Market Outlook & “The Decade Ahead” - capitalsynthesis.com€œThe... · 1990 1992 1994 1996...

Market Outlook & “The Decade Ahead”

May 2011

Jeremy Zirin, CFA Chief Equity Strategist

Wealth Management Research

This report has been prepared by UBS AG and UBS Financial Services, Inc.Please see important disclaimers and disclosures at the end of the document.

C:\Program Files\UBS\Pres\Templates\PresPrintOnScreen.pot

1

Key economic and investment messages

Economics

Investment Strategy

Our base case: profits continue to drive stocks higher in 2011.

Overweight emerging markets and secular growth stocks.

Interest rates likely to rise from very low levels.

Sustainable economic recovery is on firm ground – but some soft spots are likely along the way.

Recovery has come with a pretty hefty price tag.

The Decade Ahead

Equities unlikely to suffer another “lost decade”.

Low valuation starting point bodes well for long-run returns.

Economic Outlook

A low growth, but sustainable expansion


3

Near-term “soft patch” to be transitoryUS real GDP, quarter over quarter annualized

Source: DataStream, UBS WMR estimates

-8

-6

-4

-2

0

2

4

6

8

10

1Q00 1Q01 1Q02 1Q03 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12


4

Home prices continue to “bounce along the bottom”S&P/Case-Shiller Home Price Index, 20 city composite

Source: Bloomberg, UBS WMR

50

75

100

125

150

175

200

225

250

2000 2002 2004 2006 2008 2010 2012


5

Home prices certainly no longer “expensive”Median home price divided by median household income


3.00

3.25

3.50

3.75

4.00

4.25

4.50

4.75

5.00

1975 1980 1985 1990 1995 2000 2005 2010 2015

Median home price divided by median household income Average


6

Housing affordability at all-time highsUS Housing Affordability Index

Source: DataStream, UBS WMR

50

70

90

110

130

150

170

190

210

1971 1976 1981 1986 1991 1996 2001 2006 2011 2016


7

Manufacturing rebound remains on solid footing ISM Manufacturing PMI Composite Index


30

35

40

45

50

55

60

65

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012


8

Labor market recovery has significantly lagged past cycles…US non-farm payroll growth following recessions

95

100

105

110

0 4 8 12 16 20 24Postwar recessions (average) 2008/09 recession

US nonfarm private payrolls (recession trough = 100)

# of months (recession trough = 0)



9

…but is improving Initial jobless claims – 4 week moving average


200

250

300

350

400

450

500

550

600

650

700

2000 2002 2004 2006 2008 2010 2012


10

Small business sentiment is rebounding NFIB index of small business optimism

70

75

80

85

90

95

100

105

110

1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014



11

Improved lending standards highly correlated to job growthNonfarm payrolls and lending standards


-3000

-2500

-2000

-1500

-1000

-500

0

500

1000

1500

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

-40%

-20%

0%

20%

40%

60%

80%

100%

Nonfarm payrolls (quarterly change in thousands, left scale)Lending standards (net % of banks tightening, right scale)


12

Monetary policy to tighten but remain very accommodative Fed funds target rate, in %

Source: DataStream, UBS WMR

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012


13

In the early-to-middle innings of consumer deleveraging cycleRatio of US household financial liabilities to disposable income

Source: Thomson Reuters, UBS WMR

0%

20%

40%

60%

80%

100%

120%

140%

160%

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015


14

Deficit reduction tactics lie aheadUS federal budget breakout, in %

Source: Office of Management and Budget estimates, UBS WMR

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Entitlements Mandatory Defense Discretionary Interest

2009 2019

Tactical Asset Allocation

Better relative value in stocks


16

Stocks still poised to outperformCore asset allocation, Tactical deviations from benchmark

Tactical deviations from benchmark: Scale for charts - Symbol Description/Definition

+ moderate overweight vs. benchmark

-moderate underweight vs. benchmark

nNeutral, i.e. on benchmark

++ overweight vs. benchmark -- underweight vs. benchmark

+++strong overweight vs. benchmark

--- strong underweight vs. benchmark

Source: UBS WMR

Equity

Fixed Income

Cash

Commodities

+ ++ +++–– –– – – n

Underweight Overweight


17

Equity valuations are undemandingS&P 500 P/E based on next 12 months consensus earnings estimates

Source: FactSet, S&P, UBS WMR

5

10

15

20

25

30

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015P/E Average


18

30-year bull market in bonds is likely over10-year treasury bond yield

Source: Bloomberg and UBS WMR

0

2

4

6

8

10

12

14

16

18

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 201510-year treasury bond yield Average


19

Corporate profits have rebounded sharplyS&P 500 earnings per share

Note: 2011-2012 UBS WMR earnings estimates. Source: FactSet, UBS WMR

$100

$108

$0

$20

$40

$60

$80

$100

$120

2000 2002 2004 2006 2008 2010 2012

S&P 500 EPS

16%

8%

-30%

-20%

-10%

0%

10%

20%

30%

40%

2000 2002 2004 2006 2008 2010 2012S&P 500 EPS y/y change

S&P 500 EPS, y/y percent change


20

S&P 500 EPS is not US GDP

US GDP

* Other include: Technology, Healthcare, Telecom, Utilities, Financials. Source: FactSet, UBS WMR

S&P 500 EPS

Net Exports-3%Government

19%

Investment13%

Consumer71%

Other*55.4%

Industrial / Commodity

24.3%

Consumer-related 20.4%

21

S&P 500 (ex-financials) cash as a % of assets

Corporate cash continues to build

Note: Current constituents. Source: Bloomberg, UBS WMR

0%

2%

4%

6%

8%

10%

12%

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

22

S&P 500 dividends per share and earnings per share year-over-year percent change

Strong increases in dividends should follow surging profits

Source: FactSet and UBS WMR

-60%

-40%

-20%

0%

20%

40%

60%

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

S&P 500 EPS - 1 yr fwd, LHS S&P 500 DPS, RHS


23

Shifting focus to mid-cycle, global beneficiariesSector allocation, tactical deviations from benchmark








Source: UBS WMR

Tech

Industrials

Consumer Staples

Materials

HealthCare

Financials

Utilities

Telecom

Energy

Cons Discretionary

+ ++ +++–– –– – – n

underweight overweight


24

Emerging markets best positioned regionally Regional asset allocation, tactical deviations from benchmark








Source: UBS WMR

Emerging markets

UK

US

Other Developed

Japan

Eurozone

+ ++ +++–– –– – – n

Underweight Overweight


25

Emerging markets the source for growth in the world economyContribution to global GDP growth, in %

Source: International Monetary Fund, UBS WMR

0

20

40

60

80

100

1981 1986 1991 1996 2001 2006 2011

Advanced economies Emerging and developing economies

Key investment debate #1

Have corporate profits only benefited from cost cutting?


27

Decent revenue growthS&P 500 (ex-financials) revenues, year over year percent change

Source: FactSet, UBS WMR

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12


Are profit margins are unsustainably high?


29

Little evidence of margin collapse barring recession

Note: Profit margin proxy for this analysis was based on the Bureau of Economic Analysis ‘Corporate profits with inventory valuation and capital consumption adjustments’ account dividend by nominal GDP. Change in nominal GDP growth rate is equal to the last 12 months nominal GDP growth rate minus the prior 12 month nominal GDP growth rate. Source: Bureau of Economic Analysis, UBS WMR estimates

Average change in profit margins for a given change in nominal GDP growth

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

<5% -5% - 0% 0% - 5% 5%+


Will end of QE2 dry up market liquidity?


31

End of QE1 not a template for end of QE2 S&P 500 & Fed balance sheet


S&P 500 & fed funds target rate

0

1

2

3

4

5

6

7

00 02 04 06 08 10 12700

800

900

1000

1100

1200

1300

1400

1500

1600

Fed Funds Target Rate, % (LHS)S&P 500 (RHS)

$1,400

$1,600

$1,800

$2,000

$2,200

$2,400

$2,600

2009 2010 2011 2012600

700

800

900

1000

1100

1200

1300

1400

1500

Fed Balance Sheet, $bil (LHS)S&P 500 (RHS)

Looser

Tighter


Will rising oil prices derail equity market rally?


33

Oil prices haven’t reached the “tipping point”Correlation between S&P 500 and change in oil prices


-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

< 40% -40% to -20%

-20% to0%

0% to 20% 20% to40%

40% to60%

60% to80%

> 80%

Oil at $110


Won’t stocks suffer when leading economic indicators roll over?


35

The “macro trade” has been all that has mattered recentlyISM Manufacturing Index and S&P 500 y/y percent change


-60%

-40%

-20%

0%

20%

40%

60%

1955 1965 1975 1985 1995 2005 201530

40

50

60

70

S&P 500 y/y % chg (LHS) ISM Mfg Index (RHS)


36

A maturing business cycle does not mean weak market returnsS&P 500 12-month performance after ISM peaks


2.0%

-5.4%

7.1%

-10%

-5%

0%

5%

10%

All periods Recession follows No recession follows


Are large-caps much cheaper than small-caps?


38

Neutral between large- and small-capsRelative P/E valuation – large vs small

Note: earnings estimated growth are consensus. Source: FactSet, UBS WMR

16%13%

42%

34%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

2011 2012S&P 500 EPS y/y Russell 2000 EPS y/y

Earnings growth rate - consensus

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1978 1990 2002 2014Relative P/E valuation – large vs smallAverage

Large-caps cheap vs small-caps

Large-caps expensive vs small-caps

The Decade AheadStocks poised to outperform bonds


40

GDP growth is not the only driver of stock returnsReal US GDP growth rate and S&P 500 total return, in %

Source: Bureau of Economic Analysis, Standard and Poor's, UBS WMR

0

1

2

3

4

5

6

1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s0

3

6

9

12

15

18

Real GDP growth (lhs) S&P 500 total return (rhs)


41

Stocks were extremely expensive ten years agoPrice-to-earnings (P/E) ratio, earnings based on trailing 10-year adjusted real operating earnings per share

Source: Shiller (2011), Standard and Poor's, UBS WMR estimates

0

5

10

15

20

25

30

35

40

1900 1920 1940 1960 1980 2000


42

Valuation negatively correlated with decade-ahead returnsP/E ratio versus annualized S&P 500 total return of next 10 years, in %


-5

0

5

10

15

20

25

0 5 10 15 20 25 30P/E ratio

Annu

alize

d S&

P 50

0 to

tal r

etur

n of

nex

t 10

year

s

1998-2000


43

Higher sector concentration increases market riskDifference between first- and second-largest S&P 500 sector, as % of S&P 500


0

5

10

15

20

25

1990 1995 2000 2005 2010

Tech bubble

Financial crisis


44

Stocks likely to rebound after pronounced weakness10-year rolling compound annual return of stocks minus bonds, in %


-10

-5

0

5

10

15

20

1880 1900 1920 1940 1960 1980 2000


45

Estimated 9% CAGR for S&P 500 total return for next 10 years2020 S&P 500 “target” or fair-value estimate for S&P 500: 2450

Source: UBS WMR estimates

•Trend S&P 500 earnings = $165 per share by the end of 2020

•Applying the average P/E multiple since 1940 of 14.7x

•2020 S&P 500 target: 2450

•6.5% annualized gain + 2.0% dividend yield = 8.5% annual return


46

DisclaimerWealth Management Research is published by Wealth Management & Swiss Bank and Wealth Management Americas, Business Divisions of UBS AG (UBS) or an affiliate thereof. In certain countries UBS AG is referred to as UBS SA. This publication is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. Certain services and products are subject to legal restrictions and cannot be offered worldwide on an unrestricted basis and/or may not be eligible for sale to all investors. All information and opinions expressed in this document were obtained from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to its accuracy or completeness (other than disclosures relating to UBS and its affiliates). All information and opinions as well as any prices indicated are currently only as of the date of this report, and are subject to change without notice. Opinions expressed herein may differ or be contrary to those expressed by other business areas or divisions of UBS as a result of using different assumptions and/or criteria. At any time UBS AG and other companies in the UBS group (or employees thereof) may have a long or short position, or deal as principal or agent, in relevant securities or provide advisory or other services to the issuer of relevant securities or to a company connected with an issuer. Some investments may not be readily realisable since the market in the securities is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult to quantify. UBS relies on information barriers to control the flow of information contained in one or more areas within UBS, into other areas, units, divisions or affiliates of UBS. Futures and options trading is considered risky. Past performance of an investment is no guarantee for its future performance. Some investments may be subject to sudden and large falls in value and on realisation you may receive back less than you invested or may be required to pay more. Changes in FX rates may have an adverse effect on the price, value or income of an investment. We are of necessity unable to take into account the particular investment objectives, financial situation and needs of our individual clients and we would recommend that you take financial and/or tax advice as to the implications (including tax) of investing in any of the products mentioned herein. This document may not be reproduced or copies circulated without prior authority of UBS or a subsidiary of UBS. UBS expressly prohibits the distribution and transfer of this document to third parties for any reason. UBS will not be liable for any claims or lawsuits from any third parties arising from the use or distribution of this document. This report is for distribution only under such circumstances as may be permitted by applicable law.

Australia: Distributed by UBS Wealth Management Australia Ltd (Holder of Australian Financial Services License No. 231127), Chifley Tower, 2 Chifley Square, Sydney, New South Wales, NSW 2000. Bahamas: This publication is distributed to private clients of UBS (Bahamas) Ltd and is not intended for distribution to persons designated as a Bahamian citizen or resident under the Bahamas Exchange Control Regulations. Canada: In Canada, this publication is distributed to clients of UBS Wealth Management Canada by UBS Investment Management Canada Inc.. Dubai: Research is issued by UBS AG Dubai Branch within the DIFC, is intended for professional clients only and is not for onward distribution within the United Arab Emirates. France: This publication is distributed by UBS (France) S.A., French “société anonyme” with share capital of € 125.726.944, 69, boulevard Haussmann F-75008 Paris, R.C.S. Paris B 421 255 670, to its clients and prospects. UBS (France) S.A. is a provider of investment services duly authorized according to the terms of the “Code Monétaire et Financier,” regulated by French banking and financial authorities as the “Banque de France” and the “Autorité des Marchés Financiers.” Germany: The issuer under German Law is UBS Deutschland AG, Stephanstrasse 14-16, 60313 Frankfurt am Main. UBS Deutschland AG is authorized and regulated by the “Bundesanstalt für Finanzdienstleistungsaufsicht.“ Hong Kong: This publication is distributed to clients of UBS AG Hong Kong Branch by UBS AG Hong Kong Branch, a licensed bank under the Hong Kong Banking Ordinance and a registered institution under the Securities and Futures Ordinance. Indonesia: This research or publication is not intended and not prepared for purposes of public offering of securities under the Indonesian Capital Market Law and its implementing regulations. Securities mentioned in this material have not been, and will not be, registered under the Indonesian Capital Market Law and regulations. Italy: This publication is distributed to the clients of UBS (Italia) S.p.A., via del vecchio politecnico 3 - Milano, an Italian bank duly authorized by Bank of Italy to the provision of financial services and supervised by “Consob” and Bank of Italy. Jersey: UBS AG, Jersey Branch is regulated by the Jersey Financial Services Commission to carry on investment business and trust company business under the Financial Services (Jersey) Law 1998 (as amended) and to carry on banking business under the Banking Business (Jersey) Law 1991 (as amended). Luxembourg/Austria: This publication is not intended to constitute a public offer under Luxembourg/Austrian law, but might be made available for information purposes to clients of UBS (Luxembourg) S.A./UBS (Luxembourg) S.A. Niederlassung Österreich, a regulated bank under the supervision of the “Commission de Surveillance du Secteur Financier” (CSSF), to which this publication has not been submitted for approval. Singapore: Please contact UBS AG Singapore branch, an exempt financial adviser under the Singapore Financial Advisers Act (Cap. 110) and a wholesale bank licensed under the Singapore Banking Act (Cap. 19) regulated by the Monetary Authority of Singapore, in respect of any matters arising from, or in connection with, the analysis or report. Spain: This publication is distributed to clients of UBS Bank, S.A. by UBS Bank, S.A., a bank registered with the Bank of Spain. UAE: This research report is not intended to constitute an offer, sale or delivery of shares or other securities under the laws of the United Arab Emirates (UAE). The contents of this report have not been and will not be approved by any authority in the United Arab Emirates including the UAE Central Bank or Dubai Financial Authorities, the Emirates Securities and Commodities Authority, the Dubai Financial Market, the Abu Dhabi Securities market or any other UAE exchange. UK: Approved by UBS AG, authorised and regulated in the UK by the Financial Services Authority. A member of the London Stock Exchange. This publication is distributed to private clients of UBS London in the UK. Where products or services are provided from outside the UK they will not be covered by the UK regulatory regime or the Financial Services Compensation Scheme. USA: Distributed to US persons by UBS Financial Services Inc., a subsidiary of UBS AG. UBS Securities LLC is a subsidiary of UBS AG and an affiliate of UBS Financial Services Inc. UBS Financial Services Inc. accepts responsibility for the content of a report prepared by a non-US affiliate when it distributes reports to US persons. All transactions by a US person in the securities mentioned in this report should be effected through a US-registered broker dealer affiliated with UBS, and not through a non-US affiliate.

UBS 2011. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.

Market Outlook & “The Decade Ahead” - capitalsynthesis.com€œThe... · 1990 1992 1994 1996...

Documents

Transcript of Market Outlook & “The Decade Ahead” - capitalsynthesis.com€œThe... · 1990 1992 1994 1996...