 2.10 1.95 1.85
USDMXN 13.8 12.7 12.5 12.3
Asia
USDCNY 6.37 6.30 6.25 6.15
USDINR 57.1 53.0 54.0 55.0
USDIDR 9'480 9'300 9'200 9'000
USDKRW 1'157 1'130 1'110 1'050
USDSGD 1.28 1.24 1.23 1.22
EMEA
EURPLN 4.25 4.35 4.15 4.00
EURHUF 286 305 285 310
EURCZK 25.9 26.0 25.0 24.3
USDTRY 1.81 1.75 1.78 1.78
USDZAR 8.43 7.90 7.75 7.50
USDRUB 32.9 33.5 32.0 31.0
Source: Bloomberg, UBS CIO, as of 27 June 2012
Note: Past performance is not an indication of future returns.1
32
For further information please contact CIO's asset class specialists Michael Bolliger, michael.bolliger@ubs.com or Teck-Leng Tan, teck-leng.tan@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Section 2.D
Asset class views
NTAC: Commodities, Listed real estate, Hedge funds and
Private equity
Commodities overview
Commodities – Key points
• Broadly diversified commodity indices, which declined by about 10% in May, found some support in
June. The sideways move was visible across all commodity sectors, with gold (precious metals)
delivering a temporary price uptick after the May US nonfarm payroll release.
• Despite signs of price stabilization, diversified commodity indices are likely to decline in the
coming weeks. Sluggish economic activity should put upward pressure on most commodity
inventories. To mitigate inventory buildups, lower prices are required, in our view. Production cuts for
cyclical commodities need to be incentivized, while demand needs a push.
• The starting point for gold (precious metals) remains challenging, with supply likely to outpace
demand this year. However, the chance of further monetary easing (QE3) by the Fed - which is not our
base case - is an upside risk to the gold price. Given the weak fundamental situation combined with
the substantial QE3 risk we maintain our neutral position.
• Easing geopolitical tensions related to Iran and further inventory builds in crude oil shifted the
market's attention to sluggish demand growth. With muted incremental crude oil consumption, crude
oil prices are likely to remain under pressure. But as production cuts are likely to kick in, downward
price momentum should slow meaningfully. OPEC production cuts of up to 0.5 mbpd are needed in
the coming months, and should allow the Brent price to stabilize in the USD 80.5 - 90/bbl range (WTI
with a USD 12/bbl discount). But a sideways move in crude oil is not good enough to be long the
commodity. The Brent forward curve has joined WTI and moved into contango as well. Hence, we
keep our underweight position.
• With regards to base metals, prices have room to soften in the very short run (4-6 weeks). Copper
prices are likely to decline to USD 6,600/mt in order to weigh on scrap supply and compensate for
deteriorating Chinese import volumes. But the price decline in copper and other base metals should be
short lived. Fiscal and monetary easing in China provide the basis for an acceleration in base metal
demand and should keep prices largely flat on a 6-month horizon. Moreover, metals like aluminum
and nickel are already trading deeply into the production cost curve, which we regard as
unsustainable over the long run. We keep a neutral position on base metals until we see further
confirmation of a pickup in Chinese economic activity.
• The outlook for ample supply in agricultural commodities, especially for corn, should still weigh on
the grain complex towards the end of the year. Some short-term price support from dry US Midwest
weather conditions in recent weeks is not altering our negative stance. Soft commodities are also
battling with higher inventories, which will not bode well for prices in 3Q 2012.
Preferences (6 months)
Commodities
total
Precious
Metals
Energy
Base Metals
Agricultural
underweight
new
Source: UBS CIO, as of 22 June 2012
neutral
Note: Past performance is not an indication of future returns.
old
overweight
34
For further information please contact CIO's asset class specialists Dominic Schnider, dominic.schnider@ubs.com or Giovanni Staunovo, giovanni.staunovo@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Precious metals Preference: neutral
Gold (25 Jun): USD 1,573/oz (last month: USD 1,573/oz)
UBS View (gold)
6-month target: USD 1,650/oz
• The price outlook for gold is largely tied to quantitative easing by the Fed. Although the probability has
increased on weak US data, our base case still calls for no QE. Hence, current prices run on thin ice, in our
view. In the absence of any monetary stimulus, the gold market is likely to be oversupplied by more than
400 tons this year.
• Physical demand out of Asia remains lackluster. With the USDINR trading at a record high, the world's
second-largest gold market, India, is likely to witness a steep decline in jewelry consumption and a rather
firm increase in scrap supply. Central bank buying, estimated at 300 tons (7% of total demand) in 2012,
will not be enough to clear the market. Right incentives – i.e. temporary price setbacks – are needed to
motivate enough demand, before prices should manage to rebound towards USD 1,650/oz in 6 months.
• The negative stance from a absolute return perspective, should not overshadow the relative
attractiveness of the yellow metal. The higher probability of QE3 by the Fed poses an upside risk to the
gold price. Hence, we maintain our neutral position.
� Positive scenario 6-month target: USD 1,920/oz
• Additional quantitative easing measures by the US Fed and the ECB are implemented, or inflation
accelerates sharply in emerging markets. This would drive the gold price towards USD 1,920/oz again.
� Negative scenario 6-month target: USD 1,250/oz
• A liquidity crisis would curtail financial demand and weigh on the gold price. A similar impact would
come from deflationary pressure (positive real rates), or a combined Chinese and Indian hard landing.
Recommendations
Tactical (up to 6 months)
• In case of a conversion into gold, investors
should hold the position and target reconversion
at the original strike level. Over
three months, we regard strike levels
around USD 1,460–1,520/oz as attractive.
With option volatility on the rise, the risk
reward for selling volatility has improved.
Strategic (1 to 2 years)
• The risks for debt monetization in the
developed world and double-digit wage
growth in China and India, the two largest
gold markets, should ensure a steady rise
in demand for gold and platinum over
time. Physically backed ETF positions allow
investors to participate effectively in
higher prices. Positive real interest rates
present a threat to this view.
Gold in INR terms and Indian gold
demand
What we're watching
Physical demand/supply
Flows & rates
Why it matters
Further INR weakness in the coming months should determine jewelry demand
from India. The health of coin and bar demand should be visible in the World
Gold Council mid-August release. After the drop in PGM production,
keeping an eye on South African PGM output is a must.
To judge gold-related financing deals, we track gold export/import between
Hong Kong and China. In addition we follow the latest uptick in ETF gold
holdings and futures positions in gold to proxy investment demand strength.
From an opportunity-cost perspective (real interest rate standpoint), we also
look at the upcoming meetings of the ECB on 5 July and Fed on 1 August.
300
Standardized to 100
250
200
150
100
50
0
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12
India's gold quarterly demand - in tons (rhs)
Gold in USD terms (lhs)
Gold in INR terms (lhs)
Source: WGC, Bloomberg, UBS CIO, as of 19 June 2012
Note: Past performance is not an indication of future returns.
500
400
300
200
100
0
35
For further information please contact CIO's asset class specialists Dominic Schnider, dominic.schnider@ubs.com or Giovanni Staunovo, giovanni.staunovo@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Energy
Brent (25 Jun): USD 91/bbl (last month: USD 109/bbl)
UBS View (crude oil) Brent 6-month target: USD 100/bbl
• A combination of renewed economic concerns about the Eurozone, easing geopolitical tensions between
Iran and the West, and further inventory builds in crude oil triggered a sharp decline in the Brent crude oil
price to USD 92/bbl and USD80/bbl for WTI.
• We think the crude oil market is oversupplied, which is likely to push up OECD crude oil inventories to 62
days of consumption in the coming months. While it seems that Saudi Arabia has slightly reduced its
production in May from 10.1 mbpd in April, the country could be in a wait-and-see position for longer.
First, the EU/US sanctions on Iran take effect at the end of June/early July, and bring some additional supply
uncertainty. Second, Saudi Arabia also sees the need for lower prices in the short run to support economic
activity in the developed world. But to prevent inventories from swelling too strongly, additional
production cuts of up to 0.5 mbpd (0.55% of global demand) are needed in the coming months.
• So what should investors do at current levels? Although downward momentum in crude oil prices is likely
to fade, a sideways move should still lead to negative investment returns in the short run. The Brent
forward curve flipped into contango from backwardation, which is deteriorating the risk reward payoff of
the energy sector. Hence, we currently maintain our underweight position.
� Positive scenario
Brent 6-month target: USD 140-180/bbl
• Iranian oil exports gets subject to a complete embargo, or military interventions affect crude oil supply
via the Strait of Hormuz. Alternative OPEC supply routs would not be in a position to compensate for such
a supply shortfall. In order to curb demand, prices would need to spike towards USD 180/bbl.
� Negative scenario Brent 6-month target: USD 75-80/bbl
• Economic growth in the developed world contracts, thereby triggering a 0.5% to 1% decline in world
crude oil consumption. Although to a lesser degree, fading Iranian tensions and no supply cuts by OPEC
would allow crude oil inventories to build firmly and push Brent prices down towards USD 80/bbl.
What we're watching Why it matters
Iran tensions Resurfacing Iranian tensions could cause prices to spike higher, but an escalation is
less likely, in our view. The focus is on remaining Iranian exports (currently around
1.6mbpd versus 2.4 mbpd in 2011).
Supply US crude oil supply has come in strongly – reaching 6.4 mbpd. Further supply
growth would not bode well for WTI crude oil. We also look at oil supply related to
Sudan, Syria and Yemen, which caused a 0.5 mbpd decline in global crude oil
production capacity. It seems that these production capabilities will remain offline
for a longer period – potentially until 2014.
Oil market reports Key dates: 12 July, IEA Medium Term Oil market report. Another round of
(EIA/IEA/OPEC) downward revisions to demand, like in June, is not expected. The latest forecast
changes to demand have been meaningful.
65
60
55
50
Preference: underweight
Recommendations
Tactical (6 months)
• We foresee further short-term weakness
although less pronounced than the past
month – we expect Brent to stabilize in
the range of USD 80.5 - 90/bbl in the next
3 months. Production cuts and a pick up in
emerging market demand should push
Brent crude oil above current levels.
Strategic (1 to 2 years)
• After the demand slump in 1H 2012, we
expect Brent crude oil to trade at USD
110/bbl in 12 months. This higher price
level for 2013 reflects our expectation that
economic activity should provide price
support in 2013. Thus, three-year crude oil
futures contracts at USD 90/bbl remain for
us mispriced and an attractive investment
solution for strategy-oriented crude oil
investors.
OECD crude oil industry inventories on
the rise
Days of consumption
45
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
range 2007-2011 2012 average 2007-2011
Source: EIA, UBS CIO as of 19 June 2012
Note: Past performance is not an indication of future returns.
36
For further information please contact CIO's asset class specialists Dominic Schnider, dominic.schnider@ubs.com or Giovanni Staunovo, giovanni.staunovo@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Base metals
Preference: neutral
Current (last month): copper USD 7,317/mt(7792); nickel USD 16,528/mt(16833); aluminum USD 1,825/mt(1989)
UBS View 6-month target: copper: UDS 7,400/mt nickel: USD 18,000/mt; aluminum: USD 2,200/mt
• With the exception of aluminum, base metal prices stabilized broadly in June. But we see room for
somewhat lower prices in the short run (4-6 weeks). Deteriorating industrial activity in Asian countries,
weak US data and the Euro-zone crisis remain a price burden for the sector in the early part of 3Q12.
• To weigh on scrap supply and compensated for lower Chinese copper imports, copper prices are likely to
decline towards USD 6600/mt, in our view. For the rest of the base metals, prices could move deeper into
the cost curve of production. When it comes to aluminum and nickel, however, prices have already
declined deeply into the production cost curve. In both cases supply cuts could come quicker and limit the
price downside from current levels.
• In addition, supply uncertainty related to aluminum and nickel needs to be considered as well.
Indonesia's new regulations on ore exports could jack up Chinese import costs by around 20% in the
coming quarters. We think such an increase would be meaningfully, as 60% of China's nickel pig iron (NPI)
production and 80% of China's bauxite imports depend on Indonesia.
• The reason why base metals overall should trade at current levels or higher in six months from now,
relates to China. We think the People's Bank of China has made the right monetary policy steps to achieve
stronger credit activity and higher sequential GDP growth in 2H 2012. With this fairly balanced risk reward
on a six-month horizon, we maintain our neutral position.
� Positive scenario
• China eases monetary policy aggressively, by pushing credit growth beyond 20% y/y. Additional QE in
the US paired with stable European and Japanese demand would allow the sector to rally by around 25%.
� Negative scenario
• Chinese monetary conditions remain behind the curve, resulting in an economic hard landing. A severe
escalation of the Eurozone crisis (deep recession/global impact) could also bring prices close to 2009 levels.
What we're watching Why it matters
Demand The latest uptick in Chinese imports, driven by technical factors, do not
reflect stronger end demand. The June figures (on 10 July) should give some
clarity. That said, the attractiveness to import from an arbitrage perspective
SHFE to LME has improved. Interest for physically backed copper ETFs needs to
be tracked as exchange inventories are structurally low.
Supply
Copper supply has room to improve in 2H 2012 from poor mine output in 1H
2012. Fading supply disruptions and capacity additions put copper at risk.
Indonesia's new export rules could have a positive one-off impact on aluminum
and nickel.
Economic data/forward
curve
People's Bank of China meeting, Chinese economic data (especially IP and loan
growth by financial institutions) Key dates: 11–15 July
Recommendations
Tactical (3-6 months)
• From a timing perspective, building up
exposure to base metals is not yet
advised. While we still expect higher
prices over the next 6–12 months, the
short-term downside risks should offer
investors better entry points, particularly
for copper. That said, existing aluminum
and nickel positions should be kept.
Strategic (>1 year )
• Rising energy and labor costs provide the
backdrop for base metal prices to trend
higher. The strongest performance is
likely to come from zinc and lead, where
existing mine capacity is expected to peak
in 2014. Environmentally challenged base
metals, like tin, should be in line with the
sector average. For nickel and aluminum,
ample production capacity should lead to
an underperformance in the long run.
Due to its high current price versus
production costs, copper should lag too.
Heavy industrial activity in China, with
high commodity use, slumped
Source: Bloomberg, UBS CIO, as of 18 June 2012
Note: Past performance is not an indication of future returns.
37
For further information please contact CIO's asset class specialists Dominic Schnider, dominic.schnider@ubs.com or Giovanni Staunovo, giovanni.staunovo@ubs.com
Please see important disclaimer and disclosures at the end of the document.
25
20
15
10
5
0
Cumulative year-on-year values, in %
Feb-99 Feb-02 Feb-05 Feb-08 Feb-11
Light industry value added
Heavy industry value added
Agriculture
Preference: underweight
Current (25 June) (last month): Soybeans, USD 14.79/bu (USD13.82/bu); Corn, USD 6.09/bu(USD 5.79/bu);
Wheat, USD 6.91/bu (USD 6.80/bu)
UBS View 6-month target: Soybeans, USD 13.5/bu; Corn, USD 5.10/bu; Wheat, USD 6.00/bu
• Besides the overall commodity price backdrop, prevailing dry weather conditions in the US have been
price supportive for the grains and added to firmer prices.
• While weather-related news flows might support grain prices in the short run (downward revisions in
grain yield estimates, especially corn), the 6–12 month price outlook remains negative. Global corn
inventories should grow beyond 10% in 2012/13. We think this will more than compensate for firmer
wheat fundaments (lower inventory estimates) in the coming months. For soybeans, current price levels
sufficiently factor in the poor supply figures seen in recent months. This would be especially true, if South
American planting gets a boost due to soybeans' relative price improvement.
• A strong supply backdrop for Brazilian coffee along with a weaker BRL has kept coffee prices under
pressure. For 2012/13, Brazilian coffee and sugar exports are likely to increase by 12% and 2% y/y
respectively, and keep the global market well supplied in 2012. Cotton prices saw some bouts of strength,
but demand has yet to work off high inventory levels at 74–75mn bales. With ample inventories and
economic conditions at risk, renewed price weakness is likely.
� Positive scenario
Soybeans 6-month USD 16/bu
• Lower acreage and yield figures for the US can tighten the supply backdrop until 1Q 2013 (until the new
South American crop comes). On the demand side, higher soybean use for bio diesel in Argentina and
strong Chinese imports (improvements in crush margins) are catalysts for prices to rally.
� Negative scenario
Soybeans 6-month USD 12/bu
• Unexpected Chinese government stock sale of soybeans and deteriorating crushing margins for soybean
oil/meal production, would leave soybean prices vulnerable to a price correction.
What we're watching
USDA WASDE report
(monthly)
Grains stock report
(quarterly)
USDA crop progress
(weekly, Monday)
COT (weekly, Friday)
Why it matters
US corn yields could be at risk in the upcoming WASDE release. Key date : 11
July 2012
Corn and soybean inventories could be lowered vs. current estimates, reflecting
the strong export activity in corn during March–May and higher soybean crushing
during the same period. Key date: 28 September 2012
Dry weather conditions in the US has impacted the crop conditions (rating),
which deteriorated in recent weeks.
Investors have scaled back their long exposure in corn. At the present speed, net
positions would close in on zero over the next two months.
Recommendations
Tactical
• The forward curve in corn already factors
in a steep decline by the end of the year,
thereby mitigating the expected negative
return. With lower corn prices, wheat
should come under pressure as well. Most
agricultural commodities are generally
well supplied, so unless the weather
surprises on the downside, we expect
further weakness.
Strategic
• Strategic agricultural positions are not
recommended at present. Our return
outlook for the grains stands at –7.5% to
– 5% over the next 12 months. Although
the softs have a positive return outlook
over the same period, investors should
bide their time. Short-term price setbacks
of 10% or more are still likely over the
next two to three months.
Global corn surplus as % of demand to
advance towards 5-year high
12%
8%
4%
0%
-4%
-8%
2009/10 2010/11 2011/12 2012/13E
Corn Soybeans Wheat
Source: USDA, UBS CIO, as of 18 June 2012
Note: Past performance is not an indication of future returns.
38
For further information please contact CIO's asset class specialists Dominic Schnider, dominic.schnider@ubs.com or Giovanni Staunovo, giovanni.staunovo@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Listed real estate Preference: neutral
UBS Global Index DTR (28 June): 1,375 (last month: 1,320)
UBS View UBS Global Index DTR (6-month target): 1,400
• A slight positive monthly performance has been driven by rebounds in the higher beta markets,
respectively Hong Kong, Japan and Singapore.
• Listed real estate is still attractively valued on different earnings ratios and trade on a slight discount to
NAV. Earnings yields over 5 year swap rate are attractive currently attractive, yet the flattening of interest
curves has come to a halt and we see less support from it in the future.
• Little supply of commercial space across the globe leads vacancy rates to gradually decline and low
capitalization rates in core markets support capital values. Also rental yields remain attractive compared to
high grade bond yields. However, further significant capital appreciation is unlikely. This is especially due a
slow down in rental income as economic growth is subdued. Hence, future performance is limited.
• Although slightly reduced, we maintain our preference for US REITs due to stable fundamentals and like
Australia as a conservative play. We slightly overweight Hong Kong, stay neutral towards Singapore, but
maintain a slight underweight in Japan as fundamentals remain unconvincing.
� Positive scenario UBS Global Index DTR (6-month target): 1,500
• Improving macroeconomic data in the US, positive economic surprises in Europe followed by monetary
easing in China help to increase growth prospects that support rental income growth, while refinancing
costs remain low in a low inflation environment. Real estate offers a comparatively attractive yield.
� Negative scenario UBS Global Index DTR (6-month target): 1,300
• The US growth path disappoints investor expectations and causes the comparatively high valuation levels
there to correct, significantly affecting global real estate. Furthermore, a more severe recession in Europe
triggers a tightening of credit standards, making listed real estate more dependent than ever on bank
financing at a time when credit markets are already fragile. Real estate underperforms global equities
because the correlation between the availability of credit and short-term performance is high.
Note: Scenarios refer to global economic scenarios (see slide 7)
What we're watching
Capitalization rates and
rental yields
Transaction volumes and
future rental growth in
direct markets
Credit markets and
financing costs
Why it matters
We do not expect capitalization rates to decrease much from now. Rental yields
have already been pushed down by decreasing bond yields; we see a diminishing
support from the interest curve, which has significantly flattened in the past.
Global commercial real estate transaction volumes are down year-on-year due to
a lack of product in core markets and constraints on debt financing. Global rental
growth has softened and very modest growth will feature major markets overall.
Lending conditions have been a little tightened. However, well financed listed
companies have still good access to credit, while others are more restricted.
Recommendations
Tactical (6 months)
• We maintain our neutral stance towards
listed real estate after a good performance
year-to-date and due to a relative less
attractive valuation compared to global
equities. Going forward returns are limited
by subdued revenue growth. However, we
still expect listed real estate to stay
comparatively attractive in a low growth,
low rates environment.
Strategic (1 to 2 years)
• A cyclical slowdown in rents limits growth,
but attractive refinancing conditions are
supportive. We see potential for higher
payout ratios in the US and Asia, while
Europe has to consolidate balance sheets.
Preference (6 months)
Our market preferences for listed real estate*
North America
Continental Europe
UK
Japan
Hong Kong
Singapore
Australia
-- - neutral + ++
Old
New
* This is our relative preference within the global real estate
sector based on UBS Global Real Estate Index domestic total
return, which is not the overall sector view
Source: UBS CIO, as of 26 June 2012
Note: Past performance is not an indication of future returns.
39
For further information please contact CIO's asset class specialist Thomas Veraguth, thomas.veraguth@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Hedge funds
UBS View
Prefer Relative value and Event-driven
• We expect hedge funds (HF) to offer positive asymmetric returns characteristics vs. the S&P 500 due to
active management and stop-loss strategies. (HF were down 1.9% in May 2012 vs MSCI world at –8.5%)
• Decelerating global growth prospects, the next leg in the ongoing Eurozone crisis, is challenging mostly
equity long-short managers, who are net-long the market. While event-driven managers share some of
the performance drivers, idiosyncratic bets (event) reduce the exposure to markets. The real reason to own
this strategy, however, is the potential for out-sized return in distressed, high yield and other credit
investments as the Eurozone crisis plays out. The inherent hedging in relative-value should remain
appealing. Credit relative-value managers should perform well in this environment of higher fixed income
volatility and increasing pricing anomalies created by central bank interventions (OT2) and limited
competition.
� Positive scenario
Prefer Equity long-short
• A reduction of uncertainty (e.g. resolution in Europe) lowers equities' correlation and volatility. This
helps bottom-up fundamental analysis and equity long/short managers the most. Also, CEOs will likely
make more corporate transactions that can be monetized by event-driven managers, and a clearer
macroeconomic environment with more persistent trends would be supportive for macro managers
� Negative scenario Prefer Trading (Global Macro + CTA)
• A 2011-type scenario in which hedge fund managers get whipsawed through the year with risk-on and
risk-off circumstances, driven by a multitude of political interventions, is difficult to anticipate. That would
impact long-short managers, event-driven, and to a lesser extent global macro managers.
Note: Scenarios refer to global economic scenarios (see slide 7)
What we're watching Why it matters
Global equity direction
/ economic cycle
The outlook for global equities becomes an important HF performance driver.
The economic cycle impacts the strategies differently.
Correlation
Correlation among pair-stocks; an important performance/alpha driver for
equity long/short, the largest HF strategy by assets under management.
Leverage
Gross and net leverage are key to monitoring risk.
Volatility The direction influences certain HF strategies (e.g. convertible arbitrage).
Liquidity Particularly for large HF that are less nimble to enter and exit their strategies
Regulation
Volcker's rule, USCITS III/IV
Recommendations
Strategic (1 to 2 years)
• Active risk management is instrumental for
capital preservation during adverse market
conditions. At the moment, we therefore
favor relative value and event-driven
strategies, since they are less hinged to
equity markets and other risky assets than
trading is.
• Value proposition: Hedge funds should
achieve robust performance over an
extended horizon, while displaying limited
volatility vis-à-vis equities and other risky
assets, in general. Hedge funds minimize
downside losses in adverse market
conditions (e.g. active risk management)
and play a crucial role in wealth
appreciation, since there is less ground to
regain in the recovery phase and
ultimately greater chances for superior
long-term returns.
Performance (year-to-date)
Relative value
Event driven
Trading
Equity hedge
Hedge Funds
-1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0%
Source: HFRI, UBS CIO, as of 18 June 2012
Note: Past performance is not an indication of future returns.
40
For further information please contact CIO's asset class specialist Cesare Valeggia, cesare.valeggia@ubs.com
Please see important disclaimer and disclosures at the end of the document.
Private Equity
Prefer small/mid-cap buyout in US / emerging markets;
UBS View distressed debt in Europe
• Private equity deals in today's volatile and uncertain markets are conservatively financed, with an average
equity cushion of 40%. We like mid-market buyout strategies, which offer long-term exposure to attractive
corporate assets and which rely less on large bank debt syndications.
• Our house view sees large parts of Europe in a stagnation, and business owners are reluctant to sell their
companies, reducing PE deal flow in the region significantly. We therefore prefer North America, which
will see continuous (albeit suboptimal) growth, and emerging markets, which show positive fundamentals.
• Prices for PE transactions have corrected by around 10% this year, although they are still 20% above the
attractive levels seen during the successful years between 2000 and 2004. However, significant dry powder
and high cash positions at corporations keep competition high and hinder prices from falling much further.
� Positive scenario
Prefer small-/mid-cap buyout and secondaries
• An abating Eurozone debt crisis and improved business confidence would increase deal flow and exit
opportunities for private equity managers, but would also increase entry prices. In such a positive scenario,
we would perceive commitment strategies to secondary funds as attractive for building exposure to an
invested private equity portfolio.
� Negative scenario Prefer distressed debt
• A renewed escalation of the debt crisis would significantly impact deal activity, the availability of debt
and company owners' willingness to sell. At the same time, it would offer attractive opportunities within
distressed strategies and lower entry prices for long-term private equity investors.
Note: Scenarios refer to global economic scenarios (see slide 7)
What we're watching
Credit markets
Capital overhang
Purchasing prices (Enterprise
value / EDITDA)
Why it matters
Availability of leverage and credit spreads are important signs of the health of
buyout markets. Small/mid caps are currently financed at 4.3x EBITDA (vs 4.6x
for large-caps) and are more attractive given their lower reliance on bank
financing in a period of ongoing bank deleveraging.
We track deal/exit activity to understand the pressure to invest, future price
dynamics and draw-down profiles for investors. More than USD 930bn of uninvested
capital and expiring investment periods will keep prices elevated.
Price multiples offer valuable insight into private company valuations. YTD
May 2012, buyouts occurred at 8.1x, down from 8.8x seen in 2011. Large-cap
buyouts have come down 10% from the peak last year to 8.6x.
USD bn
Recommendations
Strategic (1 to 2 years)
• We prefer small-/mid-cap buyouts in North
America given the better economic
outlook vs Europe, higher transaction
certainty and more attractive entry prices.
• Investors looking for downside protection
and stability during economic
uncertainties can consider large-cap
buyouts in the US, which offer exposure
to large, diversified companies at more
attractive prices.
• In Europe, the crisis and ongoing
deleveraging have led to attractive
opportunities for special situations. We
thus recommend investing in distressed
debt to benefit from the macroeconomic
adjustment process and selling pressure
for many European banks.
• We advise investors make an ongoing
allocation to private equity in emerging
markets, which offer an attractive way to
capture superior long-term growth and
provide access to small/mid-cap companies
not available through the stock market.
Private equity deals continue to be defensively
financed amidst economic uncertainty
100
90
80
70
60
50
40
30
20
10
0
5.2
33%
30% 31%
31.8
54.2
31%
64.7
40.7
39%
46% 41%
2004 2005 2006 2007 2008 2009 2010 2011 YTD May 12
PE backed high yield issuances (lhs)
28.3
90.6
38%
72.2
Equity cushion in LBOs (rhs)
Source: S&P, UBS CIO, as of May 2012
Note: Past performance is not an indication of future returns.
40%
38.7
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Equity cushion (% of transaction
value)
For further information please contact CIO's asset class specialist Stefan Brägger, stefan.braegger@ubs.com
41
Please see important disclaimer and disclosures at the end of the document.
Note: We emphasize the equal importance of fund manager selection and the commitment strategy. Please note that private equity is an illiquid asset class and must be held at least until the end of the fund (10+ years).
Please note that UBS might not have a product available which reflects our UBS CIO private equity recommendations. Private equity is only suitable for qualified investors (> USD 5m investable assets).
Contact list
UBS WM Global Chief Investment Officer
Alexander Friedman
alexander.friedman@ubs.com
Global Head of Investment
Mark Haefele
mark.haefele@ubs.com
Global Investment Office
Themes / UHNW
Simon Smiles
simon.smiles@ubs.com
Asset Allocation Advisory
Mark Andersen
mark.andersen@ubs.com
Asset Allocation Discretionary
Mads Pedersen
mads.pedersen@ubs.com
Kiran Ganesh
kiran.ganesh@ubs.com
Karsten Bagger
karsten.bagger@ubs.com
Walter Edelmann
walter.edelmann@ubs.com
James Purcell
james.purcell@ubs.com
Achim Peijan
achim.peijan@ubs.com
Markus Irngartinger, CFA
markus.irngartinger@ubs.com
Christopher Wright
christopher-zb.wright@ubs.com
Philipp Schöttler
philipp.schoettler@ubs.com
Oliver Malitius
oliver.malitius@ubs.com
Matthias Uhl
matthias-w.uhl@ubs.com
Regional Chief Investment Officers
Regional CIO Europe
Andreas Höfert
andreas.hoefert@ubs.com
Regional CIO Asia-Pacific
Yonghao Pu
yonghao.pu@ubs.com
Regional CIO Emerging Markets
Jorge Mariscal
jorge.mariscal@ubs.com
Regional CIO Switzerland
Daniel Kalt
daniel.kalt@ubs.com
42
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