982973

Investment Strategy Guide US EditionCIO Wealth Management Research

Also inside In Context: Shifting gears

In Focus: US housing market a slow but steady recovery

UBS HouseViewJune 2015

Next steps for central banks

2 UBS HOUSE VIEW JUNE 2015

A MESSAGE FROM THE REGIONAL CIO

TACTICAL PREFERENCES 1

FEATURE 2Next steps for central banksby Mark Haefele

IN CONTEXT 7Shifting gearsby Mike Ryan

PREFERRED INVESTMENT VIEWS 8

MONTH IN REVIEW 9

AT A GLANCE 9

GLOBAL ECONOMIC OUTLOOK 10

ASSET CLASSES OVERVIEW 12EquitiesFixed incomeCommoditiesForeign exchange

IN FOCUS 18US housing market a slow but steady recoveryby Jon Woloshin and Brian Rose

TOP THEMES 20Eurozone comeback

Liability optimization

North American energy independence: Reenergized

KEY FORECASTS 22

DETAILED ASSET ALLOCATION 23

PERFORMANCE MEASUREMENT 31

APPENDIX 34

PUBLICATION DETAILS 38

CONTENTS

This report has been prepared by UBS Financial Services Inc. (UBS FS) and UBS AG.

Please see important disclaimers and disclosures beginning on page 35.

Dear reader,With news services breathlessly reporting on each and every utterance from the lips of Fed Chairman Janet Yellen and Mario Draghi alternately deified and demonized for the extraordinary and unprecedented actions taken by the ECB its pretty clear that central bank policy still matters a great deal for both the real economy and financial markets. So in this months Feature article, we debate the next steps to be taken by central banks, and the implications these will have for investors. We argue that while the path is narrowing and policy choices from here are not without risks, the just-right goldilocks economic recovery provides central bank-ers ample latitude to retain an accommodative policy mix overall.

Against this backdrop we remain overweight risk assets, with preferences for both Eurozone equities and high yield credit. We recognize, however, that some adjustments to our tactical market posi-tioning are required amid changes in the economic backdrop, shifts in policy outlook, and/or re-pricing within and across asset classes. So this months In Context section outlines a shifting of gears, specifically: upgrading REITS; downgrading retailers; extending out on the corporate credit curve; and recommitting to our North American energy independence theme.

One of the developments that has likely added to the uncertainty around the Feds decision-making process has been the recent economic soft patch including some disappointing housing data. We argue in the In Focus article this month that the weakness in housing has largely been weather related and that the overall backdrop for housing activity remains constructive (pun intended). In fact, we look for housing starts to eventu-ally reach the 1.31.4 million units per year level.

One thing is for sure, as policy makers continue to sort through the mixed signals on the economy and plot out the proper policy path, this summer is likely to be anything but boring

Regards,

Mike Ryan, CFAChief Investment Strategist, WMARegional CIO, Wealth Management US

JUNE 2015 UBS HOUSE VIEW 1

Tactical preferencesWe favor stocks over bonds. Eurozone equities are more attractive than US markets. Within fixed income, we prefer US corporate bonds.

TACTICAL ASSET ALLOCATION

LEGEND

Overweight: Tactical recommendation to hold more of the asset class than specified in the moderate risk strategic asset allocation (see page 23) Underweight: Tactical recommendation to hold less of the asset class than specified in the moderate risk strategic asset allocation (see page 23) Neutral: Tactical recommendation to hold the asset class in line with its weight in the moderate risk strategic asset allocation (see page 23)

Each bar represents a +/- 2% tactical tilt or part thereof (i.e., one bar = 0.5% to 2%, 2 bars = 2.5% to 4%, 3 bars = over 4%).

NOTE: TACTICAL TIME HORIZON IS APPROXIMATELY SIX MONTHS

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3) Foreign exchange We add a new preference for the British pound over the Austral-ian dollar.

1) Equities The Eurozone is our favorite mar-ket. In the US we favor small-caps over large-caps.

2) Fixed income We favor US corporate bonds over government bonds.

Asset ClassesTactical asset allocation

THIS MONTH


Since the financial crisis, the US Federal Reserve, the Bank of England, the Bank of Japan (BoJ), and the European Central Bank (ECB), have printed a combined USD 5.7trn. Thats enough to build a six-lane freeway out of USD 100 bills that circles the globe twice.

Perhaps unsurprisingly, given the extent of the easing, global central bank policy has been the key factor in determining investment performance in that period.

Again this year, the general idea that investors should follow the lead of central banks has worked. The Eurozone and Japan, both running aggressive quantitative easing (QE) schemes, have been the best-performing developed markets. Chinese equities have also responded very well to easing from the Peoples Bank of China (PBoC).

The fix has been in for risky assets and investors expect it to remain in place. At our recent Davos investor forum, investors overseeing a combined USD 11trn unanimously agreed that policy would continue to support risky assets this year. Still, nothing lasts forever.

More than six years into QE, central bankers are warning that the path is narrowing and it is not without risks. ECB President Mario Draghi and Fed Chair Janet Yellen have both recently warned that the possible threats arising from QE need to be care-fully monitored. So while policy is likely to remain stimulative through 2015, we need to examine how this outlook might alter based on changes in such variables as growth, inflation, employment, wages, asset prices, and inequality.

I see three paths central banks can take in the near term. The most comfortable path, and our base case, is one in which just-right Goldilocks economic recoveries with low inflation, gradually improving growth, and modest wage increases allow central bankers to retain accomodative policy before steadily pulling back. This environment

The next steps for central banks

Mark HaefeleGlobal Chief Investment OfficerWealth Management

More than six years into quantitative easing, central bankers are warning that the path is narrowing and that the policy is not without risks.

Our base case remains that just-right Goldilocks economic recoveries allow central bankers to retain loose policy before steadily pulling back.

But investors will need to remain conscious of alternative scenarios, includ-ing a possible tightening tantrum or QE infinity.

In our tactical asset allocation, we remain positive on equities and high yield credit, and initiate an overweight position in the British pound relative to the Australian dollar.


FEATURE

should prove supportive of risky assets like equities and high yield credit. But on either side of our base case are the more troubling paths of a tightening tantrum and QE infinity.

Lets look at some of the signposts that might indicate which path we are heading down.

Tightening tantrum: Fast-track interest rate hikesIn our base case, we expect the Fed to start increasing rates in September. Uncertainty about the precise path of rate hikes may increase equity volatility from current low levels. But with the Fed continuing to support growth, we think the rewards of staying positive on the likes of equities and high yield credit will more than make up for the risks.

One development that could cause our confidence to fade would be evidence that the Fed is falling behind the curve in containing inflation. This would likely lead to a more rapid rise in interest rates than we currently expect raising the threat of a tightening tantrum similar to the bond and equity sell-off we saw in mid-2013 when the Fed hinted at tapering QE. A larger-than-anticipated Fed rate hike could occur in one of two ways: inflation with growth or inflation without growth.

The key signpost pointing to the first and more benign outcome will be wage growth. Most data suggest salary pressures are low. Overall average hourly wages grew by a modest 2.2% year-on-year to April. That isnt notably higher than the 2% average rate of the past five years, despite a near halving of unemployment since its 2009 peak. But this figure may be depressed by the creation of more low-paid positions. Other data that better reflect existing individual worker situations, rather than a sim-ple aggregate, suggest that wage demands could be rising. The Employment Cost Index data released this month hints that existing workers are succeeding in extracting slightly higher pay packets: it rose 2.6% in the year to March (see Fig. 1). While such early signs of wage inflation have proven misleading before, we will need to remain vigilant if this index rises any further.

More troubling still would be stagflation: a pick-up in price pressures without greater accompanying growth. The wage-price spirals typical of the 1970s seem unlikely

> The Fed should continue to support growth

> But this could change if we see a pickup in inflation

> There are some early signs of higher wage growth...

> ...and stagflation risks need to be closely monitored

Source: Bloomberg, UBS, as of 20 May 2015

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2007 2008 2009 2010 2011 201420132012 2015

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Fig. 1: Tightening tantrum? Early signs of US wage growth have emergedEmployment Cost Index, y/y growth in %

> Existing US employees are winning the largest pay increases since 2008


FEATURE

today. However, a different type of stagflation asset-price stagflation is worth monitoring. As I described in my last letter, markets fueled by QE are producing asset-price inflation that could continue until excess leverage and speculation suck too many resources from productive sectors of the economy. Then the Fed or other central banks may pull the stimulus despite sluggish growth.

I dont think developed market central banks are poised to start pricking bubbles, real or imagined. Major equity markets are not cheap for sure, but neither are they dra-matically overpriced. The MSCI All Country World Index currently trades on 16.9x price-to-forward-earnings, relative to a 15-year average of 14.8x. We also currently see few signs of overheating in wages, growth, or consumer spending.

QE infinity: An endless road Another concern is that stimulus fails to generate sufficient growth. Even in the flex-ible US economy, there is a non-negligible chance that policymakers could be forced to resume easing. The US has, for the third time in succession, appeared to stall shortly after the end of a QE program. In structurally weaker economies like the Euro-zone, there is an even greater danger that QE will not stimulate enough growth, lead-ing to monetary easing stretching out into infinity. Japan provides a cautionary tale on how this can happen (see Fig. 2).

Ultra-low bond yields, a weak euro, and low oil prices have given the Eurozone a tem-porary boost. But convincing evidence of a self-sustaining recovery is still missing, and recent market moves have shown how quickly such temporary effects can swing into reverse. Lifting growth on a lasting basis will require measures such as liberalizing la-bor markets and opening up industries to competition. Unfortunately, the pace of productivity-enhancing structural reform in the Eurozone continues to disappoint notably in Italy and France.

Without a sustained pickup in growth, the ECB could be forced into further bouts of QE. This need not be bad for equities in the near term: the QE fix has helped to fuel these markets the past six years and will remain a powerful force. But the longer QE

> So far, however, central banks do not need to prick asset-price bubbles

> QE may also fail to generate an economic lift-off

> The Eurozone economy has not yet achieved self-sustaining growth

> Indefinite QE increases the risk of over-leverag-ing, speculation and excessive inequality


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1990 1995 2000 2005 2010 2015

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Fig. 2: QE-infinity: in the footsteps of Japan?Japan 3-month LIBOR, in %

> Japan has been stuck with interest rates near to zero since the late 1990s


drags out, the greater are the chances that some of its adverse side effects, such as speculation, over-leveraging, and excessive inequality, will materialize.

Staying the courseOver the past few years, it could be said that the greatest challenge for investors was staying the course, and betting that central banks were determined to make the fix work. This challenge could become greater still in the months ahead if the volatility gripping currency and bond markets since the beginning of the year extends to the equity market. Still, overall, we believe that much of the data leads toward a benign outlook for central bank policy over our tactical horizon. Growth should be sufficient for risky assets to perform well (see Fig. 3).

In the US, GDP growth, though slightly below par, is heading for 2.3% this year. Prices remain under control, and there may be more scope for non-inflationary job growth as discouraged workers return to the labor market.

In Europe, growth has surprised positively so far this year, and with unemployment still elevated, the ECB should be able to maintain loose monetary policy without fearing a sharp rise in inflation. The ECBs willingness to be proactive about addressing potential market disruptions, as demonstrated again in the past week, is a further positive es-pecially if the Greek situation deteriorates.

Japan is also making some progress. BoJ Governor Haruhiko Kuroda recently claimed that the nations output gap has closed to about zero and inflation will soon start to rise to healthier levels.

In addition, there are grounds for optimism about the Chinese economy, in the near term at least. The PBoC has extended some local government debt maturities and already cut borrowing costs three times over the past six months. The Chinese govern-ments ability to influence economic activity should not be underestimated.

Asset allocationSo where does this leave us? We will remain vigilant for any signs that central banks will be forced away from their preferred path of pro-growth policies. But over our tactical six-month investment horizon, we do not currently see economic pressures

> Still, global data outlook gives grounds for optimism that central banks can continue on their current path

FEATURE

Source: UBS, as of 20 May 2015

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World US Eurozone Japan

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Fig. 3: Economic growth should be sufficient for risky assets to performFull-year GDP growth forecasts for 2015, in %

> US GDP is expected to grow by 2.3% this year, against 1.6% in the Eurozone and 0.7% in Japan


emerging that will cause central bankers to deviate. While the threat of deflation has abated, there are no immediate indications that inflation is accelerating too fast. The growth trajectory looks relatively promising in the US, Europe, and Japan, without any immediate signs of overheating.

We therefore remain overweight risky assets, both equities and high yield credit, with our largest overweight position in Eurozone equities. They should continue to benefit from policies of the ECB, which seems to be the central bank most committed to stay-ing the course with its QE program.

To become incrementally more positive on risky assets, we would like to see greater low-inflation growth in the major economies ideally including some combination of a pickup in US consumer spending, a sustained improvement in Eurozone domestic demand, greater global earnings momentum, and a rise in business confidence that translates into stronger capital spending.

In our tactical asset allocation this month, we are initiating an overweight position in the British pound relative to the Australian dollar. We believe the recent strengthening of the British economy and the weakening of commodity-reliant Australia will lead to a divergence in monetary policy. An unwinding of existing carry trades in the AUD has yet to be fully priced into the market. AUDGBP is currently overvalued by 18%, in our view. We also look to take advantage of the most recent backup in rates and pick up some incremental yield by extending out the credit curve and shifting from shorter- to longer duration investment grade corporate bonds.

Elsewhere, we maintain our overweight positions in equities and high yield credit. Global economic growth should remain underpinned by central bank policies that support near-term growth. Eurozone companies in particular are well placed to benefit from a weak euro, low debt-refinancing costs and the regions accelerat-ing economy. Eurozone equities are our most preferred asset class over our six-month investment horizon.

Mark HaefeleGlobal Chief Investment OfficerWealth Management

> We remain overweight risky assets, both equities and high yield credit

> We are adding a tactical overweight position in the British pound relative to the Australian dollar

> Eurozone equities are our most preferred asset class over our tactical investment horizon

FEATURE


IN CONTEXT Perspective from the Regional Chief Investment Officer US

Mike RyanRegional Chief Investment OfficerWealth Management US

Shifting gearsAnyone who has driven a car with a stick shift on the north shore of Long Island understands that careful attention and frequent action are required to deal with the varying weather conditions and topography. Downshifting is necessary to save the brakes on a steep decline, while lower gear operations help navigate snow drifts or Noreasters.

As investors, we are periodically required to do a bit of gear-shifting of our own amid changes across the investment landscape. This month is a good example as we opt to make a number of adjustments to our tactical positioning in light of the following environmental shifts: While much of the economic drag during the first quarter was due to temporary factors, the

economy has still failed to meaningfully break out of the slow-growth channel that has persisted since the recovery began.

The minutes from the last FOMC meeting suggest that while the Fed is edging ever closer to normalization, the path will be a deliberate and cautious one. So although we still view Sep-tember as the most likely date for a rate hike, the Fed could well opt to defer such action until December or even later.

Despite the economic soft patch and temporary earnings stall in 1Q, equity markets have continued to grind higher. While valuations are by no means overextended, the prospects for further re-ratings of equities are now more limited in our view. Further market gains will therefore require a reacceleration in earnings.

After having fallen sharply through the end of the first quarter, crude prices have since re-bounded by nearly 25% thus far in 2Q. We look for energy prices to stabilize further going forward.

Although the recent backup in US rates has been more modest than the abrupt rise in global bond yields, 10-year Treasury rates have still risen by 50 basis points just since the end of January. We now look for yields to remain more range bound for the balance of the year.

Against this backdrop, we recommend that investors make the following tactical shifts to posi-tion portfolios for the second half of the year:

We are reducing our exposure to the consumer discretionary sector, by downgrading the re-tailers to neutral. After having outperformed the S&P 500 by nearly 1,400 basis points since October 2014 due in part to falling gas prices and improving consumer fundamentals performance prospects will likely be more modest since positive earnings revision momentum has stalled and valuations appear stretched.

We are increasing the financial sector to an overweight, by closing our underweight position in real estate investment trusts (REITs) and retaining our overweight to the banks. A more fa-vorable earnings outlook, coupled with the backup in yields, deliberate pace to Fed rate hikes, and recent underperformance of REITs, suggests that the downside risks for this industry group are more limited and a neutral stance is now warranted. With bonds expected to re-main within narrower trading ranges for the rest of the year, we look to take advantage of the recent backup in rates and pick up some incremental yield by extending out the credit curve and shifting from shorter- to longer-duration investment grade corporate bonds.

Finally, we have upgraded our North American energy independence theme to preferred status amid the recent stabilization of energy prices.

Mike Ryan, CFA

> While much of the economic drag during the first quarter was due to temporary fac-tors, the economy has still failed to meaning-fully break out.

PREFERRED INVESTMENT VIEWSAs of 21 May 2015

Asset Class Most preferred Least preferred

Equities US small caps Eurozone The rising Millennials North American energy independence () US capex Cancer therapeutics

Emerging markets UK

Bonds US high yield US investment grade Mortgage interest-only US senior loans Beyond benchmark fixed income

investing

Government bonds

Foreign exchange*

GBP ()

AUD ()

Alternative investments

Cash

Recent upgrades Recent downgrades

*For more information on recent changes, see CIO Note: EURUSD risks now more balanced, 5 May 2015


At a glanceEconomy

Recent data suggest that US economic growth fell into negative territory in the first quarter. While industrial production and retail sales continued to disappoint in April, the crucial labor market remained on an improving path. The Fed is still ex-pected to hike its policy rate toward the end of the year, but the path will likely be less steep than in past cycles. Meanwhile, ECB President Mario Draghi reiterated his commitment to pursue quantitative easing as long as there is no material pickup in investment, consumption and inflation in the Eurozone. In China, the government is pursuing large multi-year infrastructure projects and easing monetary policy in an attempt to stabilize economic growth.

Equities The Eurozone is our most preferred equity market for the next six months. Eurozone companies benefit from a weak euro and low debt refinancing costs. The ECBs large bond-buying program will likely keep both factors in place. Furthermore, domestic earnings are supported by the acceleration of the Eurozones economy. On the other hand, we are holding underweight positions in emerging market and UK equities. In both regions, earnings are still suffering. A relatively strong pound as well as low commodity prices weigh on large parts of the UK stock market. Emerging market companies are still faced with a challeng-ing fundamental backdrop, as growth is decelerating in many emerging economies.

Fixed income The surprisingly strong rise in government bond yields over the past month espe-cially for German Bunds has been supported by technical factors, such as over-extended investor positioning and thin market liquidity. Total returns turned sharply negative, in particular for bonds with long maturities. While we do not ex-pect the sell-off in government bonds to continue at the same pace over the next six months, we are maintaining our preference for corporate bonds. In particular, high yield bonds both in USD and EUR held up well during the recent episode, as falling spreads compensated for part of the rise in government yields. Within in-vestment grade corporate bonds, we recommend avoiding bonds with very long maturities of 15 years or more.

Foreign exchange

While we still expect fundamental factors to support the US dollar and weigh on the euro in the medium term, rising short-term risks made us close our USD over-weight position on 5 May. A remarkable rise in German Bund yields has made the euro slightly more attractive, and a rise in oil prices weighs on the USD at the mar-gin. We are opening an overweight in the British pound against the Australian dol-lar. The GBP should ultimately benefit from rising policy rates. The outcome of Mays general elections has reduced political uncertainty in the UK. The AUD is still overvalue in our view and the Australian economy is facing headwinds from low commodity prices.

MONTH IN REVIEW

Nonfarm payrolls grew by 223,000 in April, broadly in line with con-sensus and an improvement over the weak data from March. Unem-ployment claims over the past four weeks were recorded at a 15-year low. Other US data were mixed, with the April ISM non-manu-facturing index rising to 57.8 and housing starts hitting their highest level since the financial crisis, while retail sales were disappointing. US Treasury bond yields moved higher, although minutes from the latest FOMC meeting suggest that a June rate hike is unlikely. Fed Chair Janet Yellens remarks on high stock valuations sent some waves through the market, but the S&P 500 still reached a record high.

Across the Atlantic, recoveries in the euro and oil prices have caused Eurozone equities to decline from a mid-April peak; however, the earnings outlook remains positive and the ECBs announcement that it would front-load some of its QE bond purchases provided a boost. On 12 May, Greece avoided a de-fault by completing a EUR 750m repayment to the IMF.

Brent crude recently climbed to its highest level of 2015, ending a yearlong price slump, as US rig counts declined further.

Emerging markets continued to generate gain, led by Chinese eq-uities, which have been among the best-performing in the world year-to-date. Emerging bond markets have also performed well despite higher volatility.



Eurozone to grow solidly in 2015Ricardo Garcia, CFA

CIO VIEW Probability: 70%

Solid growth in 2015Despite recent oil price increases and Greek-related risks, economic growth in 2015 is set to be robust. Inflation is expected to move up only slowly to about 1% toward the year-end. The ECBs expansionary policy is expected to support the economic acceleration in 2015.

POSITIVE SCENARIO Probability: 20%Better-than-expected growth and fiscal stabilizationOil prices and the euro decline more than expected, with loan demand and the economy recovering faster than en-visaged. France and Italy follow a credible reform path and speed up fiscal consolidation. Political risks fade further.

NEGATIVE SCENARIO Probability: 10%Deflation spiralThe Eurozone slips into a deflation spiral due to a shock such as Greece leaving the Eurozone, a sharp escalation in the Ukraine conflict, or China suffering a severe eco-nomic downturn.

KEY FINANCIAL MARKET DRIVERS

Global economic outlookBrian Rose, PhD; Ricardo Garcia, CFA; Gary Tsang

Global growth has been somewhat disappointing so far in 2015 despite support from ex-tremely loose monetary policy. In the US, a steep decline in energy-related investment and the stronger USD have weighed on growth. Consumer spending has also fallen short of our ex-pectations. However, the labor market continues to improve and we still believe that the Fed will start raising rates before the end of the year. Among the other big economies, China has been struggling to maintain growth despite fiscal and monetary stimulus, while the Eurozone finally appears to have achieved escape velocity. Inflation remains subdued in most countries. Global growth in 2015 will likely be similar to 2014.

US rebound from a weak start Brian Rose, PhD


Robust expansionWe expect robust US growth for the rest of 2015 after temporary weakness early in the year. Core inflation will likely stay well below the Feds target of 2% over the next six months. We expect the first Fed rate hike later this year and the pace of tightening to be gradual.

POSITIVE SCENARIO Probability: 10%Strong expansion

US real GDP growth accelerates to 4% or more, propelled by an expansive monetary policy, a more rapidly fading fiscal drag, improved business and consumer confidence, strong housing investment, and subsiding risks overseas. The Fed raises policy rates several times in 2015.

NEGATIVE SCENARIO Probability: 20%Growth recession

US growth fails to pick up after the weakness in 1Q15. Consumers save rather than spend the windfall from lower energy prices, while businesses lack enough confidence to hire workers and boost investment spending. The Fed remains on hold throughout 2015.

Moderating Chinese growthGary Tsang


Moderating Chinese growthThe growth momentum has been weak in recent months and the government will likely step up its efforts to sup-port growth. Export growth is expected to improve in the coming quarters, helped by the recovery in the Eurozone and reacceleration of US growth. Intensifying policy sup-port will likely lead to a temporary improvement in eco-nomic growth in 2Q15.

POSITIVE SCENARIO Probability: 10%Growth acceleration

Annual growth accelerates in 2015 as a result of more substantial policy stimulus measures from the government or a strong pickup in external demand.

NEGATIVE SCENARIO Probability: 25%Sharp economic downturn

Annual growth falls by more than one percentage point in 2015 due to a sharp downturn in property investment, more widespread credit events, or tighter liquidity as the government reins in shadow-banking activity.

Real GDP growth in % Inflation in %2014 2015F 2016F 2014 2015F 2016F

US 2.4 2.3 2.8 1.6 0.0 2.5Canada 2.4 2.9 2.8 2.1 2.2 2.0Brazil 0.1 -0.5 1.3 6.4 7.9 5.2Japan 0.0 0.7 1.8 2.8 0.8 0.9Australia 2.7 2.2 2.8 2.5 1.7 2.8China 7.4 6.8 6.5 2.0 1.2 1.6India 7.3 7.5 8.3 5.9 5.3 5.0Eurozone 0.9 1.6 2.0 0.4 0.1 1.5UK 2.6 2.4 2.9 1.5 0.2 1.7Switzerland 2.0 0.5 1.1 0.0 -1.0 0.2Russia 0.6 -4.5 0.0 7.8 15.4 5.6World 3.4 3.3 3.8 3.3 3.0 3.3

GLOBAL GROWTH EXPECTED TO BE 3.3% IN 2015KEY DATES> 1 JUNE 2015 US ISM manufacturing for May The manufacturing index remained unchanged

in April, with some lingering effects from the West Coast port strike. Production and new or-ders improved from March, making the details of the report slightly more favorable for growth. We expect the index to gradually recover in the months ahead.

> 5 JUNE 2015 US labor market report for May Nonfarm payrolls increased by 223,000 jobs in

April, while March was revised lower to 85,000. Overall the labor report was slightly weaker than expected due to the downward revision to March payrolls and soft earnings growth. Payrolls have slowed year-to-date, averaging slightly less than 200,000. We expect payroll growth to remain strong enough for the Fed to raise rates later in the year.

> 11 JUNE 2015 US retail sales for May Overall retail sales were flat month-on-month in

April, due in part to weaker auto sales. At least so far, consumers have saved the windfall from lower energy prices. The improving labor market should support spending in the months ahead.

> 16 JUNE 2015 US housing starts for May Housing starts surged in April, making up for

some of the weather-induced weakness in the first quarter and reaching the highest level in more than seven years. While it is still difficult to judge the underlying trend in housing starts, for the rest of 2015 we expect to see solid gains over 2014 levels.

> 18 JUNE 2015 US CPI for May The core consumer price index (excluding food

and energy) has risen by at least 0.2% every month so far in 2015. Housing rent remains the biggest driver of inflation, while the strong dol-lar is keeping downward pressure on goods prices. Low inflation in the months ahead would make it more difficult for the Fed to start hiking rates.


Source: Reuters EcoWin, IMF, UBS CIO WMR, as of 21 May 2015Note: 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.


Equities

Emerging Markets We are underweight emerging market (EM) equities. The consensus ex-pectation is for EM earnings to grow around 9% over the next 12 months. We are more cautious, however, and expect around 57% growth. We forecast the trailing price-to-earnings (P/E) to will move slightly below its current level of 13.3x. We prefer India, the Philippines and Taiwan to South Korea, Malaysia and Thailand.

MSCI EM (index points, current: 1,036) six-month target

House view 1,060

Positive scenario 1,165 Negative scenario 800

ASSET CLASSES OVERVIEW

Jeremy Zirin, CFA; Brian Nick, CAIA; David Lefkowitz, CFA; Manish Bangard, CFA; Markus Irngartinger, PhD, CFA

Eurozone

We are overweight Eurozone equities. Corporate earnings growth has started to improve, supported by solidly advancing revenues. Positive economic momentum differentiates the Eurozone from other developed as well as emerging markets and should help accelerate earnings growth. In the unlikely event of Greece exiting the euro, we do not anticipate a permanent or a significant drawdown in Eurozone equities. Our most preferred sectors are financials, consumer discretionary and consumer staples.

EURO STOXX (index points, current: 380) six-month target

House view 397

Positive scenario 430 Negative scenario 300

Japan

We are neutral on Japanese equities. We forecast earnings growth of 15% in FY2015 and 4% in FY2016. A lower oil price and corporate tax cut in 2015 should help domestic consumer companies earnings to re-cover as well. The state pension funds increased equity purchases and the BoJs potential further monetary easing should limit the downside risk on Japanese equities. Companies recent move to buy back more shares to increase return on equity should also limit the downside. The Tokyo Stock Exchange plans to implement Japans corporate governance code in June, and we believe this will result in higher share buybacks and ROE. However, the Topix trailing P/E is likely to re-rate from 18.1x currently to 17.2x in the next six months, despite the solid earnings growth in FY2015. Overall, we think the Topix is fairly valued and will move in line with global equity markets over the next six months.

TOPIX (index points, current: 1,643) six-month target

House view 1,675

Positive scenario 1,850 Negative scenario 1,300

UK

We have an underweight stance on UK equities. Earnings dynamics re-main weaker in the UK than in other countries. Lower commodity prices weigh on trailing company earnings and the currency is not a tailwind like in other regions. In the UK market, the energy sector has a 15% weight-ing and the materials sector 8%. Due to its defensive sector stance, the market will likely benefit less from an improving economic outlook in developed markets. Within the UK, our preferred investment strategy is UK value, which tends to outperform in periods of strong economic performance ahead of interest rate rises.

FTSE 100 (index points, current: 7,007) six-month target

House view 7,125

Positive scenario 7,650

Negative scenario 5,700

The Eurozone is our most preferred equity market for the next six months. Eurozone companies benefit from a weak euro and low debt refinancing costs. The ECBs large bond-buying program will likely keep both factors in place. Furthermore, domestic earnings are supported by the acceleration of the Eurozones economy. On the other hand, we are holding underweight posi-tions in emerging market and UK equities. In both regions, earnings are still suffering. A relatively strong pound as well as low commodity prices weigh on large parts of the UK stock market. Emerging market companies are still faced with a challenging fundamental backdrop, as growth is decelerating in many emerging economies.

Global equities



US Equities overview US stocks continued to reach new all-time highs, but do not confuse record highs with market peaks. S&P 500 earnings per share (EPS) are also at all-time highs and continued profit growth can justify further share price gains. While first quarter profit growth was flattish for US large-caps in aggregate, S&P 500 EPS, excluding the energy sector, rose nearly 10% year-on-year. There is no evidence of a broad-based profit slowdown. Small- and mid-cap earnings growth was even stronger in the first quarter. We expect that the drag from lower energy profits and the strong dollar will fade as the year progresses. We forecast 2015 and 2016 S&P 500 EPS of USD 124 (+4%) and USD 138 (+11%) respectively. We roll forward our six month S&P 500 price target to 2,200.

S&P 500 (index points, current: 2,126) six-month target

House view 2,200

Positive scenario 2,450 Negative scenario 1,825

US SectorsThis month, we upgrade financials to a moderate overweight by raising the real estate subsector from underweight to neutral. This leaves us overweight the banks and neutral on each of the other financial sub-sectors (diversified financials, insurance, real estate). The recent rise in bond yields, if sustained, should boost bank profitability. And after un-derperforming the S&P 500 by nearly 15% since late January, we choose to close our underweight allocation to real estate. We also trim our sector overweight in the consumer discretionary sector by downgrading retailers to neutral. Year-to-date, the retail subsector has outperformed the S&P

US stocks are poised for further gains over the next six months, but upside potential appears greater in European equities. US economic indicators have downshifted somewhat recently, likely due to temporary factors such as weaker exports due to a strong dollar, and lower oil and gas drilling activity. These economic headwinds should abate in the second half of the year. Corporate profit growth, excluding the severe slump in the energy sector, has remained resilient and provided market support. Market valuation is fair to somewhat elevated, but stocks remain attractively valued relative to low-yielding bonds. We continue to favor technology stocks, but we trim our overweight in the consumer discretionary sector and upgrade financials to over-weight. Small-caps remain most preferred among US size segments.

US equities

500 by 7% and valuations now appear somewhat stretched. Within consumer discretionary, we favor the consumer durables subsector. Finally, we continue to overweight technology and transportation (within the industrials sector) and underweight utilities, telecom and materials.

US Equities sizeThere has been very little performance differentiation within size segments thus far in 2015. As of 19 May, large-, mid- and small-caps have all gained approximately 4% year-to-date. Smaller companies (both small-caps and mid-caps) outperformed large-caps earlier in the year, likely driven by falling oil prices (small-caps have higher consumer exposure) and a rising dollar (small-caps have lower global exposure). As these trends have reversed over the past few weeks oil prices have rebounded and the dollar rally has faded large-caps have gained ground relative to small- and mid-caps. Looking ahead, we expect stronger profit fundamentals for smaller com-panies to trump currency and oil price fluctuations. Further, we maintain our preference for small-caps.

US Equities styleGrowth stocks have outperformed value stocks year-to-date, but all of the outperformance occurred in the first two months of the year. Since the end of February, these style segments have largely moved together. We currently do not see a compelling investment case to favor either style segment. Growth stocks do appear inexpensive relative to value, but sector influences play a strong role in the relative performance be-tween growth and value. Our upgrade of financials (a value dominated sector) incrementally favors value but this is offset by our tech sector overweight, which favors growth. We remain neutral.

Source: FactSet, UBS, as of 20 May 2015

0

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Fig. 2: Small-cap growth outpacing larger size segments

1Q15 revenue and EPS growth year-on-year, ex-energy, in %

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Source: FactSet, UBS, as of 20 May 2015

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Fig. 1: S&P 500 EPS growth ex-energy remains solid

S&P 500 EPS ex-energy, year-on-year growth, in %


Fixed income


Leslie Falconio; Thomas McLoughlin; Barry McAlinden, CFA; Achim Peijan, PhD, CEFA; Philipp Schoettler; Thomas Wacker, CFA

We prefer developed market investment grade (IG) corporate bonds and high yield (HY) to government bonds, as the yield pickup allows for carry gains. Moderate economic growth and inflation, as well as expansionary monetary policy in the Eurozone and the US, support IG corporate bonds, with the ECBs easing measures lending particular support. HY bonds gen-erally have a lower rate-sensitivity and during the recent rise in benchmark rates, HY held up very well. We expect the nega-tive correlation between rates and HY spreads to continuously support HY returns in times of rising rates. Sentiment toward EM bonds has improved in recent months on the back of a more dovish interpretation of the Fed and stabilizing EM growth expectations. We recommend a neutral allocation to EM sovereign and EM corporate bonds.

Emerging Market Bonds

We recommend a neutral preference for EM sovereign and corporate bonds denominated in USD as the improved sentiment toward EM bonds balances the gradual weakening of corporate and sovereign fundamen-tals. From a valuation perspective, EM bonds are fairly valued relative to fundamentals, in our view. The fragile economic recovery and financial vulnerabilities pose headwinds for corporate issuers. Credit rating down-grades accelerated in recent months and reflect the challenging funding and operating environment. We continue to expect a gradual deteriora-tion of the credit quality, a modest increase of corporate default rates from the currently very low levels.

EMBI / CEMBI SPREAD (Current: 330bps / 315bps) Six-month target

House view 350bps / 350bps

Positive scenario 260bps / 250bps Negative scenario 480bps / 470bps

Government Bonds

We expect the 10-year US Treasury yield to trend moderately higher as the Feds first rate hike in nearly a decade approaches. US rates have been steadily increasing over the past month despite benign payroll data. The rising rates in Europe and an increase in government bond supply have been contributors to the recent yield increases. Rates remain well above the lows seen in January, and our forecast remains for a gradual longer-term rise as we see a reacceleration in 2Q15.

US 10-YEAR YIELD (Current: 2.25%) Six-month target

House view 2.3%

Positive scenario 2.73.1% Negative scenario 1.62.0%

US High Yield Corporate Bonds

High yield (HY) bonds held up well against the rise in benchmark rates over the past month, as tighter spreads compensated for part of the rate rise. We expect the negative correlation of rates and spreads to persist as long as rising rates come along with a strengthening global growth backdrop. We continue to hold a tactical overweight in HY as we expect spreads to tighten further on the back of low default rates and investors continued search for yield. We expect defaults of 3% over the next year, which remains below average. With a total yield-to-worst of 6%, HY offers attractive risk-return prospects, in our view.

USD HY SPREAD (Current: 499bps) Six-month target

House view 400bps

Positive scenario 325bps Negative scenario 900bps

US Investment Grade Corporate Bonds

While credit spreads remained by and large unchanged over the past month, the sharp rise of benchmark yields weighed on investment grade (IG) bond total returns. An influx of supply pressured long-dated IG bonds (30% of the index has a maturity of 10 years or more). We see tightening potential in the long end as supply pressures fade and the Treasury curve flattens. However, our preferred maturity segment lies in IG bonds with medium maturities of 5-10 years. Within financials, we prefer bonds lower in bank and financial issuer capital structures; in non-financials, we favor select issuers that are deleveraging.

US IG SPREAD (Current: 128bps*) Six-month target

House view 115bps

Positive scenario 75bps Negative scenario 250bps*Data based on Barclays Corporate Aggregate Indexes.



Additional US taxable fixed income (TFI) segmentsAgency Bonds

Agency debt spreads continue to trade in a relatively narrow range of incremental spreads versus matched maturity Treasury notes, largely mirroring the movement in the Treasury yield curve (e.g., spreads widen as curves flatten) and market volatility. Thus, despite their respectable total return performance year-to-date, it follows that our forecast for rising rates, flatter curves and more volatility does not augur well for the product. Thus, our recommendation continues to be that investors underweight the market within the context of their US taxable fixed income portfolios.

Current agency benchmark spread of +15bps over 5-year UST (versus +15bps last month)

Mortgage-Backed Securities (MBS)

Mortgage spreads continue to trade in a range-bound manner. Current coupon MBS sits at 100bps versus the 5-year/10-year blend. Year-to-date,

Treasury Inflation-Protected Securities (TIPS)

The TIPS outperformance we witnessed last month has cooled off a bit given the current fixed income market volatility. With oil and gold showing some price increases this past month, TIPS are still on investors radar. However, they have taken a back seat to the next FOMC guidance on the start of the hiking cycle. We maintain negative on the TIPS index due to its long duration and would remain in the shorter 2-year and 5-year areas of the curve.

Current 10-year break-even inflation rate of 1.88% (1.88% last month)

Preferred Securities

Rates and spreads turned abruptly in mid-April, resulting in a marginal loss for the month of -0.1% for the broad BoA Core Plus preferred index. However, spreads have snapped back since early May and with rates stabilizing, the sector has rebounded sharply and is on track to post a slightly positive return for the month. With the yield-to-worst for the index at 5.2% and OAS spreads near the low end of the trailing 24-month range, we consider valuations to be fair. We believe the volatility in recent weeks validates our defensive positioning, as the occasional market spasm could still recur over the next few quarters. Thus, we favor preferreds with fixed-to-floating rate structures that pay back-end spreads and high fixed-rate coupons with near-term call dates.

Current spread of +280bps over 10-year UST (+321bps last month)

Municipal Bonds

Month-to-date, munis (-0.8%) are holding up better than their taxable fixed income counterparts. By comparison, US Treasuries and investment grade corporate bonds are down 1.2% and 1.3%, respectively. We attribute this reversal in muni relative performance in large part to rates. Munis often lag the yield movements occurring in the Treasury bond market. On the credit side, the city of Chicago was downgraded dra-matically in the wake of the Illinois Supreme Courts decision on pension reform. Muni redemptions are set to rise, increasing demand from in-vestors interested in reinvesting in municipals.

Current AAA 10-year muni-to-Treasury yield ratio: 103.1% (last month: 101.5%)

Fig. 2: The shape of the yield curve has shied in thepast month


Spread between the 30-year and 5-year Treasuries in bps

200175150125100

275250225

300

SpreadAverage

May-13 Aug-13 Nov-13 Feb-14 May-14 Aug-14 Nov-14 Feb-15 May-15

Fig. 1: CIO WMR interest rate forecastsIn %

Americas 18 May-15 3 months 6 months 12 months

USD 3M Libor 0.3 0.7 0.9 1.5

USD 2Y Treas. 0.6 0.9 1.1 1.6

USD 5Y Treas. 1.5 1.6 1.8 2.0

USD 10Y Treas. 2.2 2.2 2.3 2.4

USD 30Y Treas. 3.0 2.9 2.9 2.9

Source: Bloomberg, UBS CIO WMR, as of 18 May 2015

spread range has been 90-105bps. Although the carry and liquidity are attractive, the asset class is not cheap at these levels. Hence, we remain neutral on MBS. One factor we continue to watch is the Feds commit-ment to reinvest monthly mortgage payments back into the product. Reinvestments remain today, but probably not by the next summer.

Current MBS spread of 100bps over the blend of 5-year and 10-year Treasuries (versus +101bps last month)

Non-US Developed Fixed Income

Government bond yields reversed course and moved higher in many coun-tries over the past month. Investors began to question the extremely low yield levels and market momentum took over, bringing yields back near where they were at the start of the year. However, the dollar also reversed course, weakening against many other currencies, which helped to boost returns on non-US bonds when measured in dollars. As a result, despite the drop in bond prices, non-US developed fixed income has been one of the best-performing asset classes in dollar terms over the past month. We expect non-US bond yields to stay near current levels over the next six months, but in our view the dollar is likely to strengthen over that time period, hurting returns in US dollar terms.



Commodities

Precious metalsThe latest US labor data suggest that the Fed is likely to raise policy rates in September. With the unemployment rate falling toward 5% and the fixed income market only pricing in a modest increase in short-term interest rates, we expect the gold price to come under renewed downward pres-sure once market expectations shift higher. Soft demand from Asia (China and India) adds to an unfavorable price outlook for gold and silver.

GOLD (Current: USD 1,210/oz) six-month target

House view USD 1,100/oz

Positive scenario USD 1,450/oz Negative scenario USD 900/oz

Crude oil We expected crude oil prices to trough in 2Q15; but so far, it seems Brent found its low in January and WTI in late March. Strong demand from fi-nancial investors via the futures market has played a key role in prices early recovery. Investor interest has been sparked by expectations of a peak in US crude production in late March and the first weekly drop in crude inventories at Cushing/Oklahoma at the end of April. Marginal price support came from a weaker USD in recent weeks. Fundamentally, the crude oil market has yet to rebalance. We think it will be oversupplied by almost 2mbpd in 2Q15, so prices are still vulnerable to setbacks during this period. However, we do expect the market to rebalance steadily in 2H15, with demand seasonally accelerating and non-OPEC supply growth stalling versus 1H15. We therefore expect the Brent crude oil price to trade at USD 65/bbl in six months.

BRENT (Current: USD 65.2/bbl) six-month target

House view USD 65/bbl

Positive scenario USD 8595/bbl Negative scenario USD 3040/bbl

Base metals Base metal prices rallied sharply in April. While we still see further price upside in copper, aluminum and nickel; zinc and lead prices are likely to consolidate. Expectations of additional Chinese stimulus via the fiscal

Commodities Dominic Schnider, CFA, CAIA; Giovanni Staunovo; Thomas Veraguth

April saw a reversal of fortunes for commodity prices. Broadly diversified commodity indices rose around 6%, erasing all the weakness seen in the previous month. However, we believe the price rally is running out of steam, as the strength in energy and some base metal prices does not fully match the fundamental supply-and-demand backdrop we see. This leaves room for temporary price setbacks. Considering the roll-yield cost of 2% over the next six months, we expect the asset class to deliver negative returns in the mid-single digits. As such, we regard broadly diversified commodity investments as unattractive. We see the most downside risk to commodity exposure in precious metals and energy. While the negative expected performance in precious metals is spot driven, high single-digit roll-yield costs should weigh on the energy sector. For base metals, the run-up in prices has reduced the positive expected return to less than 2% over the next six months. The outlook for agricultural prices remains negative in the mid-single digits, driven by grains, whereas prices for softs should be more stable.

and monetary policies fueled the price increase, besides seasonal demand considerations. We believe Chinas efforts aim to stabilize growth, but not to accelerate it. As such, demand-driven expectations for base metals leave room for disappointments at some stage in 3Q15. Our preference for copper and aluminum is due to supply challenges, and production cost considerations for the latter.

AgricultureNorthern hemisphere spring conditions improved over April. EU crop re-ports, the US spring planting pace and US winter wheat crop tours pro-vided plenty of optimism for yields in 2015/16, particularly as wheat prices fell nearly 9% over April. In addition, price weakness followed Russias announcement that it intends to lift early the export duty on wheat, which was introduced in February. While wheat markets look well supplied, renewed warnings that the El Nio phenomenon could strengthen in 2H15 could add to production risks. However, in the near term, accelerat-ing palm oil production and good US spring weather is negative for veg-etable oil and feed grain prices. Soybean plantings in the US are expected to set a new record and the Brazil harvest has been bumpy; hence we see further downside as seasonal impacts start to weigh heavily on prices.

Other asset classes

Listed real estateListed real estate has strongly rebounded from its October 2014 low. After reaching a peak around end-January, the index has traded sideways due to a lack of near-term fundamental improvements and increased volatility in the bond markets. The asset class is currently trading at unattractive high levels and sees easing price momentum. The expected Fed rate hike is not fully priced in, in our view. We see higher price volatility in the coming months and expect total returns to be slightly negative over six months. However, over 12 months, net asset values may grow 9% and dividend yields 3.7%.

FTSE EPRA/NAREIT Developed TR USD (Current: 4,405)

six-month target

House view USD 4,250

Positive scenario USD 4,500 Negative scenario USD 4,100

and other asset classes



USD The US dollar has dropped since March when data started painting an uglier picture of US economic momentum. Keep in mind that this dollar softness comes only after a rapid period of appreciation since early 2014; the USD index (DXY) remains a full 20% stronger than a year ago even after the dollar has come off recent highs. We think the US expansion will pick up again going into the second half of the year and expect the greenback to recover, but not beyond highs seen earlier this year.

EUR The European economy appears to be picking up steam, with the ECBs expansive monetary policy at least partly taking credit. Cheap financing costs and a lower currency have helped European companies. Inflation seems to have found a bottom. We think the risk that the ECB will limit its QE program is small, especially in 2015. Markets seem relieved that the Greek saga is no longer front and center and looks increasingly like a turbulent sideshow; if anything, the EUR could gain in a relief rally once the Greek debt issue has been resolved. We look for the EURUSD to continue to trade in a 1.051.15 range this year.

GBP The GBP has seen a decent rebound thanks to the very clear election outcome in the UK. The alternative election result could have presented persistent political uncertainty. We expect the focus to shift back to the strong UK economic data. Inflation is currently close to zero but is expected to pick up sharply in th coming months. In addition to further strengthen-ing of the labor market, this should eventually lead to rate hikes, which should continue to support the GBP.

JPY The USDJPY has stabilized around 120 in recent months as the Japanese economy has performed better than initially expected, leading many market participants to scale back expectations for further QE from the Bank of Japan. However, as the BoJ is still far away from its 2% inflation target, we believe it is likely to introduce further expansionary policies to eventually lift the USDJPY toward 124.

CHF The Swiss franc seems to have found a new equilibrium against the EUR around 1.04 after the removal of the 1.20 floor. We expect the EURCHF exchange rate to remain around the current level for the next few months. Deeply negative interest rates and lackluster economic activity make Switzerland a relatively unenticing investment opportunity. However, the

franc continues to appeal due to its negative correlation to risk events. Should a disorderly default in Greece or other geopolitical troubles occur, the CHF could appreciate sharply.

Other developed market currencies Commodity-exporter and Scandinavian currencies remain under pres-sure due to low commodity prices, the resulting drag on these econo-mies, and low inflation. The Australian dollar should remain under particular pressure in the coming months as a weak domestic economy, slowing Chinese activity, lower commodity prices and US rate hike expectations all depress the appetite for the AUD as a carry trade. The New Zealand dollar too may fall prey to a reduction in carry trading. The Canadian dollar may be an exception as the Bank of Canada be-comes less dovish and the economy recovers. The Norwegian NOK also has limited upside as oil prices remain low enough to keep the Norges Bank considering cuts. The Swedish SEK has rebounded lately after suffering from the Riksbanks expansionary monetary policy. As we expect the policy to persist, we remain cautious on the SEK.

Foreign exchangeKatie Klingensmith; Thomas Flury

The US dollar has come under pressure as a spate of data suggested that the soft patch in the economy in the first quarter may have been deeper and less ephemeral than expected. However, there are signs of hope, and we expect that the US recovery will justify a Fed hike this year. Over the next six months, we foresee the large and the rising yield differential and political uncertainties in the Eurozone pushing the EURUSD somewhat lower. Financial markets seem increasingly impervious to the ongoing Greek saga, and we expect that even if Greece exits the Eurozone the official response and market readiness will limit but not eliminate contagion. We add an overweight in the British pound, as we think the currency will retain its post-election strength. We finance this with an underweight in the Australian dollar, which is overvalued in our view given a structurally weakening economy.

UBS CIO FX forecasts20-May-15 3M 6M 12M PPP*

EURUSD 1.110 1.05 1.08 1.10 1.28

USDJPY 121.2 124 124 120 76

USDCAD 1.223 1.22 1.18 1.15 1.19

AUDUSD 0.788 0.75 0.70 0.70 0.69

GBPUSD 1.556 1.52 1.56 1.58 1.63

NZDUSD 0.731 0.71 0.70 0.70 0.57

USDCHF 0.939 0.98 0.97 0.95 1.02

EURCHF 1.042 1.03 1.05 1.05 1.30

GBPCHF 1.460 1.49 1.52 1.51 1.66

EURJPY 134.6 130 134 132 97

EURGBP 0.714 0.69 0.69 0.70 0.78

EURSEK 9.279 9.40 9.40 9.20 9.12

EURNOK 8.407 8.30 8.60 8.60 9.68

Source: Thomson Reuters, UBS CIO WMR, as of 20 May 2015Note: Past performance is not an indication of future returns.*PPP = Purchasing Power Parity


Housing starts rebounded strongly in April, rising more than 20% sequentially to a new post-crisis high rate of 1.14 million units (Fig. 1). Some of this strength appears to be making up for starts that were delayed earlier in the year due to bad weather. Although future months are unlikely to see such sequential strength, we do believe the backdrop for housing starts remains biased to the upside, particularly given the strong demand for multifamily units and the gradual return of the entry-level buyer. Based on our projections for population and the number of households, we expect housing starts to eventually reach 1.31.4 million units.

Interest rates have recently moved higher, which would nor-mally be considered negative for housing demand because of the impact on monthly mortgage payments. However, in the short term, rising rates can act as a stimulus, encouraging buy-ers who are on the fence to act before rates go up even fur-ther. From a historical perspective, mortgage rates are low,

and we expect only a gradual rise over the next 12 months. Higher rates should therefore not prevent the housing market from strengthening further. To put mortgage rates in perspec-tive, based on a current median existing home price of USD 213,500 and a down payment of 10%, a 50bps rise in mort-gage rates would add only USD 55 to the monthly pre-tax mortgage payment while a 100bps increase would add around USD 125. We believe these are manageable levels for the median homebuyer given current household income levels.

From the January 2012 low, existing home prices have staged a strong recovery, appreciating more than 38% nationally. In our view, there are two key contributing factors to this strength. The first is the emergence of the institutional buyer of single-family homes. We estimate that over the course of the recovery, institutions purchased more than 550,000 homes, the majority of which were in severely distressed mar-kets. The institutions were instrumental in absorbing dis-tressed inventory and putting price floors in markets that pre-viously were in free fall. This ultimately led to increased market confidence and rising prices. The second factor is the supply-constrained market that continues to persist today.

IN FOCUS

Jon Woloshin, CFACo-Head of US Sector Research CIO Wealth Management Research

US housing market a slow but steady recovery

Source: US Census Bureau, UBS, as of 19 May 2015

600

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Single familyMultifamily

Fig. 1: Housing starts rebounded in April

Housing starts, seasonally adjusted annual rate, in 000s

Brian Rose, PhDUS economistCIO Wealth Management Research


IN FOCUS

Nationally, the supply of available inventory is good for ap-proximately 4.5 months, well below the long-term average of 7.5 months and pre-crash levels of nine months. At some poin, supply will eventually catch up to the rising demand for housing. However, the slow thaw in available inventory is likely to help keep prices rising above long-term averages over the next several years.

Although unemployment is down and jobless claims are at significantly reduced levels, the housing market is challenged by relatively stagnant wage growth. Preceding the housing bubble, there was a strong relationship between home price and wage growth. This relationship clearly splintered during the housing boom only to retrace to historical norms post the bursting of the bubble. However, the solid price recovery be-ginning in 2012 has once again distorted the relationship be-tween prices and wages (Fig. 2). Unless wages break their stagnant trend, affordability could become a bigger issue for housing, particularly if interest rates begin to rise.

Another issue facing housing is the continued decline in homeownership rates (Fig. 3). After retracing the bubble-era rise, homeownership rates have continued to decline, break-ing below the long-term average of just over 65%. We be-lieve there are a number of factors that explain this decline including the demographic forces of the Millennials, the

explosion in student debt, the new conforming mortgage rules which have led to more restrictive mortgage lending, and the need for flexibility in a more globally integrated world. The clear beneficiary of these trends has been the mul-tifamily sector. In our view, the demand for multifamily hous-ing will remain robust owing to a combination of the afore-mentioned factors negatively influencing homeownership rates, as well as the re-urbanization trend that we are wit-nessing with both the Millennial generation and many of the retiring baby boomers who are not yet ready for senior hous-ing and no longer desire the responsibilities of suburban liv-ing. Thus, we believe it is essential that when evaluating the housing market, we consider the market in its totality single-family ownership, single-family rental and multifamily rental as declining rates of homeownership can mask strong trends in overall demand for shelter.

An improving housing market would have a positive impact on the overall health of the economy. For every new single-family house built, it is estimated that four new jobs are cre-ated, and house buyers typically spend thousands of extra dollars in the first year on furnishings, appliances, etc. Rising housing starts would help to use up the remaining slack in the labor market, and would be a signal to the Fed that the economy is strong enough to withstand higher interest rates.

Source: NAR, US Census Bureau, UBS, as of 19 May 2015

Home pricesMedian household income

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Fig. 2: Home prices elevated relative to income

Household income and home prices, index 1990 = 100

Source: US Census Bureau, UBS, as of 19 May 2015

AverageHomeownership Rates

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Fig. 3: Homeownership rates continue falling

In %


We view the current market environ-ment as an opportune time for inves-tors to optimize their liabilities in order to add potential alpha to their balance sheets. The main monetary policy response to the financial crisis of 20072008 was clear and direct in its intention to reduce interest rates. Indeed, the last remaining vestige of the financial crisis can be seen today in the low levels of prevailing rates. Low rates provide an excellent oppor-tunity on the liability side of the bal-ance sheet to lock in low borrowing costs and express views on interest rates and inflation.

Additionally, utilizing low-rate debt while keeping investment assets pro-ductive could significantly impact a households net worth over a longer time horizon. Looking forward, port-folio returns are likely to outpace the current cost of debt which, after years and decades of compounding, could lead to enhanced investment returns.

Investors looking for something outside the US to put into their portfolios might find that Eurozone equities are an at-tractive choice. The Eurozone economy was hit hard by the global financial cri-sis. GDP is still below its pre-crisis peak and corporate earnings are at depressed levels. However, recent data have sur-prised on the upside and we are seeing encouraging signs that the credit crunch that has restrained growth is starting to ease.

Another positive factor is the weak euro which, along with the ECBs QE, will provide a tailwind for the economy and earnings. Given that economic condi-tions in Germany are much stronger than in the rest of the Eurozone, an op-tion to consider is investing in Eurozone equities using a fund that focuses on Germany. The situation in Greece pres-ents a risk for all Eurozone assets, but we believe that the fallout from a Greek default would be limited.

Top themes

u Utilize lending

uMulti-year decade theme

uPortfolio integration

Historically low interest rates create an oppor-tune time for investors to extend the duration of their liabilities and take advantage of low rates.

uFull report

Balance sheet optimization

uEconomic rebound boosting earnings

uMedium-term: 6 to 12 months


Funds tracking the broad Eurozone equity market are available, and Germany-only country funds are an option to consider.

uFull report

European equities: Eurozone comeback

Eurozone comebackBrian Rose, PhD

Highlights from our monthly selection of highest conviction investment themes across the asset class spectrum

Portfolio context

Liability optimizationMichael Crook

Source: Datastream, IBES, UBS, as of 14 May 2015

11

10

9

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2012 2013 2014 2015

Eurozone earnings comeback beginning

12-month trailing Eurozone EPS


10-year TIPS10-year Treasury

6

4

2

0

2

8

10

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

Interest rates continue to decline

Treasury rates, in %

Non-US equity

Context planning


North America continues to make prog-ress in achieving greater energy inde-pendence. We expect more self-suffi-ciency by the end of the decade and that the US will soon be a net exporter of natural gas. Trends such as robust drilling activity for oil and natural gas, infrastructure build-out, and wide-spread availability of reliable and afford-able energy supplies are driving op-portunities for investors.

Technologies for extracting oil and gas are driving improved well productivity and reducing costs. We believe the US competitive landscape favors the stron-ger operators. A potential shakeout among US shale operators could enable the more efficient operators to benefit from industry consolidation and come out even better positioned to capture future growth opportunities.

Meanwhile, we expect energy consum-ers to enjoy the ongoing benefits of lower-cost energy.

Portfolio context

The investment themes highlighted in

this section are among our highest conviction

thematic recommendations. The full list of

most preferred themes (see below) is

discussed in our monthly publication

entitled Top themes. Preferred themes

Adding value(s) to investing: Sustainable investing

Beyond benchmark fixed income investing

Capex rising...finally

Eurozone comeback

Liability optimization

Major advances in cancer therapeutics

MBS IOs Positive returns when rates rise


The rising Millennials

US senior loans

Ask your Financial Advisor for a copy

of this publication.

u Equity growth and income

uMulti-year decade theme


We have identified a list of stocks that are poised to benefit from positive trends related to North Americas burgeoning energy independence.

uFull report


North American energy independence: Reenergized Nicole Decker; David Lefkowitz, CFA

ab

Thematic investment ideas from CIO Wealth Management Research

Top themesReenergizing North American energy independence

June 2015

Highlights from our monthly selection of highest conviction investment themes across the asset class spectrum

Top themes

US crude oil inventory builds are subsiding

Source: Energy Information Administration, UBS, as of 18 May 2015

In millions of barrels

350325300275250

475450425400375

500

10yr range 2013 201510yr average 2014

Mar Jun Sep Dec

US equity


KEY FORECASTS

6-month forecast

Asset class TAA1 Change Benchmark Valuem/m perf.

in %2 House View Positive

scenarioNegative scenario

EQUITIES

USA S&P 500 2126 2.1% 2200 2450 1825

Eurozone Euro Stoxx 380 0.7% 397 430 300

UK FTSE 100 7007 0.2% 7125 7650 5700

Japan Topix 1643 3.4% 1675 1850 1300

Switzerland SMI 9320 0.8% 9500 10170 8000

Emerging Markets MSCI EM 1036 -0.6% 1060 1165 800

BONDS

US Government bonds 10yr yield 2.25% -1.8% 2.3% 2.7-3.1% 1.6-2.0%

US Corporate bonds Spread 128 bps -2.7% 115 bps 75 bps 250 bps

US High yield bonds Spread 449 bps 0.1% 400 bps 325 bps 900 bps

EM Sovereign Spread 330 bps 0.0% 350 bps 260 bps 480 bps

EM Corporate Spread 315 bps -0.6% 350 bps 250 bps 470 bps

OTHER ASSET CLASSES

Commodities DJUBS ER Index 103 1.1% NA NA NA

Listed Real Estate EPRA/NAREIT DTR 4405 -0.4% 4250 4500 4100

CURRENCIES Currency pair

USD NA NA NA NA NA

EUR EURUSD 1.11 2.7% 1.08 1.00 1.15

GBP GBPUSD 1.55 3.8% 1.56 NA NAJPY USDJPY 121 2.1% 124 125 110

CHF USDCHF 0.94 -1.6% 0.97 NA NA

Source: UBS CIO WMR, Bloomberg1 TAA = Tactical asset allocation, 2 Month over month

For more information on recent changes, see CIO Note: EURUSD risks now more balanced, 5 May 2015

Past performance is no indication of future performance. Forecasts are not a reliable indicator of future performance.

Overweight

Neutral

Underweight

KEY FORECASTSAs of 21 May 2015



DETAILED ASSET ALLOCATION

Detailed asset allocation taxable with non-traditional assets

Investor risk profile

Conservative Moderately conservative

Moderate Moderately aggressive

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Cash 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0

Fixed Income 69.0 -1.5 67.5 57.0 -2.0 55.0 46.5 -2.5 44.0 41.0 -2.5 38.5 33.0 -2.5 30.5

US Fixed Income 62.0 +0.5 62.5 51.0 +0.0 51.0 40.5 -0.5 40.0 34.0 -0.5 33.5 26.0 -0.5 25.5

US Govt 7.0 -2.5 4.5 5.5 -3.0 2.5 4.0 -4.0 0.0 3.5 -3.5 0.0 2.0 -2.0 0.0

US Municipal 50.0 -1.0 49.0 39.0 -1.0 38.0 30.0 -0.5 29.5 24.0 -1.0 23.0 17.0 -2.5 14.5

p US IG total market 4.0 +1.5 +1.0 5.5 3.5 +1.5 +1.0 5.0 3.0 +1.5 +1.0 4.5 2.5 +1.5 +1.0 4.0 2.0 +1.5 +1.0 3.5 q US IG 15 years 0.0 +1.0 -1.0 1.0 0.0 +1.0 -1.0 1.0 0.0 +1.0 -1.0 1.0 0.0 +1.0 -1.0 1.0 0.0 +1.0 -1.0 1.0

US HY Corp 1.0 +1.5 2.5 3.0 +1.5 4.5 3.5 +1.5 5.0 4.0 +1.5 5.5 5.0 +1.5 6.5

Intl Fixed Income 7.0 -2.0 5.0 6.0 -2.0 4.0 6.0 -2.0 4.0 7.0 -2.0 5.0 7.0 -2.0 5.0

Intl Developed Markets 6.0 -2.0 4.0 4.0 -2.0 2.0 3.0 -2.0 1.0 3.0 -2.0 1.0 2.0 -2.0 0.0

Emerging Markets 1.0 +0.0 1.0 2.0 +0.0 2.0 3.0 +0.0 3.0 4.0 +0.0 4.0 5.0 +0.0 5.0

Equity 16.0 +1.5 17.5 27.0 +2.0 29.0 34.5 +2.5 37.0 45.0 +2.5 47.5 55.0 +2.5 57.5

US Equity 9.0 +0.5 9.5 15.0 +0.0 15.0 20.0 +0.5 20.5 26.0 +0.5 26.5 31.0 +0.5 31.5

US Large cap Growth 2.5 -0.5 2.0 4.5 -1.0 3.5 6.0 -1.0 5.0 8.0 -1.0 7.0 9.5 -1.0 8.5

US Large cap Value 2.5 -0.5 2.0 4.5 -1.0 3.5 6.0 -1.0 5.0 8.0 -1.0 7.0 9.5 -1.0 8.5

US Mid cap 3.0 +0.0 3.0 4.0 +0.0 4.0 5.0 +0.0 5.0 7.0 +0.0 7.0 8.0 +0.0 8.0

US Small cap 1.0 +1.5 2.5 2.0 +2.0 4.0 3.0 +2.5 5.5 3.0 +2.5 5.5 4.0 +2.5 6.5

International Equity 7.0 +1.0 8.0 12.0 +2.0 14.0 14.5 +2.0 16.5 19.0 +2.0 21.0 24.0 +2.0 26.0

Intl Developed Markets 4.0 +1.5 5.5 7.0 +2.5 9.5 8.5 +3.0 11.5 11.0 +3.0 14.0 14.0 +3.0 17.0

Emerging Markets 3.0 -0.5 2.5 5.0 -0.5 4.5 6.0 -1.0 5.0 8.0 -1.0 7.0 10.0 -1.0 9.0

Commodities 4.0 +0.0 4.0 4.0 +0.0 4.0 4.0 +0.0 4.0 5.0 +0.0 5.0 5.0 +0.0 5.0

Non-traditional 11.0 +0.0 11.0 12.0 +0.0 12.0 15.0 +0.0 15.0 9.0 +0.0 9.0 7.0 +0.0 7.0

Hedge Funds 11.0 +0.0 11.0 12.0 +0.0 12.0 10.0 +0.0 10.0 3.0 +0.0 3.0 0.0 +0.0 0.0

Private Equity 0.0 +0.0 0.0 0.0 +0.0 0.0 5.0 +0.0 5.0 6.0 +0.0 6.0 7.0 +0.0 7.0

Private Real Estate 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0

WMR tactical deviation legend: Overweight Underweight Neutral Change legend: p Upgrade q Downgrade *Refers to moderate-risk profile. 1The current allocation column is the sum of the strategic asset allocation and the tactical deviation column.

Source: UBS CIO WMR and WMA AAC, 21 May 2015. See appendix for information regarding sources of strategic asset allocations and their suitability, investor risk profiles, and the interpretation of the suggested tactical deviations from the strategic asset allocations.



Detailed asset allocationtaxable without non-traditional assets




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Cash 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0

Fixed Income 80.0 -1.5 78.5 66.0 -2.0 64.0 54.5 -2.5 52.0 44.0 -2.5 41.5 33.0 -2.5 30.5

US Fixed Income 72.0 +0.5 72.5 58.0 +0.5 58.5 47.0 -0.5 46.5 36.0 -0.5 35.5 26.0 -0.5 25.5

US Govt 8.0 -2.5 5.5 7.0 -3.0 4.0 5.0 -4.0 1.0 3.0 -3.0 0.0 2.0 -2.0 0.0

US Municipal 58.0 -1.0 57.0 45.0 -1.0 44.0 35.0 -1.0 34.0 26.0 -2.0 24.0 16.0 -2.5 13.5


US HY Corp 2.0 +1.5 3.5 3.0 +1.5 4.5 4.0 +1.5 5.5 5.0 +1.5 6.5 7.0 +1.5 8.5




Equity 16.0 +1.5 17.5 30.0 +2.0 32.0 40.5 +2.5 43.0 51.0 +2.5 53.5 62.0 +2.5 64.5

US Equity 9.0 +0.5 9.5 18.0 +0.0 18.0 23.0 +0.5 23.5 29.0 +0.5 29.5 36.0 +0.5 36.5

US Large cap Growth 3.0 -0.5 2.5 5.0 -1.0 4.0 7.0 -1.0 6.0 9.0 -1.0 8.0 11.0 -1.0 10.0

US Large cap Value 3.0 -0.5 2.5 5.0 -1.0 4.0 7.0 -1.0 6.0 9.0 -1.0 8.0 11.0 -1.0 10.0

US Mid cap 2.0 +0.0 2.0 5.0 +0.0 5.0 6.0 +0.0 6.0 7.0 +0.0 7.0 9.0 +0.0 9.0

US Small cap 1.0 +1.5 2.5 3.0 +2.0 5.0 3.0 +2.5 5.5 4.0 +2.5 6.5 5.0 +2.5 7.5

International Equity 7.0 +1.0 8.0 12.0 +2.0 14.0 17.5 +2.0 19.5 22.0 +2.0 24.0 26.0 +2.0 28.0

Intl Developed Markets 4.0 +1.5 5.5 7.0 +2.5 9.5 10.0 +3.0 13.0 12.5 +3.0 15.5 15.0 +3.0 18.0

Emerging Markets 3.0 -0.5 2.5 5.0 -0.5 4.5 7.5 -1.0 6.5 9.5 -1.0 8.5 11.0 -1.0 10.0

Commodities 4.0 +0.0 4.0 4.0 +0.0 4.0 5.0 +0.0 5.0 5.0 +0.0 5.0 5.0 +0.0 5.0

WMR tactical deviation legend: Overweight Underweight Neutral Change legend: p Upgrade q Downgrade *Refers to moderate-risk profile. 1The current allocation column is the sum of the strategic asset allocation and the tactical deviation column.




Detailed asset allocation non-taxable with non-traditional assets





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Cash 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0

Fixed Income 68.0 -1.5 66.5 56.0 -2.0 54.0 46.5 -2.5 44.0 39.0 -2.5 36.5 33.0 -2.5 30.5

US Fixed Income 60.0 +0.5 60.5 49.0 +0.0 49.0 40.0 -0.5 39.5 32.5 -0.5 32.0 26.0 -0.5 25.5

US Govt 47.0 -4.0 43.0 36.0 -5.5 30.5 28.0 -7.0 21.0 19.5 -7.0 12.5 13.0 -7.0 6.0

US Municipal 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0 0.0 +0.0 0.0


US HY Corp 4.0 +1.5 5.5 6.0 +2.0 8.0 7.0 +2.5 9.5 9.0 +2.5 11.5 11.0 +2.5 13.5




Equity 17.0 +1.5 18.5 28.0 +

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