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CIO WM Global Investment Office
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UBS CIO Monthly Extended
November 2012
Published
25 October 2012
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.
Table of Contents
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Section 1 Base slides 2
Section 2 Asset class views 11
2.A Equities 12
2.B Fixed income 22
2.C Foreign exchange 29
2.D NTAC: Commodities, Listed real estate, Hedge funds
and Private equity 33
1
Section 1
Base slides
Summary
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"Global growth
is showing
broad-based
signs of
improvement."
�
�
�
�
�
Economy
Global growth is showing broad-based signs of improvement, supported by decisive
monetary policy from the world's major central banks. In the US, the housing market
recovery continues and the labor market remains on a modest uptrend. This has helped
improve the sentiment of US consumers, and consumption remains the most important
contributor to US GDP growth. Growth has also begun to pick up in key areas of the
emerging markets, including China and Brazil. While the Eurozone economy remains weak,
we expect Q3 2012 to mark the bottom, and that growth will begin to get "less bad" from
Q4 2012.
Equities
Equity markets have been supported by central bank action and the recent improvements
in economic data. Our preferred markets remain the US and Emerging Markets (EM).
Investor funds have started to flow back into EM, as economic data is improving and
inflation remains under control. Canada and Australia remain our least favored regions
due to falling earnings.
Fixed Income
US high yield bonds remain supported by strong corporate fundamentals, modest
economic growth, and the broad demand for yield-generating assets. Given this, we see
potential for further spread tightening. Meanwhile, benchmark rates are expected to rise
gradually on better economic data, while short rates remain ultra-low. While investment
grade corporate bond spreads are approximately fair value, we continue to view their
absolute yields as attractive.
Commodities
We keep a neutral stance on commodities. Increased global liquidity has pushed prices up
over the last few months, however, for a more sustained price increase we likely need to
see further evidence of an acceleration in global growth.
Foreign Exchange
We remain underweight the Japanese yen. The Japanese economy continues to weaken
against its peers, leading to rising pressure for the Bank of Japan to engage in further
quantitative easing. We have closed our preference for the Canadian dollar following its
recent strength, and therefore close our offsetting short CHF position.
Please see important disclaimer and disclosures at the end of the document.
3
Cross-asset preferences
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Most preferred
Least preferred
Portfolio weights
Equities
Fixed income
• US
• Western winners from EM
growth
• High quality dividend yields
• Event-driven and relative value
hedge funds
• Natural gas growth gainers
• US high yield
• Global investment grade credit
• EM corporate bonds
• Event-driven and relative value
hedge funds
• Canada
• Australia
• Developed market
government bonds
Commodities
5%
Real Estate
5%
Hedge Funds /
Private Equity
10%
Equities USA
10%
Liquidity
10%
High Grade
Bonds
7%
Inv Grade
Corporates
Bonds
9%
High Yield
Bonds
6%
Emerging
Markets Bonds
3%
Equities
Equities Other
Europe
23% EmMa Equities
6%
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.
Foreign
exchange
• GBP
• Emerging markets (�)
• JPY
Commodities
�
Recent upgrades
�
Recent downgrades
4
Please see important disclaimer and disclosures at the end of the document.
Recommended tactical asset allocation
Tactical asset allocation deviations from benchmark*
Currency allocation
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underweight
neutral
overweight
underweight
neutral
overweight
Cash
USD
Equities total
US
Eurozone
EUR
GBP
Equities
UK
Japan
Switzerland
EM
JPY
CHF
SEK
Other
NOK
Bonds
Bonds total
Government bonds
Corporate bonds (IG)
High yield bonds
CAD
NZD
AUD
EM bonds (USD)
Commodities total
new
old
Commodities
Precious metals
Energy
Base metals
Agricultural
Listed Real Estate
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 slightly
deviate from the "unconstrained" asset allocation shown above, depending on
benchmarks, currency positions and for other implementation considerations.
Source: UBS CIO WM Global Investment Office – as of 25.10.2012
5
Please see important disclaimer and disclosures at the end of the document.
Preferred themes
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�
�
�
�
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 (sourced from existing equity
holdings)
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.
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
4%.
� 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 selected 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 540 basis points still price in a more dire economic outcome
than we expect. Historically, US high yield bonds have delivered similar
returns as 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 mid single digit returns over the next 6
months. Senior loans are exposed to similar positive fundamentals, and
offer an attractive, floating rate alternative to US high yield.
�
�
The place to be in Hedge Funds
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 currencies: An underappreciated asset class (sourced from
government bonds – CIO UW)
The currencies of emerging 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 welldiversified
portfolio. We believe that this is especially relevant now that
the developed world is settling into an extended period of very low
interest rates.
= New theme
Please see important disclaimer and disclosures at the end of the document.
6
Global economic outlook – Summary
Key questions
• What are the prospects for the global economy in 4Q 2012 and 1Q 2013?
• What are the risks that the US economic recovery will falter in the near term?
• When is the European economy likely to emerge from contraction?
• What is the near-term outlook for the Chinese economy?
CIO View (Probability: 75%*)
Sluggish expansion
• Global economic activity has shown signs of improvement over the last month – albeit from a low base. Importantly,
the JPM global composite PMI (a survey measuring economic activity) rose significantly to 52.5 in September from 50.9
in August. The increase was driven by improvements in both manufacturing and service sector activity. Thus, the
global manufacturing PMI rose marginally to 48.9 from 48.1, while the services PMI jumped two index points to 54.
• Geographically, improvements were concentrated in the emerging markets and the US. Indeed, we think that
downside risks in the US have diminished lately and we expect the moderate recovery to continue ahead. Chinese data
are still mixed, but we think that an improvement in the economic momentum is in the cards in 4Q. In the EMU and
UK, recent PMI surveys deteriorated but we still expect the EMU to improve gradually in coming quarters. Overall, we
expect the moderate improvement in global economic activity to continue ahead. A key driver here is the latest wave
of ultra-expansionary monetary policy. Downside risks have diminished somewhat in recent months. We expect Greece
to stay in the euro this year and sign a new memorandum in November. In the US modest fiscal tightening is expected
with the Fed mitigating downside growth risks. The risk of an idiosyncratic slowdown in Asia has declined as the latest
Chinese data confirms that the economy has bottomed."
• Global consumer price inflation peaked in summer 2011 and has since fallen gradually. Base effects and rising
commodity prices since June may push up the global headline rate of inflation in coming months.
� Positive scenario (Probability: 10%*)
Return to long-term trend
• The Eurozone crisis abates. Financial market conditions recover, mitigating the drag from fiscal austerity.
• Growth in Western Europe turns decisively positive by early 2013 and the US economy grows above trend.
� 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
sharp fiscal contraction in the US, and 3) a sharp deceleration of the Chinese economy. Each of these risks could
precipitate a significant downturn of the global economy.
Key dates
TBA
Troika report on Greece
2 Nov Nonfarm payrolls and unemployment rate for October
6 Nov US presidential and congressional elections
8 Nov The 18th National Congress of the Communist Party of China
22–23 Nov European Council
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Global growth expected to be around 3% in
2012 and 2013
Real GDP growth in % Inflation in %
2011 2012F 2013F 2011 2012F 2013F
Americas US 1.8 2.1 2.3 3.1 2.1 1.7
Canada 2.4 2.0 2.3 2.9 2.0 2.3
Brazil 2.7 1.5 4.5 6.5 5.4 6.5
Asia/Pacific Japan -0.8 2.3 2.0 -0.3 0.0 0.3
Australia 2.1 3.7 3.2 3.4 1.7 2.5
China 9.3 7.5 7.8 5.4 2.8 3.6
India 6.5 5.5 6.5 8.0 7.5 7.0
Europe Eurozone 1.5 -0.4 0.2 2.7 2.4 1.9
Germany 3.1 0.9 1.1 2.5 1.7 1.5
France 1.7 0.2 0.4 2.1 2.0 1.3
Italy 0.5 -2.4 -0.2 2.9 3.3 2.7
Spain 0.4 -1.6 -1.7 3.1 2.4 2.7
UK 0.9 -0.3 1.0 4.5 2.7 2.3
Switzerland 1.9 1.1 1.4 0.2 -0.5 1.2
Russia 4.3 3.8 3.7 8.5 5.1 6.8
World 3.2 2.7 3.1 3.9 2.9 3.0
Source: UBS CIO, as of 24 October 2012
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.
Services and manufacturing diverging
(Global PMIs, 3-month moving averages)
65
60
55
50
45
Manufacturing Services
40
Composite No-change line
35
08 09 10 11 12
Source: Bloomberg, UBS CIO, as of September 2012
Note: Past performance is not an indication of future returns.
*Scenario probabilities are based on qualitative assessment.
For further information please contact CIO economist Dirk Faltin, dirk.faltin@ubs.com and CIO economist Ricardo Garcia, ricardo-za.garcia@ubs.com
Please see important disclaimer and disclosures at the end of the document.
7
Key financial market driver 1 –
Eurozone crisis
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Key questions
• What do we expect from the economy and ECB policy?
• Can Spain and Italy continue to tap the primary market if they ask for a support program?
• How much more support will Greece receive and will it be able to stay in the Eurozone next year?
CIO View (Probability: 70%*)
Austerity and weak growth
• We think the Eurozone economy troughed in 3Q. We expect flattish growth in 4Q 2012 and 1Q 2013 (in line with
consensus). Beyond this, uncertainties regarding the debt crisis and continuing fiscal austerity efforts will likely keep
the pace of recovery subdued. The ECB is still in easing mode but after announcing a conditional bond purchasing
program, it would take a marked worsening of the debt crisis and/or a worsening of economic data to trigger any
further policy action.
• There is political pressure on Spain to apply for official financial support (OMT by the ECB and direct support from
the EFSF/ESM). However, the government may hesitate until market pressure rises and/or clear political benefits are on
offer. We think that Italy will have to apply for an aid package similar to Spain’s. We see a high probability of Spain
being downgraded to junk by at least one rating agency.
• OMT bond purchases in the secondary market will focus on maturities of up to three years and countries will be
expected to maintain their funding profiles by also issuing longer-dated bonds. Hence, longer yields should stay
elevated as bondholders remain concerned about countries' ability and willingness to implement necessary reforms,
and about the de-facto subordination to ECB holdings and official loans. The central banking supervision at the ECB is
unlikely to be ready by January 2013, meaning that direct bank recapitalization through the ESM remains unavailable.
• We think Greece will not exit the euro in 2012 but will sign a new memorandum by November, although further
delay is possible. We think that Greece's failure to meet targets may trigger a cut-off from funding by early 2013 and
a possible gradual exit later. Portugal and Ireland should remain on track with their bailout packages, Cyprus will
likely get a new package and Slovenia may ask for help soon.
� 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 complies with the new austerity plans and market confidence is restored.
� Negative scenario (Probability: 15%*)
Major shock
• Major shocks include Spain and Italy being fully cut off from bond markets, i.e. requiring all new funding through
EFSF/ESM/IMF loans, with European rescue funds only able to cover them until the end of 2013; resistance from core
countries against the ECB program and further support; a Portuguese default; a Greek euro exit before the end of
2012; or a major external shock.
Key dates
TBD
Troika report on Greece
8 Nov ECB press conference
12 Nov Eurogroup meeting
15 Nov Eurozone GDP 3Q: first estimate
22 Nov Eurozone composite purchasing managers index
22–23 Nov European Council
Purchasing managers indices point to
ongoing contraction in 3Q
65
60
55
50
45
40
35
30
25
Source: Bloomberg, UBS, as of October 2012
Yield of Spanish and Italian 10-year bonds
over German Bunds (in bps)
700
600
500
400
300
200
100
07 08 09 10 11 12
Manufacturing Services
Composite No-change line
0
03/2011 06/2011 09/2011 12/2011 03/2012 06/2012 09/2012
Italy
Spain
Source: UBS, Bloomberg, as of 16 October 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 economic outlook
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Key questions
• Is the nascent growth recovery sustainable? Will the Fed stimulus boost growth?
• How will the election result change fiscal policy deliberations?
• Can politicians find an agreement to avoid a sharp fiscal contraction in early 2013 (i.e. the "fiscal cliff")?
CIO View (Probability: 70%*)
Moderate expansion
• The economy stays on a moderate growth path but the unemployment rate comes down only very gradually – the
September report exaggerated the pace of improvement. Core personal consumption expenditure (PCE) inflation stays
slightly below or close to the Federal Reserve's target of 2%. UBS forecasts real GDP growth of 2.0% in 3Q 2012
(consensus: 1.8%) and 1.6% in 4Q 2012 (consensus: 1.9%). The Fed has added considerable stimulus: it extended
Operation Twist and its interest rate forward guidance, indicated that it will stay highly accommodative even after the
recovery strengthens, launched an open-ended agency mortgage-backed securities (MBS) purchase program of USD
40bn per month, and shows a strong easing bias tied to the state of the labor market. The Fed actions effectively
mitigate downside growth risks, but they are unlikely to dramatically boost growth.
• In the elections, Republicans will likely lose seats in the House on a net basis but retain a majority; we expect them
to be even with Democrats in the Senate. Obama will likely retain the White House. Such an electoral outcome would
prolong the existing gridlock between Republicans and Democrats.
• Due to the ongoing political gridlock, we expect modest fiscal tightening. The government will likely let
unemployment benefits phase out and payroll tax cuts expire, but postpone income tax hikes and sequester spending
cuts. Such a decision would lower the federal deficit by 0.7% of GDP, with a likely lower real GDP growth impact as
households could buffer the income loss with lower savings.
� Positive scenario (Probability: 10%*)
Strong expansion
• Propelled by expansive monetary policy and a fading Eurozone crisis, growth accelerates persistently above 3.0%.
This leads to higher inflation and the Fed responds by halting QE3 and raising rates sooner.
• The better economic outlook raises the odds of an Obama reelection and makes it harder for Republicans to gain
seats in Congress. Faster-rising tax collection and 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: 20%*)
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 much further. The Fed massively purchases agency
MBS and Treasuries under its QE3 program.
• The debt limit is reached earlier and the Treasury runs out of money before year-end. Political gridlock becomes
dysfunctional, thus sending the country over the "fiscal cliff," with fiscal policy tightening by
USD 607 billion (3.7% of UBS estimate of 2013 GDP) in 2013. The US credit rating is downgraded.
Key dates
30 Oct Conference Board consumer confidence
1 Nov ISM manufacturing purchasing managers index for October
2 Nov Nonfarm payrolls and unemployment rate for October
6 Nov US presidential and Congressional elections
US growth to pick up throughout 2013
US real GDP and its components, quarter-over-quarter
annualized in %
8%
6%
4%
2%
0%
-2%
-4%
-6%
-8%
-10%
-12%
Q1
2006
q/q annualized
Q1
2007