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  a b Weekly  23 October 2017 UBS House View United States CIO Americas, WM This report has been prepared by UBS Financial Services Inc. and UBS Switzerland AG. Please see important disclosures and disclaimer on  the last  page. Key messages Investor spotlight u  Flows out, Abe in. The past week saw Japanese equity funds suffering record outflows reflecting investor uncertainty ahead of Shinzo Abe’s victory on 22 October. u  Robots managing portfolios? The first ETF in which robots will select stocks launched last week, amid tech funds seeing their largest inflows in 38 weeks. Week ahead u  How will the ECB handle tapering? The Euro-pean Central Bank is expected to outline its plan to reduce the pace of its bond purchases this week. We believe President Mario Draghi will sig-nal a reduction in monthly purchases to EUR 30bn from next January to September, from EUR 60bn at present. This move is now widely priced into markets so we don’t expect a further boost to the euro, which is already up around 12.5% year-to-date versus the US dollar. Our six-month forecast for EURUSD is 1.18. u  Can the US economy keep up the momen-tum? The week ends with a ra of data releases from the US, including third quarter GDP growth, personal consumption, consumer condence, and the personal consumption expenditure gauge – the Fed’s favorite measure of ination. We expect this data to conrm that US growth remains robust. We stay overweight global equities. u  Will the US earnings season live up to expec-tations? More than 200 of the MSCI US rms release third quarter results this week. Overall, we forecast earnings per share to climb around 5–6%. But this is depressed by around 2–3 per-centage points by storm costs. That said, underly- ing prot growth looks set to remain strong. If the week’s results come in line with expectations, this would support our global equity overweight position. Market moves Level1-w chgYTD chg S&P 5002,5750.86%16.28%DJIA 23,3292.00%19.45%Nasdaq6,6290.35%23.81%Nikkei 22521,4581.43%12.26%Eurostoxx 503,6050.01%9.56%MSCI EM*1,117–0.42%29.53%MSCI World*2,0330.48%16.11%MSCI EAFE*2,0060.52%19.12%DXY940.66%–8.32%Gold$ 1,281/oz–1.74%11.65%Brent crude oil$ 57.8/bbl1.15%1.78%US 10-year yield2.381% 11bps–6bpsVIX9.970.36pts–4.1pts Source: Bloomberg, as of 20 October 2017, EST 4:30 pm.Note: All returns are in local currency* As of 19 October 2017 u  1. Trying to time the market can backfire. This October marks the 30-year anniversary of Black Monday, when the S&P 500 dropped 20% in a single day. While many investors view this event as a warning of how risky and unpredictable markets can be, we believe the main lesson is that attempts to time the market usually fail. Even if an investor had predicted the crash, selling any more than 20 months early would have been worse than staying invested. And it took just 12 months after the crash for the index to recover the lost ground. A longer historical perspective underlines this point. Since 1936 an investor with good market timing – able to sell 10 months before a market peak and buy back 10 months after a trough – would still have ended up worse off (by 19%) relative to a buy-and-hold investor. Takeaway: We believe global equities can continue to grind higher, and investors should avoid trying to time markets. u  2. Brighter times for active management?  Results from Blackrock, the world’s largest asset manager, showed continued strong inflows into passively managed funds. In the industry as a whole, the share of equity mutual funds and ETFs that are passively managed has climbed from 22% to 46% over the past decade, no doubt helped by 93% of S&P 500-benchmarked fund managers failing to beat the market between 2013 and 2016. However, the outlook for active managers could be improving. The potential for alpha is increasing, helped by falling correlations and high valuation dispersion. Active managers are starting to outperform: US equity mutual funds have outperformed by 1 percentage point year-to-date. And investors are just starting to respond: last week saw active managers earn their first inflow in 11 weeks. Takeaway: We could be entering an environment more favorable to active management. u  3. Value in China’s new economy stocks after the Party Congress. A week of contrasts in China. Xi Jinping’s Party Congress speech emphasized that stability remains a key priority. Yet central bank governor Zhou warned that the country needs to defend against the risk of a “Minsky Moment,” against a backdrop of debt-to-GDP rising from around 150% in 2008 to over 260% today. His comments helped send the Hang Seng down 1.9%. We believe China will need to deleverage and rebalance its economy, and in this context we continue to like asset-light new economy stocks, which account for a growing share of China’s expanding service sector, now already near 55% of GDP. Takeaway: We favor new economy stocks within the Chinese market, with a focus on ecommerce, healthcare, financials/insurance. We welcome your feedback. For more key messages on the week ahead from Justin Waring, click here.  2 UBS House View  Weekly — 23 October 2017 Bottom line For more than 10 years, passive investing has gained equity market share at the expense of actively managed funds. In equity markets driven by swings from risk-on to risk-o, active managers have struggled to outperform and only a small proportion have beaten their benchmarks. But now, low correlations, wide valuation dispersion, and monetary tightening suggest active managers may start to outperform.  Deeper dive Is active investing ready for a comeback? For more than a decade, money has owed out of actively managed funds into passive ones. Active US equity funds’ last calendar year of net inows was 2005. In contrast, ETFs are growing rapidly; in the rst nine months of 2017, assets invested in global ETFs rose by almost 25% to reach a new high of USD 4.3 trillion. Equity ETFs have led the rise; they account for three quarters of the total, and passive funds are the vast majority. The proportion of equity ETF and mutual fund assets that are passively managed has also grown signicantly, as well as in absolute terms; rising to 46% from 22% in the US, and to 35% from 11% in Europe, since 2007. The ETF market is now more than USD 1trn larger than the entire hedge fund industry, and over 10% of the global equity market cap is now managed passively.Investor preference for passive funds has been supported by lower costs and “risk-on, risk-o” equity markets, which made it difcult for active managers to outperform. Be -tween 2013 and 2016, more than 93% of fund managers benchmarked against the S&P 500 failed to beat the market. Over a longer time period, active managers have still strug-gled. Less than 15% of US stock fund managers managed to beat their benchmarks over the past 15 years.But while growth in passive investing in recent years is understandable, there are reasons why some active manage-ment strategies could outperform indexes in the future:1. Falling correlations should help managers generate alpha. Earlier this month, one-month implied correlation between the S&P 500’s top 50 stocks fell to a record low of 9.2%, compared with a 20-year average of 44%. From 2000–2016, equity long-short strategies generated aver-age annual alpha of 6.5% or more when correlation was lower than the median. 2. While S&P 500 stock price dispersion has yet to rise much, the dispersion in valuation between the cheap-est and most expensive stocks is very wide (at the 80th percentile of the range since 1991). This suggests price dispersion could rise a lot if investor focus shis to valua -tions – creating an attractive environment for long-short managers.3. As normalizing interest rates replace loose monetary policy, active managers could see trading opportunities. Hedge funds typically outperform other asset classes when rates are rising. In the US, during the past three rate hiking cycles over the last 20 years, equity long-short hedge funds produced annualized total returns close to 14%, compared with slightly less than 8% for the S&P 500. These dynamics are already having an eect. Returns to active management appear to be picking up. In 1H 2017, 54% of US active managers surpassed their benchmarks. As of end-September, global equity long-short hedge funds have gained 9.6% year-to-date, their best performance since 2013. If correlations stay low and price dispersion increases, this trend could prove durable. Mark Haefele Global Chief Investment Ofcer WM Mark Haefele  3 UBS House View  Weekly — 23 October 2017 Top of the Morning daily podcast “Week in Review/Preview” with Jason Draho, Head of Tactical Asset Allocation Americas www.ubs.com/topohemorning Regional view The year of the cryptocurrency This year we have seen an explosion of investor interest in cryptocurrencies and their underlying technology – blockchain. This can be seen, at least in part, from Bitcoin’s 580% surge in value against the US dollar since the start of the year. These emergent technologies may, in the future, be applicable to a wide variety of industries. We believe blockchain could dramatically reduce the costs and im- prove the efciency of transactions, trad -ing and settlement, and general record management, to name a few examples. Although these kinds of applications are in their infancy, expectation has fueled the rapid appreciation in some cryptocur-rencies’ value. Anything but boring Bitcoin, for example, has enjoyed an outsized return on investment this year. However, this has not happened without signicant volatility. In mid-March, Bitcoin lost over 30% of its value when the Se-curities and Exchange Commission (SEC) denied approval of a proposed Bitcoin exchange-traded fund. Bitcoin dropped again in September – this time by over 25% – aer regulators in China banned all cryptocurrency exchanges and trading by Chinese citizens. It may be in a bubble We caution that some cryptocurrencies may be displaying characteristics similar to past bubbles, such as investor exu-berance and aggressive value apprecia-tion over a short time. In a September interview, Nobel laureate Robert Shiller, author of Irrational Exuberance, pointed to Bitcoin as “the best example” of a cur-rent market bubble. Mr. Shiller famously warned about market excesses ahead of the dotcom and housing bubbles. Bubbles normally occur when the price of an asset deviates from its fundamen-tally-based value. However, prices move much more quickly than fundamentals, which can oen result in a signicant disconnect. The “fair value” of crypto-currencies is highly uncertain, given the emergent nature of blockchain technolo-gy, and with thousands of competing ver-sions it is unclear which will end up being successful. Further, fundamentally-based models are not always accurate and may not explain market pricing. With crypto-currencies, the fundamental value can be difcult to assess, therefore making it even more challenging to determine if the market price is reasonable. Blockchain applications We do believe that blockchain has ex-citing potential. Its decentralized nature could facilitate greater transparency and eliminate the need for trusted third par-ties. This is because, with blockchain, all transactions are automatically reconciled. We estimate that blockchain could add as much as USD 300–400bn of global economic value by 2027. Further, we believe blockchain as a technology can gain widespread adoption even without cryptocurrency. Outlook and implications Going forward, we believe regulatory action will be important. So far, the SEC and the Commodities Futures Trading Commission (CFTC) have maintained a “light touch” in an attempt to not stie innovation. However, if cryptocurrencies become further entwined with nancial markets, regulators will likely revise their approach. We believe investors should remain cautious in the short term and fully un-derstand the risks before investing in any cryptocurrency or blockchain technology. For more commentary on cryptocur-rencies and blockchain, see our latest publication Beneath the bubble.Kind regards, Matthew DeMichiel and  Kevin Dennean Kevin Dennean, CFA  Technology and Telecom Equity Sector Strategist Americas Matthew DeMichiel Thematic Strategist Bubbles normally occur when the price of an asset deviates from its fundamentally-based value.  4 UBS House View  Weekly — 23 October 2017 Strategy and performance TAA and market returns: Cross asset and equities MTDYTD2016 1.8819.457.860.296.552.09NANANA Notes These tables represent the tactical asset allocation for a moderate, taxable investor without alternative investments.See the latest UBS House View: Investment Strategy Guide  for an interpretation of the tactical deviations and an explanation of the corresponding benchmark allocation. Tactical time horizon is approximately six months. Total return market performance is from Bloomberg as of close of business on source date, using representative indices, and is provided for information only. +–Indicates +/– change Terms and abbreviations EMU = European Monetary Union and is comprised of European countries that have adopted the Euro as their currency. Int’l = international. YTD = year-to-date. MTD = month-to-date. USD = US dollar. TAA = tactical asset allocation. MTDYTD2016 NANANA1.6815.8212.741.779.8317.342.8124.127.081.5113.4213.800.7811.8121.311.6721.961.003.2931.9811.19 Asset classes Note: Indexes used to calculate returns are MSCI All Country World (for Equity), Barclays Capi-tal Global Aggregate Index (for Fixed Income), Dow Jones-UBS Commodity Index Total Return Source: UBS, as of 20 October 2017 Large-Cap ValueLarge-Cap GrowthMid-CapSmall-Cap Int’l DevelopedEmerging MarketsUSGlobal nneutral– ––++++++underweightoverweight– – – Equities Note: Indexes used to calculate returns are MSCI All Country World (for Equity), Barclays Capi-tal Global Aggregate Index (for Fixed Income), Dow Jones-UBS Commodity Index Total Return Source: UBS, as of 20 October 2017Total return indices in USD, in %Total return indices in USD, in % S&P 500 forecast CIO-A WM 6-month rolling price targetUSD 25502016 earnings per share actualUSD 119.12017 earnings per share estimateUSD 131.02018 earnings per share estimateUSD 146.0 Source: UBS, as of 20 October 2017 WeeklyMTDYTD2016 –0.041.1713.255.00–0.940.296.884.21–0.70–1.11–7.6727.790.811.9314.6521.681.702.5123.32–3.560.221.5215.8618.070.313.2131.4512.22–0.232.4918.7015.78–0.691.639.142.560.86–3.77–8.2922.271.273.3515.6215.06 Cons. StaplesEnergyFinancialsHealthcareIndustrialsTechnologyMaterialsReal EstateTelecomUtilitiesCons. Discr.nneutral– – – + ++ +++underweight overweight– – – US equity sectors Note: S&P 500 Sector Indexes used to calculate returns. Source: UBS, as of 20 October 2017 MTDYTD2016 0.7428.561.160.3616.16–1.182.9317.992.963.4216.3010.891.7513.8824.18–0.6420.68–5.07NANANA UKJapanAustraliaCanadaSwitzerlandOtherEMUnneutral– – – + ++ +++underweight overweight– – – International developed equities Note: MSCI Region or Country Indexes used to calculate returns. Preference in hedged terms (excluding currency movements). Source: UBS, as of 20 October 2017Total return indices in USD, in %Total return indices in USD, in % + Moderate overweight vs. benchmark++Overweight vs. benchmark+++Strong overweight vs. benchmarknNeutral, i.e. on benchmark – Moderate underweight vs. benchmark – – Underweight vs. benchmark – – – Strong underweight vs. benchmark Tactical deviations from benchmark symbols Past performance is no indication of future performance.The overweight and underweight recommendations represent tactical deviations that can be applied to any appropriate benchmark portfolio allocation. They reect CIO-A WM’s assessment of market opportunities and risks in the respective asset classes and market segments. The benchmark allocation is not specied here. Please see the most recent UBS House View: Investment Strategy Guide  for denitions/explanations of benchmark allocati - on. They should be chosen in line with the risk prole of the investor. Note that the Regional Bond Strategy is provided on an unhedged basis (i.e., it is assumed that investors carry the underlying currency risk of such investments). Thus, the deviations from the benchmark reect our views of the underlying equity and bond markets in combination with our as -sessment of the associated currencies. Fixed IncomeCashEquitynneutral– ––++++++underweightoverweight– – –
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