UBS House View april '14 by Institutional Insider

UBS HouseView Investment Strategy Guide

US Edition CIO Wealth Management Research April 2014

Investing through uncertainty Also inside Five years young

contents

A message from the regional CIO

tactical preferences

feature

Investing through uncertainty by Alexander S. Friedman preferred investment views

month in review

At a glance

global economic outlook

Asset classes overview

Equities Fixed income Commodities Foreign exchange in focus

Five years young by Jeremy Zirin TOP themes

Capex rising...finally North American energy independence: reenergized US senior loans Key forecasts

detailed asset allocation

Performance measurement

appendix

publication details

ubs house view april 2014

Dear reader, Events of the past several weeks – which have included the Russian annexation of Crimea, continued soft economic data out of China, and a shift in the Fed’s policy guidance – serve as sobering reminders that markets will continue to be impacted by developments on the geopolitical, macroeconomic, and policy fronts. So placing these sorts of events into proper context, and then assessing the likely impact across different asset classes and regions, is absolutely critical to successful investing. Because while disruptive changes may add to market volatility in the very short run, they also often unlock opportunities for investors with longer-term horizons. This trade-off between potential market moving events and the opportunities they can create is explored in some detail within this month’s Feature article. What we find is that the events that may come to dominate the 24-hour news cycle are rarely the key factors behind informed investment decision making. We therefore opt to peer through this ever-present veil of uncertainty and elect to retain our preference for risk assets with a continued emphasis on US and European equities – as well as domestic high yield and municipal bonds. We strike a similar chord in the Focus article, where we take stock of the current bull market in US equities as it reaches its five-year anniversary. While some fear that the impressive run for stocks may be growing a bit long in the tooth, we argue that bull markets simply don’t die of old age. Keep in mind that valuations are far from stretched, the growth outlook continues to improve, and the policy backdrop is still supportive. So it appears we are likely to see at least a few more “happy anniversaries” for this current bull run. Sincerely,

Mike Ryan, CFA Chief Investment Strategist, WMA Regional CIO, Wealth Management US

tactical asset allocation

Tactical preferences Despite geopolitical uncertainties, we expect the global economy to accelerate this year, providing support to US and Eurozone equities as well as high yield bonds.

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Tot al

Com mo dit ies

US Mid cap

EUR

US Large cap Value

GBP

Asset Classes Tactical asset allocation

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CHF

cap Large th w Gro

JPY

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Oth er

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USD

US Small cap

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Int’ Dev l Ma elope rke d ts Em Ma ergi rke ng ts

Int’l Developed Emerg Markets i Mark ng ets

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US IG Corp* i un US M

US HY Corp

this month

1) Equities We maintain a preference for the US and the Eurozone.

2) Fixed income We prefer high yield corporate bonds and, in taxable portfolios, municipal bonds.

3) Foreign exchange We prefer the USD versus the EUR and the JPY.

Legend

Overweight: Tactical recommendation to hold more of the asset class than specified in the moderate risk strategic asset allocation (see page 25) Underweight: Tactical recommendation to hold less of the asset class than specified in the moderate risk strategic asset allocation (see page 25) Neutral: Tactical recommendation to hold the asset class in line with its weight in the moderate risk strategic asset allocation (see page 25) *Investment grade corporates are overweight in tax-exempt portfolios but underweight in taxable portfolios, where we prefer municipal bonds.

Note: Tactical time horizon is approximately six months

april 2014 UBS house view

Feature

Investing through uncertainty Alexander S. Friedman

Global Chief Investment Officer Wealth Management

 Investors tend to react to unexpected uncertainty by hiding in assets perceived to

be safe havens.  But we should embrace uncertainty because it is the environment in which outsized

returns can be earned, as evidenced by the performance of the S&P 500 since 2009.  Investors should take advantage of recent uncertainty and diversify away from the

Swiss franc, Japanese yen, and high grade bonds.  US assets including equities, high yield credit, and the dollar, should benefit in the

long term from the country’s energy revolution.

It is usually foolish to claim that a certain conclusion will always be true. But in the case of the statement, “we live in a world defined by uncertainty,” I suspect it isn’t too risky. Investors’ knee-jerk reaction to unexpected uncertainty is often to “hide” in assets perceived to be safe havens. Indeed, with the most recent crisis in the Ukraine, it is not surprising to see the Swiss franc, Japanese yen, and government bonds supported by safe haven flows. But in today’s financial markets there is no such thing as a true “safe haven,” and reacting to uncertainty in a calm and measured manner is key to successful long-term investing. The best investment opportunities often come about when uncertainty is at its highest. The tendency for markets to overreact to events means that for longer-term investors, periods of fear are usually an opportunity. US equities provide a good example. Five years ago this month the S&P 500 troughed at an intraday index level of 667. At the time, as investors grappled with the prospect of a global depression, a collapse in trade financing, and the aftermath of major bank failures, it seemed inconceivable that we would subsequently experience a bull market that would span five years and provide annualized returns of greater than 20% (see Fig. 1). Yet, at the time of writing, the S&P 500 is trading at 1,861, and it now seems likely that the index will reach 2,000 within the next two years. As investors, we should embrace uncertainty because it is the environment in which outsized returns can be earned. So, in this letter I want to review some of the key uncertainties facing the world today – with a focus on Russia/Ukraine, China, and the US – and highlight potential associated investment opportunities. Russia and Crimea A month ago the prospect of war on the European continent seemed inconceivable, so it is no surprise that Russia’s recent actions have generated significant market uncertainty.

ubs house view april 2014

Feature

As analysts weigh whether tensions will escalate, it is worth noting that we are now 100 years from the beginning of the First World War, which in 1914 moved from inconceivable to inevitable over the course of just 37 days.

> From a purely rational perspective, a significant escalation in the Crimean conflict is unlikely

From a purely rational perspective, a significant escalation in this conflict should be unlikely. It is in neither Russia’s nor the West’s interest. Russia’s consumers were already showing signs of strain as we entered this year, with real income growth and retail sales visibly deteriorating. The 10% decline in the ruble this year (see Fig. 2), associated higher rates of inflation, and the subsequent 1.5% interest rate hike is only likely to worsen this situation. The most recent consensus forecasts for 2014 GDP growth range between 0.6% and 1.4%, notably lower than expectations of just over 2.0% at the start of the year. Neither side would benefit from a breach in Russian oil and gas supplies, whether due to a disruption to pipelines in the Ukraine, or through outright sanctions. Russia is the largest crude oil producer in the world, representing 12% of global consumption, the secondlargest exporter, providing 8% of global consumption, and satisfies around 30% of European energy demand.

> Europe would struggle to replace Russian gas supply quickly

Europe would struggle to replace Russian supply quickly without significant investment, and would experience a sharp increase in energy prices. We estimate that a disruption to the flow of Russian oil and gas through the Ukraine would push Brent crude oil prices into the range of USD 115–125/bbl, from USD 106/bbl today, and higher still if Iran-style sanctions were imposed. In our view, such an increase, if sustained, would be enough to damage global growth and could lead us to revise our currently positive outlook for global risk assets.

> Oil and gas products make up over two-thirds of Russia's exports

And for Russia, oil and gas products make up over two-thirds of exports and more than half of tax revenues. Even with open energy markets, Russia requires an oil price of approximately USD 110/bbl to balance its federal budget. In the long run, severe sanctions would be highly damaging – particularly if they lead to efforts from Europe to diversify supply, potentially including liquefied natural gas from the US. As of today, we assign a relatively small probability to a major escalation of hostilities between Russia and the West. But, it may be dangerous to assume that all actors will remain rational. It appears as though Russia is intent on broadening its sphere of influence, and

Fig. 1: US equities have returned more than 20%, annualized, since 2009 S&P 500 index 2000 1800 1600 1400 1200 1000 800 Jan-14

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> In the midst of the 08-09 financial crisis, it seemed inconceivable that we would see a bull market that would span five years

Source: Bloomberg, as of 19 March 2014

april 2014 UBS house view

Feature

tensions with the West could increase in coming months if Russia fails to engage in constructive talks with Ukraine and the West, potentially leading to more severe economic sanctions. The uncertainty is clear, but the investment opportunities are perhaps less obvious. One potential area longer-term investors might consider is, counterintuitively, Russian equities, which are trading more than 10% lower than a month ago. At these levels, Russian equities should offer long-term value, with a price-to-earnings ratio of 4.4x and a dividend yield of 4.0%. But after Russia’s actions in Crimea, the risk premium on Russian equities is likely to remain elevated over our tactical investment horizon of six months. We therefore recommend a neutral position in Russian equities for the near term.

> A clearer near-term opportunity might exist in reducing holdings in “safe haven” assets

A clearer near-term opportunity might exist in reducing holdings in the “safe haven” assets, such as the Swiss franc, Japanese yen, and high grade bonds, which have been supported by investors’ knee-jerk reactions to the recent uncertainty. Fundamentally, the Japanese yen and Swiss franc are likely to depreciate in the months ahead, as the Bank of Japan likely expands its stimulus efforts in response to April’s consumption tax hike, and with the Swiss franc linked to an overvalued euro.

> The Fed’s “tapering” process is now firmly under way

The US and the energy revolution The fundamental outlook for high grade bonds is likely to be heavily dictated by changes in Federal Reserve policy. The Fed’s “tapering” process is now firmly under way, and the Fed reduced bond purchases once again this week by USD 10bn. But the focus is now shifting toward the timing of interest rate hikes. On the one hand, US unemployment is still relatively high and inflation is low. And at Wednesday’s meeting of the Federal Open Market Committee (FOMC), new Chair Janet Yellen was at pains to emphasize that the Fed funds rate will remain below its long-run level for “some time” even when employment and inflation are back to normal.

> High rates of unemployment could be structural in nature

But the FOMC does appear to be increasingly coming to the view that the high rates of unemployment could be structural in nature. This was reflected in the Fed dropping its unemployment threshold in favor of a wider range of labor market indicators, and, if this is true, it would mean that economic growth translates more quickly into higher wage settlements, inflation, and a requirement to raise interest rates. The median view of FOMC

Fig. 2: Russian assets have dropped sharply on uncertainty over Crimea

> Russian equities should offer long-term value, but their risk premium is likely to remain elevated over our 6-month horizon

MICEX index and Russian ruble, rebased 105 100 95 90 85

Source: Bloomberg, as of 19 March 2014

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Russian equities Ruble vs US dollar

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Feature

members is now that interest rates should be 1.0% by the end of 2015, up from 0.75% at the previous meeting.

> Earlier-than-expected rate hikes would be clearly negative for the bond market

Earlier-than-expected rate hikes would be clearly negative for the bond market and positive for the US dollar. For equities, however, the impact would be more nuanced. While likely a short-term negative, in the long term it is the strength of the US economy which is most critical for market opportunity. A perfect example of this long-term strength is the transformation currently under way within the US energy sector. Since 2005, new shale gas extraction techniques have led natural gas production to grow almost twice as fast as consumption (see Fig. 3), and sent local energy prices plummeting. Natural gas prices in the US are now just USD 4.4/mmbtu. Prices in Europe are around 2.1x higher, and in Asia almost 4x higher. Keep in mind that in 2004, US gas prices were the world’s highest.

> Energy-intensive industries, such as autos and chemicals, are being drawn back to the US

This transformation is already impacting US economic growth and the prospects for American industry. Between 2007 and 2013, employment in US oil and gas rose 40% compared to a c.3% decline in the overall economy. In 2012, the state of North Dakota, home of the Bakken shale field, saw real economic growth of a massive 13.4%. With this low cost of gas, energy-intensive industries, such as autos and chemicals, are being drawn back to the US. A recent survey by Boston Consulting Group showed that more than half of US-based manufacturing executives at companies with sales greater than USD 1bn are actively considering re-shoring production to the US. This is a stark change in the energy supply of the world’s largest economy, and it is important to consider some of the wider potential implications. To date, the effects of the US energy revolution have been largely confined to the North American continent. New liquefied natural gas export capacity is yet to come online, and crude oil exports are effectively banned, due to the US’s long-standing energy security policy. A combination of environmental concerns and lobbying efforts from US refiners have helped maintain this status quo. But the aforementioned rise in tensions between the US and Russia could change this dynamic. We have already seen increased lobbying efforts from oil and gas companies to use the US’s newfound energy supplies as a counterweight to Russia’s leverage in Europe. If this results in gas export application procedures being

Fig. 3: US gas production has soared in recent years Total US natural gas marketed production (cubic , bn, 3mma)

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> New extraction techniques have led natural gas production to grow almost twice as fast as consumption and sent local energy prices plummeting

Source: Bloomberg, as of 19 March 2014

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simplified and an easing of regulations on crude oil, this would have the potential to, over the long term, fundamentally reshape the global economic and geopolitical balance. If the US energy revolution is better conveyed into global markets, US production will be further stimulated and the country’s current account deficit will be reduced. The US current account deficit hasn’t proven to be a major problem for the country, given the dollar’s position as the world’s reserve currency. But a smaller deficit would necessarily restrict the supply of US dollars globally, raising financing costs.

> The advancement of the energy story should further the opportunity in US equities and credit

For investors, the advancement of the energy story should present an opportunity in US equities and credit, as a result of its positive impact on growth, and for the US dollar, due to the effects of greater energy production on the country’s current account deficit.

> Heavy subsidies to certain industries have diminished China’s economic efficiency

Yet today, the driver of this growth is in question. Heavy subsidies to some industries, whether through an artificially weak currency, through cheap loans directed via state banks, or through explicit government infrastructure spending have diminished China’s economic efficiency. This has led to overcapacity, producer price deflation, and problems with pollution.

China’s growth model The third major uncertainty in the world today is Chinese economic growth. China’s rapid rise from the 11th-largest economy in the world in 1990 to the world’s second-largest economy by 2010 led to embedded expectations that such growth would go on indefinitely.

Maintaining rapid economic growth has been crucial for China, helping engender popular support for the ruling elite. Given the lack of a social safety net, economic growth has been imperative to maintain the social contract. But as growth slows, this comes into question. One option might be for the government to turn to nationalism and saber-rattling, potentially over the disputed islands in the East China Sea, in an effort to earn popular support in the absence of economic growth. A similar destabilizing dynamic may currently be at work in Russia.

Fig. 4: Metals prices have tumbled on uncertainty over China’s growth Copper and iron ore prices, rebased 105 100 95 90 85 80 75

Source: Bloomberg, as of 19 March 2014

ubs house view april 2014

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> The Chinese government appears committed to steadily withdrawing the "hand" of the state

Fortunately, China has, for now at least, turned to economic reforms. The government appears committed to steadily withdrawing the hand of the state in favor of Adam Smith’s infamous “invisible hand of the market.” This “handover” is, however, generating its own uncertainty. This is particularly evident in those areas that have (implicitly or otherwise) been backed by the state. Volatility in the state-managed Chinese yuan has spiked in the past month, as it moves toward a more market-determined exchange rate. State-owned banks have reportedly cut lending to some sectors by as much as 20%. China last week experienced its first corporate bond default, and Premier Li Keqiang claimed further defaults were “unavoidable.”

> Uncertainty is perhaps being felt most keenly in bulk commodities and metals

The uncertainty is perhaps being felt most keenly in bulk commodities and metals (see Fig. 4). Iron ore, a key input into China’s oversupplied steel sector, has fallen in price by 17% year-to-date. Copper is down by 8% in this month alone, not just due to concerns about underlying demand, but also due to its role as collateral in financing deals that some corporations began to use when state-bank supplied funds started to dry up.

> In the long run, the “handover” China is undertaking is a good thing

It is important to remember that in the long run, the “handover” China is undertaking is a good thing. History, and economic theory, demonstrate that economies with marketdetermined pricing have tended to grow more sustainably than those without. China is substituting short-term pain for long-term gain. Therefore, while there is considerable uncertainty in resources and heavy industry, there may be an opportunity for longer-term investors who can pick those sectors within China likely to be boosted by the “invisible hand” to benefit.

> The currency should resume its appreciation trend

For example, liberalization of capital markets and energy prices should benefit brokerages and companies helping to improve energy efficiency respectively. And, while the government has recently injected uncertainty into Chinese yuan fixings, over time the currency should resume its appreciation trend. China still runs a current account surplus and attracts net foreign direct investment inflows – both factors speaking for currency appreciation in a liberalized trading environment. Technology and productivity growth Ultimately, economic growth in all countries comes down to productivity growth. After five to six years of relatively weak economic performance, some investors have concluded

Fig. 5: The yield spread between Treasuries and Bunds is near a 7-year high 10-year US Treasury yield minus 10-year German Bund yield (ppts) 1.5 1 0.5 0 –0.5

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> An increasing interest rate differential between US and Eurozone government bonds should support the US dollar

Source: Bloomberg, as of 19 March 2014

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that productivity growth has stalled, and that we might even face a “secular stagnation.”

> Technology seems to attract skepticism

Historically, technological development has been a major driver in transforming economic potential. However, today technology seems to attract more skepticism in this regard, with advances seemingly focused on areas like social media, and concern over tech valuations. Clearly, some companies will need to prove their business models in the years ahead to justify valuation multiples. But, in my view, these are something of a distraction to the bigger and slower moving trends affecting technology (and productivity) today. Energy is a great example of how new technologies can boost economic growth potential. But it is not the only one. Analysts project an additional 2–3 billion people could be plugged into the global economy as a result of improvements in mobile connectivity. Advances in robotics could have a significant impact on labor productivity, and new additive manufacturing techniques could reduce the length of supply chains and save commodity wastage. Combined, these effects of new technology could add 0.5–0.7% to global growth over the next decade.

> The vast majority of the US technology sector is leveraged to business spending

Even for the technology sector itself, the social media buzz is something of a distraction from the underlying investment opportunity. The vast majority of the technology sector, in the US in particular, is leveraged to business spending. In fact, around 75% of US technology sector revenues are derived from enterprise spending, with just 25% from consumer spending. In part due to our expectations that business spending is set to pick up in the US this year and act as a major driver of growth, we have added to our overweight position in the sector this month. Conclusion for investment positioning So where does this leave us?

> Investors with patience should look for opportunity amid uncertainty

Over the near term, the uncertainties I have highlighted add risk. But investors with patience should see some of these uncertainties as opportunities to benefit from slower moving trends in demographics, energy production, and technological development.

> We remain overweight risky assets

We remain overweight risky assets, in particular US and Eurozone equities, US high yield credit, and European loans. In the US these positions are underscored by the ongoing strength in the US economy, supported in part by the energy story I discussed above, but also a continued recovery in house prices, low corporate and household borrowing costs, and a likely pickup in capital spending. In the Eurozone, our overweights are backed up by still loose monetary policy and a recovery in corporate margins, which should build momentum over the coming year. Clearly, developments in geopolitics will be crucial to monitor over the next month. As I mentioned above, our base case assumption is that actors remain rational and the Russia/ Ukraine crisis does not escalate significantly. With both Europe and Russia highly dependent on the flow of, and receipts from, energy, many interim measures would surely be taken before Iran-style sanctions are imposed. However, in the risk scenario that energy supply from Russia is restricted and global oil prices rise sharply, we would likely see damage to equity markets, and the Eurozone market in particular, given its economic reliance on Russian energy. If oil prices increase by USD 10-20/bbl over a prolonged period, consumer and business confidence would be adversely affected, real economic activity would slow, and the cyclical earnings recovery would be

ubs house view april 2014

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threatened. This would pose a risk to both the Eurozone equity market itself, and to our position in Eurozone equities relative to UK equities. We note, however, that energy supply is plentiful and likely to grow faster than demand, creating more resiliency than during prior episodes of geopolitical tensions. This should exert downward pressure on energy prices during the balance of the year. More generally, we continue to recommend that investors de-emphasize commodities within their portfolios. We recommend a tactical underweight to commodities relative to developed market equities, which are better positioned to benefit from the global economic expansion.

> We still prefer the US dollar and British pound over the euro, Japanese yen, and Swiss franc

Meanwhile, in the currency space, we still prefer the US dollar and British pound over the euro, Japanese yen, and Swiss franc. On a structural basis, the dollar could see support from a shrinking current account deficit, although more crucial for the near term is likely to be an increasing interest rate differential between US and European government bonds. The spread between Treasury and Bund yields is already at a seven-year high (see Fig. 5). Thanks for reading this letter, and I hope you have found it useful in highlighting some of the investment opportunities we see amid todayâ&#x20AC;&#x2122;s many uncertainties.

Sincerely,

Alexander S. Friedman Global Chief Investment Officer Wealth Management

april 2014 UBS house view

Preferred investment views As of 21 March 2014

Asset Class

Most preferred

Least preferred

Equities

• US • Eurozone • US small and mid caps • US technology • US capex • North American energy independence

• UK

Bonds

• US high yield • Investment grade credit1 • Capital securities • US senior loans

• Government bonds

Foreign exchange

• USD • GBP

• EUR • CHF • JPY

Alternative investments

• Credit alternatives to diversify bond portfolios

Cash

• Tiptoeing out the yield curve

 Recent upgrades  Recent downgrades 1

Municipal bonds preferred in taxable portfolios, investment grade corporates in tax-exempt portfolios.

ubs house view april 2014

Month in Review Ukraine dominated headlines in March. A referendum was held mid-month in which a significant Crimean majority voted in favor of Russian annexation. That said, the legality of the election is widely disputed, and although President Obama has ruled out military action, US and EU officials lambasted Russia amid a further wave of limited sanctions. We continue to watch for Russia’s response but believe that despite the rhetoric and saber-rattling, a significant escalation in the crisis still seems unlikely. Surprisingly, market response to the unfolding crisis was relatively limited: after some initial unease, attention shifted to the inaugural Janet Yellen-chaired FOMC meeting. The Federal Reserve announced another USD 10bn in tapering, but scrapped the 6.5% unemployment rate threshold for the first rate hike in favor of more qualitative guidance. We expect this to lead to greater volatility in the future because there is a wider margin for investors to interpret Fed views. Furthermore, although 20 March was officially the spring equinox, a large number of US economic releases published earlier in the month showed that data had thawed from the chillier numbers we saw earlier in the year. In China, a deluge of softer economic data worried investors, and Premier Li warned of challenging times ahead amid fresh urbanization plans. Finally, the disappearance, and likely loss, of Malaysia Airlines flight MH370 stumped the world, as the search widened amid a swirl of perplexing theories.

At a glance Economy The latest data has confirmed our expectation that the US economy is slowly waking up from its “winter freeze.” Both the ISM leading indicator and employment growth improved in February, allowing the Fed to taper its quantitative easing (QE) program by a further USD 10bn this month. However, the European Central Bank (ECB) did not counter deflationary threats after its March meeting despite inflation of just 0.7%, far below the central bank’s target. The current conflict in the Ukraine remains an immediate risk; however we do not expect significant military or economic escalation. Equities The ongoing Crimean crisis reminds us that geopolitical risks have the potential to disrupt financial markets. But history shows that such events can create attractive entry opportunities if global growth remains unscathed. We believe that rising company earnings will drive equity prices higher in both the US and the Eurozone over the coming months. We hold overweight positions in both regions. The UK is our least preferred equity market as large-cap earnings keep falling as the British pound strengthens. We retain a neutral weight on emerging market equities, where we see attractive headline valuations balanced by weak earnings and political risks. Fixed income Developed market corporate bonds are among the best-performing asset classes so far this year and we hold overweight positions in both investment grade (municipal bonds in taxable portfolios) and US high yield bonds. As recent history shows, the asset class can perform very well both in an environment of rising rates (as in 2013) as well as falling rates (year to date in 2014). Spreads still offer tightening potential as default losses remain very low. On the other hand, government bonds are unlikely to deliver positive returns from current levels as we forecast yields to rise substantially over the next six months. Commodities Extreme weather conditions in the US and parts of Brazil, as well as geopolitical tensions between Russia and Ukraine, have stirred up agricultural prices. We believe these short-term support factors will run out of steam over the next 6-12 months and broad commodity prices should reverse. Our six-month forecasts are USD 1,250/ oz for gold and USD 105/bbl for oil (Brent). Foreign exchange Divergent monetary policy trends in the US and the Eurozone will likely weigh on the euro in the months ahead. Meanwhile, the Bank of Japan (BoJ) is likely to ease monetary policy further following the consumption tax hike in early April. We underweight both the yen and the euro against the US dollar. The British pound should get further support from the strong UK economy and we prefer the currency over the Swiss franc.

april 2014

UBS house view

Key financial market drivers

Global economic outlook Thomas Berner, CFA; Ricardo Garcia, CFA; Gary Tsang

US growth data showed signs of thawing, confirming that at least some of the recent weakness was driven by harsh weather conditions. We therefore continue to expect a significant re-acceleration in real GDP growth in 2Q14 and onward. The Eurozone recovery became more entrenched and sovereign bond spreads narrowed visibly. However, the challenge remains to boost inflation from very low levels. The weak start to 2014 and uncertainties about China’s export recovery led us to cut our 2014 real GDP growth forecast to 7.5% from 7.8%.

Robust US expansion

Eurozone in the focus

Thomas Berner, CFA

Ricardo Garcia, CFA

CIO View Probability: 70%

CIO View Probability: 60%

Robust expansion We expect US growth to be robust in 2014, driven by stronger private-sector demand. Inflation will likely stay below the Fed’s target of 2% over the next six months. The Fed’s QE3 will likely last until 4Q14, with a tapering of USD 10bn per meeting, and ultimately total USD 1.62tr.

Moderate growth The Eurozone economy is set to grow around its trend of approximately 0.3% quarter on quarter in coming quarters. Inflation is expected to remain low. The ECB retains an easing bias but to a lesser extent than previously expected. We don’t expect a lasting impact on Europe’s energy supply or growth outlook from the Russia-Ukraine conflict.

POSITIVE SCENARIO Probability: 20%  Strong expansion

Growth accelerates persistently above 3.5–4%, 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 earlier and raises policy rates sooner than mid-2015. NEGATIVE SCENARIO Probability: 10% à Growth recession

Fading US growth momentum as Fed stimulus is curtailed or an escalation of the Eurozone crisis upsets the privatesector recovery. Real GDP growth deteriorates, raising the fiscal deficit and leading to more aggressive bond-buying by the Fed.

ubs house view april 2014

POSITIVE SCENARIO 

Probability: 20%

Strong growth and fiscal stabilization

Bond yields converge closer than expected as peripheral countries consolidate their budgets and economic activity recovers faster. France and Italy follow a credible reform path at a faster pace and political risks fade further. NEGATIVE SCENARIO à

Probability: 20%

Major shock

Political uncertainty and the bank stress-test remain the key risks for Italian bonds, while persistent deficit overshoots are the key risk for Spain. Other major risks include Spain or Italy requiring funding support; persistent disinflation or deflation; Portugal requiring a debt restructuring; and massive fiscal slippage in France. The severity of economic sanctions on Russia increases. We assign a 10% probability to a military confrontation between Russia, on the one side, and Ukraine on the other side, with some kind of involvement by the West.

Global growth expected to be in 2014

US Canada Brazil Japan Australia China India Eurozone UK Switzerland Russia World

Real GDP growth in % 2013 2014F 2015F 1.9 3.0 3.2 1.6 2.6 3.1 2.2 2.3 2.0 1.6 1.5 1.2 2.4 3.0 3.2 7.7 7.5 7.0 4.7 5.7 5.3 -0.4 1.1 1.5 1.8 2.8 2.7 2.0 2.1 2.4 1.3 1.5 2.0 2.5 3.3 3.4

3.3% Inflation in % 2013 2014F 1.5 1.9 0.9 1.6 5.9 6.2 0.3 2.7 2.4 2.8 2.6 2.7 9.5 7.6 1.4 1.1 2.6 1.9 -0.2 0.2 6.8 6.1 2.9 3.1

2015F 2.4 2.2 6.0 1.8 2.4 3.0 6.4 1.5 2.0 0.7 5.4 3.2

Source: Reuters EcoWin, IMF, UBS CIO WMR, as of 18 March 2014. Please see disclaimer in appendix.

China growth to moderate Gary Tsang

1 april 2014

3 april 2014

US ISM manufacturing In the latest slew of data, manufacturing activity regains momentum after a brief winter lull, placating concerns that the softer data wasn’t just weather-related and reinforcing faith in a broader economic recovery. European Central Bank (ECB) meeting With the euro surging against the dollar recently, the question of whether this would have disinflationary ramifications was raised. The ECB is likely to discuss whether it ought to do more to support growth and inflation moving forward.

Moderating growth We now expect 2014 GDP growth of 7.5%, versus our previous forecast of 7.8%. This is in line with the stable economic targets set by the National People’s Congress for 2014. While small-scale credit events are likely this year, the process should pose no systemic risks. Probability: 10%

Growth acceleration

Economic growth accelerates significantly above 8% in the coming quarters as a result of more substantial fiscal, monetary and credit policy support from the government, or a strong pickup in external demand. NEGATIVE SCENARIO à

4 april 2014

CIO View Probability: 70%

POSITIVE SCENARIO 

Key Dates

Probability: 20%

Sharp economic downturn

The government heavily reins in shadow banking; interbank rates surge for a prolonged period; a rapid rise/decline in residential property prices or inflation triggers aggressive policy tightening; demand for Chinese exports plunges.

US jobs report We continue to expect an improvement in labor market conditions as adverse weather effects fade and high-frequency data pointed to strengthening of labor market conditions. Weekly jobless claims were at their lowest levels since early December.

14 april 2014

april 2014

US retail sales Despite flatter consumer sentiment, improving labor market conditions as well as fading adverse weather conditions will likely be reflected in improved spending and solid growth in retail sales in March.

Chinese economic data Amid a series of lackluster data releases attributed to the Lunar New Year and Premier Li’s warning that the Chinese economy could face “severe challenges” in 2014, indicators such as total social financing, retail sales, industrial production and fixed investment will be closely scrutinized.

Global politics Several important presidential and parliamentary elections will be held in Afghanistan, India, Hungary, Indonesia and Iraq.

april 2014 UBS house view

Asset Classes Overview

Equities Jeremy Zirin, CFA; David Lefkowitz, CFA; Stephen Freedman, PhD, CFA; Markus Irngartinger, PhD, CFA

We believe that accelerating economic growth and rising company earnings will drive equity prices higher in both the US and the Eurozone over the coming months. We hold overweight positions in both regions, although we recommend hedging the currency when investing in the Eurozone. The UK is our least preferred equity market as large-cap earnings keep falling as the British pound strengthens. We retain a neutral weight on emerging market equities, where we see attractive headline valuations balanced by weak earnings and political risks. The ongoing Crimean crisis reminds us that geopolitical risks have the potential to disrupt financial markets. But history shows that such events can create attractive entry opportunities if, as we assume, global growth remains unscathed.

Global equities Emerging Markets

Eurozone We have an overweight position on Eurozone equities but recommend that investors seek to hedge the risk of a declining euro. The region’s economic growth momentum, combined with an uptick in global manufacturing, bodes well for the Eurozone corporate earnings outlook. Coming from a low base and with profit margins improving, Eurozone earnings have considerable upside potential. We prefer the consumer discretionary sector as it offers good revenue and earnings growth and generates a high free-cash-flow. Financials offer attractive valuations and superior earnings growth. Utilities are cheap and earnings will return to growth. Our least preferred sectors are Consumer Staples, Materials and Telecom.

We are holding a neutral position in EM equities. We expect real GDP growth in emerging markets (EM) to average 4.6% in 2014 and 2015. The consensus expectation is for EM earnings to grow by 10.6% over the next 12 months. We are more cautious, however, and expect around 9%. The weakness in EM earnings is currently counterbalanced by relatively attractive valuations on a historical basis and relative to developed market valuations. This matters for longer-term investors, but is not a short-term trigger. We do not foresee a material rerating of EM equities over the next six months. We prefer China, Mexico, South Korea, and Taiwan over Malaysia, Thailand, and Turkey. MSCI EM (index points, current: 951)

Euro Stoxx (index points, current: 315)

six-month target

House view

980

House view

330

 Positive scenario

1100

 Positive scenario

380

à Negative scenario

780

à Negative scenario

260

We are neutral on Japanese equities. We believe corporate earnings growth will start slowing as the effect of the yen’s weakness peters out. Over the coming 12 months, corporate earnings growth should slow down to 10% year-on-year. This compares to 55% in fiscal year 2013. A severe risk for the next six months is a negative impact from the consumption tax hike in April 2014. We expect the BoJ to react in 2Q14 by providing more QE. We are waiting to see how the Abe administration stimulates Japan’s corporate investments and clears the uncertainty about 2014 economic growth.

We have an underweight stance on UK equities relative to global equities. We expect UK equities to underperform as the market’s earnings growth is still negative and clearly below growth rates of global equities. Defensive sectors account for slightly more than half of the MSCI UK market cap, and their weight in the UK equity market is about 15 percentage points higher than that in the global market. Thus, UK companies are expected to benefit less from a cyclical recovery than global peers. The strong pound is a drag on earnings given the high portion of FTSE 100 sales generated abroad. The UK’s valuation discount to global equities is slightly less than in the past. Investors wishing to benefit from the UK’s domestic recovery should invest in UK mid-cap companies via the FTSE 250 index.

Topix (index points, current: 1,164)

FTSE 100 (index points, current: 6,573)

Japan

six-month target

House view

1,210

House view

6,725

 Positive scenario

1,410

 Positive scenario

7,500

à Negative scenario

5,700

à Negative scenario

970

We now include six-month price targets for each of the regional equity markets covered by CIO WMR strategists in this report, including the US. This time frame aligns with the horizon for our tactical asset allocation recommendations. Price target updates will be provided on a monthly frequency in this publication and on an ad hoc basis as market conditions dictate. Current targets are as of 21 March 2014.

ubs house view april 2014

Asset Classes Overview

US equities US stocks have proved relatively resilient thus far in 2014 to the heightened geopolitical risks in Russia/Ukraine and broader emerging market growth concerns. We believe that this is largely due to: 1) the likelihood remains low that these potential risk factors have a meaningful negative impact on US economic or corporate profit growth, and 2) US economic data modestly improved in February following weather-induced weakness earlier in the year. Our favorable view on US equities remains unchanged as earnings growth should moderately accelerate over the course of the year; monetary conditions remain accommodative despite reduced asset purchases by the Fed, and broad US market valuation gauges are fair. We favor cyclical over defensive sectors, smaller size over large companies, and growth over value stocks. US Equities overview Despite the impact of the unfavorable weather in recent months, we believe US economic growth is poised to accelerate driven by gains in consumer wealth, less drag from higher taxes and lower government spending, and a notable increase in business investment and spending. UBS economists recently raised their 2014 real business equipment spending growth estimate from 5% to 7.5%. Accelerating commercial and industrial loan activity over the past six weeks further supports this view. We forecast US equities will continue to advance, largely in line with S&P 500 earnings growth, which we forecast to be up 8% this year. We raise our six-month forecast to 1,950. S&P 500 (index points, current: 1,861)

six-month target

House view

1,950

 Positive scenario

2,150

à Negative scenario

1,600

US Sectors We modestly increase our pro-cyclical sector positioning by boosting our overweight to Technology and further reducing our Utilities sector weighting. We estimate that roughly three-quarters of Technology sector revenues is derived from enterprise end-markets, which should benefit from an expected acceleration in aggregate capital spending. Low valuations and aggressive return of capital further bolster our view on the Tech sector. Industrials and Financials also appear attractive in the current

environment. Utilities have benefited from falling interest rates so far this year, but look particularly vulnerable should interest rates rise, as we expect. US Equities – size We maintain our overweight stance on both small- and mid-caps. Similar to 2013, small size segments have continued to outperform large-caps so far in 2014. Rising equity markets, faster small- and mid-cap earnings growth, and improving cyclical dynamics (such as rising M&A, declining credit spreads) should continue to support our long-standing overweight allocations to these segments of the US equity market. While relative valuations are somewhat high, faster earnings growth should continue to justify their premium valuation. Both small- and mid-cap earnings rose 14% in 4Q13 compared to 9% for large caps. US Equities – style Growth stocks are modestly outperforming value stocks so far this year, a trend we expect to continue. Sector composition plays a large role in the relative performance of growth versus value. The aggregation of our sector preferences continues to signal that a moderate growth style bias is warranted – particularly our overweight allocation to the Technology sector and our cautious stance on the “value-heavy” Energy, Telecom, and Utilities sectors. Growth stocks also appear inexpensive relative to value stocks trading at a 28% valuation premium (on a price-to-earnings basis) compared to its 34-year average premium of 46%.

Higher capital expenditures — positive for cyclicals UBS equipment spending growth forecast, inflation adjusted, in % 12 10 8 6 4 2 0 2013

2014E

2015E

Old New / Actual Source: UBS Investment Research, as of 18 March 2014

april 2014 UBS house view

Asset Classes Overview

Fixed income Thomas McLoughlin; Barry McAlinden, CFA; Achim Peijan, PhD, CEFA; Philipp Schoettler; Thomas Wacker, CFA

The FOMC’s shift toward a fully qualitative interest rate forward guidance will likely lead to higher interest rate volatility as investors have more leeway in deducing how the Fed will interpret incoming data points. Despite the communication shift, we don’t interpret it as a significant change in the FOMC’s policy intentions. We still expect an initial rate hike in mid-2015 and for the Treasury yield curve to adjust upward. As rates rise, higher quality fixed income segments will give back some of the recent gains, and we maintain a preference for credit sensitive segments that offer incremental spread compression. For taxable portfolios, we maintain a greater overweight in municipal bonds relative to IG corporates. Within municipals, we see technical factors remaining positive in the near term but we also see headline risk related to specific credits as ongoing.

US Investment Grade Corporate Bonds

Government Bonds US Treasury yields rose slightly across all maturities over the last month. Improving US growth data assuaged fears that the recent slowdown was more than just weather-induced. The Fed’s new Fed funds rate projections and written statement fueled the sell-off as investors interpreted them as signs of a more hawkish Fed. The Ukrainian crisis, however, capped the Treasury losses as it stoked fears of a global economic and financial contagion. We continue to expect the 10-year US Treasury rate to trend higher to 3.2% in 6 months and 3.4% in 12 months as global growth re-accelerates, the timing of the Fed’s first rate hike draws closer, and the Ukrainian situation does not escalate further. While the Fed’s new vaguer qualitative forward guidance will likely raise interest rate volatility, we don’t think it will accelerate the ascent in rates. We think the Fed’s reaction function is unchanged and still expect the first rate hike in mid-2015. US 10-year yield (Current: 2.8%) House view  Positive scenario à Negative scenario

six-month target 3.2% 3.3–3.9% 2.0–2.8%

High yield (HY) bond spreads rose toward 395 basis points (bps) in midMarch, before rallying sharply following the 19 March FOMC meeting. Spread valuations have declined from last month with the current HY spread at 374bps. Our six-month spread target of 350bps will provide a price cushion to help offset the drag from rising benchmark rates and we forecast coupon driven returns of 3–4%. We expect the default rate to remain well below 2% through 2014, supported by our constructive economic outlook, solid corporate fundamentals, and favorable funding conditions. US corporates remain in a middle stage of the credit cycle, which entails gradual re-leveraging and incrementally tighter spreads. six-month target

House view

350bps

 Positive scenario

300bps

à Negative scenario

900bps

ubs house view april 2014

us IG spread (Current: 110bps*) House view

six-month target 100bps

 Positive scenario

85bps

à Negative scenario

350bps

*Data based on Barclay’s Corporate Aggregate Indexes.

Emerging Market Bonds

US High Yield Corporate Bonds

USD HY spread (Current: 374bps)

We are overweight investment grade (IG) corporate bonds in tax-exempt accounts but underweight in taxable portfolios where we prefer municipal bonds. Declining benchmark rates and positive supply/demand conditions have led to a strong 2.1% year-to-date total return. Although the fundamental and economic backdrop for IG credit remains constructive, investment grade (IG) will remain sensitive to rising rates. IG spreads have stabilized at around 110bps, which is only slightly above our six-month target of 100bps. We look for weakness in IG prices to be offset by coupon income, with our six-month return projection at only 0–1%. Lower rated IG segments (BBB) should offer better return potential than higher rated issuers and short/intermediate maturities outperform longer maturities.

We retain a neutral preference for both EM sovereign bonds and EM corporate bonds denominated in USD. From a valuation perspective, both segments are fairly valued compared to government bonds. The fragile economic recovery and financial vulnerabilities in lower rated countries are headwinds for EM sovereign bonds. In addition, corporate credit indicators such as leverage ratios and rating trends have weakened in recent quarters. Within sovereign bonds, we prefer sovereign issuers with current account surpluses or manageable small deficits, coupled with attractive valuations. EMBI / CEMBI spread (Current: 350bps / 345bps) six-month target House view

350bps / 350bps

 Positive scenario

310bps / 300bps

à Negative scenario

450bps / 520bps

Asset Classes Overview

Municipal Bonds

Non-US Developed Fixed Income

Year-to-date, municipals (3.6%) are outpacing the total returns for both US Treasury securities (1.3%) and IG corporate bonds (2.1%). We attribute the stronger performance in large part to three factors. First, tight new issuance has provided support to prices. Second, on the demand side, net cash inflows to muni funds have occurred on a weekly basis since the middle of January. Third, Puerto Rico successfully sold USD 3.5bn of general obligation bonds earlier in March. Thus, market access risk that could have influenced broader investor sentiment has been reduced. We continue to believe munis are attractive on an after-tax basis.

Year-to-date, bond yields in most of the major non-US developed markets have moved in line with the US. Eurozone peripheral sovereign bonds have rallied in some countries, pushing yields down to their lowest levels since the global financial crisis began. While this is good news for those countries, in our view the lower yields on peripheral bonds have reduced their attractiveness. In the months ahead, we expect Japanese and Eurozone bond yields to rise by somewhat less than Treasury yields. However, we also expect the dollar to gain against both the yen and euro, hurting returns on non-US developed fixed income when measured in dollar terms.

Current AAA 10-year muni-to-Treasury yield ratio: 89.6% (last month: 90.2%)

Additional US taxable fixed income (TFI) segments Agency Bonds

Mortgage-Backed Securities (MBS)

Within our US TFI allocation, we are underweight agency debt to the same degree as Treasuries. Within the agency market, we are ambivalent on callable bonds versus bullets (i.e., non-callable bonds) because we think the incremental spread is roughly commensurate with the incremental risk. In bullets, we find the best relative value around the three- to four-year area of the yield curve because it offers the best expected carry and roll down. In callables, we like 4-year finals with 6-month lockouts and 1x calls.

We have a neutral recommendation for the mortgage sector within our US TFI allocation, which represents a relative overweight to Treasuries and agencies. Our reasoning here is that the additional spread that mortgage securities offer generates relative total return outperformance potential in the medium term, assuming our Treasury rate and Fed tapering projections are correct. We prefer higher coupon pass-throughs versus lower coupons because they offer relatively more protection from duration extension risk (i.e., they are relatively less responsive to rising interest rates).

Current agency benchmark spread of +26bps over 5-year UST (versus +26bps last month)

Current MBS spread of 123bps to blend of 5-year and 10-year Treasuries (versus +128bps last month)

Treasury Inflation-Protected Securities (TIPS)

Preferred Securities

Real yields are lower since the beginning of the year due to temporary weakness in the US economic data, but real yields rose in line with nominals following the March Fed meeting. We expect real yields to continue this rising trend along with the ongoing economic recovery and the phase-out of quantitative easing, so we believe the real yield component of TIPS will suffer in the coming months. While we see some value in TIPS relative to matched maturity nominal Treasuries on a breakeven inflation basis, we believe a tactical investor will find better entry points to buy inflation protection in the medium to longer term. Within our US fixed income allocation, we remain underweight TIPS by the same magnitude as Treasuries.

Preferreds are off to an exceptionally strong start to the year (+7%) as the decline in Treasury yields has led to strong demand. Issuer fundamentals remain sound and fund flows have stabilized. Further credit spread compression is possible for preferreds, which can help support prices in a rising rate environment. However, the pace of recent price gains is not sustainable and we look for prices to become more susceptible to rising rates. Given their income advantage, we look for preferreds to outperform US IG corporate bonds where we only expect flattish returns over the next 6 to 12 months. Current spread of +244bps over 10-year UST (+268bps last month)

Current 10-year breakeven inflation rate of 2.14% (2.14% last month)

CIO WMR interest rate forecasts Americas USD 3M Libor

As rates rise, high quality fixed income gains to reverse

20-Mar-14

3 mths

6 mths

12 mths

End 14

0.2

0.3

0.5

USD 2Y Treas.

0.4

0.5

0.7

1.0

USD 5Y Treas.

1.7

1.9

2.1

2.4

USD 10Y Treas.

2.8

3.0

3.2

3.4

USD 30Y Treas.

3.7

4.0

4.1

4.2

Source: Bloomberg, UBS CIO WMR, as of 20 March 2014

Cumulative Total Return, in USD, index 31 Dec. 2013 = 100 107 106 105 104 103 102 101 100 99 98

31-Dec

10-Jan

Treasuries HY Corporates

20-Jan

30-Jan

TIPS Preferreds

09-Feb

19-Feb

01-Mar

Municipals EM Sovereigns

11-Mar

21-Mar

IG Corporates EM Corporates

Source: BofAML, UBS CIO WMR, as of 17 March 2014

april 2014 UBS house view

Asset Classes Overview

Commodities and other asset classes Dominic Schnider, CFA, CAIA; Giovanni Staunovo; Thomas Veraguth

Extreme weather conditions in the US and parts of Brazil, as well as geopolitical tensions between Russia and Ukraine, have stirred up energy, agricultural and precious metal prices in recent weeks. Although the insurance character of commodities against extreme weather and geopolitical tensions has delivered positive returns year to date, we believe these price-supportive factors should run out of steam over the next 6–12 months and allow commodity prices to reverse.

Commodities Precious metals Once geopolitical concerns ebb, macroeconomic data improves globally, risk appetite returns and investors realize that US monetary policy normalization is ongoing with higher interest rates looming in 2015, renewed gold ETF outflows should bring the gold price down to USD 1,250/oz in 6 months. A lower gold price tends to have negative spillover effects on silver, especially as the silver market faces a large fabrication surplus. Platinum and palladium remain our metals of choice. Mine strikes in South Africa – which started on 23 January – are still ongoing, with no resolution in sight. Signs of supply stress in the platinum and palladium market might soon emerge and should give both metals an attractive return outlook over the coming 3–6 months. Gold (Current: USD 1,327/oz)

six-month target

House view

USD 1,250/oz

 Positive scenario

USD 1,500/oz

à Negative scenario

USD 900/oz

Crude oil We expect financial markets to command a higher supply risk premium in crude oil (USD 5–10/bbl) due to the geopolitical tensions in Eastern Europe and heightened social tensions in Venezuela. That said, geopolitical concerns are likely to subside over the next 6–12 months, putting the focus on ample supply availability. Strong non-OPEC crude oil production growth should bring Brent crude oil prices down to USD 105/bbl in six months, with room to reach USD 100/bbl during 2014. In natural gas, extreme low inventories require elevated prices in 2Q14 to incentivize the switch-back to coal from natural gas in the power generation sector, before prices are expected to decline toward USD 4/mmbtu at the end of 2H14. Brent (Current: USD 105.7/bbl) House view  Positive scenario à Negative scenario

six-month target USD 105/bbl USD 130–165/bbl USD 80–90/bbl

Base metals Stronger global economic activity should allow base metals to deliver modest positive returns in 1H14, followed by price pullbacks as supply reacts to higher prices, and global economic growth momentum peaks over the next two quarters. Within base metals, the focus is on minor metals like zinc, nickel, and especially lead. These metals are expected to

ubs house view april 2014

see a deficit in the refined market or are challenged on the supply side, such as nickel due to Indonesia’s export ban on mineral ores. While we initially saw value in holding copper with prices going below USD 7,000/ mt, Chinese financing deals, which gave the metal demand support, might fade in the short run and add to price weakness; copper is our least preferred metal for the time being.

Agriculture The latest developments on both the weather and geopolitical fronts have curtailed rising inventory estimates across the agriculture sector. Nevertheless, we continue to expect a well-supplied grain market if normal weather conditions prevail in the US during spring/summer. Soybean prices are expected to fall once Brazilian shipments start picking up in the coming months. While corn prices benefited from strong US exports, the outlook of solid US corn supply for the next season is likely to bring down prices back to USD 4.20/bu. There is a possibility of an El Niño weather pattern – which causes severe dryness in Australia and could undermine wheat exports (more than 10% of global exports) – developing in 2H14. In softs, coffee and sugar markets are seeing a transition from a surplus to a deficit as persistent dryness in Brazil is weighing on yield prospects for both crops. We believe the price rise in coffee is excessive as the market has enough inventories to cushion this deficit. Moderately better supply prospects for next year’s US cotton crop and the risk of lower Chinese cotton imports due to potential changes in the country’s reserve policy make cotton unattractive.

Other asset classes Listed real estate Listed real estate is currently performing slightly below global equities. Yet, renewed market concerns about economic growth, slightly lower interest rates, and a flattening interest-rate curve have been supportive. The latter has eased investors’ concerns over future property values and debt costs. The range-bound market that began in May 2013 is expected to continue until investors have coped with the expected rise in interest rates. We subsequently expect listed real estate to become gradually and relatively more attractively valued compared to equities. FTSE EPRA/NAREIT Developed TR USD (Current: 3,752)

six-month target

House view

USD 4,020

 Positive scenario

USD 4,240

à Negative scenario

USD 3,600

Asset Classes Overview

Foreign exchange Katie Klingensmith; Thomas Flury

Janet Yellen’s first press conference as Fed Chair changed the tone for exchange rates – which had been moving in sympathy with geopolitical and Chinese growth concerns – suggesting that an earlier Fed rate hike would push the EURUSD down from multi-year highs. The Japanese yen has benefited from global fears, reversing slightly after the FOMC. We continue to recommend the dollar versus both the euro and the yen, and we also remain long the British pound versus the Swiss franc. However, with concerns about global growth, some softness in US data, and an ECB seemingly impervious to deflation, these trends could materialize slowly. Elsewhere, the Reserve Bank of New Zealand (RBNZ) became the first G10 central bank to hike rates, and lifted its target to 2.75%. The RBNZ hike in spite of the New Zealand dollar being expensive suggests that global monetary conditions are gradually returning to normal.

USD The FOMC continued its taper, shifted to qualitative forward guidance and suggested that rate hikes could come earlier, lifting the dollar against many other major currencies. While this new approach does not challenge our view that the Fed will first hike rates in mid-2015, it shows the Fed’s concurrence that the mixed US data is largely attributable to the extremely cold weather. We think there has been little that would prevent the Fed from continuing to reduce asset purchases, and that decent economic momentum coupled with monetary policy normalization will indeed be good for the US dollar.

EUR Before the Fed decision, the euro rose against the dollar to levels not seen since 2011 despite the geopolitical risks threatening the Eurozone. While this shows that financial markets do not yet consider an escalation of Ukrainian conflict as likely, it also reflects the ECB’s surprising indifference to low price levels. According to the most recent ECB staff estimates, inflation will rise to 1.6% in two years, below the 2% target, and overly optimistic in our view. We expect that the ECB will need to further loosen monetary conditions, and that this will play out as the Fed is beginning to consider hiking interest rates.

Swiss National Bank suggest that the floor will remain in place; despite improving growth momentum and a hot real estate market, Switzerland is in no place to tolerate a higher exchange rate. Geopolitical jitters have not given rise to a stronger franc. We expect USDCHF to rise when the dollar begins to gain broadly, and find the franc a more promising short against the pound than the euro.

Other developed market currencies The Reserve Bank of Australia (RBA) will not follow the RBNZ to hike, and instead has welcomed the fall in the Australian dollar. We expect both the Australian and the New Zealand dollars to come under pressure when the Fed approaches rate hikes. In contrast, the Canadian dollar has experienced a year-long losing streak. However, we think the Bank of Canada (BoC) is no longer as concerned about the potential for deflation, and that the commodity price and balance of payments deterioration will reverse. We continue to find long-term positions in the Canadian dollar attractive. Both the Norwegian kroner and the Swedish krona have lost some of their growth and interest rate advantages but may show some recovery against the euro later this year.

gbp We continue to find UK economic data reassuring and favor the pound. While the Bank of England (BoE) keeps its policy settings on hold, we think it may consider hiking rates as early as this year. Purchasing managers’ indices, business investments, and labor momentum are encouraging, but consumer and business confidence remains in negative territory. The previous 7% employment “threshold” has nearly been achieved, but the BoE will likely wait until inflation looks more threatening. The stronger currency does not seem to be a worry at present.

JPY The Japanese yen has been the clear “winner” from the increase in concerns about Chinese growth and tensions over Ukraine. However, the BoJ does not appreciate this victory and we expect it will be all the more likely to implement further measures to stimulate the economy and push USDJPY back up toward 110 in order to achieve its 2% inflation target. However, in the meantime, the pair will likely continue to reflect global market confidence and Fed policy expectations.

CHF The Swiss franc remains tightly tied to the euro, with the pair trading between EURCHF 1.21 and 1.25. Current inflation and as forecast by the

UBS CIO FX forecasts 19-Mar-14

12M

PPP*

EURUSD

1.391

1.34

1.28

1.24

1.30

USDJPY

101.6

105

107

110

USDCAD

1.118

1.10

1.07

1.05

0.99

AUDUSD

0.910

0.88

0.85

0.76

GBPUSD

1.662

1.65

1.62

1.67

NZDUSD

0.862

0.83

0.78

0.61

USDCHF

0.875

0.92

0.96

0.99

1.00

EURCHF

1.217

1.23

1.30

GBPCHF

1.454

1.51

1.58

1.60

1.67

EURJPY

141.2

141

137

136

105

EURGBP

0.837

0.81

0.78

0.77

0.78

EURSEK

8.838

8.80

8.60

8.40

8.57

EURNOK

8.328

8.50

8.40

8.10

8.40

Source: Thomson Reuters, UBS CIO WMR, as of 20 March 2014 Note: Past performance is not an indication of future returns. *PPP = Purchasing Power Parity

april 2014 UBS house view

in focus

Five years young corporate earnings. Using quarter-end data, the S&P 500 has increased by 135% since the end of the first quarter in 2009. Similarly, trailing 12-month S&P 500 operating earnings per share (EPS) have increased by 120% since bottoming in mid2009. Simply stated, in our view, the five-year bull market has not been driven by investor speculation or by the Fed’s quantitative easing programs supposedly “forcing” investors into riskier assets, but rather by improving market fundamentals – i.e., strong corporate profit growth.

Jeremy Zirin, CFA Chief US Equity Strategist CIO Wealth Management Research

The current bull market in US equities turned five in March 2014. Like most five-year-olds, the market can be volatile and throw an unpleasant (to be kind) temper tantrum now and again. The nearly 20% market swoon during the summer of 2011 when European sovereign debt markets were imploding and US politicians were acting more like toddlers going through the “terrible twos” stage comes to mind as an example. But more positively, I would also stretch the analogy further to say that similar to a five-year-old, the current bull market in US equities has also become more self-sufficient, exhibiting meaningful developmental (i.e., fundamental) growth. Market gains have been hard “earned” This “fundamental” growth can be attributed largely to an impressive rebound in corporate profits. In the long run, while market valuations tend to oscillate within a wide range around their long-term average, ultimately it is earnings that anchor the market’s fundamental value. From this perspective, the market advance over the past five years has not been excessive, and has in fact closely mirrored the gains in 20

ubs house view april 2014

Not that long, not that strong, and not that expensive Strong earnings fundamentals aside, we see little evidence from other market cycle gauges suggesting that the current bull market is poised to peter out. Compared to the prior 11 US equity bull markets since 1940, the current rally actually seems quite average. While the length of the current bull market may have just surpassed five years, the average bull market has lasted 4.7 years with a wide range of 2.2 to 12.3 years. Similarly, the annualized S&P 500 price appreciation of 20% over the past five years also matches the average annualized gain of 19% delivered during previous bull markets. Finally, as we show in Fig. 1, bull markets typically end at higher valuation levels. The current S&P 500 price-to-earnings (P/E) ratio is 16.6, or roughly 10% below the average P/E valuation at the end of past bull markets. We are not suggesting through these comparisons that stocks must continue to advance. We simply mean to illustrate that in terms of its length, cumulative price appreciation, and current valuation, this bull market has actually been quite normal, and there is little evidence of “froth” or excess in US equities. Bull markets die from excesses, not from old age So if there are no obvious “red flags” warning of a bull market that is getting long in the tooth, what signals should investors monitor as indications that price gains are coming to an end? First and foremost, bull markets are nearly always ushered in by the unwinding of excesses that lead to an economic recession. The two most recent examples were the bursting of the tech valuation bubble starting in 2000 and subsequently the housing/credit bubble in the latter stages of the last decade. In these more extreme cases, capital was ultimately improperly allocated (on a large scale) on the

In Focus

misguided belief that we were in a new technological paradigm in the late 1990s or that US home prices would continuously rise. The main reason we expect the bull market to advance to a sixth (and probably a seventh) year is that we believe a recession over the next 1–2 years appears exceedingly unlikely. There is simply not much to recess. More likely, the US economic expansion is still in the early to middle stages of the business cycle. While housing market activity has rebounded off its extreme lows, housing starts remain 40% below their long-term average. Nonresidential construction, which typically lags the rebound in the residential sector, has likewise been sluggish, as have long-term capital investments made by corporations. Not only is a recession unlikely, but most leading economic indicators are signaling further positive momentum and expansion (see Fig. 2). With consumer balance sheets now largely repaired following the debt deleveraging and asset price gains of the past five years, we expect US GDP growth to accelerate and reach 3% for both calendar

2014 and 2015. In this regard, the current economic expansion can best be categorized as “a late bloomer.” More room to run As such, corporate profits should continue to advance. After rising between 6% and 7% in each of the past two calendar years, we forecast S&P 500 operating EPS growth to modestly accelerate to 8% this year and we raise our rolling sixmonth price target to 1,950. The bull market in US equities is not over. It just turned five years young.

„ Fig. 1: The current bull market has been very average“

Fig. 2: Leading economic indicators are rising

Current and historical US equity bull markets

US leading index of 10 economic indicators, year-over-year percent change

Duration

Price gain

Trailing P/E

Annualized Starting

Ending

20 15

Start

End

(years)

Total

Apr-42

May-46

4.1

150%

25%

7.5

22.1

Jun-49

Jul-56

7.1

136%

13%

5.9

13.9

Dec-57

Dec-61

4.0

79%

16%

11.9

22.4

–5

10 5

Jun-62

Apr-66

3.8

66%

14%

15.8

16.9

–10

Sep-66

Nov-68

2.2

42%

17%

13.9

19.0

–15

Jun-70

Dec-72

2.5

62%

21%

13.2

18.4

–20

Sep-74

Dec-76

2.3

69%

26%

7.0

10.8

–25

Feb-78

Nov-80

2.8

61%

19%

8.0

9.5

Jul-82

Aug-87

5.1

208%

25%

7.7

21.7

Nov-87

Mar-00

12.3

551%

16%

13.7

28.1

Sep-02

Oct-07

5.1

90%

13%

17.6

17.5

5.0

153%

20%

12.2

16.6

19%

11.1

18.2

Feb-09 Average

4.7

1980

1985

1990

1995

2000

2005

2010

2015

Source: Conference Board, UBS CIO as of March 2014 Note: Shaded areas denote recessions.

Source: Bloomberg, FactSet, and UBS CIO, as of March 2014

april 2014 UBS house view

Top themes Highlights from our monthly selection of highest conviction investment themes across the asset class spectrum

Capex rising...finally

North American energy independence: reenergized

Jeremy Zirin, CFA; David Lefkowitz, CFA; Matthew Baredes

Nicole Decker; David Lefkowitz, CFA

Portfolio context US equity

u Global

recovery story

u Medium-term

horizon

(6–12 months)

u Portfolio

integration

We’ve identified a list of stocks that are poised to benefit from an upturn in capital spending. u Full

report

“Capex rising…finally,” 6 March 2014

The preconditions for a pickup in capital spending are in place. The nation’s stock of plant and equipment is old and companies have access to low cost funding. The missing ingredient has been a need to ramp up production. But with Europe out of recession and US growth picking up, we believe companies will increasingly replace old equipment and invest in capacity additions. The recent uptick in capacity utilization underscores this need. In addition, a reflaring of macro risks is unlikely. Policy uncertainty continues to improve (the Fed is winding down asset purchases and federal budget battles have been deferred until at least March 2015) and the global financial system is much healthier. Finally, as interest rates rise we believe the marginal equity investor will become more growth-oriented and less focused on income, favoring companies that are prudently investing for growth.

Current capital stock is as old as it has been in 50 years

Portfolio context US equity

u Equity growth and

income u Long-term

horizon (>12 months)

u Portfolio

We’ve identified a list of stocks that are poised to benefit from positive trends related to North America’s burgeoning energy independence. u Full

5.0

600

4.8

500

4.6

4.4

4.2

18 4.0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

ubs house view april 2014

Technologies for extracting oil and gas are driving improved well productivity (see chart) and reducing costs. More oil and gas pipelines and processing plants are needed. The US will construct several LNG export facilities before the end of the decade. For the year ahead, we see opportunities in energy providers and advantaged energy consumers across several industry sectors: energy infrastructure, chemicals, auto and steel manufacturers, and utilities.

Average first-month oil production (barrels per day)

Source: Bureau of Economic Analysis, UBS CIO WMR, as of 24 February 2014

report

“North America energy independence: reenergized,” 22 January 2014

Trends – such as robust drilling activity for oil and natural gas, infrastructure build-out, and widespread availability of reliable and affordable energy supplies – are driving opportunities for investors.

New oil wells are more productive

Average age of fixed assets and consumer durable goods

Fixed assets, le Consumer durable goods, right

integration

North America continues to make progress in achieving greater energy independence. We expect greater self-sufficiency by the end of the decade and that the US will soon be a net exporter of natural gas. Relatively inexpensive natural gas will likely create a competitive advantage for the US and will bolster energy-intensive petrochemical and materials sectors.

400 300 200 100 0 Bakken

Eagle Ford

Niobrara

March 2013 March 2014 Source: Energy Information Administration, UBS CIO WMR

Permian

Top themes Highlights from our monthly selection of highest conviction investment themes across the asset class spectrum

US senior loans Barry McAlinden, CFA; Philipp Schoettler

Top themes Portfolio context

US fixed income u Yield

enhancement

u Medium-term

horizon

(6–12 months)

u Portfolio

integration

This theme can be integrated into a diversified fixed income portfolio as a complement to the high yield bond allocation. Loans are investible either through open and closed-end mutual funds or ETFs. u Full

report

“US senior loans update,” 19 March 2014

Senior loans (or leveraged loans) are issued by speculative-grade companies but have a senior secured status within a company’s capital structure. The same positive fundamental trends evident in the US high yield bond market also apply to loans, including improved balance sheets and debt maturity profiles. Loan coupon rates reset regularly based on 3-month USD LIBOR, which has historically allowed loans to perform well when interest rates rise. Even though LIBOR floors prevent coupons from resetting higher right away, their low duration and strong demand should provide loans with an advantage over government and IG corporate bonds as rates rise. There has been an increase in aggressive types of issuance in the loan market such as covenant-lite deals. We view these trends as representative of a highly accessible market environment within the middle stages of the credit cycle, rather than signaling an overheating market.

Thematic investment ideas from CIO Wealth Management Research February 2014

Enhanced cash yields

Energy independence

Credit alternatives Capital securities

Eurozone rebound Capex

Tech Senior loans

The investment themes highlighted in this section are among our highest conviction thematic recommendations. The full list of most preferred themes (see below) is discussed in our new monthly publication entitled “Top themes.”

Top themes • Capex rising...finally • Diversify bond portfolios into credit alternatives • Favor Eurozone equities within Europe • N orth American energy independence: reenergized • O pportunities in financial sector capital securities

S&P/LSTA Loan Index spread

• Tiptoeing out the yield curve

Spread to maturity over LIBOR, in bps

• US senior loans

L+1800.00 L+1600.00 L+1400.00 L+1200.00 L+1000.00 L+800.00 L+600.00 L+400.00 L+200.00 L+.00

• US technology: secular growth, on sale

Ask your Financial Advisor for a copy of this publication.

1997

1999

2001

2003

2005

2007

2009

2011

2013

Spread-to-maturity Pre-crisis average Source: S&P LCD, UBS CIO WMR, as of 14 March 2014

april 2014 UBS house view

Key forecasts

Overweight Neutral

As of 20 March 2014

Underweight

TAA1 Change

Asset class

Benchmark

6-month forecast Positive Negative House View scenario scenario

Value4

m/m perf.2 in %

1861

1.2%

1950

2150

1600

Equities

–

USA

–

S&P 500

Eurozone

–

Euro Stoxx

315

-1.2%

330

380

260

–

FTSE 100

6573

-1.4%

6725

7500

5700

Japan

–

Topix

1164

-1.6%

1210

1410

970

Switzerland

–

SMI

8227

-2.3%

8475

9200

7600

Emerging Markets

–

MSCI EM

951

-0.7%

980

1100

780

US Government bonds

–

10yr yield

2.8

-0.1%

US Corporate bonds

–

Spread

110 bps

0.2%

100 bps

85 bps

350 bps

US High yield bonds

–

Spread

374 bps

1.2%

350 bps

300 bps

900 bps

Emerging Markets Bonds (Sovereign/Corporate)

–

Spread

350 bps/ 345 bps

0.9%/ 1.4%

350 bps/ 350 bps

310 bps/ 300 bps

450 bps/ 520 bps

Commodities

–

DJUBS ER Index

135

3.2%

Listed Real Estate

–

EPRA/NAREIT DTR

3752

-0.3%

4020

4240

3600

Bonds 3

3.2% 3.3%-3.9% 2.0%-2.8%

Other asset classes

Currencies

Currency pair

USD

–

EUR

–

EURUSD

1.39

1.0%

1.28

1.40

1.20

GBP

–

GBPUSD

1.66

-1.2%

1.62

JPY

–

USDJPY

102

0.5%

107

110

CHF

–

USDCHF

0.88

-1.3%

0.96

Source: UBS CIO WMR, Bloomberg 1 TAA = Tactical asset allocation, 2 Month-on-month performance. 3 Investment grade corporates are overweight in tax-exempt portfolios but underweight in taxable portfolios, where we prefer municipal bonds. 4 As of 19 March 2014, except for Emerging Markets Bonds data as of 18 March 2014. Past performance is no indication of future performance. Forecasts are not a reliable indicator of future performance.

ubs house view april 2014

detailed asset allocation

Detailed asset allocation taxable with non-traditional assets

0.0

Current allocation1

0.0 +0.0

Change this month

0.0

WMR tactical deviation

Strategic asset allocation

Aggressive

Current allocation1

0.0 +0.0

Change this month

Strategic asset allocation

0.0

WMR tactical deviation

Current allocation1

0.0 +0.0

Moderately aggressive

Change this month

0.0

WMR tactical deviation

Strategic asset allocation

Moderate

Current allocation1

0.0 +0.0

Change this month

0.0

WMR tactical deviation

Change this month

Strategic asset allocation

0.0 +0.0

Moderately conservative

Current allocation1

Cash

WMR tactical deviation

Change this month*

All figures in %

Conservative

Strategic asset allocation

Investor risk profile

Fixed Income

69.0 -1.5

67.5 57.0 -2.0

55.0 46.5 -2.5

44.0 41.0 -2.5

38.5 33.0 -2.5

30.5

US Fixed Income

62.0 +2.5

64.5 51.0 +2.0

53.0 40.5 +0.5

41.0 34.0 +0.5

34.5 26.0 -0.5

25.5

US Gov’t

-3.0

4.0

50.0 +1.0

51.0

US IG Corp

4.0 +0.5

4.5

3.5

-0.5

3.0

-2.0

1.0

2.5

US HY Corp

1.0 +4.0

5.0

3.0 +5.0

8.0

3.5 +5.0

7.0 -4.0

3.0

6.0 -4.0

2.0

6.0 -3.0

US Municipal

Int’l Fixed Income

7.0

5.5

-4.0

1.5

39.0 +1.5

40.5

4.0

-4.0

0.0

30.0 +1.5

31.5

3.5

-3.5

0.0

2.0

-2.0

0.0

24.0 +1.5

25.5

17.0

-1.5

15.5

-2.5

0.0

2.0

-2.0

0.0

8.5

4.0 +5.0

9.0

5.0 +5.0

10.0

3.0

7.0 -3.0

4.0

7.0 -2.0

5.0

Int’l Developed Markets

6.0

-4.0

2.0

4.0

-4.0

0.0

3.0

-3.0

0.0

3.0

-3.0

0.0

2.0

-2.0

0.0

Emerging Markets

1.0 +0.0

1.0

2.0 +0.0

2.0

3.0 +0.0

3.0

4.0 +0.0

4.0

5.0 +0.0

5.0

Equity US Equity

16.0 +2.5

18.5 27.0 +3.5

30.5 34.5 +4.5

39.0 45.0 +4.5

49.5 55.0 +4.5

59.5

9.0 +2.0

11.0 15.0 +2.5

17.5 20.0 +3.5

23.5 26.0 +3.5

29.5 31.0 +3.5

34.5

US Large cap Growth

2.5 +1.0

3.5

4.5 +1.0

5.5

6.0 +1.5

7.5

8.0 +1.5

9.5

9.5 +1.5

US Large cap Value

2.5

-1.0

1.5

4.5

-1.5

3.0

6.0

-2.0

4.0

8.0

-2.0

6.0

9.5

-2.0

7.5

US Mid cap

3.0 +1.0

4.0

4.0 +1.5

5.5

5.0 +2.0

7.0

7.0 +2.0

9.0

8.0 +2.0

10.0

US Small cap

1.0 +1.0

2.0

2.0 +1.5

3.5

3.0 +2.0

5.0

3.0 +2.0

5.0

4.0 +2.0

6.0

20.0 24.0 +1.0

25.0

International Equity

7.0 +0.5

Int’l Developed Markets

4.0 +0.5

4.5

7.0 +1.0

8.0

8.5 +1.0

9.5

11.0 +1.0

12.0

14.0 +1.0

15.0

Emerging Markets

3.0 +0.0

3.0

5.0 +0.0

5.0

6.0 +0.0

6.0

8.0 +0.0

8.0

10.0 +0.0

10.0

Commodities

4.0 -1.0

3.0

4.0 -1.5

2.5

4.0 -2.0

2.0

5.0 -2.0

3.0

5.0 -2.0

3.0

12.0 15.0 +0.0

15.0

9.0 +0.0

9.0

7.0 +0.0

7.0

Non-traditional

11.0 +0.0

7.5 12.0 +1.0

11.0 12.0 +0.0

13.0 14.5 +1.0

15.5 19.0 +1.0

11.0

Hedge Funds

11.0 +0.0

11.0

12.0 +0.0

12.0

10.0 +0.0

10.0

3.0 +0.0

3.0

0.0 +0.0

0.0

Private Equity

0.0 +0.0

0.0

0.0 +0.0

0.0

5.0 +0.0

5.0

6.0 +0.0

6.0

7.0 +0.0

7.0

Private Real Estate

0.0 +0.0

0.0

0.0 +0.0

0.0

0.0 +0.0

0.0

0.0 +0.0

0.0

0.0 +0.0

0.0

“WMR tactical deviation” legend: Overweight Underweight Neutral “Change” legend: p Upgrade q Downgrade *Refers to moderate-risk profile. 1 The current allocation column is the sum of the strategic asset allocation and the tactical deviation column. Source: UBS CIO WMR and WMA AAC, 20 March 2014. See appendix for information regarding sources of strategic asset allocations and their suitability, investor risk profiles, and the interpretation of the suggested tactical deviations from the strategic asset allocations.

april 2014 UBS house view

Detailed asset allocation

Detailed asset allocation taxable without non-traditional assets

0.0

Current allocation1

0.0 +0.0

Change this month

0.0

WMR tactical deviation

Strategic asset allocation

0.0 +0.0

Aggressive

Current allocation1

0.0

Change this month

Benchmark allocation

WMR tactical deviation

Current allocation1

0.0 +0.0

Moderately aggressive

Change this month

0.0

WMR tactical deviation

Strategic asset allocation

Moderate

Current allocation1

0.0 +0.0

Change this month

0.0

WMR tactical deviation

Change this month

Strategic asset allocation

0.0 +0.0

Moderately conservative

Current allocation1

Cash

WMR tactical deviation

Change this month*

All figures in %

Conservative

Strategic asset allocation

Investor risk profile

Fixed Income

80.0 -1.5

78.5 66.0 -2.0

64.0 54.5 -2.5

52.0 44.0 -2.5

41.5 33.0 -2.5

30.5

US Fixed Income

72.0 +2.5

74.5 58.0 +3.0

61.0 47.0 +1.5

48.5 36.0 +0.5

36.5 26.0 -0.5

25.5

US Gov’t

8.0

-3.0

5.0

58.0

+1.0

US IG Corp

4.0

US HY Corp

2.0

US Municipal

Int’l Fixed Income

7.0

-4.0

3.0

5.0

-5.0

0.0

35.0 +2.0

37.0

3.0

-3.0

0.0

2.0

-2.0

0.0

59.0

45.0 +1.5

46.5

26.0 +0.5

26.5

16.0

-2.5

13.5

+0.5

4.5

3.0 +0.5

3.5

3.0

-0.5

2.5

2.0

-2.0

0.0

1.0

-1.0

0.0

+4.0

6.0

3.0 +5.0

8.0

4.0 +5.0

9.0

5.0 +5.0

10.0

7.0 +5.0

12.0

8.0 -4.0

4.0

8.0 -5.0

3.0

7.5 -4.0

3.5

8.0 -3.0

5.0

7.0 -2.0

5.0

Int’l Developed Markets

6.0

-4.0

2.0

5.0

-5.0

0.0

4.0

-4.0

0.0

3.0

-3.0

0.0

2.0

-2.0

0.0

Emerging Markets

2.0

+0.0

2.0

3.0 +0.0

3.0

3.5 +0.0

3.5

5.0 +0.0

5.0

5.0 +0.0

5.0

Equity US Equity

16.0 +2.5

18.5 30.0 +3.5

33.5 40.5 +4.5

45.0 51.0 +4.5

55.5 62.0 +4.5

66.5

9.0 +2.0

11.0 18.0 +2.5

20.5 23.0 +3.5

26.5 29.0 +3.5

32.5 36.0 +3.5

39.5

US Large cap Growth

3.0

+1.0

4.0

5.0 +1.0

6.0

7.0 +1.5

8.5

9.0 +1.5

US Large cap Value

3.0

-1.0

2.0

5.0

-1.5

3.5

7.0

-2.0

5.0

9.0

-2.0

7.0

US Mid cap

2.0

+1.0

3.0

5.0 +1.5

6.5

6.0 +2.0

8.0

7.0 +2.0

US Small cap

1.0

+1.0

2.0

3.0 +1.5

4.5

3.0 +2.0

5.0

4.0 +2.0

International Equity

7.0 +0.5

7.5 12.0 +1.0

13.0 17.5 +1.0

18.5 22.0 +1.0

10.5

11.0 +1.5 11.0

12.5

-2.0

9.0

9.0 +2.0

11.0

6.0

5.0 +2.0

7.0

23.0 26.0 +1.0

27.0

Int’l Developed Markets

4.0

+0.5

4.5

7.0 +1.0

8.0

10.0 +1.0

11.0

12.5 +1.0

13.5

15.0 +1.0

16.0

Emerging Markets

3.0

+0.0

3.0

5.0 +0.0

5.0

7.5 +0.0

7.5

9.5 +0.0

9.5

11.0 +0.0

11.0

4.0 -1.0

3.0

4.0 -1.5

2.5

5.0 -2.0

3.0

5.0 -2.0

3.0

5.0 -2.0

3.0

Commodities

ubs house view April 2014

detailed asset allocation

Detailed asset allocation

non-taxable with non-traditional assets

0.0

Current allocation1

0.0 +0.0

Change this month

0.0

WMR tactical deviation

Strategic asset allocation

Aggressive

Current allocation1

0.0 +0.0

Change this month

Strategic asset allocation

0.0

WMR tactical deviation

Current allocation1

0.0 +0.0

Moderately aggressive

Change this month

0.0

WMR tactical deviation

Strategic asset allocation

Moderate

Current allocation1

0.0 +0.0

Change this month

0.0

WMR tactical deviation

Change this month

Strategic asset allocation

0.0 +0.0

Moderately conservative

Current allocation1

Cash

WMR tactical deviation

Change this month*

All figures in %

Conservative

Strategic asset allocation

Investor risk profile

Fixed Income

68.0 -1.5

66.5 56.0 -2.0

54.0 46.5 -2.5

44.0 39.0 -2.5

36.5 33.0 -2.5

30.5

US Fixed Income

60.0 +2.5

62.5 49.0 +2.0

51.0 40.0 +1.0

41.0 32.5 +0.0

32.5 26.0 -0.5

25.5

US Gov’t

-4.0

43.0

US Municipal

0.0 +0.0

US IG Corp US HY Corp Int’l Fixed Income

47.0

36.0

-5.5

30.5

0.0

0.0 +0.0

9.0 +2.5

11.5

4.0 +4.0 8.0 -4.0

28.0

-7.5

20.5

0.0

0.0 +0.0

7.0 +2.5

9.5

8.0

6.0 +5.0

4.0

7.0 -4.0

19.5

-8.5

11.0

0.0

0.0 +0.0

5.0 +3.0

8.0

11.0

7.0 +5.5

3.0

6.5 -3.5

13.0

-9.0

4.0

0.0

0.0 +0.0

0.0

4.0 +3.0

7.0

2.0 +3.0

5.0

12.5

9.0 +5.5

14.5

11.0 +5.5

16.5

3.0

6.5 -2.5

4.0

7.0 -2.0

5.0

Int’l Developed Markets

6.0

-4.0

2.0

4.0

-4.0

0.0

3.5

-3.5

0.0

2.5

-2.5

0.0

2.0

-2.0

0.0

Emerging Markets

2.0 +0.0

2.0

3.0 +0.0

3.0

3.0 +0.0

3.0

4.0 +0.0

4.0

5.0 +0.0

5.0

Equity

17.0 +2.5

19.5 28.0 +3.5

31.5 34.5 +4.5

39.0 42.0 +4.5

46.5 53.0 +4.5

57.5

US Equity

10.0 +2.0

12.0 16.0 +2.5

18.5 20.5 +3.5

24.0 24.0 +3.5

27.5 31.0 +3.5

34.5

US Large cap Growth

3.0 +1.0

4.0

5.0 +1.0

6.0

6.0 +1.5

7.5

7.5 +1.5

9.0

9.5 +1.5

US Large cap Value

3.0

-1.0

2.0

5.0

-1.5

3.5

6.0

-2.0

4.0

7.5

-2.0

5.5

9.5

-2.0

7.5

US Mid cap

2.5 +1.0

3.5

4.0 +1.5

5.5

5.5 +2.0

7.5

6.0 +2.0

8.0

8.0 +2.0

10.0

US Small cap

1.5 +1.0

2.5

2.0 +1.5

3.5

3.0 +2.0

5.0

3.0 +2.0

5.0

4.0 +2.0

6.0

19.0 22.0 +1.0

23.0

International Equity

7.0 +0.5

Int’l Developed Markets

4.0 +0.5

4.5

7.0 +1.0

8.0

8.0 +1.0

9.0

10.0 +1.0

11.0

13.0 +1.0

14.0

Emerging Markets

3.0 +0.0

3.0

5.0 +0.0

5.0

6.0 +0.0

6.0

8.0 +0.0

8.0

9.0 +0.0

9.0

Commodities

4.0 -1.0

3.0

4.0 -1.5

2.5

4.0 -2.0

2.0

5.0 -2.0

3.0

5.0 -2.0

3.0

15.0 14.0 +0.0

14.0

9.0 +0.0

9.0

Non-traditional

11.0 +0.0

7.5 12.0 +1.0

11.0 12.0 +0.0

13.0 14.0 +1.0

12.0 15.0 +0.0

15.0 18.0 +1.0

11.0

Hedge Funds

11.0 +0.0

11.0

12.0 +0.0

12.0

10.0 +0.0

10.0

8.0 +0.0

8.0

3.0 +0.0

3.0

Private Equity

0.0 +0.0

0.0

0.0 +0.0

0.0

5.0 +0.0

5.0

6.0 +0.0

6.0

6.0 +0.0

6.0

Private Real Estate

0.0 +0.0

0.0

0.0 +0.0

0.0

0.0 +0.0

0.0

0.0 +0.0

0.0

0.0 +0.0

0.0

april 2014 UBS house view

Detailed asset allocation

non-taxable without non-traditional assets

0.0 +0.0

0.0

Current allocation1

Change this month

0.0

WMR tactical deviation

Strategic asset allocation

0.0 +0.0

Aggressive

Current allocation1

0.0

Change this month

Benchmark allocation

WMR tactical deviation

Current allocation1

0.0 +0.0

Moderately aggressive

Change this month

0.0

WMR tactical deviation

Strategic asset allocation

Moderate

Current allocation1

0.0 +0.0

Change this month

0.0

WMR tactical deviation

Change this month

Strategic asset allocation

0.0 +0.0

Moderately conservative

Current allocation1

Cash

WMR tactical deviation

Change this month*

All figures in %

Conservative

Strategic asset allocation

Investor risk profile

Fixed Income

78.0 -1.5

76.5 65.0 -2.0

63.0 55.0 -2.5

52.5 46.0 -2.5

43.5 36.0 -2.5

33.5

US Fixed Income

69.0 +2.5

71.5 57.0 +3.0

60.0 47.0 +1.5

48.5 38.0 +0.5

38.5 29.0 -0.5

28.5

US Gov’t

55.0

-4.0

51.0

0.0

+0.0

US IG Corp

10.0

US HY Corp

4.0

US Municipal

Int’l Fixed Income

42.0

-5.5

36.5

0.0

0.0 +0.0

+2.5

12.5

+4.0

9.0 -4.0

32.0

-7.0

25.0

0.0

0.0 +0.0

8.0 +3.5

11.5

8.0

7.0 +5.0

5.0

8.0 -5.0

23.0

-8.0

15.0

0.0

0.0 +0.0

6.0 +3.0

9.0

12.0

9.0 +5.5

3.0

8.0 -4.0

13.0

-9.0

4.0

0.0

0.0 +0.0

0.0

4.0 +3.0

7.0

3.0 +3.0

6.0

14.5

11.0 +5.5

16.5

13.0 +5.5

18.5

4.0

8.0 -3.0

5.0

7.0 -2.0

5.0

Int’l Developed Markets

7.0

-4.0

3.0

5.0

-5.0

0.0

4.0

-4.0

0.0

3.0

-3.0

0.0

2.0

-2.0

0.0

Emerging Markets

2.0

+0.0

2.0

3.0 +0.0

3.0

4.0 +0.0

4.0

5.0 +0.0

5.0

5.0 +0.0

5.0

Equity

18.0 +2.5

20.5 31.0 +3.5

34.5 41.0 +4.5

45.5 50.0 +4.5

54.5 59.0 +4.5

63.5

US Equity

10.0 +2.0

12.0 18.0 +2.5

20.5 23.0 +3.5

26.5 28.0 +3.5

31.5 33.0 +3.5

36.5

US Large cap Growth

3.0

+1.0

4.0

5.5 +1.0

6.5

7.0 +1.5

8.5

8.5 +1.5

US Large cap Value

3.0

-1.0

2.0

5.5

-1.5

4.0

7.0

-2.0

5.0

8.5

-2.0

6.5

US Mid cap

3.0

+1.0

4.0

5.0 +1.5

6.5

6.0 +2.0

8.0

7.0 +2.0

US Small cap

1.0

+1.0

2.0

2.0 +1.5

3.5

3.0 +2.0

5.0

4.0 +2.0

International Equity

8.0 +0.5

8.5 13.0 +1.0

14.0 18.0 +1.0

19.0 22.0 +1.0

10.0

10.0 +1.5 10.0

11.5

-2.0

8.0

9.0

9.0 +2.0

11.0

6.0

4.0 +2.0

6.0

23.0 26.0 +1.0

27.0

Int’l Developed Markets

4.0

+0.5

4.5

8.0 +1.0

9.0

10.0 +1.0

11.0

12.0 +1.0

13.0

14.0 +1.0

15.0

Emerging Markets

4.0

+0.0

4.0

5.0 +0.0

5.0

8.0 +0.0

8.0

10.0 +0.0

10.0

12.0 +0.0

12.0

4.0 -1.0

3.0

4.0 -1.5

2.5

4.0 -2.0

2.0

4.0 -2.0

2.0

5.0 -2.0

3.0

Commodities

ubs house view april 2014

detailed asset allocation

Portfolio Analytics The portfolio analytics shown for each risk profileâ&#x20AC;&#x2122;s benchmark allocations are based on estimated forward-looking return and standard deviation assumptions (capital market assumptions), which are based on UBS proprietary research. The development process includes a review of a variety of factors, including the return, risk, correlations and historical performance of various asset classes, inflation and risk premium. These capital market assumptions do not assume any particular investment time horizon. The process assumes a situation where the supply and demand for investments is in balance, and in which expected returns of all asset classes are a reflection of their expected risk and correlations regardless of time frame. Please note that these assumptions are not guarantees and are subject to change. UBS has changed its risk and return assumptions in the past and may do so in the future. Neither UBS nor your Financial Advisor is required to provide you with an updated analysis based upon changes to these or other underlying assumptions.

Risk Profile ==>>

In order to create the analysis shown, the rates of return for each asset class are combined in the same proportion as the asset allocations illustrated (e.g., if the asset allocation indicates 40% equities, then 40% of the results shown for the allocation will be based upon the estimated hypothetical return and standard deviation assumptions shown below). You should understand that the analysis shown and assumptions used are hypothetical estimates provided for your general information. The results are not guarantees and pertain to the asset allocation and/or asset class in general, not the performance of specific securities or investments. Your actual results may vary significantly from the results shown in this report, as can the performance of any individual security or investment.

Moderately Moderately Conservative conservative Moderate aggressive Aggressive

Taxable with non-traditional assets Estimated Return

4.4%

5.1%

5.9%

6.4%

7.0%

Estimated Risk

5.6%

7.4%

9.6%

11.5%

13.5%

Taxable without non-traditional assets Estimated Return

4.0%

4.8%

5.5%

6.1%

6.8%

Estimated Risk

5.4%

7.5%

9.5%

11.5%

13.5%

Non-taxable with non-traditional assets Estimated Return

4.3%

5.0%

5.8%

6.4%

7.0%

Estimated Risk

5.5%

7.4%

9.5%

11.4%

13.4%

Non-taxable without non-traditional assets

Asset Class

Annual risk

US Cash

2.5%

0.5%

US Government Fixed Income

2.2%

4.3%

US Municipal Fixed Income

2.9%

4.7%

US Corporate Investment Grade Fixed Income

3.5%

5.9%

US Corporate High Yield Fixed Income

5.6%

11.7%

International Developed Markets Fixed Income

4.0%

9.0%

Emerging Markets Fixed Income

4.9%

9.1%

US Large Cap Equity

7.5%

16.8%

US Mid Cap Equity

8.4%

19.6%

US Small Cap Equity

8.6%

21.8%

International Developed Markets Equity

8.5%

19.7%

10.0%

25.5%

Commodities

6.4%

18.9%

Hedge Funds

6.2%

6.7%

Private Equity

11.8%

24.4%

8.5%

11.8%

Emerging Markets Equity

Estimated Return

4.0%

4.8%

5.5%

6.1%

6.8%

Estimated Risk

5.4%

7.5%

9.5%

11.4%

13.5%

Capital Market Assumptions Annual total return

Private Real Estate

april 2014 UBS house view

detailed asset allocation

Additional Asset Allocation Models US Taxable Fixed Income Allocation, in % Benchmark allocation1

CIO WMR Tactical deviation2 Previous Current

Current allocation3

Treasuries

25.0

-7.0

18.0

Treasury Inflation Protected Securities (TIPS)

19.0

-7.0

12.0

Agencies

11.0

-6.0

5.0

Agency Mortgage-Backed Securities

13.0

0.0

13.0

Investment Grade Corporates

13.0

3.0

16.0

High-Yield Corporates

14.0

9.0

23.0

5.0

8.0

13.0

Preferred Securities

Source: UBS CIO WMR, as of 21 March 2014 Note: The shift in weights represents a combination of two factors: 1) An increased preference for High Yield corporates versus last month, 2) an increase in tracking error (see UBS House View Update: Methodological change to tactical asset allocation models, 13 January 2014)

International Developed Markets (Non-US) Equity Module, in %

EMU / Eurozone

Benchmark allocation1 28.0

CIO WMR Tactical deviation2 Previous Current +10.0 +10.0

20.0

-10.0

Japan

Current allocation3 38.0

-10.0

10.0 19.0

19.0

+0.0

Australia

7.0

+0.0

7.0

Canada

9.0

+0.0

9.0

Switzerland

8.0

+0.0

8.0

Other

9.0

+0.0

9.0

WMR Tactical deviation2 Previous Current -10.0 -10.0

Current allocation3

Source: UBS CIO WMR, as of 21 March 2014

International Developed Markets (Non-US) Fixed Income Module, in %

EMU / Eurozone UK

Benchmark allocation1 42.0

32.0

9.0

+25.0

34.0

Japan

32.0

-10.0

22.0

Other

17.0

-5.0

12.0

Source: UBS CIO WMR, as of 21 March 2014 The benchmark allocation refers to a moderate risk profile. For the second and third tables on this page, it represents the relative market capitalization weights of each country or region. See “Deviations from strategic asset allocation or benchmark allocation” in the appendix for an explanation regarding the interpretation of the suggested tactical deviations from benchmark. The “current” column refers to the tactical deviation that applies as of the date of this publication. The “previous” column refers to the tactical deviation that was in place at the date of the previous edition of the Investment Strategy Guide or the last Investment Strategy Guide Update. 3 The current allocation column is the sum of the benchmark allocation and the tactical deviation columns. 1 2

ubs house view april 2014

detailed asset allocation

Additional Asset Allocation Models US Equity Industry Group Allocation, in %

Consumer Discretionary

S&P 500 Benchmark allocation1 12.3

CIO WMR Tactical deviation2 Numeric Symbol Previous Current Previous Current +0.0 +0.0 n n

Current allocation3 12.3

Auto & Components

1.2

+0.0

1.2

Consumer Services

1.8

+0.0

1.8

Media

3.6

+0.0

3.6

Retailing

4.4

+0.0

4.4

Consumer, Durables & Apparel

1.3

+0.0

1.3

Consumer Staples

9.5

-2.0

––

7.5

Food, Beverage & Tobacco

5.1

-0.5

–

4.6

Food & Staples Retailing

2.3

-1.0

–

1.3

Household & Personal Products

2.1

-0.5

–

1.6

Energy

10.0

-1.0

–

9.0

Financials

16.2

+2.0

18.2

Banks

6.2

+0.5

6.7

Diversified Financials

5.0

+1.0

6.0

Insurance

2.9

+0.5

3.4

Real Estate

2.1

+0.0

2.1

13.7

+0.0

13.7

HC Equipment & Services

4.3

+0.0

4.3

Pharmaceuticals & Biotechnology

9.3

+0.0

10.7

+2.0

12.7

Capital Goods

8.0

+1.0

9.0

Commercial Services & Supplies

0.7

+0.0

0.7

Transportation

2.0

+1.0

Information Technology

18.7

+2.0

+2.5

+++

21.2

Software & Services

Healthcare

Industrials

9.3

3.0

10.5

+1.0

11.5

Technology Hardware & Equipment

6.1

+1.0

7.1

Semiconductors

2.1

+0.0

+0.5

2.6

Materials

3.5

+0.0

3.5

Telecom

2.4

-1.0

–

1.4

Utilities

3.0

-2.0

-2.5

––

–––

0.5

Source: S&P, UBS CIO WMR, as of 21 March 2014 The benchmark allocation, as well as the tactical deviations, are intended to be applicable to the US equity portion of a portfolio across investor risk profiles. 1 The benchmark allocation is based on S&P 500 weights. 2 See “Deviations from Benchmark Allocations” in the appendix for an explanation regarding the interpretation of the suggested tactical deviations from benchmark. The “current” column refers to the tactical deviation that applies as of the date of this publication. The “previous” column refers to the tactical deviation that was in place at the date of the previous edition of the Investment Strategy Guide or the last Investment Strategy Guide Update. 3 The current allocation column is the sum of the S&P 500 benchmark allocation and the CIO WMR tactical deviation columns.

april 2014 UBS house view

performance measurement

Tactical Asset Allocation Performance Measurement The performance calculations shown in Table A commence on 25 January 2013, the first date upon which the Investment Strategy Guide was published following the release of the new UBS WMA strategic asset allocation (SAA) models. The performance is based on the SAA without non-traditional assets for a moderate risk profile investor, and the SAA with the tactical shift (see detailed asset allocation tables where the SAA with the tactical shift is referred to as “current allocation”). Performance is calculated utilizing the returns of the indices identified in Table B as applied to the respective allocations in the SAA and the SAA with the tactical shift. For example, if US Mid Cap Equity is allocated 10% in the SAA and 12% in the SAA with the tactical shift, the US Mid Cap Equity index respectively contributed to 10% and 12% of the results shown. Prior to 25 January 2013, CIO WMR published tactical asset allocation recommendations in the Investment Strategy Guide using a different set of asset classes and sectors. The performance of these tactical recommendations is reflected in Table C. The performance attributable to the CIO WMR tactical deviations is reflected in the column in Tables A and C labeled “Excess return,” which shows the difference between the performance of the SAA and the performance of the SAA with the tactical shift. The “Information ratio” is a riskadjusted performance measure, which adjusts the excess returns for the tracking error risk of the tactical deviations.

Specifically the information ratio is calculated as the ratio of the annualized excess return over a given time period and the annualized standard deviation of daily excess returns over the same period. Additional background information regarding the computation of the information ratio figures provided below are available upon request. The calculations assume that the portfolios are rebalanced whenever changes are made to tactical deviations, typically upon publication of the Investment Strategy Guide on a monthly basis. Occasionally, changes in the tactical deviations are made intra-month when warranted by market conditions and communicated through an Investment Strategy Guide Update. The computations assume portfolio rebalancing upon such intra-month changes as well. Performance shown is based on total returns, but does not include transaction costs, such as commissions, fees, margin interest, and interest charges. Actual total returns adjusted for such transaction costs will be reduced. A complete record of all the recommendations upon which this performance report is based is available from UBS Financial Services Inc. upon written request. Past performance is not an indication of future results.

Table A: Moderate Risk Profile Performance Measurement (25 January 2013 to present) SAA

SAA with tactical shift

Excess return

Information ratio (annualized)

Russell 3000 stock index (total return)

Barclays Capital US Aggregate bond index (total return)

25 January 2013 to 31 March 2013

0.79%

0.83%

0.04%

+0.9

5.59%

0.11%

01 April 2013 to 28 June 2013

-2.18%

-2.14%

0.04%

+0.3

2.69%

-2.33%

28 June 2013 to 30 September 2013

3.60%

3.86%

0.26%

+2.4

6.35%

0.57%

30 September 2013 to 31 December 2013

3.05%

3.23%

0.18%

+2.9

10.10%

-0.14%

01 January 2014 to 19 March 2014

1.81%

1.79%

-0.02%

-0.1

1.64%

1.46%

Since inception (25 January 2013)

7.05%

7.57%

0.51%

+0.9

28.29%

0.02%

Source: CIO WMR, as of 19 March 2014

ubs house view april 2014

performance measurement

Tactical Asset Allocation Performance Measurement Table B: SAA for moderate risk profile investor, and underlying indices (all figures in %) 25 Jan 2013 to present US Large Cap Growth (Russell 1000 Growth)

7.0

US Large Cap Value (Russell 1000 Value)

7.0

US Mid Cap (Russell Mid Cap)

6.0

US Small Cap (Russell 2000)

3.0

International Dev. Eq (MSCI EAFE)

10.0

Emerging Markets Eq. (MSCI EMF)

7.5

US Government Fixed Income (BarCap US Agg Government) US Municipal Fixed Income (BarCap Municipal Bond) US Investment Grade Fixed Income (BarCap US Agg Credit)

5.0 35.0 3.0

US Corporate High Yield Fixed Income (BarCap US Agg Corp HY)

4.0

International Dev. Fixed Income (BarCap Global Agg xUS)

4.0

Emerging Markets Fixed Income (50% BarCap EM Gov and 50% BarCap Global EM (USD))

3.5

Commodities (Dow Jones-UBS Commodity Index)

5.0

Source: CIO WMR

The performance calculations shown in Table C, which start on 25 August 2008 and end on 24 January 2013, have been provided for historical information purposes only. They are based on prior SAAs (referred to as benchmark allocations) with non-traditional assets for a moderate risk profile investor, and on prior SAAs with tactical shifts as published in the Investment Strategy Guide during the same time period. Performance is calculated utilizing the returns of the indices identified in Table D as applied to the respective allocations in the SAA and the SAA with the tactical shift. See the discussion in connection with Table A, previous page, regarding the meanings of the “Excess return” and “Information ratio” columns and how the “Information ratio” column is calculated.

From 25 August 2008 through 27 May 2009, the Investment Strategy Guide had at times published a more detailed set of tactical deviations, whereby the categories “Non-US Developed Equities” and “Non-US Fixed Income” were further subdivided into regional blocks. Only the cumulative recommendations at the level of “Non-US Developed Equities” and “Non-US Fixed Income” were taken into account in calculating the performance shown in Table C opposite. Prior to 25 August 2008, WMR published tactical asset allocation recommendations in the “US Asset Allocation Strategist” using a less comprehensive set of asset classes and sectors, which makes a comparison with the subsequent models difficult.

april 2014 UBS house view

performance measurement

Tactical Asset Allocation Performance Measurement Table C: Moderate Risk Profile Performance Measurement (25 August 2008 to 24 January 2013) Benchmark Allocations (SAA)

Benchmark Allocation (SAA) with tactical shift

25 Aug 08 to 31 Dec 08

Excess Information ratio return (annualized)

Russell 3000 stock index (total return)

Barclays Capital US Aggregate bond index (total return)

-16.59%

-15.64%

0.96%

+2.0

-29.00%

3.33%

2009 Q1

-5.52%

-5.45%

0.07%

+0.3

-10.80%

0.12%

2009 Q2

11.18%

11.37%

0.18%

+1.0

16.82%

1.78%

2009 Q3

10.44%

11.07%

0.63%

+2.1

16.31%

3.74%

2009 Q4

2.99%

3.30%

0.31%

+1.1

5.90%

0.20%

2010 Q1

2.74%

2.56%

-0.18%

-0.9

5.94%

1.78%

2010 Q2

-4.56%

-4.87%

-0.31%

-1.4

-11.32%

3.49%

2010 Q3

8.34%

7.99%

-0.35%

-2.1

11.53%

2.48%

2010 Q4

5.18%

5.17%

-0.01%

-0.1

11.59%

-1.30%

2011 Q1

3.23%

3.15%

-0.08%

-0.4

6.38%

0.42%

2011 Q2

0.62%

0.47%

-0.16%

-0.9

-0.03%

2.29%

2011 Q3

-7.65%

-8.56%

-0.90%

-2.5

-15.28%

3.82%

2011 Q4

4.66%

4.39%

-0.27%

-0.8

12.12%

1.12%

2012 Q1

5.89%

5.41%

-0.48%

-2.3

12.87%

0.30%

2012 Q2

-1.59%

-1.57%

0.02%

+0.2

-3.15%

2.06%

2012 Q3

4.18%

4.08%

-0.10%

-1.1

6.23%

1.59%

2012 Q4

0.69%

0.65%

-0.04%

-0.7

0.25%

0.21%

01 Jan 13 to 24 Jan 13

2.17%

2.20%

0.03%

+2.5

5.19%

-0.23%

25 Aug 08 to 24 Jan 13

24.86%

24.10%

-0.76%

-0.1

31.81%

30.76%

Source: CIO WMR

Table D: SAAs for moderate risk profile investor, and underlying indices (all figures in %) 25 Aug 2008 to 23 Feb 2009

24 Feb 2009 to 24 Jan 2013

US Large Cap Value (Russell 1000 Value)

12.5

US Large Cap Value (Russell 1000 Value)

11.0

US Large Cap Growth (Russell 1000 Growth)

12.5

US Large Cap Growth (Russell 1000 Growth)

11.0

US Small Cap Value (Russell 2000 Value)

2.0

US Mid Cap (Russell Midcap)

5.0

US Small Cap Growth (Russell 2000 Growth)

2.0

US Small Cap (Russell 2000)

3.0

US REITs (FTSE NAREIT All REITs)

1.5

US REITs (FTSE NAREIT All REITs)

Non-US Dev. Eq (MSCI Gross World ex-US) Emerging Markets Eq. (MSCI Gross EM USD) US Fixed Income (BarCap US Aggregate)

10.5

Developed Markets (MSCI Gross World ex-US)

2.0 10.0

2.0

Emerging Markets (MSCI Gross EM USD)

2.0

30.0

US Fixed Income (BarCap US Aggregate)

29.0

Non-US Fixed Income (BarCap Global Aggregate ex-USD)

8.0

Non-US Fixed Income (BarCap Global Aggregate ex-USD)

Cash (JP Morgan Cash Index USD 1 month)

2.0

Cash (JP Morgan Cash Index USD 1 month)

2.0

Commodities (DJ UBS total return index)

5.0

Commodities (DJ UBS total return index)

5.0

Alternative Investments (HFRX Equal Weighted Strategies) Source: CIO WMR

ubs house view april 2014

12.0

Alternative Investments (HFRX Equal Weighted Strategies)

8.0

12.0

appendix

Investment Committee Global Investment Process and Committee Description The UBS investment process is designed to achieve replicable, high quality results through applying intellectual rigor, strong process governance, clear responsibility and a culture of challenge. Based on the analyses and assessments conducted and vetted throughout the investment process, the Chief Investment Officer (CIO) formulates the UBS Wealth Management Investment House View (e.g., overweight, neutral, underweight stance for asset classes and market segments relative to their benchmark allocation) at the Global Investment Committee (GIC). Senior investment professionals from across UBS, complemented by selected external experts, debate and rigorously challenge the investment strategy to ensure consistency and risk control. Global Investment Committee Composition The GIC is comprised of 13 members, representing top market and investment expertise from across all divisions of UBS: Alex Friedman (Chair) Mark Andersen • Mark Haefele • Andreas Höfert • Jorge Mariscal • Mads Pedersen • Mike Ryan • Simon Smiles • Larry Hatheway (*) • Bruno Marxer (*) • Curt Custard (*) • Andreas Koester (*) • Andrew Williamson (*) (*) Business areas distinct from Chief Investment Office/ Wealth Management Research • •

WMA Asset Allocation Committee Description We recognize that a globally derived house view is most effective when complemented by local perspective and application. As such, UBS has formed a Wealth Management Americas Asset Allocation Committee (WMA AAC). WMA AAC is responsible for the development and monitoring of UBS WMA’s strategic asset allocation models and capital market assumptions. The WMA AAC sets parameters for the CIO WMR Americas Investment Strategy Group to follow during the translation process of the GIC’s House Views and the incorporation of US-specific asset class views into the USspecific tactical asset allocation models. WMA Asset Allocation Committee Composition The WMA Asset Allocation Committee is comprised of six members: Mike Ryan Michael Crook • Stephen Freedman • Richard Hollmann (*) • Brian Nick • Jeremy Zirin (*) Business areas distinct from Chief Investment Office/ Wealth Management Research • •

april 2014 UBS house view

appendix

Explanations about Asset Classes Sources of strategic asset allocations and investor risk profiles Strategic asset allocations represent the longer-term allocation of assets that is deemed suitable for a particular investor. The strategic asset allocation models discussed in this publication, and the capital market assumptions used for the strategic asset allocations, were developed and approved by the WMA AAC. The strategic asset allocations are provided for illustrative purposes only and were designed by the WMA AAC for hypothetical US investors with a total return objective under five different Investor Risk Profiles ranging from conservative to aggressive. In general, strategic asset allocations will differ among investors according to their individual circumstances, risk tolerance, return objectives and time horizon. Therefore, the strategic asset allocations in this publication may not be suitable for all investors or investment goals and should not be used as the sole basis of any investment decision. Minimum net worth requirements may apply to allocations to non-traditional assets. As always, please consult your UBS Financial Advisor to see how these weightings should be applied or modified according to your individual profile and investment goals. The process by which the strategic asset allocations were derived is described in detail in the publication entitled “UBS WMA’s Capital Markets Model: Explained, Part II: Methodology,” published on 22 January 2013. Your Financial Advisor can provide you with a copy.

Deviations from strategic asset allocation or benchmark allocation The recommended tactical deviations from the strategic asset allocation or benchmark allocation are provided by the Global Investment Committee and the Investment Strategy Group within Wealth Management Research Americas. They reflect the short- to medium-term assessment of market opportunities and risks in the respective asset classes and market segments. Positive / zero / negative tactical deviations correspond to an overweight / neutral / underweight stance for each respective asset class and market segment relative to their strategic allocation. The current allocation is the sum of the strategic asset allocation and the tactical deviation. Note that the regional allocations on the International Equities page are provided on an unhedged basis (i.e., it is assumed that investors carry the underlying currency risk of such investments). Thus, the deviations from the strategic asset allocation reflect the views of the underlying equity and bond markets in combination with the assessment of the associated currencies. The detailed asset allocation tables integrate the country preferences within each asset class with the asset class preferences stated earlier in the report.

Scale for tactical deviation charts Symbol

Description/Definition

Symbol

Description/Definition

Symbol

Description/Definition

moderate overweight vs. benchmark

–

moderate underweight vs. benchmark

neutral, i.e., on benchmark

overweight vs. benchmark

––

underweight vs. benchmark

n/a

not applicable

+++

strong overweight vs. benchmark

–––

strong underweight vs. benchmark

Source: CIO WM Research

ubs house view april 2014

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Appendix Emerging Market Investments Investors should be aware that Emerging Market assets are subject to, among others, potential risks linked to currency volatility, abrupt changes in the cost of capital and the economic growth outlook, as well as regulatory and sociopolitical risk, interest rate risk and higher credit risk. Assets can sometimes be very illiquid and liquidity conditions can abruptly worsen. WMR generally recommends only those securities it believes have been registered under Federal US registration rules (Section 12 of the Securities Exchange Act of 1934) and individual State registration rules (commonly known as “Blue Sky” laws). Prospective investors should be aware that to the extent permitted under US law, WMR may from time to time recommend bonds that are not registered under US or State securities laws. These bonds may be issued in jurisdictions where the level of required disclosures to be made by issuers is not as frequent or complete as that required by US laws. For more background on emerging markets generally, see the WMR Education Notes “Investing in Emerging Markets (Part 1): Equities,” 27 August 2007, “Emerging Market Bonds: Understanding Emerging Market Bonds,” 12 August 2009 and “Emerging Markets Bonds: Understanding Sovereign Risk,” 17 December 2009. Investors interested in holding bonds for a longer period are advised to select the bonds of those sovereigns with the highest credit ratings (in the investment grade band). Such an approach should decrease the risk that an investor could end up holding bonds on which the sovereign has defaulted. Subinvestment grade bonds are recommended only for clients with a higher risk tolerance and who seek to hold higher-yielding bonds for shorter periods only. Nontraditional Assets Nontraditional asset classes are alternative investments that include hedge funds, private equity, real estate, and managed futures (collectively, alternative investments). Interests of alternative investment funds are sold only to qualified investors, and only by means of offering documents that include information about the risks, performance and expenses of alternative investment funds, and which clients are urged to read carefully before subscribing and retain. An investment in an alternative investment fund is speculative and involves significant risks. Specifically, these investments (1) are not mutual funds and are not subject to the same regulatory requirements as mutual funds; (2) may have performance that is volatile, and investors may lose all or a substantial amount of their investment; (3) may engage in leverage and other speculative investment practices that may increase the risk of investment loss; (4) are long-term, illiquid investments; there is generally no secondary market for the interests of a fund, and none is expected to develop; (5) interests of alternative investment funds typically will be illiquid and subject to restrictions on transfer; (6) may not be required to provide periodic pricing or valuation information to investors; (7) generally involve complex tax strategies and there may be delays in distributing tax information to investors; (8) are subject to high fees, including management fees and other fees and expenses, all of which will reduce profits.

financial ability and willingness to accept them for an extended period of time before making an investment in an alternative investment fund and should consider an alternative investment fund as a supplement to an overall investment program. In addition to the risks that apply to alternative investments generally, the following are additional risks related to an investment in these strategies: • Hedge Fund Risk: There are risks specifically associated with investing in hedge funds, which may include risks associated with investing in short sales, options, small-cap stocks, “junk bonds,” derivatives, distressed securities, non-US securities and illiquid investments. • Managed Futures: There are risks specifically associated with investing in managed futures programs. For example, not all managers focus on all strategies at all times, and managed futures strategies may have material directional elements. • Real Estate: There are risks specifically associated with investing in real estate products and real estate investment trusts. They involve risks associated with debt, adverse changes in general economic or local market conditions, changes in governmental, tax, real estate and zoning laws or regulations, risks associated with capital calls and, for some real estate products, the risks associated with the ability to qualify for favorable treatment under the federal tax laws. • Private Equity: There are risks specifically associated with investing in private equity. Capital calls can be made on short notice, and the failure to meet capital calls can result in significant adverse consequences including, but not limited to, a total loss of investment. • Foreign Exchange/Currency Risk: Investors in securities of issuers located outside of the United States should be aware that even for securities denominated in US dollars, changes in the exchange rate between the US dollar and the issuer’s “home” currency can have unexpected effects on the market value and liquidity of those securities. Those securities may also be affected by other risks (such as political, economic or regulatory changes) that may not be readily known to a US investor.

Interests in alternative investment funds are not deposits or obligations of, or guaranteed or endorsed by, any bank or other insured depository institution, and are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other governmental agency. Prospective investors should understand these risks and have the

april 2014 UBS house view

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Disclaimer Chief Investment Office (CIO) Wealth Management Research is published by Wealth Management & Swiss Bank 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. The analysis contained herein does not constitute a personal recommendation or take into account the particular investment objectives, investment strategies, financial situation and needs of any specific recipient. It is based on numerous assumptions. Different assumptions could result in materially different results. We recommend that you obtain financial and/or tax advice as to the implications (including tax) of investing in the manner described or in any of the products mentioned herein. 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 and its affiliates). All information and opinions as well as any prices indicated are current only as of the date of this report, and are subject to change without notice. Opinions expressed herein may differ or be contrary to those expressed by other business areas or divisions of UBS as a result of using different assumptions and/or criteria. At any time, investment decisions (including whether to buy, sell or hold securities) made by UBS AG, its affiliates, subsidiaries and employees may differ from or be contrary to the opinions expressed in UBS research publications. Some investments may not be readily realizable since the market in the securities is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult to quantify. 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. 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 FX rates may have an adverse effect on the price, value or income of an investment. This report is for distribution only under such circumstances as may be permitted by applicable law.

ubs house view april 2014

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Publication details Publisher UBS Financial Services Inc. Wealth Management Research 1285 Avenue of the Americas, 13th Floor New York, NY 10019 This report has been prepared by UBS Financial Services Inc. (“UBS FS”) and UBS AG. Please see important disclaimers and disclosures at the end of the document. This report was published on 21 March 2014. Lead authors Alexander S. Friedman Mike Ryan Authors (in alphabetical order) Matt Baredes Thomas Berner Rebecca Clarke Nicole Decker Robert Faulkner Andrea Fisher Thomas Flury Stephen Freedman Ricardo Garcia Patrick Ho Maryam Khan Markus Irngartinger Katie Klingensmith David Lefkowitz Barry McAlinden Thomas McLoughlin Kathleen McNamara Brian Nick Achim Peijan James Rhodes Brian Rose Carsten Schlufter Dominic Schnider Philipp Schoettler Giovanni Staunovo Alexander Stiehler Gary Tsang Thomas Veraguth Thomas Wacker Jonathan Woloshin Henry Wong Glenda Yu Jeremy Zirin Editor CLS Communication, Inc. Project Management Paul Leeming Alessandra Gonzalez Desktop Publishing George Stilabower Cognizant Group – Basavaraj Gudihal, Srinivas Addugula, Pavan Mekala and Virender Negi Sections of this report were originally published outside the US and have been customized for US distribution.

april 2014 UBS house view

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