2011 A fractured world

21 January 2010

Rudolf LeemannWealth Management Research

UBS global outlook, 6th EFAC Assembly Technology Conference, Davos

1

Table of contents

Introduction

Section 1 Global economy divided in 2011

Section 2 Capital investments: The deep cuts are over

Section 3 New rules: No major currency should be considered safe

Section 4 Our view on financial investments

Disclaimer

This report has been prepared by UBS AG.Past performance is no indication of future performance. The market prices provided are closing prices on the respective principal exchange. This applies to all performance charts and tables in this publication.

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Introduction

• Although markets generally recovered in 2010 we think that if you scratch below the surface there are difficult economic issues to be faced.

• We are seeing the global economy is becoming more fractured – not down the traditional lines of West versus East or Developed versus Developing – but the strong versus the weak.

• Record deficit levels, previously unheard of stimulus measures and uneven levels of economic growth – will force many countries to face hard political choices and shape the environment in 2011.

• Emerging markets are leading us out of the recession.

• Balance sheets are much stronger today. We expect this to trigger a new M&A cycle, as companies try to grow through acquisition in order to offset slower global growth resulting from the severe downturn.

• Automation is among the first industries to come out of the downturn with strong momentum (even more so for mining, oil & gas related projects)

Section 1

Global economy divided in 2011

4

Global growth led by emerging economiesReal annual GDP growth and forecasts in %

5

Divergence between weak and strong countriesSelected countries grouped according to expected fiscal and current account balance 2011 in % of GDP

6

GLOBAL: Global economic data surprising positively

Economic Surprise Indicator

-100

-50

0

50

100

150

Nov.09 Jan.10 Mar.10 May.10 Jul.10 Sep.10

US EUR UK JAP

Citigroup Economic Surprise Indicator

Source: Citigroup; UBS WMR

7

Roll-over in PMIs reversed for now

25

30

35

40

45

50

55

60

65

Mar.06 Sep.06 Mar.07 Sep.07 Mar.08 Sep.08 Mar.09 Sep.09 Mar.10 Sep.10

Eurozone Japan UK US

Contraction

Expansion

Source: Bloomberg; UBS WMR

Purchase Manager Indices (PMI) Manufacturing

8

New orders-to-inventories signals lower ISM (US Supply Mgmt)

ISM Manufacturing New orders / InventoriesSource: Reuters EcoWin, UBS WMR

82 84 86 88 90 92 94 96 98 00 02 04 06 08 1025

30

35

40

45

50

55

60

65

70

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

ISM Manufacturing vs. new order-to-inventories ratio

9

Consumer confidence – continued divergenceUS vs. Eurozone consumer confidence index

Source: Thomson Reuters; UBS WMR

10

US: Job growth is stabilizing

Source: Thomson Reuters; UBS WMR

Monthly change in US private non-farm payrolls

-800

-600

-400

-200

0

200

400

2002 2003 2004 2005 2006 2007 2008 2009 2010

11

APAC: Chinese PMI trending higherIn

dex

Source: Thomson Reuters; UBS WMR

China Manufacturing Purchase Manager Index (PMI)

12

APAC: Chinese monetary widening and tightening

Source: Thomson Reuters; UBS WMR

China loan growth (6m growth rate in %)

0

5

10

15

20

25

30

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

13

APAC: Monetary policy on the rise

China (Lending Rate 6 months)India (Repo Cut-off Rate)

Australia (Cash target rate)

Feb07

May Aug Nov08

Feb May Aug Nov09

Feb May Aug Nov10

Feb May Aug Nov

Perc

ent

3

4

5

6

7

8

9

Source: Thomson Reuters; UBS WMR

Policy rates

14

UBS forecasts for real GDP growth and inflation

Global economy

Real GDP growth in % Inflation in %2010F 2011F 2012F 2010F 2011F 2012F

Americas US 2.8 2.7 2.8 1.6 1.6 2.1

Canada 3.1 2.8 2.6 1.8 2.1 2.0

Brazil 7.9 5.4 5.1 5.8 5.4 4.8

Asia/Pacific Japan 3.5 1.4 2.0 -0.7 -0.3 0.4

Australia 3.4 3.8 3.4 2.9 3.0 3.0

China 10.0 9.0 9.0 3.3 4.3 4.0

India 9.0 8.0 8.6 9.2 6.0 6.8

Rest of Asia 5.3 4.3 4.3 2.7 3.2 3.2

Europe Eurozone 1.8 1.9 1.9 1.9 1.8 2.1 Germany 3.3 2.2 2.0 1.4 1.6 1.7 France 1.7 2.0 1.9 1.6 1.8 1.7 Italy 1.2 1.6 1.4 2.0 2.0 2.2 Spain 0.0 0.5 0.8 2.1 1.5 1.8UK 1.6 2.3 2.2 3.3 2.7 1.9

Switzerland 2.7 2.3 2.1 0.7 0.9 1.7

Russia 4.1 4.8 4.5 6.9 8.5 7.7

World 4.1 3.7 3.8 3.0 3.0 3.4

indicates increased forecast

indicates decreased forecastSource: UBS

Section 2

Capital investments: The deep cuts are over

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Germany still steaming ahead…

Unemployment rate (reversed) Ifo indexSource: Reuters EcoWin, UBS WMR

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.0

11.5

12.0

12.580

85

90

95

100

105

110

German business sentiment (Ifo index) vs. unemployment rate (reversed)

Source: Thomson Reuters; UBS WMR

17

…but losing momentum

Industrial production (y/y) New orders manufacturing industry (y/y)

97 98 99 00 01 02 03 04 05 06 07 08 09 10

Perc

ent

-40

-30

-20

-10

0

10

20

30

40

Source: Thomson Reuters; UBS WMR

German industrial production and new manufacturing orders (y/y)

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Europe: Cyclical status quo

-4

-3

-2

-1

0

1

2

3

-0.5 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 0.3 0.4

GER

EMU

ITA

SPA

FRA

UK

Downswing (above average and

falling)

Expansion(above average and

rising)

Contraction (below average and

falling)

Upswing(below average and rising)

Jan '07

GRE

19

Eurozone: Sectoral status quo

-4

-3

-3

-2

-2

-1

-1

0

1

1

2

2

-0.6 -0.4 -0.2 0 0.2 0.4

Industry

ServicesConsumption

Construction

Jan '07Downswing (above average and

falling)

Expansion(above average and

rising)

Contraction (below average and

falling)

Upswing(below average and rising)

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End-market recoveryMining, Automation already top – Power Generation, T&D still challenging

Source: Morgan Stanley, UBS WMR

21

(40)

(30)

(20)

(10)

0

10

20

30

40

50

2005 2006 2007 2008 2009 2010E 2011E 2012E

Oil & Gas Utilities Metals & Mining Automotive Consumer Industrial Chemicals Pulp & Paper Median

Global capital spending resuming125 global companies' survey

Source: JPMorgan, UBS WMR

Capital spending review of global diversified industrial companies, aggregated JPMorgan sector estimates

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Conclusions

• Capex spending resumes, benefiting the automation industry

• Geographically positive drivers are emerging markets and European exporters

• US and Japan continues to be challenged, albeit recovering

• Monetary policy supportive of growth, but expected to slow down

• Positive sector drivers are automotive, mining, healthcare, consumers

• Recovery now; followed by stable, less exciting growth

• Biggest risks: inflation, further currency dislocations

Section 3

New rules: No major currency should be considered safe

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Currencies: a search for safety

• We expect the traditional big four (USD, EUR, GBP and JPY) to be under pressure in 2011:

– Quantitative easing, high government debt levels and a poor economic outlook will continue to challenge.

– It is difficult to avoid the major currencies altogether but we recommend diversification amongst the big four

– Many investors may wish to consider the currencies of commodity producers and emerging markets

– The problem is that some of these currencies (for example the AUD, NZD and Brazilian real) have become expensive – thus investors should look to trade tactically and add exposure on the dips.

25

Commodity currencies (AUD and NZD) show strengthValuation according to PPP versus 3-month interest rate

26

Euro to remain weakMostly flat in a 12 months basis (but for a weaker JPY)

* Estimates of equilibrium exchange rates based on Purchasing Power Parity (PPP) calculation

Source: Thomson Reuters, UBS WMR

27

Swiss Franc to remain 'safe haven'Despite minor weakening an ongoing challenge for exporters

* Estimates of equilibrium exchange rates based on Purchasing Power Parity (PPP) calculation

Source: Thomson Reuters, UBS WMR

28

Conclusions

• In currencies, we expect the traditional big four (USD, EUR, GBP and JPY) to be under pressure in 2011.

– We recommend diversification amongst the Big Four

– Consider the currencies of commodity producers and emerging markets (some are expensive so buy on the dips).

• For commodities, loose monetary policy and abundant liquidity should allow a re-acceleration in commodity demand, especially from emerging markets:

– We favor gold, copper and corn

– Oil to move up to USD 100/bbl over the next 12 months

Section 4

Our view on financial investments

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Attractive valuation of equity marketsP/E ratio based on consensus earnings forecasts bars indicate 20-year average

31

Improving 2011 earnings expectations for Germany and emerging marketsConsensus forecasts for earnings per share in 2011; normalized to 100 in Feb 2009

32

Risk map for selected developed and emerging bond marketsThe size of the bubble reflects the level of real interest rates

33

Corporate, high yield and emerging market bonds are still attractiveYield to maturity of selected USD bond market segments

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Conclusions

• Equities are well-positioned for a year of accommodative central banks, are able to weather the risks of inflation better than most, and offer attractive value going into 2011.

– We continue to recommend emerging market assets – and like the BRICs (Brazil, Russia, India and China)

– And Core Europe – i.e. Germany.

• Within fixed income, rules have changed – government debt is far from risk-free

– Avoid European peripheral sovereign debt

– We prefer short to medium maturities in countries with low public deficits and healthy external balances in emerging and developed markets

– There is some value in corporate bonds.

• Generally, investors should not forget about other non-traditional investments:

– The picture for hedge funds remains bright, especially within global macro and event- driven strategies

– Within real estate, good monetary conditions, easing lending standards and better-than- expected market fundamentals will be supportive

– Such investments do have different risks, but also different sources of return.

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