Ubs Investor Guide 5.27

UBS investors guide
Wealth Management Research 27 May 2011
Strong currencies to the fore

Eurozone debt crisis Investors are underestimating the impact of a Greek sovereign default New head of IMF Yes, why not an emerging market candidate? Market outlook Beyond the uncertainty Research evolution: See inside front cover for important information on this report. Analyst certication and required disclosures begin on page 41. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the rm may have a conict of interest that could aect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
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Contents
Editorial ............................................. 3 Focus ............................................... 4-7 Interview ........................................ 8-9 Asset allocation .......................... 10-11 Economy ..................................... 12-16 Fault lines ........................................ 17 Stock recommendations ............ 18-21 Technical analysis ....................... 22-23 Equity market ............................. 24-29 Bond market ............................... 30-33 Currencies ................................... 34-35 Commodities .............................. 36-38 Readers questions .......................... 39 Market scenarios ............................. 40 Appendix .................................... 41-43
Research evolution! Two of WMRs agship publications are joining forces. Beginning next month, we will combine the content you have come to expect in this report with the comprehensive market guidance of an improved Investment Strategy Guide our most popular publication. While this edition of the Investors Guide will be the last, we are condent you will enjoy our new publication and welcome your feedback as we continually work to improve our oering. For more information, please contact your Financial Advisor.
8 June 2011 Wealth Management Research publishes a UBS research focus on ination.
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Editorial
Dear readers, So far, 2011 has been stirred by dense news ow. Catastrophes and unsavory events have pursued each other, especially across the weekend stage, with regularity in the last couple of months. However, beside the billowing threat of Icelandic volcanic ash, one undisputed serial recurs almost weekly and delivers continual drama: the tragedy of Greek debt. Regular readers know our unaltered conviction for over a year now that Greece will ultimately have to restructure its debt and that bondholders will receive hey haircuts. A year ago the call was still rather bold many then saw us as too pessimistic but now it is market consensus. Much of available research and commentary on Greece now begins by saying, it is not a question of whether but of when. In this edition of the UBS Investors Guide, credit analyst Thomas Wacker, among the earliest to signal warning, answers questions on the Greek situation and its impact on the Eurozone. Another long-time call of WMR has been to prefer smaller currencies to the big four USD, EUR, JPY and GBP each with its own problems. The question stemming from this view for internationally exposed investors is how to optimally structure currency portfolios that were previously heavily weighted in USD or EUR. Currency expert Thomas Flury discusses this in the focus article. He delivers a catchy rule of thumb that should enable investors to navigate the traditionally rough seas of currency amid heaving storms of bad news.
Emerging markets need to work together a lot better to have a bigger impact in international policy-making.
Andreas Hfert Chief Economist
For our weekly market outlook, please see the UBS Weekly Guide. It features a focus article with in-depth thematic commentary, the weeks most important economic/market indicators and an overview of market performance and WMR investment strategy.
UBS investors guide 27 May 2011
Focus
Last arguments for strong currencies
The world does not have a reserve currency that inspires condence.In arguing the case for a strong currency, taking the size of nancial markets as a benchmark, one must plea on behalf of a strong US dollar and strong euro. The prospects of achieving this, however, are poor.We, therefore, make the argument that investors should gain exposure to strong, liquid currencies other than the big two in order to hedge against a depreciation in the dollar and euro.
Thomas Flury, Analyst, UBS AG
Debating whether the dollar will forfeit its status as the worlds anchor currency is idle in our view, as it has long given up this role in the reserve management domain. Although the dollar continues to be the principal means of payment and invoicing in international trade, as a store of value it has long since ceased to be the center of interest. It lost its dominance as an investment currency at the end of the 20th century. The turn of the century marked the end of the Asia crisis, the long-term integration of the largest emerging markets and the creation of the euro. It also saw the bursting of the Internet bubble, which at the time represented the severest collapse of the capital markets since World War Two. Up to that point the dollar mirrored the growth of the world economy. The sustained expansion of the emerging markets and the common nancial market in the Eurozone have weakened the standing of the US. The dollar will only be able to regain its role as the sole reserve currency if global economic development shis into reverse.
Focus
A downward trend The dollar index, a measure of the dollars strength against key, highly developed trading partners, set an interim high in 2002. Since then the trend has been downward. The negative trend relative to other liquid currency alternatives has not only caught the attention of currency specialists in the centers of nance, it has become very evident in the emerging markets. One of the main reasons behind the long-term depreciation in the dollar has been the ever-expanding US foreign trade decit and foreign trade debt. In addition, the nancial crisis has seen US government debt jump from 60% of GDP to 100%. If investors are to believe once more in the leading role of the United States and regain trust in the dollar and the US Treasury, the US national debt will need to fall to 60% of GDP again. New perspectives for investors in the emerging markets The stability of emerging market currencies since the Asia crisis has led investors there to look more closely at the parities of the dollar to alternatives such as the euro, the British pound, Swiss franc and Australian dollar. In the period between World War Two and the Asia crisis, most emerging markets had to deal with the problem of being overindebted and/or of severe downward pressure on their currencies. From the perspective of a company in an emerging market with its own risks, the uctuations between the US dollar and D-mark, pound and franc were of negligible importance. The discussion over whether the dollar, franc or D-mark was the best investment appeared to take a backseat, as the dollar was the currency that was most accepted on the market and the one in which transactions were invoiced. There were hardly any advantages in holding another freely convertible currency. Only in the past ve to 10 years, with the sustained upturn in the BRIC economies (Brazil, Russia, India and China) and
the stabilization of their currencies, has irritation over the steady depreciation of the US dollar become widespread. Lack of a logical alternative forces diversication The fate of the dollar as the reserve currency would have been sealed long ago if there had been an obvious alternative to the greenback. But the globalized world of the 21st century is not so neatly organized. The nancial crisis hit all major currency areas hard: the Eurozone, the United Kingdom and Japan. Soaring levels of debt in all regions are both a brake on growth and an inationary risk. Condence in all major currency areas has been dented. As a result, none of the big four can assume the role of the dominant reserve currency. US dollar an illusory safe haven Some currency analysts believe the dollar is still a safe haven for investors in uncertain times even though its value has declined in recent years. In this view, the dollar will remain predominant for cautious portfolio allocations. We have serious doubts. During the nancial crisis, the greenback appreciated strongly on two occasions, but the peak of its recovery in 2008 and 2010 was still far below 2000-2006 levels. The appreciation of the dollar in times of crisis is nothing more than a counter-reaction to strong downward pressure on the dollar during periods of growth. The recovery in the dollar is based not so much on the strengths of the US economy, but on temporary weaknesses of the growth regions in the emerging markets. The two major nancial crises, the bursting of the Internet bubble in 2002 and the nancial crisis of 2008, both had their origins in the United States and badly shook the stock market there. We are therefore skeptical as to whether the dollar will inspire much condence in future crises. There are objective reasons why investors should look for other havens. 5
Focus
Financial crisis submits no proof of safe havens The key question is this: What benet do investors derive from safety when during the crisis of the century this safety has failed to recoup even the losses of the past ten years? The recovery of the dollar was temporary and short-lived. Newsow and price movements during the crisis suggest that long-term orientated investors, such as central banks and sovereign wealth funds, wound down their dollar holdings in phases of strength. The legacy of the US accumulation of debt to overseas creditors over the past 15 years has been to make the dollar vulnerable in times of crisis. Even now the US government has no convincing strategy for reducing its foreign debt. Consequently, we believe international investors will sell the dollar in the next crisis-induced boom as well. Each time round the dollar will nd it harder to recover. 50-50 rule no longer applies The nancial crisis has also pushed the euro into a crisis of condence. Before the nancial crisis, we could follow the 50-50 rule with a clear conscience. This rule states that an investor with 50% euros and 50% US dollars can ensure a balanced portfolio and have some protection against the uctuations of the currency markets. The reasoning behind this was the euro would appreciate in periods of growth, counterbalanced by the gains made by the dollar in periods of crisis. For an investor with the USD as a reference currency, our 50-50 rule would have come under serious strain even before the crisis. Europes debt crisis, the aermath of which will continue to aect the region for a long time, has held back the upward potential of the euro so much that investors need to look for additional diversication. Why should anyone diversify if their investment income, expenses and assets are all in US dollars? We would, of course, argue in favor of a rigorous matching of income and expenses 6
(currency matching). This requires holding a certain percentage in the reference currency. But additional assets should be held in a range of currencies. An investor exposed purely to dollars would have seen the erosion of purchasing power caused by the increase in the cost of living and energy over the past few years eat away at the (real) value of his assets. Interest income was well below ination. Investment in commodity currencies the Norwegian krone, Australian dollars and Canadian dollars would have reduced losses. Exposures to other liquid currencies from very stable countries, such as Swiss francs or Swedish krone, would of course have limited these losses. The ve friends Making the claim to be a reserve currency must be backed by value stability and liquidity, meaning a currency can be easily sold in all market environments. Because of liquidity requirements, freely convertible currencies, such as the Australian dollar (AUD), the Canadian dollar (CAD), the Swedish krona (SEK), the Norwegian krone (NOK) and the Swiss franc (CHF), have muscled their way in. All ve have in recent years been stable in times of crisis, and they should benet from lower levels of debt and high growth potential going forward. Our pragmatic advice is to hold more or less equal weightings of the ve currencies. Each of the ve currencies has its own specialties and will appear more attractive depending on the cycle. The NOK and CAD are heavily linked to oil prices. The AUD is more dependent on China, coal and base metals. The CHF is a safe haven and benets from diversied exports in banking and industry. As for the SEK, it is closely correlated with the stock market. The CHF, SEK and NOK benet from any appreciation in the euro, while the CAD is positioned against the dollar. Depending on the economic cycle and the focus of global growth, any one of these currencies should be particularly strong and oer scope for prot-taking.
Focus
and their relationship to the BRIC countries The dierent characteristics of the ve friends allow genuine diversication. But they have one characteristic in common: All create a link in one way or another between the G4 currencies and the largest emerging markets, the BRIC nations. As relatively small countries, the ve are heavily dependent on exports. Since the 1990s trading ties to the emerging markets have been expanded everywhere. As a result, by gaining exposure to the ve currencies, investors are gaining exposure to the currencies of emerging markets without the downside of restrictions on the movement of capital. There are other currencies besides the dollar, euro, pound and yen. A combination of fundamentally stable and liquid currencies should, in our view, prove to be a more successful strategy in the long run than placing all ones chips on the dollar or euro. Investors with no such exposure at present should start building one up now. We therefore make the case for substituting the 50-50 rule with a 30-30-30 rule in favor of the US dollar, euro, and the ve friends.
Recipes for currency diversication We advise investors whose reference currency is the Swiss franc to rst compare planned expenditure and income to determine how much investment capital they have available for investing in currencies other than the franc. Investors should set a cautious home bias for this available amount and invest the rest systematically in foreign currencies. We consider a very cautious home bias to be around 50-70%. There are two key factors involved in allocating assets to foreign currencies: the size of a currency area in terms of GDP and the equity market capitalization of the individual country. Focusing on the size of the equity market has the advantage of ensuring that investors are exposed to currencies that have well-developed capital markets. For example, diversication currencies such as the Australian dollar are nding their way into investor portfolios as Australian share prices rise. A longterm performance comparison shows that a currency portfolio diversied strongly along equity market lines outperforms a pure Swiss franc portfolio over long periods.
Interview
Investors are underestimating the impact of a Greek sovereign default

Thomas Wacker, Credit Analyst at Wealth Management Research, expects Greece to declare itself insolvent at the earliest next year.
Interview: Simone Hofer Frei, Editor, UBS AG
Mr. Wacker, how likely is it that Greece will leave the Eurozone? In the short term, very unlikely, as leaving would cast Greece into an even deeper crisis and would be seen as a sign that the Eurozone had failed. What would be the likely impact of Greece taking itself out of the Eurozone? Economically speaking, leaving would enable Greece to devalue against other currencies and so become more competitive again relatively quickly, which would be far less painful than trying to do it by slashing wages. The rst country to leave could trigger the same course of action by others if they came to see that it brought more than just disadvantages with it, provided they could remain in the European Union. That sort of scenario is probably rather less critical from an economic point of view than from a political one. The Eurozone could even become economically stronger if weaker countries were to leave it. Greek debt adds up to something like EUR 340 billion, owed to the following lenders that we know of: EUR 14.6 billion to the International Monetary Fund, EUR 29.2 8
billion to the Eurozone, approximately EUR 70 billion to the European Central Bank, EUR 58 billion to Greek banks, EUR 30 billion to other EU banks and EUR 15 billion to insurers. It has not been possible to trace the lenders of the remaining EUR 110 billion. What are the risks inherent in this? We see the unknown part of the debt as a serious risk, as any restructuring would at once raise the question of who would have to bear the losses associated with these EUR 110 billion and whether this might make it difcult for other debtors to pay up. Even though Greece is small compared to, say, Spain, is there a systemic risk here? There certainly is aer all, EUR 340 billion, which is what the debts add up to, is a very large amount of money. More to the point, knock-on eects such as Greek banks and companies going bankrupt and a downturn in the prices of bonds issued by other nancially weak countries would batter the nancial system still further. If Greece were to default, would we have to expect the same sort of shock wave on the markets that set in aer Lehman Brothers went down? The problem common to both these examples is that most market players seem to assume that another rescue is on the way. Announcing reUBS investors guide 27 May 2011
Interview
structuring would take a lot of investors by surprise, and I think a very large number of them underestimate just how far-reaching the eects of a sovereign default would be. What would a Greek default mean for the future of the Eurozone? It would certainly put it to a serious test, but in the long term it could also give impetus to the reforms that the Eurozone needs, thus making the EU stronger. A scal union with constant transfer payments would be needed to stop this sort of thing happening in the future. Whether there will be a strong EU or one that partially disintegrates depends on whether or not the member states are willing to take this step involving scal transfers. How does the restructuring of sovereign debt in an orderly manner actually work? Unfortunately, there actually isnt a proper process for it, as bankruptcy is the result of the parties concerned not being able to agree on further support measures. Once the government has admitted that its debts are unmanageable and that they need to be restructured, it has to make an oer to its creditors, for example a proposal to exchange the debt for new bonds with lower coupons and longer maturities. As lenders want to lose as little as possible of whats owed to them, several rounds of talks are generally needed before an agreement on a creditors meeting is reached. Quite oen the process takes several years.
made the sort of progress that would make it possible to decouple from Greece. Quite apart from that, the banking sector is still too fragile. I think it makes sense to wait another year until banks can be expected to digest these losses without additional support. What is the danger if restructuring is drawn out for too long? As long as the debt burden remains excessive, most eorts to cut back on spending will come to nothing, as the debt that has to be serviced is far too great. Simply paying the interest requires new indebtedness. I dont think it encourages market players to manage risks sensibly if taxpayers money keeps on being used to keep highly risky investments from defaulting. How great is the risk of other highly indebted Eurozone countries Portugal, Ireland and Spain, for example going the same way? At the moment, the risk is very great, and I think Belgium and Italy would also be aected if restructuring were to happen too quickly. We believe this risk should become less pronounced over the next two years, provided these countries can manage to get their consolidation plans o the ground.
The US and Japan are just as indebted. Is there a risk of this problem spreading to them? A default in Europe would spark renewed worldwide debate about the long-term safety of US government bonds. Japan, on the other If it does restructure its debts, what are hand, sells its bonds almost exclusively on the the prospects for Greece? As I see it, it will take Greece at least 10 years to domestic market, so theres no immediate risk make a lasting recovery. To do that it will need of contagion. two things fundamental reforms and a reduction in its debt burden. Why is the restructuring being delayed? The other countries on the EUs periphery embarked on their own consolidation programs just a few months ago. So far they havent
Asset allocation Outlook
Beyond the uncertainty

Global economic growth shows signs of a slowdown as ination picks up. This marks a more mature stage in the business cycle, but it does not mean the end of equity performance. We expect higher market volatility in coming months but recommend holding on to positions in attractively valued stocks and corporate bonds.
Philipp Schttler and Mark Andersen, Strategists, UBS AG
Economy moderates next stage The increase in economic output has been fastpaced in recent quarters, in a traditional recovery aer an un-traditional hard recession during 2008 and much of 2009. The next stage of the cycle is emerging with moderate growth and rising ination. This is not unusual, but it marks the next stage for nancial asset returns as well: equity investors should expect high single-digit annual returns in this period. Alongside the end of the US central banks extraordinary liquidity injection (the so-called Quantitative Easing 2 program), market volatility is expected to rise. We advise investors to stick to equities throughout as they are still backed by attractive valuations and corporate earnings growth.
Markets may be shaken at times as this story inevitably unfolds. In such a risk scenario, our call for German equities will most likely suer as well, though that market should still perform well compared to others in the Eurozone. For the euro, we expect further weakness ahead with EURUSD trading back toward the 1.30 to 1.40 range over the next few months. Our 12-month horizon foresees more US dollar weakness in store. Cherry-pick from ve friends currencies Better alternatives to the troubled major currencies can still be found in our favorite 5. The Canadian dollar and the Swedish and Norwegian krona have corrected recently, approaching
Greece in the news again The Eurozone debt drama now includes speculaAsset allocation strategy tion about the early restructuring of Greek sovereign debt. The euro consequently weakened and Equity government bond yields of the large developed countries declined. We see some form of default Fixed income as inevitable to unravel the situation, but we upCash hold our base case that such an event will not occur before the European Financial Stability Facility (EFSF) runs out in 2013. Premature or disor- Commodities ---n + ++ +++ derly restructuring poses a substantial risk to the underweight neutral overweight European nancial sector and other peripheral countries, foremost Spain, behooving European politicians to avoid such a scenario. Given the Source: UBS WMR, as of 25 May 2011. For more information, please read the most recent US Investment diverging political interests, the risks are clearly Strategy Guide. See Scale for Investment Strategy in the Appendix for an to the downside and should not be disregarded. explanation of the strategy. 10
Outlook Asset allocation
levels that make entry positions attractive. The Commodity setback opens selected Swiss franc and the Australian dollar still look opportunities expensive; we advise against chasing their rally. Most commodities were hit hard during the rst week of May. In our view, the strong downward move was an overreaction, as we do not share Diversify into corporate bonds We still prefer corporate bonds over govern- the pessimism that is currently getting priced ment bonds, where we expect the recent price into commodities. Although global growth conappreciation to revert. While corporate bond cerns are likely to persist in the short run and yields are at fairly low levels, we believe their commodities may remain volatile in coming spreads versus government paper are reason- weeks, we believe the price correction can be ably priced. Given strong corporate balance used to build up selected long positions. Our fasheets, we expect rating and default trends to vorites include crude oil, gold and copper. remain supportive. Corporate bonds, both in Investment Grade and High Yield, should be able to outperform Treasuries in line with the yield advantage that they provide.
Extended asset allocation

Asset class Tactical view* Comment
US equities Non-US developed market equities Emerging market (EM) equities US xed income Non-US xed income Cash (USD) Commodities
+ + + n
Solid earnings growth and loose monetary policy to persist. This currently osets valuations, which are less attractive than abroad. While valuations are more attractive than in the US, sovereign debt concerns in the Eurozone and recession in Japan oset the valuation argument. Strong valuation, earnings growth and scal fundamentals are partly oset by the risk of ination and monetary tightening. We prefer US over non-US xed income as the dollar has started to rebound from very low levels. Extremely low yields and overvalued yen make Japanese debt unattractive. Euro under pressure from ongoing debt crisis and structural issues. We prefer cash to non-US Fixed Income. While we expect commodity prices to rise further this year, negative roll yields (resulting from contango term structure of futures prices) should signicantly trim total returns.
Source: UBS WMR and Investment Solutions, as of 25 May 2011. *See Scale for Investment Strategy in the Appendix for an explanation. For more information, please read the most recent US Investment Strategy Guide.
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Economy US
Patchy data belie solid underlying growth trend

Economic data has been patchy recently. The disasters in the southern US as well as the Japanese earthquake are showing their undoing here and there in the data. The apparently much more mixed picture represents mostly transitory noise, in our view. We still expect real GDP growth to rebound in 2Q11 aer decelerating in 1Q11.
Thomas Berner, Analyst, UBS Financial Services Inc.
Real GDP decelerated to 1.8% q/q annualized in 1Q11 from its 3.1% pace in 4Q10. With nominal GDP growth remaining fairly steady (3.8% in 1Q11 versus 3.5% in 4Q10), it seems fair to conclude that it was mainly the energy-led surge in ination that sapped real purchasing power. In our view, the underlying growth rate is still closer to 3% than 2% in real terms. The oil price has already retreated from
its recent peak of almost USD 115/barrel to around USD 100/barrel. Data has not painted a signicant change in the fundamentals for oil. That leaves a speculative run for the exits aer the signicant surge as the most likely reason for the sell-o. In any case, we still expect an oil price of USD 110/barrel in 12 months, but the rapid rise in ination in the ve months through April will very likely not be repeated. If we are right about the underlying growth resilience in real terms and ination also moderates again, we should see a decent rebound in real GDP growth in 2Q11.
US economic forecasts (see latest WMR Forecast Tables for additional US and global forecasts)
in % Real GDP year-over-year (y/y) CPI (y/y) Core CPI (y/y) Unemployment rate Fed funds rate* 2007 1.9 2.9 2.3 4.6 4.25 2008 0.0 3.8 2.3 5.8 0.25 2009 -2.6 -0.3 1.7 9.3 0.20 2010 2.9 1.6 1.0 9.6 0.10 2011F 2.7 2.6 1.2 8.7 0.25 2012F 2.7 1.4 1.6 8.4 1.75
*year-end level Source: Datastream, UBS WMR, as of 24 May 2011 About these forecasts: In developing the forecasts set forth above, WMR economists worked in collaboration with economists employed by UBS Investment Research (INV). INV is published by UBS Investment Bank. Forecasts and estimates are current only as of the date of this publication and may change without notice.
12
US Economy
New clouds have already risen on the horizon. The most recent batch of data has made it hard to conrm or refute our expectations for a growth rebound, as indicators for April have been aected by the disasters in the southern US and Japan. Initial jobless claims, one of the timeliest and important indicators, have risen visibly since April. School breaks in New York and New Jersey, a new unemployment program in Oregon, and auto manufacturing disruptions related to Japan all distorted the data higher. Only the most recent report showed moderation and builds the case for data aberrations rather than a worsening trend. We continue to expect the downtrend to resume, in line with overall improvement in labor market conditions. The other rather negative development was a plunge in the ISM Non-Manufacturing index from a loy 57.3 in March to 52.8 in April. Key growth sub-indexes for new orders, business activity and employment all sagged in similar fashion but remained above 50 and are therefore signaling growth. In sharp contrast, the ISM Manufacturing index stayed at an elevated level of 60.4 in April. Historically, the ISM Manufacturing index is more important to signaling cyclical turning points in the business cycle. Even though manufacturing makes up only about
12% of the economy, it is a much more volatile industry than services and thus dictates the business cycle uctuations. In the past, the ISM NonManufacturing index has tended to lag the ISM Manufacturing index by up to three months during sharp turning points. For these reasons, we think the plunge in the ISM Non-manufacturing index should not command too much attention. Whats also important to correctly gauge the most recent economic data landscape is the fact that the April labor market report was very solid. No signs of weakness here. Finally, and this is probably the biggest concern regarding data weakness, the three regional manufacturing climate indexes that have been reported so far for May showed substantial drops. The Richmond Fed index even fell into contraction territory. We continue to think that the underlying growth trend is solid, but these developments bear close monitoring. One reason for comfort is that these regional indexes can be rather volatile and during the spring months of last year they also deteriorated sharply, but the national ISM Manufacturing index never fell below 55. A similar pattern is very likely this year. We continue to call for real GPD growth of 3.5% q/q annualized in 2Q11 and for 3% in 2H11.
Fig. 1: Regional manufacturing climate indexes Fig. 2: Initial jobless claims surge seems over Initial jobless claims and non-farm payrolls, in thousands weakened in May Three regional and national ISM manufacturing climate indexes
60 40 20 0 (20) (40) (60) Jul-01 Jul-03 Jul-05 Jul-07 Jul-09 Jul-11 Empire State (lhs) Richmond (lhs) Philly Fed (lhs) ISM (rhs) Another so patch? 80 70 60 50 40 30 20 400 200 0 (200) (400) (600) (800) (1,000) Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 900 800 700 600 500 400 300 200
Non-farm payrolls (lhs)
Initial jobless claims (rhs)
Source: Bloomberg, UBS WMR, as of 27 May 27
Source: Bloomberg, UBS WMR, as of 27 May 2011
13
Economy Global
Global
Emerging markets
A healthy midcycle development

Global leading indicators are rolling over. Purchasing managers indices (PMIs) saw a cyclical peak just before recent shocks in March, which included the Arab spring uprisings and the earthquake in Japan. While perceptions view the current environment as generally high, expectations in the economy have cooled somewhat. As part of the cycle it is normal that an economy bounces back strongly from a recession, but indicators eventually need to stabilize at a more sustainable level. This normalization runs parallel to inationary pressures due to rising commodity prices an unattractive combination for investors. Sensing this dynamic, nancial markets make discounts, which have led to the sell-o of risky assets such as commodities. Ironically, this supports the economy, as lower commodity prices reduce production costs and the need of central banks to engage in more aggressive monetary tightening. Depending on how commodity prices develop further, headline ination numbers may peak in many countries in coming months. This would yield a better growth-ination mix in the second half of the year with leading indicators at more sustainable levels. We therefore see current dynamics as a healthy mid-cycle development and remain optimistic for the medium term.
Ricardo Garcia, Economist, UBS AG
Ination peak awaited

For buyers of emerging market assets, ination has been a key concern for several months now: How much central bank tightening still lies ahead? What if the authorities tighten too much and thereby cause a hard landing? It appears that, for several reasons, the year-on-year ination numbers in the bigger emerging economies are likely to peak in the second half of 2011 and trend lower into 2012. The rst reason is that monetary policy tightening has been ongoing there for some time now. Brazil began hiking rates more than a year ago and has increased its policy rate by 3.4 percentage points over that period to around 12%. China has raised its banks reserve ratio by 5.5 percentage points over the past 18 months, thereby making it more difcult for people to get credit. Both countries also tightened monetary policy through additional measures, including via the exchange rate. We have thus seen impressive tightening in the emerging markets. A technical factor should also help ination. Given that food and commodity prices have risen dramatically over the past year, this makes it more likely that the yearon-year ination prole should peak soon and fall into 1H 2012 because of the base eect.
Costa Vayenas, Analyst, UBS AG
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Regions Economy
Asia
1Q11 GDP growth in North Asia generally surprised on the upside, while countries in South Asia mostly trailed expectations. Despite the volatility in global commodity prices and concerns about the supply chain disruptions caused by Japans earthquake and nuclear crisis, recent data suggested that production weakness should be short-lived. Moreover, external demand for Asian exports remains strong. Adjusted seasonally, Asian exports rose 11.8% m/m in March, following a 9.6% decline in February. However, momentum is likely to slow in the near term given that leading indicators like PMI data for China and India moderated in April.
Eurozone
Aer Spain apparently decoupled from troubled Eurozone countries, speculation about Greece reopened earnest debt discussion. Hobbled progress in Greece and the stubbornly high market interest rate effectively preclude public market renancing in 2012, meaning a liquidity shortfall would occur next year. We believe restructuring will be necessary at some point. However, the Econ meeting and remarks from German Chancellor Angela Merkel have eliminated a full-scale, near-term restructuring for now, in our view.
Japan
First-quarter GDP data surprised on the downside, falling 0.9% q/q (an annualized decline of 3.7%). On a contribution basis, inventory liquidation was the biggest drag on activity, accounting for -0.5 percentage point (ppt), followed by private consumption of -0.3 ppt. It is likely that GDP also contracted in the second quarter, which would be the third consecutive quarter of negative growth. Therefore, Japans growth rate is likely be negative in 2011 (the rst time since 2009), although economic activity should turn up signicantly later in the year thanks to reconstruction demand and the normalization of supply chains.
UK
Striking the balance between growth and ination remains the biggest challenge for the Bank of England. In April, headline CPI jumped from 4.0% to 4.5%, while core CPI rose from 3.2% to 3.7%. Solid retail sales data also conrmed that consumers are still willing to spend despite the governments austerity program. The British Retail Consortium reported year-on-year, like-for-like sales for April of 5.2%. This surprsingly strong number was boosted by several factors including the extra bank holiday and the Royal Wedding, but most importantly the unusually warm weather. Long may it last.
15
Economy Emerging markets
Brazil
Economic activity slowed in 1Q 2011. Growth dropped to 1.5%, down from 7.0% in the last quarter of 2010. Meanwhile, growth in retail sales also slackened, expanding only by 4.1% in March, compared to 8.2% in February. Notably, ination continues to rise, induced for example by construction prices, which surged 1.67% in May, themselves impacted by a 2.90% rise in labor costs. While these dynamics boost the Brazilian real, they also highlight the risk of more drastic monetary policy adjustments going forward, which could weigh on growth prospects
Russia
Signs of a slowing US economy and concerns that the Eurozone debt crisis could escalate further are pushing the price of oil lower and weakening the rouble. Though we expect the Russian central bank to raise interest rates in coming months to bring them towards positive territory, we do not see the rouble strengthening over the medium to long term. Higher ination than in the US and pre-election pressures for a weaker rouble from exporters should all diminish support for the rouble versus the US dollar.
India
The Indian economy had an undeniably good year 2010-11 with real growth of 8.7% y/y. Solid activity numbers, fueled by a large scal decit, brought ination right back to the levels seen before the nancial crisis. Both supply and demand factors have kept ination elevated. The Reserve Bank of India has hiked rates nine times in the present cycle, but the impact on prices has been minimal. Since some indicators (industrial activity) have remained fairly robust, wholesale price ination is likely to stay above 8% year-on-year in coming months.
China
Power shortages have emerged in some Chinese provinces in recent weeks. While this could slow the short-term growth of some heavy industries (like cement, nonferrous metals, iron, steel, etc.), we do not expect power shortages to translate into a hard-landing scenario for the Chinese economy. This is mainly due to a strong inventory build-up during the rst quarter, which is likely to oer a good buer to the slowdown in production. We expect GDP growth to decelerate in the second quarter, followed by an acceleration of growth momentum in the latter part of the year as the power supply issues are addressed.
Investors should be aware that Emerging Market assets are subject to, among others, potential risks linked to currency volatility, abrupt changes in the cost of capital and the economic growth outlook, as well as regulatory and sociopolitical risk, interest rate risk and higher credit risk. Assets can sometimes be very illiquid and liquidity conditions can abruptly worsen. WMR generally recommends only those securities it believes have been registered under Federal U.S. registration rules (Section 12 of the Securities Exchange Act of 1934) and individual State registration rules (commonly known as Blue Sky laws). Prospective investors should be aware that to the extent permitted under US law, WMR may from time to time recommend bonds that are not registered under US or State securities laws. These bonds may be issued in jurisdictions where the level of required disclosures to be made by issuers is not as frequent or complete as that required by US laws. For more background see the WMR Education Notes, Investing in Emerging Markets (Part 1): Equities, 27 August 2007, Emerging Market Bonds: Understanding Emerging Market Bonds, 12 August 2009 and Emerging Markets Bonds: Understanding Sovereign Risk, 17 December 2009. Clients interested in gaining exposure to emerging markets sovereign USD bonds may either buy a diversified fund of such bonds (preferably an actively managed portfolio of such bonds), or they may wish to select bonds from specific countries. Investors interested in holding bonds for a longer period are advised to select the bonds of those sovereigns with the highest credit ratings (in the investmentgrade band). Such an approach should minimize the risk that an investor could end up holding bonds on which the sovereign has defaulted. Subinvestment grade bonds are recommended only for clients that have a higher risk profile and who seek to hold higher-yielding bonds for only shorter periods.
16
Fault lines
Head of IMF: Yes, why not an emerging market candidate?

Andreas Hfert, Chief Economist, UBS AG
The doors of Rikers Island jail facility in New York City were barely closed behind Dominique Strauss-Kahn, the former Managing Director of the International Monetary Fund, before the erce ght for his succession began. An unwritten rule holds that a European leads the International Monetary Fund, while an American heads the World Bank. Emerging market representatives criticize this situation, arguing that their increasing weight in the world economy calls for better representation on the management boards of international economic organizations. The Europeans counter-argued with three main points: 1) the quality of the potential candidate, 2) Europes leading proportion of IMF funding contributions, and 3) that the present Greek or more broadly, European sovereign debt crisis is better understood and managed by a European. What should we make of these arguments? Granted, there are very good candidates from Europe: current French Finance Minister Christine Lagarde, former British Prime Minister Gordon Brown, former Bundesbank President Axel Weber, or even the Swiss CEO of Deutsche Bank, Joe Ackermann, were among the widely quoted names. But in emerging markets there were equally good potential candidates. Turkish economist and former Head of the United Nations Development Program, Kemal Dervi, for instance. Trevor Manuel, current South African Minister of Planning, is another. We can also consider Zhou Xiaochuan, the current governor of the Peoples Bank of China, who has also written profoundly on reforming the International Monetary System.
The argument that Europe is still the IMFs main nancial contributor has diminishing validity. The truth is that China, the worlds top emerging market, is now the sixth main contributor to the IMF, but by 2013 China will rank third behind the US and Japan. Moreover, by then Brazil, Russia and India will also rank among the top ten contributors. The nal argument for a European head of the IMF was stated most prominently by German Chancellor Angela Merkel: Given that we have considerable problems with the euro and that the IMF is very strongly involved here, much can be said for the possibility of installing a European candidate. In my view, this is intellectually slightly dishonest. One could ask: Why then was the IMF head not chosen from Latin America during the Argentinean crisis, or from Asia during the Asian crisis? Further, isnt there a conict of interest if the IMF head during the European crisis comes from Europe? And if Europeans are such experts at solving their own problems, why do they need the IMF at all? Nevertheless, as I write this article, it seems that the Europeans will have their way once again. Here the emerging markets should take note: They need to work together a lot better to have a bigger impact in international policymaking. That Mr. Strauss-Kahn would leave soon in any case was known; he had eyes for the French presidency. Hence, what were the emerging markets waiting for? Where is their agreed candidate? They should take a lesson from Europes experience in inter-governmental co-ordination.
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Stock recommendations
U.S. Top 25 Stock List

Recommendation list
Company Adobe Systems Ameriprise Apple Applied Materials Broadcom Coca-Cola Colgate-Palmolive Dow Chemical Emerson Electric FedEx General Mills Halliburton Hewlett-Packard Humana Illinois Tool Works Intel Lear Corp McDonalds Medtronic MetLife Schlumberger Starwood Teva Pharmaceuticals Thermo Fisher Scientic US Bancorp Ticker ADBE AMP AAPL AMAT BRCM KO CL DOW EMR FDX GIS HAL HPQ HUM ITW INTC LEA MCD MDT MET SLB HOT TEVA TMO USB Data as of 20 May 2011 Sector Technology Financials Technology Technology Technology Consumer Staples Consumer Staples Materials Industrials Industrials Consumer Staples Energy Technology Healthcare Industrials Technology Consumer Disc. Consumer Disc. Healthcare Financials Energy Consumer Disc. Healthcare Healthcare Financials Price $35.31 $62.17 $335.22 $14.09 $33.51 $68.30 $86.55 $36.01 $54.09 $93.82 $39.72 $47.18 $35.98 $79.79 $57.09 $23.22 $49.98 $82.33 $42.21 $44.22 $83.50 $59.21 $49.87 $65.18 $25.20
Performance
Since inception on 18 January 2006 Period Since inception 2011 year-to-date 2010 2009 2008 2007 2006** Top 25 24.1% 4.1% 9.7% 29.5% -39.9% 20.6% 15.8% S&P 500 16.1% 6.8% 15.1% 26.5% -37.0% 5.5% 12.4%
Stock recommendation lists and performance can be found in the UBS Weekly Guide in the future. For more information, ask your Financial Advisor.
Source: FactSet, Thomson Financial and UBS WMR. Prices and performance as of 20 May 2011. Since inception, the U.S. Top 25 Stock List has included 132 stock recommendations, of which 77 advanced and 55 declined while on the list. See the Appendix for important information regarding performance calculations. For adetailed discussion of the methodology underlying the U.S. Top 25 Stock List and updates to the list, please see the most recent U.S. Top 25 Stock List. Stocks which are only covered by UBS Investment Research are annotated as such with a + sign. UBS Investment Research is part of UBS Investment Bank (the UBS business group that includes, among others, UBS Securities LLC). ** 2006 data include the total return from the lists inception on 18 January 2006.
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ADR (American depository receipt) top list

Recommendation list
Company ABB American Movil Anheuser-Busch InBev Banco Santander Brasil Bank of Nova Scotia Barrick Gold BHP Bombardier British American Tobacco China Unicom Eni Honda Motor ING Lloyds Banking Magna International Nestle Nexen Novartis Repsol YPF Rio Tinto Royal Dutch Shell SAP Taiwan Semiconductor Talisman Energy Telefonica Teva Pharmaceutical Veolia Environnement Ticker ABB AMOV BUD BSBR BNS ABX BHP BDRBF BTI CHU E HMC ING LYG MGA NSRGY NXY NVS REPYY RIO RDS.A SAP TSM TLM TEF TEVA VE Data as of 20 May 2011 Country Switzerland Mexico Belgium Brazil Canada Canada Australia Brazil UK China Italy Japan Netherlands UK Canada Switzerland Canada Switzerland Spain UK UK Germany Taiwan Canada Spain Israel France Price $26.32 $51.20 $60.44 $10.84 $60.13 $45.60 $93.18 $6.87 $89.47 $21.24 $48.10 $37.29 $11.70 $3.33 $49.07 $62.24 $22.89 $61.39 $31.65 $66.59 $69.64 $61.72 $13.41 $20.87 $23.77 $49.87 $29.98
Performance
Since inception on 26 October 2009 Period Since inception 2011 year-to-date 2010 2009** ADR List 13.6% 3.3% 7.2% 2.5% S&P ADR Index 13.9% 3.7% 7.5% 2.2%
Source: FactSet, Thomson Financial and UBS WMR. Prices and performance as of 20 May 2011. Since inception, the ADR Top List has included 47 stock recommendations, of which 27 advanced and 20 declined while on the list. See the Appendix for important information regarding performance calculations. For adetailed discussion of the methodology underlying the ADR Top List and updates to the list, please see the most recent ADR Top List. For additional information, see Education Note: Understanding ADRs, 29 Nov. 2007. Stocks are covered by UBS Investment Research. UBS Investment Research is part of UBS Investment Bank (the UBS business group that includes, among others, UBS Securities LLC). ** 2009 data include the total return from the lists inception on 26 October 2009.
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Q-GARP (quality growth at a reasonable price)

The Q-GARP stock list provides investors with stocks that we believe should be included in a well-balanced portfolio to take advantage of the fundamental and cyclical trends that are likely to favor true secular growth stocks in the current market environment. We believe these companies oer attractive valuations relative to their high levels of sustainable growth, relative margin stability, and high protability. In our view, at this stage of the recovery, the risk-reward trade-o favors higher-quality stocks. Recommendation List
Company 3M Adobe Systems AFLAC Apple Bed Bath & Beyond Coach Coca-Cola Colgate-Palmolive Danaher Darden Restaurants Emerson Electric Exxon Mobil General Mills Home Depot Illinois Tool Works McDonalds Medco Health Solutions Medtronic Microso Murphy Oil Nike PepsiCo Procter & Gamble Rockwell Collins Starbucks United Parcel Service United Technologies Walgreen Ticker MMM ADBE AFL AAPL BBBY COH KO CL DHR DRI EMR XOM GIS HD ITW MCD MHS MDT MSFT MUR NKE PEP PG COL SBUX UPS UTX WAG Data as of 20 May 2011 Price $93.56 $35.31 $49.57 $335.22 $53.83 $59.48 $68.30 $86.55 $54.66 $51.52 $54.09 $81.57 $39.72 $37.05 $57.09 $82.33 $64.30 $42.21 $24.49 $66.88 $85.05 $71.30 $67.36 $61.66 $36.61 $74.05 $87.50 $44.37
Performance
Since inception on 31 May 2007 Period Since inception 2011 year-to-date 2010 2009 2008 2007** Q-GARP 18.4% 6.6% 17.2% 28.3% -27.7% 2.1% S&P 500 -5.0% 6.8% 15.1% 26.5% -37.0% -3.0%
Stock recommendation lists and performance can be found in the UBS Weekly Guide in the future. For more information, ask your Financial Advisor.
Source: FactSet, Thomson Financial and UBS WMR. Prices and performance as of 20 May 2011. Since inception, the Q-GARP stock list has included 93 stock recommendations, of which 56 advanced and 37 declined while on the list. See the Appendix for important information regarding performance calculations. For a detailed discussion of the methodology underlying the Q-GARP stock list and updates to the list, please see the most recent The world according to Q-GARP report. Stocks which are only covered by UBS Investment Research are annotated as such with a + sign. UBS Investment Research is part of UBS Investment Bank (the UBS business group that includes, among others, UBS Securities LLC). ** 2007 data include the total return from the lists inception on 31 May 2007
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Dividend Ruler Stocks

Over the past 100 years, dividends have contributed nearly half of the total return from US equity markets. We believe investors likely will be more attracted to stocks where they are paid to wait. The Dividend Ruler Stocks screen for companies that oer a reasonable current dividend yield and have a strong track record of dividend growth. Dividend growth is important since it not only showcases the ability of the current management, but provides some ination protection for investors who receive an income stream that grows over time. Domestic companies
Company 3M AFLAC Air Products & Chemicals AT&T Boeing Coca-Cola Colgate-Palmolive Emerson Electric ExxonMobil General Mills Home Depot Illinois Tool Works Intel Johnson & Johnson Medtronic Inc. McDonalds NextEra Energy Northeast Utilities PepsiCo Praxair Procter & Gamble Raytheon United Parcel Service United Technologies Ticker MMM AFL APD T BA KO CL EMR XOM GIS HD ITW INTC JNJ MDT MCD NEE NU PEP PX PG RTN UPS UTX Data as of 20 May 2011 Dividend yield 2.4% 2.4% 2.5% 5.5% 2.2% 2.8% 2.7% 2.6% 2.3% 2.8% 2.7% 2.4% 3.6% 3.5% 2.1% 3.0% 3.8% 3.0% 2.9% 1.9% 3.1% 3.5% 2.8% 2.2% Price $93.56 $49.57 $91.27 $31.32 $77.52 $68.30 $86.55 $54.09 $81.57 $39.72 $37.05 $57.09 $23.22 $65.69 $42.21 $82.33 $57.78 $36.10 $71.30 $104.47 $67.36 $49.45 $74.05 $87.50
International companies
Company British American Tobacco + National Grid + Nestle + Novartis + Ntt Docomo + Pearson + Sano-Aventis + Veolia Environnement + Ticker BTI NGG NSRGY NVS DCM PSO SNY VE
Data as of 20 May 2011 Dividend yield 4.2% 5.8% 3.6% 4.1% 3.8% 3.4% 4.6% 5.4% Price $89.47 $51.45 $62.24 $61.39 $17.90 $18.71 $38.29 $29.98
Performance of Dividend Ruler Stocks

Since inception on 17 October 2003 Period Since inception 2011 year-to-date 2010 2009 2008 2007 2006 2005 2004 2003** Div. ruler 105.6% 9.3% 10.9% 23.2% -23.8% 5.6% 22.8% 5.3% 23.4% 7.2% S&P 500 S&P Global 1200 49.4% 6.8% 15.1% 26.5% -37.0% 5.5% 15.8% 4.9% 10.9% 7.4% 71.1% 5.8% 11.9% 31.7% -40.1% 10.2% 21.5% 10.2% 14.9% 8.1%
Source: FactSet, Thomson Financial and UBS WMR. Prices and performance as of 20 May 2011. Since inception, the Dividend Ruler Stock list has included 206 stock recommendations, of which 140 advanced and 66 declined while on the list. See the Appendix for important information regarding performance calculations. For a detailed discussion of the methodology underlying the Dividend Ruler Stock list and updates to the list, please see the most recent Dividend Ruler Stock list report. Stocks which are only covered by UBS Investment Research are annotated as such with a + sign. UBS Investment Research is part of UBS Investment Bank (the UBS business group that includes, among others, UBS Securities LLC). ** 2003 data include the total return from the lists inception on 17 October 2003.
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Technical Analysis
Inection points across nancial markets

Concerns over Europes sovereign debt crisis, weakness across various commodity sectors and select Emerging Markets equities, as well as subtle shis towards more defensive sectors of the US equities market, may give investors pause as we approach the summer months. We think now is a good time to review the technical situation across various nancial markets.
Jon Beck, Technical Strategist, UBS Financial Services Inc.
Every year at about this time the sell in May and go away trading theory makes its way into the front pages of business publications and receives widespread coverage from the media. And every year traders/investors fret about a major market setback during the summer months. So is this trading phenomenon a reliable indicator? Our technical study on the S&P 500 (SPX) dating back to 1929 suggests the three consecutive months during the sum-
mer (June, July and August) are indeed a challenging period generating average SPX gains of 0.45%. However, we are pleasantly surprised to nd that if we delve further into this study, we notice that during pre-election years (2011) the SPX returns are decisively stronger as the sell in May and go away approach did not work as advertised. During the three consecutive months over the summer, SPX produced cumulative average gains of 2.92%, coming close to the cumulative average gains of 4.36% during the three strongest consecutive months during the fall (November to January). Since this year is another pre-election year cycle, we suspect the market may be upwardly biased. So what is the
Test of key S&P 500 suggests an inection point

1369 1349 1329 1309 1289 1269 1249 Mar Apr May
ups ide gap
Source: Bloomberg and UBS WMR (prices of 23 May 2011)
22
Technical Analysis
market tape telling us about the future technical outlook for US equities? The convergence of a number of our short-term technical indicators strongly suggests SPX may be approaching an inection point. It appears the 2+ week correction is nearing a critical phase and the outcome of this battle between the bulls and the bears. We suspect 1,313-1,318 is a signicant nearterm support zone as there are approximately a half dozen technical indicators converging at this area. The ability to nd support here may set the stage for the next sustainable rally. Our 2011 technical projection remains basically the same; 1,440-1,460 as early as the next 1-3 months. On the downside, a convincing violation of 1,313-1,318 warns of a near-term top leading to another decline to 1,294.70 and a retest of the pivotal April 2011 low. 1,2201,250 remains key intermediate-term support. Violation here conrms a major top and the start of a major downturn. It remains our contention that the US Dollar Index remains in a longer-term structural bear market, evident by a multi-decade complex head and shoulders distribution top pattern. However, on a near-term basis an extreme oversold condition can oen produce a sharp and explosive rally. The recent two-week rally is one of these powerful countertrend rallies partly driven by short covering and by the unwinding of carry trades, in our view. Similar to the key test taking place in the US equities market, the
US dollar is also nearing a critical juncture as it tests important supply near 76-78. Ten-year Treasury yields are also undergoing a critical test as they approach important support near 3.15% +/- .05%. A convincing break of support here would conrm a shortterm head/shoulders top and suggests downside risks for TNX toward key secondary support at 2.75%-2.80%. The top of a three-year symmetrical triangle at 3.8% provides key supply. We suspect that TNX will be locked in a volatile trading range between 2.5% and 3.8% over the intermediate-term horizon. Our longer-term structural bullish call for the commodities market in general remains intact. However, the sharp sell-os over the past few weeks have been unnerving for traders/ investors. We suspect that they will become increasingly selective as dispersions are developing within commodities. Sharp sell-os in silver and crude oil suggest a transition into wide trading ranges. SPX has been relatively outperforming its foreign counterparts including Europe (EAFE), Japan (Nikkei 225) and Emerging Markets (MSCI Emerging Index). However, the structural trends still favor outperformance coming from Emerging Markets in the years ahead.
Technical levels
S&P 500 Support 1313-1319 1290-1295 Resistance 1350-1360 1370.58 DJIA 12100-12300 11555.48 12600-12700 12876 NASDAQ 2700-2710 2603.5 2800 2887.75 10-Yr. Treasury (%) 3.10-3.15% 2.75-2.80% 3.30%-3.40% 3.75%-3.80%
Source: UBS WMR as of 23 May 2011
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Equity market US sectors
Below are excerpts from our US Equity Sector monthly reports which, along with updates, are located in the Equity section of the Online Services Research website. For sector strategy, see the most recent Investment Strategy Guide.
Industrials
High Conviction Calls 3M Co. Danaher FedEx Illinois Tool Works United Technologies Outperform Outperform Outperform Outperform Outperform
Consumer Staples
High Conviction Calls Coca-Cola Outperform
Should continue to outperform

Our equity strategy group recently raised its recommended weighting for US Consumer Staples from Moderate Overweight to Overweight. On balance, the sectors fundamental outlook appears sound. Near-term earnings growth has been tempered as input costs rise more quickly than companies can pass through pricing. However, we continue to believe earnings growth should accelerate as the year unfolds, and we view the sectors relative valuation as undemanding. Our top picks continue to reect our bias toward consumer packaged goods companies with emerging markets exposure and our view that leading brands are best poised to grow in developed and emerging markets. We look for companies with successful productivity or cost savings initiatives that can fund investments to drive future growth. Taken together, these attributes should contribute to a companys ability to post upside to earnings expectations. Other important considerations include management quality, nancial exibility, solid dividend yields, and attractive valuation. Among consumer packaged goods companies, we see the most appealing opportunities in household products/cosmetics and beverage stocks, reecting their generally higher weighting in international markets.
Sally Dessloch Analyst, UBS Financial Services Inc.
The answer to trailing sector performance may lie in 2Q11E expectations

Tallying the results from the rst quarter 2011 earnings season for the both the S&P Industrial sector and the S&P 500 suggest the market may have already discounted the sectors good results, leading to a sell on the news event. The S&P Industrials sector posted sales and earnings growth of 9% and 35%, versus the 9% and 21% logged by the S&P 500. Despite posting better earnings growth, the S&P Industrials sectors total return performance has substantially lagged the S&P 500 since our last report (27 April 23 May). During this period the S&P Industrials sector has fallen 4.8% versus a 2.8% decline in the total return for the S&P 500. We believe the relative underperformance may lay in the 2Q11E consensus expectations that appear to have lapped the period of relative outperformance. At present, the consensus estimates for sales and earnings growth peg the S&P Industrials sectors sales and earnings growth at 7% and 14% slightly behind the 10% and 14% anticipated for the S&P 500.
Andrew Sutphin, Jonathan Woloshin Analysts, UBS Financial Services Inc.
High Conviction Calls Sector analysts are required to have at least one high conviction outperform or underperform call for each sector they cover. Analysts have discretion over the selection of a recommendation as high conviction and the grounds for selection (e.g., greatest upside/downside to price target, most/least compelling investment case, etc.). The basis for each high conviction call is set forth in any research report identifying a recommendation as such.
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US sectors Equity market
Consumer discretionary
High Conviction Calls Comcast Dana Holdings Dollar General Lear Corp Magna International Starbucks Starwood Hotels & Resorts Outperform Outperform Outperform Outperform Outperform Outperform Outperform
Information technology
High Conviction Calls Qualcomm Underperform
Climbing the wall of worry!

Intel has taken a prominent place in the news of late. First it was the blow-out earnings numbers and strong guidance. Second was the announcement of a fundamental change in their construction of transistors to a tri-gate technology. Most recently was a downgrade of their stock by a prominent sell-side analyst and the pall it casts over much of the technology sector. Do you think Intel would provide aggressive guidance if they actually stued the channel with product? Weve seen consumer PC weakness at Hewlett-Packard and Dell but theyre also seeing PC strength continue within the enterprise as the refresh cycle continues. Investor worries are exacerbated by mixed commentary from the PC supply chain as well as the source of demand strength. Both are based mostly in Asia. Is the weakness at one notebook manufacturer actually market share loss to another manufacturer? Do market research services that most analysts used for unit demand forecasts really have as good a handle on sales in Sichuan Province or Bangalore as they do in New York or London? The uncertainties create the wall of worry, the uncertainty. But thats the technology sector and for it to be anything dierent would be abnormal. So well stick with our strategy of focusing on stocks with product-centric catalysts and/or market share gains. We believe these stocks should outperform.
Bob Faulkner Analyst, UBS Financial Services Inc.
Despite bad weather, consumer spending is healthy

Year-to-date, the Consumer Discretionary sector posted a 6.0% gain (as of May 24, 2011), outperforming the S&P 500 by 1.3 percentage points. We have a moderate underweight on the Consumer Discretionary sector. Our sector thesis reects our view that macroeconomic factors, including the recent spike in gas prices, continue to weigh on consumers. Spring started without much to celebrate. April weather was cool and very rainy across the US. In isolated areas, tornadoes caused natural disaster zones. Despite the seemingly unfavorable conditions, consumer spending stayed on its positive trajectory (year/year) through the end of April. According to the US Census Department, retail and food service sales grew 7.6% year/ year (adjusted for seasonal variation, holidays and trading-day dierences). Early indications for May do not signal major deterioration from April, despite continued bad weather. However, our sense is the consumer environment has not signicantly picked up since the end of last month. We prefer the sub-sectors of Autos & Auto Components and Consumer Services (restaurants, hotels).
Alexandra Mahoney, George Lambertson, Jon Woloshin Analysts, UBS Financial Services Inc.
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Financials
High Conviction Calls Ameriprise Financial Camden Properties JPMorgan Chase Metlife Piedmont Office Realty US Bancorp Wells Fargo Outperform Outperform Outperform Outperform Underperform Outperform Outperform
Healthcare
High Conviction Calls Celgene Corp. Teva Pharmaceuticals Outperform Outperform
Valuation catch-up
Year-to-date, healthcare was the best performing sector of the S&P 500up 12.6% compared to the S&P 500 Index of 4.7%begging the question of whether anything has changed in the healthcare marketplace since last year when healthcare stocks were the worst performing sector of the S&P 500. Fundamentally, we believe little has changed in healthcare markets and, if anything, we continue to think that the seemingly never-ending focus on healthcare costs will lead to increased pricing pressure and low healthcare utilization (e.g., fewer hospital admissions and physician visits) for a sustained period. However, the appeal of defensive stocks, especially those with attractive valuations such as healthcare, has led to stellar performance year-to-date of the sectors. The best performing healthcare subsector has been managed care organizations (MCOs), up 40% this year, partly because of lower medical costs. Mid-cap healthcare subsectors, such as mid-cap pharmaceuticals, biotechnology and healthcare IT, have also done quite well, because of improving fundamentals. Many other healthcare subsectors, particularly large-cap pharmaceuticals, medical technology and biotechnology, have also outperformed the market index. However, such performance is mostly not related to improving fundamentals and, in our opinion, is mostly valuation catch up from underperformance from last year.
Jerome Brimeyer Analyst, UBS Financial Services Inc.
Sector overview
We remain neutral on the banks. The group has underperformed the market in 2Q to date on concerns, we believe, related to a weak loan growth and revenue outlook, based on sluggish macroeconomic trends, continued weak housing data and the impact of regulation. Yet, asset quality continues to improve and we have seen signs of improving loan trends in 2Q. In addition, capital levels and liquidity are at high levels and valuations are more attractive given the weakness in the quarter. Our positive view on the Insurance industry group is based on attractive valuations, stable to growing earnings and solid capital positions. Although we prefer Life over P&C Insurers as they have more positive catalysts, P&C insurers could benet from higher premium rates driven by recent catastrophe losses. Asset Managers have beneted from rising equity markets and improved ows. Exchanges continue to be impacted by mergers and acquisitions activity and speculation. Real Estate Investment Trusts (REIT) continue to benet from low interest rates, access to capital, generally improving fundamentals and a relative yield advantage. Our concern centers on REITs prices and what funds from operations and net operating income growth rates are currently being discounted. We continue to believe the multifamily group is the most attractive subsector in the REIT industry group. For a further discussion on this topic, we wish to highlight our report, Housings pain is multifamilys gain, 8 September 2010.
Michael Dion, Dean Ungar and Jonathan Woloshin Analysts, UBS Financial Services Inc.
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US sectors Equity market
Utilities
High Conviction Calls Calpine ITC Holdings Corp NextEra Energy Outperform Outperform Outperform
Energy
High Conviction Calls Andarko Petroleum Devon Energy Halliburton Hess Outperform Outperform Outperform Outperform Outperform
Why so excited?
We recently lowered our rating on the Utilities sector from Moderate Underweight to Underweight. Year-to-date, the sector is up 7.0%, outperforming the S&P 500 by more than 220 basis points (bps). We believe this outperformance, which is a reversal from the 270 bps of year-to-date underperformance as of the last monthly sector report published on 28 April, has been largely sentiment-driven and is unsupported by fundamentals. We believe the recent rotation into defensive sectors (and regulated utilities in particular), due to concerns about a period of slower economic growth, has largely run its course. We expect this to reverse in the coming months as lower interest rates and slightly lower oil prices provide a modest boost to consumer spending. Importantly, we believe the economy is in a sustainable economic expansion driven by moderate but durable labor market gains. Within the regulated utility subgroup we prefer companies that can benet from continued investments in transmission infrastructure or have low relative valuations. Merchant power generatorswhich comprise 40% of the Utilities benchmarkperform best when natural gas prices rise (there is a strong correlation between gas and power prices). Natural gas prices remain depressed, and our commodity team expects them to rise only modestly this year. That being said, there are some select merchant power generators that should see volumes increase as power markets begin to tighten. In the big picture, power markets are getting into better balance and we expect a cyclical upturn in merchant power generator earnings to materialize at some point in the next 12 to 24 months.
David Lefkowitz Analyst, UBS Financial Services Inc.
Schlumberger
Improved risk/reward
With oil prices now below USD 100/bbl, we believe that current oil and rened product prices are sustainable from a demand perspective. In the last week, the national average retail gasoline price has fallen once again to below USD 4.00/gallon. This should halt negative demand trends and remove some of the risk of a further decline in oil prices. We continue to estimate an average oil price of USD 105/barrel (bbl) for 2011. We project stronger oil market fundamentals in the second half of this year, driven by positive economic trends that would support worldwide oil demand growth. Under this scenario, which is healthier than when oil price shocks are driven by supply concerns, we expect oil demand to be more resilient. We estimate that energy equities reect just USD 90/bbl oil. We believe the risk/reward for oil levered equities has turned positive for the next twelve months. Further downside in oil prices might be limited by Middle East uncertainty, as well as by the positive near-term fundamental outlook. Assuming oil prices stabilize around current levels over the intermediate term, we believe energy equities hold some unrealized value.
Nicole Decker Analyst, UBS Financial Services Inc.
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Telecommunications services
High Conviction Calls American Tower CenturyLink Outperform Outperform
Materials
High Conviction Calls Alcoa Celanese Corp Dow Chemical Potash of Saskatchewan Air Products Underperform Outperform Outperform Outperform Outperform
AT&T supports telecom sector outperformance

The S&P 500 Telecommunications Index registered a 3% total return over the last month compared to -1.4% for the S&P 500. It has also outperformed the S&P 500 year-to-date, with a total return of 7.5%. The outperformance is signicantly due to the strong performance of AT&T, which is up 9.1% on a total return basis year-to-date and has the largest market cap in the telecom index. We expect AT&T to benet from substantial merger synergies, an improved wireless pricing environment, an improved spectrum position and an attractive merger valuation. We think it has recently become more of a consensus view that wireless telecom operators need to be in a position to cover the costs of a robust telecom network that will be more important as data trafc increases and customers and companies use increasingly powerful smart phones with data intensive consumer and enterprise applications. Therefore, we are increasingly positive about the likelihood of the AT&T/T-mobile merger to be approved by the Federal Communications Commission and the Department of Justice. But we also think that there will be plenty of conditions for approval of the merger. These conditions are likely to include divestitures of markets and spectrum as well as behavioral conditions such as privacy, pricing for specic wireless plans, and possibly unbundled broadband.
George Lambertson Analyst, UBS Financial Services Inc.
Great expectations met in 1Q11 results, but the dollar hurts

In the rst quarter (1Q11) reporting period, the S&P Materials sector posted sales growth of 17% and earnings growth of 55%, surpassing the S&P 500s growth of 9% and 21% respectively. In fact, 77% of the S&P Materials sector exceeded sales expectations for the quarter and 73% beat earnings expectations. This compares favorably to the 1Q11 results posted by the S&P 500, which saw 64% of reporting companies surpass sales expectations and 66% beat anticipated earnings estimates. Despite these strong 1Q11 results posted by the Materials sector, their total return performance lagged the overall market. While the S&P 500 has posted year-to-date and monthly (11 April - 12 May) total returns of 8.0% and 2.0%, the Materials sector has lagged with total returns of 2.5% and (1.3%) over the same periods. Investor concern focused on: 1. potential slowing global economic growth; 2. continued monetary tightening by China; 3. the end of the second round of Quantitative Easing; and 4. tensions in the Middle East, which may have contributed to the recent strength in the US dollar and the slide in commodity prices.
Andrew Sutphin Analyst, UBS Financial Services Inc.
28
Emerging markets Equity market
Emerging markets Investors still scared by ination

For emerging market equities buyers, ination has been a key concern for several months: How much further will central banks tighten to slay the ination dragon, and what if authorities tighten too much and cause a hard landing? These concerns cloud the investment outlook and are cited as reasons why emerging market equities are up by only 1%, 5% behind developed stock markets. declining into 2012. Central banks in many emerging countries have been tightening monetary policy for a while now. China and Brazil began hiking rates more than a year ago, and Brazil increased its policy rate by more than 350 bps over that period. We expect falling year-onyear ination rates in 2H 2011 and into 1H 2012 due to the base eect. Second, the recent setback in commodity prices is likely to drag down headline ination near-term. Combining both factors we expect lower ination rates into the second half to support emerging equity markets. As a result, commodity-export oriented markets such as Russia might experience less appealing returns, whereas commodity-import oriented countries are likely to benet.
Outlook expected to improve in second half of the year If investors see beyond todays uncertainties, the argument goes, emerging market assets, and equities in particular, should gain support. Recognizing present investor concerns, there are several factors that we believe will support emerging market equities in the year ahead. Growth should support equity markets First, we see ination peaking in many emerging Third, the economic growth outlook looks supmarket countries in the second half of 2011 and portive for both 2011 and 2012, when we expect average emerging market real GDP growth to outperform that in the developed markets by around 4% per year. If we add in the higher avMSCI Emerging markets vs. MSCI World erage ination rates in the emerging markets, 12-month performance, local currencies we get average nominal GDP growth rates of around 12% (6% growth + 6% ination) for 125 120 this year and next three times as much as the 115 4% projected for developed countries (2% 110 growth + 2% ination). Since equities are ulti105 mately about earnings growth, we expect 100 emerging market equity prices to eventually 95 90 validate this higher growth outlook. In addition, 85 the 10% valuation discount of emerging market equities indicates that higher growth expectaJan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 tions are not yet discounted in emerging market Emerging Markets stock market prices.
World Source: Thomson Finacial, UBS WMR, as of 25 May 2011
Oliver Dettmann, Analyst, UBS AG
29
Bond market US Sectors
Healthcare: Patient is healing
The political battle over the Patient Protection and Aordable Care Act (healthcare reform) is behind us, and short-term visibility has improved. However, as discussed in our The Decade Ahead publication, we believe the sector is bound for further major changes. Aging individuals have greater demand for healthcare services, putting pressure on costs. In addition, a population that is aging at a faster pace than medical schools ability to provide the system with new doctors is likely to eventually result in a shortage of physicians. Addressing this probable scenario will require innovative measures such as the development of comprehensive electronic health records, and genetic analysis to determine disease potential and drug selection among others. Healthcare spending in the US is already high relative to other members of the Organization for Economic Cooperation and Development (OECD). Curing this situation will require better coordination between sector participants to avoid the inefcient use of technology, and unnecessary tests to name a few. Oentimes, apparently unnecessary tests are conducted preemptively as protection against possible malpractice-related lawsuits, suggesting that tort reform is also well overdue. Some of the managed care organizations (MCOs) we follow are already moving in the right direction by acting as consolidators in a sector that is still fragmented. New payment schemes are emerging with fee-for-service 30
gradually giving way to bundled payment. More MCOs are now reimbursing for the entire episode of care, rather than for each component of the episode, resulting in better coordination between participants involved, and signicant cost savings. Although encouraging, the road ahead for MCOs will not be pothole-free. Stubbornly high unemployment in the US will likely continue to constrain MCOs commercial business growth. Most have been successful in imposing cost discipline, delivering lower-than-expected medical loss ratios (MLRs) and stable margins. However, efciency gains may have some negative side-eects. The healthcare reform mandates a minimum payout of 80% of premiums for individuals and small groups, and 85% for large groups eective 1 January 2011. MCOs that consistently deliver below-mandate MLRs will have to eventually lower premiums to comply with the law. All things considered, we continue to see more value in MCOs and pharmacy benet managers than in drug producers (pharma). Pharma credits boast strong fundamentals, but valuations are relatively tight, and credit ratings for several drug producers have come under pressure due to large acquisitions, and/or a shi toward a more aggressive nancial strategy designed to boost equity returns at the expense of bondholders. That said, if an investor has a preference for pharma, we suggest genericslevered credits.
Donald McLauchlan, Analyst, UBS Financial Services Inc.
US Sectors Bond market
Technology: A new found fondness for debt
As the market anticipates an end to cheap credit after the end of QE2, more companies have issued debt to take advantage of historically low rates. This has been pronounced in the tech space, with companies such as Google announcing an inaugural USD 3 bn debt oering. We expect that these companies will continue to be frequent issuers in the future as, in most instances, balance sheets can accommodate additional debt, and debt nancing may be the most cost-eective method of nancing transactions in an industry that has been very active with M&A activity. The largest business risk for companies in this sector is technology risk the risk that in a rapidly changing sector, a companys technology is surpassed by its rivals, thus leading to a precipitous drop in nancial results, and thus credit ratings. However, we view the probability of such an event as unlikely, given the ability of many of these companies to become entrenched in the operations of their business customers, and the daily lives of retail customers. Other risks to the sector that have been highlighted in the media include potential disruptions to technology supply chains due to the earthquake in Japan, further unrest in the Middle East, North Africa region, and a secular slowdown in PC sales. Still, corporate earnings reports have provided little evidence that this is the case thus far. As demonstrated by recent earnings announcements, PC sales remain strong, despite a secular shi to smartphone and tabUBS investors guide 27 May 2011
let usage. Nonetheless, consumer demand has been so in developed economies, though this is partially oset by stronger demand in emerging markets, and corporations have remained somewhat cautious with regard to IT spend due to the volatile macroeconomic climate and continued high unemployment rates. While management teams have historically been rather conservative in balancing business needs versus the demands of shareholders, the allocation of funds to shareholder-friendly activities has increased in the past year. Companies have taken to instituting or increasing dividends, and share repurchase programs have been revitalized. In general, we think the ability of these companies to generate cash will allow them to fund these activities through operations and maintain very strong investment grade ratings. Tech companies have been extremely active in recent years in acquiring new technologies from smaller players that added new capabilities or brought potential threats in-house. The M&A front remains active in 2011 with companies making bolt-on acquisitions that diversify their business or sometimes entering new business segments that are in direct competition with others in the industry. We see the rapid pace of M&A transactions continuing, especially in the soware and services spaces due to the lack of organic growth.
David Wang, Associate, UBS Financial Services Inc.
Credit Sector reports and our Corporate Bond Valuation Reports are located in the Credit section of the Online Services Research website.
31
Bond market US Sectors
Finance: A shell of its former self
The Non-bank Financial sector has experienced meaningful change over the past few years as credit rating downgrades, changing business models, and business unit sales have resulted in a number of issuers being dropped from the index. Today, only three issuers comprise over 95% of the index with General Electric Capital Corp (GECC) making up the vast majority. This sector once featured a number of captive and non-captive specialty lenders that nanced a range of asset purchases for retail consumers and businesses both large and small. At that time, most of these entities relied on wholesale funding markets, issuing debt at favorable rates in the capital markets, and then protably lending to customers. This business model was tested by the nancial crises from 2008-2010, and many issuers in this sector failed this test. For a period of time, debt capital markets grew more ckle. Only the highest-quality borrowers were able to tap the markets. Less credit-worthy entities were eventually able to do so as well, but at unfavorable rates. As a result, issuers in this sector that relied on readily accessing cheap funding in the debt markets found that they were unprepared for a credit crisis, and their business models were no longer viable. Credit ratings downgrades ensued en masse and companies found debt markets increasingly more difcult to access. The response to this new world varied by issuer. Some were able to convert their business models and 32
achieve bank holding company (BHC) status. Though more cumbersome operationally, BHC status oers greater access to liquidity and allows for deposit funding, which is less volatile than a pure wholesale funding model. Other issuers were less fortunate as asset quality deteriorated and showed little sign of improvement over time. As a result, many former index constituents have been downgraded out of the investment-grade category. These include issuers such as AIG afliates, International Lease Finance and American General, as well as lender CIT Group, all of which had signicant positions in the index as recently as 2008. Many continue to struggle to adapt to this more restrictive lending environment, where customer credit concerns remain paramount, and access to capital remains difcult. Going forward, we believe this sector is unlikely to revert to its pre-credit crisis form. Specialty lenders appear to be less viable in a more credit-restrictive environment, and lending activities will more likely be conducted with larger, deposit-funded entities.
Michael Tagliaferro, Analyst, UBS Financial Services
Municipal bonds Bond market
Major health system merger
In April, the nations largest Catholic healthcare system Ascension Health announced its intent to acquire the Alexian Brothers Health System - a large tertiary provider located in the northwest Chicago suburbs. The combination would result in a system with 81 hospitals and health-related facilities in 20 states and the District of Columbia. As of 30 June 2010, the combined systems reported USD 14.9 bn of total revenues, USD 1.2 bn of operating cash ow, USD 7.412 bn of cash and investments on the balance sheet, and combined debt of approximately USD 4.6 bn. The transaction mirrors the trend of consolidation currently underway in the for-prot healthcare sector. Community Health Systems (CHS) has been engaging in an ongoing effort to acquire Tenet Healthcare. Transactions including mergers and acquisitions between non-prots as well as the acquisition of formerly non-prot institutions by for-prot providers have increased in the last year. These include the sale of substantially all of the assets of Mercy Health Partners in Scranton, PA to CHS that was recently announced earlier and the acquisition of bankrupt Forum Health, in Youngstown, OH. Saints Medical Center in Lowell, MA is set to be acquired by Steward, a for-prot provider based in Boston that had previously acquired six facilities operated by the non-prot Caritas Christi system. The long-troubled non-prot Detroit Medical Center in MI was acquired in December, 2010 by the for-prot Vanguard Health Systems. The theme of consolidation and size being
an important characteristic of stronger ratings for not-for-prot hospital systems versus those of stand-alone credits especially small rural providers has been a consistent one from WMR Municipals as health reform legislation was enacted and implemented.
Joseph Krist, Analyst, UBS Financial Services Inc.
33
Currencies Spotlight
Temporary weakness in Asia ex-Japan currencies

Asia ex-Japan currencies made some gains versus the USD in recent weeks, as risk sentiment lowered due to several events. Speculation of a Greek debt restructuring fueled fears of contagion eects in peripheral nations. Commodities such as crude oil and silver experienced price drops, the speed and magnitude of which spooked some nancial investors. As markets curbed risk-taking, the USD rebounded smartly as investors bought back the greenback used as a nancing currency for risky trades. Does this mark a turning point for Asia ex-Japan currencies, which have trended up against the USD since March 2009? Several factors signal this is unlikely. In contrast to the sluggish economic activity in some developed countries, economic growth in Asia stays robust, with Singapore and Taiwan recently raising GDP forecasts for 2011. Resilient export growth, and high fuel and food prices continue to push ination higher; it stands at multi-year highs in countries such as Malaysia and South Korea. Central banks in Asia are known to intervene in the FX markets to keep their currencies from strengthening too much. However, with the balance of risks tilted strongly towards ination rather than growth concerns, we expect Asian monetary authorities to welcome currency appreciation to counter ination. We see Asia ex-Japan currencies gaining around 5% versus the USD over the next 12 months.
Teck-Leng Tan, Analyst, UBS AG
Structural uptrend remains intact, despite recent pullback Asian dollar index versus US dollar
120
Asia FX Foreign Reserves (in USD bn) Aggressive FX intervention keeps Asian currencies undervalued
6000 5000
115
4000 3000
110
2000 1000
May 09
Nov 09
May 10
Nov 10
May 11
1997
1999
2001
2003
2005
2007
2009
Source: Bloomberg, UBS WMR, as of 24 May 2011 Source: Bloomberg, UBS WMR, as of May 2011
Source: Bloomberg, UBS WMR, as of 24 May 2011 Source: Bloomberg, UBS WMR, as of May 2011
34
Currency pairs
GBPUSD
British pound per US dollar
AUDUSD
Australian dollar per US dollar
Despite high ination and low GDP gures, the UK is moving slowly towards a rst rate hike. The USD rallied briey on Eurozone problems and advancing data. However, this should be short-term and we advise selling the USD below GBPUSD 1.60 and aim for 1.70 in six months.
AUDUSD fell around 5% to the 1.05 level aer reaching a 29-year high of 1.101 in early May, pressured by falling commodity prices and a strengthening USD. The growth-sensitive AUD is prone to further prot-taking amid renewed concerns about Eurozone peripheral issues and worries about over-tightening in China.
1.20
1.9 1.8 1.7 1.6 1.5
Source: Thomson Reuters, UBS WMR Volatility Range Forecast Forward Volatility Range May 12 Sep 12
1.10 1.00 0.90 0.80 Source: Thomson Reuters, UBS WMR
Volatility Range Forward Forecast Volatility Range
May10 Sep 10 Jan 11 May 11 Sep 11 Jan 12
May 10 Sep 10 Jan 11 May 11 Sep 11 Jan 12 May 12 Sep 12
EURUSD
Euro per US dollar
USDJPY
US dollar per Japanese yen
Short-term pressure on the euro is rising after local elections in Spain led to extreme losses by the ruling socialist party and discussion about debt restructuring in Greece surged again. We expect EURUSD to revert to the 1.301.40 range.
The Japanese economic situation is weaker than initial expectations aer the earthquake suggested. Markets therefore showed a lot of respect for the 80 USDJPY intervention level. We believe risk aversion and repatriation, however, prevent a more meaningful depreciation of the yen.
100
1.70 1.60 1.50 1.40 1.30 1.20 Source: Thomson Reuters, UBS WMR Volatility Range May 12 Sep 12 Volatility Range Forecast Forward
95 90 85 80 75 70 Source: Thomson Reuters, UBS WMR
Forecast Volatility Range Forward
Volatility Range
May 10 Sep 10 Jan 11 May 11 Sep 11 Jan 12
May 10 Sep 10 Jan 11 May 11 Sep 11 Jan 11 May 12 Sep 12
35
Commodities Spotlight
Investors cautious on commodities

Commodity prices dropped in recent weeks, the Dow Jones UBS Composite Index down some 10% from April highs. So macroeconomic data triggered global growth concerns. Economic activity in the US signals sharper moderation; strong ination in China requires more monetary policy tightening. Broad stimulus will eventually fade, so lower growth momentum induced investors to take risks o the table. This situation oers investment opportunities, in our view. The sharp drop in crude oil prices is unlikely to persist. The supply side is struggling to compensate for losses in Libyan oil production by 1.2 mbpd while crude production in the North Sea has failed to meet market expectations. European supply will thus remain tight. On the demand side, Chinas projected electricity shortage should trigger rm crude oil demand. We uphold our view that WTI prices will move towards USD 110/bbl in 12 months, with Brent prices to rise above USD 120/bbl. Silver has seen greater pressure than crude oil, but the metal is not yet a buy. The price runup this year is driven by short-term investors and lacks liquidity. The fabrication balance remains in rm surplus, which should allow prices to realign towards USD 30/oz. What can investors do? Option volatility in silver, which jumped above 50%, oers the opportunity to sell insurance (put option) for an attractive premium above money market rates. With a gold price above USD 1500/oz, a sharp drop in the silver price below USD 30/oz is not expected. At these levels we expect nancial demand to show renewed interest and Chinas net import of silver to remain elevated. Chinese silver imports were key in the metals rise to USD 30/oz in the rst place.
Dominic Schnider, Analyst, UBS AG
36
Outlook Commodities
Copper
Shanghai Futures Exchange (SHFE) copper inventories continue to fall; price dierential to the London Metal Exchange (LME) narrowed considerably. While the import arbitrage window remains closed for 3-month contracts, it has opened recently on a cash basis; this suggests a tightening Chinese copper market. If Chinas production of copper products goes on improving, then prices could move towards USD 11,500/mt. The nations power supply problems are a risk that could result in power rationing and disruptions. Thus copper output and consumption could be negatively aected, inducing price volatility.
24.05.2011 Forecast
Lead
Prices of lead dropped 20% since April to USD 2,345/mt. LME inventories continue to climb, reaching 316kt in May. The dominant long position of warrants dropped from 90-100% to 80-90%. We believe this decline could go on and weaken near-term prices. The latest production data from China show rened lead output climbed 31.8% year-on-year in April to 398kt. Thus, present metal supply is sufcient, especially as production growth of vehicles in China braked sharply. These demand and supply trends result in downward risk to our 12-month forecast at USD 2,650/mt.
USD 8776/mt
3 months
Forecast
912 months
24.05.2011
Forecast
USD 2465/mt
3 months
Forecast
912 months
Sugar
Since early February, sugar prices have plunged some 35% on larger output estimates for 201112. However, given the record low stock-to-use ratio, surplus production is required to rebuild depleted inventories next year. In Brazil, the worlds largest producer, diversion of sugarcane to ethanol or to sugar production will draw market focus. Presently, ethanol is being favored, and recent talks on abolishing the ethanol import duty in the US promotes cane diversion to the fuel sector. To impede this, sugar prices need to stay above USD 0.22/lb.
Wheat
Wheat prices appreciated more than 10% over the last few days. Unfavorable weather conditions in the US and Europe could severely impact yield prospects. Given lower US exports for 201112, exports from European countries will gain attention. On the demand side, expensive corn protein should support feed substitution from corn to wheat. As the global stock-to-use ratio stays slightly above 25%, global inventories for 201112 remain tight. Prices could approach USD 8.5/bu in the short run.
24.05.2011
Forecast
USD 0.215/lb
3 months
Forecast
912 months
24.05.2011
Forecast
USD 8.07/bu
3 months
Forecast
912 months
Arrows indicate whether the commodity is expected to strengthen, weaken or trend sideways.
37
Commodities Investment idea
Opportunity from oil price volatility

We view the sharp price drop in West Texas Intermediate (WTI) as overdone, as it is inconsistent with the latest supply and demand as well as inventory data. Global economic activity should remain robust in the short run and demand supportive.
Dominic Schnider, Analyst, UBS AG, Giovanni Staunovo, Strategist, UBS AG
Price correction oers opportunities A set of disappointing economic data releases across the globe dragged WTI temporarily to around USD 95/bbl, followed by a small bounce in prices. We view the magnitude of the price correction as overdone, as it is inconsistent with the latest supply and demand as well as inventory data. Oil supply not keeping pace with demand Global crude oil demand reached 90 million barrels per day (mbpd) in March this year and brought year-over-year demand growth above 3%. We think this picture goes in line with rm Chinese import demand growing around 11% year-over-year in the rst three months of 2011. Moreover, the US has seen some stronger-thanexpected declines in crude oil related product inventories. Since the OPEC supply in April was down by 0.95mbpd compared to February, crude oil fundamentals should allow prices to recover to balance supply and demand trends. With crude oil demand growth not showing signs of ipping into negative territory and supSelling crude oil option volatility remains attractive Volatility in crude oil (WTI)
50 45 40 35 30 25 Jan 10 Apr 10 Jul 10 3-month option volatility
ply constraints prevailing, we expect WTI to move towards USD 120/bbl. Recommendation We like to sell volatility for a premium. Option volatility soared sharply (around 30%-40% in put options), making insurance selling in crude oil attractive. We would use crude oil price levels below USD 85/bbl when selling volatility.
At a glance We view the sharp price drop in WTI as overdone, as it is inconsistent with the latest supply and demand as well as inventory data. With crude oil demand growth not showing signs of ipping into negative territory and supply constraints prevailing, we expect WTI to move towards USD 120/bbl. We think that, under these circumstances, selling volatility in crude oil remains a very attractive investment strategy.
Oct 10
Jan 11
Apr 11
3-month historical volatility 1-month option volatility Source: Boomberg, UBS WMR Source: Bloomberg, UBS WMR
38
Readers questions
Are commodities a USD asset and why are they so volatile?

A reader from Sion, Switzerland
Giovanni Staunovo, Dominic Schnider, Analysts, UBS AG
The most important exchanges for commodities are all located in the US. As a consequence, commodities are mainly quoted in US dollars (USD). This does not make them a USD asset per se. Most commodities are consumed and produced by countries that do not use the USD as their legal tender, so a commoditys value transcends the USD. However, a broad weakening of the USD due to excessive printing of money impacts commodity prices directly. The positive impact on commodities requires that suppliers have the choice to export them to other countries, reecting competition for supply. Internationally traded goods should therefore directly mimic changes in USD value. Markets that are more regional or where supply is largely USDbased should show a much better reaction. US natural gas is one good example. The lack of export capabilities and ample domestic supply makes it more a USD asset than gold or oil. It therefore cannot be used as a tool to hedge USD weakness. High volatility in commodities results from supply and demand behavior and inventory levels. Low inventories imply a smaller buer to oset supply outages by drawing from stocks. Lower inventories induce greater swings in price. Goods that cannot be stored, like electricity, should thus exhibit high volatility, and the price of electricity in fact has among the highest of volatilities. Other factors have inuence too, such as storage costs. High investment cost, such as for a mine or a renery, is also important. Low elasticity on the supply or the demand side limUBS investors guide 27 May 2011 UBS investors guide 27 May 2011
its market balancing based on small changes in price, requiring instead large price swings to clear the market. Food and energy provide examples. Consumers are unlikely to change their habits before costs rise prohibitively. On the supply side, high upfront investment costs are only taken into consideration if a price move seems permanent and sufcient to cover sizable expansion costs. The reverse occurs if demand slumps sharply. To cover some x costs, suppliers may sell commodities at large discounts to total production costs. The resulting ups and downs in prices have nothing to do with nancial speculation. That said, nancial demand can temporarily exacerbate price trends.
Whats on your mind?

> Ask the expert at: ask-ig@ubs.com
39 39
Market scenarios (next 12 months)
The global economy appears headed for moderate growth in the months ahead. Both scal and monetary policies remain generally supportive of growth although most countries have started the normalization process. Strong corporate prots and balance sheets oer upside potential for investment spending. However, recent economic data has been generally weaker than expected, raising the probability of a renewed downturn.
Moderate Recovery
High Growth Low Growth Negative Growth
Goldilocks
Supercycle
60%
Deation Negative Ination
Stagation Low Ination High Ination
The global economy remains on a self-sustaining but unspectacular expansion course. Rapid growth in the emerging markets helps to sustain global aggregate demand. The recovery in developed countries is more subdued than in prior cycles because of deleveraging pressures on the consumer and the nancial sector. The abundant slack in the US economy keeps inationary pressures from building up despite easy monetary policy. Food price ination abates during the second half of 2011. High prot margins and low interest rates encourage a surge in investment spending. Improvements in the labor market and in credit conditions allow a more dynamic consumer recovery. Global GDP growth accelerates in the second half of 2011. Commodity prices rise further due to spreading political instability in the Middle East and/or poor agricultural harvests, setting an inationary process in motion. Rising price levels and weak growth prospects pose signicant challenges to most nancial assets.
Strong Recovery
Goldilocks
Supercycle
15%
(down from 20%)
Stagation
15%
Goldilocks
Supercycle
Renewed Downturn
Goldilocks
Supercycle
10%
(up from 5%)
The fragile recovery in the developed world stalls as tighter scal and monetary policy creates additional headwinds. Credit markets take a turn for the worse, making it difcult for borrowers to take advantage of low interest rates. Falling commodity prices and a rise in excess capacities lead to negative consumer price ination (deation).
Source: UBS WMR, as of 25 May 2011

Brian Rose, Strategist, UBS Financial Services Inc. and Stephen R. Freedman, Strategist, UBS Financial Services Inc.
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Disclosures
Required disclosures
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Each research analyst primarily responsible for the content of this research report, in whole or in part, certies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reect his 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 specic recommendations or views expressed by that research analyst in the research report. For a complete set of Required Disclosures relating to the companies that are the subject of this report, please mail a request to UBS Wealth Management Research Business Management, 1285 Avenue of the Americas, 13th Floor, New York, NY 10019.
Statement of risk
Stock and bond market returns are difcult to forecast because of uctuations in the economy, investor psychology, geopolitical conditions and other important variables.
Stock Recommendation System

Analysts provide a relative rating, which is based on the stocks total return potential against the total estimated return of the appropriate sector benchmark over the next 12 months. Industry Sector Relative Stock View Outperform (OUT) Expected to outperform the sector benchmark over the next 12 months. Marketperform (MKT) Expected to perform in line with the sector benchmark over the next 12 months. Underperform (UND) Expected to underperform the sector benchmark over the next 12 months. Under review: Upon special events that require further analysis, the stock rating may be agged as Under review by the analyst. Suspended: An outperform or underperform rating may be suspended when the stocks performance materially diverges from the performance of its respective benchmark. Restricted: Issuing of research on a company by WMR can be restricted due to legal, regulatory, contractual or best businesspractice obligations which are normally caused by UBS Investment Banks involvement in an investment banking transaction in regard to the concerned company. Sector bellwethers, or stocks that are of high importance or relevance to the sector, that are not placed on either the outperform or underperform list (i.e., are not expected to either outperform or underperform the sector benchmark) will be classied as marketperform. Stocks that are rated Marketperform that are not sector bellwethers are not assigned a price target. The overweight and underweight recommendations represent tactical deviations that can be applied to any appropriate benchmark portfolio allocation. They reect WMRs short to mediumterm assessment of market opportunities and risks in the respective asset classes and market segments. The benchmark allocation is not specied here. It should be chosen in line with the risk prole of the investor. For more information, please read the most recent US Investment Strategy Guide.
Scale for Investment Strategy charts

Symbol + Description/ Denition moderate overweight vs. benchmark overweight vs. benchmark strong overweight vs. benchmark neutral, i.e., on benchmark Symbol Description/ Denition moderate underweight vs. benchmark underweight vs. benchmark strong underweight vs. benchmark
++ +++
Source: UBS WMR
41
Disclosures
UBS Financial Services Inc. Technical Research Dept.: Denitions and Distribution
UBS Financial Services Rating Bullish Denition and Criteria Welldened, reliable uptrend, an increase in the rate of change (or strong momentum) and conrming technical indicators Positive overall trend, momentum and conrming technical indicators Trading range trend, a at rate of change and conrming technical indicators Weakened trend, momentum and conrming technical indicators Negative trend, momentum and conrming technical indicators Not enough historical data to make an evaluation Corresponding Rating Category Buy
Mod. Bullish Neutral Mod. Bearish Bearish N/A
Buy Neutral/Hold Sell Sell N/A
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The indicated performance for Dividend Ruler Stocks, Quality Growth at a Reasonable Price, U.S. Top 25 Stock List and ADR Top List is based on capital appreciation plus dividends of an equal weight portfolio, but does not include transaction costs, such as commissions, fees, margin interest and interest charges. Actual transactions adjusted for such transaction costs will result in reduced total returns. Prices of stocks used in performance calculations generally reect closing prices one trading day aer the addition or deletion to ensure that changes to the list are announced in a manner that allows clients to match the lists performance. For ADR Top List, we will typically publish changes to the list aer the close and prices used for performance calculation purposes are the closing prices on the following trading day aer the date on the published report. In cases where we publish the ADR Top List in the morning prior to the New York Stock Exchange open, as was the case for our initial report on 26 October 2009, we will use the closing price of the date on the report for performance calculation purposes, which still reects one full day of trading aer the publication of the report. A complete record of all the recommendations upon which the performance calculations are based is available from UBS Financial Services Inc. upon written request. Past performance is not an indication of future results.
UBS Investment Research

For information on the ways in which UBS manages conicts and maintains independence of its research product; historical performance information; and certain additional disclosures concerning UBS research recommendations, please visit www.ubs. com/disclosures. Global Equity Rating Denitions UBS 12Month Rating Buy Neutral Sell Denition FSR is > 6% above the MRA. FSR is between 6% and 6% of the MRA. FSR is > 6% below the MRA.
KEY DEFINITIONS Forecast Stock Return (FSR) is dened as expected percentage price appreciation plus gross dividend yield over the next 12 months. Market Return Assumption (MRA) is dened as the oneyear local market interest rate plus 5% (a proxy for, and not a forecast of, the equity risk premium). Under Review (UR) Stocks may be agged as UR by the analyst, indicating that the stocks price target and/or rating are subject to possible change in the near term, usually in response to an event that may aect the investment case or valuation. EXCEPTIONS AND SPECIAL CASES Core Banding Exceptions (CBE): Exceptions to the standard +/6% bands may be granted by the Investment Review Committee (IRC). Factors considered by the IRC include the stocks volatility and the credit spread of the respective companys debt. 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 identied in the Companies Mentioned or Company Disclosure table in the relevant research piece.
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UBS investors guide

Wealth Management Research 27 May 2011

Strong currencies to the fore

Andreas Hfert Chief Economist

Last arguments for strong currencies

UBS investors guide 27 May 2011

Investors are underestimating the impact of a Greek sovereign default

UBS investors guide 27 May 2011

Asset allocation Outlook

Beyond the uncertainty

Outlook Asset allocation

Extended asset allocation

UBS investors guide 27 May 2011

Patchy data belie solid underlying growth trend

UBS investors guide 27 May 2011

Non-farm payrolls (lhs)

Initial jobless claims (rhs)

Source: Bloomberg, UBS WMR, as of 27 May 27

Source: Bloomberg, UBS WMR, as of 27 May 2011

UBS investors guide 27 May 2011

A healthy midcycle development

Ination peak awaited

UBS investors guide 27 May 2011

UBS investors guide 27 May 2011

Economy Emerging markets

UBS investors guide 27 May 2011

Head of IMF: Yes, why not an emerging market candidate?

U.S. Top 25 Stock List

UBS investors guide 27 May 2011

ADR (American depository receipt) top list

UBS investors guide 27 May 2011

Q-GARP (quality growth at a reasonable price)

UBS investors guide 27 May 2011

Dividend Ruler Stocks

Performance of Dividend Ruler Stocks

UBS investors guide 27 May 2011

Inection points across nancial markets

Test of key S&P 500 suggests an inection point

Source: Bloomberg and UBS WMR (prices of 23 May 2011)

UBS investors guide 27 May 2011

Source: UBS WMR as of 23 May 2011

UBS investors guide 27 May 2011

Equity market US sectors

Should continue to outperform

The answer to trailing sector performance may lie in 2Q11E expectations

UBS investors guide 27 May 2011

US sectors Equity market

Climbing the wall of worry!

Despite bad weather, consumer spending is healthy

UBS investors guide 27 May 2011

Equity market US sectors

UBS investors guide 27 May 2011

US sectors Equity market

UBS investors guide 27 May 2011

Equity market US sectors

AT&T supports telecom sector outperformance

Great expectations met in 1Q11 results, but the dollar hurts

UBS investors guide 27 May 2011

Emerging markets Equity market

Emerging markets Investors still scared by ination

UBS investors guide 27 May 2011

Bond market US Sectors

Healthcare: Patient is healing