May 2014

ConfidentialGlobal Asset Management

Tracey McNaughton

Head of Investment Strategy, Australia

A World in Transition

Economic & Market Outlook

1

2

The economist disclaimer

CAN WE TRUSTTHE

STATISTICS?

SURE, JUST NOT THE WAY WE INTERPRET

THEM…

A World in Transition– Cautiously optimistic

“Prediction is very difficult especially if it’s about the future” – Niels Bohr

Source: UBS, OECD, IMF

EU

Healing is underway,

inflation weak;

political uncertainty

remains

2014: 1.2%

2015: 1.7%

UK

Rising consumption

and housing; falling

unemp; rates steady

until 2015

2014: 3.2%

2015: 2.7%

AU

Mining inv down,

exports and housing

strong, weak emp

2014: 2.6%

2015: 2.9%

US

QE ends 2014; rates

steady until 2015;

housing and bus inv

improve; unemp

easing

2014: 2.6%

2015: 3.5% China

Structural reform,

improving domestic

demand, inflation

contained

2014:7.5%

2015: 7.2%

Japan

Abenomics positive,

investment and

currency help pickup

in inflation and

activity2014:1.2%

2015: 1.2%

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22 years (and counting) of uninterrupted growth

10 of our top 12 export markets are in AsiaAustralian GDP (yoy%)

Source: Bloomberg, UBS

-3

-2

-1

0

1

2

3

4

5

6

7

91 92 93 94 95 97 98 99 00 01 02 04 05 06 07 08 09 11 12 13

%

QoQ YoY

“This is the recession we had to have.” – Paul Keating4

Growth to return to trend by 2015

Source: Bloomberg, UBS

5

Mining investment as a share of GDP

Mining investment boom over…

Outlook – lower, but no collapse now

“It is only when the tide goes out that you learn who's been swimming naked” –Warren Buffet6

7

Source: BREE, ABS, UBS

Vast majority committed projects are LNG/gas Export (volumes) boom just begun

…export boom just begun as the operational stage of the investment boom begins

“Everything that can be invented has been invented” – Commissioner of the US Office of Patents, 1899

Housing good - building approvals record highs

-10

-5

0

5

10

15

20

25

03 04 05 06 07 08 09 10 11 12 13 14

House Prices (yoy%)

8

Source: Bloomberg, UBS

9Sources: ABS, RBA, UBS

Population growth strong again (1.8% y/y);

record births and strong migration(Total) lending surge will lift credit growth

Housing: strong population is a key support

-30

-20

-10

0

10

20

30

40

50

-30

-20

-10

0

10

20

30

40

50

87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Finance commitments (LHS, total ex-housing refis, advanced 6 months)

Credit (RHS)

% y/y (2-month average) % y/y

“Do it for your country” – Peter Costello

1

2

3

4

5

6

7

8

9

10

00 01 02 03 04 05 06 07 08 09 10 11 13 14

Retail sales (yoy%)

Retail back to pre-crisis average – less debt averse

Average 6.3%

Average 3.6%

Less debt averse

…implies the savings rate will fall further

10

Source: Bloomberg, UBS

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

AU Employment growth(yoy%)

Employment on the mend…

Average 2.4%

Average 1.3%

4

4.5

5

5.5

6

6.5

7

7.5

8

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

AU Unemployment rate (%)

11

Source: Bloomberg, UBS

12Sources: ABS, NAB, ANZ, RBA, UBS

Employment intentions bounce

…signals turning point

Job ads strengthen

-4

-3

-2

-1

0

1

2

3

4

5

-45

-40

-35

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

89 90 91 92 93 94 96 97 98 99 00 01 03 04 05 06 07 08 10 11 12 13 14

a

RBA rate cut cycles

NAB employment intentions (adv 6 months, LHS)

Employment growth

Index % y/y

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

-60

-50

-40

-30

-20

-10

0

10

20

30

40

50

60

ANZ job ads (advanced 4 months, RHS)

Employment (LHS)

% y/y

% y/y

…leading indicators of employment improving

Business conditions – trending up

…boosted by weaker dollar

0.50

0.55

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

1.00

1.05

1.10

-24

-20

-16

-12

-8

-4

0

4

8

12

16

20

24

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

RBA rate cut cycles Business conditions (LHS) AUDUSD

Index USD

Business sector deleveraged

Sources: RBA, ABS, APRA, Bloomberg, Morningstar, States, Datastream, UBS

13

Confidence- mixed

Source: Bloomberg

-40

-30

-20

-10

0

10

20

30

Dec-00 Jan-03 Feb-05 Mar-07 Apr-09 May-11 Jun-13

NAB Business Confidence

70

80

90

100

110

120

130

Dec-00 Jan-03 Feb-05 Mar-07 Apr-09 May-11 Jun-13

Westpac Consumer Confidence

Average 5.6

Average 105

14

15

Sources: Datastream, Bloomberg, UBS forecasts

AUD: tapering key for depreciation

AUD and bond spread AUD ‘catches’ lower commodity prices

* AUD to drop further to 0.85USD

Dec-13 Dec-14 Dec-15

EUR/USD 1.38 1.25 1.20

USD/JPY 105.3 110.0 115.0

GBP/USD 1.66 1.55 1.60

AUD/USD 0.89 0.85 0.85

AUD/EUR 0.65 0.68 0.71

AUD/JPY 94.0 93.5 97.8

AUD/NZD 1.09 1.07 1.12

AUD TWI 68.9 65.5 66.7

0

25

50

75

100

125

150

175

200

225

250

275

300

325

350

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

1.00

1.05

1.10

04 05 06 07 08 09 10 11 12 13 14

AUD/USD (LHS)

10-year bond yield spread - Australia less US (RHS)

USD bps

Fed signals 'tapering'

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

10

20

30

40

50

60

70

80

90

100

110

120

130

140

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

RBA USD commodity price index (LHS)

AUD (RHS)

Index

USD

16Sources: RBA, Datastream, Reuters, UBS forecasts

3-year yields rise before last RBA cutAustralian bonds to outperform

(amid ongoing sell-off)

• RBA to hold as Fed tapering should lower AUD, and improving global economy should stabilise

economy

• Proposed fiscal policy tightening a downside risk – but probably just keeps on RBA sidelines for longer

• Rising pressure on RBA to ‘normalise’ to avoid distortions (i.e. house prices/debt)

RBA: yields to keep rising on Fed taper

Key Interest rates Latest Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15

AUSTRALIA

Cash 2.50 2.50 2.50 2.50 3.00 3.00 3.00 3.25

90 day bills 2.67 2.60 2.70 2.70 3.10 3.10 3.10 3.35

3 Year Bonds 2.89 3.50 3.50 3.70 4.00 4.00 4.00 4.00

10 Year Bonds 3.90 4.30 4.40 4.50 4.60 4.70 4.70 4.70

10-3 Year spread (bp) 101 80 90 80 60 70 70 70

10 Year Spread to US (bp) 131 110 100 100 100 100 85 70

US

Fed funds 0.13 0.13 0.13 0.13 0.13 0.25 0.75 1.25

2 Year Bonds 0.42 0.70 0.80 1.00 1.00 1.30 1.60 2.10

10 Year Bonds 2.58 3.20 3.40 3.50 3.60 3.70 3.85 4.00

10-2 Year Spread (bps) 216 250 260 250 260 240 225 1902

3

4

5

6

7

8

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

AU 3 Year bond yield and cash rate

Cash rate 3 year yield

The budget we had to have

Source: Treasury

“If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidise it” – Ronald Reagan17

China – from producer to consumer

Urban dwellers consume more than farmers

The latest urbanisation plan is to shift 21 million people per year to the cities.

“Let it [China] sleep, for when it wakes, it will shake the world” – Napoleon Bonaparte18

China – rise of the middle class

“If a little is good, and more is better, then way too much is just about right” – Mae West19

Share of population in middle class

Avg

ann

ua

l e

xp

en

ditu

re o

f m

iddle

cla

ss

Size of bubble

represents total

annual middle

class consumption

Japan – from deflation to inflation

BOJ Shock and Awe

Source: Bloomberg, UBS

Inflation (yoy%)

75

80

85

90

95

100

105

110

Jan-12 Jun-12 Nov-12 Apr-13 Sep-13 Feb-14

USD/YEN-3

-2

-1

0

1

2

00 01 02 03 04 05 07 08 09 10 11 12 14

20

4

5

6

7

8

9

10

11

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

3. US Unemployment rate (%)

53.3

51

57

61.9

67.1

70.768.8

53.1

56 56.458.4

66.1

77.7

50

55

60

65

70

75

80

31/12/01

US Household Net Worth ($tn)

-20

-15

-10

-5

0

5

10

15

20

Jan-01 Jul-02 Jan-04 Jul-05 Jan-07 Jul-08 Jan-10 Jul-11 Jan-13

yoy%

1. Case Shiller US House Prices

US – from unconventional to conventional policy

Source: Bloomberg, UBS“The vast majority of our imports come from outside the country” – G.W. Bush, Jr

21

22

Europe – from crisis to stability

Out of recession… ……but not out of the woods.

Source: Bloomberg, UBS

-6

-4

-2

0

2

4

00 01 02 03 04 06 07 08 09 10 11 13 14

%

Europe GDP

YoY

7

8

9

10

11

12

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

EU Unemployment rate (%)

“It is better to have a permanent income than to be fascinating” – Oscar Wilde22

The world is healing but …

– Currency wars around the world

– Monetary policy less effective

– Ageing demographics – increased size of government

– Political risk in Europe

– QE entry/exit strategies

– China-Japan dispute

– Re-regulation – increased influence of the government in free

market

"This is not the end. It is not even the beginning of the end. But it is,

perhaps, the end of the beginning.“ - Winston Churchill 23

24

Positioning: Cautiously optimistic

Modest global growth

– Fed completes QE tapering by end 2014

– Political uncertainties remain in Europe, but healing process underway

– Stable growth in China of around 7-7.5%

Globally fair value, cheap outside of US

Positioning:

– Positive allocation to equities, increased exposure to linear vs delta

– Overweight Europe & Canada, neutral US, underweight Australia & France

– Neutral EM with preference for North Asia (China, Sth Korea and Taiwan)

Credit spreads approaching fair value

Positioning:

– Keeping duration risk low with preference for AU over the US

– Overweight HY

Positioning:

– Largest overweights are to USD, EUR and PHP. Largest underweights are to NZD and CHF.

Macro

Equities

Bonds

FX

Source: UBS Global Asset Management.

As at January 2014

“If all the economists in the world were laid end to end, it wouldn't be a bad thing” – Peter Lynch

Current market views

Asset Allocation and Currency

UnattractiveAttractive Neutral

Bo

nd

sE

qu

itie

sC

urr

en

cie

s

US-I

US Large

Global ex US

Emerging

IG Corporates

High Yield

Emerging

Sovereign

CHF

JPY

EUR

As of February 28, 2014.

Based on UBS Global Asset Management views.

MXNUSD

GBP

CAD

AUD

SEK

NOK

NZD

25

Conclusion

The world is in transition – volatility is high

Static asset allocation strategies will underperform in this environment

Investors need to be vigilant, flexible and nimble

“Individuality is fine, as long as we all do it together” – Major Frank Burns26

A parting thought…Get a life!

Source: Economist

Relationship between working hours and premature death in OECD,

1970-2011

Pote

ntial years

of

life lost

Average annual hours worked per person engaged

1300 1800 2300 2800

12000

8000

4000

“The future will be better tomorrow” – Dan Quayle27

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