ab Global Equity Research Global UBS Investment Research Equity Strategy Global Risk Radar Investment Strategy Risk appetite declines 29 November 2010 Risk Appetite Indicator decreases www.ubs.com/globalequitystrategy The UBS Equity Risk Appetite Indicator moved considerably lower last week, closing Friday at 0.13 from 0.39, as the MSCI AC World index fell by 2.1%. The equity option volatility component was the main contributor to the downward move while the credit & FX and equity positioning components increased Jeffrey Palma marginally. Despite the fall, the indicator remained in positive territory for the Strategist seventh consecutive week. email@example.com +1-203-719 1135 Equity option volatility component decreases sharply Christopher Ferrarone The equity volatility component decreased significantly as the VIX index jumped Strategist to 22.2 from 18.0 last week. firstname.lastname@example.org +1-203-719 3727 Equities positioning component increases marginally Trevor McDonough The equities positioning component increased marginally as cyclicals Associate Strategist outperformed defensives with Technology being the top performer. Financials was email@example.com the worst performing sector for the third week in a row. Regional trends were +1-203-719 3600 mixed with US outperforming, Europe ex UK underperforming and GEM underperforming slightly. Credit & FX component also increases marginally The credit & FX component also increased marginally as the tightening of corporate credit spreads was offset by the widening of interest rate swap spreads in Europe and the US. Chart 1: UBS Global Equity Strategy Risk Indicator Chart 2: Risk Indicator by Component 2.0 4 Extreme high risk appetite 1.0 3 2 0.0 1 -1.0 0 -1 -2.0 -2 -3.0 -3 -4.0 -4 -5.0 -5 Extreme low risk appetite -6 -6.0 Jan-05 Oct-05 Jul-06 Apr-07 Jan-08 Oct-08 Jul-09 Apr-10 Jan-05 Nov-05 Sep-06 Jul-07 May-08 Mar-09 Jan-10 Nov-10 Eqty Option Vol Eqty Positioning Credit & FX Source: UBS Estimates Source: Bloomberg, UBS This report has been prepared by UBS Securities LLC ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 6. 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.
Global Risk Radar 29 November 2010A history of equity risk appetiteOur UBS Global Equity Strategy Risk Indicator was developed in June 2006 anda full discussion of the methodology used can be found in “Measuring EquityRisk – 12th June 2006”. We have historical data for the index daily going backto 1992 (shown below in Chart 3).Chart 3: Historical Risk Indicator levels 3 2 Extreme high risk appetite 1 0 -1 -2 -3 -4 Extreme low risk appetite -5 -6 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10Source: UBS, DatastreamRisk appetite is measured in standard deviations from its mean, a negativereading implies investors have a lower than average risk appetite and a positivereading a higher than average risk appetite.The back testing results we ran show that when the index moves significantlyaway from its mean in either direction, it has, in the past, acted as a goodcontrarian indicator for the equity market. 1 Our results show that selling theequity market when the index reaches a risk seeking level of +1.3 and buyingequities when the index falls to -3 yields the best results on a 12 month basis.Please refer to the appendix for the full results.Table 1: Indicator levels Date 2 weeks ago Date Last week 15-Nov-10 0.17 22-Nov-10 0.35 16-Nov-10 0.02 23-Nov-10 0.23 17-Nov-10 0.06 24-Nov-10 0.26 18-Nov-10 0.26 25-Nov-10 0.28 19-Nov-10 0.39 26-Nov-10 0.13 One Year Ago 2010 Average 2010 Max 2010 Min 0.97 0.07 1.58 -2.00Source: UBS1 Please see, UBS Global Equity Strategy “How to interpret risk appetite” 3 November 2008. UBS 2
Global Risk Radar 29 November 2010Drivers of risk appetiteOur index has three components which draw data from credit, foreign exchangeand equity markets, all of which impact risk in equity markets. These componentindices are 1) Equity market positioning, 2) Equity option volatility and 3)Credit and FX. These series are shown in Chart 4, Chart 5, and Chart 6.Chart 4: Equity market positioning Chart 5: Equity option volatility Chart 6: Credit and FX 3 2 2 2 0 0 1 -2 -2 0 -1 -4 -4 -2 -6 -6 Jan-05 Jan-07 Jan-09 Jan-05 Jan-07 Jan-09 Jan-05 Jan-07 Jan-09Source: UBS Source: UBS Source: UBS(1) Equity Market PositioningThe equity positioning component measures cyclical versus defensive sectorperformance (Chart 7) and a measure of excess performance by high betaregions (Chart 8 and sectors (not shown)).Chart 7: Equity positioning across sectors Chart 8: Equity positioning across regions 2.0 3.5 less defensive less defensive 1.5 3.0 2.5 1.0 2.0 0.5 1.5 0.0 1.0 -0.5 0.5 0.0 -1.0 -0.5 more defensive -1.5 -1.0 more defensive -2.0 -1.5 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Sectors Low beta versus high beta regionsSource: UBS, Datastream Source: UBS, DatastreamToday: Positioning across sectors and regions is less defensive than the mostextreme levels of late 2008. The degree of cyclical outperformance that markedthe 2009 rally has moderated.(2) Equity Option VolatilityThis component measures the implied volatility in both Europe and the US usingthe VIX and VDAX indices (Chart 9 and Chart 10). UBS 3
Global Risk Radar 29 November 2010Chart 9: US Implied Equity Volatility Chart 10: Long-term equity volatility Percent 90 Percent 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 Jan-05 Oct-05 Jul-06 Apr-07 Jan-08 Oct-08 Jul-09 Apr-10 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 VIX Average --1 sd +1 sd VDAX VIXSource: UBS, Bloomberg Source: UBS, BloombergToday: Having spiked above 40% in April, equity volatility has moderated backtowards its more normal, 20 percent level.(3) Credit and FX ConditionsThis component embodies credit spreads, swap spreads and currency optionvolatilities (Chart 11and Chart 12).Chart 11: Historical Credit Spreads Chart 12: EURUSD performance bps 1.7 700 USD weakness 600 1.5 500 1.3 400 1.1 300 0.9 200 USD strength 0.7 100 0 0.5 92 94 96 98 00 02 04 06 08 10 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Moodys Baa over 10y Treasuries Average EURUSDSource: UBS, Datastream Source: UBS, DatastreamToday: Corporate credit spreads have come in from their wides, currentlytrading around 320 bps. They are still high historically, having reached only 400bps in the last default cycle of 2002. The US Dollar and Japanese Yen have beenstrengthening in recent weeks. UBS 4
Global Risk Radar 29 November 2010Appendix – A contrarianindicator?Our back test results suggest that the index is an effective contrarian indicatorfor the equity market when it hits extreme levels of risk aversion or risk appetite(Chart 13).Chart 13: Average 12 month equity returns by risk index level 12 month returns 40% 30% "Sell signal" 20% 10% 0% "Buy signal" -10% -20% <-4.5 <-3.5 <-2.5 <-1.5 <-0.5 >0.5 >1.5Source: DataStream, UBSWhen the index is greater than +1.3 standard deviations from its mean, the indexis showing investors are very willing to take risk, which is when historically theindex has given its best “sell signal”. Equity returns 12 months on from suchhigh risk appetite are typically very poor, just 1% on average (Chart 14).Chart 14: 12 month return after a “sell signal” Chart 15: 12 month return after a “buy signal” 12 month return 3.0% 12 month return 2.5% 14.0% 2.0% 12.0% 1.5% 10.0% 1.0% 8.0% 0.5% 6.0% 0.0% -0.5% 4.0% -1.0% 2.0% -1.5% 0.0% 1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 >1.3 w eeks <-3 w eeksSource: DataStream, UBS Source: DataStream, UBSWhen the index is less than -3 standard deviations from its mean the index isdisplaying the opposite – that investors appear unwilling to take on risk and atthese times the index has given its best “buy signal” in the past. Equity returns12 months on from these levels was +10% on average (Chart 15).The full results of the back test of our index can be found in “How to interpretrisk appetite” – 3rd November 2008, Delaney. UBS 5
Global Risk Radar 29 November 2010 Statement of RiskInvesting in global equities poses country, industry, and company specific risk.Valuations can be impacted by changes in the macroeconomic landscape as wellas by financial market stability. 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 (2) no partof his or her compensation was, is, or will be, directly or indirectly, related tothe specific recommendations or views expressed by that research analyst in theresearch report. UBS 6
Global Risk Radar 29 November 2010Required 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 Investment Research: Global Equity Rating Allocations 1 2 UBS 12-Month Rating Rating Category Coverage IB Services Buy Buy 51% 37% Neutral Hold/Neutral 40% 33% Sell Sell 9% 22% 3 4 UBS Short-Term Rating Rating Category Coverage IB Services Buy Buy less than 1% 20% Sell Sell less than 1% 0%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 September 2010.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 7
Global Risk Radar 29 November 2010KEY 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: Jeffrey Palma; Christopher Ferrarone; Trevor McDonough.Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report. UBS 8