Financial Pacific - S&p 500 looks attractive at 11.0x forward earnings (third party)

UBS Investment Research

US Equity Strategy

3Q11 Valuation Opportunities Chart Pack

S&P 500 Looks Attractive at 11.0x Forward Earnings With the market down substantially, the S&P 500 now carries an 11.0x forwardP/E. Such a multiple is extremely low under almost any economic scenario short ofa double-dip recession. As such, we believe stocks present an attractive buyingopportunity at current levels.

Cyclical Stocks Appear to Offer Superior Value Since mid-February, the market has rotated towards defensive stocks, reflectinggrowth and macro concerns. However, over this same period, NTM earningsestimates have risen by a greater amount for more economically-sensitive names. As a result, cyclical stocks have become substantially cheaper on both an absoluteand relative basis.

Valuation Framework While multiples appear depressed broadly, the purpose of this chart pack is toidentify P/E disparities based on UBS’s proprietary “double-relative” valuation framework. This approach compares each sector’s relationship to the market todayversus its history. Please see the appendix for calculation details.

Greatest Opportunities At the sector level, Materials and Energy now look attractively valued, as do Tech,Industrials, and Financials. Telecom and Utilities look by far the most stretched. Inour view, attractively valued sub-sectors include Transportation within Industrials,Semis within Tech, Autos within Discretionary, and Banks within Financials.

Global Equity Research

Americas

Equity Strategy

Investment Strategy

29 August 2011

www.ubs.com/investmentresearch

Jonathan Golub, CFA

[email protected]

+1-212-713 8673

Manish Bangard, CFAStrategist

[email protected]+1-212-713 3036

Daniel MurphyStrategist


Vishal PatelAssociate Strategist


Thomas M. Doerflinger, Ph.D.Strategist


Natalie Garner, CFAStrategist


Exhibit 1: Sectors — Overvalued/Undervalued

-2.2

-1.0 -0.9 -0.7 -0.7

0.2

1.3 1.5

2.7 2.9

MAT TECH IND EN FIN DISCR HC STPLS TCOM UTIL

P/E

Mu

ltip

le P

oin

ts

Cyclicals Non-Cyclicals

Overvalued

Undervalued

Source: Standard & Poor’s, Compustat, Thomson Financial, FactSet, and UBS

This report has been prepared by UBS Securities LLC ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 25. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

US Equity Strategy 29 August 2011

UBS 2

Key Takeaways Market Valuations (pages 3-4)

Valuations Near 2008 Crisis Lows. During the financial crisis, multiples collapsed to a trough of 10.2x forward earnings. Stocks reached a similar level — 10.4x — on August 22, reflecting recessionary concerns. Although stocks are trading higher today at 11.0x, they are still down significantly from the end of April. However, we believe a recession will not materialize over the near term. As such, stocks present an attractive buying opportunity at current levels, in our view.

Recessionary Fears Driving Multiples. For much of the past decade, stocks multiples had primarily been anchored to corporate bond yields. However, this relationship broke down in late 2009 as the market began to discount slower long-term growth. Since April, the disparity between bond yields and earnings yields has widened further, we believe reflecting near-term recessionary fears.

P/E Dispersion Remains Extremely Tight. During the internet bubble, P/Es were widely varied, with valuations for the Technology sector more than triple those of Utilities. However, the dispersion of multiples came down sharply following the bubble’s burst and has continued to gradually decline since then.

Cyclicals vs. Non-Cyclicals (page 5)

Cyclical Stocks Compellingly Valued. Since mid-February, the market has been led by defensive stocks. At the same time, NTM earnings estimates for more economically-sensitive names have risen by a greater amount. As a result, cyclical stocks have become far cheaper on both an absolute and relative basis. We see this trend reversing.

Absolute and Relative Valuations — Sector Details (pages 6-9) Relatively Cheap: Materials, Transports, Semis, Banks, and Autos. Using UBS’s proprietary relative valuation

framework (described in the box below), we gauge relative P/Es of industry groups within each S&P 500 sector. On this basis, we believe a few groups appear particularly attractive: Materials broadly, Transportation within Industrials, Semis within Technology, Banks within Financials, and Autos within Discretionary.

Absolute Valuation Changes. Changes in P/Es are the result of movements in both price and earnings. Segments within the market that have seen significant price declines despite large EPS revisions are likely to rebound should confidence in the economy be restored. While we prefer to look at valuations on UBS’s proprietary “double-relative” basis, the following groups have experienced the largest P/E declines: Capital Goods, Transports, Media, Autos, REITs, and Insurance.

Relative Valuations — Sector and Industry Group Histories (pages 10-22) Historical Valuation Trends. Groups of stocks can stay cheap or expensive for extended periods of time. As such,

we think it is instructive to analyze valuation trends for each sector and industry group over longer-term horizons. Using this analysis, all of the cyclical sectors appear attractively valued with the exception of Consumer Discretionary. More defensive sectors, however, all appear expensive — Telecom and Utilities in particular.

UBS’s Proprietary Relative Valuation Framework

The goal of our valuation framework is to determine whether each S&P 500 sector is undervalued or overvalued relative to the overall market in the context its history. For example, over the past three years, Utilities has traded at 0.7 multiple points below the market, while Technology has traded 1 multiple point above. At present, Utilities is 2.1 multiple points above the market, while Technology is trading 0.1 multiple points below. This would suggest Utilities is overvalued, while Technology is undervalued. Using statistical measures, we are able to quantify these discrepancies to identify investment opportunities. Full details are provided in the appendix.


UBS 3

Market Valuations

Exhibit 2: S&P 500 P/E

5

10

15

20

25

83 87 91 95 99 03 07 11

Avg: 14.8x

11.0x

Source: Standard & Poor’s, Thomson Financial, FactSet, and UBS

Exhibit 3: S&P 500 E/P vs. Baa Yields

5

6

7

8

9

10

04 05 06 07 08 09 10 11

Earnings Yield ►

▲ Baa Yield

P/E Anchored to Baa Bond Yields

Slower Growth

Recession Fears

Source: Moody’s, Standard & Poor’s, Thomson Financial, FactSet, and UBS

While stocks carry an 11.0x forward P/E, this is not without precedence. The S&P 500 P/E was 7.5x in 1984. Multiples have fallen nearly 60% since peaking at 25.1x in 1999.

Between 2004 and 2009, stock multiples anchored on corporate bond yields. This relationship broke down in November 2009 — reflecting long-term growth concerns. We believe the current disparity in multiples is driven by fears of recession and should narrow to levels seen earlier this year.


UBS 4

Market Valuations

Exhibit 4: S&P 500 P/E Dispersion

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

97 99 01 03 05 07 09 11

P/E dispersion extremely tight

Source: Standard & Poor’s, Thomson Financial, FactSet, and UBS Note: P/E Dispersion defined as the standard deviation of S&P 500 sector P/Es divided by the S&P 500 index P/E.

Exhibit 5: Sector P/E Comparisons 2001 2005 Now

Telecom 18.9 13.7 15.4

Staples 18.8 17.2 13.5

Utilities 11.5 14.2 13.1

Discretionary 26.2 16.9 13.1

Industrials 20.7 16.1 11.3

Technology 36.7 18.8 10.9

Health Care 24.7 17.2 10.7

Materials 22.5 14.7 10.6

Energy 19.2 9.7 9.2

Financials 14.4 12.0 9.2

S&P 500 20.7 14.5 11.0

High-to-Low 25.2 9.1 6.2 Source: Standard & Poor’s, Thomson Financial, FactSet, and UBS

Since the tech bubble, the dispersion of stock multiples has narrowed considerably.

At the end of 2001, sector P/Es ranged from a low of 11.5x (Utilities) to a high of 36.7x (Tech). Today, they range from 9.2x (Financials) to 15.4x (Telecom). Accordingly, the high-to-low disparity has fallen from 25.2x to 6.2x.


UBS 5

Cyclicals vs. Non-Cyclicals

Exhibit 6: Forward P/E

10

11

12

13

14

15

16

Mar-09 Aug-09 Jan-10 Jun-10 Nov-10 Apr-11

◄ Cyclicals

◄ Non-Cyclicals

10.4x

12.3x

Source: Standard & Poor’s, Compustat, Thomson Financial, FactSet, and UBS Note: Cyclicals include Energy, Materials, Industrials, Consumer Discretionary, Financials and Technology while Non-Cyclicals include Consumer Staples, Health Care, Telecom, and Utilities.

Exhibit 7: Forward EPS

40

48

56

64

72

80

Mar-09 Aug-09 Jan-10 Jun-10 Nov-10 Apr-11

25

30

35

40

45

50

◄ Cyclicals

Non-Cyclicals ▼

78.8

29.0

$ of EPS

71.9

28.1

Feb 2011

Source: Standard & Poor’s, Compustat, Thomson Financial, FactSet, and UBS Note: Cyclicals include Energy, Materials, Industrials, Consumer Discretionary, Financials and Technology while Non-Cyclicals include Consumer Staples, Health Care, Telecom, and Utilities.

In January 2011, cyclical sectors carried a 0.9x multiple premium to defensive groups. This relationship has reversed, with more economically-sensitive sectors presently trading at a 1.9x discount.

Much of the shift in relative multiples between cyclical and defensive shares is the result of a market rotation. NTM earnings estimates have risen for more economically-sensitive stocks over this period as well.


UBS 6

Absolute P/E Changes — Sector Details

Exhibit 8: April 29 (Market Peak) to Today Forward P/E % Chg — Apr 29 to Now

Apr 29 Now Change Price NTM EPS

Cyclicals

Industrials 15.2 11.3 -3.9 -20.7 7.0

Capital Goods 14.9 10.8 -4.1 -22.0 7.4

Capital Goods x GE 15.1 11.0 -4.1 -21.5 7.6

Transportation 16.2 12.7 -3.5 -16.1 7.0

Commercial Svcs 16.3 13.6 -2.7 -15.9 0.2

Materials 13.8 10.6 -3.2 -16.5 8.4

Financials 11.8 9.2 -2.6 -21.3 1.5

Real Estate 45.2 40.0 -5.2 -2.3 10.5

Insurance 11.7 8.5 -3.2 -22.2 7.4

Banks 11.3 8.2 -3.1 -19.7 10.0

Diversifieds 10.5 8.2 -2.3 -25.2 -4.5

Energy 12.1 9.2 -2.9 -19.6 5.0

Discretionary 15.5 13.1 -2.4 -12.1 3.8

Media 14.6 11.2 -3.4 -20.0 5.0

Autos 10.1 6.8 -3.3 -28.4 6.7

Durables & Apparel 16.0 14.2 -1.8 -9.6 2.2

Retailing 17.2 15.6 -1.6 -8.8 0.7

Consumer Svcs 17.2 16.0 -1.2 -0.8 6.6

Technology 13.2 10.9 -2.3 -12.1 6.0

Semis 12.4 9.6 -2.8 -21.1 1.9

Software 13.9 11.8 -2.1 -10.8 5.5

Hardware 12.5 10.4 -2.1 -10.5 8.2

Non-Cyclicals

Health Care 12.2 10.7 -1.5 -9.5 3.4

Healthcare Svcs 14.1 11.4 -2.7 -12.8 7.5

Pharma & Biotech 11.3 10.3 -1.0 -7.6 1.6

Telecom 16.8 15.4 -1.4 -8.2 0.1

Staples 14.5 13.5 -1.0 -4.6 2.7

Food Retailing 13.4 12.0 -1.4 -7.3 3.5

Food, Bev & Tob 14.9 13.9 -1.0 -3.4 3.4

Household Prod 15.2 14.7 -0.5 -4.2 -0.5

Utilities 13.3 13.1 -0.2 -1.0 0.4

S&P 500 13.3 11.0 -2.3 -14.0 4.1 Source: Standard & Poor’s, Compustat, Thomson Financial, FactSet, and UBS Note: Analysis based on companies in the S&P 500 on both April 29 and August 27.

The recent shift in multiples is the result of both price and EPS changes. The areas that have seen the greatest multiple contraction are likely to snap back when confidence is restored.


UBS 7

Relative Valuation — Sector Details

Exhibit 9: Industrials – Overvalued/Undervalued

-0.9

-1.4

-0.8

0.5

Industrials Transportation Capital Goods CommercialServices

P/E

Mu

ltip

le P

oin

ts

Overvalued

Undervalued

Source: Standard & Poor’s, Compustat, Thomson Financial, FactSet, and UBS Note: Analysis performed on a 36-month rolling basis.

Exhibit 10: Technology – Overvalued/Undervalued

-1.0

-4.7

-1.1

-0.4

Technology Semis Hardware Software

P/E

Mu

ltip

le P

oin

ts

Overvalued

Undervalued


U.S. Industrials are dominated by later stage stocks. As a result, the group has looked expensive for much of the recovery. The group has been especially hard hit since April as short-cycle names have disappointed.

While each of the Tech groups has experienced negative price movements, Semis have underperformed Hardware and Software by more than 10% over the past four months.


UBS 8


Exhibit 11: Financials – Overvalued/Undervalued

-0.7

-3.2

-1.7

0.3

2.3

Financials Banks DiversifiedFinancials

Real Estate Insurance

P/E

Mu

ltip

le P

oin

ts

Overvalued

Undervalued


Exhibit 12: Discretionary – Overvalued/Undervalued

0.2

-3.5

0.0

0.6

1.4

1.9

Cons.Disc.

Autos Media Retailing Durables &Apparel

ConsumerServices

P/E

Mu

ltip

le P

oin

ts

Overvalued

Undervalued


Banks have been poor performers since April, but they have also had some of the highest EPS revisions. Given their more defensive nature, Insurance companies currently look more overvalued than the rest of the Financials sector.

Autos have underperformed the S&P 500 by 14% since the market’s 2011 peak, despite an NTM EPS increase of 6.7%.


UBS 9


Exhibit 13: Staples – Overvalued/Undervalued

1.5

0.7

1.5

1.9

Cons. Staples Food & StaplesRetail

HouseholdProducts

Food, Bev. &Tobacco

P/E

Mu

ltip

le P

oin

ts

Overvalued

Undervalued


Exhibit 14: Health Care – Overvalued/Undervalued

1.3

1.0

1.4

Health Care Health Care Equipment Pharma & Biotech

P/E

Mu

ltip

le P

oin

ts

Overvalued

Undervalued


Food, Beverage, & Tobacco companies have been among the best performing groups since April. However, they have experienced less than average EPS revisions.

Both Health Care subgroups currently appear overvalued.


UBS 10

Relative Valuation — Sector Histories

Exhibit 15: Industrials vs. Technology

-2.4

-1.4

-0.4

0.6

1.6

2.6

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-2.3

-1.4

-0.5

0.4

1.3

2.2

◄ IndustrialsTechnology ►

Overvalued

Undervalued

Source: First Call, Standard & Poor’s, FactSet, and UBS Note: Analysis performed on a 36-month rolling basis.

Exhibit 16: Consumer Discretionary vs. Financials

-1.2

-0.2

0.8

1.8

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-2.0

-0.6

0.8

2.1

◄ Discretionary

Financials ►

Overvalued

Undervalued


Industrials valuations have come down sharply. Tech looks cheaper than the broad market.

Financials are more than one standard deviation below their historical valuation.


UBS 11


Exhibit 17: Energy vs. Materials

-3.7

-2.7

-1.7

-0.7

0.3

1.3

2.3

3.3

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-4.2

-3.0

-1.7

-0.4

0.8

2.1

3.4

4.6

◄ Energy

Materials ►

Overvalued

Undervalued


Exhibit 18: Telecommunication Services vs. Utilities

-2.9

-1.9

-0.9

0.1

1.1

2.1

3.1

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-3.6

-2.3

-1.1

0.2

1.4

2.7

3.9

◄ Telecom

Utilities ►

Overvalued

Undervalued


Materials appear cheap versus Energy.

Telecom and Utilities look extremely overvalued.


UBS 12


Exhibit 19: Health Care vs. Staples

-3.0

-2.0

-1.0

0.0

1.0

2.0

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-2.5

-1.5

-0.6

0.4

1.4

2.4

◄ Health Care Staples ►

Overvalued

Undervalued

Source: First Call, Standard & Poor’s, FactSet and UBS Note: Analysis performed on a 36-month rolling basis.

While expensive, Health Care and Staples appear more attractively valued than Utilities or Telecom.


UBS 13

Relative Valuation — Industry Group Histories

Exhibit 20: Industrials — Capital Goods

-2.4

-1.4

-0.4

0.6

1.6

2.6

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-2.6

-1.6

-0.5

0.6

1.7

2.8Industrials ▼

Cap Goods ►

Overvalued

Undervalued


Exhibit 21: Industrials — Commercial Services

-2.4

-1.4

-0.4

0.6

1.6

2.6

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-3.1

-1.8

-0.5

0.8

2.1

3.3

Industrials ▼

Overvalued

Undervalued

Commercial Svcs ►

Source: S&P, Thomson Financial, FactSet, and UBS


UBS 14


Exhibit 22: Industrials — Transportation

-2.4

-1.4

-0.4

0.6

1.6

2.6

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-3.1

-1.6

-0.2

1.3

2.7

4.2

▼ IndustrialsTransportation ►

Overvalued

Undervalued


Exhibit 23: Technology — Hardware

-2.6

-1.6

-0.6

0.4

1.4

2.4

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-3.3

-1.9

-0.6

0.7

2.0

3.3

▼ Technology

Hardware ►

Overvalued

Undervalued



UBS 15


Exhibit 24: Technology — Software

-2.6

-1.6

-0.6

0.4

1.4

2.4

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-4.3

-2.8

-1.4

0.1

1.6

3.1

▼ Technology

Software ►

Overvalued

Undervalued


Exhibit 25: Technology — Semiconductors

-2.6

-1.6

-0.6

0.4

1.4

2.4

06 08 10

P/E

Mu

ltip

le P

oin

ts

-20.8

-12.7

-4.6

3.4

11.5

19.6

◄ Technology

Semis ►

Overvalued

Undervalued

Source: S&P, Thomson Financial, FactSet, and UBS Note: Semiconductors were not classified a separate industry group prior to 2006.


UBS 16


Exhibit 26: Financials — Banks

-2.4

-1.4

-0.4

0.6

1.6

2.6

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-7.4

-5.2

-2.9

-0.7

1.5

3.7

◄ Financials

Overvalued

Undervalued

Banks ►


Exhibit 27: Financials — Diversifieds

-2.4

-1.4

-0.4

0.6

1.6

2.6

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-4.4

-2.7

-1.1

0.6

2.3

4.0

◄ Financials

Diversifieds ►Overvalued

Undervalued



UBS 17


Exhibit 28: Financials — Insurance

-2.4

-1.4

-0.4

0.6

1.6

2.6

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-3.8

-1.5

0.8

3.1

5.4

7.8

Financials ▼

Insurance ▼

Overvalued

Undervalued


Exhibit 29: Financials — REITs

-2.4

-1.4

-0.4

0.6

1.6

2.6

01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-54.5

-37.7

-20.9

-4.0

12.8

29.6

◄ Financials

▲ Real Estate

Overvalued

Undervalued

Source: S&P, Thomson Financial, FactSet, and UBS Note: Real Estate did not exist as an industry group prior to 2001.


UBS 18


Exhibit 30: Discretionary — Autos

-1.7

-0.7

0.3

1.3

2.3

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-10.8

-5.2

0.3

5.8

11.3

◄ DiscretionaryAutos ►

Overvalued

Undervalued


Exhibit 31: Discretionary — Durables & Apparel

-1.7

-0.7

0.3

1.3

2.3

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-4.5

-2.1

0.3

2.7

5.1

◄ Discretionary

Durables & Apparel ▼

Overvalued

Undervalued



UBS 19


Exhibit 32: Discretionary — Consumer Services

-1.7

-0.7

0.3

1.3

2.3

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-4.5

-2.1

0.2

2.6

5.0

◄ Discretionary

Consumer ► Services ►

Overvalued

Undervalued


Exhibit 33: Discretionary — Media

-1.7

-0.7

0.3

1.3

2.3

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-6.4

-3.4

-0.4

2.6

5.7

◄ Discretionary

▲ Media

Overvalued

Undervalued



UBS 20


Exhibit 34: Discretionary — Retailing

-1.7

-0.7

0.3

1.3

2.3

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-3.7

-1.7

0.3

2.3

4.4

◄ Discretionary

Retailing ►

Overvalued

Undervalued


Exhibit 35: Staples — Food Retailing

-2.6

-1.6

-0.6

0.4

1.4

2.4

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-2.6

-1.6

-0.6

0.5

1.5

2.5

◄ Staples

Food Retailing ►

Overvalued

Undervalued



UBS 21


Exhibit 36: Staples — Food, Beverage, & Tobacco

-2.6

-1.6

-0.6

0.4

1.4

2.4

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-3.7

-2.4

-1.2

0.0

1.2

2.4

◄ Staples

Food, Bev ► & Tob. ►

Overvalued

Undervalued


Exhibit 37: Staples — Household Products

-2.6

-1.6

-0.6

0.4

1.4

2.4

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-3.9

-2.5

-1.2

0.2

1.5

2.9

▲ Staples

Household Products ►

Overvalued

Undervalued



UBS 22


Exhibit 38: Health Care — Equipment & Services

-3.0

-2.0

-1.0

0.0

1.0

2.0

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-3.1

-1.9

-0.8

0.4

1.6

2.7

◄ Health Care

▼ Equip & Svcs

Overvalued

Undervalued


Exhibit 39: Health Care — Pharmaceuticals & Biotech

-3.0

-2.0

-1.0

0.0

1.0

2.0

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

-3.1

-2.1

-1.1

0.0

1.0

2.0

◄ Health Care▼ Pharma & ▼ Biotech

Overvalued

Undervalued



UBS 23

Appendix: Inter-Sector Valuation The goal of our inter-sector valuation work is to gauge whether each S&P 500 sector is undervalued or overvalued relative to the overall market. Our analysis is based upon the historical valuation relationships between sectors. Importantly, we normalize sector valuations for three dynamics that could potentially provide spurious results, if not accounted for correctly:

Some sectors tend to be more expensive than others on a systematic basis (e.g., Tech consistently trades at a higher P/E than Financials).

The valuation dispersion between sectors is wide in some environments (e.g., the late-90s) and tight in others (e.g., 2008-09). In other words, a multiple point today is not necessarily the same as a multiple point yesterday.

Sector dynamics change over time. For example, Health Care carried a premium multiple throughout the 90’s, but has traded at a discount over the past decade.

Our inter-sector valuation work suggests that relative sector valuations are mean-reverting over medium-term time frames. As such, we view our inter-sector valuation rankings as a good starting point in determining sector recommendations. However, we note that sectors can stay cheap or expensive for multi-year time periods.

Ranking Overview In order to properly normalize inter-sector valuations over time, our analysis focuses on how many standard deviations away each sector’s P/E is from the market’s P/E. (For our fellow math geeks, this is known as cross-sectional standard deviation analysis.) We then put this calculation into a historical context on a sector-by-sector basis.

In the table below, we provide an overview of the calculations behind our inter-sector valuation rankings. On the following page, we walk though our calculations on a step-by-step basis.

Inter-Sector Valuation Ranking Overview — Hypothetical Example

(A) (B) (C=A-B) (D) (E=C/D) (F) (G=E-F) (H)Sector S&P 500 Premium S&P 500 Z Score Avg Z Net Z

Sector Fwd P/E Fwd P/E (Current) Std Dev (1) Current (Trail 36M) Current RankUtilities 11.8x 14.1x -2.3 1.7 -1.4 0.0 -1.4 1Health Care 11.7x 14.1x -2.5 1.7 -1.5 -0.2 -1.3 2Cons. Staples 14.0x 14.1x -0.1 1.7 -0.1 0.8 -0.9 3Telecom 12.7x 14.1x -1.5 1.7 -0.9 -0.2 -0.7 4Technology 15.7x 14.1x 1.6 1.7 0.9 1.2 -0.3 5Cons. Discretionary 15.6x 14.1x 1.4 1.7 0.9 0.7 0.2 6Energy 13.4x 14.1x -0.7 1.7 -0.4 -0.8 0.4 7Financials 13.9x 14.1x -0.2 1.7 -0.1 -0.7 0.6 8Industrials 16.2x 14.1x 2.1 1.7 1.2 0.2 1.0 9Materials 17.4x 14.1x 3.2 1.7 1.9 0.8 1.1 10

(1) Represents the standard deviation of the S&P 500’s Forward P/E. Source: First Call, Standard & Poor’s, and UBS


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Step-by-Step Calculations (1) Aggregate P/Es and Standard Deviations (columns A, B, and D). First, we calculate a forward P/E

for the S&P 500 and all 10 of its sectors, using consensus EPS estimates over the next 12 months. We also calculate the weighted average standard deviation of the market’s forward P/E.

(2) Calculate Z-Scores (column C). Next, we calculate a Z-Score for each sector. This expresses each sector’s P/E as a number of standard deviations away from the market’s P/E. This is calculated by subtracting the market’s P/E from each sector’s P/E and dividing the result by the weighted average standard deviation of the market’s forward P/E.

Z-Score Calculation

Market P/E

MarketSector

)P/E(P/EScore-Sector Z

σ−=

Source: UBS

(3) Put Current Valuations in Historical Context (columns E, F, and G). A Net Z-Score is then calculated for each sector by comparing current Z-Scores to average Z-Scores over the prior 36 months. We perform our analysis on a rolling 36-month basis to account for secular changes in sector dynamics (e.g., new governmental regulations).

Net Z-Score — Valuation in Historical Terms

AverageMonth -36CurrentScore- Z Score- ZScore-Net Z minus=

Source: UBS

(4) Rank Sectors from Most to Least Expensive (column H). We then rank all 10 sectors based upon their Net Z-Scores (i.e., how expensive or cheap each sector’s current Z-Score is in comparison to its historical average). Sectors with negative scores are cheap on a relative basis. Sectors with positive scores are expensive.

(5) Convert Net Z-Scores into Current P/E Multiple Points. To make the visual interpretation of our analysis easier to understand, we covert each sector’s historical Net Z-Scores into current P/E multiple points (cheap or expensive). This is done by multiplying the historical Net Z-Scores by the current weighted average standard deviation of the market’s forward P/E.

Health Care — Multiple Points Cheap / Expensive

-3

-2

-1

0

1

2

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

Overvalued

Undervalued

Source: Standard & Poor’s, Thomson Financial, FactSet, and UBS


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Analyst Certification

Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers and were prepared in an independent manner, including with respect to UBS, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report.


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Required Disclosures

This report has been prepared by UBS Securities LLC, an affiliate of UBS AG. UBS AG, its subsidiaries, branches and affiliates are referred to herein as UBS.

For information on the ways in which UBS manages conflicts and maintains independence of its research product; historical performance information; and certain additional disclosures concerning UBS research recommendations, please visit www.ubs.com/disclosures. The figures contained in performance charts refer to the past; past performance is not a reliable indicator of future results. Additional information will be made available upon request. UBS Securities Co. Limited is licensed to conduct securities investment consultancy businesses by the China Securities Regulatory Commission.

UBS Investment Research: Global Equity Rating Allocations

UBS 12-Month Rating Rating Category Coverage1 IB Services2

Buy Buy 54% 39%Neutral Hold/Neutral 39% 35%Sell Sell 7% 14%

UBS Short-Term Rating Rating Category Coverage3 IB Services4

Buy Buy less than 1% 33%Sell Sell less than 1% 25%

1:Percentage of companies under coverage globally within the 12-month rating category. 2:Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided within the past 12 months. 3:Percentage of companies under coverage globally within the Short-Term rating category. 4:Percentage of companies within the Short-Term rating category for which investment banking (IB) services were provided within the past 12 months. Source: UBS. Rating allocations are as of 30 June 2011. UBS Investment Research: Global Equity Rating Definitions

UBS 12-Month Rating Definition

Buy FSR is > 6% above the MRA. Neutral FSR is between -6% and 6% of the MRA. Sell FSR is > 6% below the MRA.

UBS Short-Term Rating Definition

Buy Buy: Stock price expected to rise within three months from the time the rating was assigned because of a specific catalyst or event.

Sell Sell: Stock price expected to fall within three months from the time the rating was assigned because of a specific catalyst or event.


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KEY DEFINITIONS

Forecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12 months. Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not a forecast of, the equity risk premium). Under Review (UR) Stocks may be flagged as UR by the analyst, indicating that the stock's price target and/or rating are subject to possible change in the near term, usually in response to an event that may affect the investment case or valuation. Short-Term Ratings reflect the expected near-term (up to three months) performance of the stock and do not reflect any change in the fundamental view or investment case. Equity Price Targets have an investment horizon of 12 months.

EXCEPTIONS AND SPECIAL CASES

UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell: Negative on factors such as structure, management, performance record, discount. Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment Review Committee (IRC). Factors considered by the IRC include the stock's volatility and the credit spread of the respective company's debt. As a result, stocks deemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating. When such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece.

Research analysts contributing to this report who are employed by any non-US affiliate of UBS Securities LLC are not registered/qualified as research analysts with the NASD and NYSE and therefore are not subject to the restrictions contained in the NASD and NYSE rules on communications with a subject company, public appearances, and trading securities held by a research analyst account. The name of each affiliate and analyst employed by that affiliate contributing to this report, if any, follows.

UBS Securities LLC: Jonathan Golub, CFA; Manish Bangard, CFA; Daniel Murphy; Vishal Patel; Thomas M. Doerflinger, Ph.D.; Natalie Garner, CFA. Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report.


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Financial Pacific - S&p 500 looks attractive at 11.0x forward earnings (third party)

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