Published 15 December 2016 UBS House View Monthly Base January 2017 Chief Investment Office WM This report was prepared by UBS AG. Please see the important disclaimer at the end of the document. This document is a snapshot view. We update the tactical asset allocation as changes occur and resend it to subscribers. For all other forecasts and information, we advise you to check the Investment Views section in your E- Banking or in Quotes.
Transcript
Published 15 December 2016
UBS House View Monthly Base January 2017
Chief Investment Office WM
This report was prepared by UBS AG.
Please see the important disclaimer at the end of the document.
This document is a snapshot view. We update the tactical asset allocation as changes occur and resend it to subscribers. For all other forecasts and information, we advise you to check the Investment Views section in your E- Banking or in Quotes.
Financial Market Outlook – short-term (6 months) Global Tactical Asset Allocation
• Asset allocation
We keep our overweight positions in US equities and Euro high yield vs. high grade bonds. Solid global economic growth, as signaled
by a composite of global purchasing manager indices, supports a moderate tactical risk-on stance. The simultaneous pick-up in
inflation globally supports the potential for higher earnings generation into 2017. At the same time, the growth-inflation mix,
particularly in the US, remains attractive for risk asset prices. Company refinancing costs, as measured by US corporate bond yields, are still 100bps below their 10-year average. So, despite the slightly more hawkish communication by the US Fed and higher US yields
over the past month, the environment is supportive for risk assets. The Fed is still expected to raise rates only gradually and in line with
improving economic data. We interpret the ECB's latest policy measures as primarily an extension of quantitative easing for the foreseeable future.
• Equities
While we continue to hold an overweight position in US equities vs. HG bonds, we have reduced the position recently, taking some
profits as HG bonds have underperformed US equities by a wide margin since the US elections. While the rise in US government bond
yields was supportive of the position's performance, an unhalted continuation thereof could become harmful for economic growth
and thus equities beyond a certain level. US equities are a long-duration instrument and their discounted future earnings growth is
compressed by higher bond yields. Still, the ongoing pick-up in corporate earnings on the back of solid US private consumption and increasing margins supports a continued overweight position in US stocks against HG bonds. Furthermore, we are keeping our
preference for EM equities over Swiss stocks. The strong Swiss franc remains a drag on Swiss earnings. Meanwhile, EM firms benefit
from the recovery in domestic growth. EM company earnings have stabilized in past months.
• Bonds
Following the substantial rise in global government yields over the past month, we expect them to move by and large sideways in the months ahead. US inflation protected securities (TIPS) are likely to continue outperforming nominal bonds, as inflation is rising
gradually, so we are keeping our overweight position. We are overweight euro high yield vs HG bonds. We find current valuations
attractive, as credit quality is solid and default rates are likely to remain low. Qualified investors with a tolerance for somewhat less
liquid assets should have an increased exposure to US senior loans, which are still offering average yields close to 6%.
• Foreign exchange We expect the euro to appreciate to 1.15 against the US dollar over the next six months and are overweight the currency. The euro is
substantially undervalued according to purchasing power parity. The economic recovery in the Eurozone is on track and the ECB has
likely reached the peak of its monetary easing measures for now, suggesting a stronger currency. We furthermore prefer a basket of EM currencies (BRL, INR, RUB, ZAR) over selected DM currencies (AUD, CAD, SEK). The position offers an interest rate carry of around
8% p.a. Meanwhile, the cyclical and commodity- sensitive nature of the underweight basket helps to stabilize the position.
For further information please contact Head, Global Asset Allocation Mads N. S. Pedersen, [email protected] or CIO asset class specialist Philipp Schöttler, [email protected]
US earnings growth set to accelerate
Source: Thomson Reuters, UBS CIO, as of December 2016
Average credit quality in euro high yield has improved
• CIO constructs the SAAs for its model portfolios to offer investors the best risk-return trade-off. They are consistent with the modern
portfolio theory approach of investing in traditional, relatively liquid asset classes and making use of diversification to reduce risk. These
SAAs are set up to withstand different types of market environments and are reviewed at least annually. Each asset class enters the
portfolio based on our internally constructed Capital Markets Assumptions (CMAs), which are forward-looking risk and return
expectations.
• In recent years, CIO has added exposure to high yield bonds and emerging market (EM) sovereign and corporate bonds and reduced
the cash allocation. CIO recommends global exposure to equities, a larger spectrum of bonds diversified across styles, quality, regions, central bank exposures and durations, and exposure to multi-strategy alternative investments.
• Since 2015, CIO has advised against direct commodity investing, including investments in precious metals. The expected risk-return trade- off of the asset class is not attractive enough, in CIO's view.
• CIO recommends fully hedging foreign currency exposure on a strategic level (except for EM equities). The expected returns do not compensate for the volatility of the asset class and the potential for structural shifts in FX regimes.
• Although high grade bonds have underperformed recently, especially since the US presidential election, developed market equities have delivered positive returns, ensuring that our model portfolios have performed in line with CIO's expectations across risk profiles.
This highlights the importance of investing in a diversified manner.
For further information please contact Head Global Asset Allocation Mads N. S. Pedersen, [email protected] or Head Strategic Asset Allocation Christophe de Montrichard, [email protected]
Illustration of a Strategic Asset Allocation (USD) for a balanced investor risk profile
Source: UBS CIO, as of December 2016
High grade bond yields (in %)
Source: UBS CIO, as of December 2016
4
Cross-asset preferences
Global model portfolio (EUR)
• Developed market high grade bonds
• Replacing "well-worn" bonds
• Corporate hybrids
• US leveraged loans
• US TIPS
• EUR HY
Most preferred Least preferred
• US equities
• US share buybacks and dividends
• US technology
• Emerging markets
• Sustainable value creation in EMs
Recent upgrades Recent downgrades
Equities
Bonds
Precious Metals & Commodities
Foreign exchange
Hedge Funds • Navigating rising US rates with
hedge funds
• EM FX (BRL, INR, RUB, ZAR)
• EUR
• DM FX (AUD, CAD, SEK)
• USD
As of 15 December 2016 Note: Portfolio weightings are for a EUR model portfolio, with a balanced risk profile (including TAA). We expect a balanced portfolio (excluding TAA) to have an average total return of 4.2% p.a. and volatility of 8.2% p.a. over the next five years.
• Switzerland
5
Global tactical asset allocation Tactical asset allocation deviations from benchmark*
Source: UBS, as of 15 December 2016
Currency allocation
*Please note that the bar charts show total portfolio preferences. Thus, it can be interpreted as the recommended deviation from the relevant portfolio benchmark for any given asset class and sub-asset class.
**The EM FX basket consists of the Brazilian real, the Indian rupee, the Russian ruble and the South African rand. The DM FX basket consists of the Australian dollar, the Canadian dollar and the Swedish krona (all with equal weights).
6
CIO themes in focus
Equities
• US technology: Secular growth, on sale Secular growth drivers (online advertising, cyber security, cloud investments) are likely to propel US technology sector earnings over the coming years. More tactically, we expect the sector to continue
to benefit from resilient business spending and ongoing labor market gains. Relative valuations are near 20-year lows and companies are returning large sums of cash to shareholders without increasing leverage.
• Profit from US share buybacks and dividends US companies are generally in good shape: they generate high free cash flow, have plenty of cash on their balance sheets and enjoy low financing costs. The stock market has rewarded investors in companies that return capital through dividends and share buybacks. These companies offer attractive yields in the current low-growth, low-interest-rate environment. On average, S&P 500 companies
returning cash to shareholders via dividends and/or share repurchases offer investors a total yield of 5-6% (when combining share buyback and dividend yields). Around two-thirds of this yield come from share buybacks. With borrowing costs low, companies have an incentive to return cash to shareholders, and good free cash flow generation is a key factor for this theme. As buybacks are made at
management's discretion, we recommend investing in a diversified basket of stocks.
• Sustainable value creation in emerging markets EM equities offer investors the opportunity to add value to their portfolios by incorporating environmental, social and corporate governance (ESG) considerations into their investment decisions. We
argue that the wide disparity among individual companies on ESG performance, particularly regarding governance issues, necessitates focusing on those with a strong management to reduce tail-risk events such as severe environmental accidents or weak corporate governance (e.g. accounting/audit issues). As corporate governance rules in emerging markets are often less strict than those in
developed countries, risks and opportunities are hard to quantify, which suggests that understanding how companies are exposed to ESG risks and opportunities and how they manage them should
factor in highly when determining corporate value.
Bonds
• A tip on TIPS: Benefiting from rising inflation We believe future consumer price inflation in the US is underestimated by current market pricing as measured by the breakeven inflation (BEI) rate. A tighter labor market, stabilizing oil prices and
slowing USD appreciation should provide support for headline inflation to move higher. We think this provides an opportunity for a long position in US Treasury Inflation Protected Securities (TIPS) funded by a short position in nominal US Treasuries. This so-called inflation breakeven trade delivered over 2% excess return in 2016 and we see potential for a further 1-2% for investors with a minimum
investment horizon of 6-12 months. The 3-7-year maturity spectrum of the curve is our best "tip". TIPS also add portfolio diversification and provide some hedge against a fall in the real value of
accumulated capital should inflation climb further.
• Replacing well-worn bonds Risk-free yields in most major developed markets are either below or close to zero. Even if rates were to remain unchanged, many short- to medium-term bonds would deliver negative total returns. Investors who avoid negative yields and instead add longer-dated paper at a slightly positive yield often take an even greater risk, as evidenced in the recent correction. We do not intend to take a
strong view on the highly uncertain path of inflation and yield curves, but we believe that investors can preserve wealth by taking profits on assets that will deliver negative total returns (exceeding costs
of switching out) in most likely scenarios. More attractive alternatives can be found on CIO's bond recommendation lists.
• US loans – Attractive floating yield We believe US senior loans are an attractive alternative to more traditional fixed income segments. Loans provide exposure to the most senior part of a company's capital structure and are often secured by the company's assets, leading to higher recovery rates than for bonds. Also, loans offer a floating coupon rate, which benefits from a rise in short-term US interest rates. The recent rise in the USD
LIBOR rate above 0.9% supports the investment case. The current yield (to 3-year takeout) at roughly 5.9% is attractive. We expect the default rate to moderately increase towards its long-term average
of 3% in 12 months. With an index weight of 4.4%, exposure to the oil and gas sector is much more limited than in US high yield bonds. We think US loans present an attractive investment opportunity for qualified investors who are comfortable holding less liquid asset classes.
7
CIO themes in focus
This selection of themes is a subset of a larger theme universe. The selection represents the highest conviction themes of the UBS Chief Investment Office WM, taking the current market environment and
risk-return characteristics into account.
Alternative investments
• Navigating rising US rates with hedge funds The US Federal Reserve has started to hike interest rates. Based on historical data, we find that most hedge fund strategies are resilient to rising interest rates while high grade bonds performed
poorly. Investors looking for an alternative to their high grade bond exposure should consider a diversified hedge fund portfolio characterized by a low directional exposure to both fixed income and equities.
Bonds
• Yield pick-up with corporate hybrids Corporate hybrids are a niche segment in the corporate bond market. At current spread levels, investors with a suitable risk tolerance are well compensated for assuming the risks associated with these bonds. We expect mid-single-digit percentage returns on selected instruments over 12 months.
8
CIO longer-term investment themes in focus
Equities
• Security and safety Security and safety touch lives everywhere, from governments securing infrastructure to enterprises protecting data and consumers trusting products as varied as baby food and fire alarms. Several long-term drivers support the theme, such as urbanization, tighter regulation and growing consumer awareness about product quality, data security, environmental protection and social responsibility.
• Automation and robotics We believe smart automation is powering the ongoing industrial revolution, combining the innovation capabilities of industrial and IT processes to drive global manufacturing productivity gains. Rising wages and challenging demographic developments will pressure costs of manufacturing companies in emerging markets, driving automation investments. By powering machine intelligence, artificial intelligence should take automation to the next level.
• Emerging market tourism Urbanization and income growth in emerging markets (EMs) are fueling a boom in global travel. Aviation services can be accessed in EMs’ largest cities, which are expanding due to migration, and have the highest incomes. EM governments are supporting tourism as a strategy to diversify their economies. Policy support comes in the form of visa openness, public investment in aviation infrastructure and new air links.
• Energy efficiency Energy efficiency covers wide-ranging issues with numerous characteristics and starting points for promising investment opportunities. In general, energy efficiency as a field is gaining importance all over the world, and developments are driven more and more by governmental initiatives. Rising environmental pollution has led to an increased worldwide awareness.
• Digital data Driven by strong urbanization, the global digital universe is expected to expand 50-fold between 2010 and 2020. From an investment perspective, digital data is a trend that offers solid long- term growth opportunities as significant investments are required to support the surge in data. Investors can participate by investing in either data enablers or data infrastructure companies.
This selection of themes is a subset of a larger theme universe. The selection represents the highest conviction themes of the UBS Chief Investment Office WM, taking the current market environment
and risk-return characteristics into account. The Longer Term Investment (LTI) theme series focuses on inevitable global trends such as population growth, aging and urbanization. These trends create a
variety of opportunities, with certain companies and sub-sectors experiencing higher-than-GDP levels of revenue growth. Here we include a subset of a larger universe of longer-term investment themes
that are expected to offer good entry points for theme-oriented investors over the coming months and highlight our preference for a diversified approach to themes.
UBS Chief Investment Office WM considers the highlighted themes as fitting the sustainability framework.
9
Key financial market driver 1 – Central bank policy
CIO view (Probability: 60%*) Policy is diverging
• Donald Trump's election as US president raises questions about the future direction of the Fed, with two new governors to
be appointed and given the president-elect's previous statements about Janet Yellen's future. Trump is also reported to be
sympathetic to congressional attempts to challenge the independence and flexibility of the Fed. This adds uncertainty to the 2017 policy outlook. Nonetheless, the lack of spare capacity for skilled and semi-skilled labor is producing increasing labor
cost pressures, which create price inflation pressures and reinforces the arguments for continued policy tightening. Our base
case of two rate hikes in 2017 with a slow decline in the balance-sheet-to-GDP ratio suggests a Fed tolerant of the rising inflation pressures.
• The ECB has set out its quantitative policy path for 2017, moderately reducing monthly bond buying from EUR 80bn to EUR 60bn from April onwards. We do not see economic conditions unfolding that would warrant a reversal of this reduction,
and instead expect a tapering of bond purchases in 2018.
• The Bank of England is expected to leave policy unchanged for the time being as the consequences of the earlier decline in
sterling continue to percolate through to the real economy. The Swiss National Bank has held its policy steady, and we
believe it will continue with its current negative rate position for the next 12 months. The SNB is expected to continue intervening in the foreign exchange markets when necessary. The Bank of Japan seems content to leave policy unchanged
for the time being, albeit the level of the yen is likely to be a particular concern.
Key dates
Jan 1
Jan 19
Jan 31
Feb 1
US Federal Reserve voting membership changes (annual rotation)
Has buying bonds changed Eurozone inflation? ECB balance-sheet-to-GDP ratio and core CPI inflation rate
Source: Haver, UBS, as of 7 December 2016
Some quantitative policy has peaked, most has not
Central bank balance sheets as a % of GDP
Source: Haver, UBS, as of 7 December 2016
Key points • Following its second rate hike in this cycle in December 2016, the US Federal Reserve is expected to continue monetary policy
tightening and a slow, subtle quantitative policy tightening in 2017.
• We believe that rising inflation and reasonable economic growth will keep the ECB on the policy path unveiled at the December 2016 meeting, with the prospect of further reductions in bond buying via a tapering of policy in 2018.
• Currency volatility reduces visibility on Bank of England policy.
• The inflation effect of fiscal stimulus in the US leads to a stronger Fed response and a tight monetary, loose fiscal policy combination (similar to Reagan's presidency). Higher labor market costs and some commodity price pressures lead to higher
European inflation rates, generating early signals of a more rapid tapering of ECB quantitative policy.
10
Key financial market driver 2 – Rising Political Uncertainty
Positive scenario (Probability: 10%*) • Significantly improving labor market conditions for low skilled workers lead to wage increases, which is either accompanied
by improved credit access or compensates sufficiently for the loss of credit access post-2008; this reduces income and consumption inequality. Governments and economists successfully communicate the net economic benefits of global trade and diversity.
Negative scenario (Probability: 20%*) • Nationalist tendencies are encouraged by single issue politics and social media. Traditional party structures fail to address the
demands of significant sections of the electorate, encouraging populism. Election outcomes are increasingly unpredictable as opinion polls offer less and less guidance. Established parties adopt policies that attempt to appeal to populist supporters, increasing uncertainty about mainstream policy programs. Lower income groups' standards of living are hurt by populist policies, fueling further demands for radical and unpredictable change.
Key dates
Jan 20 Mar 15 Apr 23 May 7 May
Inauguration of Trump as new US President Dutch general election French presidential election first round French presidential election second round North Rhine Westphalia (Germany) government elections
political populism Real global trade as % real global GDP
Source: UBS, as of 7 December 2016
Rising income inequality fuels populism
and political uncertainty
Gini coefficients – higher rating = more unequal
income distribution
Source: Euromonitor, UBS, as of 7 December 2016
Key points • The last quarter century has seen a dramatic decline in the number of people living in poverty. At the same time, certain
individuals within developed economies have been "left behind" by the increase in economic prosperity. The persistence
of these economic circumstances, which have encouraged anti-establishment or "populist" politics, mean that political uncertainty is likely to remain a risk for financial markets.
• The demographic that has been "left behind" by the growth over the past 25 years tends to be older, lower skilled,
lower income, and rural. Financial market participants (investors, traders, institutional managers) do not fit this demographic, meaning that the appeal of populism may be underappreciated in markets.
• Populist ideas are more likely to impact trend rates of growth than significantly alter the near -term economic cycle.
However, specific companies or sectors of the economy may become political targets and could suffer in the near term.
CIO view (Probability: 70%*) • Current income inequality and future economic redistribution associated with the structural changes of the fourth industrial
revolution will fuel discontent among less flexible, lower skilled workers in major economies. Any rise in food and energy prices is likely to exacerbate a perception of declining relative and absolute living standards by this group by adding to inflation inequality.
• The sense of relative decline supports the emergence of scapegoat economics – those seeking to blame an identifiable group for one's economic woes. Scapegoat economics will tend to (inaccurately) focus on foreigners and globalization as the causes of the relative economic decline. The detail of the populist policy response to scapegoat economics is difficult to predict.
• Opinion polls fail to capture the extent of populism accurately; low response rates, inaccurate answers, and "shy voter" syndrome conspire to increase the problems of interpreting opinion polls. Economic big data is likely to exclude those lower income groups that are inclined to populism, thereby creating complacency about the economic drivers of inequality and anti- establishment politics.
11
Key financial market driver 3 – US earnings growth may accelerate into 2017
CIO view (Probability: 60%*) Earnings trends improving, Trump could give a further boost
• US third-quarter earnings rose by a better-than-expected 4%, the first quarter of growth in over a year. Growth is poised to
continue accelerating as the huge drags from poor energy sector results and the strong dollar finally end.
• The improving profit trend is underpinned by solid US consumer spending and a rebound in US manufacturing activity as
energy investment spending and emerging market demand bottom out.
• The Trump administration's policies could further boost earnings growth through lower taxes (corporate, individual, and
repatriation of overseas cash), greater fiscal spending, less regulation, and a steeper yield curve (which benefits banks).
However, many details have yet to be worked out and House Republicans will have to get comfortable with the resulting larger budget deficits.
• We maintain our 2016 S&P 500 EPS forecast of USD 120 (+1%). For 2017 we expect a growth rate of 7% to 12%, accounting for the likelihood that some of the new administration's policies will make it into law by next year. Our 2017
estimate may have additional upside but is highly contingent on the outcome of corporate tax reform. We expect growth to
remain solid in 2018.
Positive scenario (Probability: 20%*) Trump's policies boost earnings more than expected
• The Trump administration's policies, especially corporate tax reform, generate faster profit growth. Higher interest rates and
deregulation further boost financial sector earnings. Business and consumer confidence improves and investment spending
picks up.
Negative scenario (Probability: 20%*) Downturn in sentiment
• Trade and geopolitical tensions flare up as a result of the incoming administration's policy priorities, depressing business and consumer sentiment. Wage pressures, without improving consumer and business demand, could pressure profit
margins and earnings growth rates. Persistently low short-term interest rates and renewed declines in long-term
interest rates could pressure financial sector earnings.
Earnings are hitting new highs S&P 500 EPS, lighter bars denote UBS estimates, in
USD
Source: FactSet, UBS, as of 9 December 2016
3Q was one of the stronger earnings seasons in
4- plus years
S&P 500 earnings "beat": change in bottom-up S&P
500 EPS estimate since quarter-end
Source: FactSet, UBS, as of 9 December 2016
Key points • US earnings growth has resumed and will likely accelerate into 2017
• The incoming Trump administration's policies could boost EPS further
• High profit margins are likely to be sustained
12
Global economic outlook – Summary Key points • Political uncertainty is an investor focus. The tweeting of US policy intentions has moved individual equities. Europe's electoral
cycle has increased investor nervousness. The economic cycle has not been disrupted, but trend growth may be affected.
• The US Federal Reserve is expected to raise interest rates twice in 2017. The latest extension of quantitative policy in Europe should represent the last period of policy easing this cycle; we expect a tapering of bond buying in 2018.
• Growth momentum in the major economies remains relatively good as the year draws to a close. Labor market indicators
have stayed relatively strong. As a result, underlying inflation pressures continue to build, supplementing oil base effects.
• Global growth is supported at a trend-like level. Trade protectionism increases but is generally specific rather than general in
scope.
• Shortages of skilled and semi-skilled labor in the US push up wages, leading to improved consumer spending and stronger
domestic growth. European growth is aided by improving labor market conditions in larger economies, but oil prices and the
euro have a dampening effect. Asia and emerging markets see slow, positive growth in external demand; domestic demand is mixed.
• Headline inflation rates in the developed world gradually rise as oil base effects are removed from the year-on-year calculation. Labor costs add to current increases in the US, fueling local inflation forces.
• The US Federal Reserve raises rates twice in 2017 and continues its very slow quantitative policy tightening (providing less
liquidity relative to the demands of the US economy). Real policy interest rates become more negative (discounted using CPI).
The ECB signals its intention to taper its bond buying program in 2018.
• US consumers suffer lower real disposable income as domestic inflation pressures increase. Eurozone growth weakens as bank lending reverses. Political uncertainty impacts European consumer and investment spending.
• Trade protectionism increases. Global capital flows become disruptive, with capital account protectionism being used in retaliation for current account protectionism.
*Scenario probabilities are based on qualitative assessment.
For further information please contact UBS WM Global Chief Economist Paul Donovan, [email protected]
Global growth remains around trend
Source: UBS, as of 14 December 2016 In developing the CIO economic forecasts, CIO economists worked in collaboration with economists employed by UBS Investment Research. Forecasts and estimates are current only as of the date of this publication, and may change without notice.
Clear signs of a tight US labor market (before stimulus is applied)
• US growth stumbles. Uncertainty following the election and tighter financial conditions weigh on business investment and consumer spending. The Fed stays on hold.
* Scenario probabilities are based on qualitative assessment.
Key dates
Dec 16
Dec 22 Dec 22
Jan 3
Housing starts for November
Personal income and spending, PCE price index for November
Durable goods orders for November ISM manufacturing
For further information please contact US economist Brian Rose, [email protected]
PMIs consistent with moderate growth Purchasing managers' indices
Source: Bloomberg, UBS, as of 8 December 2016
Inflation should gradually move toward Fed's 2% target US headline and core PCE price index, year-on-year in %
Source: Bloomberg, UBS, as of 8 December 2016 Note: PCE = personal consumption expenditures
Key points • We expect the US economy to grow at a moderate pace over the next 12 months.
• Inflation should gradually trend higher as the recovery continues.
• We expect the Federal Reserve to raise rates by 50 basis points in 2017.
CIO view (Probability: 70%*) Moderate expansion
• We expect the US economy to grow at a moderate pace over the next 12 months. The labor market is still improving, with
the unemployment rate below 5% and signs that labor shortages are promoting faster wage growth. Rising household
income should enable robust consumer spending.
• Housing starts and home prices should remain on an upward trend, contributing modestly to overall economic growth.
• Energy sector fixed investment appears to be bottoming out following the rebound in oil prices. The manufacturing sector
has shown some improvement but will likely remain restrained by weak global demand and the strong US dollar.
• Personal consumption expenditure (PCE) price inflation has been gradually trending higher as the labor market moves closer
to full employment. We expect this trend to continue in 2017. The forces helping to keep inflation down up until now,
including the strong US dollar, low energy prices, and smaller-than-usual increases in healthcare costs, are fading.
• Fiscal policy is likely to become looser given the Republican election sweep, with priority given to tax cuts, infrastructure, and
military spending. However, it will take some time for legislation to be passed, and the impact on economic growth in 2017 should be limited.
• Considerable progress has been made toward fulfilling the Fed's dual mandates of full employment and price stability. We expect 25bps rate hikes in June and December 2017.
14
Eurozone economy– Resilient growth
CIO view (Probability: 60%*) Resilient growth
• We expect the Eurozone economy to weather growth concerns thanks to resilient business and consumer confidence as well
as a strong monetary impulse, allowing it to limit the negative impact of political uncertainty. Inflation is set to continue
rising strongly through early next year. We expect the ECB to taper its QE program following the extension announced on 8 December. We think that the ECB will then taper its QE program very slowly for 9–12 months from January 2018 onwards.
• In Germany, fundamentals such as consumer confidence, construction, and capital-expenditure planning remain robust. We
expect Angela Merkel to win the elections in 2017. In France, better dynamics in construction and corporate investments are helping solidify growth. We expect François Fillon to emerge as the winner from the 2017 elections.
• Italian economic growth should consolidate at low rates, supported by a stabilizing construction sector. We expect elections
in 2H17 or 1Q18. Spain is still posting strong growth, even if the momentum is set to moderate.
Key dates
Dec 21
Jan 4
Jan 9
Jan 12
Jan 19
Consumer confidence (December)
CPI estimate (December)
Unemployment rate (November) Industrial production (November)
ECB press conference
For further information please contact CIO European economist Ricardo Garcia, [email protected]
Eurozone growth expected to remain solid
Source: Haver Analytics, UBS, as of December 2016
ECB balance sheet boosted by QE and TLTROs Total assets in national currency (index: 2007=100)
Source: Haver Analytics, UBS, data as of November 2016 (ECB and SNB, as of October 2016)
Key points • We expect economic growth to remain resilient despite political uncertainties in the UK, US, and the Eurozone.
• Inflation should continue to quickly rebound, supported by energy base effects.
• The ECB is expected to taper its QE program in 2018 following the renewed extension.
• The Eurozone slips into a deflationary spiral due to a shock, such as Greece leaving the Eurozone, a sharp escalation in the
Ukraine conflict, or China suffering a severe economic downturn.
*Scenario probabilities are based on qualitative assessment.
15
Chinese economy – Orderly deceleration
CIO view (Probability: 80%*) Balance between economic stability and mild reforms
• China's economy further stabilized in November thanks to the property boom from 3Q16. November manufacturing PMI
further rose to 51.7, a 28-month record high, due to rising product prices and mild inventory expansion.
• November CPI inflation rose to 2.3% y/y from 2.1% y/y in October and PPI inflation surged to 3.3% y/y, the first time since March 2012 that it has been in positive territory for three consecutive months. We expect CPI inflation to stay below 3% in
2017.
• Fixed asset investment (FAI) from January to November grew 8.3% y/y thanks to FAI in infrastructure. But private investment growth, which accounts for over 60% of total FAI and is considered a top risk in China, remained 3.1% y/y in November
(10.1% in 2015).
• November retail sales grew 10.8% y/y from 10.0% y/y in October. The monthly increase was mainly driven by robust auto sales due to the coming expiration (December) of a sales tax cut. Online sales in November continued to surge (up 33.7%
y/y), helped by the record 11/11 shopping festival.
• November FX reserves fell sharply (by USD 69bn) mainly due to revaluation. Following Trump's presidential victory, China's FX reserves shrank by about USD 30bn because of the rise in US interest rates and another USD 30bn was lost due to the
USD surge (USD-denominated assets account for 60% of China's total USD 3trn FX reserves). Thus, capital outflows in
November were about USD 10bn, in line with USD 10–20bn monthly outflows following the implementation of capital controls in January. We expect FX reserves to remain above USD 3trn by end-2016 and USD 2.7trn by end-2017.
• Fiscal policy is likely to remain accommodative. Infrastructure investment by local governments will likely remain an important
buffer for maintaining economic stability.
• Monetary policy should gradually shift to avoid a credit crunch and maintain economic stability, given the better-than-
expected growth data. The PBoC recently instructed banks to improve liquidity management and lessen investment duration
• A strong growth downturn occurs abruptly, defined as sub-6% real GDP growth for more than two quarters, driven by a
sharper fall in investment and widespread credit defaults.
*Scenario probabilities are based on qualitative assessment.
Key dates
Dec 27
Jan 1
Jan 9
Real estate data for November
PMI for January
CPI, PPI for December
For further information please contact CIO China economist Yifan Hu, [email protected]
China's FAI has stabilized due to government- supported infrastructure investment
Source: CEIC, UBS, as of 14 December 2016
November FX reserves dropped sharply mainly due to revaluation
Source: CEIC, UBS, as of 14 December 2016
Key points • China is striking a balance between economic stability and mild reforms. GDP growth continues its orderly deceleration.
• CPI inflation remains mild, while PPI inflation rose faster than expected in November, improving industrial profits and adding
pressure on interest rates. • Monetary policy focus should become more prudent as there is less concern about economic stability.
16
Swiss economy – Broadening of the Swiss recovery in 2017
CIO view (Probability: 60%*) Moderate recovery
• The Swiss economy stagnated in 3Q16. We expect the Swiss economy to grow by 1.4% in 2016 on the back of the strong
first half of the year. In 2017, the recovery is likely to broaden but not necessarily accelerate – we foresee GDP growth to
stay at 1.4%. We expect GDP growth to return to trend (1.8%) only in 2018.
• Employment growth was flat in 3Q16. However, employment may eventually pick up and force a trend reversal in the
unemployment rate as we expect the recovery to broaden in the coming quarters.
• The manufacturing PMI continued to trend up in November and points to a rebound of GDP growth in 4Q16.
• CPI inflation remained in negative territory in November. It is expected to turn positive in the coming months as the effects of
the weaker oil price and the stronger franc fade.
• The main goal of the Swiss National Bank (SNB) in the short term is to prevent the franc from appreciating sharply to
safeguard the Swiss economic recovery. To achieve this, the SNB will likely first intervene in the FX market. Only if
interventions do not suffice would it resort to a further rate cut. A rate hike is not in the cards in the coming quarters. The SNB will not likely raise rates until the ECB has slowed down its QE program significantly.
• The initiative against mass immigration has to be implemented by February 2017. The Swiss parliament plans to implement the initiative by establishing a "soft" national priority clause. While this implementation may only cause minor problems with
the EU, it could trigger a new initiative by the Swiss People's Party, which could also threaten the bilateral agreements.
Positive scenario (Probability: 20%*) Swiss franc shock already digested
• Export growth gathers further momentum as Swiss companies have already fully digested the Swiss franc shock.
Negative scenario (Probability: 20%*) Stagnating Swiss economy in coming months
• Populist parties win next year's elections in the EU, triggering fears in financial markets that the Eurozone may break
apart. The subsequent economic cooling and a strengthening of the Swiss franc stall the Swiss recovery.
* Scenario probabilities are based on qualitative assessment.
Disclaimer Generic financial research – Risk information: UBS Chief Investment Office WM's investment views are prepared and published by Wealth Management and Personal & Corporate Banking or Wealth Management Americas, Business Divisions of UBS AG (regulated by FINMA in Switzerland), its subsidiary or
affiliate ("UBS"). In certain countries UBS AG is referred to as UBS SA. This material is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. Certain services and products are subject to legal restrictions and cannot be
offered worldwide on an unrestricted basis and/or may not be eligible for sale to all investors. All information and opinions expressed in this material were obtained from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to its accuracy or
completeness (other than disclosures relating to UBS). All information and opinions as well as any prices indicated are current as of the date of this report, and are subject to change without notice. The market prices provided in performance charts and tables are closing prices on the respective principal stock
exchange. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. Opinions expressed herein may differ or be contrary to those expressed by other business areas or divisions of UBS as a result of using different assumptions and/or
criteria. UBS and any of its directors or employees may be entitled at any time to hold long or short positions in investment instruments referred to herein, carry out transactions involving relevant investment instruments in the capacity of principal or agent, or provide any other services or have officers, who
serve as directors, either to/for the issuer, the investment instrument itself or to/for any company commercially or financially affiliated to such issuers. At any time, investment decisions (including whether to buy, sell or hold securities) made by UBS and its employees may differ from or be contrary to the
opinions expressed in UBS research publications. Some investments may not be readily realizable since the market in the securities is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult to quantify. UBS relies on information barriers to control the flow
of information contained in one or more areas within UBS, into other areas, units, divisions or affiliates of UBS. Futures and Options trading is not suitable for every investor as there is a substantial risk of loss, and losses in excess of an initial investment may occur. Past performance of an investment is no
guarantee for its future performance. Additional information will be made available upon request. Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in foreign exchange rates may have
an adverse effect on the price, value or income of an investment. The analyst(s) responsible for the preparation of this report may interact with trading desk personnel, sales personnel and other constituencies for the purpose of gathering, synthesizing and interpreting market information. Tax treatment
depends on the individual circumstances and may be subject to change in the future. UBS does not provide legal or tax advice and makes no representations as to the tax treatment of assets or the investment returns thereon both in general or with reference to specific client's circumstances and needs. We
are of necessity unable to take into account the particular investment objectives, financial situation and needs of our individual clients and we would recommend that you take financial and/or tax advice as to the implications (including tax) of investing in any of the products mentioned herein. This material
may not be reproduced or copies circulated without prior authority of UBS. UBS expressly prohibits the distribution and transfer of this material to third parties for any reason. UBS accepts no liability whatsoever for any claims or lawsuits from any third parties arising from the use or distribution of this
material. This report is for distribution only under such circumstances as may be permitted by applicable law. In developing the Chief Investment Office (CIO) economic forecasts, CIO economists worked in collaboration with economists employed by UBS Investment Research. Forecasts and estimates are
current only as of the date of this publication and may change without notice. For information on the ways in which UBS CIO WM manages conflicts and maintains independence of its investment views and publication offering, and research and rating methodologies, please visit www.ubs.com/research.
Additional information on the relevant authors of this publication and other CIO publication(s) referenced in this report; and copies of any past reports on this topic; are available upon request from your client advisor.
External Asset Managers / External Financial Consultants: In case this research or publication is provided to an External Asset Manager or an External Financial Consultant, UBS expressly prohibits that it is redistributed by the External Asset Manager or the External Financial Consultant and is made
available to their clients and/or third parties. Australia: This notice is issued by UBS AG ABN 47 088 129 613 (Holder of Australian Financial Services Licence No 231087): This Document is issued and distributed by UBS AG. This is the case despite anything to the contrary in the Document. The Document is
intended for use only by “Wholesale Clients” as defined in section 761G (“Wholesale Clients”) of the Corporations Act 2001 (Cth) (“Corporations Act”). In no circumstances may the Document be made available by UBS AG to a “Retail Client” as defined in section 761G of the Corporations Act. UBS AG’s
research services are only available to Wholesale Clients. The Document is general information only and does not take into account any person’s investment objectives, financial and taxation situation or particular needs. Austria: This publication is not intended to constitute a public offer under Austrian law,
but might be made available for information purposes to clients of UBS Europe SE, Niederlassung Österreich, with place of business at Wächtergasse 1, A-1010 Wien. UBS Europe SE, Niederlassung Österreich is a branch of UBS Europe SE, a credit institution constituted under German Law in the form of a
Societas Europaea, duly authorized by the German Federal Financial Services Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin), and is subject to the joint supervision of BaFin, the central bank of Germany (Deutsche Bundesbank), as well as of the Austrian supervisory authority
(Finanzmarktaufsicht, FMA), to which this publication has not been submitted for approval. Bahamas: This publication is distributed to private clients of UBS (Bahamas) Ltd and is not intended for distribution to persons designated as a Bahamian citizen or resident under the Bahamas Exchange Control
Regulations. Bahrain: UBS is a Swiss bank not licensed, supervised or regulated in Bahrain by the Central Bank of Bahrain and does not undertake banking or investment business activities in Bahrain. Therefore, Clients have no protection under local banking and investment services laws and regulations.
Brazil: Prepared by UBS Brasil Administradora de Valores Mobiliários Ltda, entity regulated by Comissão de Valores Mobiliários ("CVM"). Canada: In Canada, this publication is distributed to clients of UBS Wealth Management Canada by UBS Investment Management Canada Inc.. Czech Republic: UBS is not
a licensed bank in Czech Republic and thus is not allowed to provide regulated banking or investment services in Czech Republic. This material is distributed for marketing purposes. Denmark: This publication is not intended to constitute a public offer under Danish law, but might be distributed by UBS
Europe SE, Denmark Branch, filial af UBS Europe SE, with place of business at Sankt Annae Plads 13, 1250 Copenhagen, Denmark, registered with the Danish Commerce and Companies Agency, under the No. 38 17 24 33. UBS Europe SE, Denmark Branch, filial af UBS Europe SE is a branch of UBS Europe SE,
a credit institution constituted under German Law in the form of a Societas Europaea, duly authorized by the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin). UBS Europe SE, Denmark Branch, filial af UBS Europe SE is subject to the joint supervision of
the BaFin, the central bank of Germany (Deutsche Bundesbank) and the Danish Financial Supervisory Authority (DFSA) (Finanstilsynet), to which this document has not been submitted for approval. France: This publication is distributed by UBS (France) S.A., French "société anonyme" with share capital of €
125.726.944, 69, boulevard Haussmann F-75008 Paris, R.C.S. Paris B 421 255 670, to its clients and prospects. UBS (France) S.A. is a provider of investment services duly authorized according to the terms of the "Code Monétaire et Financier", regulated by French banking and financial authorities as the
"Autorité de Contrôle Prudentiel et de Résolution". Germany: The issuer under German Law is UBS Europe SE, Bockenheimer Landstrasse 2-4, 60306 Frankfurt am Main. UBS Europe SE is authorized and regulated by the "Bundesanstalt für Finanzdienstleistungsaufsicht". Hong Kong: This publication is
distributed to clients of UBS AG Hong Kong Branch by UBS AG Hong Kong Branch, a licensed bank under the Hong Kong Banking Ordinance and a registered institution under the Securities and Futures Ordinance. India: Distributed by UBS Securities India Private Ltd. 2/F, 2 North Avenue, Maker Maxity,
Bandra Kurla Complex, Bandra (East), Mumbai (India) 400051. Phone: +912261556000. SEBI Registration Numbers: NSE (Capital Market Segment): INB230951431, NSE (F&O Segment) INF230951431, BSE (Capital Market Segment) INB010951437. Indonesia: This research or publication is not intended and
not prepared for purposes of public offering of securities under the Indonesian Capital Market Law and its implementing regulations. Securities mentioned in this material have not been, and will not be, registered under the Indonesian Capital Market Law and Regulations. Israel: UBS Switzerland AG is
registered as a Foreign Dealer in cooperation with UBS Wealth Management Israel Ltd, a wholly owned UBS subsidiary. UBS Wealth Management Israel Ltd is a licensed Portfolio Manager which engages also in Investment Marketing and is regulated by the Israel Securities Authority. This publication shall not
replace any investment advice and/or investment marketing provided by a relevant licensee which is adjusted to your personal needs. Italy: This publication is distributed to the clients of UBS Europe SE, Succursale Italia, Via del Vecchio Politecnico, 3 - 20121 Milano, the branch of a German bank duly
authorized by the “Bundesanstalt für Finanzdienstleistungsaufsicht” to the provision of financial services and supervised by "Consob". Jersey: UBS AG, Jersey Branch, is regulated and authorized by the Jersey Financial Services Commission for the conduct of banking, funds and investment business. Where
services are provided from outside Jersey, they will not be covered by the Jersey regulatory regime. UBS AG, Jersey Branch is a branch of UBS AG a public company limited by shares, incorporated in Switzerland whose registered offices are at Aeschenvorstadt 1, CH-4051 Basel and Bahnhofstrasse 45, CH 8001
Zurich. UBS AG, Jersey Branch's principal place business is P.O. Box 350, 24 Union Street, St Helier, Jersey JE4 8UJ. Luxembourg: This publication is not intended to constitute a public offer under Luxembourg law, but might be made available for information purposes to clients of UBS Europe SE, Luxembourg
Branch, with place of business at 33A, Avenue J. F. Kennedy, L-1855 Luxembourg. UBS Europe SE, Luxembourg Branch is a branch of UBS Europe SE, a credit institution constituted under German Law in the form of a Societas Europaea, duly authorized by the German Federal Financial Services Supervisory
Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin), and is subject to the joint supervision of BaFin, the central bank of Germany (Deutsche Bundesbank), as well as of the Luxembourg supervisory authority, the Commission de Surveillance du Secteur Financier (the "CSSF"), to which this
publication has not been submitted for approval. Mexico: This document has been distributed by UBS Asesores México, S.A. de C.V., a company which is not part of UBS Grupo Financiero, S.A. de C.V. or of any other Mexican financial group and whose obligations are not guaranteed by any third party. UBS
Asesores México, S.A. de C.V. does not guarantee any yield whatsoever. Netherlands: This publication is not intended to constitute a public offering or a comparable solicitation under Dutch law, but might be made available for information purposes to clients of UBS Europe SE, Netherlands branch, a branch
of a German bank duly authorized by the “Bundesanstalt für Finanzdienstleistungsaufsicht” for the provision of financial services and supervised by "Autoriteit Financiële Markten” (AFM) in the Netherlands , to which this publication has not been submitted for approval. New Zealand: This notice is
distributed to clients of UBS Wealth Management Australia Limited ABN 50 005 311 937 (Holder of Australian Financial Services Licence No. 231127), Chifley Tower, 2 Chifley Square, Sydney, New South Wales, NSW 2000, by UBS Wealth Management Australia Ltd. You are being provided with this UBS
publication or material because you have indicated to UBS that you are a client certified as a wholesale investor and/or an eligible investor ("Certified Client") located in New Zealand. This publication or material is not intended for clients who are not Certified Clients ("Non-Certified Clients"), and if you are a
Non-Certified Client you must not rely on this publication or material. If despite this warning you nevertheless rely on this publication or material, you hereby (i) acknowledge that you may not rely on the content of this publication or material and that any recommendations or opinions in this publication or
material are not made or provided to you, and (ii) to the maximum extent permitted by law (a) indemnify UBS and its associates or related entities (and their respective directors, officers, agents and advisers (each a "Relevant Person") for any loss, damage, liability or claim any of them may incur or suffer as a
result of, or in connection with, your unauthorised reliance on this publication or material and (b) waive any rights or remedies you may have against any Relevant Person for (or in respect of) any loss, damage, liability or claim you may incur or suffer as a result of, or in connection with, your unauthorised
reliance on this publication or material. Saudi Arabia: This publication has been approved by UBS Saudi Arabia (a subsidiary of UBS AG), a Saudi Arabian closed joint stock company incorporated in the Kingdom of Saudi Arabia under commercial register number 1010257812 having its registered office at
Tatweer Towers, P.O. Box 75724, Riyadh 11588, Kingdom of Saudi Arabia. UBS Saudi Arabia is authorized and regulated by the Capital Market Authority of Saudi Arabia. Singapore: Please contact UBS AG Singapore branch, an exempt financial adviser under the Singapore Financial Advisers Act (Cap. 110)
and a wholesale bank licensed under the Singapore Banking Act (Cap. 19) regulated by the Monetary Authority of Singapore, in respect of any matters arising from, or in connection with, the analysis or report. Spain: This publication is distributed to its clients by UBS Europe SE, Sucursal en España, with
registered office at Calle María de Molina 4, C.P. 28006, Madrid, entity supervised by Banco de España and the Bundesanstalt für Finanzdienstleistungsaufsicht. UBS Europe SE, Sucursal en España is a branch of UBS Europe SE, a credit institution constituted in the form of a Societas Europaea authorized and
regulated by the Bundesanstalt für Finanzdienstleistungsaufsich. Sweden: This publication is not intended to constitute a public offer under Swedish law, but might be distributed by UBS Europe SE, Sweden Bankfilial with place of business at Regeringsgatan 38, 11153 Stockholm, Sweden, registered with the
Swedish Companies Registration Office under the Reg. No 516406-1011. UBS Europe SE, Sweden Bankfilial is a branch of UBS Europe SE, a credit institution constituted under German Law in the form of a Societas Europaea, duly authorized by the German Federal Financial Supervisory Authority
(Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin). UBS Europe SE, Sweden Bankfilial is subject to the joint supervision of the BaFin, the central bank of Germany (Deutsche Bundesbank) and the Swedish financial supervisory authority (Finansinspektionen), to which this document has not been submitted
for approval. Taiwan: This material is provided by UBS AG, Taipei Branch in accordance with laws of Taiwan, in agreement with or at the request of clients/prospects. UAE: This research report is not intended to constitute an offer, sale or delivery of shares or other securities under the laws of the United Arab
Emirates (UAE). The contents of this report have not been and will not be approved by any authority in the United Arab Emirates including the UAE Central Bank or Dubai Financial Authorities, the Emirates Securities and Commodities Authority, the Dubai Financial Market, the Abu Dhabi Securities market or
any other UAE exchange. This material is intended for professional clients only. UBS AG Dubai Branch is regulated by the DFSA in the DIFC. UBS AG/UBS Switzerland AG is not licensed to provide banking services in the UAE by the Central Bank of the UAE nor is it licensed by the UAE Securities and
Commodities Authority. The UBS AG Representative Office in Abu Dhabi is licensed by the Central Bank of the UAE to operate a representative office. UK: Approved by UBS AG, authorised and regulated by the Financial Market Supervisory Authority in Switzerland. In the United Kingdom, UBS AG is
authorised by the Prudential Regulation Authority and subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. Details about the extent of our regulation by the Prudential Regulation Authority are available from us on request. A member of the
London Stock Exchange. This publication is distributed to private clients of UBS London in the UK. Where products or services are provided from outside the UK, they will not be covered by the UK regulatory regime or the Financial Services Compensation Scheme. USA: This document is not intended for
distribution into the US, to US persons, or by US-based UBS personnel. UBS Securities LLC is a subsidiary of UBS AG and an affiliate of UBS Financial Services Inc., UBS Financial Services Inc. is a subsidiary of UBS AG.
Version 11/2016.
UBS 2016. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.
