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UBS investor’s guideWealth Management Research 30 April 2009 United States

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FocusObama’s mixed first 100 days

InvestmentsSwine flu’s implications for asset allocation

Real EstateEnergy efficency pays off

2 UBS investor’s guide 30 April 2009 UBS investor’s guide 30 April 2009 3

Contents Editorial

Michael Ryan, CFAHead, WMR Americas

ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 36

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. Customers of UBS in the UnitedStates can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customerscan access this independent research at www.ubs.com/independentresearch or may call +1 877-208-5700 to request a copy of this research.

UBSFS accepts responsibility for the contents of this report. U.S. persons who receivethis report and wish to effect any transactions in any security discussed in this reportshould do so with UBSFS and not UBS AG.

This report has been prepared by UBS AGand UBS Financial Services Inc.

Barack Obama hasnow been in officefor 100 days. Although the firstgreen shoots of recovery may be appearing, the new

US president’s initial economic record is very mixed.This edition investigates the situation in several arti-cles, including our Focus piece on page 6.Photo: Jason Alden/Keystone/Landov

30 April 2009

Editorial 3Investment outlook 4Key forecasts 5Focus 6Financial crisis thermometers 10Economy: USA 12Economy: Japan and Europe 13Economy: Calendar 14Economy: Forecasts 15Reader’s corner 16Equity market: USD 17Equities: Strategy 18Equity market: Eurozone 20Equity market: Asia-Pacific 21Bond market: USD 22Municipal securities 23Bonds: Strategy 24Real estate 26Foreign exchange 28Foreign exchange: Strategy 30Portfolio 31Emerging markets 32Technical analysis 34Appendix 36

Dear Reader,

The ritual of critiquing the first 100 days ofeach new Administration has taken on spe-cial significance with President BarackObama. No President since Franklin Roo-sevelt has faced the challenges that thispresident has been confronted with sincetaking the oath of office. The economy wasmired in one of the deepest recessions ofthe post-war era, the financial sector hov-ered near the very brink of collapse and theAmerican consumer faced a debt burden socrushing that it could hobble any hope ofrecovery.

But no other president since Roosevelthas charted out a more aggressive govern-ment response to tackling these challengesthan Barack Obama. It is precisely this setof circumstances that has prompted suchclose scrutiny of the new administration.Because while President Roosevelt wascredited with helping restore the confi-dence of a nation, his legacy also includeda fundamental shift in the role between thepublic sector and private sector thatendured for almost half a century.

It’s clear that the success or failure of BarackObama’s presidency will not be determinedby his first 100 days in office, but instead bythe 1,360 that follow. However, the coursethat this president has charted during thefirst three-plus months in the White Housecould well shift the dynamic between thepublic and private sectors for another halfcentury. It is this aspect of PresidentObama’s first 100 days in office that gener-ates both hope and fear, and thereforecommands our attention.


Investment Outlook Key Forecasts

Asset Allocation Regional Equity Strategy

US Equity Sector Strategy

US Equity Size and Style

US Fixed Income Strategy

Scale for Investment Strategy charts

Symbol Description/ Symbol Description/Definition Definition

+ moderate – moderateoverweight vs. underweight vs.

benchmark benchmark

++ overweight vs. – – underweight vs.benchmark benchmark

+++ strong – – – strongoverweight vs. underweight vs.

benchmark benchmark

n neutral, i.e.,on benchmark

Source: UBS WMR

The overweight and underweight recommendations represent tactical deviations that can be applied to any appropriate bench-mark portfolio allocation. They reflect WMR’s short- to medium-term assessment of market opportunities and risks in the respec-tive asset classes and market segments. The benchmark allocation is not specified here. It should be chosen in line with the riskprofile of the investor. Note that the Regional Equity Strategy is provided on an unhedged basis (i.e., it is assumed that investors carry the underlying cur-rency risk of such investments). Thus, the deviations from the benchmark reflect our views of the underlying equity in combinationwith our assessment of the associated currencies.

For more information, please read the most recent US Investment Strategy Guide.

Technical Levels

S&P 500 DJIA NASDAQ 10-Yr. Treasury

Support 825–835 7750–7800 1550–1600 2.46%–2.64%

780–815 7435–7450 1440–1490 2.04%–2.16%

Resistance 875–880 8200–8400 1750–1785 3.05%–3.10%

950+/–25 9000–9200 1875–1900 3.25%–3.30%Source: UBS WMR

-0.03 -0.02 -0.01 0 0.01 0.02 0.0

Equity

Ficed income

underweight neutral overweight

Commodities

- - - - - - n + ++ +++

Cash

neutral

neutral

neutral

neutral

-0.03 -0.02 -0.01 0 0.01 0.02 0.0underweight neutral overweight

- - - - - - n + ++ +++Japan

US

Other developed

Emerging Markets

UK

Eurozone


- - - - - - n + ++ +++Utilities

Materials

Consumer staples

Health Care

Financials

Telecom

Energy

Consumer Discr.

TechnologyIndustrials


- - - - - - n + ++ +++

Inv. Grade Corporates

High Yield Corporates

TIPS

Mortgages

Agencies

Preferred Securities

Emerging Markets

Treasuries


- - - - - - n + ++ +++

Small-Cap

Mid-Cap

Large Cap Growth

Large Cap Value

in % 2004 2005 2006 2007 2008 2009F

Real GDP (y/y) 3.6 2.9 2.8 2.0 1.1 –2.2

CPI (y/y) 2.7 3.4 3.2 2.9 3.8 –1.0

Core CPI (y/y) 1.8 2.2 2.5 2.3 2.3 1.3

Unemployment rate 5.5 5.1 4.6 4.6 5.8 9.3

10-year yield* 4.24 4.39 4.7 4.0 2.4 3.2

Fed funds rate* 2.25 4.25 5.25 4.25 0.25 0.25* year-end level Sources: Thomson Financial, UBS WMR

US Economic forecasts

Exchange rates

PPP1 2008 2 28.4.09 3 M 3 6 M 3 12 M 3

vs USDEURUSD 1.26 1.39 1.30 1.37 1.45 1.50

USDJPY 95 91 96 103 105 110

GBPUSD 1.74 1.46 1.46 1.48 1.54 1.60

USDCHF 1.20 1.07 1.16 1.13 1.07 1.05

AUDUSD 0.65 0.71 0.70 0.68 0.75 0.80

USDCAD 1.15 1.21 1.22 1.23 1.17 1.15

USDMXN 12.35 13.64 14.05 13.8 15.00 14.00

USDBRL 2.78 2.31 2.22 2.28 2.40 2.301 Purchasing Power Parity 2 end of year 3 UBS WMR ForecastSources: Thomson Reuters, UBS WMR

Commodity Price Forecasts

2005 2006 2007 2008 9–12months

view

WTI Crude Oil $/bbl 58.0 66.2 72.4 100.0 70.0

Gold $/oz 443 604 697 872 980

Silver $/oz 7.20 11.60 13.40 15.00 11.50

Copper $/mt* 3577 6725 7139 6961 5000

Aluminum $/mt* 1875 2480 2641 2573 1689

Zinc $/mt* 1350 3275 3257 1885 1790Note: All prices are yearly averages*mt = metric ton Sources: Thomson Financials, UBS WMR


Focus Focus

Obama’s mixed first 100 days

The tradition of critiquing a President’sfirst 100 days in office traces back toFranklin Roosevelt’s first term. With thecountry in the grips of a severe economicdepression, the Roosevelt Administrationhad engaged in a frenzy of legislate activ-ity to help jump-start the economy. Thecurrent financial crisis and global eco-nomic recession draws comparisons to theGreat Depression.

The EconomyPresident Obama inherited an economythat was already deeply mired in one ofthe nastiest recessions of the post-war eraamid the aftershocks from the bursting ofthe housing bubble. In addition to the col-lapse in housing activity, broader meas-ures of economic activity have also fallensharply: consumer confidence continuesto hover near a three decade low, the ISM

manufacturing index has plunged to itslowest reading since 1980, and the unem-ployment rate has spiked to 8.5%. Whilewe expect the US to emerge from thedepths of the recession during the secondhalf of this year, we are still looking for theeconomy to contract at a 2.2% pace dur-ing 2009.

Much of the early focus for the ObamaAdministration has centered upon pas-sage of the President’s economic stimuluspackage. While the record USD 789 billionpackage moved through Congress at arapid pace, it’s still too early to tell justhow effective these measures will be inhelping to jump-start the economy.According to our US economist, ThomasBerner, the full impact from the packagewill be spread out over several years.What’s more, the package is loaded withinefficient spending programs that willprovide little in the way of sustainablesupport to the economy. So, while thestimulus package will contribute towardrecovery during the second half of theyear, the effectiveness has been muted bythe political process.

Looking more broadly, the Administra-tion appears to be charting a much moreinterventionist course with regard to theeconomy. Whether out of necessity or bydesign, the Obama Administration is farmore open to allowing government toassume a much broader role in the over-all economy. The Administration is seek-

ing a prominent role in activities rangingfrom energy, to healthcare, to trade, tomanufacturing. While greater govern-ment support can help jump-start initia-tives such as solar energy, smart electricpower grids, and online health data, thelong-run trade-off could well be lowerproductivity, higher budget deficits, andslower growth.

Financial marketsThe first days of the Obama presidencywere fairly anxious ones for financial mar-ket participants, with the S&P 500 plung-ing more than 5% on inauguration dayand equity markets breaking through theNovember lows. A steady stream ofdreadful economic data and renewedconcerns over the stability of financialinstitutions certainly contributed to thevolatility. President Obama didn’t helpmatters with his downbeat assessment ofthe cyclical outlook aimed at generatingsupport for his stimulus package. TreasurySecretary Geithner was placed in theunenviable position of having to deliver acomprehensive proposal to stabilize thefinancial system with virtually no seniorstaff.

Yet, while the Administration may havebeen shaky out of the gate, they appearto have gained their footing in recentweeks. Once the fiscal stimulus packagepassed, President Obama was able to shiftto a more upbeat tone in his messaging.Public pronouncements by banks thatthey were generating operating profits,coupled with marginally “less worse” eco-nomic data, helped validate the Presi-dent’s message. Markets have also beenbolstered by Treasury Secretary Geithner’sprogress in fleshing out credible plans forboth recapitalizing financial institutions

(PPIP) as well as disposing of the legacy oftoxic assets (TALF).

However, sustained recovery withinfinancial markets will still require a com-prehensive policy approach, evidence thatcredit conditions are easing, and indica-tions that the earnings cycle is reaching atrough. The Administration continues towork closely with Treasury and Fed offi-cials to address the health and stability ofthe banking system. But unlocking creditmarkets will take time. At the same time,the earnings cycle is still bottoming as cor-porations struggle with the effects of theglobal recession. So while the Administra-tion has worked to provide broader policysupport, the ability to ease credit condi-tions and restore corporate profitability islimited.

Policy actionsThe Obama Administration can’t beblamed for a lack of boldness with regardto policy initiatives. Even before taking theoath of office, the President spent weekstalking up the need for a stimulus planand garnering support within Congress.The Administration’s success in passing amassive USD 789 billion fiscal package hasprompted the White House to seek topush more aggressively on the budgetfront. The President has submitted a USD3.6 trillion budget for 2010, which incor-porates proposals to reduce carbon emis-sions, introduce comprehensive health-care reform, and expand educational ini-tiatives.

As we have already noted, the Admin-istration has worked closely with both theTreasury and the Fed to stabilize the finan-cial system and to stimulate the economy.The expansion of the TARP program,launch of the second stage of the TALF

While the Obama Administration searches for solutions to help remedy a crip-pled financial system, a dormant consumer sector, and collapsing global trade,we offer our own assessment of the President’s first 100 days in office on fivecritical fronts: the economy, the financial markets, public policy choices, the do-mestic political arena, and the global geopolitical stage.

President Obama’s approval rating

No OpinionTerriblePoorJust OkayGoodExcellent

35

20

10

30

25

15

5

0

Source: Gallup as of April 20–21, 2009

Respondents

%


Focus Focus

plan, and announcement of the PPIP ini-tiative are reflective of the Administra-tion’s aggressive approach. While it’s stilltoo early to determine just how success-ful these programs will be in easing thefinancial crisis, they have offered supportto some of the most threatened sectors ofthe banking system.

Despite the President’s successes on thepolicy front, concerns have been raisedwith regard to the approach taken tosecure passage of the stimulus package.President Obama campaigned on a plat-form centered upon changing the politi-cal culture in Washington. However, ifthis is the standard the Administrationwishes to be judged by, then the stimuluspackage was a bitter disappointment. Ina rush to secure passage of the plan, theWhite House ceded many decisions on theplan to Congressional Democrats, result-ing in a bloated and wasteful spendingplan.

Domestic politicsWhile his poll numbers have fallen sincetaking the oath of office, PresidentObama still enjoys high public approvalratings among voters. According to theGallup organization, 62% of those polledapprove of the job the President is doing.These high approval ratings have providedthe Obama Administration with amplepolitical capital to push through anaggressive legislative agenda. As we havealready noted, the President was able tosecure passage of his stimulus packagewithin just 25 days of taking the oath ofoffice.

But if President Obama is popular, he isalso polarizing. The gap between thenumber of Democrats and Republicans

who approve of the President is similar tothe waning days of President Bush’s sec-ond term in office. The partisan rhetoricthat has helped to energize PresidentObama’s Democratic base has also servedto alienate Republican voters. Early effortsto attract bi-partisan support for theAdministration’s policies have not bornefruit, with few Republicans crossing overto support the President’s legislative initia-tives.

The President has encountered otherdifficulties on the domestic political frontas well, with a number of his initial nom-inees for cabinet posts having to with-draw due to failure to report income andpay taxes. This has hobbled the Adminis-tration in several critical areas, most no-tably within the Treasury and Health & Hu-man Services departments. Many seniorposts within Treasury have been left un-filled due to the increased rigor of thescreening process, while Senator Daschle’sforced withdrawal from consideration asHead of Health and Human Services hasslowed the President’s healthcare plan.

Geopolitical stageIt is on the global stage where the Presi-dent’s star appears to have shown mostbrightly. In his initial trip abroad to Europeas Head of State, the President was hailedas a conquering hero. His willingness tomend fences with allies and to reach outto adversaries was lauded in most quar-ters around the globe as a welcomedeparture from the policies of the BushAdministration. On a more substantivebasis, the President has also sought com-mon ground on issues such as remedia-tion of global climate change, strengthen-ing the global financial structure, and eas-

ing of tensions in the Middle East. Whilelooking to disengage in Iraq, the Presidenthas also sought allied support in battlingthe Taliban in Afghanistan.

But not all has gone seamlessly on theglobal front during the President’s firstdays in office. The inability to secure astronger commitment from EU partners tostimulate growth, coupled with France &Germany’s increasingly independent poli-cy path, illustrate the limitations to affectchange on the Continent. The President’sefforts to engage adversaries have alsobeen less than fruitful, with Iran movingahead with development of nuclearweapons programs and North Korea testfiring rockets with the potential to reachAmerican soil. The President’s recent visitto Latin American also received mixed re-views with both Venezuelan PresidentChavez and Nicaraguan President Ortegausing the Summit of the Americas to un-leash anti-American tirades.

It’s the coming 1,360 days that matterWhile supporters and critics of PresidentObama sharply differ in their assessmentsof the President’s first 100 days, both arelikely to agree on three key points: (1) thePresident is mapping out an aggressivelegislative agenda; (2) the Administrationrepresents a sharp departure from thepolicies of the Bush Administration; (3)Obama supports a much more expandedrole for the public sector. It is these threekey areas where the success or failure ofthis President will be determined. Theearly tests will center upon the financialcrisis and the recession, but longer termchallenges will include efforts to mitigateclimate change, healthcare reform, edu-cational initiatives, and tax policies. There

is perhaps one additional point that bothcritics and supporters of President Obamawill also agree upon: the success of thisPresidency will not be determined overthe first 100 days, but rather in the 1,360that follow.

For more information, see EconomicTheme, Obamanomics Part X: The first100 days, 29 April 2009.Mike Ryan, CFAHead, WMR [email protected]

UBS investor’s guide 30 April 2009 1110 UBS investor’s guide 30 April 2009

Financial crisis thermometers Financial crisis thermometers

An update on the financial crisis thermometers

Financial health thermometerNormal index = (sample: 1 Jan 2006 –20 Jul 2007) = 100, as of 24 April 2009

Economic health thermometerNormal index = (sample: Feb. 1969– curr. month = 100), as of 3 April 2009

104

102

103

101

99

100

Source: Thomson Financial, UBS WMR

Jan 06 Jan 07 Jan 08 Jan 09

Unhealthy

Healthy

Index level


Feb 69 Feb 79 Feb 89 Feb 99 Feb 09

Unhealthy (too hot)

99

102

96

97

98

100

101

Unhealthy (too cold)

Index level

Healthy (normal)

Credit health thermometerNormal index = (sample: Jan. 1973– curr. month) = 100, as of 17 April 2009

105

102

104

100

98

103

101

99


Jan 73 Jan 83 Jan 93 Jan 03

Unhealthy

Healthy

Index level

In this section, we seek to provide regularinsight on the common question “whereare we in the current financial crisis?” Ineach report, you will find “thermometers”measuring financial, economic and credithealth along with explanations for eachmeasurement. In this update, we introduceconsistent scaling for all thermometers.

Financial health This thermometer is updated weekly andwas last updated on 24 April 2009. It is aweighted average of four relevant compo-nents to determine the stress on the finan-cial market: liquidity (measured by the dif-ference between money market rates andcentral bank rates), credit (measured by thedifference between corporate bond ratesand government bond rates), financialintermediaries (measured by credit defaultswap spreads of the banking sector), andequities (measured by the volatility index).

All of the four components of the USfinancial health thermometer improved from103.1 on 10 April to 102.8 on 17 April.However, the US financial health thermome-

ter deteriorated slightly from 102.8 on 17April to 102.9 on 24 April. Implied equityvolatility and the credit default swap (CDS)spread deteriorated, but the 3-month USDLIBOR to Federal Funds Rate spread and the10-year corporate bond to Treasury spreadimproved. Overall, the net effect was a slightdeterioration of financial health.

The Eurozone financial health thermome-ter improved slightly from 102.2 on 10 Aprilto to 102.1 on 24 April. The UK financialhealth thermometer improved from102.7 on 10 April to 102.4 on 24 April.The Japan financial health thermometer,introduced earlier this month, improved from101.4 on 10 April to 101.3 on 24 April.

Economic health This thermometer is updated monthly andwas last updated on 3 April 2009. It gaugesthe stance of the US economy in a singleand timely measure. This gauge will helpinvestors assess whether the US economy ismoving out of recession before it shows upin the GDP figures. The thermometer sum-marizes the information contained in the

ISM Manufacturing PMI (level), the Confer-ence Board consumer confidence index(level) and non-farm payrolls (monthlygrowth rate) in one indicator.

The US economic health thermometerpractically stalled at 96.7 in March. At thatlevel, it is still in deep recessionary territoryand merely points to a stabilization of realactivity at a very low level. We would haveto see the thermometer rise above98.5 before sounding the “all clear” on agrowth recovery. For more information,please see Economic Theme, US recessionthermometer, 13 March 2009. In our view,the two sentiment indicators will likelyimprove further while non-farm payrollgrowth is still stabilizing in the near-term.

Credit health This thermometer is updated monthly andwas last updated on 17 April 2009. It is a sim-ple average of five “standardized” indica-tors: real (inflation-adjusted) credit lendingfrom commercial banks (monthly growthrate), three-month Eurodollar deposit ratefed funds rate spread, Moody’s ‘Aaa’ corpo-rate yield to 20-year Treasury yield spread,Moody’s ‘Baa’ corporate yield to 20-year

Treasury yield spread, and the willingness ofbanks to give installment loans to con-sumers. In this context, “standardized”means that each indicator is adjusted to havea mean of zero and a standard deviation(volatility) of one. The overall index has amean of zero and a standard deviation of0.58 using data through February 2009.

The US credit health thermometer hasimproved from a historical high of 104.8in December 2008 to 103.8 in March2009. However, it rose a tad from February’s103.5. Furthermore, at the current level, itsignals credit conditions are tighter thanduring the 1980s recessions. For moreinformation on how credit conditions aremeasured, see Economic Theme, “Measur-ing the credit impact,” 21 October 2008.

All components of the thermometer,except lending standards, deteriorated inMarch. Thus, from February to March, thespread of the 3-month Eurodollar depositrate over the Fed funds rate rose a bit, thespreads of Moody’s 20-year AAA and BAAinterest rates over the 20-year governmentbond widened, and the pace of contractionin real (inflation-adjusted) commercial banklending deepened. We are of the opinionthat the credit health thermometer willlikely not improve much in 2009, as possi-bly narrowing credit spreads will be offsetby further drops in bank lending. We onlyexpect a meaningful improvement in late2009 or early 2010.

See Economic Theme, Financial CrisisThermometers, 27 April 2008, for detailedexplanations of the thermometers.Andreas HoefertEconomist, UBS Financial Services [email protected] Berner, CFAUS Economist, UBS Financial Services [email protected]


Economy: USA Economy: Japan and Europe

Money revolution Japan Europe

Money revolution4500

2000

1000

2500

3000

3500

4000

1500

500

12000

8000

4000

10000

6000

2000

2005 2008 20111996 1999 2002


USD billion USD billion

UBS

WM

R fo

reca

sts

M0 (lhs)M2 (rhs)

Exports bottoming outJapanese exports fell 46% year-over-year inMarch. Surprisingly, the market consideredthis to be good news, and some economistshave recently raised their 2009 GDP growthforecasts. Exports fell by nearly 50% in Feb-ruary, so, relatively speaking, even a 46%drop is an improvement. There are alsosome signs of hope for the months ahead.Inventories have been reduced, bothdomestically and in many of Japan’s exportmarkets. Even if final demand remainsweak, this should allow for a partial recov-ery in exports. Government stimulus meas-ures, which include cash giveaways andrebates on environmentally-friendly con-sumer durables, may also help the manu-facturing sector. One area of concern, how-ever, is the recent rally in the yen. If sus-tained, it would make it much more diffi-cult for exporters to return to profitability,and could result in a more painful adjust-ment in wages and employment.Brian RoseEconomist, UBS AG

A first glimmer of hope Euro area surveys of business activity sug-gest that the pace of economic contractionis easing. The Purchasing Managers’ Index,a key leading indicator, recorded a secondconsecutive rise in April, reaching its high-est reading since October of last year. How-ever, at a level of just 40.5, it remains farbelow the 50 no-change mark. Signs ofimprovement were evident across manu-facturing and services. Employment inten-tions remain firmly in negative territory,though, and will likely remain so until anyrecovery gains a solid foothold. Overall, wethink that economic activity is likely toremain subdued in the foreseeable future. Dirk FaltinEconomist, UBS AG

The pace of contraction is slowing down5

3

1

–1

4

2

0

–2

–9Source: Reuters EcoWin, UBS WMR

98 99 0100 02 03 04 05 06 07 08 09

Euroframe Eurozone growth indicator

%

Exports hit bottom30

10

–20

–40

–10

20

0

–30

–50Source: UBS WMR

Export value (yen)Export volume

% y/y

Mar 05 Mar 06 Mar 07 Mar 08 Mar 09

Credit conditions tightened again in March,after improving somewhat since December2008. Our US credit heath thermometer,which summarizes data on credit spreads,lending standards, and credit volume in onemetric, now stands about 3.8 standarddeviations above its long-term mean of100. This is the fourth worst reading sinceinception in January 1973. As tight creditconditions cripple growth, the Fed has andwill continue to have to flood the systemwith liquidity. Within the framework of ourmacro model we estimate that the Fed willhave to increase central bank money or M0from USD 1.64tn in March to about USD4tn by year-end 2010 to counteract thedark force of tight credit conditions. Moneywill eventually work its magic by pushingend-borrower interest rates lower and pro-viding ample liquidity to the banking sys-tem. The good news is that the govern-ment’s programs envision an expansion ofM0 to about USD 5tn by year-end 2010.The bad news is that many things could gowrong in this money revolution.

Why is so much money necessary toimprove credit conditions? Once the Fed-eral Funds Rate target hit zero last fall theonly way the Fed was able to push longer-term interest rates lower was by pumpingmassive liquidity into system. If the Fed buyscertain securities outright, like mortgage-backed securities (MBS), it directly affectsthe liquidity and thus the interest rate in therespective market. Since November 2008,when the Fed first announced its agencyMBS purchase program, the 30-year fixedconforming interest rate has fallen fromabout 6% to 4.7% recently. The Fedincreased the scope of its operations whenit announced in March that it would alsostart buying Treasuries. In doing so itincreases the liquidity in the Treasury mar-ket with the net effect of pushing Treasuryyields and consequently all end-borrowerrates lower.

Now, the trillion US dollar question ishow much money expansion will be neededto offset the very tight credit conditions andeventually lead to normalization? Withinthe framework of our macro model wecome to the conclusion that M0 will haveto grow from USD 1.64tn in March to aboutUSD 4tn by year-end 2010. This would leadto positive economic growth without lead-ing to an accelerating inflation spiral in theout-years. Since we are in uncharted terri-tory we can’t be confident that more or lessmight be appropriate. Too little could meandeflation, too much could mean too muchinflation in the medium and long term.Thomas Berner, CFAUS Economist, UBS Financial Services [email protected]


Economy: Calendar Economy: Forecasts

Expected economic indicators

Other economic events

Growth and Inflation

Interest rates

2007 2008 28/04/09 6M1 12M

United States 3m 4.7 1.5 1.1 0.3 0.3

10y 4.0 2.1 2.9 2.7 3.2

Japan 3m 0.9 0.7 0.6 0.3 0.3

10y 1.5 1.2 1.4 1.5 1.5

Eurozone 3m 4.7 2.9 1.4 1.0 1.0

10y 4.3 1.7 3.1 2.9 3.0

UK 3m 6.0 2.3 1.5 0.9 0.9

10y 4.5 3.1 3.5 3.2 3.5

Switzerland 3m 2.8 0.3 0.4 0.3 0.3

10y 3.0 2.2 2.1 2.1 2.5

Australia 3m 7.2 4.5 3.6 2.8 2.8

10y 6.3 4.0 4.6 4.1 4.4

Canada 3m 4.6 1.6 0.9 0.7 0.7

10y 4.0 2.7 3.0 2.7 2.91 UBS WMR Forecast Sources: Reuters, UBS WMR

GDP Real GDP growth (%) Consumer Price Inflation (%)Weight1 2005 2006 2007 2008 2009F 2 2010F 2 2005 2006 2007 2008 2009F 2 2010F 2

USA 20.3 2.9 2.8 2.0 1.1 –2.2 2.0 3.4 3.2 2.9 3.8 –1.0 1.4

Japan 6.5 1.9 2.0 2.4 –0.7 –5.0 1.5 –0.3 0.2 0.0 1.4 –0.8 0.5

UK 3.2 2.1 2.8 3.0 0.7 –3.4 –0.2 2.1 2.3 2.4 3.6 0.7 1.4

Eurozone 14.8 1.8 3.0 2.6 0.7 –3.5 –0.2 2.2 2.2 1.9 3.3 0.5 1.3

Switzerland 0.4 2.5 3.4 3.3 1.6 –2.8 –0.4 1.2 1.1 0.7 2.4 –0.4 0.6

Mexico 1.5 (IMF) 3.1 4.9 3.2 1.3 –3.7 2.5 3.3 4.1 3.8 6.5 4.4 3.5

Brazil 2.5 (IMF) 3.2 4.0 5.7 5.1 –1.2 3.7 5.7 3.1 4.5 5.9 4.5 4.5

India 6.3 9.4 9.6 9.0 6.4 5.5 6.3 4.7 4.8 4.8 8.5 0.0 5.0

Russia 2.7 (IMF) 6.3 7.3 8.1 6.5 –2.0 3.0 10.9 9.0 11.9 14.0 11.0 9.0

Australia 1.0 (IMF) 2.8 2.9 4.0 2.5 –1.0 1.0 2.7 3.5 2.3 4.4 2.0 2.0

China 14.1 10.4 11.6 11.9 9.0 7.8 8.5 1.8 1.5 4.8 6.1 –1.2 1.6

Asia ex Jp/Cn/In 3 5.4 5.0 5.5 5.7 3.0 –2.6 3.1 3.8 3.8 2.8 5.7 1.7 2.71 Weight in world GDP, based on World Bank purchasing power calculations 2 UBS WMR Forecasts 3 Annual averages Source: UBS WMR, Thomson Financial

Date Country Indicator Unit Month Frequency Forecast 1 Consensus 2 Previous

4-May GE Retail Sales (real) % yoy Mar m –0.5 –0.4 –5.3

4-May CH Purchasing Managers' Index (PMI) level Apr m 35.0 32.6

5-May CH Consumer sentiment level Feb m –26.0 –23

7-May CH CPI % yoy Apr m –0.6 –0.4

8-May US Change In Non-farm Payrolls 1000 Apr m –700 –606 –663

8-May US Unemployment Rate level % Apr m 9.0 8.5

8-May CH Unemployment Rate s.a. level % Apr m 3.4 3.3

11-May FR Industrial Production % yoy Mar m –15.5

12-May US Trade Balance bn USD Mar m –25.965

12-May UK Industrial Production % yoy Mar m –12.5

12-May UK RICS House Price Balance level% Apr m –73.1

12-May GE HICP % yoy May m 0.2 0.7

13-May US Retail Sales % yoy Apr m –9.4

13-May US Retail Sales Less Autos % yoy Apr m –0.9

13-May UK Average Earnings (3Mts/Year) level % Mar m 3.2

13-May FR CPI % yoy Apr m 0.3

13-May EMU Industrial Production % yoy Mar m –18.4

14-May US PPI (finished goods) % yoy Apr m –3.5

15-May US Industrial Production % yoy Apr m –12.8

15-May US Capacity Utilisation level % Apr m 69.3

15-May US Empire State Manufacturing Survey level May m –14.65

15-May US CPI % yoy Apr m –0.4

15-May GE Real GDP % qoq Q1 P q –2.5 –2.1

15-May EMU Real GDP % qoq Q1 A q –1.7 –1.6

15-May EMU HICP % yoy Apr m 0.7 0.6

15-May CH Retail Sales (real) % yoy Mar m –3.81 UBS Wealth Management Research Forecast 2 Bloomberg Survey Source: UBS WMR, Bloomberg, Reuters

Date Country Event

04-May EC ECB’s Papademos Speaks at a Conference on the Crisis.07-May UK BoE announces interest rate decision. We expect rate to remain unchanged at 0.50.07-May EC Trichet speaks at ECB Monthly News Conference.12-May US Bernanke speaks on Fincancial Crises at Jekyll Island, Georgia.13-May UK BoE releases Quarterly Inflation Report.Source: Bloomberg

UBS investor’s guide 30 April 2009 1716 UBS investor’s guide 30 April 2009

Reader’s corner Equity market: USD

What’s on your mind? Ask the expert at:

[email protected]

I don’t buy your inflation callDear Andreas, In the last issue of UBS investor’s guide you argued that inflation could become a bigissue going forward. I don’t understand why. The latest inflation reading out of the USwas negative, and given the current state of the business cycle it is rather deflation thatwe need to fear. What am I missing here?

A client from Minneapolis

An inflection point is forming for equity markets

There is currently a debate amongst econ-omists whether we are heading for defla-tion or inflation. However, the two seem-ingly antithetic scenarios can be reconciledif one sees them as consecutive, i.e. we willfirst see some very low and even negativeinflation rates and, at a later stage, a pick-up in inflation.

The negative inflation rates we are spot-ting so far are not at all a surprise. Bear inmind that last year in July, a barrel of oil wastrading at nearly 150 US dollars. By year-end 2008, it had retreated below 40 USD.This is a roughly 75% fall. Even if oil andrelated products were only representing5% of a consumer price index, the oil pricecrash would still shave 3.5 percentagepoints off the inflation rate. Core inflation(which excludes the volatile price compo-nents of energy and food, and is thereforemore representative) revealed a priceincrease of +1.8% over the year in the USin March 2009.

It is true that the current recession willhold back core inflation in the next coupleof months. Wages are at best stagnatingand falling demand for goods and servicesis driving prices down. That said, the reces-sion will not last forever. Moreover, we maysee price inceases occur exactly where wepreviously saw them crash, i.e. in com-modities. The underlying story used to jus-tify higher commodity prices during the lastdecade, i.e. convergence and catching-up

of emerging markets, has not just vanished.Some larger emerging markets, like Chinaor India, have proven quite resilient. More-over, given the tremendous money creationof the Federal Reserve, the US dollar ispoised to weaken on a trade-weighted baseunless all other central banks around theglobe mimic the Fed. Some do, but othersare more reluctant.

Thus, while we expect inflation to trendlower until the third quarter of this year atleast, it could rebound as soon as year-end2009. Moreover, remember that it is notcurrent inflation rates but inflation expec-tations which matter when making aninvestment decision. These expectationscould trend higher quickly.Andreas HoefertEconomist, UBS Financial Services [email protected]

200

160

100

120

180

140

80

602003 20052004 2006 2007 2008 2009

MSCI USAMSCI World

Source: Thomson Financial

MSCI USA vs. MSCI WorldRegional indicators

US Consensus estimates

P/E (x)* 13.0

P/B (x)* 1.9

2009 Consensus S&P 500 EPS USD 58

2009 UBS WMR S&P 500 EPS USD 45

2010 Consensus S&P 500 EPS USD 74

2010 UBS WMR S&P 500 EPS USD 62*Note: Consensus 12 month forward estimatesSource: Bloomberg, FactSet & Thomson Financial

The equity market recovery since March 9largely reflects investor confidence that pol-icy actions are reducing the risks of eitheranother financial panic or a further drop inglobal economic activity. Moreover,investors are encouraged by the fact thateconomic activity is no longer deterioratingat the same pace of late last year. Relativeto where investor expectations had arrivedat the nadir of markets in early March, evi-dence that economic and financial condi-tions are ‘less bad’ has been sufficient togenerate higher asset prices. However, withglobal activity and earnings slow to recover,and given the headwinds of de-leveraging,equity market performance will be increas-ingly determined by the scope for multipleexpansion.

The upbeat start to the Q1 2009 earningsseason should provide some support forequities. Of the S&P 500 companies thatalready have reported, 67% were aboveconsensus analyst expectations. We expecta tug-of-war will persist for another fewmonths between investor enthusiasmregarding positive 1Q 2009 earnings sur-

prises (relative to significantly loweredexpectations) and improvement in macro-economic data on one hand vs. continuingpolicy uncertainty and poor earnings out-look on the other. In general, there are rea-sons to expect sequential earnings improve-ment this year: inventory restocking, recentcost-cutting programs which should boostmargins, less onerous currency trends areprobable, and the benefit of the US andChinese stimulus programs.Michael J. ConstantinouStrategist, UBS Financial Services [email protected]


Equities: Strategy Equities: Strategy

Doubters beware – equities are looking beyond the bottom

The S&P 500 has had a remarkable rallyover the past eight weeks, rising 28%since 9 March – the fastest 25%-plus rallyin 70 years, and only the fifth time in his-tory that stocks have rallied more than25% during such a stretch. Many punditsbelieve that the market is due for a pull-back because stocks have rallied so far insuch a short period. We believe that therecent market gains have simply pricedout the tail risks of a broad-based sys-temic financial meltdown as concernsabout bank nationalization have sub-sided. Continued equity market gains willlikely be contingent on further evidence ofeconomic stabilization. Although a near-term breather certainly cannot be ruledout, valuation indicators are still favor-able, suggesting that significant downsiderisks are low barring another financialpanic.

Gradually increase exposure to cycli-cal sectorsEach sector has fallen at least 20% fromthe October 2007 market peak. However,defensive sectors (Healthcare, ConsumerStaples, Telecom, Utilities) have signifi-cantly outperformed cyclicals (ConsumerDiscretionary, Materials, Technology,Industrials) over the past 18 months.Defensives have fallen 31% versus a 45%decline in cyclicals. With the prospect ofnear-term economic stabilization increas-

ing, we think investors should graduallyincrease their exposure to these beaten-down cyclical sectors. Equity markets areanticipatory. On average, stocks reachbottom two-thirds of the way throughrecessions. They are typically led by eco-nomically-sensitive sectors. Valuationsalso appear more supportive of cyclicals,which are trading at an 8% P/E discountto their long-term average, relative todefensives. We believe that cyclical oppor-tunities are strongest in Consumer Discre-tionary stocks, where the earnings declineis already quite advanced. We are morecautious on Technology and Industrials,where earnings estimates still appear tohave more room to fall short of consen-sus estimates.

Temper expectations on future returnsGiven both the magnitude of the recentrally and the scope for a tepid economicrecovery over the next one to two years,investors should continue to temper expec-tations for future returns. We are notexpecting “normal” GDP growth (long-runaverage over the past 60 years is 3.4%) toreturn anytime soon as the consumer de-levering process is far from over, and finan-cial leverage was a key ingredient for earn-ings over the past few years. Examining theequity bear markets over the past 90 years,there has been a strong relationship

between the depth of the market declineand the number of years it took for stocksto reach their previous bull market peak.Using these data, if past is prologue, theS&P 500 may not reach its October 2007peak until the year 2020. But from currentlevels, even in that case, investors wouldgenerate a healthy 6.0% return annualized(before dividends) from current levels, inline with the average long-term returnsfrom stocks.We believe valuations remain supportivefor equity markets to continue adding torecent gains, albeit at a slower pace thanin the past eight weeks. Although valua-tions are not as inexpensive as they wereeight weeks ago, on several traditionalvaluation metrics, stocks remain wellbelow their long-term averages. When

incorporating cyclically adjusted earnings(10-year average of real operating earn-ings), the S&P 500 is currently trading at12.3 times, well below the 90-year average of 16.0 times. Usingreported earnings instead of operatingearnings, the S&P 500 is trading at 15.1times (versus the average of 16.7 times).We expect that cyclical sectors shouldstart to recover following their steepunderperformance during the past 18months. Consumer Cyclicals are our pre-ferred early-cycle cyclical stocks.Michael J. ConstantinouStrategist, UBS Financial Services [email protected]

Over the past 90 years, there has been a strong relationship between the depthof the market decline and the number of years it took for stocks to reach theirprevious peak. From current levels, investors would need to generate a healthyannual 6% return through 2020 to reach the October 2007 peak.

UBS WMR U.S. Top 25 Stock List

Company Ticker Sector Price ($)(04/27)

Darden DRI Cons. Discretionary 38.53

DIRECTV DTV Cons. Discretionary 25.07

Coca-Cola KO Consumer Staples 42.24

Colgate-Palmolive CL Consumer Staples 59.37

CVS/Caremark + CVS Consumer Staples 29.92

Wal-Mart + WMT Consumer Staples 48.51

Apache APA Energy 68.15

Exxon Mobil XOM Energy 66.13

Total TOT Energy 49.66

NY Community Bancorp NYB Financials 11.35

Travelers TRV Financials 40.33

Aetna AET Health Care 23.94

Genzyme GENZ Health Care 54.66For more information, please read the most recent U.S. Top 25 Stock List

Company Ticker Sector Price ($)(04/27)

Teva Pharma + TEVA Health Care 44.86

Thermo Fisher + TMO Health Care 32.79

3M MMM Industrials 57.35

Union Pacific UNP Industrials 47.38

Air Products APD Materials 62.42

Monsanto MON Materials 81.20

Cognizant Technology CTSH Technology 22.98

Google GOOG Technology 385.95

Taiwan Semiconductor TSM Technology 9.14

AT&T T Telecom Services 25.31

China Mobile CHL Telecom Services 43.65

Wisconsin Energy WEC Utilities 39.88

Source: Bloomberg and UBS WMR

Stocks which are only covered by UBS Investment Research are annotated as such with a ‘‘a” sign. These stocks have a 12-month rated Buy or Neutralrecommendation. UBS Investment Research is part of UBS Investment Bank (the UBS business group that includes, among others, UBS Securities LLC).


Equity market: Eurozone

Regional indicators

MSCI Europe vs. MSCI World

Equity market: Asia-Pacific

MSCI Asia ex Japan vs. MSCI World

Regional indicators

Retreat for a new attack Singapore shines less brightlyThe DJ STOXX 600 Index came close to ourtarget of 200 that we mentioned twoweeks ago. Technically we remain medium-term bullish, because of the broken near-term downtrend and the bullish ‘gap‘ on 9April. But in the near term, the probabilityfor further sideways trading is high, with arisk for a mild descent to the 185 level (6%below the close of 196.5 on Monday, 27April). This correction could actually berather constructive, and an ultimate breakabove the 200 level would complete a so-called ‘inverted head and shoulders‘ bot-tom formation. This should take the indexto 240, above the important 200-day mov-ing average (currently at 221) as well asabove a next downtrend line. We empha-size, however, that unless the index breaksabove 200, this scenario remains wishfulthinking. Medium-term downside shouldbe contained by the 180 support level (-8%).

It could well remain wishful thinking ifearnings for 1Q09 and outlook statementsare worse than expected or the Swine fluturns out to be nastier than expected. InEurope, no conclusive earnings data areavailable yet, with only about 50 of the 600companies having reported. But in the US,where over 200 S&P500 companies

reported results, the first signs are encour-aging. We are seeing a so-called ‘positivesecond derivative‘: the rate of earningsdecreases is coming down. Earnings in4Q08 were only about one-third of whatthey were a year earlier. Consensus 1Q09earnings forecasts are for about two-thirdsof those a year earlier. So although earningsare lower compared to the same period ayear ago, the rate of decline is less severe.Moreover, most companies in the US wereable to post positive surprises for 1Q09 andanalysts continue to reduce forecasts forthe whole of 2009. Previous recessionsshow that stock markets tend to recoverwhile estimates continue to be cut. Euro-pean markets are likely to take the US, asan example. Also, the consumer discre-tionary sector, which our strategists over-weight, serves as a light beacon with themost positive surprises.Hans SandersAnalyst, UBS AG

220

200

140

100

160

180

120

80

602003 20052004 2006 2007 2008 2009

MSCI EuropeMSCI World


Following the strong market rally of recentweeks, we are adjusting our Asia ex-Japanstrategy and have moved Singapore from‘overweight‘ to ‘neutral‘. During the heightof the financial crisis, a key reason for main-taining an overweight position on Singa-pore was that its economy looked less vul-nerable to systemic risk than most of theother markets. This is because Singaporehas some of the strongest economic funda-mentals in the region, such as low leverage,a sound financial system and a healthy cur-rent account. This situation has notchanged, but after additional funding fromthe IMF boosted the outlook for emergingmarkets, the risk of an acute crisis else-where has fallen considerably. In this envi-ronment, Singapore‘s strong economic fun-damentals are less of a relative advantage.Looking ahead, we believe that the poten-tial for an economic recovery in Singapore,although certainly present, is smaller thanin other Asian countries as constructionactivity and a weak labor market are likelyto remain drags on economic growth. Sin-gapore‘s performance in recent weeks hassomewhat reduced its relative valuationadvantage to other markets. Yet Singaporeremains one of the more attractively valuedmarkets. Therefore, our downgrade neither

means that we have turned negative on theSingapore market nor indicates any need torush out of the market.

However, we do believe that other mar-kets, such as China and India, are currentlyoffering more attractive investment oppor-tunities than Singapore does. China contin-ues to be our favorite market as valuationslook reasonable and China‘s domesticdemand is likely to stay considerablystronger than in other markets, not leastbecause of additional government spend-ing. India also looks well positioned as itseconomy is overwhelmingly focused on thedomestic market and should be lessaffected by weaker global growth. Yves BogniStrategist, UBS AG

380

340

140

180

220

260

300

100

602003 20052004 2006 2007 2008 2009

MSCI Asia ex JapanMSCI World


Eurozone Estimates

PE 2010 (x) 8.9

PB 2009 (x) 1.0

ROE 2009 (%) 11.7

EPS Growth 2009 (%) –12.4Sources: MSCI, IBES

Asia Ex Japan Estimates

PE 2010 (x) 12.0

PB 2009 (x) 1.4

ROE 2009 (%) 13.8

EPS Growth 2009 (%) –8.4Sources: MSCI, IBES


Bond market: USD Municipal securities

May fixed income update Build America Bonds (BABs): a new wave of taxable munisWe continue to believe that government pol-

icy will be the primary driving force thatshapes the performance in the fixed incomemarkets. Lately, we have been asked whetherthe numerous government programs toaddress the financial crisis are actually work-ing. Our answer is yes, but some have beenmore effective than others. Among the moreeffective programs, the Temporary LiquidityGuarantee Program (TLGP) and the BuildAmerica Bonds (BABs) program have createdtwo new – and well received – classes ofbonds. In the agency and mortgage backedsecurities market, the decision of Fannie Maeand Freddie Mac’s regulator, the FHFA, toplace the companies into conservatorshipand the Fed’s subsequent purchase of theirdebentures and MBS have caused spreads tonarrow significantly. And, the Fed’s purchasesof Treasury debt has helped to keep Treasuryyields in a 50bps range between 2.5% and3.0% so far this year. While government pro-grams have helped to improve liquidity in thebond market and narrower spreads are pos-itive, the market remains too fragile for pol-icy makers to take off the training wheels.

For risk averse investors who have beenoverweight cash, we recommend moving

into the highest quality sectors of the bondmarket, such as FDIC insured bonds, high-grade municipals, and TIPS. For investors witha moderate risk tolerance, we continue tobelieve that corporate bonds, municipals, andTIPS offer the best relative value. Within thecorporate bond market, investors with ahigher risk appetite may explore movingdown the credit spectrum, where the ‘BBB’-rated sector offers approximately 230bps ofadditional yield over ‘A’-rated bonds. Finan-cial sector bonds continue to demonstrateadditional volatility over non-Financials, andhave underperformed. However, we con-tinue to believe that systemically importantfinancial institutions will be supported by thegovernment, and that those that can with-stand the volatility might find interestingopportunities in the shorter-dated bonds ofthese companies.Barry McAlinden, CFAUBS Financial Services, [email protected]

US 10-year Treasury yield4.5

4.0

2.0

3.5

2.5

Source: Bloomberg

Oct 08 Dec 08 Feb 09 Nov 08 Jan 09 Mar 09 Apr 09

10-Year Treasury Yield

%

US government program summary

Program Acronym

ABCP Money Market Mutual Fund Liquidity Facility AMLFCommercial Paper Funding Facility CPFF

Federal Reserve purchase of GSE debtMoney Market Investor Funding Facility MMIFFPublic-Private Investment Program PPIP

Primary Dealer Credit Facility PDCFReciprocal Currency Arrangements

Temporary Guarantee Program for Money Market FundsTemporary Liquidity Guarantee Program TLGPTerm Asset-Backed Securities Loan Facility TALFTerm Auction Facility TAFTerm Securities Lending Facility TSLFTrouble Asset Relief Program TARPSource: UBS WMR, 27 April 2009

What are BABs? BABs were established in the AmericanRecovery and Reinvestment Act of 2009(ARRA) and signed into law by PresidentObama on 17 February 2009. BABs allowstate and local governments to issue tax-able bonds that provide federal subsidies tooffset a portion of their borrowing costs.The subsidies can take the form of either taxcredits for investors or refundable tax cred-its paid to state and local governmentissuers of the bonds. So far, most issuersseem to be opting for the cash subsidy. Aspart of the economic stimulus plan, the pur-pose of the initiative is to help rebuild thecountry’s infrastructure while providing costsavings to issuers of state and local govern-ment debt. Many municipalities seekingaccess to the capital markets are facinghigher financing costs created by the finan-cial crisis. Issuing debt at a taxable rate witha federal subsidy may result in a lower netinterest cost for an issuer than is possible inthe tax-exempt market. A small and rela-tively unknown taxable municipal marketalready exists. However, this is the first timemunicipal issuers can issue debt in the tax-able market and receive cash subsidies fromthe federal government. Note that the pro-vision is temporary and is set to expire at theend of 2010. For more information onBABs and how they work, see EducationNote, Build America Bonds: a new wave oftaxable munis, 20 April 2009, and Munici-pal Report, Muni market rallies as BABs takethe stage, 24 April 2009.

Initial BABs well receivedBABs are broadening access to municipalcredits for investors that do not typicallypurchase tax-exempt bonds, including pen-sion funds, taxable fixed-income mutualfunds, insurance companies, and sometrust accounts. BABs are likely to take someof the supply pressure off the traditionaltax-exempt market and to afford taxablebond buyers a more extensive opportunityto invest in municipals. So far, the bulk ofBABs issuance has been at or around the30-year maturity. The state of California,New Jersey Turnpike Authority, and NewYork’s Metropolitan Transportation Author-ity (MTA) have brought some initial BABofferings to market over the past twoweeks.

Potential market implications So far, most issuers have opted to issueBABs with relatively long maturities ofabout 30 years, displacing tax-exempt sup-ply in this segment of the market. If theinvestor interest remains as strong as it hasbeen for the initial issues, we expect BABsto replace a share of traditional tax-exemptbonds. We view this as a near-term positiveas it is likely to diminish the pressure of sup-ply on yields, particularly on the longest partof the curve. Tax-exempt yields shoulddecline relative to benchmark taxable yieldsand Libor rates.Kathleen McNamara, CFA, CFP®Strategist, UBS Financial Services, Inc. [email protected]


Bonds: Strategy Bonds: Strategy

Bond yields at the mercy of supply and growth shocks

Budget deficits reach record highs

SwitzerlandCanadaGermanyEuro ZoneJapanUSUK

0

–6

–4

–10

–2

–8

–12

–14Source: Consenus forecasts; UBS WMR

Budget balance

Income development does not react yet9

4

2

5

6

7

8

3

1

0

5

7

4

3

2

1

6

8

1995 2004 2007 20101986 1989 1992 1998 2001

Source: Source: Bloomberg, UBS WMR

y/y

US Unemployment Rate (lhs)US Avg Hourly Earnings (rhs)

Budget forecasts, like those presented bythe UK government a few days ago, aredeteriorating all around the world. Signif-icant tax shortfalls are expected to pushthe UK government deficit to around12% of GDP this year, slightly above thelevel expected for the US. The figures maybe a little less gloomy in other countries(see chart), but the direction is the same.As the deficits need to be funded by issu-ing government bonds, investors are in-creasingly concerned that yields will haveto rise (and prices fall) in order for in-vestors to have an incentive to buy.

Additional demand from centralbanks and consumersThere are a few trends that could defusethis danger in the short term, however.For example, central banks are buying up

these bonds in greater number. Throughsuch unconventional monetary policymeasures – which go beyond merely set-ting short-term interest rates – they areboosting money supply and stabilizing in-flation expectations. The Bank of England,for instance, has announced that it will bespending some GBP 75 billion on govern-ment and corporate bonds over the nextthree months. This is part of a GBP 150billion program that has been approvedand that will finance a large part of thedeficit for this year, expected to be in theregion of GBP 175 billion. The situation inthe US is similar; there too, the expansionin the Fed’s balance sheet is large enoughto fund much of the country’s new debt.

Central banks are not the only onesdriving up demand for governmentbonds; so too are consumers, who are

saving a larger slice of their income in theUK and US in particular. Corporate bondissuance also tends to be low in periods ofrecession, as there is less need for financ-ing owing to lower capital expenditure. Assuch, both the supply and the demandsides contribute to bringing down yieldsin periods of weak growth.

Caution needed in upturnIn the upturn phase that lies ahead, how-ever, the tide is likely to turn against bondinvestors. Central banks will then sellbonds on the market in order to mop upliquidity, and at the same time the supplyof corporate debt will grow. Increasedsupply and reduced demand will thentranslate into rising yields in real terms. In-vestors can protect themselves againstthis development by buying bonds withrelatively short maturities, which are lesssensitive to interest rate movements. Werecommend a strategy of this kind forbonds denominated in Swiss francs, yenor Canadian dollars in particular.

Yields could first go even lowerHowever, we still do not know how quick-ly a sustainable upturn will set in. Wethink there is a very real likelihood thatnegative inflation rates could push yieldsdown even further in the coming months,especially if the global rise in unemploy-ment significantly dents salary growth.We are already witnessing such a scenarioin the UK (taking into account bonuses),but not yet in the US (see chart) or othercountries. Significantly weaker salarygrowth could then spell lower core infla-

tion and inflation expectations as well. Wesee the greatest likelihood of falling yieldsin the near term for bonds denominatedin Australian dollars, sterling and euros.Achim PeijanStrategist, UBS AG

Many investors are increasingly concerned that bond yields are going to risesharply as a result of ever-growing government deficits. However, unconvention-al monetary policy measures and the sluggish economic performance that areexpected are likely to limit their rise.

For corporate bond recommendations,please read the most recent Bond Recommendations US – Relative Value


Real estateReal estate

It pays to invest in green building

Consuming about 40% of the energy inindustrialized countries, buildings representa large potential for reducing greenhousegas emissions. This is increasingly being rec-ognized in climate change strategies world-wide and has also been included in manyfiscal stimulus packages. Retrofitting andweatherizing buildings are viewed as an

ideal way to combine climate change goals,job creation and reducing dependency onforeign oil. Many investors, however, arestill skeptical: Does energy-efficient buildingreally pay off?

According to the US Department ofEnergy, green buildings can reduce energycosts by up to 30% with existing technol-ogy. Particularly for commercial buildings,where energy costs normally amount to 30-40% of operating costs, investments inenergy efficiency can pay off relativelyquickly. A survey of US architects, engineersand contractors carried out by McGraw-Hillin 2005 concluded that energy-efficientbuildings have an average cost premium of2% but are expected to lead to an improve-ment of return on investment of 6.6%. Thisimproved return is due to lower operatingcosts as well as an increase in building value,occupancy rate and rental yield. The averagepremium for sustainable building (whichoften includes additional aspects next toenergy efficiency) in developed countries isestimated to be around 5%. Comparisonsof cost premiums and payback times acrosscountries always have to be interpretedcarefully, as average building energy effi-ciency and building standards vary consider-ably. The notion of what is energy efficientmay differ accordingly. There are plenty oflow-hanging fruit across the world in therenovation area. For new buildings, meas-ures beyond what is already mandated maybe rather costly in countries with compara-tively strict building standards.

Tenants versus landlordsThere is another tricky issue that appears tobe bothering investors. Many of the bene-fits of energy-efficient buildings accrue tothe user and not to the owner of the prop-erty. Although owner-users may base theirdecision on criteria such as increased well-being or lower dependency on energy pricemovements, this is not the case for non-occupying owners. As the energy bill is nor-mally paid by the tenant, the landlord haslittle incentive to increase energy standards.The big question is, therefore, whether ten-ants are ready to pay a premium for sustain-able or energy efficient buildings or not.Some investors still do not seem to be con-vinced this premium can be claimed – whichis necessary in order to offset higher initialor retrofitting costs.

Strong driversSeveral developments should improve thebusiness case of energy efficient building inthe near future and help to convince theskeptics, in our view. Indeed, energy pricesare currently low and the general economicenvironment probably discourages biginvestments in energy efficiency. To put itsimply, when energy prices decline by half,the payback time of an investment intoenergy efficiency doubles. However, wethink energy prices may climb to USD 90 asearly as 2010, increasing the attractivenessof energy efficiency again. This should besupported by ever stricter building stan-dards worldwide. Such requirements maymandate a specific green certification (e.g.LEED, EnergyStar), but they may alsoinclude incentives such as density bonuses,expedited permitting or grants and reducedtaxes for projects which achieve specifiedstandards. Moreover, pressure from tenantsand home buyers is likely to increase, par-

ticularly in Europe, owing to the mandatedintroduction of the energy certificate. Thiscertificate is a user-friendly tool to give ten-ants and landlords, owners and potentialpurchasers information as to the conditionof the building in terms of construction andenergy consumption, and the recom-mended measures for renovation. It alsohas to be noted that investors can increas-ingly profit from favorable mortgage andcredit conditions, which further reduces thepayback time of energy efficiency invest-ments.

Market increasingly rewards energy-efficient buildingWe therefore see a high likelihood of thevalue differential between sustainable orenergy efficient and ‘non-energy efficient‘buildings to increase in the future. A studybased on US office property suggests theresale premium for green buildings could beas high as 16%1. To some extent, thesehigher valuations simply reflect the higherbuilding costs, but they may also factor inexpected lower future operating and com-pliance costs. We not only expect premiumsfor energy efficient buildings, but also dis-counts for badly-insulated property, forexample. The forward-looking propertyinvestor will therefore likely envisage value-adding building retrofits for the very nearfuture.Agathe BolliClaudio SaputelliAnalysts, UBS AG

Although the environmental benefits of energy-efficient building or retrofittingproperties are largely undisputed, many investors still doubt whether the addi-tional costs actually pay off. Evidence is increasing that the market is rewardingsuch measures.

1 Eichholtz, Kok, Quigley: Doing Well by Doing Good?Green Office Buildings. Maastricht University/Universityof California, April 2008

Sustainable and energy efficient build-ing rating schemes across the worldSustainable building rating and certification schemesreflect the priorities of the specific countries fromwhich they are originating

Scheme Country

LEED (Leadership in Energy US (mainly),and Environmental Design) Canada,Green Building Rating System other countries

Energy Star US (mainly)

BREEAM (Building Research UK (mainly)Establishment’s EnvironmentalAssessment Method)

Minergie, incl. Minergie-Eco Switzerlandand Minergie-P

Nabers (National Australian AustraliaBuilt Environment Rating System)

Green Star Australia

HQE (Haute Qualité FranceEnvironnementale)

CASBEE (Comprehensive Assess- Japanment System for Building BuildingEnvironmental Efficiency)

TQ (Total Quality) Austria

DGNB (Deutsches Gütesiegel Germanyfür Nachhaltiges Bauen)Sources: UBS WMR


Foreign exchange

AUDUSD

AUDUSD

GBPUSD

GBPUSD

EURUSD USDJPY

EURUSD USDJPY

Foreign exchange

Source: Reuters, UBS WMR

Volatility Range

Forecast

Forward

Volatility Range

Aug 09 Dec 09 Apr 10 Aug 10 Aug 08Apr 08 Dec 08 Apr 09

1.60

1.50

1.40

1.30

1.20

1.10

115

105

95

85

75


Volatility Range

Volatility Range

Forward

Forecast



Forward

Volatility Range

Volatility Range

Forecast

2.2

2.0

1.6

1.8

1.4

1.2

1.0



Volatility Range

Volatility Range

Forward

Forecast

0.90

1.00

0.80

0.70

0.60

0.50


Watch out for risky eventsThe financial and economic crisis is expen-sive and, at the same time, complicated.Until not very long ago, we observed arecovery of EURUSD because marketsfound relief in the IMF promises to providemore funds to rattled economies. CentralEurope, one of the most challenged regionscurrently, was thought to be the main ben-eficiary of such funds and, therefore, theeuro found a nice support. Meanwhile, thesudden appearance of human-to-humantransmission of swine flu has changed thefates of currencies again. The worries aboutpandemic sickness is pressuring equity mar-kets and, therefore, also EURUSD. Majorsupport is found at levels of 1.30, 1.2820,1.2550 and 1.2460. Longer-term investorsmight again find a window of opportunityto enter longer-term EUR long positionswhenever the exchange rate is diving.Thomas FluryAnalyst, UBS AG

A new lease of life, for nowThe outbreak of the swine flu in Mexico.The uncertainty surrounding the bank stresstesting exercise in the US. The reportedchanges to the currency margin trade rulesthat would drastically reduce the leverageand attractiveness of carry trades in Japan.Although entirely unrelated, these eventsbear one common consequence: a sharpretrenchment in risk appetite in the finan-cial markets. This bodes unsurprisingly wellfor the yen, recouping a chunk of the ear-lier depreciation. These events also high-light the fragility of the global financial mar-kets, corroborating our view that in thenear term weak risk sentiment appears todominate. We, nonetheless, reiterate thatthe yen weakness should becomeentrenched on a more decisive comeback ofrisk taking at a later stage. We believe thecurrent dips in the USDJPY pair offer niceopportunities to buy USD versus JPY, target-ing our 3-month forecast of 103.Andy JiAnalyst, UBS AG

Accumulate as risk appetite fadesThe Reserve Bank of Australia (RBA) low-ered its key policy rate by 25bps in its Aprilmeeting, defying market expectations of asecond consecutive pause. However, in itsaccompanying policy statement, the RBAhinted that the easing cycle might be near-ing its end. This offered some optimism toinvestors, which lifted the AUDUSD cur-rency pair above 0.7, and somewhat liftedrisk appetite in financial markets. We, nev-ertheless, deem the improvement in risksentiment unsustainable, especially if theeconomic data continues to deteriorate.The situation is made worse by the out-break of swine flu in Mexico. We maintainthat, only when the global economy defi-nitely starts its recovery path, the risk senti-ment will improve more sustainably. As aresult, we recommend accumulating theAussie on near-term weakness to positionfor its longer-term appreciation potential.Andy JiAnalyst, UBS AG

Heading for our three-month targetThe pound is slowly but steadily risingtowards our three-month forecast of 1.48USD per GBP. If equity markets continue toreflect some rebound from recent lows andthe exchange rate settles above 1.48, wewill have to watch out for our current six-month forecast of 1.54. This level seems stillvery ambitious, however, and far off in thecurrent environment. Indeed, somewhatstronger GDP and financial markets in botheconomies are needed for such a move. Weestimate an equilibrium rate of GBP versusUSD at 1.74. Therefore, a rise to 1.54 wouldbe a step ahead towards normalization.Investors should be aware that such movesmight come rather suddenly. For this reasonwe would already position for a higher GBPversus USD. In fact, the USD and, maybe,the Japanese yen are the only two curren-cies that we see depreciating against thepound.Thomas FluryAnalyst, UBS AG

30 UBS investor’s guide 30 April 2009

Foreign exchange: Strategy

UBS investor’s guide 30 April 2009 31

Portfolio

Swine flu – more caution while assessing the risksof a pandemic

Softening the US dollar in just 100 days

Looking at the first 100 days of BarackObama’s presidency, we find that the dollaris not one of the top priorities of the newUS administration. In fact, the sum of thestatements that were linked to foreignexchange reveals a lot of inconsistencies,rather than a clear currency strategy.

The administration’s main conflictabout the USDThe main conflict the administration met -and tried to circumvent – is that some pol-icy goals would be supported by a strongUSD while others call for a weaker USD. Aweak US dollar would be favorable for theexport industry. During the elections, manyobservers claimed that Barack Obamafavors a weak dollar as a Democrat withimportant roots in the Chicago industryarea. In the meantime, we know that indus-try support is done by direct fiscal measuresrather than by using the currency for exportpromotion. The potential need for a strongUS dollar comes from the need for externaldebt financing. The government, and theUS as a whole, rely on foreign demand for

USD assets, in particular safe Treasuries. Fora foreigner, the stability of the currency isone measure of safety. In this respect, it isinteresting to note that Treasury SecretaryGeithner showed very confusing responsesto the Chinese proposal to reduce theweight of the US dollar in global currencyreserves. This process of reducing the USDshare, which will take place later during theObama presidency, is likely to weigh on theUS dollar. As the main conflict continues todrive policy, the US administration is likelyto partially like and partially dislike thatdevelopment.

Crisis support fadingLooking at the USD trade-weighted index,which reflects the greenback’s value versusthe currencies of the main trading partners,we see that the US dollar has risen duringthe election period. That was the time whenbank write-downs and risk aversion sup-ported the USD. After the election, how-ever, Obama’s policy of very decisively fight-ing the crisis changed the trend for thegreenback from rising to sideways. Eventhough currency policy was not part of the(explicit) strategy, the sideways trend has sofar been the best solution to the conflict. Asthe crisis eases, we expect the USD to turnagain from “on hold” to ”weaker”.Thomas FluryAnalyst, UBS AG

With Obama dollar moves sideways90

80

85

75

70Source: Thomson Reuters

USD-Index

Jun 08 Aug 08 Dec 08 Feb 09 Apr 09

Nomination

Inauguration 100 daysElection

From a scientific point of view, it is still tooearly to draw a clear-cut conclusion on theoutbreak of the swine flu. Clearly, moredetails are needed. However, we expectheadline risk to remain high . Uncertainty islikely to be reflected by higher financialmarket volatility. This suggests a more cau-tious stance in respect to exposure to riskyasset classes in the short-term. We, there-fore, recently reduced our equity stance toa neutral allocation.

The current outbreak of the swine flubrings back memories of the avian (bird) fluevents in 2005/06. Although many parallelsare obvious, there are differences that alertus – and make us attribute a higher pan-demic risk to this event than to the avian fluoutbreak.

It is not our intention to suggest a panicreaction to the ongoing events. As said, fur-ther scientific assessments need to be per-formed. From an investor’s point of view,we simply think a more cautious stance willallow to better withstand the unavoidableuncertainty of the coming weeks. In ourasset allocation, this is expressed by thedowngrade of equity from Overweight toNeutral.

Since early March, risky asset classes (e.g.equities) experienced a robust rebound,driven by timid, but repetitive, signs that theeconomic environment has slightlyimproved, or at least not deteriorated fur-ther. Additionally, the corporate results forthe first quarter 2009 have so far proven tobe better than generally expected. We sus-pect that the uncertainty around the natureof the swine flu transmission and, conse-quently, the dimension of a possible pan-

demic is likely to reduce part of the newlyregained investors’ risk appetite in the com-ing weeks.

Among the most affected sectors areTransportation, Leisure (less traveling) and,to some extent, Luxury Goods (less tourism,an important source of revenues). On theother hand, antiviral drugs suppliers andreagents suppliers normally experiencestrong demand in this situation, not leastdriven by government spending.

The macroeconomic impact of the cur-rent swine flu outbreak is hard to predict atthis stage and could range from negligible(as in the case of the bird flu outbreak) todramatic. For the 2003 SARS crisis, the costsin terms of loss in GDP for different Asianeconomies were estimated to be between0.6% and 2% of GDP. In a worst case, theWorld Bank estimated the costs of a globalflu pandemic in terms of loss in global GDPto be around 4.8% (or USD 3 trillion).

UBS Wealth Management Research willcontinue updating our readers on eventsthat, in our view, qualify for well-foundeddecision making.Stefan SchneiderGiorgio CortianaDaniel KaltAnalysts, UBS AG


Emerging markets Emerging markets

Spring is not here yet

In the midst of the panic in October 2008,when a broad range of assets declined sub-stantially in value, emerging market bondscame under particular selling pressure.Emerging market sovereign bonds, denom-inated in US dollars, saw their averagespread (or premium) over US Treasurieswiden from the all-time low of about 1.5percentage points in 2007 to a peak ofnearly 9 percentage points. By the end ofApril 2009, this spread had narrowed forseveral consecutive months, to just below 6percentage points. In other words, it wasone-third below its October 2008 level.

There is an irony in this narrowing be-cause, since October 2008, the economicoutlook for the emerging markets has de-teriorated substantially. The first table be-low shows the forecasts of the Internation-

al Monetary Fund (IMF) for 2009 and 2010,made in April 2009, compared with sixmonths ago. For both years, and across allregions, the outlook has darkened marked-ly. Lower growth usually means that thereis less cash around, not only for the privatesector, but also for governments. For bondholders, it should also mean that the risk ofnot getting paid is higher today than it washalf a year ago. Why, then, do spreads sug-gest the opposite view?

Lower risk of extreme outcomes?As the fundamentals have not improved,the narrowing of spreads appears to sug-gest that the possibility of extreme out-comes, such as widespread sovereigndefaults, has diminished somewhat. TheG20 decision in April 2009 to provide the

IMF with resources of over USD 1 trillion tolend to emerging market governments hascontributed significantly to this improvedsentiment. But it is important to note thatthis money is not available to all govern-ments and under all conditions.

The risk of governments defaulting is notnegligible, therefore. The Seychelles andEcuador defaulted on their foreign curren-cy debt over the past six months. Othercountries whose US dollar governmentdebt is currently trading at distressed levels(more than 10 percentage points above USTreasuries) include Argentina, Belize, Geor-gia, Ghana, Jamaica, Pakistan, Sri Lanka,Ukraine and Venezuela. Not far behind (ataround 9 percentage points above US Treas-uries), we find the USD government bondsof the Dominican Republic, Gabon, Iraq,Kazakhstan and Serbia. IMF assistance, orthe prospect of IMF assistance, may not beenough to avoid defaults. For this reason,we remain cautious on the outlook for theriskier borrowers, notwithstanding the bull-ish signals from narrowing spreads.

However, as table 2 shows, the better-ratedemerging market governments are payingmuch less to issue debt in US dollars thanthe more indebted governments.

This is a reflection of their comparativelybetter fundamentals. Given the uncertainoutlook for the global economy, we wouldadvise investors to continue to opt forhigher-rated bonds. There is a reason whyhigher-rated bonds have lower yields.Costa Vayenas, Analyst, UBS AGMing Lei, Analyst, UBS AG

Emerging market bonds, both sovereign and corporate, are trading at strongerlevels than the highly distressed levels seen last year. The irony is that this im-provement comes despite an ongoing deterioration in the economic outlook. Weremain cautious.

2009 2010Forecast date Apr. 09 Oct. 08 Differ. Apr. 09 Oct. 08 Differ.

Real GDP, % annual changeEmerging countries 2 6 –4 4 7 –3

Developing Asia 5 8 –3 6 8 –2

ASEAN-5* 0 5 –5 2 6 –3

Central and Eastern Europe –4 3 –7 1 5 –4

Latin America –2 3 –5 2 4 –3

Middle East 3 6 –3 4 6 –2

Africa 2 6 –4 4 6 –2*Indonesia, Malaysia, Philippines, Thailand, VietnamSource: IMF

Deterioration in growth prospects

Yields (%) on USD government bonds

China 3.7Chile 5.9South Africa 6.3Mexico 6.7Brazil 6.9Philippines 7.0Turkey 7.2Russia 8.1Hungary 8.3Indonesia 9.0Venezuela 15.7Ukraine 19.1Source: Bloomberg, 24 April 2009

Investors should be aware that Emerging Market assets are subject to, amongst others, potential risks linked tocurrency volatility, abrupt changes in the cost of capital and the economic growth outlook, as well as regulatoryand socio-political risk, interest rate risk and higher credit risk. Assets can sometimes be very illiquid and liquidi-ty conditions can abruptly worsen. WMR generally recommends only those securities it believes have been reg-istered under Federal U.S. registration rules (Section 12 of the Securities Exchange Act of 1934) and individualState registration rules (commonly known as “Blue Sky” laws). Prospective investors should be aware that to theextent permitted under US law, WMR may from time to time recommend bonds that are not registered underUS or State securities laws. These bonds may be issued in jurisdictions where the level of required disclosures tobe made by issuers is not as frequent or complete as that required by US laws.

For more background see the WMR Education Note “Investing in Emerging Markets (Part 2): EM bonds,” 20November 2007. Clients interested in gaining exposure to emerging markets sovereign USD bonds may eitherbuy a diversified fund of such bonds (preferably an actively managed portfolio of such bonds), or they may wishto select bonds from specific countries.

Investors interested in holding bonds for a longer period are advised to select the bonds of those sovereigns withthe highest credit ratings (in the investment-grade band). Such an approach should minimize the risk that aninvestor could end up holding bonds on which the sovereign has defaulted. Sub-investment grade bonds are rec-ommended only for clients that have a higher risk profile and who seek to hold higher yielding bonds for onlyshorter periods.


Technical analysis Technical analysis

Relative strength, technically speaking

Source: Thomson Reuters, UBS WMR

EEM – Encouraging accumulation pattern Using momentum to forecast price

Technical analysis studies past price move-ments to predict future performance. His-torical data is crucial to this discipline, butprice comparisons are also important for aninvestment decision. Relative strength stud-ies can be useful here. We present examplesof relative strength data and explain somebasic terminology.

Technical analysis employs many meth-ods to analyze price movements. These mayinclude trend analysis, chart pattern recog-nition, support and resistance identifica-tion, and more. Price comparisons are alsoimportant for an investment decision. Butfor the uninitiated, the terminology associ-ated with these studies can be confusing.This is because relative strength can refereither to a Relative Strength Index (RSI) orto Indexed Relative Strength (IRS).

Put simply, RSI compares a set of datafrom a stock or a market at different pointsin time. On the other hand, IRS comparesdata at the same point in time but for dif-ferent stocks or markets. Below, we offersome real life examples of both types of rel-ative strength data.

Relative Strength IndexTechnical analysts talk a lot about momen-tum, which is seen as a measure of internalstrength that can be used across all mar-kets. Momentum indicators often oscillatearound a mean value, have extreme highsand lows, or adhere to some sort ofcrossover application. Interestingly, stan-dard chart analysis (trends and patternrecognition) can be applied here as well. Itsmovements are used to visually detect over-bought or oversold conditions, positive ornegative divergences, or in a stand-alonetrading strategy. One of the most widelyused momentum indicators, developed in1978 by J. Welles Wilder, is called the Rela-tive Strength Index. Simply, the RelativeStrength Index (RSI) smoothes out the aver-age gains or losses and oscillates between0 and 100.

Let’s use the GBPUSD currency pair as ourexample. Chart 1 shows that it may beforming some sort of rounding bottom for-mation, which looks like an elongated “U.”Breakouts from this pattern are often diffi-cult to project, so we look to the RSI chart

for help. In the case of the GBPUSD, RSI hasbeen rising since the Oct. 2008 sell-off,which would be a bullish positive diver-gence. So, in this example, since momen-tum indicators can sometimes lead theprice, we can use the bullish divergencewith the RSI to help anticipate a breakout.

Indexed relative strengthAn indexed relative strength study pits oneinvestment versus another to determinewhich is outperforming. Since supply anddemand drive prices up and down, relativestrength also enables us to determinewhich areas of the market money is flow-ing into. The index usually begins with abase of 100 and then divides one price bythe other, accumulates the out or underper-formance and graphically represents it overtime. For example, say that the 1-year rel-ative strength reading of stock ABC vs. mar-ket XYZ is 115. This would imply that a USD100 investment in ABC would now beworth USD 15 more than if you hadinvested in XYZ over the last year. In orderto improve a portfolio‘s performance, it isalways important to try to invest in the sec-tors or markets that are the relative outper-

formers. Unlike RSI, this is not an oscillatorand therefore cannot be used to indicate anoverbought or oversold condition or diver-gences.

Chart 2 looks at the global equity mar-kets to detect any signs of leadership. In our8 April 2009 International exchange tradedfund (ETF) report, we ran relative strengthstudies for ETFs designed to mimic the inter-national equities markets, both developedand emerging. Combined with classicaltechnical chart analysis, relative strengthanalysis confirmed that significant basingefforts were underway. In fact, many ofemerging market ETFs that we track look tobe retaining relative strength leaderships, atleast versus the broad-based US large capequities market (SPX). See our report forfurther details.Peter Lee, Chief Technical StrategistJonathan Beck, Technical AnalystUBS Financial Services [email protected]@ubs.com

Source: Thomson Reuters, UBS WMR


AppendixAppendix

Analysts provide two ratings, an absolute rating and a relative rating. The absolute rating is based on the current EstimatedFair Value Range (EFVR) for the stock and the recent trading price for that stock. The relative rating is based on the stock’stotal return potential against the total estimated return of the appropriate sector benchmark over the next year.

The EFVR is the price range within which the analyst estimates the stock to be fairly valued. The estimation of the EFVR isbased on methods such as Discounted Cash Flow model or valuation multiples comparison. In the definition of the EFVR,analysts take into account the risk profile (predictability) of the stock.

Absolute Stock Rating System

BuyWe believe the stock is undervalued relative to current market pricesHoldWe believe the stock's current market valuation is within a fair range. SellWe believe the stock is overvalued relative to current market pricesUnder reviewUpon special events that require further analysis, the stock rating may be flagged as “Under review” by the analyst. SuspendedIf data is not valid anymore, the stock rating may be flagged as “Suspended” by the analyst.RestrictedIssuing of research on a company by WMR can be restricted due to legal, regulatory, contractual or best business practiceobligations which are normally caused by UBS Investment Bank’s involvement in an investment banking transaction in regard to the concerned company.

Industry Sector Relative Stock View

Outperform (OUT) Expected to outperform the benchmarkMarketperform (MKT) Expected performance in line with the benchmarkUnderperform (UND) Expected to underperform the benchmark.Current WMR Global Rating Distribution (as of last month-end)

Buy 24%** (55%*) Outperform 32%*** (47%*)Hold 72%** (53%*) Marketperform 52%*** (45%*)Sell 4%** (39%*) Underperform 16%*** (45%*)

* Percentage of companies within this rating for which investment banking services were provided by UBS AG or UBS Securities LLC or its affiliates within the past 12 months. Source: UBS WMR, as of 1 April 2009.** At present, not all securities in WMR’s global coverage universe have been assigned an Absolute Stock Rating in a Corporate Report. The Absolute Stock Rating distribution calculation includes only securities that have been assigned anAbsolute Stock Rating as of the last month-end.*** Under our Industry Sector Relative Stock View system, “Outperform” most closely corresponds with a “Buy” recom-mendation, “Marketperform” most closely corresponds with a “Hold” recommendation, and “Underperform” most closely corresponds with a “Sell” recommendation.

Stock Recommendation System

Analyst CertificationEach research analyst primarily responsible for the content of this research report, in whole or in part, certifies that withrespect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflecthis or her personal views about those securities or issuers; 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 researchreport. If the date of this report is not current, the investment opinion and contents may not reflect the analyst's currentthinking.UBS Securities LLC is a subsidiary of UBS AG and an affiliate of UBS Financial Services Inc.For a complete set of required disclosures relating to the companies that are the subject of this report, please mail a requestto UBS Wealth Management Research Business Management, 1285 Avenue of the Americas, 13th Floor, New York, NY 10019.UBSFS and/or its affiliates trade as principal in the fixed income securities discussed in this report.

Required disclosures UBS Financial Services Inc. Technical Research Dept.: Definitions and Distribution

UBS Financial Definiton and Criteria CorrespondingServices Rating Rating

CategoryBullish Well-defined, reliable up-trend, an increase in the rate Buy

of change (or strong momentum) and confirming technical indicators

Mod. Bullish Positive overall trend, momentum and confirming Buytechnical indicators

Neutral Trading range trend, a flat rate of change and Neutral/Holdconfirming technical indicators

Mod. Bearish Weakened trend, momentum and confirming Selltechnical indicators

Bearish Negative trend, momentum and confirming Selltechnical indicators

N/A Not enough historical data to make an evaluation N/A

For information on the ways in which UBS manages conflicts and maintains independence of its research product; his-torical performance information; and certain additional disclosures concerning UBS research recommendations, pleasevisit www.ubs.com/disclosures.

Global Equity Rating AllocationsUBS 12-Month Rating Rating Category Coverage1 IB Services2

Buy Buy 51% 36%Neutral Hold/Neutral 37% 31%Sell Sell 12% 22%1Percentage of companies under coverage globally within the 12-month rating category.2Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided within the past 12 months.Source: UBS. Rating allocations as of 31 March 2009.

Global Equity Rating DefinitionsUBS 12-Month Rating DefinitionBuy FSR is > 6% above the MRA.Neutral FSR is between –6% and 6% of the MRA.Sell FSR is > 6% below the MRA.KEY DEFINITIONSForecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12months. Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not a fore-cast 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 subjectto possible change in the near term, usually in response to an event that may affect the investment case or valuation.

EXCEPTIONS AND SPECIAL CASESCore Banding Exceptions (CBE): Exceptions to the standard +/–6% bands may be granted by the Investment ReviewCommittee (IRC). Factors considered by the IRC include the stock’s volatility and the credit spread of the respective company’sdebt. 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 Companies Mentioned or Company Disclosure table in the relevantresearch piece.

UBS Investment Research

UBS Closed-End Funds Ratings: Definitions and Allocations

UBS Financial Definiton and Criteria % of companies % for which IBServices Rating under coverage services have

with this rating been providedBuy Higher stability of principal and higher stability of dividends 43.0 17.0Hold Potential loss of principal, lower degree of dividend stability 40.0 37.0Sell High potential for loss of principal and dividend risk 17.0 67.0Source: UBS WMR, as of 1 April 2009

Statement of riskStock and bond market returns are difficult to forecast because of fluctuations in the economy, investors psychology, geopo-litical conditions and other important variables.

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AppendixAppendix

Credit Issuer/Bond Recommendation Definitions

Recommen- Time WMR Definitiondation Horizon Terminology

WMR Credit/Bond*Rating

WMR CreditTrend

Longer Term

Review wit -hin a coupleof monthsReview wit -hin a coupleof months

AAA

High AAMid AALow AAHigh AMid ALow AHigh BBBMid BBBLow BBBHigh BBMid BBLow BBHigh BMid BLow BHigh CCCMid CCCLow CCCCCCD

Improving

Stable

Deteriorating

Watch +

Watch –

Issuer /Bonds have exceptionally strong credit quality.AAA is the best credit quality.Issuer /Bonds have very strong credit quality.

Issuer /Bonds have high credit quality.

Issuer /Bonds have adequate credit quality. This is the lowest Investment Grade category.

Issuer /Bonds have weak credit quality. This is the highest Speculative Grade category.

Issuer /Bonds have very weak credit quality.

Issuer /Bonds have extremely weak credit quality.

Issuer /Bonds have very high risk of default.

Obligor failed to make payment on one or more of its financial com-mitments. This is the lowest quality of the Speculative Grade category.The WMR Credit Trend reflects the analyst’s expectation that the company’s credit fundamentals will improve.The WMR Credit Trend reflects the analyst’s expectation that the company’s credit fundamentals will remain stable.The WMR Credit Trend reflects the analyst’s expectation that the company’s credit fundamentals will deteriorate.Increased likelihood of WMR Credit Rating upgrade(s).

Increased likelihood of WMR Credit Rating downgrade(s).

Recommen- WMR Terminology Definitiondation

Outperform (OUT) The bond is expected to earn a higher total return than a liquid bond benchmark representing a comparable level of risk.

Marketperform (MKT) The bond is expected to earn a total return in line with a liquid Bond bond benchmark representing a comparable level of risk.Recommen- Underperform (UND) The bond is expected to earn a lower total return than a liquid dation bond benchmark representing a comparable level of risk.

Sell (SELL) In light of substantial downside credit or default risk, and the expectation of a lower total return than a liquid bond benchmark representing a comparable risk, investors should sell these bonds.

*The Bond Rating reflects WMR’s opinion of the credit quality of a bond. The WMR Bond Rating is derived by adjusting the WMR Credit Rating of the issuer for anycollateral-type and capital structure considerations specific to that bond. This may result in the bond having a different risk profile, and therefore a different ratingthan the issuer, as well as other bonds of the issuer.

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Other Important DisclosuresIn certain countries UBS AG is referred to as UBS SA. This publication is for our clients’ information only and is not intended as anoffer, or a solicitation of an offer, to buy or sell any investment or other specific product. It does not constitute a personal recom-mendation or take into account the particular investment objectives, financial situation and needs of any specific recipient. We rec-ommend that recipients take financial and/or tax advice as to the implications of investing in any of the products mentioned here-in. We do not provide tax advice. The analysis contained herein is based on numerous assumptions. Different assumptions couldresult in materially different results. Other than disclosures relating to UBS AG, its subsidiaries and affiliates, all informationexpressed in this document were obtained from sources believed to be reliable and in good faith, but no representation or warran-ty, express or implied, is made as to its accuracy or completeness. All information and opinions are current only as of the date ofthis report, and are subject to change without notice. This publication is not intended to be a complete statement or summary ofthe securities, mar-kets or developments referred to in the report.

Opinions may differ or be contrary to those expressed by other business areas or groups of UBS AG, its subsidiaries and affiliates.UBS Wealth Management Research (UBS WMR) is written by, and intended for use by clients of, UBS Global Wealth Manage-ment and Business Banking. UBS Investment Research is written by UBS Investment Bank. The research process of UBS WMR isindependent of UBS Investment Research. As a consequence research methodologies applied and assumptions made by UBSWMR and UBS Investment Research may differ, for example, in terms of investment horizon, model assumptions, and valuationmethods. Therefore investment recommendations independently provided by the two UBS research organizations can be different. The analyst(s) responsible for the preparation of this report may interact with trading desk personnel, sales personnel and other con-stituencies for the purpose of gathering, synthesizing and interpreting market information. The compensation of the analyst(s) whoprepared this report is determined exclusively by research management and senior management (not including investment bank-ing). Analyst compensation is not based on investment banking revenues, however, compensation may relate to the revenues ofUBS Global Wealth Management and Business Banking as a whole, of which investment banking, sales and trading are a part.

At any time UBS AG, its subsidiaries and affiliates (or employees thereof) may make investment decisions that are inconsistent withthe opinions expressed in this publication, may have a long or short positions in or act as principal or agent in, the securities (or de-rivatives thereof) of an issuer identified in this publication, or provide advisory or other services to the issuer or to a company con-nected with an issuer. Some investments may not be readily realisable since the market in the securities is illiquid and therefore valu-ing the investment and identifying the risk to which you are exposed may be difficult to quantify. UBS relies on information barri-ers to control the flow of information contained in one or more areas within UBS, into other areas, units, groups or affiliates of UBS.Some investments may be subject to sudden and large falls in value and on realisation you may receive back less than you invest-ed or may be required to pay more. Changes in foreign currency exchange rates may have an adverse effect on the price, value orincome of an investment. Past performance of an investment is not a guide to its future performance. Additional information willbe made available upon request.

All Rights Reserved. This document may not be reproduced or copies circulated without prior written authority of UBS or a sub-sidiary of UBS. UBS expressly prohibits the distribution and transfer of this document to third parties for any reason. UBS will notbe liable for any claims or lawsuits from any third parties arising from the use or distribution of this document. This report is for dis-tribution only under such circumstances as may be permitted by applicable law. The securities described herein may not be eligiblefor sale in all jurisdictions or to all categories of investors.

UK: Approved by UBS AG, authorised and regulated in the UK by the Financial Services Authority. A member of the London StockExchange. This publication is distributed to private clients of UBS London in the UK. Where products or services are provided fromoutside 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 Financial Services Inc. accepts responsibilityfor the content of a report prepared by a non-US affiliate when it distributes reports to US persons. All transactions by a US personin the securities mentioned in this report should be effected through a US-registered broker dealer affiliated with UBS, and notthrough a non-US affiliate. Canada: In Canada, this publication is distributed to clients of UBS Wealth Management Canada by UBSInvestment Management Canada Inc.. Germany: Issuer under German Law is UBS Deutschland AG, Stephanstrasse 14–16, 60313Frankfurt am Main. Bahamas: This Publication is distributed to private client of UBS (Bahamas) Ltd and is not intended for distri-bution to persons designated as a Bahamian citizen or resident under the Bahamas Exchange Control Regulations. Hong Kong:This publication is dis-tributed to clients of UBS AG Hong Kong Branch by UBS AG Hong Kong Branch, a licensed bank under theHong Kong Banking Ordinance and a registered institution under the Securities and Futures Ordinance. Singapore: Distributed byUBS AG Singapore Branch, an exempt Financial Adviser under the Singapore Financial Advisers Act. Australia: Distributed by UBSWealth Management Australia Ltd (Holder of Australian Financial Services Licence No. 231127), Chifley Tower, 2 Chifley Square,Sydney, New South Wales, NSW 2000.© UBS 2009. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.

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