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UBS Wealth Management Research Study: "UBS global outlook" 2008

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Amid choppy financial market conditions and slower economic growth, equities are poised to outperform during 2008

  • Equity markets are poised to outperform during 2008 as economic growth concerns recede. The area with the best potential is large-cap developed equities.

  • Bonds will likely struggle to outperform money markets during 2008, amid higher inflation expectations and deterioration in credit market fundamentals.

  • Slower growth will continue to pressure listed real estate in the US and Europe, and certain commodity prices may experience temporary weakness.

  • Asian currencies will likely appreciate, while euro strength may recede.

A slower economic growth environment during 2008 will likely yield greater investment risks and more moderate returns in many asset classes next year, according to a new report from UBS Wealth Management Research. In its global outlook for 2008, UBS writes that equities are well positioned to outperform both bonds and certain nontraditional assets. In particular, the report identifies large-cap developed equities as being well positioned to benefit from an environment of heightened financial market volatility and slower economic growth. The outlook report also notes that commodities and real estate assets appear vulnerable, as demand may weaken along with slowing economic conditions. Meanwhile, various emerging equity markets appear to be expensive, despite the expected above-trend economic growth prospects in these countries.

Slower economic growth with contained inflation
The depressed housing market in the US and its spillover into the financial and consumer sectors will likely continue to weigh on overall growth in the coming year. According to the report, the US will likely experience a protracted phase of below-trend growth, but an outright recession is avoidable. Although economic activity throughout much of the rest of the world is in better shape, global growth has likely peaked and will be less swift next year. A large liquidity overhang and high commodity prices should only lead to inflation concerns in late 2008 or 2009.

Large-cap global equities expected to outperform
Wealth Management Research expects global equities to perform well during 2008, despite the strong returns of the past five years. Current market multiples sharply contrast with the large overvaluations in the late 1990s, which eventually led to the last bear market in equities. Although equities may struggle early in 2008, the environment will likely improve once growth worries recede. During 2008 as a whole, equities will likely outperform cash by a margin sufficient to compensate for the risk. Large-cap developed market equities started to outperform small-cap stocks in 2007 and Wealth Management Research expects this to continue in 2008.

A difficult year ahead for bonds
Bonds may find support in early 2008, with disappointing macroeconomic news out of the US and other economies. However, an economic recovery in the US later in the year and a pickup in inflation expectations as a consequence of the US Federal Reserve's easing stance, will likely place upward pressure on bond yields. Thus, over the whole of 2008, government bonds are likely to deliver sub-par returns. Although last summer's credit market downturn has brought corporate bonds back closer to fair value, deteriorating credit fundamentals limit the potential for corporate bonds to outperform government bonds.

Increased risk in real estate and commodities
Although listed real estate markets underperformed for the first time in many years, commodities moved to record highs. Low bond yields may provide some short-term relief to listed real estate. However, expensive valuation levels, tightening lending conditions, and lower income growth are likely to dominate next year, limiting return prospects for listed real estate in the US and Europe. For commodities, the longer-term interaction between supply and demand should remain supportive of prices. However, Wealth Management Research expects short-term corrections in some key commodity markets in the wake of slowing economic growth and elevated prices.

Asian currencies to appreciate, while euro strength to recede
As for the view on currencies for the next 12 months, the Swiss franc will likely take support from the country's robust economic outlook and low unemployment rate. Increasing pressure will likely mount on central banks to loosen managed currency links to the US dollar. As a result, Wealth Management Research expects Asian currencies to appreciate and extreme euro strength to recede. The research team also forecasts a weakening in the British pound, which stems from its outlook for a sharp deterioration in UK economic performance and significant monetary easing on the part of the Bank of England. Lastly, a decline in commodity prices will likely weigh on the currencies of commodity exporters, such as the Canadian dollar and Australian dollar.

Polly Leung
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