UBS expands risk appetite

Despite a broad rebound in markets during 2010, UBS has opted to extend its preference for risk assets by shifting back to an overweight in equities and retaining an overweight in credit within fixed income. The sharp run-up in equity markets, concerns over European sovereign debt and uncertainties associated with a new Congress could prompt a temporary pullback in the new year, but this could present an opportunity to add to positions given the more constructive intermediate-term outlook.

The economic recovery process is expected to remain on schedule in the year ahead, as lingering cyclical chal­lenges continue to give way to a more sustainable expan­sion. Progress will still be uneven, however, as strong de­mand drivers translate into above-trend growth within the emerging markets while ongoing balance sheet re­pair dampens growth prospects in the developed world.

This slow but steady improvement in the macro-economic backdrop is still likely to be greeted with relief and cautious optimism on the part of investors. As the economy progresses from the initial fragile phase of the rebound to the more stable stage of the expansion, risk assets are likely to outperform.

The economic growth prospects between the developed and developing world remain uneven in the aftermath of the global financial crisis and associated recession. However, the recovery in the U.S. appears to have progressed into a more durable expan­sion.

De-leveraging in the consumer sector has paused for now with the savings rate leveling out at just below the 6% mark. Meanwhile, employment pros­pects show some signs of improvement amid an easing of credit conditions and some increased visibility on the regulatory and tax fronts. The extraordinary policy measures put in place by the Fed – including an expanded commitment to quanti­tative easing – will also serve to support growth.

Still, it’s important to keep in mind that this recovery has come with a price tag. In a number of developed countries, the government debt-to-GDP ratio has risen to levels that pose serious threats to sovereign credit ratings and thus, fiscal belt-tightening is now in order.

Neither the economic outlook nor the return prospects within financial markets are without risk. So spots in the expansion and pullbacks in equity and credit markets are expected along the way. While many factors may have an impact on both growth and market returns, UBS sees the continuing Eurozone debt crisis and tighter monetary policy in the emerging markets as the the most serious challenges.

While UBS is overweighting equities, it admits there is room for a pullback early in the year following the sharp run-up in equities since early November. It has introduced a new feature to its tactical asset allocation guidance that is referred to as a “short-term bias indicator.” It offers shorter-term perspective for those looking to better time market entry and exit points. At present, the short-term indicator is “mixed”, which suggests there is a risk of a 5-10% pull­back in stocks early in 2011.

Over the next 12 months, new and unforeseen threats will likely emerge – but so too will opportunities. UBS stands ready to make tactical ad­justments to forecasts, projections or asset class weightings as they become necessary due to changing fundamentals, shifts in policy stance or significant repric­ing within markets. While both the economy and financial markets appear to be on smooth roads, some potholes and even an occasional detour are certain to lie ahead.

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.