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Forecast: Worst of the Storm has Passed
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Forecast: Worst of the Storm has Passed

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No one can know for certain when the global economy will find a bottom, but UBS Wealth ManagementResearch – mericas (WMR) analysts have been predicting a moderate cyclical recovery in the second half …

No one can know for certain when the global economy will find a bottom, but UBS Wealth ManagementResearch – mericas (WMR) analysts have been predicting a moderate cyclical recovery in the second half of 2009. Their recommendations may very well affect your portfolio.

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  • 1. ab Market outlook Forecast: worst of the storm has passed Market outlook is a monthly publication to help inform your investment strategy August 2009 No one can know for certain when the global economy WMR assigned a 55% probability rate to its “Moderate will find a bottom, but UBS Wealth Management Portfolio” scenario for the 12-month horizon, indicating a Research – Americas (WMR) analysts have been recovery that falls into the low-growth, “not too hot, not too predicting a moderate cyclical recovery in the second cold” Goldilocks zone.) half of 2009. Their recommendations may very well affect your portfolio. “While we’re fairly confident a recovery is in the making, we do not expect it to represent a rapid return to business Signs of recovery: as usual,” stresses Stephen Freedman, CFA®, WMR’s Global Economy gains traction, markets respond Investment Strategist. “Instead, we anticipate a cyclical In order for the ongoing rally in risky assets (where the return rebound followed by a period of several years of lower-than- is uncertain) to continue, as WMR recently explained, markets average growth.” would need hard evidence that the recovery process in both the economy and in corporate earnings was gaining traction. It’s noteworthy that the U.S. economy—first to be drawn Well, the economy and companies recently delivered and into the recession—seems to be among the first to reemerge, financial markets have responded. a tribute to the massive policy stimulus, according to WMR. Analysts point out that although it’s unlikely the economy would And while lending conditions remain tight relative to history, currently recover without government intervention, signs of self- WMR’s U.S. credit health thermometer indicates significant healing should allow the private sector to support further growth improvement since the beginning of the year, a trend WMR once the impact of public stimulus starts to fade. expects to persist and gradually provide more breathing room for businesses and consumers. Deleveraging in the economy is Given the sheer magnitude of the monetary policy response, under way and the housing market appears to be stabilizing, concerns about inflation are unsurprising, yet WMR feels with home prices increasing over the prior month for the it will be kept at bay for the near term. First, a slack in the first time since the downturn began. Another factor that economy will curtail rising prices; second, the output gap, should provide further support to GDP growth is inventory used as a measure of free capacity, is at trough levels which restocking. The extreme caution that has been prevalent in can’t be expected to generate price pressure on the markets the corporate sector has led to inventories that are unusually for goods and services in the near term; and third, the labor low even in relation to depressed sales. market is not in a position to start a wage-price spiral. “We believe inflation will overshoot the Federal Reserve’s comfort Enthusiasm over the recent positive signs must be tempered, zone, eventually reach the 4-5% range and stay there for however, by WMR’s base-case scenario of a moderate cyclical some time,” says Freedman. “However, we don’t expect recovery in the second half of this year. (See the chart, where this to happen before 2011 at the earliest—too soon to
  • 2. no longer cheap, with various sectors now trading in line with Moderate recovery marginal costs of production, yet a firming of global demand High should be accompanied by further gains in commodity growth markets. In particular, the fact that a disproportionate share of global demand for resources originates in emerging Asia is very supportive of commodities given the signs of recovery Low in that part of the world. Finally, WMR underweights fixed growth income to offset its preference for equities and commodities, but says corporate bonds remain the sweet spot. Negative Dollar weakness = tilt toward ex-U.S. growth WMR analysts recommend U.S. investors tilt their portfolios Negative Low High inflation inflation inflation away from dollar-denominated assets into foreign financial markets, not out of valuation concerns, but due to a perceived Source: UBS WMR prolonged weakness of the U.S. dollar. “While the massive policy stimulus is key to stabilizing the U.S. economy in the aggressively position portfolios for such a scenario.” near term, once the dust settles, the price tag for government intervention on such a massive scale will inevitably become WMR’s tactical asset recommendations: look to riskier asset apparent and dollar weakness will be one consequence,” classes, with a preference for equities and commodities over fixed explains Freedman. “We expect the dollar to encounter income and cash, in light of the current economic backdrop and a structural depreciation pressures this year and beyond.” recovery that is expected to be slow and uneven. Some foreign governments have taken steps to prop up their While cautioning that gains will likely not occur in a straight economies, but few have done so on such a large scale as line, WMR analysts say, overall, equities remain attractive here in the U.S., hence WMR expects international imbalances both on valuation and cyclical grounds and will move higher surrounding the U.S. economy to increase. Cyclical factors over the next 9 to 12 months. Valuations have come off their also point to dollar weakness. Throughout the financial early March lows and the S&P 500 has rallied 46%, although crisis, the dollar has served as a safe haven currency, posting valuations still offer upside to fair value. More important is gains whenever risk aversion spiked in financial markets and the phase of the cycle analysts believe is typically supportive experiencing setbacks when risk appetite returned. As risk of equity market returns; stocks generally outperform fixed appetite gradually returns, the dollar is likely to remain out of income and cash for more protracted periods than a quarter favor for awhile, in WMR’s view. following a trough in the economy. And corporate earnings, a key driver of equity markets, are in a recovery process. Within foreign stocks, WMR sees emerging markets as an Second-quarter earnings so far have brought about an attractive way to benefit from the global recovery, mainly due unusually high share of positive surprises, with companies to their tendency to outperform developed markets when the beating earnings estimates, outpacing misses three to one. global economy enters a cyclical recovery phase. Moreover, Significant cash remains on the sidelines; as confidence in the the fact that various emerging market economies (e.g., China, cyclical recovery builds, this represents a significant source Korea) are leading the pack out of the global recession is of potential demand for equities, in WMR’s view. Within further reason to believe their equities will outperform. U.S. equities, analysts prefer the more economically sensitive sectors of the market, particularly those levered to global Let’s talk about it growth, such as Industrials and Materials. To explore how some of the insights in this issue of Market Outlook might bear on your portfolio, or to discuss additional Commodities is another cyclical asset class WMR thinks research insights, please contact a UBS Financial Advisor. should perform well in a recovery. Commodity markets are There are two sources of UBS research. Reports from the first source, UBS Wealth Management Research (“WMR”), are produced by UBS Wealth Management Americas (the UBS business group that includes, among others, UBS Financial Services Inc. and UBS International Inc.), and UBS Wealth Management & Swiss Bank. The WMR report style, length and content are designed to be more easily understood by individual investors. The second source of research is UBS Investment Research, and its reports are produced by UBS Investment Bank, whose primary business focus is institutional investors. The research reports may include estimates and forecasts. A forecast is just one element of an overall report. Due to a divergence of opinions, there may sometimes be differences between the individual and institutional reports, with respect to interest rate or exchange rate forecasts. The analysts who prepare individual and institutional research use their own methodologies and assumptions to make their independent forecasts. Neither the institutional forecast nor the individual forecast is necessarily more reliable than the other. The various research content provided does not take into account the unique investment objectives, financial situation or particular needs of any specific individual investor. If you have any questions, please consult your Financial Advisor. UBS Financial Services Inc. is a subsidiary of UBS AG and an affiliate of UBS International Inc. In Canada, UBS Wealth Management Research is provided by UBS Investment Management Canada Inc. All other trademarks, registered trademarks, service marks and registered service marks are of their respective companies. As a firm providing wealth management services to clients in the U.S., we offer both investment advisory programs and brokerage accounts. Advisor services and brokerage services are separate and distinct, differ in material ways and are governed by different laws and separate contracts. For more information, please visit our website at www.ubs.com/workingwithus. UBS Financial Services Inc. and UBS International Inc. are subsidiaries of UBS AG. ©2009 UBS Financial Services Inc. All rights reserved. Member SIPC. MOC_Aug2009

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