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UBS House ViewInvestor’s Guide Global

CIO Wealth Management

September 2013

The three pillarsof confidence

2 | UBS House View September 2013

Contents

tactIcal 3aSSet allocatIon

cIo montHly letter 4

preferred 10InVeStment VIewS

at a Glance 11

aSSet claSS 14oVerVIewEquities BondsCommodities and otherasset classesCurrencies

InVeStment IdeaS 20US mid caps: The sweet spotJapanese exporters supported by weaker yenUS high yield corporate bonds

dIScloSUreS 23

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PublisherUBS AG, CIO Wealth Management Research, P.O. Box, CH-8098 Zurich

UBS House View Alexander S. Friedman,Global Chief Investment Officer WMMark Haefele, Global Head of Investment

ContactRéda Mouhid, Joscelin [email protected]

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Legend

Concerns over a reduction in asset purchases by the Fed could cause short-term market volatility. Still, we believe equities and high yield bonds offer the best outlook over a six-month horizon.

UBS House View September 2013 | 3

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CHANGESTHIS MONTH

1) Equities We are slightly reducingour US equities over-weight position, whichhad been funded by an underweight positionin high grade bonds.

2) Bonds We are slightly reducing our overweight high yieldposition, taking someprofits.

3) Currencies We are opening an overweightposition in GBP, funded by an underweight in CHF, to profit fromimproving global growth.

Overweight: Tactical recommendation to hold more of the asset class than specified in the strategic asset allocation Neutral: Tactical recommendation to hold the asset class in line with its weight in the strategic asset allocation Underweight: Tactical recommendation to hold less of the asset class than specified in the strategic asset allocation

The three pillars of confidence


CIO MOnTHly leTTeR

Alexander S. FriedmanGlobal Chief Investment Officer Wealth Management

The three pillars ofconfidence

Fig. 1: May and June saw a loss of confidence in asset prices

Source: Bloomberg, UBS, as of 21 August 2013

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Worldwide, all houses and buildings have one element in common: some kind of support that holds up the structure. Without good strong pillars, even a house that looks great can be dangerous to inhabit.

In the past month, developed market business confidence indicators have risen to multi-year highs; indexes of policy uncertainty are noticeably down from the elevated levels of recent years; and July saw record inflows into US equities.

Confidence in the business, political, and financial environ-ment is on the rise, so it is unsurprising that many markets are

close to pre-crisis levels. The question now is whether conditions are in place to provide the confidence to push financial markets even higher.

Or, put simply, is the “house” safe enough for us to move into and get comfortable?

To answer this question, we need to assess the elements that contribute to the market’s confidence. Three kinds of confidence are important.

First, confidence is needed in the underlying economic strength of a country or region. This type encourages spending, which in turn boosts hiring and wealth, and creates even more of itself.

Second, confidence is needed in asset prices. Markets must believe that assets either are attractively valued or have structural demand drivers. This kind of confidence boosts asset prices, lowers business funding costs, and puts in place the pre-conditions for a virtuous circle.

Third, confidence is needed in the political environment. Without clear direction on fiscal or monetary policy, busi-nesses will be less willing to invest, and financial markets can be easily rattled by the threat of exogenous shocks.

Therefore, to determine whether the virtuous circle in the US can continue apace and develop in other regions of the world, I want to examine these three economic pillars – confidence in


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Fig. 3: US ISM at a two-year high


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business prospects, in asset prices, and in politicians. With all three types of confidence sustainably in place, an economy has the right dynamics to grow, and riskier assets can outperform. If confidence wanes, however, then the pillars weaken and we should be wary. First, our positioning as we face the infamous “taper”The major near-term risk to the structural integrity of the markets – the ”global house” – would be a shock to confi-dence in asset prices, that might come from a reduction in the Fed’s USD 85bn per month stimulus program within the next few months.

A few months ago we saw the effect such a shock could have. As I discussed in my July CIO letter, initial concerns about the “taper” led to a period in which investors lost confidence in asset prices and unwound leveraged positions, resulting in almost all financial assets falling relative to cash. US assets outperformed, as the loss of confidence in financial assets was offset by improving economic confidence, while emerging markets suffered worst (see Fig. 1) – the tighter financial conditions there came without commensurate improvements in their economic outlooks.

Today, we believe the bulk of the expected taper is priced in. Since the beginning of May, US 10-year bond yields have risen by 120bps (see Fig. 2). A repeat of this increase would leave them at over 4%, which would be too high given the level of base interest rates. With most economists now expecting the Federal Reserve to reduce stimulus in September, we would not expect a renewed “taper tantrum” to move interest rates as far again.

It is worth remembering that should the Fed begin phasing out its purchases, it is for a good reason – economic recovery in the US. However, we should not be surprised if a Fed announce-ment that it is doing so sparks a reaction. Consider what usually happens when a hint of smoke is detected in a movie theater: people ignore instructions to “proceed in an orderly manner to the exits” and run, even if there is no visible fire.

Therefore, as we head into September we are maintaining a positive stance on risk assets but reducing our exposure to them. It remains our central case that US equities and high

yield corporate bonds will outperform government bonds over the next six months. However, as long as some market participants (including us) expect a December taper, a renewed period of market volatility could result from the next Fed meeting. In such a scenario, current levels of confidence in the growth outlook could quickly look like overconfidence. To guard against this possibility, we are tactically reducing the size of our largest pro-risk positions, US equities and US high yield credit.

Still, we have a strong relative preference for the US, which should stand up well to any real Fed stimulus phase-out, as it did to the rumor of one in May. Of all the major economies, the US boasts the strongest pillars of confidence – business sentiment is at multi-year highs, housing market momentum continues, and economic policy uncertainty is at its lowest level since 2008.

In the Eurozone, the recent return to economic growth is welcome, but the level of it is too low to be self-sustaining. Corporate earnings growth is muted, and the bank deleverag-ing process will continue to be a headwind for asset prices. Furthermore, the recent lull in political noise could come to an end following the German elections in September. Given this view, we do not believe it is the time to take on more risk in Europe.

In the emerging markets, valuations seem appealing. But many countries are suffering from a spiral of doubt as declining financial asset prices lead to higher corporate funding costs, weaker growth, and political instability. Such a dynamic could be exacerbated by any renewed concerns over the taper, and so we remain neutral on emerging market assets.

Now, let’s go into more detail on the “house” in each major market, and attempt to more closely consider the structural integrity of its pillars.

The US house – OK to move inOf the key economic regions, the US has come closest to achieving a virtuous circle of asset price, business, and political confidence. The recovery in the US is a lens through which to view the situation in other regions.


CIO MOnTHly leTTeR

Fig. 5: Eurozone banks will need to continue deleveraging

Source: UBS, as of 21 August 2013

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Asset price performance driving a virtuous circleI would argue that the most powerful force behind the US’s recovery has been the improvement in confidence in asset prices, and most particularly improvements in the housing market. House prices began rising sustainably in early 2012, and have now registered year-over-year gains of over 12%. Compared to a year ago, 1.7m fewer families are underwater on their mortgages. As rising housing prices make families feel wealthier, they spend more and amplify the positive dynamics of a consumer economy. In the financial sphere, the S&P 500 has rallied 17% in the past 12 months, ranking among the world’s best-performing major indexes and further contributing to consumer wealth. Business confidence improvingThis improvement in asset prices has boosted overall business confidence. Climbing home prices helped US homebuilder confidence hit an eight-year high this month, as measured by the nAHB sentiment index. Meanwhile, this month’s ISM manufacturing index, a leading indicator for the US economy, rose to a two-year high (see Fig. 3), despite a decline in inventories. And the non-manufacturing equivalent last month increased to 56.0 from 52.8. Political concerns diminishingThe biggest impediment to declaring that the US has fully achieved its virtuous circle is its politics. Uncertainty over the budget deficit, first reflected in the dysfunctional debates over the “debt ceiling” and later the “fiscal cliff,” have consistently undermined confidence. The net result of it has been a buildup of cash by US companies, as CEOs delay major investment plans and slow hiring in response. Indeed, cash on balance sheets held by non-financial corporations is now close to a record 10% of GDP. Today, political risks remain and the almost perpetual “debt ceiling” issue is back in the headlines; the US will once again brush up against its constitutional borrowing limit by Novem-ber. But, rightly or wrongly, it no longer seems to be undercut-ting confidence the way it once did. economic policy uncer-tainty in July fell to its lowest level since the collapse of lehman Brothers, and rating agency S&P in June upgraded its US rating outlook to “stable” in part due to its belief that any debt ceiling debate will not lead to “a sudden unplanned contraction in current spending.”

Virtuous circle largely in place – time for investment to growThe result of this confidence in asset prices, business pros-pects, and the political process, has been early signs of a genuine improvement in business investment. Durable goods orders rose by 5.0% year-over-year in June (see Fig. 4); a number of companies, including Verizon, United Technologies, and Kinder Morgan, have flagged potentially higher capital expenditures in the second half of the year; and a pickup in non-residential fixed investment helped annualized GDP growth accelerate to 1.7% in 2Q from 1.1% in 1Q.

Investment positioningIn sum, with confidence in asset prices, business prospects and (even) politicians starting to fuel corporate investment, US economic growth appears sustainable. While we remain watchful of political risks in the months ahead, we are keeping our largest overweight positions in the region, specifically within US equities, US high yield credit, and the US dollar, albeit with a tactical reduction in US equities and high yield this month due to portfolio considerations heading into a potentially volatile period in September.

The Eurozone house – less stable than it looksFor the past two years, global investor confidence has been consistently undermined by bad news in the Eurozone. As financial markets lost faith in the region’s asset prices, funding costs rose, public spending fell, social instability ensued, and politics became more complex.

yet the eurozone of the past month seems almost unrecogniz-able from that of the past two years. Spanish and Italian 10-year bond yields are now just 2.5% higher than those of Germany (from a peak of 5.5%); the eurozone composite PMI has climbed into expansionary territory; and the region officially exited recession in the second quarter, after six consecutive quarters of decline. On the surface, it seems as though the region may be on the cusp of breaking the negative spiral of tight funding and austerity that has undermined recovery for the past two years. But while the recent data is encouraging, the level of growth in the Eurozone is not yet high enough to engender a spiral of confidence.


CIO MOnTHly leTTeR

Fig. 7: UK business confidence at multi-year high


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Business confidence has improved but remains lowThe eurozone composite PMI has been improving for months, but is barely above the expansionary level of 50, consistent with the marginal 0.3% rise in GDP the region recorded in the second quarter. But growth will need to be higher before it can become self-sustaining, for two reasons.

First, unless bond yields come down further, or growth increases, debt/GDP ratios will continue to climb, potentially leading to a renewed period of public sector deleveraging that could set confidence back once more.

Second, the Eurozone is far from closing its output gap. A muted recovery will only lead to a slight improvement in productivity, not more hiring. Unemployment is therefore likely to remain at a record 12.1%. In such a scenario, it is hard to imagine a big change in consumer confidence. Furthermore, with growth in the region stuttering for so long, persistent unemployment risks long-term impairment of the region’s productivity. youth unemployment has now exceeded 40% in Spain for over three years and in Greece for more than two. This is a major social problem as it may produce a “lost generation” of Europeans who will never be productive members of society and will impose huge downstream costs on the social security net. Asset prices still face headwindsEurozone banks are likely only about halfway through their deleveraging process, with bank assets still equivalent to 3.2x the region’s GDP, compared to 2x in places such as Australia and Canada, or less than 1x in the US. In the coming months the region’s banks will also face an asset quality review as a precursor to the European Central Bank taking over as the banking regulator in 2014. This could potentially force a renewed round of deleveraging (see Fig. 5).

A deleveraging banking sector is detrimental to asset prices, as it implies a structurally high supply of financial assets relative to demand. Furthermore, with banks seeking to shrink rather than grow their balance sheets, new credit issuance is likely to remain weak, inhibiting corporate growth. In such an environment, confidence in the sustainability of rising asset prices will probably remain muted.

In the equity markets, European earnings momentum remains poor (see Fig. 6). The companies that beat expectations during the recent earnings season generally were those exposed to growth in the US rather than the Eurozone. And valuation does not offer convincing support, given that the region trades at a 20% discount to the US, in line with long-run averages, and largely due to differences in sector composition. European utilities and telecoms appear inexpensive relative to global peers, but they face unique European structural and regulatory issues.

Political uncertainty could returnFinally, the political situation in the region has been quiet in recent months, but tensions may increase through the end of the year. While the outcome of the German election appears in little doubt, once the votes are counted the Eurozone reform agenda could spring back to the forefront as Chancel-lor Angela Merkel shifts her focus from campaign priorities to regional integration and recovery issues.

Germany’s post-election moves have the potential to escalate tensions between the European periphery and core. Due to the country’s focus on domestic politics, many important German decisions vis-à-vis Europe have been postponed. Notably, Der Spiegel reported last week that the Bundesbank had told the German Finance Ministry and the International Monetary Fund (IMF) that a eUR 5.7bn payment to Greece was only approved “due to political constraints.”

Presumably, once such “political constraints” are removed, Germany may revert to being more strident in pressuring for new reforms in the European periphery, potentially unsettling already weak governments in the region, as it did through 2011 and the early part of 2012.

PositioningIn sum, Eurozone growth is too weak to inspire sharper increases in business confidence, while confidence in asset prices confronts a lack of earnings momentum and ongoing bank deleveraging, and confidence in political dynamics could stall following September’s German elections. So, it is probably too early to declare that the Eurozone has entered a self-sustaining recovery.


CIO MOnTHly leTTeR

UBS House ViewInvestor’s Guide Global

CIO Wealth Management

September 2013

The three pillarsof confidence

UBS House View Investor’s Guide The flagship report for UBS clients

CIO Monthly letter A personal letter from our Global Chief Investment Officer

September 2013

Published 22 August 2013

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.

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In contrast, the situation for the UK seems more encouraging. Business confidence is at a new high (see Fig. 7), house prices are rising at the fastest pace since the crisis, and the political situation is stable. Therefore, we enter an overweight position in the British pound relative to the Swiss franc.

Earlier in the year we removed an overweight position in the pound due to uncertainties about the change in leadership at the Bank of england (Boe). But now we are reinitiating the position. With the BoE now unveiling ”forward guidance” there is now more clarity on monetary policy, and due to the explicit link between interest rates and labor market perfor-mance, the currency and economic performance are now more closely tied than ever. We see stronger economic performance from the UK as a catalyst to close the 14% valuation gap that currently exists between the British pound and Swiss franc.

Meanwhile, we continue to believe the eURCHF 1.20 floor is solid, limiting appreciation potential for the franc, and the currency could suffer relative to both the euro and the pound if Eurozone growth continues to improve, as previous safe haven flows to Switzerland reverse.

The emerging markets house – deteriorating structural supportIf the US is experiencing a virtuous circle of confidence, the emerging markets appear to be suffering a spiral of doubt. Concerns about the emerging market (eM) growth outlook led us to downgrade EM equities at the end of April, and, as I discussed in my August CIO Letter, sudden capital outflows have since led to sharp declines in asset prices, higher funding costs for businesses and, in some cases, social and political instability.

This month the dynamic has continued, most prominently of late in Indonesia, India and Brazil (see Fig. 8). All three countries face a double deficit – both a current account and a fiscal deficit – that makes them highly vulnerable to any withdrawal of external funding.

Particularly sharp outflows were sparked in Indonesia after new data showed a wider-than-expected current account deficit. These outflows have dropped the currency, the rupiah, to a four-year low, led the Jakarta stock market to its largest four-day loss since 2008, and increased the cost of insurance against sovereign default to a two-year high. Indonesia remains one of our least preferred markets within EM.

Elsewhere, in an attempt to protect its current account position, India has imposed restrictions on outbound invest-ment. But the move has had the unintended consequence of scaring foreign investors even more, and capital flight has accelerated. The currency has since declined to a record low against the US dollar, sparking calls from the opposition BJP party for early elections.

As long as India has double deficits it will remain vulnerable to short-term capital fight. The arrival of respected former IMF economist Raghuram Rajan as new governor of the Reserve Bank of India in September may inject some confi-dence into the markets, but with the rupee still unanchored, the central bank may need to resort to tighter monetary policy with negative implications for economic and earnings growth. We have revised our view on India to neutral from most preferred. Valuations are reasonable – the MSCI India is now trading below its 5-year historical average price-to-book ratio, but earnings momentum is likely to deteriorate as local currency bond yields climb.


CIO MOnTHly leTTeR

Alexander S. FriedmanGlobal Chief Investment OfficerWealth Management22 August 2013

Even substantial foreign exchange reserves, such as those held by Brazil, have offered little protection, and the real has now dropped 8% in a month. Thus far, the central bank has preferred to intervene only to curb volatility rather than to try to reverse the currency’s decline.

As our base case, we do not expect a repeat of the 1997–98 Asian financial crisis. Foreign reserves in many emerging markets are much higher than short-term external debt positions, unlike the situation in 1997. But the decline in currencies and asset prices has resulted in higher funding costs for companies, and this month it was reported that business confidence, as measured by the HSBC emerging Markets PMI, has fallen into contractionary territory for the first time since April 2009. Poor corporate prospects are feeding back into weaker asset prices and still higher funding costs.

Political uncertainty is also high in some troubled countries. Next year India, Brazil, and Indonesia face elections that could further inhibit confidence and investment. And while recent developments in egypt have largely been ignored by financial markets, increased instability there could spark wider uncer-tainties in the remainder of the region.

In 2008–09, the emerging markets (and arguably the rest of the world) turned to China to arrest this process. Recent improvements in Chinese economic data have led to hopes that it could do so again, but the improvements have been driven by China’s traditional sources of growth – exports, real estate development, and traditional bank lending. With doubt about the sustainability of this economic growth model arguably never higher, financial markets are unlikely to be too confident in growth stemming from these “low-quality” sources. Furthermore, a sharp drop in credit creation this quarter could mean renewed concerns about liquidity at quarter-end in September; credit created outside of the official banking system fell to Cny 100bn in July, from over Cny 1,300bn in March.

PositioningIn sum, the picture for the emerging markets is unfortunately more about waning confidence than the three strong pillars we see in the US. Capital outflows are leading to declining financial asset prices, higher corporate funding costs, weaker growth and political instability. These negative dynamics could be exacerbated if, contrary to our base case scenario, global yields were to continue to rise in the near term. But weaker EM currencies also mean greater competitiveness down the road: equity valuations, already low, could become even more attractive. Thus, we remain neutral on EM assets and instead are keeping our underweight positions in Australian equities and the Australian dollar, which are more highly valued EM-growth-linked assets.

A note on JapanInvestors have become concerned about the implementation of Prime Minister Shinzo Abe’s “Third Arrow” of economic reforms, which has led to an increase in volatility in Japanese equities in the past month. A big question on the horizon is

whether a consumption tax will be introduced. Abe has thus far hesitated to commit to such a tax increase, with advisors in his liberal Democratic Party concerned about the potential risks to growth. We believe an increase in the sales tax is necessary to improve fiscal sustainability, and that any slowdown in growth would be offset by other policies and by aggressive Bank of Japan intervention.

Meanwhile, earnings growth remains solid, and companies have been beating consensus expectations by an average of 16%. We expect further yen weakness to continue to drive earnings growth and remain overweight Japanese equities. We have expressed this for some time through our overweight in Japanese exporters, which as a sector, is up approximately 50% year-to-date.

ConclusionI have spent a lot of time in this letter delineating the dynamics that support markets, but our bottom line is that we remain optimistic about the prospects for risk assets, and US assets in particular. In the US, a virtuous circle of confidence in business prospects, asset prices, and the political process seems to be taking hold. Therefore, we continue to hold a moderate overall pro-risk stance.

But with a number of uncertainties on the horizon, including the Fed taper, the German elections, and emerging market outflows, there is the potential for increased volatility in the months ahead. As a result, we are tactically reducing the size of our pro-risk positions.

As we head into the fall we expect these uncertainties to dissi-pate, at which point we will review our positions and seek opportunities to add risk in preferred markets.

Thank you for taking the time to read this letter.


Preferred investment viewsAs of 22 August 2013

Asset Class Most preferred Least preferred

Equities • US () • Japan •USfinancials•UShousinglinkedequities•USmidcaps >page20

•USsharebuybacksanddividends•Japaneseexporters >page21

•Waterlinkedinvestments•Relativevalueandequitylong/shorthedgefunds

•Australia•Australianbanks

Bonds •UShighyield() >page22

•Globalinvestmentgradecredit•Corporatehybrids•Relativevaluehedgefunds

•Tooexpensivegovernmentbonds

Other

Currencies • USD • GBP ()• CAD

• EUR • CHF ()• AUD

RecentupgradesRecentdowngrades


We believe equities offer a better risk/reward outlook than broad commodities. Gold still lacks sufficient demand from financial investors and we expect the gold price to fall to USD 1,150 in six months. The oil price has risen due to stronger seasonal demand in early 3Q13 and the recent escalation in Egypt, although over the next six months we expect both factors to fade and the oil price to fall again slightly.


At a glanceMOnTH In REVIEW

Currencies

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Is the US ready to ride without training wheels? In the widely anticipated July FOMC meeting minutes, Fed officials said they were “broadly comfortable” with Ben Bernanke’s proposal to reduce bond buying this year if the economy improves. While investors are worried about the move, and with 10-year Treasuries hitting a two-year high ahead of the meeting minutes release, the taper would signal that the Fed thinks the recovery is stable. While unemployment remains high and growth has been “modest,” leading indicators have trended higher, earnings have been positive, and equities have done well; the S&P 500 at one point soared to a new high in August.

This side of the Atlantic, there was cause for celebration as the Euro-zone posted growth for the first time since 2011. Although Germany and France drove the lion’s share of improvement, the recession also appears to be easing in the periph-eral countries. With Germany holding general elections in Septem-ber, the news is boosting Chancellor Merkel’s prospects for a third term.

Meanwhile, Chinese economic data was better than expected, India grappled with a plunging rupee and stock market, and the Reserve Bank of Australia announced another rate cut.

The Middle East and North Africa remain mired in turmoil. Alongside unprecedented violence in Syria, the power struggle in Egypt has killed close to a 1,000 already and shows little sign of abating. The suspension of US aid to Egypt is being debated, while geopolitical uncertainty has kept the price of Brent oil around USD 110/bbl.

We believe the scaling back of QE3 by the US Fed will start in Decem-ber and end by the third quarter of 2014. The policy mix will likely shift towards emphasis on forward rates guidance, and we expect the policy rate to remain low well into 2015, supporting US growth. The eurozone exited recession in 2Q13 after six quarters of economic contraction. Uneven regional growth and record-high unemployment are still major challenges. Recent Chinese export data suggests that the growth slowdown may be ending for now, but we do not foresee a re-acceleration in 2H 2013.

We expect equities to continue to benefit from the sustained improve-ment in global growth. We recommend overweight allocations to the US and Japan. US companies should benefit from their large exposure to strong domestic demand, and 2Q13 earnings suggest the market is on track to achieve 7–8% annual earnings growth. Japanese earnings stand to benefit from the sharp fall in the yen over the past year, and equity markets should be supported by the Bank of Japan upholding its loose monetary policy stance.

Government bond yields moved up sharply in recent months, aggres-sively pricing in the end of QE3, and from here we expect yields to fall slightly over the next six months. That said, we prefer global invest-ment grade and US high yield corporate bonds, which offer a yield pickup and a potential for tighter spreads as the credit cycle pro-gresses.

We are adding a new overweight in the GBP, relative to the CHF. The pound should benefit from the UK’s recent strong growth momentum, while the CHF is likely to weaken provided the euro crisis does not resurface. Furthermore, we prefer the USD over the EUR, and the CAD over the AUD.

Global economic outlook

Philipp Schöttler, Investment strategist CIO Wealth Management, UBS AG

The US Federal Reserve’s quantitative easing (Qe3) program is likely to be phased out by the third quarter of 2014, with the tapering expected to start after the December meeting as economic data continues to improve. We anticipate US real GDP growth accelerating moderately in the second half of the year. Stronger private sector demand and faster inventory accumulation will be offset by fiscal tightening. The eurozone economy is set to continue to grow sequentially in 2H13 after exiting recession. The recovery will be broad-based, with the periphery catching up and moving toward stabilization. The European Central Bank will likely remain on hold amid better economic news and steady inflation. Recent data continues to show declining growth in emerging markets (eM), with all major eM regions contributing to the slowdown. After downside forecast revisions, we expect 2013 eM real GDP to expand by 4.5%. We see growth in China slowing into 4Q13 given the ongoing credit tightening, and forecast full-year growth at 7.5%.

Austerity and weak growthFollowing the end of the recession, we expect the positive momentum to stay in place (in line with consensus). We see tentative signs that companies’ willingness to engage in working capital and invest-ment expenditures is increasing, and that banks plan to stabilize lending conditions for nonfinancial corporations after continu-ously tightening lending conditions during

the recession. The ECB is staying on hold against this economic backdrop and amid low inflation. Still, we expect the introduc-tion of ECB minutes in the coming quarters and at least a loosening of ABS collateral rules by year-end to support the EU Com mission’s lending initiative. In Ger-many, we expect Angela Merkel to retain the chancellery in a grand coalition, though the race is tight at the party level.

Moderate expansionWe expect real GDP growth to accelerate to an annualized 3.0% in 3Q13 (consen-sus: 2.3%) and 3.2% in 4Q13 (2.6%) as growth in private demand, especially consumption, picks up, while government spending continues to contract at a moderate pace. We anticipate a combina-tion of falling unemployment, rising

inflation expectations, and increasing costs associated with a growing Fed balance sheet to trigger a light tapering off of Qe3 in December and a program halt by 3Q14.

Weak growth momentumOur base case is for China’s GDP growth to stabilize at 7.5% year-on-year in 3Q13 (consensus: 7.5%) and weaken to 7.2% in 4Q13 (7.3%). While ongoing policy fine-tuning measures are likely to support sequential growth momentum in the coming quarters, we think they will not be strong enough to deliver a higher GDP

growth in 2H13 than the 7.6% pace in 1H13, given the expected slowdown in credit growth. That said, with growth not falling below the official bottom line of 7%, we expect more reform measures to tackle China’s structural issues.


Eurozonecrisis

US economicoutlook

China growth outlook

cIo VIew Probability: 60% Thomas Wacker, analyst, UBS AG

cIo VIew Probability: 70% Thomas Berner, analyst, UBS AG

cIo VIew Probability: 70% Patrick Ho, analyst, UBS AG

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Key financial market drivers

2 SeptemBer

Swiss PMI ManufacturingThe PMI reached 57.4, its highest reading since May 2011. In August, we expect a slight decline to 55.2 points.

3 SeptemBer

Swiss GDP figuresIn 2Q 2013, we expect GDP growth of 0.2% quarter-on-quarter and 1.3% year-on-year. This is mainly driven by consumption and construction.

5–6 SEPTEMBEr

G20 Summit 7 SeptemBer

Australia parliamentary electionsWe expect the opposition to win the elections, but this probably won’t help the suffering AUD.

22 SeptemBer

Germany parliamentary elections (Bundestag)We foresee Chancellor Angela Merkel keeping her lead and currently suppressed political risks in the eurozone flaring up again after the elections.

29 SeptemBer

Austria parliamentary elections

Strong growth and fiscal stabilizationBond yields converge further as peripheral countries consolidate their budgets and economic activity recovers faster than expected. Italy and Spain follow a credible reform path at a faster pace.

Major shockMajor potential shocks include Spain and/or Italy requiring funding support; resistance growing from core countries against provid-ing further debt support; Portugal and/or Ireland requiring some form of debt restructuring; a Greek euro exit; massive fiscal slippage in France; or a major external shock.

Strong expansionGrowth accelerates above 3%, propelled by an expansive monetary policy, a rapidly fading fiscal drag, strong investment in housing, and improved business and consumer confidence. The Fed halts Qe3 and raises rates sooner than in our base case.

Growth recessionUS fiscal deleveraging and an escalating Eurozone crisis upset private sector recovery. Real GDP growth deteriorates, exacerbating the challenge to lower the fiscal deficits, and leading to more aggressive Fed bond buying.

Growth accelerationeconomic growth in 2H13 is higher than the 7.6% pace in 1H13. This would require more substantial and effective fiscal, monetary, and credit policy support from the government, and possibly also a strong pick up in global demand.

Sharp economic downturnA major crackdown on shadow banking tightens liquidity and credit conditions, depressing growth. Another round of global financial recession weighs on Chinese exports. A rapid rise in residential property prices and/or inflation triggers policy tightening.


Key FInAnCIAl MARKeT DRIVeRS

poSItIVe ScenarIo Probability: 20%



neGatIVe ScenarIo Probability: 20%



Key datesGlOBAl GROWTH In 2013 exPeCTeD TO Be: 2.5%

In developing the CIO WM economic forecasts, CIO WM economists worked in collaboration with economists employed by UBS Investment Research. Forecasts and estimates may change without notice.

Real GDP growth in % Inflation in %2012 2013F1 2014F1 2012 2013F1 2014F1

US 2.8 1.6 3.0 2.1 1.5 1.8

China 7.8 7.5 7.8 2.6 2.7 3.5

Eurozone –0.5 –0.7 0.8 2.5 1.5 1.5

UK 0.2 1.1 1.8 2.8 2.8 2.9

Switzerland 1.0 0.9 1.3 –0.7 –0.3 0.7

Russia 3.4 2.5 3.6 5.1 6.6 5.5

World 2.8 2.5 3.3 3.0 2.6 2.9

Source: Reuters EcoWin, IMF, UBS; as of 22 August 2013 1 UBS Forecasts


ASSeT ClASSeS OVeRVIeW

Equities

Emerging markets

mScI em (As of 21 August 2013: 924) Six-month target

House view neutral 975

Positive scenario 1,165

Negative scenario 700

US

S&P 500 (As of 21 August 2013: 1,643) Six-month target

House view overweight 1,730


Negative scenario 1,375

We are overweight US equities. The domestic economic recovery is underpinned by improving housing activity, benign inflation, easing bank lending conditions, and less acute public policy risks. While uncertainty over the pace of the withdrawal of the Fed’s asset-buying program may increase near-term volatility, we expect the Fed to only gradually reduce its bond purchases, commensurate with the improvement in the US growth momentum. Improv-ing economic and corporate earnings growth should push US stocks higher.

Eurozone

eUro Stoxx (As of 21 August 2013: 282) Six-month target

House view neutral 295

Positive scenario 325


We have a neutral position on Eurozone equities. Eco-nomic indicators have improved further and the region as a whole has returned to modest economic growth. Still, company earnings in the second quarter fell compared to a year ago. Thus, Eurozone earnings continue to lag those in the US and Japan. We prefer the consumer dis-cretionary and healthcare sectors as they offer good rev-enue and earnings growth and generate high free cash flows.

UK

FTSE 100 (As of 21 August 2013: 6,391) Six-month target

House view neutral 6,625



We have a neutral stance on UK equities. While company earnings are improving, their overall dynamics lag those of their Japanese and US peers. The UK’s discount valua-tion versus global equities is in line with its historic aver-age. Investors wishing to benefit from the UK’s domestic recovery are advised to invest in UK mid-cap companies via the FTSE 250 index.

We recommend an overall overweight allocation to equities, expressed by an overweight in US and Japanese equities. We are cautious on Australian equities. Global economic growth is forecast to improve in the coming quarters. US consumption is holding up well and the US housing market continues to improve. Company earnings are expected to gradually advance further globally. Talk of when and by how much the Fed will reduce QE3 could result in some short-term volatility.

US monetary policy in the spotlight

Markus Irngartinger, strategist, UBS AGCarsten Schlufter, analyst, UBS AG

We are neutral on emerging market (eM) equities. The consensus expectation is for eM earnings to grow 10.9% over the next 12 months. We are a little more cautious, however, and expect it to rise 10%. We do not foresee a material re-rating of eM equities, and we expect the P/e multiple of the MSCI EM Index to stay close to its current level of 10.7x based on realized earnings. We prefer Mexico and South Korea to Indonesia, South Africa, and Taiwan.


ASSeT ClASS OVeRVIeW

Legend

Overweight: Tactical recommendation to hold more of the asset class than specified in the strategic asset allocation Neutral: Tactical recommendation to hold the asset class in line with its weight in the strategic asset allocation Underweight: Tactical recommendation to hold less of the asset class than specified in the strategic asset allocation

Japan

topIx (As of 21 August 2013: 1,122) Six-month target

House view overweight 1,200



Source: Thomson Reuters, UBS; as of 22 August 2013

–3 0 3 6 9 12 15

6m change in trailing EPS 3m change in trailing EPS

Relatively strong earnings advance in Japan and the US

Note: Past performance is not an indication of future returns

Change in trailing earnings per share, in %

Japan

Switzerland

World

US

EMU

Australia

Canada

UK

Emerging Markets

24%

Switzerland

SmI (As of 21 August 2013: 7,887) Six-month target




We are neutral on Swiss equities relative to global equi-ties. While the Swiss market offers more sustainable earn-ings growth than its key peer markets, it also more expen-sive. We see moderate optimism as companies favor capital distribution over capital expenditure. In a still-chal-lenging economic environment, particularly in Europe, we favor mid-caps given their above-average balance-sheet strength, growth potential, and attractive valuations rela-tive to the Swiss market average.

We are overweight Japanese equities. The impact of a weaker yen and solid private consumption will lead to about 50% earnings growth this fiscal year. We expect the Bank of Japan to keep the 10-year JGB yield below 1% and to support equities with a very easy policy stance, which should lead investors to rebalance their portfolios toward riskier assets. With the ruling lDP securing a clear majority in the upper house election in July, we expect progress on structural reforms in autumn.


Prefer credit over high grade bonds

Achim Peijan, analyst, UBS AGPhilipp Schöttler, analyst, UBS AG

We prefer investment-grade (IG) and US high-yield (Hy) corporate bonds over high-grade bonds (bonds with a credit rating of ‘AA-’ or higher). A strong US corporate sector, the ongoing moderate recovery of the US economy, and low historical benchmark rates are likely to support credit segments. Ongoing backing from cyclical indicators provides a positive backdrop for risk assets in the months ahead.

Bonds


Government bonds / High grade

Investment grade corporate bonds

High yield bonds

Emerging market bonds

BarclayS AA+ 5–7Y (As of 21 August 2013: 2.6% / 1.5%)

Six-month targetUSD / eUR

House view underweight 2.5% / 1.7%

Positive scenario 2.7% / 1.9%

Negative scenario 1.9% / 0.9%

Spread USd Hy (As of 21 August 2013: 477bps)

Six-month target

House view overweight 400bps

Positive scenario 350bps

Negative scenario 800bps

cUrrent GloBal Spread (As of 21 August 2013: 148bps)

Six-month target

House view overweight 140bps

Positive scenario 110bps

Negative scenario 380bps

EMBI GLOBAL/CEMBI (As of 21 August 2013: 361bps / 362bps)

Six-month target

House view neutral 300bps / 310bps

Positive scenario 250bps / 250bps

Negative scenario 550bps / 750bps

We are underweight high-grade bonds (Barclays AA+ 5–7 year) versus investment-grade and high-yield bonds. We forecast high-grade bond yields to increase slightly over the next six to 12 months. We expect performance to be slightly positive for USD but slightly negative for CHF and eUR high-grade bonds in the next six months.

We recommend holding an overweight position in invest-ment-grade (IG) corporate bonds relative to high-grade bonds. While total returns of IG corporate bonds will be moderate, the yield carry and expected slight narrowing of spreads will likely lead to outperformance. Bonds from the lower IG rating segments (‘A’ and ‘BBB’) offer better return potential than higher-rated issuers.

US high-yield (Hy) corporate bonds offer an attractive return outlook, and we advise overweighting these assets. Modest economic growth, tepid inflation, and still-strong corporate fundamentals provide a supportive backdrop. Defaults are expected to remain well below 2% for the next six to 12 months. At current spread lev-els, Hy bonds offer a buffer against rising rates and are likely to outperform high-grade bonds as rate volatility settles further.

emerging market (eM) bonds denominated in USD are attractively valued compared to USD high-grade bonds. However, the weaker eM economic environment, increas-ing corporate leverage, and lower commodity prices are headwinds for EM bonds, pointing toward further bouts of higher price volatility. Please refer to our eM bond list for issuer and bond-specific guidance.


Price advances in commodities are likely to be short-livedDominic Schnider, analyst, UBS AGGiovanni Staunovo, analyst, UBS AG

The uptick of broadly diversified commodity indices during August was driven by prices of precious and industrial metals. Energy and agricultural commodities traded largely sideways.


Commodities Hedge funds

listed real estate

Gold (As of 21 August 2013: USD 1,370/oz) Six-month target

House view USD 1,150/oz

Positive scenario USD 1,550/oz

Negative scenario USD 800/oz

crUde oIl (BrENT) (As of 21 August 2013: USD 109.8/bbl)

Six-month target

House view USD 105/bbl

Positive scenario USD 130–165/bbl

Negative scenario USD 80–90/bbl

UBS GloBal Index dtr (As of 16 August 2013: 1,677)

Six-month target




House view Prefer relativevalue and equity longshort strategies

Positive scenario Prefer equity long-short and event driven

Negative scenario Prefer trading (Global Macro + CTA)

Commodities and other asset classes

GOlDWith the Fed likely to taper bond purchases later this year, we believe investors’ willingness to hold gold will continue to decline. A low-inflation environment and a stronger USD are additional hindrances for the yellow metal. In this context, we expect volatility in gold to be elevated and the metal price to fall to USD 1,150/oz in six months. We recommend investors who hold gold in excess of their recommended strategic allocation to review their positions, with platinum being a switch opportunity.

CRUDe OIl (BRenT)We expect crude oil prices to peak in late 3Q13 or early 4Q13, with prices shifting thereafter into a lower range of USD 100–105/bbl (Brent) and WTI trading at a dis-count to Brent of at least USD 5/bbl. The strong seasonal demand pick up in 3Q13 is expected to fade in 4Q13, with refinery capacity going into maintenance. We also expect geopolitical or weather-related events to be less price supportive in 2014. And given firm north American crude oil output, the oil price should come under pres-sure and test OPeC. We favor investment strategies that benefit from a topping out of the crude oil price over six to nine months.

We are neutral on listed real estate, although it has slightly attractive value. The jump in interest rates could induce rises in capitalization rates, and the improving growth environment must still be followed by growing rental income. Presently, overall yield spreads still favor listed real estate over bonds in the medium term. We do not exclude short-term volatility. We are neutral on the US and Europe and see upside in selected Asian markets. The UK is least preferred. In the US, we like multifamily REITs, regional malls and outlets.

Central banks’ accommodative and growth-focused poli-cies have ultimately also lowered the correlations among asset classes that have impaired HF performance over the last three years. Consequently, asset classes and individ-ual securities are following their specific drivers more, as the marked yTD performance among them illustrates. This supports the multitude of relative trades that most HF managers are now relying upon; these trades should play out more effectively (alpha generation). Conse-quently our tilt this year remains on relative-value and equity long-short managers.


Currencies

ASSeT ClASSeS OVeRVIeW

USd

We expect the USD to appreciate due to stronger eco-nomic growth, the prospect of the reduction of monetary stimulus in 2H 2013 and higher bond yields in the US. We think the USD has a chance to strengthen against the euro as soon as the Fed makes it clear when it intends to taper its monetary expansion program.

eUr

Europe has recovered from a recession, which is a major relief as it reduces the risk of another country falling into a debt trap. Nonetheless, the green shoots are still very delicate. European growth is not yet strong enough to justify a tightening of monetary conditions. Although eURUSD is at the upper end of its (1.25–1.35) range, we expect the exchange rate to drop in coming weeks due to higher US growth levels and the gradual fading of easy monetary policy in the US. We are short EURUSD.

cHf

The eURCHF is in the middle of the 1.21–1.25 range. There is a good chance it will rise as the stronger Euro-pean growth limits the risk of the eURCHF hitting 1.20. We recommend entering a short CHF position versus GBP.

GBp

Jpy

UBS CIO foreign exchange forecasts

23.08.13 3M 6M 12M PPP

EURUSD 1.3365 1.28 1.30 1.34 1.30

USDJPY 97.69 98 98 105 78

GBPUSD 1.5678 1.56 1.60 1.65 1.69

USDCHF 0.9212 0.96 0.95 0.92 0.98

EURCHF 1.2312 1.23 1.23 1.23 1.27

GBPCHF 1.4443 1.50 1.51 1.51 1.66

EURJPY 130.53 125 127 141 101

EURGBP 0.8522 0.82 0.81 0.81 0.77

Source: Reuters EcoWin, IMF, UBS; as of 23 August 2013PPP = Purchasing power parity

UK growth is strong and supports the GBP, which is strongly undervalued versus all other G10 currencies – except the JPy. We expect the GBP to appreciate as long as pound strength does not interfere with the newly introduced forward guidance: The pound may rise up to a point that would hurt the UK labor market and urge the BoE to ease monetary conditions. We recommend a long position versus CHF.

We think USDJPy is limited to a trading band within 95–100. Spikes above or below these thresholds are pos-sible, but are likely to provoke policy action. A drop below 95 is a serious challenge to “Abenomics” and the attempt to help the economy with a weaker JPy. A rise above 100 currently leads to unacceptably high import price infla-tion.

G4 currencies still caught in ranges

Thomas Flury, strategist, UBS AGConstantin Bolz, analyst, UBS AG

Europe has exited recession while the US recovery maintains a healthy pace. Europe’s recovery led to a EURUSD rally within the 1.25–1.35 range. We think EURUSD will remain in this range as long as the Fed does not taper QE too quickly and the eCB keeps an easing bias. The BoJ is also not keen on easing further, keeping the USDJPy range-bound (95–100). Any drop below 95 will be a real challenge to “Abenomics.” The AUD is expected to fall further on Australian domestic weakness. We keep a short AUD against CAD position.


6 month forecast

Assetclass TAA1 Change2 Benchmark Value3 m/mperf.

in%4

ytdperf. in%5

HouseView

Positivescenario

Negativescenario

EquitiEs

US S&P 500 1,657 –2.1 16.2 1,730 1,900 1,375Eurozone – EuroStoxx 285 3.5 9.4 295 325 200UK – FTSE 100 6,463 –2.0 9.6 6,625 7,300 5,150Japan – Topix 1,142 –6.6 32.8 1,200 1,475 850Switzerland – SMI 7,982 1.1 17.0 8,150 8,900 6,750Emergingmarkets – MSCI EM 922 –4.8 –12.6 975 1,165 700

BOnDs Yield/SpreadHighgradebonds US10yryield 2.9 –1.7 –4.0 2.5% 2.7% 1.9%

German10yryield 2.0 –2.2 –2.7 1.7% 1.9% 0.9%

Corporatebonds – SpreadglobalIG 148 –1.6 –2.3 140bps 110bps 380bps

Highyieldbonds SpreadUSDHY 473 –1.8 2.4 400bps 350bps 800bps

Emergingmarket sovereignbonds

– SpreadEMBI 338 –4.5 –9.8 300bps 250bps 550bps

Emergingmarket corporatebonds

– SpreadCEMBI 361 –2.4 –4.8 310bps 250bps 750bps

OthER AssEt CLAssEsGold USD/oz 1,375 2.2 –17.9 1,150/oz 1,550/oz 800/ozCrudeoil(Brent) USD/barrel 110 2.5 4.2 105/

bbl130–165/

bbl80–90/

bblHedgefunds HFRXGlobal 1,190 –0.8 3.6Listedrealestate – FTSEEPRA/NAREITDev. 3,514 –7.2 –0.2 3,690 4,040 3,340

CuRREnCiEs CurrencypairUSD – USDCHF 0.925 1.1 –1.0 0.95

USDJPY 98.970 0.5 –12.3 98EUR – EURUSD 1.336 1.0 1.2 1.30

EURCHF 1.235 0.1 –2.2 1.23EURGBP 0.857 0.4 –5.3 0.81

GBP GBPUSD 1.558 1.4 –4.1 1.60GBPCHF 1.441 –0.3 3.2 1.51

Source:UBS,Bloomberg1TAA=Tacticalassetallocation2Changecomparedtopreviousmonth3Asof22August20134Month-on-monthperformancein%5Year-to-dateperformancein%

Past performance is no indication of future performance. Forecasts are not a reliable indicator of future performance.

Overweight

Neutral

Underweight

Key forecastsAs of 22 August 2013


INVESTMENT IDEA

EQUITIES

Jeremy Zirin, strategist, UBS FS

David Lefkowitz, strategist, UBS FS

Matthew Baredes, strategist, UBS FS

Mid caps should outperform large caps based on accelerating US growth, greater cyclical exposure, upside margin potential and greater exposure to a recovering US housing market.

The global economic backdrop favors smaller US compa-nies. As drags from higher taxes and lower government spending fade and the US housing market continues to recover, we expect US GDP growth to accelerate. Smaller companies› greater cyclical exposure versus large caps should translate into faster earnings growth for smaller size segments, driving share price outperformance.

Smaller size segments also offer greater revenue exposure to the US domestic economy, which should continue to grow faster than other developed markets. Earnings for smaller companies should also get a boost from profit margin expansion potential. large-cap margins are near prior peak levels, whereas profit margins for smaller size segments have more room to expand. While relative valuations for smaller size US equity market segments are somewhat elevated relative to large caps, they are not excessive, and we believe the favorable cyclical backdrop and stronger earnings growth will be the primary drivers of relative performance within US size segments.

Merger and acquisition activity has remained muted during the recovery. However, as fiscal and monetary policy risks continue to fade, business and investor confidence will likely grow. In conjunction with large-caps’ cash rich balance sheets, we believe that M&A activity is poised to accelerate. Smaller companies are more likely to be acquisition targets, further boosting the upside potential for mid-caps versus large caps.

recent developments and recommendationEquities have performed well this year, driven by an improving US growth outlook and fading policy risks. The higher beta, greater cyclical exposure and lower dividend yield (a positive in a rising interest rate environment) of mid caps have driven outperformance versus large caps. We believe that these drivers remain in place and would support further gains versus large caps.

Time horizon: Medium term (6–12 months)Asset class: EquitiesInitiation date: 19/04/2012

US mid caps: The sweet spot


EQUITIES

Toru Ibayashi

Analyst, UBS AG

The weak yen will continue to have a posi-tive impact on exporters’ earnings growth, which will sustain their share price momen-tum.

Since the recent peak on May 22, the Japanese stock market has experienced high volatility. A sharp increase in 10-year long-term yields in late May and Prime Minister Abe’s economic reform package announced in early June disappointed international investors. However, after the US Federal Reserve announced that the tapering off of its quantitative easing (Qe) program would likely begin over the next year, international investors’ attention returned to Japanese equities as they expected the move to give impetus to a weaker yen trend. Japan’s stable 10-year long-term yield, lowered to 0.83% from its recent high of 1.0%, also contributed to revived investor credence for the Bank of Japan (BoJ). We believe in a long term weaker yen trend driven primarily by three factors: a wider interest rate gap between Japan and the US; the BoJ’s further monetary easing; and positive inflation driven by solid economic growth in Japan.

We expect more than 75% earnings growth in Fy2013 for Japanese exporters vs. 33% earnings growth for domestically oriented companies. The weaker yen and the positive impact of cost-saving programs and business downsizing from the last 3–4 years by Japanese exporters’ should strongly drive their earnings growth, in our view. More importantly, Fy2013/2014 consensus earnings forecasts of both exporters and domestic companies have been increased during the last five weeks. We prefer Japanese exporters in the Japanese equity market.

recent developments and recommendationsThe Japanese exporters are still trading below domestically oriented companies on price/earnings valuations despite their higher earnings growth expectations. Most of our core recommendations among Japanese exporters are stocks that we believe are undervalued. We have added a few names to our preference list as we expect them to show better-than-expected earnings growth in the March 2014 financial year. Since market volatility still remains high, we believe stock-picking is getting more important. We will keep our focus on a bottom-up approach and will update our list regularly.

INVESTMENT IDEA

Time horizon: Medium term (6–12 months)Asset class: EquitiesInitiation date: 22/11/2012

Japanese exporters supported by weaker yen


BONDS

Philipp Schöttler

Strategist, UBS AG

US high yield (HY) bonds are supported by a low default rate and solid corporate fun-damentals. Current spreads can absorb a gradual rise in benchmark rates. We expect total returns of four to six percent over the next six months.

We expect the default rate to remain well below two percent through the year compared to a 4.5% long-term average. US companies used favorable financing condi-tions in recent years to issue a record amount of new debt. The bulk of this issuance was used to refinance old debt. This lowered both the interest burden and the volume of upcoming maturities, making companies’ balance sheets resilient for the years ahead. Based on our outlook for ongoing economic growth in the US driving solid earnings growth, we think that current corporate leverage levels around long-term averages are well supported.

Re-leveraging is not taking place on a large scale (yet)While «shareholder-friendly» activities (such as share buybacks, dividend payments and M&As) have increased moderately, the credit cycle is still at an early stage of re-leveraging based on aggregate leverage and use of proceeds data. Activities are far from the excesses of the last credit boom pre-2008. Meanwhile, the spread of US high yield bonds over US Treasuries is relatively high and far from previous cycle lows, offering potential to tighten toward our six-month target of 400 basis points (bps).

High yield can absorb gradually rising ratesAt current spread levels of around 480 bps, Hy bonds can absorb a gradual increase in Treasury rates. Past experi-ence shows that Hy performs well when rates rise on the back of an improving economic outlook.

recent developments and recommendationAs benchmark Treasury rates settled on their higher level, market volatility subsided, supporting inflows into US Hy funds. Spreads tightened from a high of 534 bps in June to 480 bps but remained well above the low reached in May (of 423 bps). Total returns over the last month were +1.4% (year to date: +3.2%). At the same time, return volatility on US Hy remains relatively low at below three percent (annualized) over the last 12 months.

In particular, compared to high-grade and government bonds as well as money market instruments, US Hy bonds offer a far better risk/reward outlook over the coming months.

INVESTMENT IDEA

Time horizon: Medium term (6–12 months)Asset class: BondsInitiation date: 25/09/2009

US high yield corporate bonds


IMPORTAnT InFORMATIOn FOR CIO COnTenT

UBS CIO WM Research is published by Wealth Management and Retail & Corporate 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. 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 representation or warranty, express or implied, is made as to its accuracy or completeness (other than disclosures relating to UBS AG, its subsidiaries and affiliates). All information and opinions as well as any prices indicated are current as of the date of this report, and are subject to change without notice. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. Opinions expressed herein may differ or be contrary to those expressed by other business areas or divisions of UBS, its subsidiaries and affiliates, as a result of using different assumptions and/or criteria. At any time UBS and other companies in the UBS group (or its employees) may have a long or short position, or deal as principal or agent, in relevant securities or provide advisory or other services to the issuer of relevant securities or to a company connected with an issuer. Some investments may not be readily realizable since the market in the securities is illiquid and therefore valuing the investment and identifying and quantifying the risk to which you are exposed may be difficult. UBS relies on information barriers to control the flow of information contained in one or more areas within UBS, into other areas, units, divisions or affiliates of UBS. Futures and options trading is considered risky. Past performance of an investment is no guarantee for its future performance. Additional information will be made available upon request. Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in foreign exchange rates may have an adverse effect on the price, value or income of an investment. The compensation of the analyst(s) who prepared this report is determined exclusively by research management and senior management (not including investment banking). Analyst compensation is not based on investment banking revenues, however, compensation may relate to the revenues of UBS Wealth Management & Swiss Bank as a whole, which includes investment banking, sales and trading services. We are of necessity unable to take into account the particular investment objectives, financial situation and needs of our individual clients and we would recommend that you take financial and/or tax advice as to the implications (including tax) of investing in any of the products mentioned herein. For structured financial instruments and funds the sales prospectus is legally binding. If you are interested you may attain a copy via UBS or a subsidiary of UBS. This document may not be reproduced or copies circulated without prior authority of UBS or a subsidiary of UBS. UBS expressly prohibits the distribution and transfer of this document to third parties for any reason. UBS will not be liable for any claims or lawsuits from any third parties arising from the use or distribution of this document. This report is for distribution only under such circumstances as may be permitted by applicable law. In developing the Chief Investment Office 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

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Version July 2013.© UBS 2013. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.


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