Thursday, February 5 2015 UBS Forum. Sharper opinions, smarter decisions Madrid Milan London Frankfurt Zurich
Chief Investment Office WM The Diverging World CIO Year Ahead 2015 Bill O'Neill Head of Investment Office UK UBS Wealth Management 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.
Section 1 The Diverging World
Uneven growth The main regions are at different stages of the cycle GDP growth (4qma, %) 10 8 6 4 2 0-2 -4-6 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 US Eurozone BRIC + Mexico (equally weighted) Source: Haver, UBS Please see important disclaimer and disclosures at the end of the document.
Differing growth rates point to divergent policy responses Some countries transition away from life support, and some head deeper Central bank balance sheet assets / GDP 60% Central bank balance sheet assets / GDP 30% 50% 25% 40% 20% 30% 15% 20% 10% 10% 5% 0% 2006 2007 2008 2009 2010 2011 2012 2013 2014 0% 2006 2007 2008 2009 2010 2011 2012 2013 2014 ECB BoJ Federal Reserve Source: Haver, UBS Please see important disclaimer and disclosures at the end of the document.
Inflation outlook: Flirting with deflation Inflation rates are likely to fall further in the first half of the year CPI y/y (3mma) 6 5 UBS forecast 4 3 2 1 0-1 -2 2009 2010 2011 2012 2013 2014 2015 2016 US Eurozone UK Source: Haver, UBS Please see important disclaimer and disclosures at the end of the document.
Clustered consensus Many forecasts are clustered in worrying proximity US 2015 real GDP growth forecasts (%) 50 45 45 Eurozone 2015 real GDP growth forecasts (%) 40 37 35 40 35 36 30 30 25 25 20 20 15 14 15 10 7 10 5 0 0 1 1 1 <1.0 1.5-1.99 2.0-2.49 2.5-2.99 3.0-3.49 3.5-3.99 >4.0 5 0 3 0 0 0 0 <0.0 0-0.49 0.5-0.99 1.0-1.49 1.5-1.99 2.0-2.49 >2.5 Source: Haver, UBS Please see important disclaimer and disclosures at the end of the document.
Section 2 Economic outlook 2015
US: Leading the way A broadening and a deepening of US growth drivers Growth to accelerate to 3.1% from 2.4% US real GDP growth (%) 3.1% Repair of consumer balance sheets Improvement in credit conditions Abatement of fiscal headwinds 1.6% 2.3% 2.2% 2.4% Source: Bloomberg, UBS Please see important disclaimer and disclosures at the end of the document.
Eurozone: Playing catch up Europe has been a disappointment in 2014 Growth disappointed in 2014, at 0.8% Expect modest acceleration to 1.2% in 2015 Supportive factors include the weaker euro, expansionary ECB, and an improvement in credit conditions Eurozone real GDP growth (%) 1.7 0.8 1.2 0.7 0.4 Source: Bloomberg, Thompson Reuters, UBS Please see important disclaimer and disclosures at the end of the document.
UK: Sustained GDP growth, subdued inflation UK to remain amongst the best performing G7 economies UK GDP growth to reach 3.0% in 2014, and slow to 2.6% in 2015 Inflation to moderate further in 1H15. Falling oil price increases risk of drop to 0% Still-easy credit conditions, elevated business and consumer confidence and growing real incomes 1.0 0.5 0.0-0.5-1.0-1.5-2.0 4 2 0-2 -4-6 -2.5 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 UBS forecast % q/q (lhs) % y/y (rhs) -8 Source: Haver, UBS Please see important disclaimer and disclosures at the end of the document.
UK: Monetary policy to remain accommodative in 2015 MPC to start tightening in 4Q in response to evidence of a sustainable recovery Lack of inflationary pressures point to the first rate hike in November 2015 In % The fiscal effort remains substantial Risks : general election in May, restrictive fiscal policy, and the challenging external environment (Europe) Source: Haver, UBS Please see important disclaimer and disclosures at the end of the document.
Emerging markets: Changing gears Emerging economies need to shift gears and rely less on an export model Declining growth in recent years. We see 4.5% in 2015 (4.6% in 2014) Divergences within EM based on reform agenda Asia ex-jp to see higher growth than EMEA and LatAm Source: Bloomberg, UBS Please see important disclaimer and disclosures at the end of the document.
Section 3 Investing in 2015
Equities: US and Euro vs EM US equities have superior earnings growth Equities not cheap; earnings growth to drive returns OW US equities: steady earnings growth amid a strong domestic economy OW Eurozone equities: EUR weakening supportive of European exporters' earnings UW EM equities: falling commodity prices weigh on earnings US 12m trailing earnings-per-share 200 180 Emerging markets 12m trailing earnings-per-share 200 180 160 160 140 140 120 120 100 80 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 100 80 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Bloomberg, UBS.
Bonds: Credit vs high grade Investors should seek higher yields in credit Yields exceptionally low vs history: returns likely to be limited UW high grade bonds: Low level of yields, expected to rise (US in particular) OW credit: Low default rate and supportive growth and financing conditions, focused on US high yield UW EM bonds in USD Yield and subsequent performance (%) 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% US corporate operating profits and interest payments (USDbn) 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 450 400 350 300 250 200 150 100 50 0 1964 1968 1972 1976 1980 1984 US government bond yield 1988 1992 1996 2000 2004 Performance next 5y 2008 2012 1985 1988 1991 1994 Operating profits 1997 2000 2003 2006 2009 2012 Interest payments Source: Bloomberg, BEA, UBS.
Alternatives: Equity long-short and private debt opportunities Alternatives play an important role in improving portfolio returns Comparatively attractive returns as equity/bonds returns moderate Hedge funds: prefer equity long-short funds. Cautious on macro Private markets: opportunities in private debt Intra-stock correlation (50d rolling) 0.40 HFRI equity long-short index 1,400 Nonperforming loans ratio (%) 16 0.35 0.30 0.25 0.20 0.15 0.10 0.05-2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 S&P 500 Intra-Stock-Correlation (50d-rolling) HFRI Equity Hedge 1,300 1,200 1,100 1,000 900 800 14 12 10 8 6 4 2 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 World EEC Source: Bloomberg, UBS.
Foreign exchange: US dollar vs euro Monetary policy divergences will continue in 2015 In general, investors should hedge currency exposure A diverging world presents some tactical opportunities while increasing currency volatility The US and UK to begin normalising monetary policy; ECB still on the easing path OW USD and GBP UW EUR and CHF 10-year government bond yield (%) 4.0 3.5 JP Morgan FX Volatility Index (%) 18 16 3.0 14 2.5 12 2.0 10 1.5 8 1.0 6 0.5 0.0 10/10 02/11 06/11 10/11 02/12 US 06/12 10/12 02/13 Germany 06/13 10/13 02/14 06/14 10/14 4 2 0 10/09 04/10 10/10 04/11 10/11 04/12 10/12 04/13 10/13 04/14 Source: Bloomberg, UBS.
Key takeaways Growth Divergence in growth with solid and resilient US and UK growth, while Eurozone slowly improves and China's growth weakens. Policy Divergence in monetary policy, as the US and UK begin raising interest rates while Eurozone and Japan are forced to loosen policy further. Equities Overweight US assets specifically US equities relative to EM equities. We also have a small overweight position in Eurozone equities. Bonds Prefer developed market corporate bonds (Investment grade and high yield), over high grade and EM bonds. FX and AI Overweight USD and GBP vs. EUR and CHF. Prefer equity long/short within hedge funds. Final message Monitor cash levels within portfolios given continued burden on overall returns. Avoid excessive home bias as markets diverge and volatility rises "Diversification is the only free lunch in finance. Harry Markowitz
PM Global Balanced since start of CIO investment process Cumulative relative performance contribution Tactical asset allocation (basis points) Security selection (basis points) Total Japan equity EM equity Canada equities US equity Swiss equity Europe equity UK equity HY & EM bonds Global bonds Corp. bonds Govt. bonds Cash -35-37 -5 6 2-76 1 18 11 89 108 207 290 (100) 0 100 200 300 400 Tactical Asset Allocation Total Japan equity EM equity Canada equities US equity Swiss equity Europe equity UK equity HY & EM bonds Global bonds Corp. bonds Govt. bonds Cash Cumulative excess return of 551 basis points, with both tactical asset allocation & security selection adding over 260 bps each -17-21 -11-3 0 6 22 16 19 60 53 136 261 (50) 0 50 100 150 200 250 300 Instrument Selection Source: UBS Based on TM UBS (UK) Global Balanced, from 31 st December 2011 to 31 st December 2014, gross of fees. Figures show contribution to overall portfolio relative returns against portfolio benchmark, measured in basis points. Past performance is not an indication of future returns
Disclaimer The value of an investment, and the income from it, can fall as well as rise and you may not get back the amount originally invested. UBS AG is registered as a branch in England and Wales Branch No. BR004507 (A public company limited by shares, incorporated in Switzerland whose registered offices are at Aeschenvorstadt 1, CH-4051, Basel and Bahnhofstrasse 45, CH-8001 Zurich). Registered Address: 1 Finsbury Avenue, London EC2M 2PP. Authorised and regulated by the Financial Market Supervisory Authority in Switzerland. In the United Kingdom, UBS AG is authorised by the Prudential Regulation Authority and subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. Details about the extent of our regulation by the Prudential Regulation Authority are available from us on request. A member of the London Stock Exchange. UBS 2015. All rights reserved.