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 considered." 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 demand. *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 (Chicago) "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 expectations. 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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UBS Global Asset Management: Are Developed Markets Inoculated against Contagion from Emerging Markets?