EFTA01089574

UBS CIO WM Global Investment Office CIO monthly video For smartphone users: scan the code with an app like "scan" UBS CIO Monthly Extended March 2013 Published This report has been prepared by UBS AG. Please see important disclaimers and disclosures at the end of the document. Past performance is no indication of future performance. 21 February 2013 The market prices provided are closing prices on the respective principal stock exchange. This applies to all performance charts and tables in this publication. EFTA01089574 Table of Contents Section 1 Base slides 3 Section 2 Asset class views 13 2.A Equities 14 2.B Fixed income 24 2.0 Foreign exchange 31 2.D NTAC: Commodities, Listed real estate, Hedge funds and Private equity 35 EFTA01089575 Section 1 Base slides EtUBS EFTA01089576 Summary "The recent rise • Economy We see global growth on a stronger footing than last year. In the US, rising house prices and in yields ongoing job growth support private consumption. We expect politicians to strike another last- minute fiscal deal and US GDP to grow by around 2% in 2013. The Eurozone economy is expected highlights the to lag, and recent data shows large regional divergence. While German business sentiment has improved, the outlook for the French economy remains weak as fiscal tightening still has to catch risks in owning up to other European countries. Meanwhile, the Chinese economy remains on an uptrend, government supported by strong credit growth and rising exports. • Equities bonds. We prefer Equities remain supported by improving global growth momentum and we maintain our moderate overweight recommendation. US companies continue to show the strongest earnings momentum, corporate bonds and we expect US earnings to grow by a solid 6% in 2013. Conversely, Canadian equities face relatively weak earnings dynamics, which will likely be made worse by the strong CAD, and are and equities." relatively expensive. As a result, this month we have increased our overweight to US equities, and introduced a new underweight position in Canadian equities. We also remain constructive on emerging market (EM) equities. Accelerating economic growth in key countries, stabilizing profit margins and decent valuations speak in favor of the region. • Fixed Income Government bonds reacted strongly to the improving growth picture and 10-year yields on US Treasuries and German Bunds have risen considerably since the beginning of the year. While we expect rates to remain broadly stable over the next 6 months, real returns on government bonds will likely be negative and hence we maintain our large underweight position. Better alternatives can be found in investment grade (IG), high yield (HY) and emerging market (EM) corporate bonds. IG corporate bonds are expected to achieve a better total return despite limited spread tightening potential. HY corporate bonds still offer good investment opportunities due to low expected default rates and attractive risk premiums over other fixed income segments. And EM corporate bonds offer yield income and some potential for tighter spread, with relatively low volatility. • Commodities While in particular cyclical commodities profit from accelerating global growth, we see better risk return prospects in other asset classes and maintain a neutral stance. Platinum: Attractively valued remains a CIO Preferred theme. • Foreign Exchange The British pound is our most preferred currency. After weakening year to date, we expect that the currency will be supported as economic data begins to improve. The euro, on the other hand, looks relatively expensive, especially given political risks around the Italian elections. We remain underweight the single currency. UBS 3 Please see important disclaimer and disclosures at the end of the document. EFTA01089577 Cross-asset preferences Most preferred Least preferred Portfolio weights Commodities U•quidity • • US • Canada (SO Real Estate 5% 9% High Grade 5% • Emerging markets • European telecoms Hedge Funds/ Bonds 5% hy Grade p Private Equity • US mid caps 10% Corporates Bonds OPP. • Western winners from EM 9% growth High Yield Equities Bonds • Swiss high quality dividend Equities U 3% II% EM Soy. Bonds yields 3% EM Corp. • Relative value and equity Bonds 3% long/short hedge funds Equities Other Equities 8% Europe 23% Equities EM • US high yield • Too expensive government 6% bonds (SO Note: Portfolio weights are for an advisory • Global investment grade credit client with a "EUR moderate profile. For • EM corporate bonds portfolio weights related to other risk profiles • Corporate hybrids or currencies please contact your client Fixed income advisor. • Developed Asia banks • Relative value hedge funds • Emerging markets • EUR (V) Foreign • GBP(71) exchange Commodities • Platinum %h Recent Recent upgrades a downgrades UBS Please see important disclaimer and disclosures at the end of the document. EFTA01089578 Recommended tactical asset allocation Tactical asset allocation deviations from benchmark* Currency allocation** underweLght neutral over•wrght undeNteight neutral overweight Cash USD Equities total EUR US GBP Eurozone in JPY a, UK E 3 cr Japan CHF Switzerland SEK EM N0K Other MI CAD Bonds total NZD Government bonds v. Corporate bonds (IG) AUD -o c o co High yield bonds ■ new old EM sovereign bonds (USD) * Please note that the bar charts show total portfolio preferences and thus can EM corporate bonds (USD) be interpreted as the recommended deviation from the relevant portfolio Commodities total benchmark for any given asset class and sub asset class. v. Precious metals The UBS Investment House view is largely reflected in the majority of UBS w :al Discretionary Mandates and forms the basis of UBS Advisory Mandates. Note -o Energy that the implementation in Discretionary or Advisory Mandates might deviate E Base metals E slightly from the 'unconstrained" asset allocation shown above, depending on o u Agricultural benchmarks, currency positions and due to other implementation considerations. Listed Real Estate **Note: The currency allocation has been changed on 8 February 2013, introducing the overweight in GBP and the underweight in EUR. • new old Source: UBS CIO WM Global Investment Office — as of 21.02.2013 UBS S Please see important disclaimer and disclosures at the end of the document. EFTA01089579 CIO preferred investment themes (1/2) Liquidity & Foreign Exchange • Emerging market currencies: An underappreciated asset class Emerging market corporates: A growing asset class The currencies of EM countries, collectively as an asset class and measured Within EM hard currency debt, we prefer corporate to sovereign due to its using total returns (i.e. including interest received), have the potential to more attractive valuation and higher overall yield. Moreover, our relatively contribute positively to the longer-term returns of a well-diversified portfolio. constructive current view on risk is another reason to prefer EM corporate over We believe that this is especially relevant now that the developed world is sovereign debt. Over a 6-month horizon, we expect EM corporate bonds to settling into an extended period of very low interest rates. deliver total returns of more than 4%. • GBP — the best of the majors Top-notch Asian banks shine amid weak competition The pound has come under pressure after comments from incoming Bank of Highly rated banks in developed Asia benefit from a consolidation in the England Governor Carney suggesting changes to monetary policy targets, banking industry in Europe and the US, while growth in emerging Asia Prime Minister Cameron's proposal for a referendum on the UK's membership continues to underpin their fundamentals. These issuers are, on average, AA- of the EU, and weak economic data. However, we believe that the weakness rated and we expect them to benefit from the ongoing global bank ratings of Sterling is overdone and first signs point to stronger economic data in the downtrend. Senior bonds of these developed Asian banks provide moderate months to come. As a result, the pound is our preferred major currency. yields, whilst subordinated bank bonds of the same issuers provide good potential for credit spread tightening, given the scarcity value of Basel 2 Fixed Income compliant bank capital securities and the absence of regulatory bail-in regimes. Yield pickup with corporate hybrids Overall, we expect an excess return of a basket of subordinated and senior The corporate hybrid segment is a lesser known segment of the investment Asian bank bonds of more than 1% over comparable global issues over the grade credit world that has lagged the broad-based spread recovery. As a next 6-12 months. consequence, we see attractive opportunities for investors with a suitable risk Too expensive Government bonds' tolerance or trading-orientation. We expect mid- to high-single-digit returns Improving economic data has already lead to an increase in government bond on selected instruments over a 12-month period. yields in most major markets. While tight fiscal budgets and high debt burdens in the US and Europe are unlikely to allow for a large increase in interest rates, US high yield corporate bonds even a small further rise would lead to negative total returns on benchmark Positive economic growth, robust corporate earnings, and healthy balance government bonds, and we believe that the risk-reward in the bonds of most sheets provide support to US high yield (HY) corporate bonds. Current yield weaker countries is currently poor. We therefore recommend switching out of spreads of -495 basis points still price in a more dire economic outcome than the affected bonds, which are identified in this theme. we expect. Historically, US high yield bonds have delivered similar returns to US equities with lower volatility. We continue to believe that US high yield corporate bonds have a favorable risk/return and expect mid-single digit 1 returns over the next six months. Senior loans are exposed to similar positive fundamentals, and offer an attractive, floating rate alternative to US HY. = New investment theme The CIO preferred investment themes represent the CIO's highest conviction, thematic investment ideas. We aim to recommend ideas that are attractive on a risk-reward basis and which are expected to deliver positive absolute returns. It will include the best investment themes for each of our TAA overweights, UBS further aligning the asset allocation and themes recommendations, along with a range of other short-, medium-, long-term, and SRI themes. 6 Please see important disclaimer and disclosures at the end of the document. EFTA01089580 CIO preferred investment themes (2/2) Equities • US mid caps: The sweet spot No turnaround for European telecoms US economic data has begun to stabilize and forecasts now show an Despite having already underperformed the broader Eurozone equity index, acceleration of growth in 2013. The greater domestic sales exposure of US we expect further relative downside in the coming months. Operating results, mid caps, and their more cyclical sector make-up, give greater leverage to the free cash flows and, most of all, dividends will stay in free fall, and further US recovery. For these reasons we believe that mid-cap companies will adjustments to consensus estimates are required for 2013 projections and outperform large caps in the US over the next 6-12 months. onward, in our view. Hence, we recommend investors to reduce exposure to Eurozone telecoms. • Swiss high quality dividends The Swiss equity market currently offers a dividend yield of around 3.0%, while bond yields in the Swiss franc fixed income market are typically below 1%. Before 2009, dividend yields tended to be lower than bond yields. Hedge Funds & Private Equity Moreover, unlike in the past, the Swiss dividend yield is now clearly higher • The place to be in Hedge Funds than in the US and comparable to European peer markets. Overall, Swiss The favourable conditions for relative value remain unchanged in 2013. A dividends are very attractive, in our view, in particular if investors focus on continued improvement in global growth and the supportive monetary policy companies with high quality dividends - meaning that dividends are backdrop supports spread products such as corporate bonds and securitized sustainable and steadily rising. loans. Moreover, the decline in the number of market participants due to the Volcker rule should provide more opportunities to strategies such as fixed • Emerging market equities income arbitrage. We now also like equity long short which should benefit We expect real GDP growth in emerging markets (EM) to accelerate to 5.1% from stronger equity markets. The associated lower correlations among stocks in 2013 from 4.5% in 2012, which should support EM corporate earnings. We should allow good performance for managers picking under- and overvalued see EM earnings growth of around 11% over the next 12 months, as global stocks. We are now less keen to own event driven strategies as we do not monetary policy should remain accommodative. EM equities are trading expect distressed debt managers to be able to repeat their excellent 2012 below their longer-term averages on several valuation metrics, and will likely performance in an improving economic environment. be supported by stronger EM currency performance against the US dollar over the next six months. • Western winners from emerging market growth Commodities Emerging economies continue to grow faster than developed economies. • Platinum: Attractively valued With little need to deleverage and repair balance sheets, Asian economies are Platinum remains our most preferred precious metal. Production costs also well positioned to continue outpacing their Western peers in the years continue to rise, with marginal production costs now above USD 1,600/oz. If ahead. We have identified companies from a variety of sectors in Europe, the this supply backdrop meets with improved economic activity in the latter part US and Japan which have significant exposure to the rapidly growing of 1H13 and in 2H13, the platinum market will be undersupplied by 4.5% in emerging regions. We believe a diversified portfolio of these companies will 2013. With this supportive backdrop, we target a move toward USD 1,800- reward investors seeking to profit from the robust demand growth in 1,850/oz during 2013.. emerging economies. SUBS 7 Please see important disclaimer and disclosures at the end of the document. EFTA01089581 Global economic outlook - Summary Key points Global growth expected to be 3.0% in 2013 • We expect the US economy to remain on its moderate but steady growth path. R•olg GDP row* .1 inflation in • In the Eurozone we think that economic activity is rebounding on the basis of rising sentiment in business surveys 2011 2012E 2013F 2011 2012, 2013F and less fiscal austerity relative to 2012. Americas US 1.8 22 2.3 3.1 21 1.6 Canada 2.6 20 20 21 1.6 1.9 • In the emerging markets, we expect real GDP to grow at 5% in 2013. Iran 2.7 1.1 40 6.5 5.8 6.2 Asia/Pacific Lain .0.6 2.1 1.3 .0.3 0.0 0.3 CIO View (Probability: 75%*) Sluggish expansion A62443 2A 3.6 3.0 3.3 1.8 2.4 Chna 93 72 8.0 541 2.7 3.5 • We expect the US economy to remain on its moderate but steady growth path over the next six months. Stronger India 55 6.5 8.1 7.4 private sector demand and reaccelerating inventory accumulation will likely be offset by reemerging fiscal policy Europe Et00204e 1.5 -OA 0.1 2.7 2.5 2.1 German, 3.1 09 08 75 21 uncertainty. We expect Fed's open-ended QE3 program to last till year end and the government to reach another two 17 0.2 0.4 21 20 1.3 0.5 -23 -0.4 2.9 3.4 2.6 deficit deal. This deal replaces the current sequester spending cuts but does not include further spending reductions. fWn as -1.6 3.1 2,5 3.2 • In the Eurozone, the sentiment in recent business surveys continues to improve, signaling that the recession will end UK stnuerliod 0.9 1.9 00 1.0 0.8 0.9 65 02 28 41.7 7t in 1Q 2013. We expect a return to moderate growth rates in 2013 as the pressure from fiscal tightening declines and Ruzia 4.3 34 35 8.5 5.1 6.8 world 3.2 27 30 31 2.9 2.9 the increased macro stability supports business investment spending. Inflation is expected to continue to trend downward below 2%. The ECB is concerned about the risks to money market rates from the early LTRO repayments Source: U8S, as of 12 February 2013 In developing the CIO economic forecasts, CIO economists and the rise of the euro. At this juncture though, the ECB remains in wait-and-see mode. worked in collaboration with economists employed by UBS • The Chinese economy is in a moderate upswing cycle. 3Q12 marked the cyclical bottom in terms of year-on-year Investment Research. Forecasts and estimates are current growth. Real GDP growth rebounded to 7.9% in 4Q12 and we expect around 8% growth on average in 2013. Headline only as of the date of this publication and may change CPI inflation is likely to rise gradually to 4% by year end. The government aims to keep inflation below 4% so it could without notice. be a policy concern later this year. While economic conditions are supportive in Asia and Latin America, EMEA continues to lag in the cycle. We are likely to see increased inflationary pressures in H2 2013, leading to an upward drift in EM rates. In Brazil, Russia and India, inflation has already become a policy constraint. Services and manufacturing diverging $ Positive scenario (Probability: 10%*) Return to long-term trend Global PMis • The Eurozone crisis abates. Financial market conditions recover, mitigating the drag from fiscal austerity. 65 • Growth in Western Europe turns decisively positive in the early months of the new year and the US economy grows 60 above trend. ss • Negative scenario (Probability: 15%*) Recession 50 • There are three key downside risks to the global economy: 1) a significant escalation of the Eurozone debt crisis; 2) a rs . H protracted government shutdown and a sharper fiscal contraction in the US; and 3) a sharp deceleration of the Chinese 60 r economy. Each of these risks could precipitate a significant downturn in the global economy. 35 30 25 Key dates 07 08 09 10 11 12 13 24/25 Feb EMU: Italian parliamentary elections No-change line —Manufacturing 1 Mar US: ISM manufacturing purchasing managers' index (PMI) for February —Services —Composite 1 Mar China: Manufacturing PMI (February) 5 Mar China: National People's Congress Source: JP Morgan, Bloomberg, UBS; as of January 2012 7 Mar EMU: ECB press conference Note: Past performance is not an indication of future returns. 20 Mar US: FOMC meeting results *Scenario probabilities are based on qualitative assessment. 21 Mar EMU: PMI Composite for March (flash) UBS For further information please contact CIO economist Ricardo Garcia, Please see important disclaimer and disclosures at the end of the document. 8 EFTA01089582 Key financial market driver 1- Eurozone crisis Key points Purchasing managers' indices point to • We expect the Eurozone to gradually emerge from recession. Fiscal policy will be less restrictive than in 2012. improving momentum • The Eurozone debt crisis is not over but ECB policy provides a credible backstop. 65 • We think that Spain will need external support in coming months. The debt situation in Cyprus, a possible rating 60 downgrade of Spain to junk, and general elections in Italy could further exacerbate the situation. 55 50 CIO View (Probability: 70%• ) Austerity and weak growth 45 • The Eurozone economy is expected to leave recession behind in 1H 2013 after a weak fourth quarter. We believe that 40 Spain will apply for an aid program in 1H 2013. Italy also risks needing support due to contagion from Spain and its 35 own election uncertainty. Greece's debt remains highly unsustainable, but a near-term euro exit is unlikely. Ireland 30 continues to recover gradually, but is highly indebted. We expect France to deliver negative headlines in 1H 2013 due 25 to rising concerns about its fiscal slippage on the back of economic weakness. 07 08 09 10 11 12 13 — No-change line — Manufacturing • We expect the Eurozone economy to grow slightly in 1H 2013 (moderately above consensus), with minor downside —Services —Composite risks. The latest economic indicators support our base case that the recession will end in 1H 2013 and return to modest positive growth. The increased macro stability on the back of the improving peripheral current accounts and the OMT Source: Bloomberg, UBS; as of January 2013 should support the improving economic trend. Consumer price inflation continues to fall, driven by pressure on output prices and commodity base effects. The ECB is carefully watching the strengthening of the euro and monitoring money market rates following the LTRO repayments, but remains in wait-and-see mode for now. • We think a revision of Spain's deficit targets by February could lead Moody's to cut the country's credit rating to Yields of Spanish and Italian 5-year bonds junk. This would increase the cost of covering its large funding needs and push Spain into a program in the first half of In % 2013. Italy should remain rated investment grade if the new government continues the recent reform path. • Even with OMT support, longer-term peripheral yields should stay sensitive to countries' debt trajectories as debt 8.0 levels remain very high. Banking supervision at the ECB will likely be operational by 2014, but a banking union is 7.0 unlikely to be formed in the next few years, with the most controversial aspect being joint deposit insurance. 6.0 • We think that Greece will fail to meet targets and exit risks will again increase if the current government loses its majority over further austerity demands from the IMF, possibly in 2H 2013. 5.0 4.0 71 Positive scenario (Probability: 15%• ) Growth and fiscal stabilization 3.0 • Bond yields converge as peripheral countries' budgets stay on track and economic activity across the Eurozone 2.0 recovers faster than expected. Greece complies with the new austerity plans and market confidence is restored. Negative scenario (Probability: 15%•) Major shock 1.0 • Major shocks include Spain and Italy being cut off from bond markets, i.e. requiring all new funding through 0.0 ESM/IMF loans, with European rescue funds only able to cover them until the end of 2013; resistance from core 03/2011 082011 01/2012 06/2012 11/2012 countries against further support; a near-term Portuguese debt restructuring; a Greek euro exit in 1H 2013; massive —Italy — Spain —Bond fiscal slippage in France; or a major external shock. Source: UBS, Bloomberg; as of 12 February 2013 Key dates Note: Past performance is not an indication of future returns. 24/25 Feb Italian parliamentary elections • Scenario probabilities are based on qualitative assessment. 7 Mar ECB press conference 14/15 Mar European Council conference 21 Mar PMI Composite for March (flash) UBS For further information please contact 00 analyst Thomas Wacker, and 00 economist Ricardo Garcia, Please see important disclaimer and disclosures at the end of the document. g EFTA01089583 Key financial market driver 2 - US economic outlook Key points US growth to rebound after 4Q12 • US growth should remain moderate, with accelerating private sector growth partially offset by fiscal tightening. contraction • Inflation is expected to stay slightly below the Fed's target of 2% over the next six months. US real GDP and its components, quarter-over-quarter • The Fed's open-ended QE3 has dampened downside growth risk but hasn't dramatically boosted activity. annualized in % 8% qfq annudized CIO View (Probability: 70%*) Moderate expansion osa • We expect the economy to stay on a moderate growth path and the unemployment rate to come down gradually 4% over the next six months. UBS forecasts real GDP growth of annualized 3.0% in 1Q 2013 (consensus: 1.5%) and 2.9% in 2% 0% 2Q 2013 (consensus: 2.1%), as private sector demand remains solid and very lean inventories give way to faster -2% inventory accumulation. Inflation should stay slightly below the Fed's target of 2%. -4% • Relative to 2012 policy, Congress has raised ordinary income, capital gains and dividend income tax rates for high- 6% income earners and curtailed their allowable income exemptions. It has also allowed the payroll tax to expire for all B% AtIL households, raised the estate tax, and introduced healthcare reform tax hikes. The federal budget impact of these 12% policy changes amounts to 0.9% of GDP, but the 2013 GOP growth impact will be more muted as households can lower Q1 Q1 Q1 Q1 Q1 Q1 Q1 C/1 their savings to offset the drop in after-tax income caused by higher tax rates. Congress extended all other tax and 2036 2007 2008 2009 2010 2011 2012 2013 Consumption Gemmeroal red estate investment spending provisions and delayed the sequester budget cuts until 1 March. We expect the sequester spending cuts to • Cooker expenditures Residential immanent kick in temporarily and fierce negotiations to bleed into a brief government shutdown after the current continuing • hventones whet Exports • Government —Real GDP (q/q annualized) resolution expires on 27 March. The culmination will likely be another deficit deal that replaces the current sequester spending cuts but does not include additional spending reductions. The political rift will likely lead to another US Source: Thomson Datastream, UBS; as of 12 February 2013 sovereign rating downgrade. • The Fed's open-ended QE3 program linked to labor market conditions - USD 85bn in Treasury and agency MBS purchases - mitigates downside growth risks, as weaker labor market data implies more easing, but has not US Current Activity Index (CAI) consistent dramatically boosted growth prospects. We expect QE3 to last until year-end with total purchases of USD 1.2trn. with moderate growth 74 Positive scenario (Probability: 15%•) US real GDP growth, actual and implied by US CAI, in % Strong expansion • Growth accelerates persistently above 3%, propelled by expansive monetary policy, a resolution to the US long-term 6 debt problem, strong growth in housing investment, and improved business and consumer confidence. This leads to 4 higher inflation and the Fed responds by halting QE3 and raising rates sooner. 2 • Faster-rising tax collection allows the government to cut deficits more aggressively. Fiscal policy tightens by more 0 than 1% of GDP in 2013. -2 11 Negative scenario (Probability: 15%*) Growth recession • US fiscal deleveraging and an escalating Eurozone crisis weigh on the cyclical recovery. Falling profit margins weigh -6 on business capital expenditures. Real GDP growth deteriorates. The Fed makes massive purchases of agency MBS and Treasuries under its QE3 program. -8 10 • Political gridlock becomes totally dysfunctional, thus leading to a protracted government shutdown in the first half of 2013. The US credit rating is downgraded by multiple notches. Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 — Real GDP guarter-over-guarter annualized in % (actual) Key dates — Real GDP annualized in % (implied by US CAP 1 Mar ISM manufacturing purchasing managers' index for February 8 Mar Nonfarm payrolls and unemployment rate for February Note: The US Current Activity Index (CAI) is a single composite of 25 growth indicators that correlate strongly with real GDP 13 Mar Advance retail sales for February growth. 15 Mar University of Michigan consumer sentiment for March (preliminary) 20 Mar FOMC meeting results Source: Bloomberg, UBS; as of January 2013 UBS For further information please contact US economist Thomas Berner, 10 Please see important disclaimer and disclosures at the end of the document. EFTA01089584 Key financial market driver 3 - China growth outlook Key points Softening in official PMI was largely due to • We expect a moderate growth recovery in the coming quarters. seasonal factors • Key risks to the recovery could come from uncertainties in external demand, inflation and credit. • Budget for 2013 could be more expansionary than last year's. CIO View (Probability: 70%*) Modest growth recovery • We expect the modest economic recovery to continue in the coming months, driven by some restocking activities, strength in infrastructure investments, moderate recovery in the property sector and the delayed effects of previous easing measures. Our recent on-site meetings with officials and corporations also revealed a cautiously optimistic Chinese macro outlook. We expect GDP growth to improve from 7.8% in 2012 to 8.0% in 2013 (consensus: 8.1%). We think the export sector could underperform the domestic economy given the weak growth in Europe and the battle over the US debt ceiling in the course of the year. • Given the different timing of the Chinese New Year (it was in January last year but February this year), year-on-year macro data for January or February will be heavily distorted, i.e. January data would be particularly strong and 35 February particularly weak. • The National People's Congress will be held on 5 March, with the government presenting the growth target for 2013, - -35 — 3" which is likely to remain at 7.5%, and the budget for 2013. Fiscal policy could be more expansionary, with a larger Source: Bloomberg, UBS; as of February 2013. Index budgeted fiscal deficit of CNY 1,200bn in 2013 (about 2% of GDP), up from CNY 800bn in 2012. This could pose a above/below 50 indicates expansion/contraction moderate upside risk to consensus GDP growth forecasts. Furthermore, several new heads of the regulatory bodies and the central bank will come on board after the meeting, and new policies regarding wealth management products could be announced. Nonetheless, we do not expect a material shift in policies because of the personnel changes. Demand from developed economies still • The major long-term economic and political reforms will likely be decided in the run-up to the third plenary session casts shadow over export recovery of the party's Central Committee in 2H 2013, most likely in October. We believe structural reforms - which aim to rebalance the economy and redistribute incomes and welfare to consumers - will improve the sustainability and quality 60 of China's long-term economic growth. 40 Positive scenario (Probability: 20%*) Growth acceleration • Economic momentum continues to improve and strength persists in 2013. This would require more substantial and * 20 effective fiscal, monetary and credit policy support from the government and possibly also a fast improvement in the Eurozone debt crisis and the US fiscal and debt issues. jfi 0 M Negative scenario (Probability: 10%*) Sharp economic downturn • Another round of global financial stress or recession, likely due to the Eurozone debt crisis or a fiscal policy-induced I3 C20) downturn in the US, would weigh on Chinese exports. • Despite soft aggregate demand and economic activity, residential property prices and/or consumer price inflation rise rapidly, which constrains policy maneuvers and its effectiveness in stimulating economic growth. DecC8 Dec'09 UO10 Dec-11 Deco2 —)pct's —ImpOrM • A major crackdown on shadow banking tightens liquidity and credit conditions and negatively affects growth. Source: Bloomberg, UBS; as of February 2013 Key dates Note: Past performance is not an indication of future returns. 1 Mar Manufacturing PMI (February) " Scenario probabilities are based on qualitative assessment. 5 Mar National People's Congress 9 Mar Industrial production, fixed asset investment, retail sales (January and February) UBS For further information please contact CIO's analysts Gary Tsang, Glenda Yu, S and Patrick Ho, 11 Please see important disclaimer and disclosures at the end of the document. EFTA01089585 Section 2 Asset class views EFTA01089586 Section 2.A Asset class views Equities 4 UBS EFTA01089587 Equities overview Preferences (six months) Global equity markets - Key points neutral ovenveight • We recommend an overall overweight allocation in equities (see summary on slide 3). Equities • We have increased our preference for US equities. Company earnings remain stronger than in other regions. Recent economic data confirms that domestic demand is holding up solidly, underpinning revenue growth. The recent USA US-dollar weakness provides additional support for company earnings. Canada • We maintain our neutral stance on Eurozone equities. Value is attractive compared to global equities. However, due to recessions in several countries and the recent strengthening of the euro, earnings dynamics remain weak. EMU • We maintain the overweight position in emerging market equities. Economic activity in key countries has UK bottomed out and is improving (e.g. industrial production, exports). Accordingly company earnings show signs of stabilization in some of the larger emerging markets and we expect them to improve going forward. Switzerland • We are adopting a cautious position on Canadian equities. Company earnings are currently weaker than in other Australia countries. The currency remains strong, and valuations are high compared to other markets. • We remain neutral on Australian equities. The earnings dynamics of Australian companies continue to lag those Hong Kong of other markets. Still, the pace of downward revisions on earnings in the Materials sector is clearly slowing. Improving Japan commodity demand from China and the recent rise in the iron ore price speak for a more benign outlook. Singapore • We are neutral on Swiss equities. Companies are showing solid earnings growth due to the defensive sector Global EM composition. On the other hand, the market is trading at a premium to global equities. 2 (Ins) 'a • We maintain our neutral view on UK equities. In the UK, earnings dynamics lag other markets. The market is trading at a valuation discount, and we expect earnings dynamics to improve over the coming quarters. n new old Note: Preference in hedged terms (excl. currency movements) Global equity sectors — Key points • We reiterate our overweight on IT as the sector should benefit from increased corporate and consumer spending. With earnings trends and cash flow generation strong, sector valuation is very attractive. • We confirm our positive view on Materials as the global economic outlook is improving, which provides a Sector preferences within global equity favorable backdrop for improving sector earnings. We prefer US materials and UK mining over European materials. markets • We keep our overweight on Consumer Staples and Healthcare which offer superior and long-term earnings growth with low volatility and high free cash flow generation. Both sectors have strong balance sheets, and attractive Current most Current least dividend yields as well as dividend growth prospects. Within Healthcare, we prefer European companies over US ones. preferred sectors preferred sectors • We remain underweight on Telecoms as revenue growth is weak and pricing/margin pressure is high. • We confirm our underweight on Utilities as the business environment (weak demand, regulatory pressure, and Consumer Staples Telecom lower power prices) remains tough. The earnings outlook remains muted. Health Care Utilities • Consumer Discretionary should benefit from solid consumer confidence in major countries. While sector earnings IT growth should continue to be superior, valuation is relatively high. We reiterate our neutral view. Materials • Despite some headwinds in major regions (e.g., regulatory risks, low interest rates), earnings trends for Financials are improving and we keep our neutral view. Source: UBS • With expected gradual improvement in leading indicators and early signs of a better global macro environment, Industrials should benefit. However, we remain neutral as the current sector valuation is fair. UBS For further information please contact CIO asset class specialists Markus lrngartinger, or Carsten Schlufter, 14 Please see important disclaimer and disclosures at the end of the document. EFTA01089588 US equities Preference: overweight Recommendations S&P 500 (20 Feb): 1,512 (last publication: 1,495) UBS View S&P 500 (six-month target): 1,570 Tactical (six months) • We keep our exposure to global cyclical • We maintain our preference for US equities relative to other developed equity markets. The recent Q4 earnings sectors within the US equity market that season revealed solid earnings growth of about 6% year-over-year. In our base case of ongoing economic expansion, should benefit from a sustained rebound in the upcoming fiscal policy issues do not derail the economic recovery. global growth. • This is a precondition for solid earnings growth of 5-7%, which we expect in 2013. This forecast is mainly built on • We confirm our existing overweight tilts in solid revenue growth in 2013. With margins already at high levels, we do not expect margin expansion to drive Industrials, IT and Materials as broadening earnings growth. economic growth should translate into higher • Short-term, the recent US-dollar weakness provides an additional support to earnings. earnings. • We remain cautious on Utilities, Healthcare • The Fed's very pro-growth monetary policy stance is a clear advantage for the local equity market. The end of and Telecoms, where revenue growth is low Operation Twist has been followed by additional large (net) bond buying, which we expect to last late into this year. and valuations are unattractive. • US equities are forecast to gradually advance with earnings growth. Improving manufacturing activity should allow for some modest re-rating in the price-to-earnings ratio from the current level of 14.5 times realized earnings. Strategic (one to two years) • We like medium-sized US companies, which 71 Positive scenario S&P 500 (six-month target): 1,750 are expected to show good longer-term earnings growth. • Accelerating US and global economies reduce risks to company earnings. Investors begin to shift funds into more cyclical sectors such as Industrials, IT and Materials in light of better growth prospects. In this scenario, we would expect earnings to grow by around 10% in the next 12 months, and the trailing P/E multiple to expand to around 16x. Negative scenario S&P 500 (six-month target): 1,300 • The US and global economies slide into a recession; failed debt ceiling negotiations might add additional drag. Given such an outcome, corporate earnings would fall over the coming 12 months, and we would expect risk aversion to rise Current most Current least sharply. We would also expect the WE multiple to contract towards 12.5x trailing earnings. preferred sectors preferred sectors Note: Scenarios refer to global economic scenarios (see slide 8) Industrials Health Care IT Telecom What we're watching Why it matters Materials Utilities Business sentiment The ISM is the key indicator for US manufacturing and services. Key dates: 1 Mar, ISM manufacturing; 5 March, ISM non-manufacturing Source: U8S Note: Past performance is not an indication of future returns. The Fed Hints on its monetary policy stance can influence equities. Key date: 20 Mar, Fed meeting Labor market Improvement in the labor market would support stronger consumption. Key date: 8 Mar, US labor market report for February US earnings season Consensus forecasts about 3% y/y earnings growth for Q4 results. UBS For further information please contact CIO asset class specialist Markus lrngartinger, 15 Please see important disclaimer and disclosures at the end of the document. EFTA01089589 Eurozone equities Recommendations Preference: neutral 1 Euro Stoxx (20 Feb): 267 (last publication: 269) UBS View Euro Stoxx (six-month target): 271 Tactical (six months) • We confirm our overweight on Consumer • We maintain a neutral stance on Eurozone equities. Earnings weakness is balanced by attractive valuation. Discretionary as we see increasing evidence of • The conditional bond-buying program by the ECB (OMT) implies much reduced downside risks from the sovereign strengthening global growth, which should debt crisis (see slide 9). Spain will have major refinancing needs in the coming weeks, and we could see higher volatility support sector earnings. if it faces problems issuing bonds. • We like Consumer Staples and Healthcare, • Italian elections on 24/25 February add additional uncertainty, though our base case calls for a market friendly which offer good earnings growth, solid outcome. balance sheets and growing dividends. • Besides those uncertainties, economic weakness and Southern European countries being in recession are still • We are negative on Utilities and Telecoms as dragging down earnings in the Eurozone. The strengthened euro is weighing on overseas earnings. earnings trends are negative, balance sheets are stretched and dividends at risk. • Consensus earnings growth expectations for 2013 (bottom-up) have come down to about 7% in recent weeks. We see • We keep our underweight on Materials as this growth figure as still too high; we forecast 3% to 5% earnings growth. Still, we expect further re-rating as signs of valuations are too high. economic stabilization emerge over coming months, which should more than compensate for earnings misses. Strategic (one to two years) • We have a preference for stocks paying high- 2 Positive scenario Euro Stoxx (six-month target): 330 quality dividends. • Global economic growth reaccelerates and Eurozone growth shows clear signs of bottoming out, enabling mid- • We like companies with high exposure single-digit earnings growth over the next six months. The trailing PIE ratio could re-rate to about 14.5x from its to rapidly growing emerging markets. current reading of 12.4x. Negative scenario Euro Stoxx (six-month target): 210 • Recession and debt crisis lead to renewed market pressure. However, downside risks are expected to be less severe Current most Current least now that the ECB has put its bond-buying program (OMT) in place. preferred sectors preferred sectors • Earnings could fall about 5% to 10% from current levels over the coming six months, and the trailing PIE ratio could Cons Discretionary Materials drop to a level of around 10x over a six-month period. Consumer Staples Telecom • Failure of debt ceiling negotiations in the US is also likely to affect Eurozone equities negatively. Note: Scenarios refer to global economic scenarios (see slide 8) Health Care Utilities What we're watching Why it matters Source: UBS Growth indicators Economic growth is important to avoid a flare-up of the debt crisis. Note: Past performance is not an indication of future returns. Key dates: 1 March, final PMI manufacturing, EMU; 5 March, final PMI services, EMU; 21 March, flash PMI manufacturing and flash PMI services, EMU; 22 March, Ifo business sentiment index, Germany Policy action Decisions by European politicians and the ECB affect the course of the debt crisis. Key date: 7 March, ECB meeting UBS For further information please contact O0 asset class specialists Markus Irngartinger, and Carsten schlufter, 16 Please see important disclaimer and disclosures at the end of the document. EFTA01089590 UK equities Preference: neutral Recommendations FTSE 100 (20 Feb): 6,395 (last publication: 6,198) Tactical (six months) UBS View FTSE 100 (six-month target): 6,475 • Equity dividends offer an attractive real • We maintain our neutral stance on UK equities. Earnings have continued to disappoint, showing one of the weakest income stream in a low yield environment. dynamics within our market universe. Commodity-related sectors have shown steep earnings declines. Realized We recommend stocks with dividends which earnings in the Energy as well as the Materials sector have continued to be revised down by analysts over the last three are well covered by earnings and cash flow, months. These two sectors account for 30% of the market capitalization. are sustainable and growing, and from • The Healthcare sector suffers from company-specific issues that affect earnings negatively. companies with sound fundamentals • Going forward, the earnings picture is expected to improve gradually. Earnings of materials companies are likely to • We like companies with strong sales stabilize in a delayed fashion as iron ore prices have sharply increased since fall 2012. The revision of the Basel Ill exposure to emerging markets. liquidity standards will continue to support the earnings of UK banks. Strategic (one to two years) • UK equities offer a relatively high dividend yield, and the P/E multiple of about 12.7 times realized earnings is below • The UK market's dividend yield of close to global equities. However, UK equities have traded on a discount to global equities for most of the past 10 years. 4% provides a good income stream. • Companies with pricing power are expected 7( Positive scenario FTSE 100 (six-month target): 7,100 to deliver superior earnings growth. High • A rapid strengthening in global growth and recovering demand from emerging markets leads to fast-rising pricing power provides greater margin stability through the cycle. commodity prices, helping the energy and materials sectors to lead the market higher. The market could re-rate to a P/E multiple of 13.5x, and we would expect earnings growth of 5% to 10% over 12 months. UK market trades at a PIE discount, based Negative scenario FTSE 100 (six-month target): 4,900 on realized earnings • A global recession drags down UK earnings by 15% to 20% over 12 months. The market's traditionally defensive characteristics would only partly offset its strong exposure to commodity-related sectors. We would expect the trailing P/E multiple to drop towards 10.5x. Note: Scenarios refer to global economic scenarios (see slide B) What we're watching Why it matters Growth indicators Business survey indicators and consumer spending data provide information on economic developments in the UK. Key dates: 1 Mar, PMI manufacturing; 5 Mar. PMI services Commodity prices Energy and materials together comprise about 30% of the UK market. Developments in 2001 2006 2009 2012 commodity prices affect earnings estimates. — FTSE 100: raved rF — AISC1Wald rethxd PF Policy action Loose monetary policy by the Bank of England supports equities. Key date: Source: Thomson Reuters. UBS; as of 18 February 2013 7 Mar, Bank of England policy meeting Note: Past performance is not an indication of future returns. UBS For further information please contact OO asset class specialist Markus Imgartinger, 17 Please see important disclaimer and disclosures at the end of the document. EFTA01089591 Swiss equities Recommendations Preference: neutral 1 SMI (20 Feb): 7,626 (last publication: 7,392) Tactical (six months) UBS View SMI (six-month target): 7,750 • We like stocks paying high and sustainable • We remain neutral on Swiss equities. Swiss companies are internationally well diversified, with almost two thirds of dividends, including companies paying revenues generated in the US and emerging markets. This provides a basis for solid revenue and earnings growth, income tax-exempt dividends. despite challenging economic conditions in Europe. • We favor large caps over small caps. • The defensive sector composition also plays an important role. Swings in global manufacturing activity or commodity • Within defensives, we favor the Healthcare prices affect Swiss companies' earnings less than those of companies in other countries. and Consumer Staples sectors. • Among the cyclical companies, we prefer • In January the Swiss franc weakened by 3% relative to the euro. This movement is too small and recent to have had a those with broad emerging-market exposure material effect on earnings yet. Should it continue, it could provide important support to earnings growth. and/or cheap valuations, including insurers. • In an environment of moderate economic growth, we like companies with decent earnings growth and solid balance Strategic (one to two years) sheets. Unfortunately, these characteristics have their price. Swiss equities trade at a higher valuation than their global • We favor leaders regarding the two key peers. Currently they trade at 15.8 times trailing earnings. Swiss success factors: innovation and globalization. Positive scenario SMI (six-month target): 8,100 • Eurozone economic growth reaccelerates considerably, providing further relief to Swiss financials as well as Swiss exporters. Defensive sectors would likely be left behind in a strong global relief rally. In this scenario, we would expect the equity market P/E to trade around 16x and earnings to grow by 5% over the next six months. Swiss market valuation relative to world bi Negative scenario SMI (six-month target): 5,900 equities based on P/E ratio • The global economy slides into a recession. Despite offering less cyclically sensitive products, Swiss companies would also feel the drop in global demand. In this scenario, corporate earnings are likely to drop slightly over the next six months and we would expect P/E to contract toward 12.5x. Note: Scenarios refer to global economic scenarios (see slide 8) What we're watching Why it matters Interest rates and Announcements of domestic interest rates and exchange rate decisions: 1 Mar, exchange rates SNB meeting Economic indicators Announcements of key domestic economic indicators: 27 Feb, KOF Swiss leading indicator; 1 Mar, Manufacturing PMI index kb-O? Fol3.08 Feb09 Fab.10 Fab.11 Fand2 Fah-13 — SMI moltedP4 — MSCI Wald • root:SPA Corporate news Key corporate announcement dates: 22 Feb, Straumann; 26 Feb, Georg Fischer, Source: FactSet, UBS; as of 18 February 2013 Implenia, Swissquote and Temenos; 27 Feb, Holcim and Swiss Life Note: Past performance is not an indication of future returns. UBS For further information please contact OO asset class specialist Stefan Meyer, 18 Please see important disclaimer and disclosures at the end of the document. EFTA01089592 Japanese equities Recommendations Preference: neutral 1 Topix (20 Feb): 974 (last publication: 888) UBS view Topix (six-month target): 985 Tactical (six months) • Since the weaker yen directly contributes to • We expect earnings growth of 25% over the upcoming 12 months. This relatively high year-over-year growth rate exporters' earnings, we prefer Japanese reflects fewer extraordinary items than in 2012, as well as the sharp recent weakening of the yen. Our earnings growth exporters. Higher inflationary expectations forecast is below consensus of about 35%. would not boost domestic companies' •Investors expect more positive earnings growth in March 2014 on the back of the new government's economic earnings in the near term. stimulus package and the weaker yen, supported by the BoJ's aggressive monetary easing. We are more cautious on • Among Japanese exporters, we prefer the the impact the stimulus package will have on domestic companies' earnings. auto companies as they still hold a large share •The Abe administration's expansionary fiscal stimulus may create one-time economic momentum and inflation, but of international markets unlike the we do not expect these measures to lead to sustainable, high GDP growth in the long run. technology companies. • In addition, we like trading companies that • We expect the TOPIX (trailing) PIE to drop to around 17 over the coming months, mainly due to the earnings have continued to invest in mining and other recovery; this will provide room for only moderate price increases after recent strong gains. energy resources for the last 10 years. With a weaker yen, the trading companies' net asset A Positive scenario Topix (six-month target): 1,100 values should increase in yen terms. • Stronger global demand and stabilizing European markets lead to improved risk-taking. Falling risk aversion might Strategic (one to two years) lead to a further weakening of the yen, providing an additional boost to earnings. We would expect about 25% • The recent weakening of the Japanese yen earnings growth over the coming six months with the TOPIX target based on 18x trailing P/E. increases the competitiveness of Japanese 4i Negative scenario Topix (six-month target): 700 exporters and companies with international operations. • Faltering global growth leads to weak exports, triggering negative earnings surprises. The US dollar/Japanese yen rate strengthening to below 80 and economic conflicts with China could serve as an additional drag on earnings. We Weaker Japanese yen supports TOPIX would then expect the P/E ratio to contract to 14.7x and earnings to fall during the upcoming six months. rebound Note: Scenarios refer to global economic scenarios (see slide 8) 1.600 120 115 1,400 110 What we're watching Why it matters 1,203 105 Japan industrial We expect the weaker yen to boost Japan's industrial production in January. January 100 1,003 production industrial production should provide valuable data point for assessing the impact of the 95 weaker yen on corporate activity. Key date: 28 Feb, preliminary industrial 803 90 85 production data for January 601 80 BoJ's next governor In addition to the BoJ governor, two deputy governors will be replaced in late March. 75 appointment Key date: 19 Mar, Ball governor appointment by the cabinet Cagan 08/Sep09iMayl0tlan 1CYSepll/Ma 12dan 125ep —701XIIIS — USWPY Source: Thomson Reuters, U8S; as of 8 February 2013 Note: Past performance is not an indication of future returns. UBS For further information please contact CIO asset class specialist Toru Ibayashi, 19 Please see important disclaimer and disclosures at the end of the document. EFTA01089593 Emerging market equities Preference: overweight Recommendations 1 MSCI EM (20 Feb.): 1,068 (last publication: 1,077) UBS view MSCI EM (sIx-month target): 1,120 Tactical (six months) • Within emerging markets, we see three main • Real GDP growth in the emerging markets is expected to accelerate moderately in 2013 to above 5%, compared to drivers over the next few months: first, a just 1.5% for developed countries. The growth differential between the emerging and developed economies is also cyclical recovery, supporting some of the forecasted to widen slightly in 2013 in favor of the emerging markets. higher-beta markets (like Russia, South Korea • Monetary policy in the US, the Eurozone, and Japan remains supportive of growth more broadly. We believe these and Brazil); second, a focus on local recovery low interest rate policies will enhance emerging market (EM) equity returns in US dollars by supporting EM currencies stories (like China and Brazil), and third, some more broadly against the US dollar over the next six months. However, too much currency appreciation too fast — for rotation away from those markets that have example, the rapid rise of the Korean won against the Japanese yen - erodes EM competitiveness and equity returns. done exceptionally well in recent years, • Over a six-month horizon, we do not see any sustained inflationary pressures changing the stance of EM monetary towards markets that have lagged and that policy from what is currently priced in. However, this could become more of an issue in the second half of 2013. start the year under-owned and out of favor • In our base case, we see the PIE multiple of the MSCI EM Index staying at about 12x trailing (i.e. realized) earnings (like Russia and Brazil). • Shorter-term, we see relatively less upside for over the next six months. Over the next 12 months, we expect EM earnings growth of around 11% (below the latest the more defensive market Malaysia. In the consensus estimate of 13%). case of South Africa, the currency is in a 7I Positive scenario MSCI EM (sIx-month target): 1,330 volatile phase, which is unhelpful to returns in USD terms. We expect some rotation out of • The outlook for the global economy improves, boosting EM's ability to grow more strongly in 2013. This stronger Turkey. economic growth leads to earnings growth of 15%. Investor confidence improves, leading to a better P/E multiple of 14x trailing earnings. If oil prices were to rise, too, Russia should benefit a little more in this scenario. Strategic (one to two years) Negative scenario MSCI EM (sIx-month target): 800 • Strategically, we would advise that EM • A significant escalation of the Eurozone debt crisis, a sharp fiscal contraction in the US, and a big deceleration in portfolios tilt toward cash-rich and faster- Chinese growth could each hit EM's economic prospects. In such a scenario, we would expect a 20% decline in earnings growing Asia. over 12 months. More defensive Malaysia would do better, while more cyclical South Korea and Russia would underperform. We assume, however, that the market would also be expecting some recovery in earnings for 2014, helping the P/E multiple to stabilize around 10x trailing earnings. Note: Scenarios refer to global economic scenarios (see slide 8) Country preferences within emerging What we're watching Why it matters markets (relative to MSCI EM) Current most Current least Industrial production Investors are trying to figure out in which emerging market economies growth is preferred markets preferred markets accelerating and where it might be stagnating. Key dates: GDP, industrial Brazil Malaysia production data and/or PMI manufacturing surveys for South Africa (27 Feb), China South Africa India (28 Feb), Brazil, China (1 Mar), Turkey (8 Mar), Russia (20 Mar) Russia Turkey Inflation The Achilles heel of the emerging economies is inflation. Over a six-month view, we do South Korea not see any sustained inflationary pressure that would require a change in the stance of EM monetary policy from what is currently priced in. But that could change later in 2013. UBS For further information please contact CIO asset class specialist Costa Vayenas, 20 Please see important disclaimer and disclosures at the end of the document. EFTA01089594 Asian equities (ex-Japan) Recommendations MSCI Asia ex-Japan (20 Feb): S62 (last publication: 560) UBS view MSCI Asia ex-Japan (six-month target): S85 Tactical (six months) • MSCI Asia ex-Japan is trading at 11.5x 12- • China and South Korea remain our Most Preferred markets. China's macro data was distorted to a certain extent due month forward P/E, suggesting 10% upside to the timing difference with Chinese New Year (fell in January last year). Jan exports and imports rose 25% and potential assuming a return to historical 28.8% YoY beating market expectations, while inflation fell from 2.5% to 2% YoY. The PBOC might gradually shift averages. We advise investors to continue its focus to inflation in the 2^4 half of the year due to a combination of higher labour cost, imported inflation adding Asian equities on any potential associated with QEs in major economies, rising inflation expectation locally and more importantly, lower downside weakness in the market. risk to growth. Nonetheless, valuations remain attractive with 12-mth FWD P/E trading at 16% discount to its peers. • Given the more favorable macro backdrop in • We maintain our Least Preferred ratings on Singapore and Malaysia. Singapore's non-oil domestic exports continue 2013 and attractive valuations, we are positive to underperform market expectations in Jan, recording a -1.8% month-on-month decline. Electronic exports on Chinese equities and expect further market continue to disappoint, declining by 5.6% YoY. The Malaysian government is widely expected to dissolve parliament re-rating. We also maintain our preference for in late Feb/early Mar for elections, with most observers expecting a narrower win for the incumbent party compared South Korea. Korean earnings are expected to post 19% earnings growth in 2013 and stay to the previous elections. While this in itself would not bring about a significant change in policy direction, a higher resilient, led mainly by the country's dominant possibility this time round of a government formed by the opposition is likely to pose near-term headwinds to the technology companies, due to market share stock market and currency. gains and margin expansion. 71 Positive scenario MSCI Asia ex-Japan (six-month target): 680 Strategic (one to two years) • More supportive monetary and fiscal policy, stable inflation, sustained domestic demand growth, and an improved • Consider a portfolio mix of high yield stocks largely found in Singapore, Taiwan and Hong global growth outlook lead to a better earnings outlook. In such a scenario, we expect earnings growth of 13% and Kong, complemented by growth-oriented a trailing P/E of about 15x. stocks in the rest of Asia. 11 Negative scenario MSCI Asia ex-Japan (six-month target): 420 • A hard landing in China with a global recession leads to negative earnings revisions. In this scenario, Asia ex-Japan Country preferences within Asia ex- could trade down to about 11x realized earnings. Japan (relative to MSCI Asia ex-Japan) Note: Scenarios refer to global economic scenarios (see slide 8). -5% -3% -1% 1% 3% 5% What we're watching Why it matters China Earnings growth Consensus is looking at earnings growth of 13.4% for FY2013 for Asia ex-Japan (which Haig Kong might be a tad optimistic should GDP growth disappoint, especially in China. Irdea USDJPY Sustained USDJPY weakness would be a concern for other major exporters in Asia, irdcnesia particularly South Korea and Taiwan. Kind Politics Decisions made about the US debt ceiling are important, as the US is still Asia's most aAiaysia important trading partner. The recent fiscal cliff compromise avoided a severe economic impact. We remain watchful as weaker US growth would hurt Asian exports. Phleppnes Policy responses Some other countries in the region have near-term macroeconomic issues to face due to Sengapcce fiscal and current account deficits, as well as hiccups in market and economic reforms. TaVAV1 Policy responses often come on an ad-hoc basis. nuiland • Old •New UBS For further information please contact OO asset class specialist Kelvin Tay, 21 Please see important disclaimer and disclosures at the end of the document. EFTA01089595 Equity styles Regional differentiation UBS view Prefer mid caps In US, large caps In Europe • In the US, we prefer mid to large caps. • We believe that medium-sized companies (mid caps) will outperform large caps in the US. US economic data has Moderate economic growth should support begun to stabilize and we forecast an acceleration of growth in the second half of 2013 and in 2014. The greater domestic sales exposure and more cyclical sector make-up of US mid caps make them a purer way to gain exposure to their earnings generation. the US and will give greater leverage to a US recovery. There is also potential for large caps, which are currently very • In the US, there are selective opportunities in cash-rich, to put this cash to work and 'buy growth' through acquisitions of mid-cap companies. value names that also show strong growth. • Globally, high-quality dividend-paying stocks provide a real and stable income stream to investors in the current • Globally, we like high-quality dividend-paying low-yield environment. Furthermore, they give exposure to the long-term potential of equity markets while tending stocks. to suffer less in declining markets. Importantly, we focus not on those stocks with the highest yield, but instead look Strategic (one to two years) for high-quality dividend-paying stocks, which are still able to grow and have less risk of a cut to their dividends. • We expect value strategies to outperform the $ Positive scenario Prefer value, low quality and small caps European market over a multi-year time • Leading indicators continue to move higher, and risks related to the Eurozone debt crisis continue to subside. In this horizon. case, add deep cyclical value (cheap price/book, price/earnings) regardless of the sector, with high beta and high • Globally, mid-cap stocks provide attractive leverage. In such an environment, small- and mid-cap stocks should also perform well. A dividend strategy would be opportunities over the longer term. too defensive to outperform the market. 11 Negative scenario Prefer quality and large caps • The global economic picture deteriorates markedly. In this case, buy high-quality growth companies and large caps. Improving earnings revisions point to mid- Do not look for value opportunities, but be as defensive as possible with your equity exposure. Look to high-quality, cap outperformance dividend-paying stocks for yield. US mid-cap performance relative to large caps Note: Scenarios refer to global economic scenarios (see slide 8). What we're watching Why it matters Earnings revisions - see Watch for signs of improvement in earnings revisions (aggregated from stock level). An chart (three-month moving improved earnings outlook would cause investors to add more risk - influencing our average upgrades vs. preferences among equity styles. downgrades) US and Eurozone PMIs PMIs are important for earnings generation and preferences for value, growth and size. -2% 40% Key dates: 1 Mar, PMI manufacturing Eurozone (final); 1 Mar, US ISM ;in es 1...49 gala 1.01I Nn12 Jan 13 manufacturing — Mid cap yt wrap orkemarxe —Net eam.rgs teasels Source: FactSet, UBS; as of 15 February 2013 Note: Past performance is no indication for future returns. UBS For further information please contact CIO asset class specialist Christopher Wright, 22 Please see important disclaimer and disclosures at the end of the document. EFTA01089596 Section 2.B Asset class views Fixed Income 4 UBS EFTA01089597 Bonds overview Preferences (six months) Government bonds — Key points shim duration neutral long duration • We expect government bond yields to move sideways (US and UK) or towards slightly higher ranges (EUR and CHF) over the next six months, as seen in late 2011 and early 2012. This is likely to have a negative effect on most developed USD market government bond prices, and should result in low or slightly negative total returns. • Price fluctuations in the month ahead could stem from developments in the Eurozone and the US. These include EUR (DE) possible political uncertainties originating in Italy and Spain as well as renewed concerns about Greek debt sustainability over the course of the year. In the US, where the full fiscal cliff has been avoided and the debt limit GBP temporarily suspended, the focus has shifted to the negotiations on sequester spending cuts and to raising the debt limit in early summer. While we still expect a positive outcome following a brief government shutdown, these JPY uncertainties pose a significant downside risk to US growth. • Long-term yields have risen slightly and have the potential to increase somewhat over the next several months, but CHF we expect the move to be contained. Overall, we recommend avoiding long-term bonds and focusing on short- and medium-term maturities. CAD Corporate and emerging market bonds - Key points AUD • We prefer investment-grade (IG) and US high-yield (HY) corporate bonds over government bonds. A strong US corporate sector, the ongoing moderate recovery of the US economy and determined central bank support are likely to • new old further support credit segments. The partial solution to the US fiscal cliff and ongoing support from cyclical indicators underweight neutral overweight provide a positive backdrop for risk assets in H1 2013. • US HY bonds continue to offer attractive value. The risk premium over US Treasuries is still appealing. We think lower spreads are justified by the favorable default outlook and central bank action. Investor appetite for yield assets is expected to further support US HY bonds in the coming months. While low liquidity remains a key risk for HY bonds, Government current market liquidity is at a healthy level. US HY thus remains one of our preferred asset classes. bonds • While the potential for further spread tightening is limited for IG corporate bonds, they will likely continue to outperform government bonds. We thus keep our overweight position, expecting modest positive returns. Investment grade • Emerging market (EM) bonds should continue to benefit from better fundamentals than those of developed markets corporate over the medium term. However, valuations for EM sovereign bonds (in US0) are close to fair levels. For EM corporate High yield bonds (in USD), there is still potential for spreads to trend lower in the quarters ahead as these bonds should benefit bonds from a cyclical recovery in EM. We therefore maintain our preference for EM corporate bonds over government bonds from developed markets. Emerging market sovereign Emerging market corporate ■ new old Source: UBS CIO WM Global Investment Office czt(S” UBS For further information please contact CO asset class specialists Achim Peijan, and Daniela Steinbrink Mattei, 24 Please see important disclaimer and disclosures at the end of the document. EFTA01089598 US rates Duration preference: neutral Recommendations US 10-year (20 Feb): 2.0% (last month: 1.9%) UBS view US 10-year (six-month forecast): 2.0% Tactical (six months) • US 10-year yields increased slightly over the month, validating our forecasts. Improving domestic economic and • Yields have the potential to increase somewhat sentiment data combined with temporary suspension of the debt ceiling drove yields higher. This rise was further over the coming months. However, upcoming supported by the re-pricing of an earlier end to QE3 (FOMC minutes). fiscal tightening in the US, ongoing bond • Yields will trend sideways to slightly higher within their old ranges (1.8-2.2%) over a six-month horizon. We expect a market support from central banks and the final compromise to be reached regarding the sequester spending cuts as well as the debt ceiling in early summer. The lingering euro crisis are likely to limit the yield Fed's open-ended QE3 stimulus will enable the domestic economy to remain on a moderate growth path with increase. gradually declining unemployment. This represents a clear floor with little chance of retesting the historical lows of Strategic (one to two years) July (-1.4%). In addition, the reiterated willingness of the Fed to fall behind the curve in support of the domestic labor • Yields have significant upside potential over market will increase inflation expectations over the medium term. Consequently, higher breakeven inflation the next couple of years given the expectations could trigger a rise in longer-dated nominal yields in light of a further expansion of monetary stimulus extraordinarily low current level of real interest (QE3). This implies steeper yield curves by the end of the year. rates in particular. Thus clients with a longer • At the same time, US yields should remain capped over a six month horizon due to fiscal anxiety: short-term horizon should focus on bonds with short- and uncertainties in light of a possible temporary government shutdown during the debt negotiations in spring cannot be medium-term maturities. excluded. Furthermore, domestic growth is structurally weak and the US economy is still vulnerable to spillover effects from the Eurozone. US 10-year yields and forecasts 73 Positive scenario for US economy/negative scenario for US bonds US 10-year (six-month range): 2.3-2.6% • If US growth recovers with a rapidly improving labor market, then yields rise more significantly. 5% • The ECB buying short-dated Spanish and Italian sovereign bonds increases risk appetite, EU leaders make progress towards increased fiscal integration. This reduces the flight to quality and represents an upside risk to our forecasts. 4% Negative scenario for US economy/positive scenario for US bonds US 10-year (six-month range): 1.4-1.6% • US government shutdown beyond our expectations weighs on the cyclical recovery and is a drag on yields. 3% • A re-escalation of the European debt crisis burdens yields. Risks in the ECB framework remain, given that Spain has not yet made the necessary application to receive secondary market support from the ECB. In addition, Greek debt 2% sustainability could be questioned again in 2013. These uncertainties should result in peripheral spread widening. • The labor market fails to recover, increasing the likelihood of even more MBS and Treasury purchases or alternative 1% measures, and yields stay low or fall further. Note: Scenarios refer to global economic scenarios (see slide 8). 0% Feb-10 Feb-11 Feb-12 Feb-13 Feb-14 What we're watching Why it matters forecasts US 10Y Fed policy The Fed's assessment of the labor market determines its stance on quantitative easing and is key for yields. Key dates: 8 March, Nonfarm payrolls; 20 March, Fed FOMC Source: Bloomberg, U8S; as of 11 February 2013 meeting Note: Past performance is not an indication of future returns. Inflation expectations Higher breakeven inflation expectations could trigger a rise in longer-dated nominal yields Sequester spending cuts The extent of the sequester spending cuts will weigh on cyclical growth indicators. and debt ceiling UBS For further information please contact CIO asset class specialist Daniela Steinbrink Mattel, 25 Please see important disclaimer and disclosures at the end of the document. EFTA01089599 European rates Duration preference: neutral EUR (DE) 10-year (20 Feb): 1.6% (last month: 1.5%) Recommendations UBS view EUR (DE) 10-year (six-month forecast): 1.8% Tactical (six months) • Bund yields trended slightly higher over the month in response to a less dovish ECB and a normalization of LIBOR • If the ECB were to intervene with massive markets in response to a higher EONIA rate. Markets thus currently reflect stabilizing fundamentals as well as tentative purchases in the peripheral bond markets, signs of improving financial conditions. In particular, when compared to the all-time lows witnessed in August (-1.2%), Bund yields could rise more significantly. yields are trading at decisively higher levels. This is supported by the ECB's OMT program to act as a lender of last However, for the time being, we expect only resort. The OMT program has thus far improved money market conditions, reduced fragmentation as well as volatility moderate interventions that do no meaningful and boosted cyclical economic indicators as highlighted by Mario Draghi. This progress was reflected in the higher- harm to Germany's credit quality. than-expected 3Y LTRO prepayment, which resulted in higher short-term yields in particular. Strategic (one to two years) • Over a six-month horizon, we expect yields to rise slightly, returning to the old range (1.7-2%). This is due to the • Yields have significant upside potential over decline in excess liquidity, the reduction of tail risk provided by central bank backstops, and the expected mid-term the next couple of years. Thus investors with a improvement in quarterly EMU growth rates. Additionally, we continue to forecast no further rate cuts as the ECB long time horizon should focus on bonds with remains in wait-and-see mode. However, at the same time there is a cap on yields as growth is still structurally weak, short and medium maturities. and short-term uncertainties remain (US debt ceiling and sequester spending cuts, Spain, Italy). • In the UK, economic data should stabilize and we expect the BoE to remain on hold and 10-year yields to trade slightly higher. • In Switzerland, yields increased owing to stabilizing economic data. With less pressure on the CHF, we believe Swiss Europe 10-year yields and forecasts yields will continue to normalize. 5% 71 Positive scenario for German economy/negative scenario for bonds 10-year (6-month range): 1.9-2.3% • A moderate Eurozone economic recovery kicks in. Spain and Italy are ahead on their austerity commitments without 4% needing ECB support. This reduces safe-haven inflows, driving Bund yields higher. • Alternatively, Germany gives additional guarantees and the Eurozone moves towards a transfer union. ti Negative scenario for German economy/positive scenario for bonds 10-year (6-month range): 1.2-1.5% • Risks in the ECB framework remain, given the pending application of Spain for the OMT program and possible political turmoil in Italy. These uncertainties would result in peripheral spread widening. In addition, Greek debt sustainability could be questioned again in 2013. • US sequester spending cuts and a positional government shutdown beyond our expectations weigh on the cyclical recovery and are a drag on yields. • Further non-standard policy measures by the Fed are supportive for Bunds and speak for lower yields. Feb-10 Feb-11 Feb-12 Feb-13 Feb-14 Note: Scenarios refer to global economic scenarios (see slide 8) forecasts — UK 10Y Germany 10y —SvIte1atx110Y What we're watching Why it matters Source: Bloomberg. UBS; as of 11 February 2013 Political risks The US sequester spending cuts and debt ceiling in early summer, upcoming Italian Note: Past performance is not an indication of future returns. elections, Greek debt sustainability, and Spain delaying its application for assistance add to policy uncertainty. Central banks Key dates: Feb 27, early 2nd LTRO repayment 7 March, ECB meeting Economic variables Economic sentiment and credit conditions (ECB bank lending survey) Eurozone yield spreads The level of the peripheral spreads to German bunds reflects risk aversion and thus the safe-haven discount placed on Bunds. UBS For further information, please contact CIO asset class specialists Daniela Steinbrink Mattei, Teresa Sardena, and Nina Gotthelf, Please see important disclaimer and disclosures at the end of the document. EFTA01089600 Investment grade corporate bonds Preference: overweight Current global spread (20 Feb): 145bps (last month: 142bps) Recommendations UBS View Spread target (six-month): 140bps Tactical (six months) • We keep an overweight in IG corporate bonds • Global IG bond spreads have by and large reached our spread target by January 2013. Over the last month IG spreads over government bonds. moved broadly sideways while government rates increased, causing negative total returns. Still, IG corporate bonds • In Europe, internationally diversified have outperformed government bonds year-to-date. companies from non-financial sectors offer a • While the potential for further spread tightening is limited, IG bonds will likely continue to outperform government low but stable income stream for conservative bonds, offering low volatility and stable income. We expect a total return of approximately 1% over the next investors. six months. • Financials in the US are in a better position • IG bonds remain supported by our outlook for sluggish but positive global growth, extraordinary central bank than their European peers. support measures, and ongoing investor appetite for "safe" alternatives to low-yielding government bonds. • We recommend bonds from the lower IG • Non-financial corporates: While total yields are at record lows, the pickup over government bonds and money rating segments (88B and A) over higher-rated market rates is still attractive. Spreads are expected to remain around current levels. issuers. • Financial corporates: We believe that determined central bank action provides a backstop for financials and supports modest spread tightening. US banks benefit from a better economic backdrop than their European peers and are thus Strategic (one to two years) in a better position. Regulatory challenges will likely keep global financial spreads above past lows. • We prefer corporate over sovereign debt given how much more robust companies are 7I Positive scenario Spread target (six-month): 120bps compared to the structural weakness of public • Global growth accelerates more than expected. This could compress spreads closer to pre-crisis levels. However, in finance in many countries. this case, rising benchmark yields would likely lead to slightly negative absolute total returns over six months. Relative to government bonds, IG corporate bonds will do well. Yield spreads over government bonds (bps) Negative scenario Spread target (six-month): 380bps 700 • Main risks include a sharp slowdown of the US economy. Also, risks in the Eurozone persist (e.g. Greek exit, 400 Spain/Italy getting cut off from private funding). Still, we would be unlikely to see the spread levels reached in 2009, 500 given companies' superior balance sheet positions. An additional risk to European financial issuers is a bail-in of senior 400 bond holders, which we think is unlikely to happen before 2018. Note: Scenarios refer to global economic scenarios (see slide 8). 300 What we're watching Why it matters 100 Core market yields Developed market sovereign yields are only expected to increase gradually. A sudden rise and high volatility would hurt IG credit. Key dates: 7 Mar, ECB meeting; 20 Mar, Fed 0 2007 2000 1000 2010 2011 2012 201) FOMC meeting —us Irstsuntistads EURY•430.44.0424 Corporate fundamentals Robust corporate earnings and low leverage on corporate balance sheets should help prevent defaults. Source: Bloomberg, UBS; as of 18 February 2013 New issuance As financial companies continue to deleverage, net supply on the IG market is expected Note: Past performance is not an indication of future returns. to remain close to zero. A strong increase in net supply would be a technical headwind. UBS For further information please contact CIO asset class specialist Philipp Sch0ttler, 27 Please see important disclaimer and disclosures at the end of the document. EFTA01089601 High yield corporate bonds Preference: overweight Recommendations Spread USD HY (20 Feb): 492bps (last month: 493bps) Tactical (six months) UBS View USD HY spread target (six-month): 450bps • US HY corporate bonds offer an attractive • We expect low default rates, a favorable demand backdrop from yield-seeking investors, and the commitment of return outlook and should be overweight. major central banks to provide strong monetary support, which taken together provide a strong backdrop for US high • We prefer US over European issuers given the yield corporate bonds. We thus still see potential for tighter spreads around 450bps. The recent outperformance of high proportion of peripheral and financial equities combined with higher rates has led to moderate outflows from HY funds. But a "great rotation" from fixed issuers in the European HY universe, the income assets looks unlikely at this stage. poorer economic outlook in Europe and the • While total returns this year are very likely to fall short of the extraordinarily strong performance in 2012 (+16%) we strong decline in European HY spreads over expect attractive total returns of 4-5% over the next six months. recent months. • The default rate of US high yield issuers stood at 1.4% in January (US dollar par-weighted), far below its long-term New issuance set a new annual record in 2012 median of 4%. We expect only a very gradual increase in defaults through 2013. A heavy load of new issuance in at USD 365bn and maturities in the year ahead recent months means that HY companies will be faced with a lower risk of failed refinancing going forward (e.g. in have been reduced meaningfully. case of an unexpected economic slump). • Thus, US HY bonds continue to offer attractive value. The risk premium over US Treasuries is still at appealing levels. Strategic (one to two years) We think lower spreads are justified by the favorable default outlook and central bank action. The ongoing slow • We expect US defaults to remain at below- recovery of the US economy, healthy company balance sheets, robust earnings, and strong investor appetite for yield average levels for longer. Significant re- assets provide a good backdrop. US HY thus remains one of our preferred asset classes. leveraging is unlikely in the medium term. • We believe US high yield corporate bonds will 21 Positive scenario USD HY spread target (six-month): 350bps provide good returns both relative to other • Even in the positive economic scenario, spreads are unlikely to tighten to pre-crisis lows of below 300bps due to fixed income and for absolute return-oriented lower market liquidity for the asset class. Benchmark yields would rise in this scenario, limiting HY returns to around investors. 7% over 6 months. Negative scenario USD HY spread target (six-month): 850bps Yield spreads over US Treasuries (bps) • A US recession is the major risk for US HY bonds. Based on the robust state of the US corporate sector, we would not expect spreads to surpass 'usual' recession levels of around 1,000bps. Short-term spikes are possible due to liquidity suddenly drying up, but we would expect a quick normalization. Note: Scenarios refer to global economic scenarios (see slide 8). What we're watching Why it matters Credit quality/ Balance sheets are backed by high cash levels and low debt ratios. Against this backdrop default cycle the default rate will likely remain below its long-term average. Recent US company earnings were sufficient to maintain stable leverage and coverage ratios. New issuance For now, favorable conditions in the primary market have mainly been used for refinancing. More aggressive issuance activities should be monitored. 2007 2008 2000 2010 2011 2012 2013 80 11402 EUR 1•08812 Bank lending standards Bank lending provides an important source of funding. US banks continued to relax standards in 4Q 2012 according to the Fed's latest senior loan officer survey. Source: Bloomberg, UBS; as of 18 February 2013 Note: Past performance is not an indication of future returns. UBS For further information please contact OO asset class specialist Philipp Sch0ttler, 28 Please see important disclaimer and disclosures at the end of the document. EFTA01089602 Emerging market bonds Preference: oN ci NN C gin Recommendations EMBI GlobalICEMBI spread (20 Feb): 277bps / 316bps (last month: 265bps / 309bps) Tactical (six months) UBS View EMBI Global/CEMBI spread target (six-month): 250bps / 270bps • EM corporate bonds are particularly attractive • Spreads of emerging market (EM) sovereign bonds have widened slightly in recent weeks, with EM corporate bonds due to their favorable valuations, solid moderately outperforming EM sovereign bonds. We think that EM corporate bonds offer a more attractive fundamentals, and relatively short duration. opportunity for investors than EM sovereign bonds. The gradual recovery in EM that we expect over the coming We advise investors to focus on investment quarters should support the performance of EM corporate bonds more than that of EM sovereign bonds, and the grade bonds in the current environment. We shorter average duration of EM corporate bonds should offer better protection against rising US Treasury yields in the recommend taking profit on selected EM quarters ahead. Corporate bonds tend to outperform sovereign bonds during periods of accelerating growth. sovereign bonds. Please refer to our EM bond • However, absolute returns of EM bonds will be lower than in the past year, we think, as the room for spreads to list for issuer- and bond-specific guidance. tighten further has become more limited. We expect total returns of 2% for EM sovereigns and close to 4.5% for EM corporate bonds over the next six months. Strategic (one to two years) • EM bonds are attractive for longer-term 71 Positive scenario EMBI Global/CEMBI spread target (six-month): 235bps 1230bps investors looking for higher yields. • Yield stability in Europe's core markets and higher-than-expected growth in the US provide a favorable backdrop for • Local markets in Asia offer interesting opportunities for longer-term investors EM fixed-income spreads. In such an environment, issuers of lower credit quality would likely fare better. Average because of a supportive currency outlook. spreads could tighten to below 240bps in such an environment. Si Negative scenario EMBI GlobalICEMBI spread target (six-month): 555bps / 750bps • An environment of renewed escalating risk aversion in Europe, deteriorating EM funding markets, weakening EM sovereigns relatively expensive global growth prospects, and lower commodity prices could impact EM credit negatively. Liquidity in emerging compared to EM corporates market bonds could dry up and spreads could spike. Spreads of EM bonds over US Treasuries, in bps Note: Scenarios refer to global economic scenarios (see slide 8). 600 What we're watching Why it matters 500 400 Core market yields The direction of US Treasury and German Bund yields are important for EM fixed income spreads, especially for US dollar- and euro-denominated bonds. 300 Key dates: 7 Mar, ECB interest rate decision; 20 Mar, FOMC Rate decision 200 Capital flows The European debt crisis may lead to further periods of outflows and weaker prices, 100 which could offer attractive entry levels for investors. 0 - Monetary policy cycles Inflationary conditions and monetary policy remains a key topic for local currency bonds. Feb-I0 Aug-10 Feb-1I Aug-II Feb-12 Aug-12 We look for inflation data releases in key markets. Upcoming key policy rate decisions: — Emerging market sovereign bonds IEMBI Global) Russia (1 Mar), Brazil (6 Mar), Poland (6 Mar), Indonesia (7 Mar), Mexico (8 Mar) Emerging maker corporate bonds (CEMBI Broad) Source: JP Morgan, UBS; as of 12 February 2013 Note: Past performance is not an indication of future returns. (it UBS For further information please contact CIO asset class specialists Michael Bolliger, and Kilian Reber, 29 Please see important disclaimer and disclosures at the end of the document. EFTA01089603 Section 2.0 Asset class views Foreign Exchange $ UBS EFTA01089604 Foreign exchange overview Preferences (six months) Foreign exchange - Key points • The European Central Bank dampened the 'euro-phoria' at its February meeting as President Draghi implicitly put a underweight neutral overweight cap on further EUR strength, suggesting that further appreciation could affect the price level in the medium term USD and thus could lead to interest rate cuts. The euro looks expensive now, given political risks in Italy, Greece and Spain. We keep an underweight. EUR • We expect EURUSD to trade between 1.30-1.35 in the next months. An improved growth outlook after the partial solution to the US "fiscal cliff' and the fact that the US Federal Reserve is likely to continue its current QE program GBP until year-end would support a higher EURUSD. However, the uncertainty around the upcoming US debt ceiling and JPY budget negotiations, as well as uncertainty around Italian elections, suggest that the next move is to the lower bound around 1.30. CHF • The CAD weakened in January, as the Bank of Canada pushed expectations of first rate hikes further out. We see this SEK only as a short-term drag, as it doesn't change the general view that the BoC will be the first major central bank to start hiking rates. The CAD remains a favorite currency for the longer term. NOK • GBP has been the weakest G10 currency year-to-date, besides the yen. Market expectations for UK economic growth CAD are already subdued and negative data surprises should begin to fade. Also, the speculation about a change in the Bank of England's (BoE) mandate is overdone. We thus see potential for the pound to reverse the year-to-date NZD weakness and recommend an overweight in the GBP. AUD • EURCHF still trades above 1.23. We believe the EUR strength will only be temporary and don't see potential for an even higher exchange rate. A level above 1.25 is unsustainable as long as EUR 1-month deposit rates stay close to ■ new old zero and the ECB shows no intention of hiking rates. A normalization of the yield differential would be needed for a higher EURCHF. Source: UBS CIO WM Global Investment Office • Sweden and Norway stand out for their low debt-to-GDP ratios and current account surpluses. As a consequence, both the SEK and the NOK have appreciated on diversification inflows in recent years. The Swedish Riksbank is likely to abstain from further rate cuts, contrary to some market expectations. Furthermore, economic data has started to improve. We thus think the SEK remains an attractive target for currency diversification. • The yen depreciation has gone a long way; USOJPY is up to 94 from 80 (+17.5%) within about three months. But it started topping out at the beginning of February. We don't recommend adding further JPY short positions unless the government announces a very dovish new Bank of Japan governor. We stay neutral on the JPY. • For commodity currencies, the AUD and NZD continue to trade at the top of their well-established ranges. Consequently investors should stay somewhat cautious. Short-term, AUDUSD may fall a bit lower given the current weakness in the Australian domestic economy and the possibility of further policy rate cuts. Clients with a lot of AUD exposure should start diversifying into the NZD and CAD at current levels. • Our most preferred emerging market currencies are presently the KRW, SGD, RUB, MXN, BRL, PLN and MR. We also expect the CNY to appreciate gradually against the USD. Internationally marketable instruments (such as CNH, the offshore version of the Chinese currency traded in Hong Kong) have similar appreciation potential. UBS For further information please contact CIO asset class specialist Thomas Flury, 31 Please see important disclaimer and disclosures at the end of the document. EFTA01089605 G10 currencies Recommendations UBS View See table for current exchange rates and CIO forecasts • We continue to believe that the fair range for EURUSD is 1.30-1.35. Over the medium term, a recovery in the Tactical (six months) eurozone could lead to further upside. However, recent statements by ECB President Draghi put a cap on further EUR • We remain neutral on EURUSD as we expect upside. The immediate risks in the US might be limited, but a possible US rating downgrade could still lead to a short- the pair to trade between 1.30 and 1.35 in the coming months. term spike of the USO. • GBP remains our most preferred currency, • The GBP has weakened considerably year-to-date. As negative economic surprises should begin to fade and against an underweight in EUR. speculation about a change in the BoE's policy had been overdone, we believe in a rebound of the pound. • Downside pressure on the JPY has been strong recently. We expect a consolidation around USDJPY 90. Strategic (1 to 2 years) • We recommend that investors diversify from • The SNB has shown that it can defend the EURCHF floor, so 1.20 is fixed on the downside. However, despite the large USD and EUR exposures into minor recent move higher, we see any moves above 1.25 as unsustainable as long as the yield differential stays low. currencies. Structural financing issues weigh on all the major currencies. 21 Positive scenario FX targets: EURUSD >1.35 / EURJPY 125 • We continue to have a longer-term preference • A stronger-than-expected acceleration of global growth or further European integration would be EURUSD-positive. for the GBP, as it benefits from diversification The yen should get weaker as the Bank of Japan intervenes to weaken its currency by increasing its asset purchase out of the EUR. program. • The best diversifiers based on long-term 11 Negative scenario FX targets: EURUSD <1.25 / EURJPY 100 macroeconomic fundamentals are the CAD and the SEK. The AUD, NOK and CHF should • The European growth outlook would deteriorate again falling back into recession in 2013. The euro could rapidly fall only be added at better entry levels. below 1.25. A European debt default cascade (triggered by a disorderly euro exit by Greece or political uncertainty after Italian elections ) is a tail risk for the single currency. Risk aversion would lead to a USD and JPY rally. UBS CIO FX forecasts Note: Scenarios refer to global economic scenarios (see slide 8). 21-02-13 3M 6M 12M PPP EVROS° 1.3192 _1.30_ 1.32 1.34 1.30 What we're watching Why it matters USDIPY 93.3 Ern 88 90 79 Chinese growth We expect Chinese growth to gradually pick up. In the base case, a Chinese recovery USDCAD 1.019 0.97 0.94 0.92 0.95 should support the AUD in the medium term. If China's recovery disappoints, then risk- AUOUSD 1.024 1.02 1.02 1.02 0.76 unwinding would support the USD and the JPY vs. risk-taker currencies - especially GBPVSD 1.5221 1.65 1.01 1.70 1.66 AUD. N2DUSO 0.6339 0.62 0.62 0.62 0.61 European sovereign crisis, The main focus lies on the budget review in Spain and the Italian elections, which USDCHF 0.9313 0.93 0.92 0.92 1.01 ECB policy could both trigger an application for ESIVI/EC8 or at least dampen risk sentiment. EURCHF 1.2286 1.21 1.21 1.23 1.31 Key dates: 25 Feb, Italian elections; Mid-Feb (tbd, )Spanish budget review G8PCHF 1.4177 1.94 1.94 1.S6 1.70 EURJPY 123.07 114 116 121 102 US growth and Fed policy The decisions on spending cuts and the debt ceiling will shape up over coming weeks EURGEP 0.8664 0.79 0.79 0.79 0.77 response and it will be interesting to see how the Fed responds to any fiscal tightening. EURSEK 8A655 8.20 8.00 8.00 8.65 Key dates: Late March, debt ceiling and spending cut decisions EURNOK 7.4713 7.30 7.20 7.20 8.43 Source: Thomson Reuters, UBS; as of 21 February 2013 Note: Past performance is not an indication of future returns. SUBS For further information please contact 00 asset class specialist Thomas Flury, 32 Please see important disclaimer and disclosures at the end of the document. EFTA01089606 Emerging market currencies Recommendations UBS View See table for current exchange rates and ao forecasts Tactical (six months) • We continue to like emerging market (EM) currencies over a medium-term horizon. We think monetary policies of • Several EM currencies look attractive at current major central banks will remain loose for longer, whereas the easing cycle in several emerging markets is over. This levels and we advise investors to keep existing should support EM currencies relative to major currencies (USD, EUR, and JPY). Long-term investors should therefore holdings for further gains while increasing diversify into EM currencies, using surplus exposure in USD, EUR or JPY for funding. exposure to our currently preferred EM • In Europe, higher yielding currencies like the Polish zloty (PLN) and the Russian ruble (RUB) look attractive over the currencies (CNY, KRW, SW, MXN, PLN, RUB), medium term, but we remain cautious on the Hungarian forint (HUF). The Turkish lira offers an attractive carry, but using the EUR as our preferred funding source. the appreciation potential is severely limited. The South African rand (ZAR) is currently fair to attractively valued, but Strategic (1 to 2 years) investors should be willing and able to tolerate periods of volatility due to political uncertainty, a cyclical economic • We recommend EM currencies backed by slowdown or shifts in global sentiment. stable fundamentals to diversify currency • In Asia, we like the Korean won (KRW) for its relatively cheap valuation, the Singapore dollar (SGD) for the central exposure out of major DM currencies. bank's policy of gradual currency appreciation and the Chinese renminbi (CNY) for its stability. • Our long-term favorites include the Chilean • In Latin America, the Mexican peso (MXN) is still attractively valued at current levels and offers an attractive yield peso, Mexican peso, Czech koruna, Polish zloty, Chinese renminbi, Korean won, pick-up over the USD. However, near-term volatility seems likely, given event risks in the US and Europe. In Brazil, Malaysian ringgit and Singapore dollar. authorities will likely restart exchange rate market interventions if the Brazilian real trends below USDBRL 1.95. While the BRL has an attractive carry, we think structural imbalances point towards it weakening in the longer term. UBS CIO EM FX forecasts 71 Positive scenario > outperformance of EM FX against G4 currencies over a six-month horizon 21.02.2013 3-month 6-month 12-month • Macroeconomic data comes in stronger than expected and Europe stabilizes further. EM exchange rates could Americas appreciate swiftly against major currencies (USD, EUR, and JPY). USDBRL 1.96 2.05 2.00 1.98 USDMXN 12.7 12.5 12.4 12.0 Negative scenario > 5% depreciation of EM FX across regions against USD over a six-month horizon Asia • Global growth prospects suffer a prolonged deterioration and the European debt crisis intensifies. EM exchange USDCNY 6.24 6.22 6.20 6.15 rates could see a significant, although likely temporary, sell-off across regions. USDINR 54.4 54.0 53.0 52.0 Note: Scenarios refer to global economic scenarios (see slide 8). USDIDR 9'701 9'400 9'400 9'400 USDKRW 1085 1'100 1'080 1'050 What we're watching Why it matters USDSGD 1.24 1.21 1.20 1.18 Inflation dynamics Inflation dynamics are important for the forecasting of central bank policy rate EMEA in EM decisions. Monetary easing typically weighs on EM currencies, while rate hikes tend to EURPtN 4.16 4.20 4.10 4.00 be supportive. Upcoming key policy rate decisions: Russia (1 Mar), Brazil (6 EURHUF 291 300 300 300 Mar), Poland (6 Mar), Indonesia (7 Mar), Mexico (8 Mar) EURCZK 25.4 26.0 25.5 25.0 USIDIFtY 1.79 138 1.80 1.83 European sovereign crisis Setbacks in sentiment will likely lead to bouts of EM currency depreciation, providing USIDZAR 8.91 9.00 8.70 8.50 attractive entry points for longer-term investors. USDRUB 30.3 30.5 30.5 30.5 Growth Growth in the US, Europe and China is key for sentiment and growth prospects in EM. Source: Thomson Reuters, UBS; as of 21 February 2013 Key dates: 7 Mar, ECB interest rate decision; 20 Mar, FOMC Rate decision Note: Past performance is not an indication of future returns. cat UBS For further information please contact CO asset class specialists Michael Bolliger, and Teck Leng Tan, 33 Please see important disclaimer and disclosures at the end of the document. EFTA01089607 Section 2.D Asset class views NTAC: Commodities, Listed real estate, Hedge funds and Private equity *UBS EFTA01089608 Commodities overview Commodities - Key points Preferences (six months) • Broadly diversified commodity indices have delivered a moderate performance this year, up by less than 2.5% on undeove.ght neutral overweight average. The underperformance of the asset class versus other risky assets is mainly driven by the weakness in agricultural commodity prices. Since industrial activity and fixed asset investments in China should gain further Commodities momentum after Chinese New Year, the upward trajectory of some cyclical commodity prices is set to continue. total • The structural story for a higher gold price (6-month target USD 1,825/oz) remains in place, although investment demand shows not much willingness to chase a stronger price at present. Within the precious metals our preferred Precious positions relate to industrially sensitive metals like platinum, palladium and silver. Supply challenges in South Metals Africa and fewer Russian government stock sales are putting these metals in a sweet spot during 1H13. • The window for more pronounced setbacks in base metal prices is closing. On the back of stronger industrial Energy activity, more infrastructure investments and stronger credit growth after Chinese New Year, base metal demand should gather strength. Moreover, the drag from Europe on metal demand is likely to moderate, while the US adds marginally to global metal consumption. From this angle an expected price move of 10% is possible. The Base Metals strongest and most volatile performance should be visible in zinc and nickel, while copper and aluminum should deliver moderate but steady price increases as inventories get drawn down. • An array of supply curtailments, geopolitical concerns and improved forward looking macroeconomic data have Agricultural pushed crude oil prices to multi months highs. Despite this favorable news flow at first glance, we stick to our negative crude oil view. A stronger non-OPEC supply side in the months ahead and adequate OPEC output, should allow inventories to build. Demand growth in 1Q13 is expected to remain tepid as well. Our 6-month forecast le new old remains therefore unchanged at USD 110/bbl. Additional pressure on the energy sectors should come from US Source: UBS CIO WM Global Investment Office natural gas prices, which have room to drop to USD 3/mmbtu with less inventory withdrawals than envisaged by markets. Lower natural gas demand and a pick up in supply should provide the necessary downside pressure. • The poor performance of agricultural commodities is likely to continue. Although we see more prices weakness in the grains, investors should be aware of the structurally low US inventories in corn and soybeans. Thus, our bearish stance does come with considerable forecast risks, if harvest estimates starts the surprise negatively on the back of unforeseen weather conditions. An opposite price development should be visible in the sorts, where the severe price weakness in 2012 should have cut into investments and allow market surpluses to fade over the next 6-9 months. UBS For further information please contact CIO asset class specialists Dominic Schnider, or Giovanni Staunovo, 35 Please see important disclaimer and disclosures at the end of the document. EFTA01089609 Precious metals Recommendations Preference: neutral 1 Gold (20 Feb): USD 1,568/oz (last month: USD 1,684/oz) UBS View (gold) Gold six-month target: USD 1,825/oz Tactical (up to six months) • Platinum remains our most preferred precious • The performance of gold has not met expectations - market participants and ours - in recent months. With prices metal. Rising production costs in the high showing no sign of an uptrend, financial market interest in the yellow metal started to wane. single digits and a marginal production cost • The short-term market focus was on the technical picture: The uptrend from May last year met the consolidation base above USD 1,600/oz set the preconditions trend from last October. The combination of the broken May uptrend and lower-than-expected inflation data on a that stronger economic activity in 2013 will global level now lead us to change our short-term view. However, this short-term adjustment is not altering our long- cause an undersupplied market. We estimate a term structural view on gold, merely pushing out the timing for prices to trend higher again. market deficit of 4.5% for the full year and a • From a long-term perspective the metal's far most important competitor, 'paper money,' is still at risk as monetary price move into the range of USD 1800- policy is mingling with fiscal policy to secure growth. Expanding central bank balance sheets is not a cost-free exercise 1,850/oz. Since our call has closed in on our and will take a stronger toll on money's pricing power at some stage. We expect central banks to be cautious in price target, setbacks should be used to add tighten monetary policy conditions compared to what a prudent monetary policy approach would request. Hence, a new positions. Risk-seeking investors can opt time window in which negative real interest rates drop further should allow the gold price to reach our 6-month target for palladium, which should be in a deficit of almost 9% in 2013. With a 12-month forecast at USD 1,825/oz. at USD 925/oz palladium offers a higher 71 Positive scenario six-month target: USD 1,950/oz expected return, but with more risks. Strategic (1-2 years) • The need for the ECB to widen its balance sheet once again in order to prevent a Eurozone breakup. On the other • To protect investors' portfolios from hand, considerably higher US and EM inflation readings that lead to a further drop in real interest rates. unorthodox monetary policy measures, 11 Negative scenario six-month target: USD 1,250/oz holding some gold exposure is a viable and • Stronger fiscal adjustments in the US and a constant deceleration in China's economic activity causing fading price attractive strategy to hedge against excessive pressure. The Fed backing off from its current monetary policy stance by providing signs of higher interest rates. fiscal spending and monetary debasement of the USD, EUR and 1PY. What we're watching Why it matters Physical demand/supply - Review of gold purchases by central banks. Key dates: mid-May (WGC 1Q13 report) Short term oriented investors have reduced gold exposure, which could decline further - An initiative (20 Mar) in Switzerland that would force the SNB to hold 20% of its We expect gold futures positions to bottom out foreign reserves in gold. Impact of recent tax hike on Indian jewelry demand. at 10 mn ounces by non-commercial accounts - Supply wise, structural mining issues related to South Africa remain unsolved and 35 should command extra attention, especially for platinum and indirectly for palladium. 30 - With the gold price dipping below USD 1,650/oz, scrap supply should dry up and help 25 20 to balance the market as investment demand fails to increase. 15 Investment flow - In order to reach our target, demand for bars/coins and ETF products need to pick up 10 again. Moreover, outflows in gold futures positions by non-commercial accounts have 5 0 to reverse as well. At present, gold futures positions of non-commercial accounts stand .51 at around 13.7 mn ounces while gold holdings in ETF products are at 88 mn ounces. 00) (15) Monetary policy Key dates: 19-20 Mar Fed meeting, and monthly US and EM inflation readings nlay-O3 Nov-O4 May-O6 NO,-0] klay.O9 Nov-1O May-12 mica0 COMICC6 Sheri POSI0OnS - Net positions Source: Bloomberg. UBS, as of February 2013 SUBS For further information please contact CIO asset class specialists Dominic Schnider, Note: Past performance is not an indication of future returns. or Giovanni Staunovo, 36 Please see important disclaimer and disclosures at the end of the document. EFTA01089610 Energy Preference: neutral 1 Brent (20 Feb): USD 115/bbl (last month: USD 111/bbl) Recommendations UBS View (crude oil) Brent six-month target: USD 110/bbl Tactical (six months) • Brent and WTI prices rose to their highest level since May and September 2012 respectively due to a combination of • With OPEC in a good position to balance the improving macroeconomic data, rising geopolitical tensions in the Middle East/North Africa (MENA) and reduced oil oil market and demand likely to pick up at the supply from OPEC-12 (-0.6 to -1.0mbp in Jan13 vs. Nov12). Furthermore, speculative net-long positioning at NYMEX end of 1H13 and into 2H13, price setbacks in and ICE skyrocketed to record highs above 500mb. The crowded positioning holds the key for a firm price reversal, 1Q13 should be used to build up some longs at should the current positive sentiment turn. or below USD 105/bbl for Brent. Stronger oil • US petroleum oil demand declined by 2.5% y/y to 18.6mpbd in November 2012. Preliminary data for January showed consumption than envisaged by markets in the further weakening to around 18.3mbpd. Despite improvements in US economic leading indicators, we expect US oil latter part of 2013 makes the oil market more demand to remain largely stable, declining moderately by 0.lmbpd y/y in 1H13, and rising by 0.lmbpd y/y in 2H13. vulnerable to geopolitical concerns as OPEC • In China, tax changes should have incentivized higher refinery runs in 4Q12. This coupled with an ongoing inventory needs to step up crude oil production. build-up suggests that actual end user demand might not be as strong as production data would suggest. Strategic (3-5 years) • We therefore expect global oil demand of only around 0.8 mbpd y/y in 1Q13. Further, the crude oil supply picture To satisfy emerging market demand in the outside OPEC looks promising as well. In 2Q13 we expect crude oil production to increase by 1.1 mbpd y/y or more, long run, long dated crude oil prices around thereby reducing the need for OPEC oil supply marginally. Thus, we stick to our negative price bias in the absent of a USD 90-95/bbl are unlikely to secure the further escalation in the MENA region and target a price drop to USD 105/bbl for Brent in 1Q13. needed investments to keep supply growing. This gives strategically oriented crude oil 21 Positive scenario Brent six-month target: USD 140-185/bbl investors the opportunity to build up some • Iranian oil exports are subject to a complete embargo, draining another 0.75-1 mbpd out of global crude oil supply. long-term crude oil exposure over the next Alternatively, a military confrontation affecting the supply of crude oil via the Strait of Hormuz would be the ultimate three to five years. supply shock and require crude oil to be rationed on a large scale. II Negative scenario Brent six-month target: USD 75-80/bbl Financial investors are heavily positioned • Economic activity in the Eurozone does not stabilize and raises break up concerns, which would lead to meaningful Values in mn barrels weaknesses in global trade and crude oil consumption. A restoration of Iranian exports and a sharp increase in US tight 600 oil production would push oil inventories up firmly and weaken Brent prices towards USD 80/bbl. 500 400 What we're watching Why it matters 300 Middle Eastern tensions trans' nuclear amoitions coula escalate aver tne ultimatum trom tne In ana Israel expires in 200 1Q13 with no visible changes. Further implemented US sanctions on Iran could reduce Iran's 100 exports in the next months. We also track the crude oil flows in MENA countries. 0 (100) Supply Non-OPEC supply should rise driven by higher US and Canadian oil supply in 2013. Saudi (200) production levels are likely to stabilize at levels slightly above 9mbpd, keeping OPEC Jan 93 Jan-96 lan-99 lan-02 lan-05 lan-08 lan-11 production above the "call on OPEC in 1H13. • ICE Brent (Swap Dealers and Managed Money) • Spec. Accounts: Options Demand One-off factors have supported Chinese crude oil demand in 4Q12, likely to weigh on de- ESI:ec. Accounts: Futures mand in 1Q13. Improving economic indicators should support demand from 2Q13 onwards. Source: Bloomberg, UBS, as of February 2013 Oil market reports Key dates: 12 Mar, EIA Short-term energy outlook; 13 Mar, IEA Oil market report Note: Past performance is not an indication of future returns. UBS For further information please contact CIO asset class specialists Dominic Schnider, or Giovanni Staunovo, 37 Please see important disclaimer and disclosures at the end of the document. EFTA01089611 Base metals Recommendations Preference: neutral 1 Current (20 Feb) (last month): Copper USD 7,960/mt (7,963); Nickel USD 17,170/mt (17,190); Aluminum USD 2,065/mt (2,015) Tactical (six months) UBS View Six-month target: Copper. USD 8,800/mt; Nickel: USD 20,500/mb Aluminum: USD 2,250/mt • We see room for higher base metal prices over • Improved economic prospects have rendered some support to base metal prices in early 2013. That said, recent price the next 3-6 months. The return potential on a advances have largely been driven by optimism in broader markets and to a lesser degree by specific base metal sector level should be 10% with an expected fundamentals. Lingering concerns over stronger supply growth, higher levels of inventory and rather sluggish physical volatility of around 15% (UBS CMCI Industrial demand until now have hindered prices from taking off. Metals). The key drivers behind this call root • Nevertheless, a more pronounced acceleration in industrial activity should provide the necessary base for a true on stronger Chinese industrial activity and a demand pickup on the metal side. And here the focus falls on China, which holds the key in providing the needed general pull in EM metal consumption starting stimulus for base metal prices to appreciate another 10% over the next 3-6 months. March. The pick up in demand should be • Leading indicators for China, credit activity and corporate earns data are giving promising signals for fixed asset visible in lower LME warehouse inventories. investments and industrial activity after Chinese New Year. While some Chinese figures might be distorted due to the Strategic (two years) last year's Chinese New Year, an uplift in activity should be underway. Combined with a seasonal increase in EM base • One of the strongest price performers over metal demand and a lower demand drag from Europe, global inventories should start to come under pressure. the next two years could be zinc, as mine • Copper and aluminium, the two heavy weights when it comes to sector indices, are likely to appreciate modestly but supply tops out due to ageing mines in should see steady prices advances. Mine supply growth in copper should expand 6% yoy in 2013 and ample production 2014/15. In order to compensate for mine capacities in aluminum together with high physical premiums provide a firm supply backdrop. More strength is closures and structurally higher demand, new expected from 'smaller" metals like zinc and nickel where demand swings by China and supply challenges with regards zinc mine capacity will be needed. At current to refining activity or new mine additions hold the key to stronger price swings. price levels we are unlikely to see this expansion in supply. Hence we see prices trending towards USD 2,750/mt in the long 71 Positive scenario Upside potential for the sector: + 20% run. • China eases monetary policy aggressively, thereby allowing money growth to reach 20% y/y in 2013. Central banks and politicians stabilize economic growth in Europe and provide a lift to US industrial activity. A pick up in Chinese metal demand 11 Negative scenario Downside potential for the sector - 25% expected • Chinese authorities act too passively by keeping GDP growth on a constant deceleration path. An escalation of the Eurozone crisis or a military confrontation in the Strait of Hormuz could affect global trade and metal prices severely. The pre conditions for a pick up in investments 100% 150% What we're watching Why it matters 100% Demand - Hard economic data (IP and FM) from China has yet to confirm a pick up in metal 50% demand, suggested by leading indicators and financing conditions in January. - Better PMI readings from Europe as well as political risk events related to the region 0% Supply - Export activity of copper by Chile and Peru should be tracked closely in order to gauge -50% the expected improvements in supply. Moreover, we like to have a close eye on treatment •100% charges for zinc, as it will define the recovery in Chinese zinc output. And for nickel we Apr-0B Apr-09 Apr -ID Apr -II Apr-I2 focus on Chinese NPI production and supply disruptions of new nickel projects. — Chna all system financing total yoy 3rnmavg Economic data Key dates: 1-3 Mar, Chinese / US leading indicators; 9 Mar, Chinese IP and FAI Chna nantnal enterprise profits nay 3rnmavg data Source: Bloomberg, UBS, as of February 2013 Note: Past performance is not an indication of future returns. UBS For further information please contact OO asset class specialists Dominic Schnider, or Giovanni Staunovo, 38 Please see important disclaimer and disclosures at the end of the document EFTA01089612 Agriculture Preference: neutral 1 Current (20 Feb) (last month): Soybeans, USD 14.63/bu (14.14); Corn, USD 6.90/bu (7.31); Recommendations Wheat USD 7.40/bu (7.83) Tactical UBS View Six-month target: Soybeans, USD 12.8/bu; Corn, USD 6.2/bu; Wheat USD 6.95/bu • Investor with existing corn positions should • Despite two consecutive quarterly grains reports showing lower inventory levels, grains prices were not able to rise still hold on to their longs over the next back to levels seen during mid-2012. Beside the lack of supply disappointments as of late, the market has started to month. Demand rationing is still required to focus more on South America's solid crop prospects for the grains in the coming months. Even prevailing weather limit the drag on inventories in the short run. concerns related to Argentina's crop prospects failed motivate higher price until now. The expected upside potential for such a • For corn, some demand weakness is still required to secure minimal inventories for the start of the upcoming position is limited at around 10%. marketing year. Thus, there is still scope for higher corn prices towards USD 8/bu in the near term before the US Strategic harvest kicks in. In the case of soybeans, a solid increase in South American output within the next 2-3 months should • Our expected return outlook for the grains ease supply concerns, push global inventories meaningfully up and weigh on prices. Additional upward pressure on stands at around -7 % over the next 12 inventories and downward pressure on prices should come with a 92mn ton soybean harvest in the US. And lastly wheat, better supply prospects outside the US (India, Europe) and a lack of demand particularly for US exports should months. With grain prices at elevated levels lead to further price downside 1H 13. That said inventories in wheat are likely to increase the least in 2013/14. from an historical standpoint, the supply side • The poor performance of softs in 2012 partially continued in January this year. We think the severe price weakness in is very likely to expand considerably in 2013/14 2012 should have cut into investment activity, which should allow market surpluses to fade over the next 6-12 months. and pressurize prices over the next 6-12 At the same time prices are likely to bottom out during 1H13. Our top choice is a long position in sugar. months. Hence, we recommend no long positions over a 12-month horizon. • Positive scenario Corn six-month USD 10/bu; Soybeans six-month USD 19/bu • Downward revisions to South America's harvest would require additional demand rationing and lead to higher Soybean will be the most relieved grain prices. Poor soil moisture in the US could potentially undermine yield prospects for the grains in the coming quarters. from South America's upcoming harvest • Negative scenario Corn six-month USD 6/bu; Soybeans six-month USD 12.5/bu y/y change in production - Values in mn tons • Higher-than-expected South American crop and US export slowdown. Strong supply outlook for next year's crop due to higher acreage and normalizing yields. 10 What we're watching Why it matters USDA WASDE report The March WASDE report will focus on South American crop and US grains demand. Since 0 (monthly) there was no downward revision in Argentine wheat output; we can expect some supply cuts in wheat and further downward revisions in corn output. Key date: 8 Mar US grains stock report Since the latest stock quarterly report has shown less demand rationing than expected; (quarterly) demand during Dec'12-Feb'13 is likely to be higher as well. Key date: 28 Mar 201011 20140121012/13 1010F11 2014012 2012/1 3E 201011 2011/12 2012/13E 5e•••• Can When Prospective planting Prospective planting report should provide guidance for all grains planting acreage. Corn •MjecOns nod report (Annual) and soybeans acreage will be crucial to watch. Key Date: 28 Mar Source: USDA. UBS, as of February 2013 Note: Past performance is not an indication of future returns. COT (weekly, Friday) Investors' net-long positions in grain futures remain stable at high levels. UBS For further information please contact CIO asset class specialists Dominic Schnider, or Giovanni Staunovo, 39 Please see important disclaimer and disclosures at the end of the document. EFTA01089613 Listed real estate Preference: neutral UBS Global Index DTR (20 Feb): 1,660 (last month: 1,619) Recommendations UBS View UBS Global Index DTR (six-month target): 1,680 Tactical (six months) • In the current environment we continue to recommend a neutral stance. Listed real estate's valuation is slightly • We continue to recommend to hold global expensive versus equities whereas it offers a favorable valuation relative to corporate bonds. Yet, we continue to see listed real estate at benchmark. Yield gaps still low financing costs, low supply and a good yield pick-up relative to corporate bonds as REITs are expected to continue speak in favor of the asset class against bonds, to grow their dividend yield payout in 2013. whereas the asset class is slightly expensive • Loose monetary policies in the developed world are keeping refinancing rates low, providing cheap financing for relative to equities. Another supportive factor REITs and supporting ongoing slight value appreciation. We see evidence of listed real estate companies refinancing is the current low interest rate and low growth their debt at lower yields and with longer durations. The global supply is still comparatively low. Slightly improved environment along with strong earnings leasing activities should help rents to increase slightly. Global REITs offer a good yield pick-up relative to IG corporate stability and income visibility. We maintain an credit across all major markets. Asian bias and are slightly underweight in UK • We maintain our preference for Asia over the UK on valuation and over Continental Europe, where market and continental Europe based on soft fundamentals are still comparatively weak and rental growth is at risk despite the fact that tail risks have diminished. fundamentals. The Hong Kong and Singapore governments continue to fight the overheating residential property markets by various Strategic (1-2 years) measures that should affect developers, while Chinese developers expect an ongoing rebound in markets. • The asset class is expected to deliver comparatively solid return on investment. 21 Positive scenario UBS Global Index DTR (six-month target): 1,760 Refinancing conditions are supportive and we • Ongoing reflationary monetary policies across the world push investors towards risky assets and the expectation of an expect gradually higher payout ratios coupled increase in inflation favors real estate as an inflation hedge, while attracting more loss-making bond investors. Real with portfolio optimizations. Balance sheets of estate provides a good exposure to the recovery with a beta over 1. listed companies are increasingly healthy. II Negative scenario UBS Global Index DTR (six-month target): 1,400 Weak economic growth and rightsizings limit • Global growth rates disappoint investor expectations and new recession risks trigger a tightening of credit standards rental income growth. that would cut real estate companies from the capital market, making listed real estate more dependent on bank financing. Real estate underperforms global equities. Note: Scenarios refer to global economic scenarios (see slide 8). Our market preference (six months) For listed real estate relative to global real estate' What we're watching Why it matters Global transaction Global real estate markets delivered around USD 440 billion in commercial transactions in Current most Current least volumes and rental 2012. Volumes should reach USD 500 billion in 2013, with upside in Asia and in the best preferred preferred growth in direct markets secondary US markets. Increased optimism translates into renewed growth in leasing -t.na <trig Lards—ds Ccntr'enta activities with modest prime rent increases by 2-3%. A shortage of high quality and low .apan Pr.:pert./ levels of construction support a decreasing office vacancy rate to below 13%. :apan RE:Ts Capitalization rates and We do expect capitalization rates to stay supportive at low levels or to only slightly rental yields decrease. Rental yields have already been pushed down by decreasing bond yields but AAtralla they remain favorable compared to history. A flat interest curve continues to help long- • This is our relative preference within the global real estate term refinancing in a low-growth environment despite the recent upturn in rates. markets based on U8S Global Real Estate Index domestic total return, which is not the overall sector view Credit markets and Lending conditions are still challenging for developers and private investors, which is Source: ores, as of February 2013 financing costs supportive for public companies that have very good access to credit and capital. Note: Past performance is not an indication of future returns. UBS For further information please contact Clo asset class specialist Thomas Veraguth, 40 Please see important disclaimer and disclosures at the end of the document. EFTA01089614 Hedge funds Recommendations UBS view Prefer relative value and equity long/short • HF managers attempt to capture most of the upside of risky assets while limiting drawdown. Capital protection is Strategic (1-2 years) crucial to the process as large losses are detrimental to the rate at which capital compounds. Some HF strategies have • Recommendation: We recommend equity shown to be less tied to stocks and bonds, offering important diversification in times of equity distress and rising long/short and relative value strategies. We are interest rates. becoming more positive about global equities • The recovery of the US housing market and cyclical upswings in most regions, with China and the rest of Asia with intra-stock correlations falling, an rebounding strongly, are now underway. These trends benefit equity long/short, notably net long. Falling intra- environment conducive to equity long/short stock correlations add to the positive environment for bottom-up fundamental equity long/short strategies. strategies. The stable macro economic • For relative value, the stable macroeconomic backdrop supports (non-treasury) spread products such as corporate backdrop and diminishing competition from bonds, emerging markets and securitized products (e.g. residential mortgage-backed securities). Long/ short credit bank propriety traders help relative-value managers could allocate away from duration-sensitive products over time into securities not tied to the interest rate arbitrageurs. cycle. Market participant numbers have declined significantly following the adoption of the Volcker rule, which Value proposition: Hedge funds should forced firms to exit from propriety trading desks conducive to fixed income arbitrage strategies. achieve robust performance over an extended horizon while displaying limited volatility vis-à- 21 Positive scenario Prefer equity long/short and event-driven vis equities and other risky assets. Hedge funds • Robust economies should drive up risky assets, including equities, lower intra-stock correlation and volatility, and try to minimize downside losses in adverse boost the I= cycle. These developments should help bottom-up fundamental strategies such as equity long/short market conditions (through active risk management), which plays a crucial role in and event-driven managers the most. wealth appreciation. Similarly, hedge fund SI Negative scenario Prefer trading (Global Macro + CTA) managers attempt to capture most of the • Short-term reversals due to central bank interventions and stimulus effects continue to plague the market - an upside of risky assets owing to a valid value obstacle for trend-following managers. Still, unmanaged European deleveraging (or the US fiscal deficit) could proposition. threaten risky assets. Trading can do well if such a scenario unfolds. Note: Scenarios refer to global economic scenarios (see slide 8). Performance, comparison What we're watching Why it matters Global equity direction/ The outlook for global equities is an important HF performance driver. The economic economic cycle cycle affects strategies differently. • Correlation Correlation is an important performance/alpha driver for equity long/short, the primary HF strategy by assets under management. Leverage Gross and net leverage are key to monitoring risk. Volatility The direction influences certain HF strategies (e.g. convertible arbitrage). Liquidity Important in particular for large, less nimble HFs, as it enables them to enter and exit a% 3% (ft 1% A 4% h 0% 4% I" WI 0% their strategies. Source: HFRI, Bloomberg, as of 31December 2012 Regulation Volcker rule, USCITS III/IV Note: Past performance is not an indication of future returns. UBS For further information please contact CIO asset class specialist Cesare Valeggia, Please see important disclaimer and disclosures at the end of the document. EFTA01089615 Private equity Recommendations Prefer small-/mid-cap buyouts In US/emerging markets; UBS View distressed debt in Europe Strategic (1-2 years) • The current economic environment that • Global volume has continued its downward trend since 2010, down 3% on 2011, and still a heavy 41% below includes global deleveraging, banking the peak achieved in 2007. However, H2 2012 was up 13% vs. H1, driven by a strong fourth quarter, the highest figure disintermediation in Europe and emerging in two years, showing improved confidence for deal makers. Private equity investors are also increasingly active again, market growth offers attractive opportunities with deal volumes in H2 2012 up 40% vs. the first half of the year. Exit activity also continues at a healthy pace, with for illiquid private equity strategies. diversified private equity investors obtaining attractive distributions from their mature portfolios. Private equity preferences • We prefer buyout strategies in North America, given reasonable valuations, liquid debt markets and our house view • Global private equity secondaries to of economic outperformance vs. Europe. Emerging markets offer compelling opportunities for PE investors, especially capitalize on regulation-driven sales by banks outside the main hubs (China, Brazil), which have become expensive. Direct lending to companies is also attractive in and insurance companies at attractive Europe, where debt markets are less liquid and still dominated by banks. discounts of 15-20% to net asset value. • Direct lending to companies in Europe, 11 Positive scenario Prefer small-/mid-cap buyout and secondaries where debt markets are less liquid than in the • An abating Eurozone debt crisis and improved business confidence would increase deal flow and exit opportunities US and still dominated by banks, which are for private equity managers, but would also increase entry prices. In such a positive scenario, we would perceive reducing lending. commitment strategies to secondary funds as attractive for building exposure to an invested private equity portfolio. • Growth and buyout capital in emerging Negative scenario Prefer distressed debt markets, to access superior growth and attractive consumer dynamics. • A renewed escalation of the debt crisis would significantly impact deal activity, the availability of debt and company • Within real assets, we like opportunistic owners' willingness to sell. At the same time, it would offer even more attractive opportunities within distressed strategies in US real estate and lending strategies and lower entry prices for long-term private equity investors. strategies within European commercial real Note: Scenarios refer to global economic scenarios (see slide 8). estate, which are attractive as banks shrink their loan portfolios. What we're watching Why it matters Credit markets In 2012, leveraged loan issuance, an important ingredient of PE activity, grew 34% y/y in the US, but fell by more than 34% in Europe. The US debt market is much deeper Investment preferences (new PE commitment than Europe's, raising over EUR 360bn of leveraged debt while Europe raised only EUR strategies) 29bn with more restrictive debt structures. Current most preferred Curter t leas: Exit activity Exit activity is an important indicator of the health of the PE market and a key return strategies preferred strategies driver for investors. Despite the difficult macro environment, 4Q 2012 distributions from portfolio sales (USD 73bn) have held up, and grew >65% yoy. Secondaries (global) Large-cap buyout (Europe) Prices for LBOs Average purchase prices for new buyouts in the US are at 8.3x EBITDA (full-year 2012 Direct lending (Europe) Venture capital (Europe) figures), in line with the 10-year average (8.2x); Europe is more expensive (9.3x), 5% Small-cap buyout (Latin above 2011 and 10% above the 10-year average (8.5x). America, South-East Asia) UBS For further information please contact OO asset class specialist Stefan Bragger, Pitatit see important disclaimer and disclosures at the end of the document.42 Note: We emphasize the equal importance of fund manager selection and the commitment strategy. Please note that private equity is an illiquid asset clan and must be held at least until the end of the fund (IOf years). Please note that UBS might not have a product available which reflects cur UBS OO private equity recommendations. Private equity is only suitable for qualified investors (a USD 5m investable assets). EFTA01089616 Contact list UBS WM Global Chief Investment Officer Alexander Friedman UBS WM Head of Investment Mark Haefele UBS CIO WM Investment Office Asset Allocation Advisory Asset Allocation Discretionary Themes / UHNW Alternative Investments Research Co-Head Mark Andersen Mads Pedersen Simon Smiles Andrew Lee Loris Centola Research Co-Head Philippe G. Miller UBS CIO WM Regional Chief Investment Officers Europe Switzerland Asia-Pacific Asia-Pacific (South) Emerging Markets Andreas Hofert Daniel Kalt Yonghao Pu Kelvin Tay Jorge Mariscal UBS 43 EFTA01089617 Disclaimer U8S CIO WM Research is published by Wealth Management & Swiss Bank and Wealth Management Americas, Business Divisions of 1185 AG CUBS) 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. 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