Equity and commodity markets took a leap higher into the New Year as economic sentiment improved further. While lingering debt issues in many major economies still hold potential to create a bumpy ride for investors, the direction for markets is expected to be up.

Mark Andersen, Strategist, UBS AG

Many major equity markets have reached highs not seen since before the breakout of the financial crisis in 2008. While spiraling government debt levels for developed economies put a question mark on the sustainability of this recovery and certainly for any investment into government bonds, many companies have benefited from the crisis with record earnings levels. A high unemployment rate keeps labor costs low while financing rates are kept down in an ultra-low interest rate environment. On the side of revenue demand is resurfacing in the developed world and the emerging world with China in front looks as virile as ever. The recently started end-2010 corporate earnings season is proof of the corporate world's good fortune; we are looking for another set of positive surprises.

US equities supported by government spending

US policymakers' support for the economic recovery lends buoyancy. The government's decision to extend current tax rates and add further stimulus has exceeded our expectations and caused us to increase our expectations for the economic outlook 2011. In particular personal consumption is set for a boost in the first half of 2011. While an improved US economic outlook raises appeal for global risky assets such as equities, commodities and real estate, we find that US companies could benefit the most. The flipside to this policy-induced upswing is that the US remains far from tackling its deficit problem, leaving the sustainability of the expansion questionable. Therefore we continue to advise reduced exposure to government debt held by strongly indebted nations such as the US.

Inflationary concerns hitting emerging markets

Rising inflation fueled by strong economic activity and increasing food and energy prices currently troubles many emerging countries, particularly in Asia. Policymakers there have initiated measures to fight rising inflation rates and are likely to pursue this path in months to come. While this poses a risk to investor sentiment toward the region in the short term, we believe it ultimately leads emerging Asia to a sustainable growth path.

A good outlook for the materials sector

One beneficiary of an improving economic sentiment and rising commodity prices is the materials sector, where earnings growth is likely to exceed 30% for 2011. The sector is in particular helped by continued strong demand for the underlying commodities from emerging markets and often a limited supply. During an economic upswing, the more cyclically related sectors in the economy such as Materials and Industrials usually benefit from strongly rising earnings leading to solid performance as well. However, during 2010 the materials sector has lagged the performance of other cyclical sectors, leaving valuation at still attractive levels.