No one can know for certain when the global economy will find a bottom, but UBS Wealth ManagementResearch – mericas (WMR) analysts have been predicting a moderate cyclical recovery in the second half of 2009. Their recommendations may very well affect your portfolio.

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Market outlook
Forecast: worst of the storm has passed
Market outlook is a monthly publication to help inform your investment strategy August 2009
No one can know for certain when the global economy WMR assigned a 55% probability rate to its “Moderate
will find a bottom, but UBS Wealth Management Portfolio” scenario for the 12-month horizon, indicating a
Research – Americas (WMR) analysts have been recovery that falls into the low-growth, “not too hot, not too
predicting a moderate cyclical recovery in the second cold” Goldilocks zone.)
half of 2009. Their recommendations may very well
affect your portfolio. “While we’re fairly confident a recovery is in the making,
we do not expect it to represent a rapid return to business
Signs of recovery: as usual,” stresses Stephen Freedman, CFA®, WMR’s Global
Economy gains traction, markets respond Investment Strategist. “Instead, we anticipate a cyclical
In order for the ongoing rally in risky assets (where the return rebound followed by a period of several years of lower-than-
is uncertain) to continue, as WMR recently explained, markets average growth.”
would need hard evidence that the recovery process in both
the economy and in corporate earnings was gaining traction. It’s noteworthy that the U.S. economy—first to be drawn
Well, the economy and companies recently delivered and into the recession—seems to be among the first to reemerge,
financial markets have responded. a tribute to the massive policy stimulus, according to WMR.
Analysts point out that although it’s unlikely the economy would
And while lending conditions remain tight relative to history, currently recover without government intervention, signs of self-
WMR’s U.S. credit health thermometer indicates significant healing should allow the private sector to support further growth
improvement since the beginning of the year, a trend WMR once the impact of public stimulus starts to fade.
expects to persist and gradually provide more breathing room
for businesses and consumers. Deleveraging in the economy is Given the sheer magnitude of the monetary policy response,
under way and the housing market appears to be stabilizing, concerns about inflation are unsurprising, yet WMR feels
with home prices increasing over the prior month for the it will be kept at bay for the near term. First, a slack in the
first time since the downturn began. Another factor that economy will curtail rising prices; second, the output gap,
should provide further support to GDP growth is inventory used as a measure of free capacity, is at trough levels which
restocking. The extreme caution that has been prevalent in can’t be expected to generate price pressure on the markets
the corporate sector has led to inventories that are unusually for goods and services in the near term; and third, the labor
low even in relation to depressed sales. market is not in a position to start a wage-price spiral. “We
believe inflation will overshoot the Federal Reserve’s comfort
Enthusiasm over the recent positive signs must be tempered, zone, eventually reach the 4-5% range and stay there for
however, by WMR’s base-case scenario of a moderate cyclical some time,” says Freedman. “However, we don’t expect
recovery in the second half of this year. (See the chart, where this to happen before 2011 at the earliest—too soon to

2. no longer cheap, with various sectors now trading in line with
Moderate recovery marginal costs of production, yet a firming of global demand
High should be accompanied by further gains in commodity
growth
markets. In particular, the fact that a disproportionate share
of global demand for resources originates in emerging Asia
is very supportive of commodities given the signs of recovery
Low
in that part of the world. Finally, WMR underweights fixed
growth
income to offset its preference for equities and commodities,
but says corporate bonds remain the sweet spot.
Negative Dollar weakness = tilt toward ex-U.S.
growth WMR analysts recommend U.S. investors tilt their portfolios
Negative Low High
inflation inflation inflation away from dollar-denominated assets into foreign financial
markets, not out of valuation concerns, but due to a perceived
Source: UBS WMR
prolonged weakness of the U.S. dollar. “While the massive
policy stimulus is key to stabilizing the U.S. economy in the
aggressively position portfolios for such a scenario.”
near term, once the dust settles, the price tag for government
intervention on such a massive scale will inevitably become
WMR’s tactical asset recommendations: look to riskier asset
apparent and dollar weakness will be one consequence,”
classes, with a preference for equities and commodities over fixed
explains Freedman. “We expect the dollar to encounter
income and cash, in light of the current economic backdrop and a
structural depreciation pressures this year and beyond.”
recovery that is expected to be slow and uneven.
Some foreign governments have taken steps to prop up their
While cautioning that gains will likely not occur in a straight
economies, but few have done so on such a large scale as
line, WMR analysts say, overall, equities remain attractive
here in the U.S., hence WMR expects international imbalances
both on valuation and cyclical grounds and will move higher
surrounding the U.S. economy to increase. Cyclical factors
over the next 9 to 12 months. Valuations have come off their
also point to dollar weakness. Throughout the financial
early March lows and the S&P 500 has rallied 46%, although
crisis, the dollar has served as a safe haven currency, posting
valuations still offer upside to fair value. More important is
gains whenever risk aversion spiked in financial markets and
the phase of the cycle analysts believe is typically supportive
experiencing setbacks when risk appetite returned. As risk
of equity market returns; stocks generally outperform fixed
appetite gradually returns, the dollar is likely to remain out of
income and cash for more protracted periods than a quarter
favor for awhile, in WMR’s view.
following a trough in the economy. And corporate earnings,
a key driver of equity markets, are in a recovery process.
Within foreign stocks, WMR sees emerging markets as an
Second-quarter earnings so far have brought about an
attractive way to benefit from the global recovery, mainly due
unusually high share of positive surprises, with companies
to their tendency to outperform developed markets when the
beating earnings estimates, outpacing misses three to one.
global economy enters a cyclical recovery phase. Moreover,
Significant cash remains on the sidelines; as confidence in the
the fact that various emerging market economies (e.g., China,
cyclical recovery builds, this represents a significant source
Korea) are leading the pack out of the global recession is
of potential demand for equities, in WMR’s view. Within
further reason to believe their equities will outperform.
U.S. equities, analysts prefer the more economically sensitive
sectors of the market, particularly those levered to global
Let’s talk about it
growth, such as Industrials and Materials.
To explore how some of the insights in this issue of Market
Outlook might bear on your portfolio, or to discuss additional
Commodities is another cyclical asset class WMR thinks
research insights, please contact a UBS Financial Advisor.
should perform well in a recovery. Commodity markets are
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