UBS CIO WM Global Investment Office

EFTA01089619 Dataset 9 46 pages Download original PDF
UBS CIO WM Global Investment Office UBS CIO Monthly Extended May 2013 Published 25 April 2013 CIO monthly video For smartphone users: scan the code with an app like "scan" 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. The market prices provided are closing prices on the respective principal stock exchange. This applies to all performance charts and tables in this publication. EFTA01089619 Table of Contents Section 1 Base slides 3 Section 2 Asset class views 13 2.A Equities 14 2.B Fixed income 24 2.0 Foreign exchange 32 2.D NTAC: Commodities, listed real estate, hedge funds and private equity 36 EFTA01089620 Section 1 Base slides SUBS EFTA01089621 Summary "We stick to a moderate overweight in equities and US high yield. We shift our overweight EM equities to Japan and go long USD and CAD." • Economy Recent US growth indicators have weakened, with the ISM, non-farm-payrolls, and retail sales disappointing in March. However, we believe the weakness can partly be attributed to tax hikes and sequester spending cuts, which are expected to fade. As such we believe it is likely to prove temporary. Meanwhile, we expect the Fed to taper, but not halt, QE asset purchases in 4Q13. Despite some better-than-expected economic data points in the Eurozone, such as February industrial production, recent forward-looking PMIs suggest that the Eurozone economy remains on a weak footing, and we expect the ECB to cut its refinancing rate in May. The Bank of Japan (BoJ) recently surprised with more monetary stimulus than previously expected. We foresee economic growth rising on higher government and private consumption, and core inflation climbing slowly toward positive territory. Recent regulatory measures in China are likely to weigh on sentiment in the short term but will not derail economic growth, which we expect to come in around 8% in 2013. • Equities We are sticking to our moderate overweight in equities, and remain overweight in the US, where we believe the weakness in data is likely to prove temporary. We are replacing our overweight position in emerging markets with an overweight position in Japan. Uncertainties over global growth, Chinese policy, and commodity prices could weigh on EM, while the Bank of Japan's aggressive easing policies should help support the Japanese economy and drive earnings upgrades. • Fixed Income We expect a tapering in QE from Q4 to push global yields somewhat higher. German and Japanese yields are close to historical lows, and we expect them to rise moderately along with inflation in the coming year. Within fixed income, the best investment opportunities are to be found in corporate bonds. Investment grade bonds offer a yield pickup over government bonds and low volatility, although absolute returns will likely be only modest. High yield and emerging market corporate bonds still offer potential for tighter spreads, making them attractive from a risk-return perspective. We remain overweight credit. • Commodities Precious metals have come under severe pressure recently. Gold is down 14% since the beginning of April, and silver is down 18%. The Fed signaling that it is considering tapering QE later this year, together with speculation over potential gold sales by the Bank of Cyprus, triggered the negative sentiment. We are sticking to a neutral view on commodities, given the high volatility on the asset class. • Foreign Exchange We continue to favor GBP against EUR. This week's announcement of an extension to the Funding for Lending scheme could see some MPC members back away from calls for more QE, and concerns over a change in Bank of England policy should continue to recede following March's budget. We are also overweighting USD, using CHF for funding. The US has a clear advantage in economic momentum over the Eurozone. Furthermore, we are upgrading CAD to overweight against an underweight in AUD. Recent economic indicators suggest that Canadian growth is likely to improve while we expect more economic disappointments in Australia. Furthermore, the AUD remains highly overvalued based on Purchasing Power Parity. Please see important disclaimer and disclosures at the end of the document. 3 EFTA01089622 Cross-asset preferences Equities Commodities Foreign exchange • • • • • • • • • • • • • Most preferred EM (A) equity funds grade credit funds Least preferred US Japan (X) US mid caps US housing Japanese exporters Western winners from growth Water-linked investments Relative value and long/short hedge US high yield Global investment EM corporate bonds Corporate hybrids Relative value hedge • • • Canada European telecoms Too expensive government bonds • Emerging markets • EUR • GBP • CHF (V) • CAD (a) • AUD (V) • USD (X) Recent upgrades a Recent downgrades Portfolio weightings Commodities Liquidt, Real Estate 5% 9% High Grade 5% Hedge Funds, Private Equity 10% Equities US 11% Equities Europe 23% Bonds 5% Mr Grade Corporates Bonds 9% High Yield Bonds 3% EM Sov. Bonds 3% EM Corp. Bonds 3% Equities Other 11% Equities EM 3% Note: Portfolio weightings are for an advisory client with a "EUR moderate" profile. For portfolio weights related to other risk profiles or currencies please contact your client advisor. Please see important disclaimer and disclosures at the end of the document EFTA01089623 Recommended tactical asset allocation Tactical asset allocation deviations from benchmark* underweight neut al overweight Cash Equities total ll 0 cu a = cr US Eurozone UK Japan Switzerland EM Other Bonds total ,,, -o c o co High grade bonds Corporate bonds (IG) High yield bonds EM sovereign bonds (USD) EM corporate bonds (USD) Commodities total 0 cu a -o o E E V Precious metals Energy Base metals Agricultural Listed Real Estate • new old Source: U8S CIO WM Global Investment Office - as of 25.04.2013 Currency allocation underweight neutral overweight USD EUR GBP JPv CHF SEK NOK CAD NZD AUD ■ new old * 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. The UBS Investment House view is largely reflected in the majority of UBS Discretionary Mandates and forms the basis of UBS Advisory Mandates. Note that the implementation in Discretionary or Advisory Mandates might deviate slightly from the "unconstrained' asset allocation shown above, depending on benchmarks, currency positions and other implementation considerations. Please see important disclaimer and disclosures at the end of the document. EFTA01089624 CIO preferred investment themes (1/2) Liquidity & Foreign Exchange • Emerging market currencies: An underappreciated asset class The currencies of EM countries, collectively as an asset class and measured using total returns (i.e. including interest received), have the potential to contribute positively to the longer term returns of a well-diversified portfolio. We believe that this is especially relevant now that the developed world is settling into an extended period of very low interest rates. • GBP - the best of the majors The pound had come under pressure after speculation earlier in the year over potential changes to monetary policy targets. This week's announcement of an extension to the Funding for tending scheme could see some MPC members back away from calls for more QE, and concerns over a change in Bank of England policy should continue to recede following March's budget statement. As a result, the pound is our preferred major currency. Fixed Income Yield pickup with corporate hybrids The corporate hybrid segment is a lesser known segment of the investment grade credit world that has lagged the broad-based spread recovery. As a consequence, we see attractive opportunities for investors with a suitable risk tolerance or a trading orientation. We expect mid to high single-digit returns on selected instruments over a 12-month period. US high yield corporate bonds Positive economic growth, robust corporate earnings, and healthy balance sheets provide support to US high yield (HY) corporate bonds. Current yield spreads of -478 basis points still price in a more dire economic outcome than 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 returns over the next six months. Senior loans are exposed to similar positive fundamentals and offer an attractive, floating rate alternative to US HY. Emerging market corporates: A growing asset class Within EM hard currency debt, we prefer corporate to sovereign due to its more attractive valuation and higher overall yield. Moreover, our relatively constructive current view on risk is another reason to prefer EM corporate over sovereign debt. Over a six-month horizon, we expect EM corporate bonds to deliver total returns of more than 3.5%. Government bonds too expensive Improving economic data has already led to an increase in government bond 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, even a small further rise would lead to negative total returns on benchmark government bonds, and we believe that the risk-reward in the bonds of most weaker countries is currently poor. We therefore recommend switching out of the affected bonds, which are identified in this theme. Equities • REMOVED: Emerging market equities On a tactical basis we are downgrading emerging market equities to neutral, and so removing them from ao preferred themes. With near-term uncertainties over global growth, the future of Chinese policy, and the outlook for commodities, we foresee no catalyst to help emerging markets realize their significant longer term valuation potential. • Water thirst for investments The demand for clean water should increase with a growing global population. However, the supply of clean water is constrained by the lack of water infrastructure in emerging markets. Climate change, urbanization and emerging markets' stronger focus on the industrial sector are also damaging the water supply. Furthermore, we have identified three short-term trends that should add earnings power for water-exposed companies - ship ballast water treatment US shale development and desalination. The CIO preferred investment themes represent the CIO's highest conviction, thematic investment ideas. We aim to recommend ideas that are attractive on a risk-reward basis and expected to deliver positive absolute returns. It will include the best investment themes for each of our TAA overweights, further aligning the asset allocation and themes recommendations, along with a range of other short, medium and long-term, as well as SRI, themes. 4 Please see important disclaimer and disclosures at the end of the document. 6 EFTA01089625 CIO preferred investment themes (2/2) Equities • US mid caps: The sweet spot US economic data has begun to stabilize and forecasts now show an acceleration of growth in 2013. The greater domestic sales exposure of US mid caps, and their more cyclical sector make-up, give greater leverage to the US recovery. For these reasons we believe that mid-cap companies will outperform large caps in the US over the next 6-12 months. • REMOVED: Swiss high-quality dividends With the 2013 Swiss dividend payment season largely behind us, we are removing this theme from CIO preferred. In particular, the attraction of high dividend yielders will fade for the next few months, although high-quality companies with strong cash flows and steadily rising dividends remain attractive. . Japanese exporters supported by a weaker yen We believe that the impact of an approximately 10% weaker yen over the first quarter should start emerging in earnings results, supporting exporters' outperformance until the national election in July. Given the recent underperformance of Japanese exporters vs. domestic companies, we believe the theme of Japanese exporters is now even more attractive in a Japanese context. • Western winners from emerging market growth Despite recent concerns, emerging economies continue to grow faster than developed economies. With little need to deleverage and repair their balance sheets, Asian economies are also well positioned to continue outpacing their Western peers in the years ahead. We have identified companies from a variety of sectors in Europe, the US and Japan with significant exposure to the rapidly growing emerging regions. We believe a diversified portfolio of them will reward investors seeking to profit from the robust demand growth in emerging economies. • No turnaround for European telecoms We expect further relative downside in European telecoms in the coming months. Operating results, free cash flows, and dividends will likely stay under pressure, and further adjustments to consensus forecasts are required, in our view. Share price developments are likely to remain erratic and we recommend continuing to avoid the sector. • US housing: The long grind higher US housing activity has been recovering for about a year. We believe that the recovery is sustainable and will not be hampered by the negative forces arising from fiscal austerity and sequestration. We are also slightly more optimistic than consensus regarding the speed of recovery. A sustainable US housing recovery provides opportunities for equity investments in companies with high exposure to the housing market that are still valued attractively. Hedge Funds & Private Equity • The place to be in hedge funds The favorable conditions for relative value remain unchanged in 2013. A continued improvement in global growth and the supportive monetary policy backdrop support spread products such as corporate bonds and securitized loans. Moreover, the decline in the number of market participants due to the Volcker rule should provide more opportunities for strategies such as fixed income arbitrage. We also like equity long short which should benefit from stronger equity markets. The associated lower stock correlations should enable managers picking under- and overvalued stocks to perform well. Commodities • REMOVED: Platinum: Attractively valued Platinum remains our most preferred precious metal. The lack of supply growth and an improving economy in 2H13 should enable platinum prices to move higher later this year. That said, volatility could remain elevated in the near term given platinum's exposure to gold's sell-off and the ongoing uncertainty regarding gold's investment demand. We are removing it from our CIO preferred themes due to changed risk/return characteristics. = New investment theme Please see important disclaimer and disclosures at the end of the document 7 EFTA01089626 Global economic outlook - Summary Key points • We expect moderate US growth over the next six months after a dismal 4Q12 performance and 1Q13 rebound. • In the Eurozone we think that economic activity is slowly recovering. • In the emerging markets we expect real GDP growth of around 5% in 2013, with moderately rising inflation to 2H13. CIO view (Probability: 70%*) Sluggish expansion • We expect US growth to stay moderate over the next six months after a dismal 4Q12 performance followed by growth acceleration in 1Q13. Stronger private sector demand and reaccelerating inventory accumulation will be offset by fiscal tightening and fiscal policy uncertainty. In conjunction with the debt ceiling debate in July/August and the expected passage of the FY2014 budget by September, we expect further budget agreements to add more flexibility to the implementation of the sequester spending cuts, but we don't expect any additional cuts. We estimate the 2013 fiscal drag at 1.5%, with a 1.2% GDP impact as households can lower their savings to buffer the drop in after-tax income. We expect the Fed's open-ended QE3 program to last until mid-2014 with some tapering off in 4Q13. Total purchases will likely amount to USD 1.3tn, bloating the Fed's balance sheet to USD 4tn at year-end 2013. • Latest economic data in the Eurozone points to a modest weakening of quarter-on-quarter economic growth in the second quarter. This dynamic is mainly driven by lower business surveys following the Italian elections and the Cyprus crisis. It remains to be seen how strong the impact will be. Our base case of a stabilizing economy in 1H remains intact (in line with consensus) given economic data so far. The ECB is hesitant to cut rates and wants first to see more evidence of weakening growth in the second quarter and thus remains in wait-and-see mode for now. Due to the weakening of the business surveys, the risk of a rate cut in the second quarter has increased substantially though. • We cut our GDP growth forecast for Brazil to 3.3% (from 4% previously) for 2013 and to 3.4% for 2014 (from 3.6%) due to a less benign external environment and weaker household consumption. In China, we expect growth of around 8% in coming quarters, with slightly better sequential growth in 2Q13. Inflation will gradually rise in 2H13 and could trigger a more neutral policy stance. Modest headwinds may come from real estate, credit, and liquidity policies. Indian inflation is on a slowing trend and we expect some more rate cuts in the coming months. We see growth of around 6% over the next 12-18 months. In Russia, growth is slowing, but lower inflation provides room for some monetary policy support in the coming months. We expect Russian growth of 3.5% in 2013. 71 Positive scenario (Probability: 15%1 Return to long-term trend • The Eurozone crisis abates. Financial market conditions recover, mitigating the drag from fiscal austerity. • Growth in Western Europe accelerates and the US economy grows above its 2.5% trend. 11 Negative scenario (Probability: 15%*) Recession • There are three key downside risks to the global economy: 1) a significant escalation of the Eurozone debt crisis; 2) a protracted government shutdown and a sharper fiscal contraction in the US; and 3) a sharp deceleration of the Chinese economy. Each of these risks could precipitate a significant downturn in the global economy. Key dates 1 May 2 May 3 May 10-15 May 22 May US: FOMC monetary policy decision Eurozone: ECB press conference US: Nonfarm payrolls and unemployment rate for April China: New bank loans, total social financing, money supply (April) Eurozone: EU Council Global growth expected to be 2.9% in 2013 1255=Thill JOI31 25I.II X641 200 20IY• 2014$ Antonin 05 2 ) 2 ) 10 2 1 I) 13 Canada 30 20 21 16 19 2s Prato 09 33 3a SO 6) 613 AllaiPaCIIIC oDWI 20 10 In 00 01 III antInDs 36 10 10 III )a 14 China /II •0 50 ) 7 15 a0 Aga S0 65 /0 05 /4 70 Kam. tannen• 0% 04 07 15 I7 I 6 4Aimand 09 07 II II 1! 16 fora 00 03 07 20 10 I3 Pay .21 d 2 03 3 3 IP I0 !pan I 4 .I7 00 1. 3. I5 Of 02 07 II 20 31 32 swerenand 10 09 13 07 00 OH Rutiall 34 30 40 51 65 56 Wald 26 29 34 29 28 3.2 Source: UBS, as of 23 April 2013 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. Global purchasing manager indices consolidating at expansionary levels Global PMIs 65 60 55 50 45 40 35 30 15 07 08 09 10 I I 11 I) —service — moroauvog —corroove mxionoe len Source: JP Morgan, Bloomberg, UBS; as of April 2013 Note: Past performance is not an indication of future returns. *Scenario probabilities are based on qualitative assessment. For further information please contact CIO economist Ricardo Garcia, Please see important disclaimer and disclosures at the end of the document. EFTA01089627 Key financial market driver 1- Eurozone crisis Key points • We expect the Eurozone to gradually emerge from recession. Fiscal policy will be less restrictive than in 2012. • The ECB provides a credible backstop to contain debt crisis-related break-up risk. The rate cut probability has increased. • We think that Spain is at risk of needing external support and Italy will likely call early elections in late 2013 or early 2014. CIO view (Probability: 70%*) Austerity and weak growth • Economic data so far suggests that the recession in the Eurozone has eased since the beginning of 2013, with France a key exception, though business surveys weakened following the Italian elections and the Cyprus crisis. Real activity data so far supported our base case of a stabilizing economy in the first half of the year (in line with consensus), but the impact on business confidence has created downside risks for the second quarter and could delay the fragile recovery. The ECB prefers to keep its policy rate unchanged despite a fall in consumer price inflation to 1.7% in March. The risk of a rate cut in the second quarter has increased substantially though following the weaker business surveys. • We believe that the risk of Spain requiring a support program in 1H13 remains high. The continuing recession, a much higher than initially planned budget deficit of 5.5-6%, and record-high funding needs of more than EUR 130bn are contributing to the risk. We see an about even chance of Moody's downgrading the country's credit rating to junk over the next three months, which may impair the country's access to funding at affordable rates. • Italian bond yields remain vulnerable to contagion from other peripheral countries due to the uncertainty over the timing and outcome of early elections. With a pro-reform government, Italy should remain investment grade rated. • Ireland and Portugal continue to recover gradually, but are highly indebted. A failure to fully return to the bond markets later this year may lead to the need for a second support program. We think that Greece requires a large further debt haircut and exit risks will increase if the current government loses its majority over additional austerity demands from the IMF, possibly in 2H13. We expect France to deliver negative headlines in 1H13 because of rising concerns about its fiscal slippage on the back of economic weakness. • Even with OMT support, longer term peripheral yields should stay sensitive to countries' debt trajectories as debt levels remain very high. Banking supervision at the ECB will likely be operational by 2014, but a banking union is unlikely to be formed in the next few years, with the most controversial aspect being joint deposit insurance. 71 Positive scenario (Probability: 15%•) Growth and fiscal stabilization • Bond yields converge further as peripheral countries consolidate their budgets and economic activity recovers faster than expected. Italy forms a government that continues the reform path. la Negative scenario (Probability: 15%*) Major shock • Major shocks include Spain and Italy being cut off from bond markets, i.e. requiring all new funding through ESM/IMF loans, with European rescue funds only able to cover them until the end of 2013; resistance from core countries against further support; a near-term Portuguese debt restructuring; a Greek euro exit in 1H13; massive fiscal slippage in France; or a major external shock. Key dates 2 May 22 May 23 May ECB press conference EU Council PMI Composite for May (flash) Purchasing managers' indices still signal economic weakness 65 60 55 50 45 40 35 30 25 2007 ZOOS 2009 2010 2011 2012 2013 No-cAvnge Ime — manufactunng —service composite Source: Bloomberg, UBS; as of 23 April 2013 Spreads of Spanish and Italian 5-year bonds In 70D 600 500 400 300 200 100 0 032011 082011 012012 062012 11,2012 042013 Note: Past performance is not an indication of future returns. • Scenario probabilities are based on qualitative assessment. For further information please contact OO analyst Thomas Wacker, and CIO economist Ricardo Garcia, Please see important disclaimer and disclosures at the end of the document. 9 EFTA01089628 Key financial market driver 2 - US economic outlook Key points • US growth should remain moderate, with accelerating private sector growth partially offset by fiscal tightening. • Inflation is expected to stay slightly below the Fed's target of 2% over the next six months. • The Fed's open-ended QE3 has dampened the risk to growth but has not dramatically boosted activity. CIO view (Probability: 70%*) Moderate expansion • We expect the economy to stay on a moderate growth path and the unemployment rate to come down gradually over the next six months. UBS forecasts real GDP growth of an annualized 3.0% in 1Q13 (consensus: 2.9%) and 2.9% in 2Q13 (consensus: 1.6%), as private sector demand remains solid and very lean inventories give way to faster inventory accumulation. Inflation should stay slightly below the Fed's target of 2%. • Relative to 2012 policy, Congress has raised taxes and is cutting spending. We estimate the total federal budget effect to be 1.5% of GDP in 2013. However, the 2013 GDP growth impact will likely be more muted as households can lower their savings to offset the drop in after-tax income caused by higher tax rates. We estimate a real GDP growth impact of 1.2% in 2013. So far the impact from higher taxes has been negligible as households significantly lowered their savings rates, which we expect to be increased moderately in the future. • We think the sequester spending cuts will remain in place but that new budget negotiations related to a necessary increase in the debt ceiling in July/August will provide more flexibility in implementing them. The possible political rift and insufficient cuts to stabilize the medium-term debt-to-GDP ratio will likely lead to another US sovereign rating downgrade. • The Fed's open-ended QE3 program linked to labor market conditions - USD 85bn in Treasury and agency MBS purchases per month - mitigates risks to growth, but has not dramatically boosted growth prospects. We expect QE3 to last until mid-2014 with some tapering off in 4Q13 and total purchases of USD 1.3trn. 71 Positive scenario (Probability: 15%*) Strong expansion • Growth accelerates above 3%, propelled by expansive monetary policy, a resolution to the US long-term debt problem or less austerity, strong growth in housing investment, and improved business and consumer confidence. This leads to higher inflation, which the Fed responds to by halting QE3 and raising rates sooner than in our base case. • Faster-rising tax collection enables the government to cut deficits more aggressively. Fiscal policy tightens by more than 1.5% of GDP in 2013. Negative scenario (Probability: 15%*) Growth recession • US fiscal deleveraging and an escalating Eurozone crisis weigh on the cyclical recovery. Falling profit margins weigh on business capital expenditures. Real GDP growth deteriorates. The Fed makes massive purchases of agency MBS and Treasuries under its QE3 program. • Political gridlock makes the government dysfunctional, leading to a technical Treasury default or a protracted government shutdown. The US credit rating is downgraded by multiple notches. Key dates 1 May 1 May 3 May 13 May 17 May FOMC monetary policy decision ISM manufacturing purchasing managers' index for April Nonfarm payrolls and unemployment rate for April Advance retail sales for April University of Michigan consumer sentiment for May (preliminary) US growth to rebound after 4Q12 slump US real GDP and its components, quarter-over-quarter annualized in % 8% 6% 4% 2% 0% 2% 4% 6% 8% 10% 12% QI QI 01 01 Of Q1 Q1 QI 2006 2007 2008 2009 2010 2011 2012 2013 - Consumption •Commercial real estate investment • Capital expend lures - Residential investment la Inventories • Net Exports Gcmemment Real GOP (Wq annuelaedl Source: Thomson Datastream, UBS; as of 23 April 2013 US Current Activity Index (CAI) consistent with some growth moderation in March US real GDP growth, actual and implied by US CAI, in % 6 4 2 0 2 4 -6 -8 -10 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13 — Real GDP quarter-over-quarter annualized in % (actual) — Real GDP annualized in % (implied by US CM) Note: The US Current Activity Index (CAl) is a composite of 25 growth indicators that correlate strongly with real GDP growth. Source: Bloomberg, UBS; as of 8 April 2013 For further information please contact US economist Thomas Berner, Please see important disclaimer and disclosures at the end of the document. 10 EFTA01089629 Key financial market driver 3 - China growth outlook Key points • We expect stable Chinese growth of 8% with downside risks this year. • Stable growth and low inflation may delay the expected tightening measures in the near term. • Inflation will rise only gradually and could trigger more neutral monetary policies later this year. CIO view (Probability: 70%*) Stable growth • We expect stable Chinese growth in the coming quarters. New starts in investment have been on the rise since the government reshuffle and the start of the construction season in April. Consumption is likely to recover due to the fading influence of government anti-corruption and frugality campaigns. The robust total social financing growth (TSF, a measure of total credits) in recent months should create more economic momentum as well. That said, given the disappointing performance in 1Q13 and the slow progress in economic reforms, we see downside risks to our full- year GOP growth forecast of 8%. • On the policy front, we believe stable growth and low inflation may delay the expected tightening measures in the near term. A number of key cities have announced details of local property tightening measures in response to the "national five measures" first released by the State Council in February. Overall, the local execution details are more relaxed than expected, with the exception of Beijing, which saw higher home price increases this year. We continue to expect a targeted tightening in tier one and two cities, which should have a limited impact on the economy. • On the credit/liquidity side, the new rules on wealth management products will improve regulatory oversight and sustain long-term financial development. The extent of the new regulatory measures will still depend on the growth outlook. We do not expect any interest rate or reserve requirement ratio hike in the coming six months, but the central bank will continue to use repo operations to manage relatively low interbank rates. • Inflation should not trigger immediate policy tightening in the near term, in our view, provided stable growth and low upstream price pressure prevail. We have trimmed our CPI inflation forecast for 2013 to 3% from 3.5%. Inflation will rise only gradually higher, which could trigger a more neutral monetary policy stance later this year. Positive scenario (Probability: 15%*) Growth acceleration • Economic momentum accelerates in 2013. This would require more substantial and effective fiscal, monetary and credit policy support from the government and possibly also a fast improvement in the Eurozone debt crisis and the US fiscal and debt issues. Negative scenario (Probability: 15%•) Sharp economic downturn • Another round of global financial stress or recession, likely due to the Eurozone debt crisis or a fiscal policy-induced downturn in the US, would weigh on Chinese exports and investments. • Despite soft aggregate demand and economic activity, residential property prices and/or consumer prices rise rapidly, which constrains policy maneuverability and its effectiveness in stimulating economic growth. • A major crackdown on shadow banking tightens liquidity and credit conditions and hence depresses growth. Key dates 08 May 10-15 May 13 May Trade data (April) New bank loans, total social financing, money supply (April) Industrial production, fixed asset investment, retail sales (April) The potential deceleration in TSF growth should not detract from economic growth :•:44 :•, :•: :-Nr• - ::• Source: Bloomberg, UBS; as of April 2013. Total social financing includes credits outside of the banking sector Investment, especially in infrastructure and property, will continue to drive growth • 4r4S Ar-06 44,47 :,nee 1M-09 4r-10 u.,.' ion.12 4,13 -Sea eve eatterrent ,—IrMistucture 1/2.4ntlact-crc Source: Bloomberg, UBS; as of April 2013 Note: Past performance is not an indication of future returns. • Scenario probabilities are based on qualitative assessment. For further information please contact OO analysts Gary Tsang, Glenda Vu, and Patrick Ho, Please see important disclaimer and disclosures at the end of the document. 11 EFTA01089630 Section 2 Asset class views UBS EFTA01089631 Section 2.A Asset class views Equities 4 UBS EFTA01089632 Equities overview Global equity markets - Key points • We recommend an overall overweight allocation in equities (see summary on slide 3). • We are keeping our preference for US equities. Company earnings keep moving higher. Despite some volatility in recent economic data domestic demand is holding up solidly, underpinning revenue growth. With the labor market recovering only gradually wage pressure remains muted. Thus, margins hold up well as the Q1 earnings season shows. • We are maintaining our neutral stance on Eurozone equities. Value is attractive compared to global equities, but economic growth and therefore earnings dynamics remain relatively weak. • We have a neutral stance on emerging market equities. Corporate earnings have remained depressed lagging especially the dynamics in the US and Japan. Economic data in key countries has failed to show an acceleration. The earnings weakness is balanced by attractive valuations. • We prefer Japanese equities relative to global equities. The bold monetary policy easing announced by the Bank of Japan at the beginning of April is expected to lead to further rises in Japanese risk assets. The sharp drop in the yen since autumn last year supports strong earnings growth. • We are keeping a cautious position on Canadian equities. Slowing loan growth keeps Financials' margins under pressure. The recent slump in the gold price caps the earnings upside of mining companies. Oil price weakness is a headwind for the energy sector which comprises a quarter of Canada's market capitalization. • We remain neutral on Australian equities. The earnings dynamics of Australian companies continue to lag those of other markets. While the market is expensive relative to global equities investors like its high dividend yield. • We are neutral on Swiss equities. We like the solid earnings generation and sound balance sheets of Swiss companies. The market is already trading at a premium to global equities. • We are keeping a neutral view on UK equities. While recent currency weakness supports earnings, the fall in commodity prices provides a headwind with Energy and Materials representing 30% of the market capitalization. The market currently trades at a slightly higher discount to global equities than it did over the last ten years. • We have a preference for the Consumer Discretionary sector. It should benefit from solid consumer demand in major countries. Revenue and earnings growth should continue to be superior driven by increased consumer spending in EM which we view as structural. The current macro environment favors the high-end consumers. • We are overweight the IT sector globally. While current price momentum is weak, the valuation is very attractive and cash flow generation is strong. We think IT should benefit from increased corporate and consumer spending. • We are overweight Consumer Staples and Healthcare which offer superior and long-term earnings growth with low volatility and high free cash flow generation. Both sectors have strong balance sheets, and attractive dividend yields as well as dividend growth prospects. Within Healthcare, we prefer European companies over US ones. • We have an underweight position in Telecoms and Utilities where revenue growth is weak and the earnings outlook muted. While pricing/margin pressure is high for telecoms, utilities suffer from a tough business environment (weak demand, regulatory pressure, and lower power prices). • With expected gradual improvement in leading indicators and early signs of a better global macro-economic environment, Industrials should benefit. However, we remain neutral as the current sector valuation is fair. • Despite some headwinds (e.g., regulatory risks, low interest rates) in major regions, earnings trends for Financials are improving. We have neutral stance globally. • We are neutral on Materials and Energy. Free cash flow yield is relatively low and margins are under pressure. Preferences (six months) underweight Equities total neutral cerv.eight t 2 g USA Canada EMU 2 UK W Switzerland a. Australia Hong Kong Japan Singapore 2 Global EM &LP On S) ■new geld Note: Preference in hedged terms (excl. currency movement) Sector preferences within global equity markets Current most preferred sectors Cons Discretionary Consumer Staples Health Care IT Source: UBS Current least preferred sectors Telecom Utilities For further information please contact CIO asset class specialists Markus Ir nga rtinger, or Carsten Schlufter, Please see important disclaimer and disclosures at the end of the document 14 EFTA01089633 US equities Preference: overweight 5&P 500 (24 April): 1,579 (last publication: 1,559) UBS view S&P 500 (six-month target): 1,625 • We are maintaining our preference for US equities relative to other developed equity markets. The US economy is forecast to expand at a solid pace even if the strong economic dynamics of the first quarter is unlikely to last in coming months. The recovery in the housing market keeps supporting the domestic economy. • The unemployment rate remains high, keeping wage pressure low. By keeping costs under control firms are forecast to hold up margins in 2013 at historically high levels. • We continue to forecast solid earnings growth of 5-7% for 2013 due to a mix of positive revenue growth and some margin expansion. • The Fed's pro-growth monetary policy stance is a clear advantage for the local equity market. We expect the bond buying by the Fed to continue, supporting risk assets. • US equities are forecast to gradually advance with earnings growth. US equities currently trade at about 15.0 times realized earnings. We foresee some further revaluation upside to slightly above 15 times by year-end. 21 Positive scenario S&P 500 (six-month target): 1,750 • Accelerating US and global economy reduce risks to company earnings. Investors begin to shift funds into more cyclical sectors such as Industrials, IT 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 16x. SI Negative scenario S&P 500 (six-month target): 1,325 • The US and global economy slide into a recession; failed debt ceiling negotiations might add additional drag. Given such an outcome, corporate earnings would fall over the coming 12 months, and we would expect risk aversion to rise sharply. We would also expect the P/E multiple to contract towards 12.7x trailing earnings. Note: Scenarios refer to global economic scenarios (see slide 8) What we're watching Business sentiment Labor market The Fed Earnings season Why it matters The ISM is the key indicator for US manufacturing and services. Key dates: 1 May, ISM manufacturing; 3 May, ISM non-manufacturing Improvement in the labor market supports stronger consumption. Key date: 3 May, US labor market report for April Hints on its monetary policy stance influence equities. Key date: 1 May, FOMC rate decision Earnings reporting season for Q1 2013: About 219 companies are still reporting from 29 April onwards. Recommendations Tactical (six months) • We trim our exposure to cyclical companies by downgrading Materials to neutral but remain overweight Industrials and IT, which should benefit from low valuations and a moderate pickup in global economic activity. • We raise Consumer Discretionary to overweight in order to gain more exposure to improving US housing and emerging market consumer growth. • We remain cautious on Utilities, Healthcare and Telecoms, where valuations have been pushed to lofty levels and the risk / reward is unattractive. Strategic (one to two years) We like medium-sized US companies, which are more exposed to the US domestic economy than large-sized companies and should post good longer term earnings growth. Current most preferred sectors Industrials ft Materials Current least preferred sectors Health Care Telecom Utilities Source: UBS Note: Past performance is not an indication of future returns. For further information please contact 00 asset class specialist Markus Irngartinger, Please see important disclaimer and disclosures at the end of the document 15 EFTA01089634 Eurozone equities Preference: neutral Euro Stoxx (24 April): 271 (last publication: 274) UBS view Euro Stoxx (six-month target): 277 • We are maintaining a neutral stance on Eurozone equities. Weak earnings growth is balanced by attractive valuation. • While the sovereign debt crisis keeps lingering, risks have been clearly reduced through ECB's conditional bond- buying program (OMT) (see slide 9). • Further support by the ECB through a rate cut seems likely after the recent deterioration in leading economic indicators. • As Spain has major refinancing needs this year, problems in issuing bonds could weigh on Spanish equities. However, the OMT is clearly limiting downside risks. • Trailing earnings of Eurozone companies still do not show signs of recovery. The recession in large parts of the Eurozone poses a difficult environment for companies. Earnings dynamics are therefore lagging other regions - especially the US. • Consensus earnings growth expectations for 2013 (bottom-up) have moved up to 8% year-over-year for the Euro Stoxx companies on aggregate. This increase in the growth rate stems from a lower base for comparison as realized earnings for 2012 came down further. Still, we only forecast 3% to 5% earnings growth in 2013. 21 Positive scenario Euro Stoxx (six-month target): 330 • Global economic growth reaccelerates and Eurozone growth starts to recover, enabling mid-single-digit earnings growth over the next six months. The trailing P/E ratio could re-rate to close to 15x from the current reading of 12.7x. 41 Negative scenario Euro Stoxx (six-month target): 200 • Recession and the debt crisis lead to renewed market pressure. However, downside risks due to the debt crisis have become less severe since the ECB has put its bond-buying program (OMT) in place. • Earnings could fall about 5% to 10% from current levels in the coming six months, and the trailing P/E ratio could drop to a level of 10.5x over a six-month period. Note: Scenarios refer to global economic scenarios (see slide 8) What we're watching Why it matters Growth indicators Economic growth is important to avoid a flare-up of the debt crisis. Key dates: 1 May, final PMI manufacturing, EMU; 3 May, final PMI services, EMU; 23 May, preliminary PMI manufacturing and services, EMU; 24 May, Ifo business sentiment index, Germany Policy action Decisions by European politicians and the ECB affect the course of the debt crisis. Key date: 2 May, ECB interest rate decision Recommendations Tactical (six months) • We reiterate or overweight on Consumer Staples and Healthcare, which offer good free cash flow generation and solid balance sheets. Earnings and dividends should continue to grow while dividend yields are attractive. • We continue to like Consumer Discretionary as we see evidence of strengthening global growth in the second half of the year, which should support sector earnings. • We confirm our underweight on Materials as valuations are too high. • We are negative on Utilities and Telecoms with earnings trends negative, balance sheets stretched and dividends at risk. Strategic (one to two years) • We have a preference for stocks paying high- quality dividends. • We like companies with high revenue and earnings exposure to faster growing emerging markets. Current most preferred sectors Cons Discretionary Consumer Staples Health Care Current least preferred sectors Materials Telecom Utilities Source: UBS Note: Past performance is not an indication of future returns. For further information please contact CIO asset class specialists Markus lrngartinger, and Carsten Schlufter, Please see important disclaimer and disclosures at the end of the document 16 EFTA01089635 UK equities Preference: neutral FTSE 100 (24 April): 6,432 (last publication: 6,433) UBS view FTSE 100 (six-month target): 6,515 • We are maintaining our neutral stance on UK equities. Earnings are not falling anymore. The stabilization over the last three months in the earnings dynamics is broad based across sectors with especially Financials and Healthcare seeing improvements. • The recent weakness in the British pound supports corporate earnings as FTSE 100 companies generate over 70% of earnings overseas (translation effect). • We see overinvestment in the mining industry as a structural headwind to earnings for the Materials sector. Short- term, the recent fall in commodity prices weighs on earnings of Materials companies, which comprise about 12% of the market capitalization. • Earnings dynamics in the Energy sector - the second largest sector in the UK - are lackluster. Due to a 15% drop in the Brent oil price since February the earnings picture is not expected to improve over the next months. • UK equities offer a relatively high dividend yield, and the P/E multiple of 12.4 times realized earnings is below the P/E of global equities. However, UK equities have traded at such a discount to global equities for most of the past 10 years. The cheapness of UK equities is balanced by a relatively weak earnings outlook. We keep a neutral stance. 71 Positive scenario FTSE 100 (six-month target): 7,300 • A rapid strengthening in global growth and recovering demand from emerging markets leads to fast-rising commodity prices, helping the Energy and Materials sectors lead the market higher. The market could re-rate to a P/E multiple of 13.5x, and we would expect earnings growth of close to 10% over 12 months. Negative scenario FTSE 100 (six-month target): 5,025 • A global recession drags down UK earnings by 15% to 20% over 12 months. The market's traditionally defensive characteristics would only partly offset its strong exposure to commodity -related sectors. We would expect the trailing P/E multiple to drop toward 10.5x. Note: Scenarios refer to global economic scenarios (see slide 8) What we're watching Why it matters Growth indicators Commodity prices Policy action Business survey indicators and consumer spending data provide information on economic developments in the UK. Key dates: 1 May, PMI manufacturing; 3 May, PMI services Energy and Materials together comprise about 3O% of the UK market. Developments in commodity prices affect earnings estimates. Loose monetary policy by the Bank of England supports equities. Key date: 9 May, Bank of England policy meeting Recommendations Tactical (six months) • Dividends offer an attractive real income stream in a low-yield environment. We continue to highlight our preference for companies with high-quality dividends, given the recent decline in government bond yields. In our view, those companies offering sustainable well covered dividends along with the potential for dividend growth will outperform. • We like companies with strong sales exposure to the higher growth regions, like the US and emerging markets. Strategic (one to two years) The UK's dividend yield of close to 4% will continue to look attractive to income- seeking investors. • Companies with pricing power remain a preferred theme. UK market trades at a PIE discount, based on realized earnings 24 21 Is 15 12 9 2003 2006 2009 2012 — ME 100: realized PI — A.CCl World: realized P1 Source: Thomson Reuters, UBS; as of 26 April 2013 Note: Past performance is not an indication of future returns. For further information please contact 00 asset class specialist Markus kngartinger, Please see important disclaimer and disclosures at the end of the document 17 EFTA01089636 Swiss equities Preference: neutral SMI (24 April): 7,860 (last publication: 7,848) UBS view SMI (six-month target): 8,000 • We are neutral on Swiss equities relative to global equities. Swiss companies are internationally well diversified, with almost two-thirds of revenues generated in the US and emerging markets. This provides a basis for solid revenue and earnings growth, despite challenging economic conditions in Europe. • Swings in global manufacturing activity or commodity prices affect Swiss companies' earnings less than those of companies in other countries because the Consumer Staples and