UBS Global Asset Management: Are Developed Markets Inoculated against Contagion from Emerging Markets?

  UBS Global Asset Management: Are Developed Markets Inoculated against
  Contagion from Emerging Markets?

Environment should continue to be supportive for risk assets, but risks remain

Business Wire

CHICAGO -- March 24, 2014

THE UBS GLOBAL ASSET MANAGEMENT Cyclical Market Forum, held quarterly to
discuss three plausible economic scenarios and their potential implications
for investments over the next 12 months, found its 1Q14 Forum dominated by
discussions of the outlook for emerging markets, as well as how weakness in
developing economies could spill over to developed countries. Curt Custard,
the chair of the Forum, said, “Recently, emerging markets have reminded us why
they're called emerging markets. While I don’t think that developed markets
will catch a cold from emerging markets, that risk does need to be

Three market scenarios are proposed at each Cyclical Market Forum and are
debated by UBS Global Asset Management investment teams across a wide variety
of asset classes, including equities, fixed income, multi-asset portfolios,
hedge funds, currencies, commodities and real estate. As of December 31, 2013,
UBS Global Asset Management had approximately USD 653 billion in assets under
management globally.

UBS Cyclical Market Forum 1Q14 Economic Scenarios Under Consideration

  *Scenario 1 –"Vaccination" – In this consensus scenario,  emerging market
    (EM) vulnerabilities are still present, but there is minimal feed-through
    to developed markets. Steady growth in developed markets (DMs) helps
    slightly to shore up the more export-oriented emerging countries
    (commodity-oriented ones do not fare as well) as weaker domestic demand is
    offset by improved external demand. Growth in DM capital spending picks up
    gradually, but remains at historically low levels compared to previous
    recoveries. As a result, growth in DM accelerates this year and the next,
    while the pace of activity in EM remains broadly unchanged.
  *Scenario 2 – "Global healing" – In the bullish scenario, global growth
    accelerates, supported by improved risk appetite, strong business
    confidence and loose monetary conditions. EM benefits directly from rising
    export demand, which in turns helps to offset tighter monetary conditions
    and weaker income dynamics. In such an environment, growth in DM
    accelerates substantially in both 2014 and 2015, while growth in EM picks
    up only marginally. Positive spillovers from an improved external
    environment are partially offset by the ongoing weakness in domestic
  *Scenario 3 – "Epidemic" – In the bearish scenario, contagion risk looms
    large, and the risk of EM events derailing global recovery is a distinct
    possibility. Massive outflows of EM investments trigger flight to quality
    and a further wave of sharp currency depreciations. As a result, growth in
    EM deteriorates substantially this year and stabilizes in the next, albeit
    at low levels. With current accounts in EM moving back to a surplus and
    weak domestic demand in the eurozone, the current account deficits of the
    US and UK reach historically high levels. This, combined with an
    appreciating exchange rate and import penetration, dampens US growth,
    which remains just above 2%.

A majority of the Cyclical Market Forum participants voted Scenario 1 as the
most likely. The bullish Scenario 2 was voted as the second-most likely, while
the bearish Scenario 3 was seen as the least likely outcome. In terms of asset
class expectations, a clear majority of participants expect developed markets
to strongly outperform emerging markets in equities and in currencies, while
emerging markets debt was expected to outperform developed market bonds. The
participants still believe that the outcomes for most asset classes would be
significantly impacted by the actions of central banks, particularly by the US
Federal Reserve's (Fed) tapering of asset purchases. Another wildcard is the
uncertainty over Ukraine, although the participants believe that the direct
economic effect of that situation should be limited.

Key Takeaways from the Forum:

Curt Custard, Head of Global Investment Solutions, Chair of the Cyclical
Market Forum (Chicago)

"My largest concern continues to be what will happen to asset prices after
liquidity is removed by central banks. It is hard for me to see valuations
being supported in almost every asset class if the Fed moves closer to a
normalization policy. Because of global liquidity provisions, everything seems
rich, particularly any asset with a yield. As money gets tighter, I think that
creates a more fragile environment and the risk of an exogenous shock."

Joshua McCallum, Senior Economist, Fixed Income (London)

"I don't think it makes sense to look at emerging markets as a single asset
class anymore. There seems to be a bifurcation between several relatively
strong emerging countries on one hand, and countries with weakening
currencies, political unrest and higher current account deficits on the other
hand. I don't believe we'll see a repeat of the crises of the late 1990s, but
there could be considerable volatility, particularly for those countries with
weaker fundamentals as liquidity gets scarcer."

Michele Gambera, Head of Quantitative Analysis, Global Investment Solutions

"In my view, appreciation of the euro will make life difficult for some of the
most competitive and vibrant European companies, which tend to be major
exporters. Unfortunately, the inaction of the European Central Bank
(ECB)—caused mostly by German austerity views—is having a perverse industrial
policy effect. Specifically, these exporters could help boost aggregate
demand, particularly in peripheral countries."

Comments on Specific Asset Classes:

Ian McIntosh, Senior Portfolio Manager, US Equities (Chicago)

"We are less bullish on US equities than we were at this time last year,
primarily due to valuation levels. However, we don’t foresee a mechanism that
would transfer emerging markets instability to the US economy. Furthermore,
even in the bearish scenario considered, China continues to grow at a healthy
rate and China is by a wide margin the most important emerging market for US
companies. Therefore, continued problems in emerging markets would probably
have a limited effect on US equities. An unexpected and significant weakening
of the China growth trajectory would change our view."

Scott Dolan, Co-Head of US Multi-Sector Fixed Income (Chicago)

"In my view, economic weakness in the beginning part of the year came at a
good time for US bond prices, which have been fairly steady this year after a
relatively weak 2013. I expect that the Fed will continue to taper as
expected, and that there will be no real shock unless there's a huge surprise
on the upside in terms of economic data."

David Roberts, Global Real Estate Research Economist (London)

"There was quite a bit of momentum in this asset class in 2013, and that has
continued so far this year. I'm optimistic about the outlook for real estate
under all three scenarios. If interest rates rise more quickly than predicted,
that would dampen growth. But I'd expect that such a rise in rates would
likely be accompanied by higher overall economic growth, which would be
supportive for real estate."

Uta Fehm, Portfolio Manager, Emerging Markets Debt (Frankfurt)

"I see no reason to be overly optimistic about the outlook for emerging
markets debt, but I am encouraged that several countries have begun to
implement much-needed reforms and have begun to lower their current account
deficits. However, I expect that volatility will continue, with no clear
positive or negative trend likely in the near future."

About UBS Global Asset Management

UBS Global Asset Management is a large-scale asset manager with
well-diversified businesses across regions, capabilities and distribution
channels. It offers investment capabilities and investment styles across all
major traditional and alternative asset classes. These include equity, fixed
income, currency, hedge fund, real estate, infrastructure and private equity
investment capabilities that can also be combined into multi-asset strategies.
The Fund Services unit provides professional services including legal fund
set-up, accounting and reporting for traditional investment funds and
alternative funds.

The information and opinions contained herein are a reflection of UBS Global
Asset Management’s best judgment based on current market assumptions and are
considered forward-looking statements. Any obligation to update or alter
forward-looking statement as a result of new information, future events, or
otherwise is disclaimed. There is no assurance that these projections will
ultimately be realized. Actual future results may prove to be different from

About the Cyclical Market Forum

Assessing the economic and market environment is a key part of UBS Global
Asset Management’s investment strategy-setting process across all investment
areas. Our Cyclical Market Forum, open to representatives of all investment
teams, regularly debates important economic and market themes and their
potential impact on our investment strategies. The Forum’s purpose is to
examine the main economic and market drivers – typically through scenario
analysis over a 12- to 18-month time horizon – and to foster debate between
the teams managing different asset classes. The three economic scenarios
discussed should not be considered forecasts.

The way in which the output from the Forum is used varies across UBS Global
Asset Management’s investment teams and it is just one of a number of inputs
into each team’s investment process. One of the key benefits of the Cyclical
Market Forum is the opportunity to exchange research and viewpoints from the
various investment specialists and to examine the intersection between
top-down and bottom-up drivers. As such, it broadens the input into our
strategy-setting process in a structured format.


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