This report has been prepared by UBS AG. Please see important disclaimers and ­disclosures­at­the­end­of­the document.­

UBS House ViewMonthly Letter 24 February 2022

Chief­Investment­Office­GWMInvestment Research

Ukraine

Conflict­between­Russia­and­Ukraine,­and­the­effect­of­sanctions, mean volatility is set to continue. But we think it is unlikely energy supplies will be disrupted.

Inflation

Inflation­is­running­at­multi-decade highs, but we expect it to peak soon and trend back toward central bank targets by year-end.

Fed

Market expectations point to a front-loaded­tightening­cycle,­but we don’t expect policy rate increases to derail the economic recovery.

Asset allocation

Against a backdrop of heightened uncertainty, we think now is a time for investors to be more selective, consider portfolio hedging, and seek longer-term­opportunity.

The testF.­Scott­Fitzgerald­once­said­that­“the­test­of­a­first-rate­intelligence­is­the­ability­to hold­two­opposing­ideas­in­mind­at­the­same­time­and­still­retain­the­ability­to­function.”­He­might­also­have­said­that­this­is­the­test­of­a­first-rate­portfolio.

Investors­have­faced­multiple­negative­headlines­so­far­in­2022.­Inflation­has­con-tinued­to­rise,­and­price­pressures­are­broadening.­The­Federal­Reserve­has­shifted­its focus away from stimulating economic recovery and toward managing prices. A flattening­yield­curve­has­heightened­fears­of­recession.­Most­recently,­conflict­has broken out between Russia and Ukraine.

All of this speaks in favor of reducing exposure to equities, especially when the recent­sell-off­in­bond­markets­has­increased­the­appeal­of­fixed­income­invest-ments.

But­at­the­same­time,­growth­remains­above­trend­and­various­economies­are­lifting­COVID-19­restrictions.­Supply­chain­pressures­are­easing.­We­are­likely­close­to­a­peak­in­inflation­in­the­US.­China­has­started­adding­more­stimulus.­Financial­condi-tions are still loose in an absolute sense, and market expectations are for Fed policy rates to peak only at around 2%—this is hardly a “Volcker shock,” when the Fed hiked­rates­to­20%­to­subdue­inflation.­Meanwhile,­so­far,­Russian­oil­and­gas­sup-plies­remain­mostly­unaffected­by­the­conflict.­

Markets have also not ignored the risks: They now assume between seven and eight 25-basis-point­US­interest­rate­hikes­over­the­next­two­years.­Price-to-earnings­ratios­for­global­equities­have­fallen­by­9%­in­the­past­two­months,­and­investor­sentiment, as measured by the American Association of Individual Investors’ bullish sentiment­survey,­is­close­to­its­worst­since­2016.­

So­how­do­we­continue­to­build­robust­portfolios­when­we­face­magnified­upside­and downside risks and the beginning of a new central bank policy regime, and amid geopolitical turmoil?

Mark HaefeleChief­Investment­OfficerGlobal­Wealth­Management

Follow me on LinkedInlinkedin.com/in/markhaefele

Follow me on Twittertwitter.com/UBS_CIO

The test

2February 2022 – UBS House View Monthly Letter

First, we don’t think this is a time to be outright negative on equities—sentiment is already poor, at least some of the risks have been priced in, and a combination of above-trend­global­growth­and­falling­inflation­could­quickly­make­the­picture­look­more favorable for investors.

Second, we think this is a time to consider implementing portfolio hedging strate-gies:­We­cannot­exclude­the­possibility­of­higher­inflation­expectations­forcing­the­Fed to become outright restrictive in its monetary policy. Nor can we dismiss the chance­of­a­disruption­to­global­energy­markets­stemming­from­the­Russia-Ukraine­situation.

As such, it makes sense to take some steps to prepare portfolios, initially by ­ensuring­they­are­well­diversified­geographically­and­across­asset­classes­to­mitigate­­idiosyncratic­risk,­and­subsequently­by­considering­specific­geopolitical­hedges,­including commodities.

Third, we think this is a time to be more selective about exposure within the mar-ket. Oil and energy stocks should perform well in the event of further escalation in geopolitical­tensions,­but­we­also­expect­them­to­do­well­if­the­Ukraine­conflict­sub-sides.­We­also­see­Chinese­equities­as­attractive­relative­to­other­Asian­markets,­given their exposure to economic recovery and lower valuations. Their relative insu-lation­from­rising­US­interest­rates­and­Western­geopolitical­risk­also­means­they­provide­appealing­diversification­benefits­in­a­portfolio­context.

In the rest of this letter, I explain our latest base case view on the key market driv-ers:­inflation,­the­Fed,­and­the­Russia-Ukraine­situation;­explain­why­we­are­more­positive­than­some­of­the­worst-case­scenarios­out­there;­and­consider­the­data­that­could drive us to change our views in the months ahead.

Russia-Ukraine

Background and our risk caseAt­the­time­of­writing,­sanctions­imposed­by­Western­nations­have­been­limited­to­select­financial­institutions,­issuance­of­sovereign­debt,­and­a­halt­to­the­approval­of­the­Nord Stream 2­pipeline,­though­we­expect­more­sanctions­to­materialize­in­the­coming days.

We­don’t­think­this­is­a­time­ to­be­outright­negative­on­equities;­sentiment is already poor, and some of the risks have been priced in.

Heightened fears of wider military­conflict­in­Ukraine­ have prompted increased market volatility.

06/2021 08/2021 10/2021 12/2021 02/2022

Markets have not ignored the downside risksFigure 1

AAII US Investor Sentiment Bullish minus Bearish Readings, S&P 500 forward P/E (rhs)

30 23

22

21

20

19

20

10

0

–10

–20

–30

Source: Bloomberg, UBS, as of February 2022

AAII Bull – AAII Bear S&P 500 forward P/E (rhs)

The test

3February 2022 – UBS House View Monthly Letter

In­our­view,­the­limiting­factor­on­President­Vladimir­Putin­will­not­be­Western­ sanctions themselves but his own assessment of the costs of a wider campaign in terms of resources, Ukrainian resistance, and political support at home in the event of­wider­conflict.­

The risk case is that the crisis remains a source of continued volatility for an extended period until a new point of stalemate is reached. The extreme risk case, which­we­would­define­as­one­that­has­a­lasting­and­material­negative­impact­on­global­growth,­is­that­the­conflict­escalates­to­a­level­that­pushes­Western­nations­to­accept­disruption­to­Russia’s­energy­flow.­

Mutual interests to keep energy flowingWhile­it­is­hard­to­predict­the­potential­limits­on­the­conflict,­we­think­that­President­Putin has a strong interest in continuing to sell energy and other commodities to Europe, which has a strong interest in continuing to buy them.

Russia’s energy sector accounted for close to 20% of Russian GDP and 40% of ­fiscal­revenues­in­2019.­Europe­would­suffer­profound­consequences­from­a­disrup-tion, given its reliance on Russian oil and gas and other commodities for its manu-facturing sector. And for the US, the risk of higher energy prices may not sit well against a backdrop of already sliding approval ratings for President Joe Biden in a midterm election year.

As such, in our base case, we think that President Putin continues to destabilize Ukraine and its government through a variety of tactics, but for those tactics to fall short­of­what­might­trigger­energy­sanctions­by­the­West.­

More­generally,­it­is­also­worth­noting­that­risk-off­events­linked­to­geopolitical­­turmoil­have­historically­tended­to­be­short-lived,­with­the­greater­risk­to­investors­coming­from­panic­selling­or­under-diversifying­rather­than­actual­events­on­the­ground.

What we are watchingEnergy prices will be a key factor to watch as events unfold. In most of our scenar-ios, we do not expect to see a disruption to energy supplies, but if oil prices were to rise­to­USD­125/bbl­or­higher­for­two­quarters,­it­would­result­in­roughly­half­a­per-centage­point­lower­in­global­GDP­growth,­and­higher­inflation­affecting­consumer­spending power.

A prolonged move in oil prices above­USD­125/bbl­would­make­ us more cautious.

1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020

'91: First Gulf War

'01: 9/11 attacks

'03: Iraq war

'11: Intervention in Libya

'14: Ukraine conflict

'14: Intervention in Syria

'17: Airstrike on Syrian airbase

'99: Kosovo bombing

'16: Brexit vote

The market impact of geopolitics tends to be short-livedFigure 2

S&P 500 index; shaded areas indicate US recessions

5,000

4,000

3,000

2,000

1,000

0

Source: Bloomberg, UBS, as of February 2022

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Should­Russia’s­energy­flow­be­disrupted,­higher­risk­premiums­and­lower­global­earnings­estimates­would­likely­trigger­more­long-lasting­losses­for­equity­markets.

Inflation­

Inflation data has surprised to the upsideInflation­has­continued­to­hit­multiyear­highs­in­the­first­weeks­of­2022:­In­the­12 months­to­January,­US­CPI­hit­7.5%,­a­40-year­high;­Eurozone­consumer­prices­touched­a­record­5.1%;­and­UK­CPI­was­5.5%,­a­three-decade­high.­

Data­also­suggests­this­is­not­purely­a­product­of­pandemic-related­factors,­and­price pressures may be getting more deeply rooted. The Atlanta Fed’s Sticky CPI index,­which­focuses­on­prices­that­do­not­change­often,­rose­to­4.2%­year-over-year­in­January­from­3.7%­in­December.­Services­inflation,­which­is­not­subject­to­the­same­pandemic­effects­as­goods­inflation,­has­risen­above­4%.­And­average­hourly­earnings­growth­rose­to­5.7%­in­January,­from­4.7%­in­December,­poten-tially­suggesting­the­beginnings­of­a­wage-price­spiral.

We think inflation will peak soonWhile­the­inflation­data­released­so­far­in­2022­does­point­to­a­heightened­risk­of­stagflation,­we­still­think­it­is­most­likely­that­headline­inflation­will­peak­within­the­next one or two months.

First,­past-year­comparisons­should­support­a­reduction­in­headline­inflation­rates.­In particular, the rate of increase in used car, fuel, and gas prices should all begin to slow or reverse. It’s also worth noting that, generally, the items that have experi-enced­the­highest­rates­of­inflation­over­the­past­year­are­also­the­same­items­that­have tended to experience less “persistence” in their price movements over the past two decades.

Second,­the­widespread­lifting­of­COVID-19-related­restrictions­should­ease­supply­chain backlogs. Data is already showing that semiconductor shipments, auto pro-duction,­and­shipping­volumes­are­increasing;­PMI­surveys­suggest­that­inventories­are­growing;­and­supplier­delay­times­are­decreasing.­As­well­as­being­positive­for­growth, this should reduce upward pressure on prices.

Inflation­is­running­ at­multi-decade­highs.

We­still­think­it­is­most­likely­that­headline­inflation­will­peak­within­the next one or two months.

2016 2017 2018 2019 2020 2021 2022

Sticky prices are rising in the USFigure 3

Atlanta Fed Sticky CPI, 12 months, US CPI year-over-year, in %

8

7

6

5

4

3

2

1

0

Source: Bloomberg, UBS, as of February 2022

Atlanta Fed Sticky CPI, 12 months, in % US CPI YoY, in %

The test

5February 2022 – UBS House View Monthly Letter

Third,­a­shift­in­consumption­patterns­away­from­goods­and­toward­services­should­help­reduce­inflation.­Although­services­inflation,­driven­by­tight­labor­markets,­is­a­cause­for­concern,­this­could­also­be­eased­if­a­combination­of­looser­COVID-19­restrictions,­renewed­immigration,­and­reduced­wealth­effects­(due­to­flat­stock­markets and less stimulus) boost the size of the labor force.

Overall,­in­our­base­case,­we­expect­to­see­inflation­peak­within­the­next­two­months,­before­falling­gradually­back­toward­2–3%­by­the­end­of­2022.­We­think­this­should­be­sufficient­for­market­concerns­about­inflation­to­gradually­ebb.­

What could lead us to become more cautiousSome­of­the­most­critical­data­to­watch­to­confirm­or­challenge­our­view­include­wage­growth,­services­inflation,­and­the­cost­of­shelter.­If­these­indicators­stay­ele-vated,­or­accelerate­further,­it­could­suggest­that­inflation­is­proving­more­persistent­than our base case expectations.

To­the­extent­that­an­improvement­in­supply­chain­issues­is­a­driver­of­lower­infla-tion,­we­will­also­need­to­monitor­COVID-19­policy­in­East­Asia.­China’s­zero-toler-ance policy continues to create the risk of sudden closures to factories or ports in key exporting regions for the global economy.

The Fed

Markets have repriced the path for ratesJust two months ago, the market expected that US interest rates would increase by 63bps­in­2022­and­a­further­70bps­in­2023,­before­eventually­reaching­a­terminal­rate­of­1.9%­five­years­later.­

But­fears­about­inflation­have­led­the­Fed­to­make­a­significant­shift­in­its­expected­policy­path.­Now,­markets­are­pricing­1.5%­of­hikes­in­2022­and­0.5%­in­2023—a­significantly­faster­path­to­a­market-priced­terminal­rate­of­2%.­(Fed­projections­for­the­longer-term­federal­funds­rate­remain­higher­at­2.5%.)­Meanwhile,­the­latest­FOMC­minutes­suggest­that­“a­significant­reduction­in­the­size­of­the­balance­sheet” may also be necessary.

We­are­watching­wage­growth,­­services­inflation,­and­the­cost­ of shelter for signs of more ­persistent­inflation.

Fears­about­inflation­have­led­ the­Fed­to­make­a­significant­shift­ in its expected policy path.

01/2020 04/2020 07/ 2020 10 / 2020 01/ 2021 04/ 2021 07/ 2021 10/ 2021 01/ 2022

Markets believe Fed hikes will be done within 12 monthsFigure 4

US cash rate expectations, one, two, three years from now, in %

2.5

2.0

1.5

1.0

0.5

0

–0.5

Source: Bloomberg, UBS, as of February 2022

1Y 2Y 3Y

The test

6February 2022 – UBS House View Monthly Letter

Tighter Fed policy concerns equity market investors for at least three reasons:

First,­the­Fed’s­shift­in­focus­away­from­supporting­growth­and­toward­managing­prices likely also implies that the US central bank will be less sensitive to a weaker economic­outlook­or­heightened­financial­market­volatility.­This­“lower­strike­on­the­Fed put” increases the inherent risk in equities.

Second, investors fear that the Fed might drive the economy into recession as it tries­to­meet­its­inflation­goal—a­worry­reflected­in­an­increasingly­flat­yield­curve.­An­inverted­yield­curve­(in­which­short-term­interest­rates­rise­above­the­yield­on­long-term­bonds,­typically­measured­by­two-year­versus­10-year­maturities)­has­pre-ceded­all­recessions­since­1976.

Third,­higher­interest­rates­on­cash­and­high-grade­bonds­increase­their­appeal­and­could­drive­an­equity-to-bond­rotation­if­they­become­sufficiently­attractive.

Concerns about higher rates may be overstatedHistory­tells­us­that­Fed­tightening­often­eventually­leads­to­a­recession.­But­history­also­tells­us­that­markets­often­continue­to­rally­after­the­Fed­starts­tightening.­Since­1983,­in­the­six­months­following­the­first­Fed­rate­hike­of­a­cycle,­the­S&P 500­on­average­has­gained­5.3%.­

In addition, we have reason to believe that, while higher interest rates do typically have a negative impact on economic growth, it may not hold as true this time around. Higher interest rates usually harm growth by constraining demand. But in this­cycle,­demand­is­already­constrained­by­supply­issues­and­residual­pandemic-related­restrictions.­So,­while­higher­interest­rates­may­affect­potential­demand,­if­supply challenges ease, economic activity could continue to rise regardless.

Furthermore, this Fed under Jerome Powell is hardly a Volcker Fed. Despite headlines of­inflation­spiraling­out­of­control,­markets­expect­longer-term­inflation­to­stay­low­even­with­a­relatively­modest­peak­in­interest­rates.­Markets­are­currently­projecting­that­a­peak­interest­rate­of­2%­in­the­middle­of­next­year­is­consistent­with­inflation­averaging­just­2.5%­over­the­medium­to­long­term­(based­on­five-year,­five-year­­forward­inflation­expectations).­With­a­real­interest­rate­of­-0.5%,­this­would­still­be­quite accommodative policy in an absolute sense.

And on valuations, with bond yields rising, equities have indeed gotten less attrac-tive in relative terms. Yet the yield gap—the inverse of the P/E ratio minus the 10-year­bond­yield—is­still­above­its­long-term­average,­at­3.6%­versus­3.3%.­So­is­the­global­equity­risk­premium­based­on­a­dividend­discount­model,­at­5.6%­versus­4.4%. This suggests that equities will likely outperform bonds.

At present, market pricing assumes around six interest rate hikes in 2022 and a further one to two in 2023, but it is worth noting that investors and markets have historically­tended­to­overestimate­the­consistency­and­durability­of­rate-hiking­cycles—1994­and­2009–10­are­clear­examples­of­this.

If­the­Fed­begins­hiking­rates­and­inflation­starts­to­come­down­as­we­expect,­we­could still end 2022 with a Cinderella story of a Fed that went from “behind the curve” to “threading the needle” of balancing its mandates of full employment and price stability.

Markets­often­continue­ to­rally­after­the­Fed­starts­ tightening.

The test

7February 2022 – UBS House View Monthly Letter

What could lead us to become more cautious?One­key­risk­to­our­view­is­that­longer-term­inflation­expectations­begin­to­rise,­which­would­be­a­sign­that­markets­are­starting­to­worry­that­the­projected­interest­rate­path­could­be­insufficient­to­manage­inflationary­pressures.­This­could­mean­the Fed has little choice but to hike rates more aggressively, and the increased risk of­a­Fed-induced­recession­would­make­us­demand­a­higher­risk­premium­from­equities.

An­alternative­risk­is­that­longer-term­inflation­expectations­stay­contained,­but­they­only do so because the market fears that the Fed is driving the economy into reces-sion­with­overly­tight­policy.­We­can­monitor­this­risk­by­focusing­on­the­shape­of­the­yield­curve.­If­we­see­short-term­interest­rates­rise­meaningfully­above­long-term­rates, it could indicate that the market fears recession ahead. The spread between 2-year­and­10-year­US­Treasury­yields­is­currently­40bps,­still­in­positive­territory­but­the narrowest since August 2020.

Our investment scenarios

Considering­all­the­above­factors,­we­have­revised­our­end-2022­targets­for­various­equity markets. Our forecast revisions for our base case are based on the following assumption changes:

–­ We­have­raised­our­estimate­for­10-year­bond­yields.­We­now­expect­the­10-year­US­Treasury­yield­to­end­2022­at­2.3%,­from­2.1%.­Although­estimates­of­the­pace­of­the­Fed’s­tightening­have­increased­substantially,­while­longer-term­infla-tion expectations stay low and geopolitical uncertainty persists, we think the upside­to­longer-term­yields­is­relatively­limited.­All­else­equal,­the­increase­in­our­yield forecast reduces our estimate of fair P/E valuations for equity markets by 4% based on an earnings yield model.

–­ We­keep­our­estimates­for­2022­and­2023­corporate­earnings­unchanged,­given­our­expectation­that­growth­will­remain­above­trend­this­year,­inflation­will­fall­back, and geopolitical tensions will subside by year end.

–­ We­maintain­our­year-end­estimate­for­the­equity­risk­premium.­Relative­to­our­last­update,­we­believe­that­in­the­uncertainty­associated­with­inflation,­growth,­monetary policy, and geopolitics have all risen, warranting a higher risk premium in the short term. But we believe these factors will recede by the end of 2022, leaving­our­forecast­at­290bps.

Although­we­revise­down­our­forecasts,­we­still­project­double­digit­percentage­returns for the S&P 500 and the Euro Stoxx 50 and 4% upside for the MSCI Emerg-ing Markets index. However, given the degree of uncertainty in the current environ-ment­we­have­lowered­our­downside­scenario­price­targets­more­significantly.

At a time of elevated risks and ahead of a potential slowdown in growth later in the year,­it­can­be­hard­to­envisage­meaningful­market­upside.­But­moderating­growth­momentum­need­not­present­a­problem­for­stocks:­Since­1960,­when­the­ISM­manufacturing­index­has­been­below­its­previous­three-month­average,­but­still­above­55,­subsequent­12-month­returns­have­averaged­10%.­

In addition, when solid business momentum is combined with low investor sentiment, equity­gains­historically­have­been­strong.­Since­1987,­when­the­AAII­net­­bullish­­sentiment­reading­has­been­below­21%­and­the­manufacturing­ISM­above­55,­S&P 500­returns­in­the­next­12­months­have­averaged­more­than­20%­(compared­with­an­average­return­of­10%­for­all­periods).­

Rising­longer-term­inflation­ expectations or signs of a ­Fed-induced­recession­would­ make us more cautious.

We­have­revised­up­our­ bond yield forecasts, but see further equity upside from current levels.

Solid business momentum combined with weak sentiment has proved positive for equities in the past.

The test

8February 2022 – UBS House View Monthly Letter

Key­scenarios­and­asset­class­impact

Upside Central Downside

Scenarios Inflation / central banks

Growth

COVID-19

China

Geopolitics

Inflation­fears­abate.­Major­central banks gradually reduce accommodation, but less than the market expects.

Growth stays well above long-term­trend.

The­next­COVID-19­variant­becomes indistinguishable from the common cold.Developed countries follow the Denmark example and remove­all­COVID-related­restrictions by 2H 2022.

COVID-related­restrictions­start­to­be­lifted­after­the­Winter­Olympics.­Regulatory­crackdown and property market issues ease.

Quick­de-escalation­of­the­Ukraine crisis.

US­inflation­to­peak­in­1H­before gradually falling toward 2% by late 2022. Major­central­banks­reduce­accommodation, but policy remains accommodative. The­Fed­finishes­taper­by­March, raises rates in line with market pricing, and starts quantitative tightening in 2022.

Growth slows down gradu-ally but remains above trend in 2022.

Gradual­shift­from­pandemic­to­endemic­COVID-19­con-tinues, allowing countries to continue reopening their economies.

Chinese growth stabilizes. Central bank support contin-ues.­COVID-related­restric-tions­start­to­be­lifted­in­2H.

Escalation in Ukraine does not lead to a disruption of Russian energy supply to Europe­or­a­significant­and­prolonged spike in energy prices.

Inflation­remains­high­for­longer. Energy prices remain elevated­at­least­until­mid-2022. The Fed hikes more than the market expects and starts QT at an accelerated pace.

Global growth slows down-and remains below trend throughout 2022 amid aggressive monetary tighten-ing­by­major­central­banks.

The­next­COVID-19­mutation­is more severe than omicron.Consumption does not fully recover due to continued public fear.

China fails to contain omi-cron. Economic reopening is delayed­until­after­the­Polit-buro meeting in November.More­broad-based­property­market crisis or further regu-latory tightening further weighs on growth.

Further escalation of the Ukraine crisis leads to a dis-ruption of Russia’s energy supply to Europe and a sharp spike in energy prices, with Brent­holding­above­USD 125/bbl­for­at­least­six­months.

Asset class impact

(forecasts­for­December 2022)

Spot*

S&P 500 4,179 5,100 4,800 3,700

EuroStoxx 50 3,817 4,600 4,300 3,400

MSCI EM 1,207 1,350 1,250 1,000

USD IG spread** 94 45bps­/­+1% 80bps­/­+1% 150bps­/­+2%

USD HY spread** 372 270bps­/­+6% 350bps / +4% 550bps­/­–1%

EMBIG spread** 414 300bps­/­+6% 370bps­/­+4% 550bps / –3%

EURUSD 1.11 1.20 1.13 1.07

Gold 1,927 USD­1,400–1,500/oz USD­1,700/oz USD­1,900–2,000/oz

* Spot prices as of 24 February 2022**­During­periods­of­market­stress,­credit­bid-offer­spreads­tend­to­widen­and­result­in­larger­ranges.­Percentage­changes­refer­to­expected­

total return­(t.r.)­for­the­indicated­spread­levels­

Note:­Asset­class­targets­above­refer­to­the­respective­macro­scenarios.­Individual­asset­prices­can­be­influenced­by­factors­not­reflected­in­the macro­scenarios

Source: UBS, as of February 2022

The test

9February 2022 – UBS House View Monthly Letter

How to invest

As­reflected­in­the­above­forecasts,­we­don’t­think­this­is­a­time­to­be­outright­nega-tive­on­equity­markets.­Particularly­for­investors­with­a­longer-term­perspective,­stay-ing invested and focusing on incremental portfolio changes are key.

Overall,­we­think­now­is­a­time­for­investors­to:­a)­be­more­selective;­b)­consider­portfolio­hedging;­and­c)­seek­longer-term­opportunity.­

Mark HaefeleChief­Investment­OfficerGlobal­Wealth­Management

We­don’t­think­this­is­ a time to be outright negative on equity markets.

Action Investment idea

Be selective in equity market exposure

Buy the winners from global growth

Against­a­still-strong­growth­backdrop,­we­continue­to­favor­value­and­cyclical­sectors­and­mar-kets,­including­energy,­financials,­and­Eurozone­stocks,­along­with­broad­commodities.­Current­uncertainties­about­the­effect­of­Ukraine-Russia­tensions­on­energy­supply­mean­that­energy­stocks and commodities can also play a key role in portfolios as a geopolitical hedge.

Seek opportunities in China

We­like­Chinese­equities­relative­to­other­markets­in­Asia.­Policy­is­easing,­growth­is­likely­to­accelerate into the second half of the year, valuations are relatively attractive, and earnings growth is improving. Furthermore, the market is relatively well insulated from key global risks––geopolitics­and­rising­US­interest­rates––making­it­an­appealing­diversifier­in­a­portfolio­context.

Consider portfolio hedging

Prepare for rising rates

The­financial­sector­typically­benefits­as­rates­rise­thanks­to­higher­net­interest­income.­We­would also expect value sectors to outperform growth sectors, such as technology, which face the­greatest­headwinds­from­rising­rates.­In­fixed­income,­we­see­US­senior­loans­as­offering­some­protection­from­rising­rates­due­to­their­floating-rate­structure.

Build up some defense

With­uncertainty­set­to­remain­elevated,­investors­can­consider­balancing­some­of­their­cyclical­exposures with defensive sectors and strategies. Global healthcare is our preferred defensive sector, and we also see dividend strategies, dynamic allocation strategies, and the use of struc-tured­solutions­as­potentially­attractive­means­of­improving­the­risk-return­profiles­of­overall­portfolios.

Position for US dollar strength

The­dollar­is­a­“safe-haven”­currency­that­tends­to­rally­in­case­of­heightened­geopolitical­­uncertainty­or­“risk-off”­sentiment­in­financial­markets.­In­addition,­we­think­that­expectations­of US interest rate hikes this year are likely to support the dollar in the months ahead. As such, we see the US dollar as an attractive tactical currency position at present.

Diversify with alternatives

Diversifying­beyond­stocks­and­bonds­can­help­reduce­overall­portfolio­volatility.­We­favor­expo-sure to hedge funds, as well as other alternatives including private markets, global direct real estate, and structured investments.

Seek longer-term opportunity

Position for the net-zero carbon transition

Investing in traditional commodities and commodity producers, alongside greentech, clean air, and­carbon­reduction­strategies,­is­a­diversified,­realistic­way­to­invest­in­the­major­global­trend­toward­net-zero­carbon­emissions.

Take advantage of tech volatility

Despite headwinds from rising yields, we believe the overall earnings outlook for the tech sec-tor remains robust. In particular, we see upside for companies exposed to three foundational technologies:­artificial­intelligence,­big­data,­and­cybersecurity,­or­the­“ABCs­of­tech.”

Source: UBS, as of February 2022

Charts and scenarios are for illustrative purposes only. Historical performance and forecasts are no guarantee for future performance.Please see important disclaimer at the end of the document.

The test

10February 2022 – UBS House View Monthly Letter

UBS Investor Forum InsightsAt this month’s Investor Forum, participants discussed the outlook for inflation­and­interest­rates,­and­how­to­find­returns­in­volatile­markets:

–­ Most­participants­agreed­that­inflation­is­likely­to­remain­“sticky”­given­supply bottlenecks and structural trends such as the energy transition. Commodities­were­seen­as­a­good­source­of­inflation­protection­in­port-folios, as well as a valuable hedge against escalating geopolitical ten-sions.

– Global growth is expected to decelerate, but to remain positive even with the impending rise in US interest rates. Participants considered bonds­as­a­less­effective­portfolio­diversifier,­although­some­saw­oppor-tunities in select areas like high yield bonds.

–­ With­current­market­conditions­pressuring­equity­valuations,­some­par-ticipants favored a more neutral stance on the asset class, although oth-ers urged patience and expected returns to recover. In the meantime, participants saw opportunities in value stocks, emerging market bonds, Chinese equities, and commodities.

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11February 2022 – UBS House View Monthly Letter

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Investing­ in­ structured­ investments­ involves­ significant­ risks.­ For­ a­ detailed­discussion­of­ the­ risks­ involved­ in­ investing­ in­ any­particular­structured­ investment,­you­must­read­the­relevant­offering­materials­ for­ that­ investment.­Structured­ investments­are­unsecured obligations of a particular issuer with returns linked to the performance of an underlying asset. Depending on the terms of the investment, investors could lose all or a substantial portion of their investment based on the performance of the underlying asset. Investors could also lose their entire investment if the issuer becomes insolvent. UBS Financial Services Inc. does not guarantee

12February 2022 – UBS House View Monthly Letter

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