EFTA01089574.pdf

UBS CIO WM Global Investment Office CIO monthly video For smartphone users: scan the code with an app like "scan" UBS CIO Monthly Extended March 2013 Published This report has been prepared by UBS AG. Please see important disclaimers and disclosures at the end of the document. Past performance is no indication of future performance. 21 February 2013 The market prices provided are closing prices on the respective principal stock exchange. This applies to all performance charts and tables in this publication. EFTA01089574 Table of Contents Section 1 Base slides 3 Section 2 Asset class views 13 2.A Equities 14 2.B Fixed income 24 2.0 Foreign exchange 31 2.D NTAC: Commodities, Listed real estate, Hedge funds and Private equity 35 EFTA01089575 Section 1 Base slides EtUBS EFTA01089576 Summary "The recent rise • Economy We see global growth on a stronger footing than last year. In the US, rising house prices and in yields ongoing job growth support private consumption. We expect politicians to strike another last- minute fiscal deal and US GDP to grow by around 2% in 2013. The Eurozone economy is expected highlights the to lag, and recent data shows large regional divergence. While German business sentiment has improved, the outlook for the French economy remains weak as fiscal tightening still has to catch risks in owning up to other European countries. Meanwhile, the Chinese economy remains on an uptrend, government supported by strong credit growth and rising exports. • Equities bonds. We prefer Equities remain supported by improving global growth momentum and we maintain our moderate overweight recommendation. US companies continue to show the strongest earnings momentum, corporate bonds and we expect US earnings to grow by a solid 6% in 2013. Conversely, Canadian equities face relatively weak earnings dynamics, which will likely be made worse by the strong CAD, and are and equities." relatively expensive. As a result, this month we have increased our overweight to US equities, and introduced a new underweight position in Canadian equities. We also remain constructive on emerging market (EM) equities. Accelerating economic growth in key countries, stabilizing profit margins and decent valuations speak in favor of the region. • Fixed Income Government bonds reacted strongly to the improving growth picture and 10-year yields on US Treasuries and German Bunds have risen considerably since the beginning of the year. While we expect rates to remain broadly stable over the next 6 months, real returns on government bonds will likely be negative and hence we maintain our large underweight position. Better alternatives can be found in investment grade (IG), high yield (HY) and emerging market (EM) corporate bonds. IG corporate bonds are expected to achieve a better total return despite limited spread tightening potential. HY corporate bonds still offer good investment opportunities due to low expected default rates and attractive risk premiums over other fixed income segments. And EM corporate bonds offer yield income and some potential for tighter spread, with relatively low volatility. • Commodities While in particular cyclical commodities profit from accelerating global growth, we see better risk return prospects in other asset classes and maintain a neutral stance. Platinum: Attractively valued remains a CIO Preferred theme. • Foreign Exchange The British pound is our most preferred currency. After weakening year to date, we expect that the currency will be supported as economic data begins to improve. The euro, on the other hand, looks relatively expensive, especially given political risks around the Italian elections. We remain underweight the single currency. UBS 3 Please see important disclaimer and disclosures at the end of the document. EFTA01089577 Cross-asset preferences Most preferred Least preferred Portfolio weights Commodities U•quidity • • US • Canada (SO Real Estate 5% 9% High Grade 5% • Emerging markets • European telecoms Hedge Funds/ Bonds 5% hy Grade p Private Equity • US mid caps 10% Corporates Bonds OPP. • Western winners from EM 9% growth High Yield Equities Bonds • Swiss high quality dividend Equities U 3% II% EM Soy. Bonds yields 3% EM Corp. • Relative value and equity Bonds 3% long/short hedge funds Equities Other Equities 8% Europe 23% Equities EM • US high yield • Too expensive government 6% bonds (SO Note: Portfolio weights are for an advisory • Global investment grade credit client with a "EUR moderate profile. For • EM corporate bonds portfolio weights related to other risk profiles • Corporate hybrids or currencies please contact your client Fixed income advisor. • Developed Asia banks • Relative value hedge funds • Emerging markets • EUR (V) Foreign • GBP(71) exchange Commodities • Platinum %h Recent Recent upgrades a downgrades UBS Please see important disclaimer and disclosures at the end of the document. EFTA01089578 Recommended tactical asset allocation Tactical asset allocation deviations from benchmark* Currency allocation** underweLght neutral over•wrght undeNteight neutral overweight Cash USD Equities total EUR US GBP Eurozone in JPY a, UK E 3 cr Japan CHF Switzerland SEK EM N0K Other MI CAD Bonds total NZD Government bonds v. Corporate bonds (IG) AUD -o c o co High yield bonds ■ new old EM sovereign bonds (USD) * Please note that the bar charts show total portfolio preferences and thus can EM corporate bonds (USD) be interpreted as the recommended deviation from the relevant portfolio Commodities total benchmark for any given asset class and sub asset class. v. Precious metals The UBS Investment House view is largely reflected in the majority of UBS w :al Discretionary Mandates and forms the basis of UBS Advisory Mandates. Note -o Energy that the implementation in Discretionary or Advisory Mandates might deviate E Base metals E slightly from the 'unconstrained" asset allocation shown above, depending on o u Agricultural benchmarks, currency positions and due to other implementation considerations. Listed Real Estate **Note: The currency allocation has been changed on 8 February 2013, introducing the overweight in GBP and the underweight in EUR. • new old Source: UBS CIO WM Global Investment Office — as of 21.02.2013 UBS S Please see important disclaimer and disclosures at the end of the document. EFTA01089579 CIO preferred investment themes (1/2) Liquidity & Foreign Exchange • Emerging market currencies: An underappreciated asset class Emerging market corporates: A growing asset class The currencies of EM countries, collectively as an asset class and measured Within EM hard currency debt, we prefer corporate to sovereign due to its using total returns (i.e. including interest received), have the potential to more attractive valuation and higher overall yield. Moreover, our relatively contribute positively to the longer-term returns of a well-diversified portfolio. constructive current view on risk is another reason to prefer EM corporate over We believe that this is especially relevant now that the developed world is sovereign debt. Over a 6-month horizon, we expect EM corporate bonds to settling into an extended period of very low interest rates. deliver total returns of more than 4%. • GBP — the best of the majors Top-notch Asian banks shine amid weak competition The pound has come under pressure after comments from incoming Bank of Highly rated banks in developed Asia benefit from a consolidation in the England Governor Carney suggesting changes to monetary policy targets, banking industry in Europe and the US, while growth in emerging Asia Prime Minister Cameron's proposal for a referendum on the UK's membership continues to underpin their fundamentals. These issuers are, on average, AA- of the EU, and weak economic data. However, we believe that the weakness rated and we expect them to benefit from the ongoing global bank ratings of Sterling is overdone and first signs point to stronger economic data in the downtrend. Senior bonds of these developed Asian banks provide moderate months to come. As a result, the pound is our preferred major currency. yields, whilst subordinated bank bonds of the same issuers provide good potential for credit spread tightening, given the scarcity value of Basel 2 Fixed Income compliant bank capital securities and the absence of regulatory bail-in regimes. Yield pickup with corporate hybrids Overall, we expect an excess return of a basket of subordinated and senior The corporate hybrid segment is a lesser known segment of the investment Asian bank bonds of more than 1% over comparable global issues over the grade credit world that has lagged the broad-based spread recovery. As a next 6-12 months. consequence, we see attractive opportunities for investors with a suitable risk Too expensive Government bonds' tolerance or trading-orientation. We expect mid- to high-single-digit returns Improving economic data has already lead to an increase in government bond on selected instruments over a 12-month period. yields in most major markets. While tight fiscal budgets and high debt burdens in the US and Europe are unlikely to allow for a large increase in interest rates, US high yield corporate bonds even a small further rise would lead to negative total returns on benchmark Positive economic growth, robust corporate earnings, and healthy balance government bonds, and we believe that the risk-reward in the bonds of most sheets provide support to US high yield (HY) corporate bonds. Current yield weaker countries is currently poor. We therefore recommend switching out of spreads of -495 basis points still price in a more dire economic outcome than the affected bonds, which are identified in this theme. 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 have a favorable risk/return and expect mid-single digit 1 returns over the next six months. Senior loans are exposed to similar positive fundamentals, and offer an attractive, floating rate alternative to US HY. = New investment theme The CIO preferred investment themes represent the CIO's highest conviction, thematic investment ideas. We aim to recommend ideas that are attractive on a risk-reward basis and which are expected to deliver positive absolute returns. It will include the best investment themes for each of our TAA overweights, UBS further aligning the asset allocation and themes recommendations, along with a range of other short-, medium-, long-term, and SRI themes. 6 Please see important disclaimer and disclosures at the end of the document. EFTA01089580 CIO preferred investment themes (2/2) Equities • US mid caps: The sweet spot No turnaround for European telecoms US economic data has begun to stabilize and forecasts now show an Despite having already underperformed the broader Eurozone equity index, acceleration of growth in 2013. The greater domestic sales exposure of US we expect further relative downside in the coming months. Operating results, mid caps, and their more cyclical sector make-up, give greater leverage to the free cash flows and, most of all, dividends will stay in free fall, and further US recovery. For these reasons we believe that mid-cap companies will adjustments to consensus estimates are required for 2013 projections and outperform large caps in the US over the next 6-12 months. onward, in our view. Hence, we recommend investors to reduce exposure to Eurozone telecoms. • Swiss high quality dividends The Swiss equity market currently offers a dividend yield of around 3.0%, while bond yields in the Swiss franc fixed income market are typically below 1%. Before 2009, dividend yields tended to be lower than bond yields. Hedge Funds & Private Equity Moreover, unlike in the past, the Swiss dividend yield is now clearly higher • The place to be in Hedge Funds than in the US and comparable to European peer markets. Overall, Swiss The favourable conditions for relative value remain unchanged in 2013. A dividends are very attractive, in our view, in particular if investors focus on continued improvement in global growth and the supportive monetary policy companies with high quality dividends - meaning that dividends are backdrop supports spread products such as corporate bonds and securitized sustainable and steadily rising. loans. Moreover, the decline in the number of market participants due to the Volcker rule should provide more opportunities to strategies such as fixed • Emerging market equities income arbitrage. We now also like equity long short which should benefit We expect real GDP growth in emerging markets (EM) to accelerate to 5.1% from stronger equity markets. The associated lower correlations among stocks in 2013 from 4.5% in 2012, which should support EM corporate earnings. We should allow good performance for managers picking under- and overvalued see EM earnings growth of around 11% over the next 12 months, as global stocks. We are now less keen to own event driven strategies as we do not monetary policy should remain accommodative. EM equities are trading expect distressed debt managers to be able to repeat their excellent 2012 below their longer-term averages on several valuation metrics, and will likely performance in an improving economic environment. be supported by stronger EM currency performance against the US dollar over the next six months. • Western winners from emerging market growth Commodities Emerging economies continue to grow faster than developed economies. • Platinum: Attractively valued With little need to deleverage and repair balance sheets, Asian economies are Platinum remains our most preferred precious metal. Production costs also well positioned to continue outpacing their Western peers in the years continue to rise, with marginal production costs now above USD 1,600/oz. If ahead. We have identified companies from a variety of sectors in Europe, the this supply backdrop meets with improved economic activity in the latter part US and Japan which have significant exposure to the rapidly growing of 1H13 and in 2H13, the platinum market will be undersupplied by 4.5% in emerging regions. We believe a diversified portfolio of these companies will 2013. With this supportive backdrop, we target a move toward USD 1,800- reward investors seeking to profit from the robust demand growth in 1,850/oz during 2013.. emerging economies. SUBS 7 Please see important disclaimer and disclosures at the end of the document. EFTA01089581 Global economic outlook - Summary Key points Global growth expected to be 3.0% in 2013 • We expect the US economy to remain on its moderate but steady growth path. R•olg GDP row* .1 inflation in • In the Eurozone we think that economic activity is rebounding on the basis of rising sentiment in business surveys 2011 2012E 2013F 2011 2012, 2013F and less fiscal austerity relative to 2012. Americas US 1.8 22 2.3 3.1 21 1.6 Canada 2.6 20 20 21 1.6 1.9 • In the emerging markets, we expect real GDP to grow at 5% in 2013. Iran 2.7 1.1 40 6.5 5.8 6.2 Asia/Pacific Lain .0.6 2.1 1.3 .0.3 0.0 0.3 CIO View (Probability: 75%*) Sluggish expansion A62443 2A 3.6 3.0 3.3 1.8 2.4 Chna 93 72 8.0 541 2.7 3.5 • We expect the US economy to remain on its moderate but steady growth path over the next six months. Stronger India 55 6.5 8.1 7.4 private sector demand and reaccelerating inventory accumulation will likely be offset by reemerging fiscal policy Europe Et00204e 1.5 -OA 0.1 2.7 2.5 2.1 German, 3.1 09 08 75 21 uncertainty. We expect Fed's open-ended QE3 program to last till year end and the government to reach another two 17 0.2 0.4 21 20 1.3 0.5 -23 -0.4 2.9 3.4 2.6 deficit deal. This deal replaces the current sequester spending cuts but does not include further spending reductions. fWn as -1.6 3.1 2,5 3.2 • In the Eurozone, the sentiment in recent business surveys continues to improve, signaling that the recession will end UK stnuerliod 0.9 1.9 00 1.0 0.8 0.9 65 02 28 41.7 7t in 1Q 2013. We expect a return to moderate growth rates in 2013 as the pressure from fiscal tightening declines and Ruzia 4.3 34 35 8.5 5.1 6.8 world 3.2 27 30 31 2.9 2.9 the increased macro stability supports business investment spending. Inflation is expected to continue to trend downward below 2%. The ECB is concerned about the risks to money market rates from the early LTRO repayments Source: U8S, as of 12 February 2013 In developing the CIO economic forecasts, CIO economists and the rise of the euro. At this juncture though, the ECB remains in wait-and-see mode. worked in collaboration with economists employed by UBS • The Chinese economy is in a moderate upswing cycle. 3Q12 marked the cyclical bottom in terms of year-on-year Investment Research. Forecasts and estimates are current growth. Real GDP growth rebounded to 7.9% in 4Q12 and we expect around 8% growth on average in 2013. Headline only as of the date of this publication and may change CPI inflation is likely to rise gradually to 4% by year end. The government aims to keep inflation below 4% so it could without notice. be a policy concern later this year. While economic conditions are supportive in Asia and Latin America, EMEA continues to lag in the cycle. We are likely to see increased inflationary pressures in H2 2013, leading to an upward drift in EM rates. In Brazil, Russia and India, inflation has already become a policy constraint. Services and manufacturing diverging $ Positive scenario (Probability: 10%*) Return to long-term trend Global PMis • The Eurozone crisis abates. Financial market conditions recover, mitigating the drag from fiscal austerity. 65 • Growth in Western Europe turns decisively positive in the early months of the new year and the US economy grows 60 above trend. ss • Negative scenario (Probability: 15%*) Recession 50 • There are three key downside risks to the global economy: 1) a significant escalation of the Eurozone debt crisis; 2) a rs . H protracted government shutdown and a sharper fiscal contraction in the US; and 3) a sharp deceleration of the Chinese 60 r economy. Each of these risks could precipitate a significant downturn in the global economy. 35 30 25 Key dates 07 08 09 10 11 12 13 24/25 Feb EMU: Italian parliamentary elections No-change line —Manufacturing 1 Mar US: ISM manufacturing purchasing managers' index (PMI) for February —Services —Composite 1 Mar China: Manufacturing PMI (February) 5 Mar China: National People's Congress Source: JP Morgan, Bloomberg, UBS; as of January 2012 7 Mar EMU: ECB press conference Note: Past performance is not an indication of future returns. 20 Mar US: FOMC meeting results *Scenario probabilities are based on qualitative assessment. 21 Mar EMU: PMI Composite for March (flash) UBS For further information please contact CIO economist Ricardo Garcia, Please see important disclaimer and disclosures at the end of the document. 8 EFTA01089582 Key financial market driver 1- Eurozone crisis Key points Purchasing managers' indices point to • We expect the Eurozone to gradually emerge from recession. Fiscal policy will be less restrictive than in 2012. improving momentum • The Eurozone debt crisis is not over but ECB policy provides a credible backstop. 65 • We think that Spain will need external support in coming months. The debt situation in Cyprus, a possible rating 60 downgrade of Spain to junk, and general elections in Italy could further exacerbate the situation. 55 50 CIO View (Probability: 70%• ) Austerity and weak growth 45 • The Eurozone economy is expected to leave recession behind in 1H 2013 after a weak fourth quarter. We believe that 40 Spain will apply for an aid program in 1H 2013. Italy also risks needing support due to contagion from Spain and its 35 own election uncertainty. Greece's debt remains highly unsustainable, but a near-term euro exit is unlikely. Ireland 30 continues to recover gradually, but is highly indebted. We expect France to deliver negative headlines in 1H 2013 due 25 to rising concerns about its fiscal slippage on the back of economic weakness. 07 08 09 10 11 12 13 — No-change line — Manufacturing • We expect the Eurozone economy to grow slightly in 1H 2013 (moderately above consensus), with minor downside —Services —Composite risks. The latest economic indicators support our base case that the recession will end in 1H 2013 and return to modest positive growth. The increased macro stability on the back of the improving peripheral current accounts and the OMT Source: Bloomberg, UBS; as of January 2013 should support the improving economic trend. Consumer price inflation continues to fall, driven by pressure on output prices and commodity base effects. The ECB is carefully watching the strengthening of the euro and monitoring money market rates following the LTRO repayments, but remains in wait-and-see mode for now. • We think a revision of Spain's deficit targets by February could lead Moody's to cut the country's credit rating to Yields of Spanish and Italian 5-year bonds junk. This would increase the cost of covering its large funding needs and push Spain into a program in the first half of In % 2013. Italy should remain rated investment grade if the new government continues the recent reform path. • Even with OMT support, longer-term peripheral yields should stay sensitive to countries' debt trajectories as debt 8.0 levels remain very high. Banking supervision at the ECB will likely be operational by 2014, but a banking union is 7.0 unlikely to be formed in the next few years, with the most controversial aspect being joint deposit insurance. 6.0 • We think that Greece will fail to meet targets and exit risks will again increase if the current government loses its majority over further austerity demands from the IMF, possibly in 2H 2013. 5.0 4.0 71 Positive scenario (Probability: 15%• ) Growth and fiscal stabilization 3.0 • Bond yields converge as peripheral countries' budgets stay on track and economic activity across the Eurozone 2.0 recovers faster than expected. Greece complies with the new austerity plans and market confidence is restored. Negative scenario (Probability: 15%•) Major shock 1.0 • Major shocks include Spain and Italy being cut off from bond markets, i.e. requiring all new funding through 0.0 ESM/IMF loans, with European rescue funds only able to cover them until the end of 2013; resistance from core 03/2011 082011 01/2012 06/2012 11/2012 countries against further support; a near-term Portuguese debt restructuring; a Greek euro exit in 1H 2013; massive —Italy — Spain —Bond fiscal slippage in France; or a major external shock. Source: UBS, Bloomberg; as of 12 February 2013 Key dates Note: Past performance is not an indication of future returns. 24/25 Feb Italian parliamentary elections • Scenario probabilities are based on qualitative assessment. 7 Mar ECB press conference 14/15 Mar European Council conference 21 Mar PMI Composite for March (flash) UBS For further information please contact 00 analyst Thomas Wacker, and 00 economist Ricardo Garcia, Please see important disclaimer and disclosures at the end of the document. g EFTA01089583 Key financial market driver 2 - US economic outlook Key points US growth to rebound after 4Q12 • US growth should remain moderate, with accelerating private sector growth partially offset by fiscal tightening. contraction • Inflation is expected to stay slightly below the Fed's target of 2% over the next six months. US real GDP and its components, quarter-over-quarter • The Fed's open-ended QE3 has dampened downside growth risk but hasn't dramatically boosted activity. annualized in % 8% qfq annudized CIO View (Probability: 70%*) Moderate expansion osa • We expect the economy to stay on a moderate growth path and the unemployment rate to come down gradually 4% over the next six months. UBS forecasts real GDP growth of annualized 3.0% in 1Q 2013 (consensus: 1.5%) and 2.9% in 2% 0% 2Q 2013 (consensus: 2.1%), as private sector demand remains solid and very lean inventories give way to faster -2% inventory accumulation. Inflation should stay slightly below the Fed's target of 2%. -4% • Relative to 2012 policy, Congress has raised ordinary income, capital gains and dividend income tax rates for high- 6% income earners and curtailed their allowable income exemptions. It has also allowed the payroll tax to expire for all B% AtIL households, raised the estate tax, and introduced healthcare reform tax hikes. The federal budget impact of these 12% policy changes amounts to 0.9% of GDP, but the 2013 GOP growth impact will be more muted as households can lower Q1 Q1 Q1 Q1 Q1 Q1 Q1 C/1 their savings to offset the drop in after-tax income caused by higher tax rates. Congress extended all other tax and 2036 2007 2008 2009 2010 2011 2012 2013 Consumption Gemmeroal red estate investment spending provisions and delayed the sequester budget cuts until 1 March. We expect the sequester spending cuts to • Cooker expenditures Residential immanent kick in temporarily and fierce negotiations to bleed into a brief government shutdown after the current continuing • hventones whet Exports • Government —Real GDP (q/q annualized) resolution expires on 27 March. The culmination will likely be another deficit deal that replaces the current sequester spending cuts but does not include additional spending reductions. The political rift will likely lead to another US Source: Thomson Datastream, UBS; as of 12 February 2013 sovereign rating downgrade. • The Fed's open-ended QE3 program linked to labor market conditions - USD 85bn in Treasury and agency MBS purchases - mitigates downside growth risks, as weaker labor market data implies more easing, but has not US Current Activity Index (CAI) consistent dramatically boosted growth prospects. We expect QE3 to last until year-end with total purchases of USD 1.2trn. with moderate growth 74 Positive scenario (Probability: 15%•) US real GDP growth, actual and implied by US CAI, in % Strong expansion • Growth accelerates persistently above 3%, propelled by expansive monetary policy, a resolution to the US long-term 6 debt problem, strong growth in housing investment, and improved business and consumer confidence. This leads to 4 higher inflation and the Fed responds by halting QE3 and raising rates sooner. 2 • Faster-rising tax collection allows the government to cut deficits more aggressively. Fiscal policy tightens by more 0 than 1% of GDP in 2013. -2 11 Negative scenario (Probability: 15%*) Growth recession • US fiscal deleveraging and an escalating Eurozone crisis weigh on the cyclical recovery. Falling profit margins weigh -6 on business capital expenditures. Real GDP growth deteriorates. The Fed makes massive purchases of agency MBS and Treasuries under its QE3 program. -8 10 • Political gridlock becomes totally dysfunctional, thus leading to a protracted government shutdown in the first half of 2013. The US credit rating is downgraded by multiple notches. Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 — Real GDP guarter-over-guarter annualized in % (actual) Key dates — Real GDP annualized in % (implied by US CAP 1 Mar ISM manufacturing purchasing managers' index for February 8 Mar Nonfarm payr