UBS says equities keep potential over the medium term

Share prices around the world corrected sharply at the end of February, with the World Index tumbling more than 5% in just a few days. Not only equities but other higher-risk asset classes also came under pressure. For example, yields on high-yield bonds moved higher, causing prices to drop more than 1%. The carry trades also came under pressure. These are trades in which investors borrow money in low-interest markets (such as JPY or CHF), which they then invest at higher interest rates in currencies such as the AUD. Such strategies fail if there is a strong appreciation in the currency in which the money was borrowed. The JPY rose more than 6% against the AUD in the space of a week, for example.

After a consolidation phase, uncertainty has once again taken hold in the past few days and the markets have come under renewed pressure. Talk of a recession in the United States, possibly triggered by the problems in the US mortgage sector, has exacerbated investor nervousness.

As long as this uncertainty persists, analysts at UBS expect sharp movements on the stock markets in the coming weeks. The risks on the stock market are therefore likely to remain high over the short term. Over a longer-term investment horizon, however, UBS analysts think the stock markets have upside potential and that a recovery will take hold over the course of the year.

Equities should therefore be able to generate sufficient excess returns vs bonds over a longer-term investment horizon to compensate for the increased risk. This assessment is based on the fact that the global equity market as a whole is attractively valued, which holds true even under the assumption that earnings momentum will be rather weak in the coming years.

On the other hand, UBS analysts expect the current uncertainty regarding the US economy and the financial system to abate somewhat over the year as a whole. Although

UBS anticipate below-average economic growth in the United States in the current year, they do not expect a slide into recession.

Meanwhile, other economic regions with better momentum look ready to step into the breach. In the US mortgage segment, the focus is currently on filtering out the good loans from the bad. Subprime lenders – i.e. those who have granted mortgages in the past without sufficient quality standards – are coming under pressure. However, these problems should remain restricted to the mortgage segments, without having a decisive influence on the growth risks for the economy as a whole. On the basis of this analysis of the situation, UBS analysts remain invested in stocks.