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UBS House View Investment Strategy Guide Chief Investment Office February 2021 Global Wealth Management US Edition

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UBS House View Investment Strategy Guide Chief Investment Office February 2021 Global Wealth Management US Edition UBS House View Investment Strategy Guide Chief Investment Office February 2021 Global Wealth Management US edition Sparkles and bubbles a b Dear reader, Buoyed by a December rally, the S&P 500 managed to close out 2020 with a gain of more than 16%. The surge in stocks has sparked fears that markets have gone too far, too fast. Although some elements of the market bear the hallmarks of a frothy Solita Marcelli environment, we believe that these excesses are mostly limited to select areas. Chief Investment Officer Americas, In our Feature article, we investigate the conditions that led to previous bubbles, such Global Wealth Management as cheap financing, easy access to investments, the incentive to engage in speculative activity, and a technological or political “spark.” Some of these elements do exist Follow me on LinkedIn today, but although we see pockets of speculation, the broader equity market is not in linkedin.com/solita-marcelli-ubs a bubble, in our view. We believe the equity market overall still looks appealing relative to bonds. In this month’s Asset allocation implementation section, we walk through our positive outlook on risk assets, which are supported by an improving economic recovery and accommodative policy. With COVID-19 vaccinations expected to be well underway by late 2Q, we expect economic activity to normalize by roughly the middle of the year. We keep equity and credit as the most preferred asset classes, being that equity provides good upside in the economic recovery and credit should hold steady in the new year. We prefer higher beta asset classes, such as small- and mid-caps, which typically outperform early in periods of expansion. In the Thematic Spotlight, we discuss how the events in 2020 will create long-lasting effects and investment implications in the decade ahead. The “Blue Sweep” election outcome—as well as the acceleration of technology integration stemming from the pandemic—have paved the way for sustainability and digitalization transformation to further disrupt industries in the decade ahead. We hope you enjoy this edition of the House View. Regards, Monthly House View client call: Solita Marcelli 4 February 2021 1:00 PM ET This month‘s conversation will be available through ubs.com/ciolive. This report has been prepared by UBS AG, UBS Switzerland AG, UBS AG Singapore Branch, UBS AG Hong Kong Branch and UBS Financial Services Inc. Please see important disclaimers and disclosures at the end of this document. CIO Preferences Least Neutral Most preferred preferred Also in this report Cash 04 Feature Fixed Income 16 Asset allocation implementation US Gov't FI TIPS 18 Bull Market Monitor US Municipal 19 Questions we‘re tracking US IG Corp FI 20 Top themes US HY Corp FI 22 Global outlook EM Hard Currency FI 29 Key forecasts EM Local Currency FI Equity Global Equity US Large Cap Growth US Large Cap Value US Mid Cap US Small Cap Int'l Developed Markets Emerging Markets Note: Our preferences represent the longer-term allocation of assets that is deemed suitable for a particular investor and were developed and approved by the Global Wealth Management Americas Asset Allocation Committee. Our preferences are provided for illustrative purposes only and will differ among investors according to their individual circumstances, risk tolerance, return objectives and time horizon. Therefore, our preferences in this publication may not be suitable for all investors or investment goals and should not be used as the sole basis of any investment decision. Minimum net worth requirements may apply to allocations to non-traditional assets. As always, please consult your UBS Financial Advisor to see how our preferences should be applied or modified according to your individual profile and investment goals. February 2021 UBS House View 3 FEATURE Sparkles and bubbles Equity excess? Bond bubble? Irrational exuberance? Asset allocation Some elements of the cur- By some measures, bond The cryptocurrency markets We retain a pro-risk stance. rent rally are consistent with markets can be described as are exhibiting signs of exces- We move our preference for bubbles according to our a bubble. But central banks sive speculation and the IPO/ UK equities back to neutral framework. We see pock- have almost unlimited capac- SPAC markets are the hottest after their recent good perfor- ets of speculation, but the ity to maintain their policies. in two decades. But these mance and shift focus toward broader equity market is not markets do not yet pose emerging market stocks. in a bubble, in our view. a broader systemic risk. I have some gray hairs. I am glad there are people in this world who lovingly call them “sparkles.” If you have sparkles, too, then you have also lived through some market bubbles. The experience that brought about those sparkles has taught me that market environments that feature cheap financing, easy access to investments, the incentive to engage in speculative activity, and a technological or political “spark” tend to lead to bubbles. These conditions exist today. Bond prices are so elevated that a quarter of all global bonds are trading with nega- tive interest rates. Tesla now has a market cap bigger than all major listed auto makers Mark Haefele in Europe, Japan, and the US combined. The US IPO market is the hottest in more Global Chief Investment Officer than two decades, with first-day performance averaging 40%. Tapping into investor Wealth Management demand for new listings, special-purpose acquisition companies (SPACs) raised more than USD 70bn in 2020, more than the entire prior decade combined. Bitcoin almost Follow me on LinkedIn quadrupled in just three months. linkedin.com/in/markhaefele Follow me on Twitter Last year, we noted that ultra-low interest rates and government stimulus would push twitter.com/UBS_CIO investors toward accepting the idea that “There Is No Alternative” to equities. This idea is now more widely accepted, and is leading to individual speculative bubbles. But with new fiscal stimulus being added to already accommodative monetary policy, we think the equity market overall still looks appealing relative to bonds. We therefore retain a pro-risk stance. That said, we focus equity exposure away from some of 2020’s winners (particularly US mega-caps), and toward lesser-valued emerging market stocks. We also move our preference for UK equities back to neutral after their good recent performance. Within fixed income, in the context of continued low yields, we like hard-currency emerging market sovereign bonds and, for investors based outside the US, Asia high yield credit. For long-term growth, we continue to see the best current opportunities in a diversified exposure to companies positioned in 5G, fintech, greentech, healthtech, and within private markets. My sparkles also taught me that trees don’t grow to the sky, and in the months ahead we will need to pay particular attention to risks of a monetary policy reversal, rising equity valuations, and the rate of the post-pandemic recovery. 4 UBS House View February 2021 FEATURE In the remainder of this letter, we address some of the key questions we have been asked about bubbles in today’s markets. Only one year ago, when markets were start- ing to crash, investors faced a seemingly different set of challenges than today. Yet by dealing with their emotions, diversifying, and keeping a watchful eye, investors can successfully protect and grow their wealth. Where do you see bubbles today? The presence of sufficient oxygen, heat, and fuel—the “fire triangle”—combined with a spark, will trigger a fire. InBoom and Bust: A Global History of Financial Bubbles, authors Wil- liam Quinn and John D. Turner argue that a similar principle applies to financial markets. Suffi- cient marketability, access to credit, and willingness to engage in speculative activity, combined with technological or political “sparks,” are preconditions that tend to trigger market bubbles. Today, all of the preconditions for Today, all of the bubble preconditions are in place. Financing costs are at record lows, bubbles to emerge are in place. new participants are being drawn into markets, and the combination of high accumu- lated savings and low prospective returns on traditional assets create both the means and the desire to engage in speculative activity. At the same time, accelerated digitaliza- tion has generated a compelling narrative about technological change, while elevated debt levels create the political imperative to support asset markets. Equities Government bonds Cryptocurrencies IPOs and SPACs Are prices high Yes. Equity valuations Yes. Financial repression Yes. Traditional metrics Yes. in terms of the size of relative to traditional are high based on has pushed bond prices are not applicable, but a first-day IPO price rises and measures? P/E ratios. above fair value implied fourfold increase in three the amount of capital raised by expected growth months looks excessive. by SPACs. and inflation. Are prices discounting future No. Valuations can be No. Few investors, includ- Yes. Speculation appears to Yes. First-day IPO rapid price appreciation? justified in the context ing central banks, own be playing an important performance is the highest in of bond yields. Long-term government bonds in role in rising prices. around two decades. return expectations the expectation of rising are low. prices. Are purchases No. Margin lending is Yes. Central bank balance No. High levels of volatility No. IPOs are generally not being financed by currently lower than sheets grew by USD 8 tril- mean leverage is difficult to funded by leverage. high leverage? historical norms. lion in 2020. employ. Are buyers or Yes. Call option volumes Yes. Central banks have Yes. The entire market is an Yes. SPACs are an effective companies making are elevated.
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