Financial Pacific - S&p 500 looks attractive at 11.0x forward earnings (third party)
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Financial Pacific - S&p 500 looks attractive at 11.0x forward earnings (third party)

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    Financial Pacific - S&p 500 looks attractive at 11.0x forward earnings (third party) Financial Pacific - S&p 500 looks attractive at 11.0x forward earnings (third party) Document Transcript

    •  Global Equity Research Americas UBS Investment Research Equity Strategy US Equity Strategy Investment Strategy 3Q11 Valuation Opportunities Chart Pack 29 August 2011  S&P 500 Looks Attractive at 11.0x Forward Earnings www.ubs.com/investmentresearch With the market down substantially, the S&P 500 now carries an 11.0x forward P/E. Such a multiple is extremely low under almost any economic scenario short of a double-dip recession. As such, we believe stocks present an attractive buying opportunity at current levels. Jonathan Golub, CFA Strategist  Cyclical Stocks Appear to Offer Superior Value jonathan.golub@ubs.com +1-212-713 8673 Since mid-February, the market has rotated towards defensive stocks, reflecting growth and macro concerns. However, over this same period, NTM earnings Manish Bangard, CFA estimates have risen by a greater amount for more economically-sensitive names. Strategist As a result, cyclical stocks have become substantially cheaper on both an absolute manish.bangard@ubs.com +1-212-713 3036 and relative basis. Daniel Murphy  Valuation Framework Strategist While multiples appear depressed broadly, the purpose of this chart pack is to daniel-d.murphy@ubs.com identify P/E disparities based on UBS’s proprietary “double-relative” valuation +1-212-713 3186 framework. This approach compares each sector’s relationship to the market today Vishal Patel versus its history. Please see the appendix for calculation details. Associate Strategist vishal-a.patel@ubs.com  Greatest Opportunities +1-212-713 4027 At the sector level, Materials and Energy now look attractively valued, as do Tech, Thomas M. Doerflinger, Ph.D. Industrials, and Financials. Telecom and Utilities look by far the most stretched. In Strategist our view, attractively valued sub-sectors include Transportation within Industrials, tom.doerflinger@ubs.com Semis within Tech, Autos within Discretionary, and Banks within Financials. +1-212-713 2540 Natalie Garner, CFA Strategist natalie.garner@ubs.com +1-212-713 4915 Exhibit 1: Sectors — Overvalued/Undervalued Overvalued 2.7 2.9 P/E Multiple Points 1.3 1.5 0.2 -0.9 -0.7 -0.7 -1.0 -2.2 Undervalued MAT TECH IND EN FIN DISCR HC STPLS TCOM UTIL Cyclicals Non-Cyclicals Source: Standard & Poor’s, Compustat, Thomson Financial, FactSet, and UBS This report has been prepared by UBS Securities LLC ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 25. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
    • US Equity Strategy 29 August 2011Key TakeawaysMarket Valuations (pages 3-4) Valuations Near 2008 Crisis Lows. During the financial crisis, multiples collapsed to a trough of 10.2x forward earnings. Stocks reached a similar level — 10.4x — on August 22, reflecting recessionary concerns. Although stocks are trading higher today at 11.0x, they are still down significantly from the end of April. However, we believe a recession will not materialize over the near term. As such, stocks present an attractive buying opportunity at current levels, in our view. Recessionary Fears Driving Multiples. For much of the past decade, stocks multiples had primarily been anchored to corporate bond yields. However, this relationship broke down in late 2009 as the market began to discount slower long-term growth. Since April, the disparity between bond yields and earnings yields has widened further, we believe reflecting near-term recessionary fears. P/E Dispersion Remains Extremely Tight. During the internet bubble, P/Es were widely varied, with valuations for the Technology sector more than triple those of Utilities. However, the dispersion of multiples came down sharply following the bubble’s burst and has continued to gradually decline since then.Cyclicals vs. Non-Cyclicals (page 5) Cyclical Stocks Compellingly Valued. Since mid-February, the market has been led by defensive stocks. At the same time, NTM earnings estimates for more economically-sensitive names have risen by a greater amount. As a result, cyclical stocks have become far cheaper on both an absolute and relative basis. We see this trend reversing.Absolute and Relative Valuations — Sector Details (pages 6-9) Relatively Cheap: Materials, Transports, Semis, Banks, and Autos. Using UBS’s proprietary relative valuation framework (described in the box below), we gauge relative P/Es of industry groups within each S&P 500 sector. On this basis, we believe a few groups appear particularly attractive: Materials broadly, Transportation within Industrials, Semis within Technology, Banks within Financials, and Autos within Discretionary. Absolute Valuation Changes. Changes in P/Es are the result of movements in both price and earnings. Segments within the market that have seen significant price declines despite large EPS revisions are likely to rebound should confidence in the economy be restored. While we prefer to look at valuations on UBS’s proprietary “double- relative” basis, the following groups have experienced the largest P/E declines: Capital Goods, Transports, Media, Autos, REITs, and Insurance.Relative Valuations — Sector and Industry Group Histories (pages 10-22) Historical Valuation Trends. Groups of stocks can stay cheap or expensive for extended periods of time. As such, we think it is instructive to analyze valuation trends for each sector and industry group over longer-term horizons. Using this analysis, all of the cyclical sectors appear attractively valued with the exception of Consumer Discretionary. More defensive sectors, however, all appear expensive — Telecom and Utilities in particular. UBS’s Proprietary Relative Valuation FrameworkThe goal of our valuation framework is to determine whether each S&P 500 sector is undervalued or overvaluedrelative to the overall market in the context its history. For example, over the past three years, Utilities has traded at 0.7multiple points below the market, while Technology has traded 1 multiple point above. At present, Utilities is 2.1multiple points above the market, while Technology is trading 0.1 multiple points below. This would suggest Utilitiesis overvalued, while Technology is undervalued. Using statistical measures, we are able to quantify these discrepanciesto identify investment opportunities. Full details are provided in the appendix. UBS 2
    • US Equity Strategy 29 August 2011Market ValuationsExhibit 2: S&P 500 P/E 25 While stocks carry an 11.0x forward P/E, this is not without precedence. The 20 S&P 500 P/E was 7.5x in 1984. Avg: 14.8x 15 Multiples have fallen nearly 60% since peaking at 25.1x in 1999. 10 11.0x 5 83 87 91 95 99 03 07 11Source: Standard & Poor’s, Thomson Financial, FactSet, and UBSExhibit 3: S&P 500 E/P vs. Baa Yields P/E Anchored to Slower Recession Between 2004 and 2009, 10 Baa Bond Yields Growth Fears stock multiples anchored on corporate bond yields. 9 This relationship broke down 8 in November 2009 — Earnings Yield ► reflecting long-term growth concerns. 7 6 We believe the current ▲ Baa Yield disparity in multiples is driven by fears of recession 5 and should narrow to levels 04 05 06 07 08 09 10 11 seen earlier this year.Source: Moody’s, Standard & Poor’s, Thomson Financial, FactSet, and UBS UBS 3
    • US Equity Strategy 29 August 2011Market ValuationsExhibit 4: S&P 500 P/E Dispersion 0.8 Since the tech bubble, the 0.7 dispersion of stock multiples has narrowed considerably. 0.6 0.5 P/E dispersion 0.4 extremely tight 0.3 0.2 0.1 0.0 97 99 01 03 05 07 09 11Source: Standard & Poor’s, Thomson Financial, FactSet, and UBSNote: P/E Dispersion defined as the standard deviation of S&P 500 sector P/Es divided by the S&P 500 index P/E.Exhibit 5: Sector P/E Comparisons 2001 2005 Now Telecom 18.9 13.7 15.4 At the end of 2001, sector P/Es ranged from a low of Staples 18.8 17.2 13.5 11.5x (Utilities) to a high of Utilities 11.5 14.2 13.1 36.7x (Tech). Discretionary 26.2 16.9 13.1 Industrials 20.7 16.1 11.3 Today, they range from 9.2x Technology 36.7 18.8 10.9 (Financials) to 15.4x (Telecom). Accordingly, the Health Care 24.7 17.2 10.7 high-to-low disparity has Materials 22.5 14.7 10.6 fallen from 25.2x to 6.2x. Energy 19.2 9.7 9.2 Financials 14.4 12.0 9.2 S&P 500 20.7 14.5 11.0 High-to-Low 25.2 9.1 6.2Source: Standard & Poor’s, Thomson Financial, FactSet, and UBS UBS 4
    • US Equity Strategy 29 August 2011Cyclicals vs. Non-CyclicalsExhibit 6: Forward P/E 16 In January 2011, cyclical 15 sectors carried a 0.9x multiple premium to defensive groups. 14 ◄ Cyclicals 13 This relationship has reversed, with more economically-sensitive 12 12.3x sectors presently trading at a 1.9x discount. ◄ Non-Cyclicals 11 10.4x 10 Mar-09 Aug-09 Jan-10 Jun-10 Nov-10 Apr-11Source: Standard & Poor’s, Compustat, Thomson Financial, FactSet, and UBSNote: Cyclicals include Energy, Materials, Industrials, Consumer Discretionary, Financials and Technology while Non-Cyclicals include Consumer Staples, Health Care, Telecom, and Utilities.Exhibit 7: Forward EPS $ of EPS Feb 2011 50 78.8 80 Much of the shift in relative multiples between cyclical 71.9 45 and defensive shares is the 72 result of a market rotation. 40 64 NTM earnings estimates ◄ Cyclicals have risen for more 56 35 economically-sensitive stocks over this period as well. 48 29.0 30 28.1 Non-Cyclicals ▼ 40 25 Mar-09 Aug-09 Jan-10 Jun-10 Nov-10 Apr-11Source: Standard & Poor’s, Compustat, Thomson Financial, FactSet, and UBSNote: Cyclicals include Energy, Materials, Industrials, Consumer Discretionary, Financials and Technology while Non-Cyclicals include Consumer Staples, Health Care, Telecom, and Utilities. UBS 5
    • US Equity Strategy 29 August 2011Absolute P/E Changes — Sector DetailsExhibit 8: April 29 (Market Peak) to Today Forward P/E % Chg — Apr 29 to Now Apr 29 Now Change Price NTM EPS The recent shift in multiplesCyclicals is the result of both price and Industrials 15.2 11.3 -3.9 -20.7 7.0 EPS changes. Capital Goods 14.9 10.8 -4.1 -22.0 7.4 Capital Goods x GE 15.1 11.0 -4.1 -21.5 7.6 Transportation 16.2 12.7 -3.5 -16.1 7.0 The areas that have seen the greatest multiple contraction Commercial Svcs 16.3 13.6 -2.7 -15.9 0.2 are likely to snap back when Materials 13.8 10.6 -3.2 -16.5 8.4 confidence is restored. Financials 11.8 9.2 -2.6 -21.3 1.5 Real Estate 45.2 40.0 -5.2 -2.3 10.5 Insurance 11.7 8.5 -3.2 -22.2 7.4 Banks 11.3 8.2 -3.1 -19.7 10.0 Diversifieds 10.5 8.2 -2.3 -25.2 -4.5 Energy 12.1 9.2 -2.9 -19.6 5.0 Discretionary 15.5 13.1 -2.4 -12.1 3.8 Media 14.6 11.2 -3.4 -20.0 5.0 Autos 10.1 6.8 -3.3 -28.4 6.7 Durables & Apparel 16.0 14.2 -1.8 -9.6 2.2 Retailing 17.2 15.6 -1.6 -8.8 0.7 Consumer Svcs 17.2 16.0 -1.2 -0.8 6.6 Technology 13.2 10.9 -2.3 -12.1 6.0 Semis 12.4 9.6 -2.8 -21.1 1.9 Software 13.9 11.8 -2.1 -10.8 5.5 Hardware 12.5 10.4 -2.1 -10.5 8.2Non-Cyclicals Health Care 12.2 10.7 -1.5 -9.5 3.4 Healthcare Svcs 14.1 11.4 -2.7 -12.8 7.5 Pharma & Biotech 11.3 10.3 -1.0 -7.6 1.6 Telecom 16.8 15.4 -1.4 -8.2 0.1 Staples 14.5 13.5 -1.0 -4.6 2.7 Food Retailing 13.4 12.0 -1.4 -7.3 3.5 Food, Bev & Tob 14.9 13.9 -1.0 -3.4 3.4 Household Prod 15.2 14.7 -0.5 -4.2 -0.5 Utilities 13.3 13.1 -0.2 -1.0 0.4S&P 500 13.3 11.0 -2.3 -14.0 4.1Source: Standard & Poor’s, Compustat, Thomson Financial, FactSet, and UBSNote: Analysis based on companies in the S&P 500 on both April 29 and August 27. UBS 6
    • US Equity Strategy 29 August 2011Relative Valuation — Sector DetailsExhibit 9: Industrials – Overvalued/Undervalued Overvalued 0.5 U.S. Industrials are dominated by later stage stocks. As a result, the group has looked expensive for P/E Multiple Points much of the recovery. The group has been especially hard hit since -0.9 -0.8 April as short-cycle names have disappointed. -1.4 Undervalued Industrials Transportation Capital Goods Commercial ServicesSource: Standard & Poor’s, Compustat, Thomson Financial, FactSet, and UBSNote: Analysis performed on a 36-month rolling basis.Exhibit 10: Technology – Overvalued/Undervalued Overvalued While each of the Tech groups has experienced -0.4 negative price movements, -1.0 -1.1 Semis have underperformed P/E Multiple Points Hardware and Software by more than 10% over the past four months. -4.7 Undervalued Technology Semis Hardware SoftwareSource: Standard & Poor’s, Compustat, Thomson Financial, FactSet, and UBSNote: Analysis performed on a 36-month rolling basis. UBS 7
    • US Equity Strategy 29 August 2011Relative Valuation — Sector DetailsExhibit 11: Financials – Overvalued/Undervalued Overvalued Banks have been poor 2.3 performers since April, but they have also had some of the highest EPS revisions. P/E Multiple Points 0.3 Given their more defensive nature, Insurance companies -0.7 currently look more overvalued than the rest of -1.7 the Financials sector. -3.2 Undervalued Financials Banks Diversified Real Estate Insurance FinancialsSource: Standard & Poor’s, Compustat, Thomson Financial, FactSet, and UBSNote: Analysis performed on a 36-month rolling basis.Exhibit 12: Discretionary – Overvalued/Undervalued Overvalued 1.9 1.4 Autos have underperformed the S&P 500 by 14% since 0.6 the market’s 2011 peak, 0.2 despite an NTM EPS increase P/E Multiple Points 0.0 of 6.7%. -3.5 Undervalued Cons. Autos Media Retailing Durables & Consumer Disc. Apparel ServicesSource: Standard & Poor’s, Compustat, Thomson Financial, FactSet, and UBSNote: Analysis performed on a 36-month rolling basis. UBS 8
    • US Equity Strategy 29 August 2011Relative Valuation — Sector DetailsExhibit 13: Staples – Overvalued/Undervalued Overvalued 1.9 Food, Beverage, & Tobacco companies have been among 1.5 the best performing groups 1.5 since April. However, they P/E Multiple Points have experienced less than average EPS revisions. 0.7 Undervalued Cons. Staples Food & Staples Household Food, Bev. & Retail Products TobaccoSource: Standard & Poor’s, Compustat, Thomson Financial, FactSet, and UBSNote: Analysis performed on a 36-month rolling basis.Exhibit 14: Health Care – Overvalued/Undervalued Overvalued Both Health Care subgroups 1.4 currently appear overvalued. 1.3 P/E Multiple Points 1.0 Undervalued Health Care Health Care Equipment Pharma & BiotechSource: Standard & Poor’s, Compustat, Thomson Financial, FactSet, and UBSNote: Analysis performed on a 36-month rolling basis. UBS 9
    • US Equity Strategy 29 August 2011Relative Valuation — Sector HistoriesExhibit 15: Industrials vs. Technology 2.6 2.2 Overvalued Industrials valuations have come down sharply. 1.6 1.3 P/E Multiple Points Tech looks cheaper than the 0.6 0.4 broad market. -0.4 -0.5 Technology ► ◄ Industrials -1.4 -1.4 Undervalued -2.4 -2.3 97 99 01 03 05 07 09Source: First Call, Standard & Poor’s, FactSet, and UBS Note: Analysis performed on a 36-month rolling basis.Exhibit 16: Consumer Discretionary vs. Financials 1.8 2.1 Overvalued Financials are more than one standard deviation below ◄ Discretionary their historical valuation. Financials ► P/E Multiple Points 0.8 0.8 -0.2 -0.6 Undervalued -1.2 -2.0 97 99 01 03 05 07 09Source: First Call, Standard & Poor’s, FactSet, and UBS Note: Analysis performed on a 36-month rolling basis. UBS 10
    • US Equity Strategy 29 August 2011Relative Valuation — Sector HistoriesExhibit 17: Energy vs. Materials 3.3 4.6 Overvalued Materials appear cheap 2.3 3.4 versus Energy. 1.3 ◄ Energy 2.1 P/E Multiple Points 0.3 0.8 -0.7 -0.4 -1.7 -1.7 Materials ► -2.7 -3.0 Undervalued -3.7 -4.2 97 99 01 03 05 07 09Source: First Call, Standard & Poor’s, FactSet, and UBS Note: Analysis performed on a 36-month rolling basis.Exhibit 18: Telecommunication Services vs. Utilities 3.1 Overvalued 3.9 Telecom and Utilities look 2.1 ◄ Telecom 2.7 extremely overvalued. P/E Multiple Points 1.1 1.4 0.1 0.2 -0.9 -1.1 -1.9 -2.3 Undervalued Utilities ► -2.9 -3.6 97 99 01 03 05 07 09Source: First Call, Standard & Poor’s, FactSet, and UBS Note: Analysis performed on a 36-month rolling basis. UBS 11
    • US Equity Strategy 29 August 2011Relative Valuation — Sector HistoriesExhibit 19: Health Care vs. Staples 2.0 2.4 Overvalued While expensive, Health Care and Staples appear more 1.0 ◄ Health Care Staples ► 1.4 attractively valued than Utilities or Telecom. P/E Multiple Points 0.0 0.4 -1.0 -0.6 -2.0 -1.5 Undervalued -3.0 -2.5 97 99 01 03 05 07 09Source: First Call, Standard & Poor’s, FactSet and UBS Note: Analysis performed on a 36-month rolling basis. UBS 12
    • US Equity Strategy 29 August 2011Relative Valuation — Industry Group HistoriesExhibit 20: Industrials — Capital Goods 2.6 Industrials ▼ 2.8 Overvalued 1.6 1.7 P/E Multiple Points 0.6 0.6 -0.4 -0.5 Cap Goods ► -1.4 -1.6 Undervalued -2.4 -2.6 97 99 01 03 05 07 09Source: First Call, Standard & Poor’s, FactSet and UBS Note: Analysis performed on a 36-month rolling basis.Exhibit 21: Industrials — Commercial Services 2.6 3.3 Overvalued 1.6 2.1 Industrials ▼ P/E Multiple Points 0.6 0.8 -0.4 -0.5 Commercial Svcs ► -1.4 -1.8 Undervalued -2.4 -3.1 97 99 01 03 05 07 09Source: S&P, Thomson Financial, FactSet, and UBS UBS 13
    • US Equity Strategy 29 August 2011Relative Valuation — Industry Group HistoriesExhibit 22: Industrials — Transportation 2.6 4.2 Overvalued 1.6 2.7 Transportation ► ▼ Industrials P/E Multiple Points 0.6 1.3 -0.4 -0.2 -1.4 -1.6 Undervalued -2.4 -3.1 97 99 01 03 05 07 09Source: First Call, Standard & Poor’s, FactSet, and UBS Note: Analysis performed on a 36-month rolling basis.Exhibit 23: Technology — Hardware 2.4 3.3 Overvalued 1.4 ▼ Technology 2.0 P/E Multiple Points 0.4 0.7 Hardware ► -0.6 -0.6 -1.6 -1.9 Undervalued -2.6 -3.3 97 99 01 03 05 07 09Source: S&P, Thomson Financial, FactSet, and UBS UBS 14
    • US Equity Strategy 29 August 2011Relative Valuation — Industry Group HistoriesExhibit 24: Technology — Software 2.4 3.1 Overvalued 1.4 ▼ Technology 1.6 P/E Multiple Points 0.4 0.1 -0.6 -1.4 -1.6 Software ► -2.8 Undervalued -2.6 -4.3 97 99 01 03 05 07 09Source: First Call, Standard & Poor’s, FactSet, and UBS Note: Analysis performed on a 36-month rolling basis.Exhibit 25: Technology — Semiconductors 2.4 Overvalued 19.6 1.4 Semis ► 11.5 P/E Multiple Points 0.4 3.4 -0.6 -4.6 ◄ Technology -1.6 -12.7 Undervalued -2.6 -20.8 06 08 10Source: S&P, Thomson Financial, FactSet, and UBSNote: Semiconductors were not classified a separate industry group prior to 2006. UBS 15
    • US Equity Strategy 29 August 2011Relative Valuation — Industry Group HistoriesExhibit 26: Financials — Banks 2.6 3.7 Overvalued Banks ► 1.6 1.5 P/E Multiple Points 0.6 -0.7 ◄ Financials -0.4 -2.9 -1.4 -5.2 Undervalued -2.4 -7.4 97 99 01 03 05 07 09Source: First Call, Standard & Poor’s, FactSet, and UBS Note: Analysis performed on a 36-month rolling basis.Exhibit 27: Financials — Diversifieds 2.6 4.0 Overvalued Diversifieds ► 1.6 2.3 P/E Multiple Points 0.6 ◄ Financials 0.6 -0.4 -1.1 -1.4 -2.7 Undervalued -2.4 -4.4 97 99 01 03 05 07 09Source: S&P, Thomson Financial, FactSet, and UBS UBS 16
    • US Equity Strategy 29 August 2011Relative Valuation — Industry Group HistoriesExhibit 28: Financials — Insurance 2.6 7.8 Overvalued Financials ▼ 1.6 5.4 Insurance ▼ P/E Multiple Points 0.6 3.1 -0.4 0.8 -1.4 -1.5 Undervalued -2.4 -3.8 97 99 01 03 05 07 09Source: First Call, Standard & Poor’s, FactSet, and UBS Note: Analysis performed on a 36-month rolling basis.Exhibit 29: Financials — REITs 2.6 29.6 Overvalued 1.6 12.8 P/E Multiple Points 0.6 -4.0 -0.4 -20.9 ▲ Real Estate -1.4 ◄ Financials -37.7 Undervalued -2.4 -54.5 01 03 05 07 09Source: S&P, Thomson Financial, FactSet, and UBSNote: Real Estate did not exist as an industry group prior to 2001. UBS 17
    • US Equity Strategy 29 August 2011Relative Valuation — Industry Group HistoriesExhibit 30: Discretionary — Autos 2.3 11.3 Overvalued 1.3 Autos ► 5.8 ◄ Discretionary P/E Multiple Points 0.3 0.3 -0.7 -5.2 Undervalued -1.7 -10.8 97 99 01 03 05 07 09Source: First Call, Standard & Poor’s, FactSet and UBS Note: Analysis performed on a 36-month rolling basis.Exhibit 31: Discretionary — Durables & Apparel 2.3 5.1 Overvalued Durables & Apparel ▼ 1.3 2.7 ◄ Discretionary P/E Multiple Points 0.3 0.3 -0.7 -2.1 Undervalued -1.7 -4.5 97 99 01 03 05 07 09Source: S&P, Thomson Financial, FactSet, and UBS UBS 18
    • US Equity Strategy 29 August 2011Relative Valuation — Industry Group HistoriesExhibit 32: Discretionary — Consumer Services 2.3 5.0 Overvalued Consumer ► Services ► 1.3 2.6 ◄ Discretionary P/E Multiple Points 0.3 0.2 -0.7 -2.1 Undervalued -1.7 -4.5 97 99 01 03 05 07 09Source: First Call, Standard & Poor’s, FactSet, and UBS Note: Analysis performed on a 36-month rolling basis.Exhibit 33: Discretionary — Media 2.3 5.7 Overvalued 1.3 2.6 ◄ Discretionary P/E Multiple Points 0.3 -0.4 -0.7 -3.4 ▲ Media Undervalued -1.7 -6.4 97 99 01 03 05 07 09Source: S&P, Thomson Financial, FactSet, and UBS UBS 19
    • US Equity Strategy 29 August 2011Relative Valuation — Industry Group HistoriesExhibit 34: Discretionary — Retailing 2.3 4.4 Overvalued Retailing ► 1.3 2.3 ◄ Discretionary P/E Multiple Points 0.3 0.3 -0.7 -1.7 Undervalued -1.7 -3.7 97 99 01 03 05 07 09Source: First Call, Standard & Poor’s, FactSet, and UBS Note: Analysis performed on a 36-month rolling basis.Exhibit 35: Staples — Food Retailing 2.4 2.5 Overvalued 1.4 Food Retailing ► 1.5 P/E Multiple Points 0.4 0.5 -0.6 -0.6 ◄ Staples -1.6 -1.6 Undervalued -2.6 -2.6 97 99 01 03 05 07 09Source: S&P, Thomson Financial, FactSet, and UBS UBS 20
    • US Equity Strategy 29 August 2011Relative Valuation — Industry Group HistoriesExhibit 36: Staples — Food, Beverage, & Tobacco 2.4 2.4 Overvalued 1.4 1.2 Food, Bev ► & Tob. ► P/E Multiple Points 0.4 0.0 -0.6 -1.2 ◄ Staples -1.6 -2.4 Undervalued -2.6 -3.7 97 99 01 03 05 07 09Source: First Call, Standard & Poor’s, FactSet, and UBS Note: Analysis performed on a 36-month rolling basis.Exhibit 37: Staples — Household Products 2.4 2.9 Overvalued Household Products ► 1.4 1.5 P/E Multiple Points 0.4 0.2 -0.6 -1.2 -1.6 -2.5 ▲ Staples Undervalued -2.6 -3.9 97 99 01 03 05 07 09Source: First Call, Standard & Poor’s, FactSet, and UBS Note: Analysis performed on a 36-month rolling basis. UBS 21
    • US Equity Strategy 29 August 2011Relative Valuation — Industry Group HistoriesExhibit 38: Health Care — Equipment & Services 2.0 2.7 Overvalued ▼ Equip & Svcs 1.0 1.6 P/E Multiple Points 0.0 0.4 -1.0 -0.8 -2.0 ◄ Health Care -1.9 Undervalued -3.0 -3.1 97 99 01 03 05 07 09Source: First Call, Standard & Poor’s, FactSet, and UBS Note: Analysis performed on a 36-month rolling basis.Exhibit 39: Health Care — Pharmaceuticals & Biotech 2.0 2.0 Overvalued ▼ Pharma & 1.0 ▼ Biotech ◄ Health Care 1.0 P/E Multiple Points 0.0 0.0 -1.0 -1.1 -2.0 -2.1 Undervalued -3.0 -3.1 97 99 01 03 05 07 09Source: S&P, Thomson Financial, FactSet, and UBS UBS 22
    • US Equity Strategy 29 August 2011Appendix: Inter-Sector ValuationThe goal of our inter-sector valuation work is to gauge whether each S&P 500 sector is undervalued orovervalued relative to the overall market. Our analysis is based upon the historical valuationrelationships between sectors. Importantly, we normalize sector valuations for three dynamics that couldpotentially provide spurious results, if not accounted for correctly: Some sectors tend to be more expensive than others on a systematic basis (e.g., Tech consistently trades at a higher P/E than Financials). The valuation dispersion between sectors is wide in some environments (e.g., the late-90s) and tight in others (e.g., 2008-09). In other words, a multiple point today is not necessarily the same as a multiple point yesterday. Sector dynamics change over time. For example, Health Care carried a premium multiple throughout the 90’s, but has traded at a discount over the past decade. Our inter-sector valuation work suggests that relative sector valuations are mean-reverting over medium-term time frames. As such, we view our inter-sector valuation rankings as a good starting point in determining sector recommendations. However, we note that sectors can stay cheap or expensive for multi-year time periods.Ranking OverviewIn order to properly normalize inter-sector valuations over time, our analysis focuses on how manystandard deviations away each sector’s P/E is from the market’s P/E. (For our fellow math geeks, this isknown as cross-sectional standard deviation analysis.) We then put this calculation into a historicalcontext on a sector-by-sector basis.In the table below, we provide an overview of the calculations behind our inter-sector valuationrankings. On the following page, we walk though our calculations on a step-by-step basis. Inter-Sector Valuation Ranking Overview — Hypothetical Example (A) (B) (C=A-B) (D) (E=C/D) (F) (G=E-F) (H) Sector S&P 500 Premium S&P 500 Z Score Avg Z Net Z (1)Sector Fwd P/E Fwd P/E (Current) Std Dev Current (Trail 36M) Current RankUtilities 11.8x 14.1x -2.3 1.7 -1.4 0.0 -1.4 1Health Care 11.7x 14.1x -2.5 1.7 -1.5 -0.2 -1.3 2Cons. Staples 14.0x 14.1x -0.1 1.7 -0.1 0.8 -0.9 3Telecom 12.7x 14.1x -1.5 1.7 -0.9 -0.2 -0.7 4Technology 15.7x 14.1x 1.6 1.7 0.9 1.2 -0.3 5Cons. Discretionary 15.6x 14.1x 1.4 1.7 0.9 0.7 0.2 6Energy 13.4x 14.1x -0.7 1.7 -0.4 -0.8 0.4 7Financials 13.9x 14.1x -0.2 1.7 -0.1 -0.7 0.6 8Industrials 16.2x 14.1x 2.1 1.7 1.2 0.2 1.0 9Materials 17.4x 14.1x 3.2 1.7 1.9 0.8 1.1 10(1) Represents the standard deviation of the S&P 500’s Forward P/E.Source: First Call, Standard & Poor’s, and UBS UBS 23
    • US Equity Strategy 29 August 2011Step-by-Step Calculations(1) Aggregate P/Es and Standard Deviations (columns A, B, and D). First, we calculate a forward P/E for the S&P 500 and all 10 of its sectors, using consensus EPS estimates over the next 12 months. We also calculate the weighted average standard deviation of the market’s forward P/E.(2) Calculate Z-Scores (column C). Next, we calculate a Z-Score for each sector. This expresses each sector’s P/E as a number of standard deviations away from the market’s P/E. This is calculated by subtracting the market’s P/E from each sector’s P/E and dividing the result by the weighted average standard deviation of the market’s forward P/E. Z-Score Calculation (P/E Sector − P/E Market ) Sector Z - Score = σ P/E MarketSource: UBS(3) Put Current Valuations in Historical Context (columns E, F, and G). A Net Z-Score is then calculated for each sector by comparing current Z-Scores to average Z-Scores over the prior 36 months. We perform our analysis on a rolling 36-month basis to account for secular changes in sector dynamics (e.g., new governmental regulations). Net Z-Score — Valuation in Historical Terms Net Z - Score = Z - Score minus Z - Score Current 36 - Month AverageSource: UBS(4) Rank Sectors from Most to Least Expensive (column H). We then rank all 10 sectors based upon their Net Z-Scores (i.e., how expensive or cheap each sector’s current Z-Score is in comparison to its historical average). Sectors with negative scores are cheap on a relative basis. Sectors with positive scores are expensive.(5) Convert Net Z-Scores into Current P/E Multiple Points. To make the visual interpretation of our analysis easier to understand, we covert each sector’s historical Net Z-Scores into current P/E multiple points (cheap or expensive). This is done by multiplying the historical Net Z-Scores by the current weighted average standard deviation of the market’s forward P/E. Health Care — Multiple Points Cheap / Expensive 2 Overvalued 1 P/E Multiple Points 0 -1 -2 Undervalued -3 97 99 01 03 05 07 09Source: Standard & Poor’s, Thomson Financial, FactSet, and UBS UBS 24
    • US Equity Strategy 29 August 2011 Analyst CertificationEach research analyst primarily responsible for the content of this researchreport, in whole or in part, certifies that with respect to each security or issuerthat the analyst covered in this report: (1) all of the views expressed accuratelyreflect his or her personal views about those securities or issuers and wereprepared in an independent manner, including with respect to UBS, and (2) nopart of his or her compensation was, is, or will be, directly or indirectly, relatedto the specific recommendations or views expressed by that research analyst inthe research report. UBS 25
    • US Equity Strategy 29 August 2011Required DisclosuresThis report has been prepared by UBS Securities LLC, an affiliate of UBS AG. UBS AG, its subsidiaries, branches andaffiliates are referred to herein as UBS.For information on the ways in which UBS manages conflicts and maintains independence of its research product;historical performance information; and certain additional disclosures concerning UBS research recommendations,please visit www.ubs.com/disclosures. The figures contained in performance charts refer to the past; past performance isnot a reliable indicator of future results. Additional information will be made available upon request. UBS Securities Co.Limited is licensed to conduct securities investment consultancy businesses by the China Securities RegulatoryCommission.UBS Investment Research: Global Equity Rating Allocations 1 2 UBS 12-Month Rating Rating Category Coverage IB Services Buy Buy 54% 39% Neutral Hold/Neutral 39% 35% Sell Sell 7% 14% 3 4 UBS Short-Term Rating Rating Category Coverage IB Services Buy Buy less than 1% 33% Sell Sell less than 1% 25%1:Percentage of companies under coverage globally within the 12-month rating category.2:Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided withinthe past 12 months.3:Percentage of companies under coverage globally within the Short-Term rating category.4:Percentage of companies within the Short-Term rating category for which investment banking (IB) services were providedwithin the past 12 months.Source: UBS. Rating allocations are as of 30 June 2011.UBS Investment Research: Global Equity Rating Definitions UBS 12-Month Rating Definition Buy FSR is > 6% above the MRA. Neutral FSR is between -6% and 6% of the MRA. Sell FSR is > 6% below the MRA. UBS Short-Term Rating Definition Buy: Stock price expected to rise within three months from the time the rating was assigned Buy because of a specific catalyst or event. Sell: Stock price expected to fall within three months from the time the rating was assigned Sell because of a specific catalyst or event. UBS 26
    • US Equity Strategy 29 August 2011KEY DEFINITIONS Forecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12months. Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not aforecast of, the equity risk premium). Under Review (UR) Stocks may be flagged as UR by the analyst, indicating that the stocks price target and/or rating aresubject to possible change in the near term, usually in response to an event that may affect the investment case or valuation. Short-Term Ratings reflect the expected near-term (up to three months) performance of the stock and do not reflect anychange in the fundamental view or investment case.Equity Price Targets have an investment horizon of 12 months.EXCEPTIONS AND SPECIAL CASESUK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management,performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell:Negative on factors such as structure, management, performance record, discount.Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment ReviewCommittee (IRC). Factors considered by the IRC include the stocks volatility and the credit spread of the respective companysdebt. As a result, stocks deemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating.When such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece.Research analysts contributing to this report who are employed by any non-US affiliate of UBS Securities LLC are notregistered/qualified as research analysts with the NASD and NYSE and therefore are not subject to the restrictions contained inthe NASD and NYSE rules on communications with a subject company, public appearances, and trading securities held by aresearch analyst account. The name of each affiliate and analyst employed by that affiliate contributing to this report, if any,follows.UBS Securities LLC: Jonathan Golub, CFA; Manish Bangard, CFA; Daniel Murphy; Vishal Patel; Thomas M. Doerflinger,Ph.D.; Natalie Garner, CFA.Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report. UBS 27
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