(See report).

Transcription

(See report).

UBS global outlook
Wealth Management Research
December 2010
2011
A fractured world
Global economy divided in 2011
Equities our preferred investment
New rules: No major currency should be considered safe
New rules: Reevaluation of “risk-free” within fixed income
Look beyond traditional investments
ab
Content
UBS global outlook 2011
This report has been prepared by
UBS AG. Please see the important
disclaimer at the end of the document.
Past performance is not an indication of
future returns. The market prices
provided are closing prices on the
respective principal stock exchange.
Chief Economist and Global Head of
Dr. Andreas Höfert
Head of Investment Strategy
Mark Andersen
Key investment views �� 5
Investment outlook �� 6
Equities: The place to be in 2011�� 11
Currencies: A search for safety�� 14
Fixed income: The traditional rules no longer apply�� 17
Non-traditional asset classes �� 19
Financial market performance�� 21
Selection of research publications�� 23
Publisher
UBS AG, Wealth Management Research,
P.O. Box, CH-8098 Zurich
Editor in chief
Mark Andersen
E-mail: [email protected]
Editor
Simon Taylor
Editorial deadline
19 November 2010
Project management
Valérie Iserland
Desktop
WMR Desktop
Translation
24 Translate, St. Gallen, Switzerland;
CLS Communication, Basel, Switzerland
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Printer
Druckerei Flawil AG, Flawil, Switzerland
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Published in English, German, Italian,
French, Spanish, Portuguese, Chinese
(traditional and simplified), and Russian
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SAP No. 82251E–1002
2
Editorial
Dear reader,
Looking back at 2010, we are proud of our investment views. We have been calling
for a rise in corporate bond and equity prices, the need for an investment focus on
emerging markets and the rising Asian consumer demand, and a careful stance on
investments into Europe’s periphery. What we did not expect – and what should
keep investors on their toes in 2011 – has been the extraordinary expansionary
tactics deployed by the world’s leading central banks, leaving us with unsustainably
low interest rate levels.
Andreas Höfert
Mark Andersen
The scale of governments’ issuing – and purchasing – of their own debt is unprecedented in peacetime, and the pace is set to continue in 2011. The idea is to spur
investment and spending via low interest rates – but the long-term effects are not
clear. Alan Greenspan arguably laid the groundwork for the US housing market
bubble with the historically low interest rates that followed the 2001 recession.
Whether today’s central bankers are repeating that mistake remains to be seen.
Currently, cheap credit is being channelled towards the world’s growth regions in
emerging economies, fanning the potential for a future bubble. But we are not
there yet. Prices have not yet overshot despite increasing investor interest and
capital flows. We think emerging markets offer rewarding investment opportunities
in 2011.
The aftermath of the economic crisis has revealed structural weaknesses within
some countries that previously were considered rather strong, while other economies proved surprisingly resilient. Governments and central bankers across the globe
are likely to face some tough political and economic choices, with each likely to
cross over into each other’s territory, with growing international trade and currency
tensions as a consequence.
In the UBS global outlook 2011, we argue that no investment should be considered
“safe” as inflation and currency weakness for indebted nations loom. Investors need
to reorient their understanding of “safe” fixed income investments, as many are
now anything but. In the end, when the facts change, investment strategies should
change as well. What else should they do?
All the best for 2011
Andreas Höfert
Global Head
Mark Andersen
Head of Investment Strategy
3
Key investment views
“Investors should not just continue straight ahead in
2011. A new economic environment calls for a new
investment route.”
Global economy divided
in 2011
The global economy is becoming
more fractured – not down the
traditional lines of West versus East
or Developed versus Developing,
but the strong versus the weak.
Record deficit levels, previously
unheard of stimulus measures and
uneven levels of economic growth
will force many countries to make
hard political choices to shape the
investment environment in 2011.
Equities our preferred
investment
Equities are well-positioned for a
year of accommodative central
banks, are able to weather the
risks of inflation better than most,
and offer attractive value going
into 2011. Companies that sell
products or services, generate cash
and have profit margins are
unlikely to go out of fashion soon.
We favor equities in the larger
emerging markets (BRICs) and
Core Europe.
New rules: No major currency
should be considered safe
“It’s the economy stupid” was
once a popular slogan during the
US presidential campaign in 1992,
and is the economic reality for
currency investors. The traditional
Big Four currencies (USD, EUR,
GBP and JPY) will be challenged in
2011. We recommend diversification, and many investors may wish
to consider the currencies of
commodity producers and emerging markets.
Look beyond traditional
investments
With global economic imbalances
and inflation on the horizon, we
think investors should look beyond
traditional equities and bonds.
Investments in commodities,
hedge funds and real estate could
be appropriate, where suitable.
Such investments do have different
risks, but also different sources of
return.
New rules: Reevaluation of
“risk-free” within fixed income
The rules have changed within
fixed income – government bonds
are far from risk-free. Arguably,
the fracturing of the global
economy can be best seen in the
developments of bonds issued by
peripheral European economies.
We therefore prefer debt held in
countries with low public deficits
and healthy external balances –
with no respect to geography or
development classification – and
with a short to medium maturity.
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5
Investment outlook
A fractured world means treading
carefully in 2011
A general market recovery dominated 2010, at
least on the surface (see Fig. 1). However, in
2011, investors will need to dig deep to find
investments in a fractured world that will be
entering year four of the financial crisis. It will
be a year when politicians face a number of
tough decisions on issues shaping the economic and investment environment. Investors
are advised to seek a mix of attractively valued
equities – in specific areas – and “safer” bond
exposure in order to reap positive investment
performance in 2011.
Governments and central banks spent 2009
battling the aftermath of the worst global
financial crisis since the 1930s. This year should
have been a year of recovery and normalization. However, growth remained anemic for
many developed economies, with only the
developing world managing to take another
leap forward.
Whereas 2010 was another year of reasonable
returns for most investors, the investment
environment in 2011 is likely to be shaped by
difficult political choices. We see three major
“trilemmas” – a choice among three options,
where only two can have favorable outcomes
at the same time, and where something will
have to give. This is what we see as determining the investment environment for 2011.
Andreas Höfert
Chief economist, UBS AG
Mark Andersen
Strategist, UBS AG
This has consequences for the selection of
fixed income and currency investments, which
should be placed in stronger economies,
whereas equity exposure should continue to be
directed to the world’s stronger growth
regions.
The US is in a difficult place
Despite monetary and fiscal measures unheard
of in peacetime, the US recovery has been
rather dismal so far. The financial crisis has led
to an ongoing deleveraging of US households,
tighter regulations on financial intermediaries,
and ballooning US government debt – all of
which are likely to lead to significantly lower
growth rates for the US economy.
Fig. 1: Performance of main asset classes
Fig. 2: Global growth led by emerging economies
Annual total return in local currency and %
Real annual GDP growth and forecasts in %
10
Cash
Fixed
income
Cash
Inflation-linked (Global)
Global government bonds
Global corporate bonds
High-yield
Em. market bonds
Equities
Em. market equities
Global equities
NonListed real estate
traditional
Commodities
asset classes
Hedge funds
Jan–Nov 2010
2005–2009
(annualized)
6
4
0
–2
–4
1980
0
4
Note: As of 30 November 2010.
Source: Bloomberg, Thomson Reuters, BoA Merrill Lynch, UBS WMR
Past performance is not an indication of future returns.
Forecast
8
2
-4
6
If political uncertainties exist, some economic
certainties remain, as the gap between weaker
and stronger economies and their divergent
growth paths becomes more evident in 2011
(see Fig. 2). The US, for so long the engine of
world economic growth, is in the camp of the
weak economies, while China and its Southeast Asian neighbors are in the camp of the
strong economies, as are commodity exporters
like Canada, Australia, and Brazil. Meanwhile,
the fracture line between weak and strong
economies runs through Europe – with the UK,
France and the Mediterranean countries
struggling, while Germany, Switzerland, the
Benelux countries and Scandinavia are pulling
ahead.
8
12
16
1985
1990
World
Advanced economies
Source: IMF, UBS WMR
1995
2000
Emerging economies
2005
2010
2015
Investment outlook
In an attempt to solve lower growth rates and
stubbornly high unemployment, the US Federal
Reserve announced another round of purchasing its own debt (see Fig. 4). This program aims
to “artificially” lower interest rates for longerterm debt and thereby foster credit activity and
exports via a falling US dollar. While we doubt
that these doses of quantitative easing will
kick-start the US economy, one thing is clear:
Faith in the US dollar is diminishing. At the
same time, inflation risks are rising and gold
prices are likely to go higher as a consequence.
however, is likely to bite the consumer in the
tail via rising commodity prices, and investors
should pay attention to protecting portfolio
values from rising inflation and a falling dollar.
Investments into so-called “real assets” (e.g.,
equities, commodities and real estate) should
be sought after. Another consequence is that
US Treasury bonds should, at this stage, no
longer be considered a safe-haven investment,
and investors with large US exposure should
look for safer alternatives, for example, in
Canada.
We therefore think that the US is trying to
solve their current trilemma – pursuing a
balanced budget, buoyant consumer activity
and a trade surplus all at the same time – by
downplaying the value of the dollar. This,
Stick to the European core
The European debt crisis is not over yet and
financial markets are increasingly dividing debt
in the region into safe and unsafe as a consequence, and rightfully so (see Fig. 5).
Economy: Divergence between weak and strong
limited. More worryingly, some of the big
economies – first and foremost the US, but also
France, Japan and the UK – find themselves in
poor condition. At the other end of the scale,
Switzerland, Sweden, Germany and several
emerging economies look well prepared for the
challenging economic environment ahead.
Fig. 3: Divergence between weak and strong countries
Selected countries grouped according to expected fiscal and current account balance 2011
in % of GDP
Strong
1
–1
Budget deficit 2011
The divide between weak and strong
countries to dominate investments
in 2011, in our view
The aftermath of the economic crisis has
revealed structural weaknesses within some
countries that were previously considered
rather strong, while other economies have
proved surprisingly resilient. Two major areas
of concern over the last year were international trade imbalances and high fiscal deficits,
where a wide global divergence was observed.
To separate the weaker from the stronger
economies, we grouped selected countries
according to their expected current account
and fiscal balances for 2011. Figure 3 shows
the result of this analysis, where the size of the
bubbles represents the size of the respective
economy. Economies in the right upper part of
the graph can be considered strong, whereas
those in the lower left-hand corner are on the
weak side. Not surprisingly, European peripherals Portugal and Greece can be found at the
very bottom. However, as their economies are
small, the global impact should rather be
–3
–5
–7
Portugal
–9
Canada
Brazil
Mexico
Australia
India
Spain
France
US
UK
Korea Russia
China
Netherlands
Switzerland
Sweden
Germany
Japan
–11
–13
Weak Greece
–10
–5
0
5
Current account 2011
10
15
Developed markets
Emerging markets
Note: The size of the bubble reflects GDP in USD.
Source: IMF, Bloomberg, UBS
7
Investment outlook
Asian consumption on the rise
In Germany and other successful European
nations, export-fueled growth has now
spilled over to domestic demand, leading to
virtuous growth cycles. In Sweden and
Norway, like in Australia and Canada, this has
opened a new hiking cycle by the central
banks.
These economies could use higher interest
rate levels from the European Central Bank
(ECB) to cool growth – in stark contrast to a
still-depressed southern Europe, where even
a 1% ECB policy rate is too high. The ECB will
have to manage this situation cautiously, as
every rate hike could trigger further tensions
within the eurozone.
Investors based in Europe should in the meantime seek strategically safer investments in
German and northern European bonds and
equities, where balance sheets and domestic
consumers are strong. Switzerland remains a
safe-haven investment, and interest rates are
likely to increase during 2011.
Fig. 4: The US central bank remains on an expansionary
course
Fig. 5: European peripherals’ debt issues remain a major
source of concern
Base money in billion US dollars (UBS WMR estimates for 2011)
Additional yield over a German government bond
3,000
Forecast
2,500
2,000
8
6
1,500
4
1,000
2
500
0
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
US
Eurozone
Japan
Source: Thomson Reuters, UBS WMR
8
10
Feb 08
Greece
Portugal
Jun 08
Oct 08
Feb 09
Spain
Ireland
Jun 09
Oct 09
Feb 10
Jun 10
Oct 10
Investment outlook
The impossible trinity in Asia and other
emerging markets
China continues to pull ahead after successfully cooling down its economy in spring 2010,
and growth in Asia is likely to be solid as we
go forward. However, inflation pressures
could continue to mount, even though the
People’s Bank of China has surprisingly raised
interest rates. At some stage, Chinese monetary
policy will be confronted with the impossibility
of having no capital controls, a fixed exchange
rate, and an independent (and hence inflationfighting) central bank all at the same time.
Which of the three objectives will have to give
will be one of the most important questions for
2011. Brazil has already introduced capital
controls, and some Asian countries are starting
similar measures. In our view, given the objective of the 12th Five-Year Plan to reorient the
Chinese economy from export-led growth to
spur domestic demand, the ongoing real
appreciation pressures on the Chinese yuan will
be partly met by higher inflation and only partly
by letting the currency appreciate.
Investors should therefore seek their growth
exposure in emerging markets in a diversified
way, and to some extent also indirectly via
developed market companies with a strong
accent on Asia and Latin America, in particular.
2011 a year for equities
Asset flows during 2010 were mainly directed
out of cash into bond funds – within corporate
and emerging market bonds, in particular. For
2011, the game has changed. The upside has
become more limited for corporate and
emerging market bonds, as coupons will not
rise in the event of higher inflation rates, and
bonds are now trading closer to fair value. The
opposite is true for equities that still haven’t
unlocked their full valuation potential. In
addition, many sectors should be able to raise
Investment strategy: What’s in it for me?
Return outlook 2011: equity ahead of
credit this time
This was a year of considering investments
aimed at answering the question: Where can
I achieve returns ahead of the uninteresting
yields of government bonds?
Within fixed income, the answer was to add
credit risk to the portfolio, which generated
up to double-digit returns in the higheryielding corporate bond and emerging
market spaces. For 2011, there is still some
upside potential and we envisage reasonable
single-digit returns.
A difficult political environment leaves plenty
of risks for 2011. Therefore, we are keen to
highlight the uncertainty that always surrounds
return forecasts.
Fig. 6: A good year expected for equities, negative
outlook for government bonds
UBS expected returns for 2011 and historical return ranges
Government bonds
Historical return ranges
UBS expected returns for 2011
Cash
Corporate bonds
Emerging market bonds
High-yield bonds
Commodities
Listed real estate
Equity investors reaped returns in 2010 – but
investor interest remained muted, with net
asset flow into equities being modest at best.
We expect this to change in 2011, where
equities’ relatively attractive valuations, and
their inherent inflation hedge, should lead to
inflows from cash and bonds.
Developed market equities
Emerging market equities
–10
0
10
20
30
40
Note: Historical return ranges show +/– one annualized standard deviation from 2011
expected return, based on monthly returns from the past 10 years.
Source: Bloomberg, BoA Merrill Lynch, Thomson Reuters, UBS WMR
9
Investment outlook
dividends along with potentially rising price
levels. Therefore, companies with stable
earnings generation and attractive dividend
yields should be seen as an alternative to some
corporate and government bond investments.
The outperformance for 2011 is still likely to
be in the emerging market space, but risks
remain – as highlighted by recent moves to
counter high inflows and currency appreciation
in some countries. A diversified investment
approach in a challenging and ever-evolving
world should never be neglected. Exposure to
commodities, either via commodity funds or
investments into commodity-producing
companies, should be one source of diversification – as should private equity, listed real estate
and hedge fund investments where suitable, all
of which share a positive outlook for 2011.
2011 a year for equities
Fig. 7: UBS macroeconomic forecasts
Real GDP growth in %
2010F
2011F
2012F
Inflation in %
2011F
2012F
Interest rates
in %
3-month LIBOR
6 mths 12 mths
10-year govt. bond
6 mths 12 mths
Americas
US
Canada
Brazil
2.8
3.1
7.9
2.7
2.8
5.4
2.8
2.6
5.1
1.6
1.8
5.8
1.6
2.1
5.4
2.1
2.0
4.8
Asia/Pacific
Japan
Australia
3.5
3.4
1.4
3.8
2.0
3.4
–0.7
2.9
–0.3
3.0
0.4
3.0
Switzerland
0.50
1.00
2.00
2.25
10.0
9.0
9.0
3.3
4.3
4.0
Australia
5.25
5.50
5.50
5.75
India
Rest of Asia
9.0
5.3
8.0
4.3
8.6
4.3
9.2
2.7
6.0
3.2
6.8
3.2
Eurozone
Germany
1.8
3.3
1.9
2.2
1.9
2.0
1.9
1.4
1.8
1.6
2.1
1.7
France
1.7
2.0
1.9
1.6
1.8
1.7
Exchange rates
Italy
1.2
1.6
1.4
2.0
2.0
2.2
Spain
0.0
0.5
0.8
2.1
1.5
1.8
EURUSD
USDJPY
UK
1.6
2.3
2.2
3.3
2.7
1.9
GBPUSD
1.60
1.66
1.66
Switzerland
Russia
2.7
4.1
2.3
4.8
2.1
4.5
0.7
6.9
0.9
8.5
1.7
7.7
USDCHF
0.96
0.96
1.18
USDCAD
0.97
0.95
1.03
4.1
3.7
3.8
3.0
3.0
3.4
AUDUSD
0.96
0.96
0.70
China
Europe
World
Note: F = Forecasts as of 30 November 2010
¹ 7-day Interbank rate instead of 3-month LIBOR
2
Purchasing power parity
Source: UBS
10
2010F
US
Eurozone
0.30
1.00
0.50
1.50
3.00
2.75
3.25
3.25
Japan
0.20
0.30
1.20
1.40
UK
0.75
1.00
3.50
3.75
Canada
1.50
2.00
3.50
3.75
Sweden
China1
2.00
2.90
2.75
3.30
3.00
3.80
3.50
4.00
6 mths
1.35
85
12 mths equilibrium2
1.39
89
1.24
87
NZDUSD
0.73
0.71
0.58
USDSEK
6.59
6.33
7.57
USDNOK
USDCNY
5.63
6.45
5.47
6.25
7.06
n.a.
Equities
The place to be in 2011
Core Europe: not just driven by export
demand in 2011
As most austerity measures will show their
major impact in 2011, the growth divide
across Europe is likely to persist in 2011. We
would recommend focusing on economically
strong core eurozone countries like Germany,
where strong enterprise spending continues to
In 2010, three major themes emerged that
investors should continue to consider in 2011. fill the order books and earnings are expected
Firstly, the sovereign debt crisis in the eurozone to improve (see Fig. 9). In addition, the German
unemployment rate is at its lowest level since
reminded investors that Europe is not a
homogenous region. There is a divide between unification and personal income growth is
sound, which should support equity markets.
the economically strong Core Europe and
A further interesting segment is medium-sized
southern Europe, which is coping with austerity measures. Secondly, recent further monetary German companies – many are industrials with
stronger sales tilts toward Asia than the larger
policy easing by the US central bank and the
companies.
Bank of Japan implies low interest rates
through 2011. And, finally, companies – espeSwitzerland also falls into the category of
cially those with large sales exposure to Asia
having a strong economy. However, the Swiss
and Core Europe – reported strong earnings
index is heavily tilted toward healthcare
growth in 2010. Going forward, it will be
important for investors to focus on those areas companies, which offer low earnings growth.
The consumer staples sector benefits from
of sustainable earnings growth that did not
Asian consumer demand but is not cheap
become too expensive in 2010 (see Fig. 8).
anymore. As such, we expect Swiss equity
Conversely, it is also important to remain
cautious with respect to cheap stocks that offer market performance to be in line with global
equities.
no earnings growth – so-called value traps.
Global equities have performed solidly in
2010, particularly in emerging markets,
and this trend is likely to continue in 2011
on the back of rising corporate earnings
and accommodative central banks. We still
favor Germany and emerging markets.
Markus Irngartinger
Strategist, UBS AG
Lena Lee Andresen
Strategist, UBS AG
Kilian Reber
Analyst, UBS AG
Fig. 9: Improving 2011 earnings expectations for
Germany and emerging markets
Fig. 8: Attractive valuation of equity markets
P/E ratio based on consensus earnings forecasts bars indicate 20-year average
Consensus forecasts for earnings per share in 2011; normalized to 100 in Feb 2009
30
25
125
20
115
15
105
10
World
Em. markets
UK
USA
Switzerland
Sweden
Singapore
Japan
Hong Kong
85
EMU
0
Canada
95
Australia
5
Feb 09
World
US
May 09
Sep 09
EMU
Emerging markets
Jan 10
May 10
Sep 10
Germany
11
Equities
A special case is the UK equity market, which
we continue to recommend. Although the
economy will suffer from austerity measures,
70% of large-cap companies’ sales revenue is
generated outside the UK. In addition, the
market has a strong weighting in commodityrelated sectors, providing a good hedge against
inflation going forward.
US equities: focus on companies
benefiting from corporate spending
US equities are as a whole likely to perform in
line with global equities. We would recommend focusing on companies with international exposure benefiting from increased
corporate spending (see Fig. 10). This holds
particularly for the IT sector, which is also
attractive from a valuation perspective.
Emerging market equities: attractive
returns in 2011, but not everything a buy
With central banks in the developed world
keeping interest rates low for longer and high
growth continuing in emerging markets,
“cheap money” will keep flowing towards
superior returns in emerging markets in 2011.
While we deem emerging markets equities to
be attractive overall, not everything is a buy.
Asia will likely still see the strongest growth
and earnings potential in 2011. Having said
that, some markets have recently done so well
that investors might want to wait for cheaper
entry points. We recommend exposure to the
attractively valued BRIC countries (Brazil,
Russia, India, and China). The markets we are
less positive on include Indonesia, Malaysia,
and Hungary.
Latin America should closely follow Asia in
terms of growth and earnings potential, while
emerging Europe’s need to deleverage will
likely earn the region the last rank within
emerging markets for another year. Still,
growth and earnings are expected to improve
in emerging Europe in 2011.
While this is mainly good news, 2011 may also
bring new emerging markets capital inflow
taxes – most likely in Asian and Latin American
countries – which have the potential to
increase volatility and reduce returns in the
short term. We would therefore recommend
good diversification across and within emerging equity markets.
Equity sectors: It’s all about growth, but
not at any price
What is true of individual emerging markets
also holds for some sectors with good earnings
growth prospects. Certain sectors performed
strongly in 2010 and are not cheap anymore.
This is particularly the case for Consumer
Discretionary, Consumer Staples and Industrials. While the earnings expectations for these
sectors seem intact, their valuations are in
Fig. 10: Catch-up potential for enterprise spending
Fig. 11: Basic Materials sector offers upside potential
US nonresidential private fixed investment as a percentage of GDP
Comparison of 12-months forward P/E ratios across selected global sectors
15
18
17
16
15
14
13
12
11
10
12
9
6
3
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Nov 09
Equipment and soware
Total
Consumer staples
Basic materials
12
Feb 10
May 10
Consumer discretionary
Industrials
Aug 10
Nov 10
Equities
some areas rather high. However, the Basic
Materials sector still has strong earnings
growth potential and is attractively valued
(see Fig. 11). The sector should benefit from
renewed infrastructure building in China. In
addition, low US interest rates encourage
money to flow into emerging markets in search
of yield – leading to increased investment
activity, which should benefit commodity prices
and hence the materials sector.
Equity sectors: Some are cheap for a reason
While valuation is important, cheap valuations
do not always indicate a bargain – sometimes,
they imply poor earnings growth for a company. From a sector perspective, European
Utilities could be such a “value trap”. Providing
water and electricity is a largely stable business,
but excess profits might be taxed by governments – as already planned in Germany and
Spain. Growth prospects also look dire for the
healthcare sector – as long as positive news
flow on the drug pipeline is lacking. Within
banking, the impact of regulatory change and
Basel III will likely weigh on the sector as banks
retain earnings, cut dividends and raise funds
to meet the new capital requirements.
Equities
Share buybacks, dividends and M&A on
the menu
When the financial crisis hit, companies
started heavy cost-cutting programs and
strongly reduced debt. Now, with earnings
recovering, they are accumulating increasing
amounts of cash. With borrowing costs at
almost negligible levels and equity valuations
low, share buybacks and acquisitions are
becoming particularly attractive. We find this
trend supportive of overall equity prices into
2011.
could lead to more mergers and acquisitions
activity (M&A). News about an M&A deal
usually causes a takeover candidate’s share
price to skyrocket.
Besides investing excess cash in fixed capital,
a company can also buy back its own shares
(thus increasing earnings and price per
share). Another alternative is to increase
dividends, either as a special dividend or by
permanently increasing dividend payments
– however, companies have to make sure
that these increases are well-covered, as
markets usually punish dividend cuts. Finally,
high cash levels and low borrowing costs
Fig. 12: Plenty of cash and strong balance sheets
European companies’ free cash flow vs. net debt to EBITDA
2,000
9
1,500
8
1,000
7
500
6
0
5
1995
1998
2001
2004
2007
2010
Free cash flow (in million USD – le scale)
Net debt to EBITDA (right scale)
13
Currencies
A search for safety
The important consequences of the profound
weakness of the major reserve currencies have
been that investors have started to move into
the currencies of commodity producers and
emerging markets. The motives differ from the
simple yield hunting and carry trades that
dominated activity before the financial crisis.
Today, the run into emerging markets and
commodity producers is driven by a search for
safety and exposure to economic growth.
The challenge for 2011 and for currency
markets is that the obvious targets for diversification have become very expensive. Currencies
like the Australian dollar, the Swiss franc and
the Brazilian real have reached extreme levels.
QE2 is not a friend of the US dollar
The implementation of a second round of
quantitative easing (QE2) by the US Federal
Reserve (Fed) has enhanced the need to find a
safe alternative to the US dollar. Before QE2,
the US dollar tended to fall versus the euro
when economic conditions improved, as risk
aversion fell and equities gained (see Fig. 13).
Now, with QE2, the Fed has indicated it will
increase money supply in adverse times. As a
result, when the global economy rises, the
dollar is likely to weaken because other
countries will offer a better growth environment; and when the economy falters, investors
will flee the US dollar as the Fed is likely to
increase the speed of money printing. The Fed
has therefore left the US dollar in dire straits,
and only an expected policy change toward
tighter rates will be able to change this
process, in our view. However, increases in
interest rates in 2011 are unlikely and, as a
consequence, the US dollar is likely to continue
on a downward path.
S&P 500 equity index vs. EURUSD exchange rate
1.6
1900
1.5
1700
1.4
1500
1.3
1300
1.2
1100
1.1
900
1
700
2004
2005
2006
2007
2008
EURUSD (le scale)
S&P 500 (right scale)
Source: Bloomberg, UBS WMR
14
2009
2010
Michael Bolliger
Analyst, UBS AG
Fig. 14: Commodity currencies (AUD and NZD) show
strength
Fig. 13: The euro tends to benefit when equities gain
2003
Thomas Flury
Strategist, UBS AG
The euro is also not a favorite
The euro is not the best alternative to the US
dollar. Europe is challenged by some members
struggling to service their debts. In 2011, we
expect the bond-issuing schedule of Spain,
Ireland and others will challenge investors in
the euro. In contrast, the economic environment is extremely friendly for the strong
exporters of Germany, the Netherlands and
even Austria. For this reason, we believe the
European Central Bank (ECB) will not want to
overly strengthen the euro. As long as the
central bank has the choice, it would rather
2011
Valuation according to PPP versus 3-month interest rate
50
Valuation according to PPP
2010 challenged all four major currencies
as the US dollar, the euro, the British
pound and the Japanese yen, at times,
came under severe pressure. We expect
this trend to continue in 2011.
Expensive
AUD
40
NZD
30
20
CHF
10
JPY
0
EUR SEK
CAD
NOK
GBP
–10
3-month interest rate
USD
–20
Cheap
–30
–1
0
Source: Fitch, Bloomberg, UBS WMR
1
2
3
4
5
Currencies
keep interest rates low to help the challenged
countries, rather than bring a more restrictive
stance to the others via a strong euro.
Diversify on dips
We continue to advise investors to seek
alternatives to the US dollar and euro. Given
the strength of alternatives (see Fig. 14) such
as the Australian dollar or the Swiss franc, we
recommend investors add these currencies on
the dips. Although buying into weakness
carries downside risk, we expect these currencies to appreciate over the long term. Secondly,
diversified investments in the smaller developed world (e.g., Swedish krona and Norwegian krone) and in emerging market currencies
(see below) may be prudent.
In terms of the EURUSD, we expect the rate
to fluctuate in a broad 1.50–1.20 range. We
expect European debt problems to limit the
euro’s rise above 1.50. On the other hand,
should the EURUSD go against our expectations
and dip below 1.20, we expect US dollar-rich
Asian and Middle Eastern investors to unwind
their greenback exposure and limit the rise.
Emerging market currencies
However, as emerging markets currencies
grow stronger, particularly in the face of
quantitative easing in developed markets,
we expect increasing central bank intervention and the introduction of capital controls
in emerging markets in 2011. Such concerns
are focused to a greater extent on Asia and
Latin America and less so on emerging
Europe. These measures will likely lead to
higher exchange rate volatility going forward,
but should not fundamentally affect the
longer-term attractiveness of emerging
markets currencies.
Fig. 15: High FX reserves and high interest rates suggest
appreciation potential
FX reserve changes in the last 6 months and real interest rates
Real interest rates (10-yr gov. bonds)
Still attractive despite intervention
Strong economic growth and higher interest
rates in emerging markets next year, coupled
with low rates in many developed countries for
longer, should continue to see capital flowing
to emerging markets in 2011. We expect Asian
and Latin American currencies, in particular, to
remain supported. Additionally, for some
currencies, higher foreign exchange reserves
and rising interest rates suggest appreciation
potential over the long term.
5
4
Hungary
3
2
Attractive
Brazil
S. Africa
Chile
Malaysia
1
Unattractive
0
–10
–5
India
Turkey
Poland
Mexico
Korea
Czech Rep.
Russia
China
Philippines
Indonesia
0
5
10
FX reserves changes (last 6 months)
15
20
Source: Bloomberg, UBS WMR
15
“Investors need to tread
carefully in 2011.”
Fixed income
The traditional rules no longer apply
Investors should look beyond the traditional classification of risky versus
“risk-free” when selecting bond markets.
We prefer high-yield debt, emerging
market government debt, corporates and
selective short-maturity government debt.
Traditionally, government bonds of developed
countries were characterized as “risk-free”
investments, while emerging market bonds,
among others, were classified as risky investments. This seemingly clear-cut distinction has
become questionable today, as the recent
financial crisis has deteriorated public finances
in some developed markets.
Beyond the old classification
Many emerging countries were only affected
marginally by the crisis. With stronger economic
growth and less exposure to toxic banking
assets, several emerging markets actually
became stronger, in relative terms, against
several developed economies. China, Russia and
Indonesia all exhibit low budget deficits and
current account surpluses, which makes them
the best positioned within the emerging
markets. Brazil and Turkey also do not seem to
be overly at risk. Several countries within the
Europe, Middle East, Africa region (EMEA),
however, tend to be less well-positioned –
South Africa, for example, but also Hungary,
due to its high debt-to-GDP ratio (see Fig. 16).
Regarding the eurozone, financial markets
have recognized that several member countries
are in particularly vulnerable positions. We
reiterate our recommendation to sell Greek
sovereign debt, as we think there is a high
likelihood of a debt restructuring during the
next couple of years. Similarly, we have sell
recommendations on bonds issued or guaranteed by Portugal and Spain, and medium- to
longer-term bonds of Ireland, despite seemingly attractive yields.
Achim Peijan
Strategist, UBS AG
Philipp Schöttler
Strategist, UBS AG
Risks arising from high debt and global
imbalances
In 2011, a number of countries will have to
implement further austerity measures and incur
more social and political tension. In countries
where austerity measures might need to be
postponed for political reasons, yields are likely
to go up as investors assume an increased
likelihood of default and/or inflation.
Rising international tensions are likely to
remain prominent in 2011. Frictions in trade or
capital flows would be particularly unfavorable
for countries running large current account
deficits (such as the US) that will have to rely
Fig. 16: Risk map for selected developed and emerging
bond markets
Fig. 17: Corporate, high yield and emerging market
bonds are still attractive
The size of the bubble reflects the level of real interest rates
Yield to maturity of selected USD bond market segments
Budget deficit 2011
Brazil
Turkey
Australia
Spain
South Africa
Poland
US
–3
–5
–7
Portugal
–9
–11
–13
–15
Russia
Canada
–1
Lower risk
Indonesia
Hungary
China Sweden
Germany
Malaysia
UK
Greece
–10
Developed markets
Emerging markets
20
15
10
5
0
Higher risk
–15
25
Switzerland
Yield-to-maturity
1
–5
0
Current account 2011
Source: UBS, IMF, Bloomberg
5
10
15
Jan 06
Jan 07
Treasury bills 3m
US Government bonds
Jan 08
Corporate bonds
High-yield bonds
Jan 09
Jan 10
Jan 11
Emerging markets
Source: BoA Merill Lynch, JP Morgan, UBS WMR
17
Fixed income
further on foreign capital. To replace foreign
savings and stimulate domestic savings,
interest rates would need to increase if
international tensions resulted in trade or
capital restrictions. On the other hand,
countries enjoying trade and current account
surpluses (e.g., Switzerland, Sweden, Germany,
Japan) will find that savings would need to be
invested more intensively domestically, which
could support bond prices to some degree.
Focus on short and medium maturities
Overall, we prefer countries with low public
deficits and healthy external balances in
emerging and developed markets. However,
even here prices could come under pressure as
the offered yield-to-maturities have dropped to
unattractive levels. Another drag for bonds
could be inflation, which may well overshoot
current market expectations in the medium to
long term even though some central banks are
likely to start (e.g., Swiss National Bank) or
continue (e.g., Sweden, Australia, Canada) to
retreat from the ultra-loose monetary policy of
2010. We thus recommend focusing on bonds
with short and medium maturities. Also,
selected emerging markets and corporate
bonds (see box) are, in general, likely to
outperform most developed government bond
markets (see Fig. 17).
Corporate bonds
The rally is over – but a solid year is
expected
Investment-grade and high-yield corporate
bonds had a stellar performance in 2010.
The yield-to-maturity advantage over
government bonds declined further from its
2008 historical high, and has returned close
to long-term averages.
We believe this search for yield will continue
in 2011. However, the risk of rising interest
rates and inflation has increased compared
to a year ago, which could start to weigh on
corporate bonds, as the buffer from higher
yields is limited going forward. We recommend investment-grade corporate bonds
with shorter durations in light of increased
interest rate risk.
Generally, the yield advantage of corporate
bonds over government bonds remains
attractive, but the appreciation potential is
now limited. In particular, strong balance
18
sheets and rising cash flows remain supportive
for high-yield bonds and should help to keep
the company default rate low. Overall, we
envisage decent but more “normal” total
returns over the coming year.
Fig. 18: Few defaults expected to keep yields low in 2011
US high-yield default rate vs. global high-yield spread
16
14
12
10
8
6
4
2
0
25
20
15
10
5
0
2000
2002
2004
2006
Default rate WMR forecast (le scale)
High-yield default rate (le scale)
Source: Moody’s, BoA Merrill Lynch, UBS WMR
2008
2010
2012
High-yield bond yield in excess of
government bonds (right scale)
Non-traditional asset classes
Listed real estate
Real estate equities poised for further
solid performance
Hedge funds
New structures make accessing hedge
funds easier
Cesare Valeggia
Analyst, UBS AG
Good monetary conditions, easing lending
standards and better-than-expected market
fundamentals have acted supportively for the
global real estate market. The new round of
quantitative easing by the US Federal Reserve is
fueling the market by putting downward
pressure on long-term interest rates. In
addition, investors have raised their inflation
expectations and extended their exposure to
The picture for hedge funds remains bright (see listed real estate, which is viewed as a natural
hedge against inflation.
Fig. 19) with the accent on global macro and
event-driven strategies, in our view. We
US real estate equities have accordingly
continue to expect a bipolar world, in other
recorded the best performance compared
words strong economic growth in the emerging markets and below-average performance in to peers on a year-to-date basis (see Fig. 20).
the developed economies, offering opportuni- In Europe, the environment has also become
more favorable with a number of stocks
ties for global macro managers. Event-driven
establishing new highs. However, rental
strategies, on the other hand, are currently
able to take advantage of a pick-up in transac- growth is now needed globally for further
improvements. We therefore like real estate
tion activities (e.g., acquisitions) or balance
equities with above-average dividend yields,
sheet restructurings (debt refinancing, asset
sales and stock issuances). Given less competi- especially in Germany, Sweden, France and the
US, while the UK’s attractive valuation reflects
tion in the hedge fund space – from fewer
risks. We expect commercial real estate to
hedge funds and bank trading desks – we
outperform in Hong Kong, Singapore and
continue to be supportive of the sector.
Australia on strong employment and constrained supply.
An evolving trend in the hedge fund world is
the growth of UCITS (Undertakings for
Collective Investment in Transferable Securities), a legal structure in the European Union
that requires funds to fulfil three key requirements: transparency, liquidity and diversification. It aims to give investors some security and
enhance their risk management.
Fig. 19: Hedge funds continued to succeed in 2010
Thomas Veraguth
Economist, UBS AG
Fig. 20: Listed real estate strongly supported by further
monetary easing
Year-to-date performance in %
Performance of global equities and global listed real estate
Multi-strategy
250
Long/short equity
200
Global macro
150
Event-driven
100
Equity market neutral
50
Dedicated short bias
0
2005
Dow Jones Credit Suisse Hedge Fund Index
–15
–10
–5
Source: CS Tremont
0
5
10
Europe
Asia
2006
Americas
Oceania
2007
2008
2009
2010
2011
Global Equities
Note: indexed: 01.01.2005 = 100; As of 15 November 2010.
Source: Bloomberg, GPR, UBS WMR
NTAC investments may not be suitable for all clients, please contact your client advisor for further information.
19
Commodities
Well-positioned for 2011
Private equity
Getting back in vogue, probably too much
The sweet spot for commodities in the last
quarter of 2010 still leaves room for higher
prices during 2011. Loose monetary policy and
abundant liquidity should allow a reacceleration in commodity demand, especially from
emerging markets. While developed world
growth is likely to remain moderate and
bumpy, overall demand should hold up. In
addition, financial investors in search of
protection against currency and inflation risks
are likely to favor commodities.
We advocate 2011 to be a busy time for exits
by private equity firms as market conditions
improve. From an investor standpoint, this
means that the window of opportunity is,
arguably, beginning to close.
Dominic Schnider
Strategist, UBS AG
Cesare Valeggia
Analyst, UBS AG
The profitability of traditional private equity
deals benefits from low debt financing costs, a
positive economic environment and attractive
prices. While the former are supportive aspects,
the acquisition price is more questionable.
Private equity firms already have considerable
As such, commodity prices across all sectors are reserves of investable capital at their disposal
expected to rise further (see Fig. 21). We favor due to the elevated inflows of funds before the
economic downturn. In tandem with the
commodities where supply growth is limited,
increased interest from asset managers (see
such as gold, copper and corn, and where
prices haven’t seen exponential increases, such Fig. 22), private equity valuations may creep up
(and the potential entry point for investors may
as cotton and silver. The reduction in OPEC
become more expensive).
spare capacity on the back of firm Asian oil
demand should pave the way for price moves
to USD 100/bbl over the next 12 months. As a Sector-wise, investors have been paying
attention to later-stage companies and
consequence of a lack of trust in the major
currencies and inflation concerns, further price information technology overall is responsible
for the largest number of venture deals. There
rises are likely, with gold seeing peak levels at
is also activity in medical services and we see
around USD 1,650/oz, in our view.
potential growth in the leveraged buyout
market as access to finance becomes easier.
Fig. 22: 2011 should see inflows into private equity
Fig. 21: A very strong year for precious metals and
so commodities
Amount of capital investors plan to commit to private equity funds in 2011 compared to 2010
Commodity performance by sector
180
160
140
120
100
80
60
40
20
0
12%
39%
49%
Jan 08
Jul 08
Energy
Precious metals
Jan 09
Industrial metals
Grains
Jul 09
Jan 10
Jul 10
Jan 11
Sos
Livestock
Note: indexed: 01.01.2008 = 100; As of 15 November 2010.
Source: DJ UBS, Bloomberg, UBS WMR
Source: Preqin
NTAC investments may not be suitable for all clients, please contact your client advisor for further information.
20
More capital in 2011 than
in 2010
Same amount of capital in 2011
as in 2010
Less capital in 2011 than
in 2010
Financial market performance
3-month
YTD
Equities
Markets
Global
US
Japan
Canada
Eurozone
UK
Sweden
Switzerland
Australia
Emerging markets
Asia
Emerging Europe, Middle East & Africa
Latin America
Total return, in local currency and %
YTD
3-mo
1-yr
5-yr
4.6
9.5
8.5
0.4
8.2
13.5
10.4
1.1
–3.4
5.6
5.3
–8.9
10.2
8.4
13.1
6.6
–1.9
4.2
3.7
–0.6
5.1
6.8
9.7
4.0
20.8
10.8
22.3
7.1
–0.2
1.9
4.4
–0.7
–2.7
3.6
0.7
4.5
9.5
9.0
14.1
11.9
10.2
8.7
15.1
13.0
12.4
10.8
19.6
3.7
5.7
9.2
8.2
16.0
Sectors
Consumer discretionary
Consumer staples
Energy
Financials
Healthcare
Industrials
IT
Materials
Telecom
Utilities
18.0
8.3
3.5
–3.7
–1.8
13.5
3.6
8.9
7.8
–2.6
17.3
5.9
15.5
2.5
5.5
13.2
15.2
15.2
4.7
–0.3
25.8
11.2
5.8
–2.8
1.8
18.5
10.7
14.4
11.5
3.0
1.1
6.9
4.2
–8.7
0.9
1.4
1.1
7.8
4.7
3.1
Total return, in USD and %
YTD
3-mo
1-yr
4.6
10.8
6.5
8.2
13.5
10.4
7.4
6.8
8.2
12.5
11.3
16.1
–11.0
6.9
–10.1
1.4
7.4
4.1
22.6
16.3
21.5
3.5
4.7
5.2
3.7
10.9
5.5
11.2
11.1
15.7
12.3
10.9
17.4
9.1
10.0
13.9
8.0
11.7
10.2
19.2
7.8
2.2
–3.7
–1.9
14.4
4.5
9.2
5.7
–4.6
18.4
7.0
16.6
4.3
6.4
14.5
15.6
17.7
6.1
0.7
23.9
9.0
3.5
–4.7
0.1
16.6
10.4
12.2
6.7
–1.8
5-yr
2.0
1.1
–2.2
9.4
1.4
1.8
10.2
5.0
10.1
12.9
13.4
4.4
18.6
–10
–10 –5
–5
00
55
10
10 15
15 20
20 25
25
–4
–2
–4 –2
–4 –2
00
0
22
2
44
4
3.3
8.3
4.8
–7.0
2.0
3.6
2.6
10.3
5.9
4.6
Fixed income
Money market
US
Japan
Eurozone
UK
Switzerland
Government bonds
US
Japan
Germany
UK
Switzerland
Global inflation-linked bonds
Investment-grade corporate bonds
USD-denominated
EUR-denominated
High-yield corporate bonds
USD-denominated
EUR-denominated
Emerging markets USD sovereign bonds
Global
Asia
Eastern Europe
Latin America
YTD
3-mo
1-yr
5-yr
0.4
0.1
0.4
3.4
0.4
0.1
0.4
0.7
1.0
0.3
1.1
3.3
0.9
0.3
0.9
4.2
0.3
0.1
0.4
1.8
8.1
1.8
7.7
7.7
4.7
–0.5
–1.1
–2.2
–2.1
–1.6
5.2
1.9
6.7
4.8
4.8
6.2
1.9
4.8
5.2
3.5
2.4
0.8
–1.0
5.5
Historical 3-month LIBOR rates, in %
Current
3-mo
1-yr
5-yr
0.3
0.3
0.3
4.4
0.2
0.2
0.3
0.1
1.0
0.8
0.7
2.5
0.7
0.7
0.6
4.6
0.2
0.2
0.3
1.0
Historical 10-year govt. yields, in %
2.8
2.5
3.2
4.5
1.2
1.0
1.3
1.4
2.7
2.1
3.2
3.5
3.2
2.9
3.5
4.2
1.6
1.2
1.8
2.2
YTD
3-mo
1-yr
5-yr
5.2
–0.4
3.8
5.0
YTD
3-mo
1-yr
5-yr
10.6
0.2
9.5
6.4
5.2
–1.6
5.1
3.4
Option-adjusted spread, in bps
Current
3-mo
1-yr
5-yr
182
192
221
97
187
179
173
47
13.2
11.9
4.2
0.8
16.7
14.6
8.6
7.0
622
653
689
678
765
813
367
365
12.6
14.1
10.4
13.1
0.2
–0.8
0.3
0.4
12.8
15.6
11.5
12.3
9.0
10.5
8.2
8.3
322
193
316
388
321
190
312
388
342
278
332
383
237
217
224
274
66
6
88
8
10
10
16
–4
0
4
8
12
16
–4
0
4
8
12
16
–4
–4
00
44
88
12
12
16
16
Listed real estate
Commodities
YTD
3-mo
1-yr
5-yr
13.8
7.1
20.3
0.2
–
–
–
–
YTD
3-mo
1-yr
5-yr
15.3
8.6
19.4
2.5
5.5
11.0
7.5
–11.8
–4
0
4
8
12
16
Currencies
EUR
GBP
JPY
CAD
CHF
SEK
AUD
Change versus the USD, in %
YTD
3-mo
1-yr
5-yr
–9.4
2.5
–13.3
2.0
–3.6
0.7
–5.1
–2.1
11.3
1.1
3.1
7.4
1.9
3.3
3.0
2.6
3.1
2.3
0.3
5.6
1.8
5.4
–0.1
2.8
6.8
7.5
5.1
5.4
EURUSD
GBPUSD
USDJPY
USDCAD
USDCHF
USDSEK
AUDUSD
Exchange rates
Current
1.30 USDCNY
1.56 NZDUSD
84 EURCHF
1.03 EURGBP
1.00
EURJPY
7.03
EURSEK
0.96 EURNOK
Current
6.67
0.74
1.30
0.83
109
9.13
8.06
–12
–8
–4
0
4
8
12
Note: Information through 30 November 2010. Returns over five years are annualized. Past performance is not an indication of future returns. The market prices provided are closing prices on the respective principal stock
exchange. This applies to all performance charts and tables in this publication.
Source: Bloomberg, GPR, HFR, J.P. Morgan, Merrill Lynch, MSCI, Thomson Reuters, UBS WMR
21
Wealth Management Research is published by Wealth Management & Swiss Bank and Wealth Management Americas, Business Divisions of UBS AG (UBS) or an affiliate thereof. In certain countries, UBS AG is referred to as UBS SA. This publication is for your information only and is not intended as an offer, or a solicitation of an
offer, to buy or sell any investment or other specific product. The analysis contained herein is based on numerous assumptions. Different assumptions could result in
materially different results. Certain services and products are subject to legal restrictions and cannot be offered worldwide on an unrestricted basis and/or may not be
eligible for sale to all investors. All information and opinions expressed in this document were obtained from sources believed to be reliable and in good faith, but no
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