financial pacific - volatility to remain elevated (third party)

UBS Investment Research

U.S. Small Cap Strategy

Small Cap Navigator — September 2011

Welcome to the Small-Cap Navigator This monthly guide provides a summary of the UBS U.S. small-cap equity market outlook, including proprietary analytics and other useful information on marketreturns, company profits, valuation, sectors, and the economy.

Volatility to Remain Elevated We continue to believe that a recession will be avoided. However, recent eventshave most likely caused some contraction in underlying business and consumeractivity that will lead to mixed economic readings over near-term. Additionally, the European sovereign debt situation remains tenuous. We expect volatility toremain elevated until incoming data begins to stabilize, and it becomes apparentthat a negative credit event will be averted.

Earnings Results Should Be Decent in the Second Half Despite anemic growth in the first half of the year, Russell 2000 companies haveposted earnings growth of 33% and an aggregate beat of almost 5% thus far in 2Qreports. We expect decent 3Q and 4Q earnings results relative to loweredexpectations. However, 2012 earnings forecasts appear stretched.

Long-Term Concerns Are Driving Company and Investor Behavior We believe that fiscal imbalances and long-term growth concerns are driving companies to keep balance sheets fortified, remain very tight on expenses, andissue overly conservative guidance. Our sense is that these same issues will likelykeep investors intently focused on companies posting the best top-line results, and those with the cheapest valuations relative to medium-term earnings prospects.

Global Equity Research

Americas

Equity Strategy

Investment Strategy

8 September 2011

www.ubs.com/investmentresearch

Chip Miller, CFA

[email protected]

+1-203-719 3720

Jonathan Golub, CFAStrategist

[email protected]+1-212-713 8673

This report has been prepared by UBS Securities LLC ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 58. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

U.S. Small Cap Strategy 8 September 2011

UBS 2

UBS Strategy & Economics Teams

U.S. Equity StrategyJonathan Golub Chief Strategist [email protected] Chip Miller Small-Cap Strategist [email protected]

Manish Bangard Strategist [email protected] Tom Doerflinger Strategist [email protected] Patel Associate [email protected] Natalie Garner Strategist [email protected]

Maury Harris Chief Economist [email protected]

Drew Matus Economist [email protected]

Samuel Coffin Economist [email protected] Paul Donovan Economist [email protected]

Kevin Cummins Economist [email protected] Andrew Cates Economist [email protected]

George Magnus Senior Advisor [email protected]

Janet Pegg Analyst [email protected] Jonathan Anderson Emg Markets [email protected]

Sunil Kapadia Asset Allocation [email protected]

Mitchell Revsine Strategist [email protected]

Jeffrey Palma Chief Strategist [email protected]

Andrew Kligerman Financials [email protected] Chris Ferrarone Strategist [email protected]

N. Theodosopoulos Technology [email protected] Jerry McGuire Associate [email protected]

David Strauss Industrials [email protected]

David Palmer Consumer [email protected] Nicholas Smithie Strategist [email protected]

John Hodulik Telecom [email protected] Jennifer Delaney Strategist [email protected]

Bill Featherston Energy [email protected] Stephen Mo Strategist [email protected]

Ron Barone Energy [email protected]

Justin Lake Health Care [email protected] Stephane Deo Europe [email protected]

Amit Kara UK [email protected]

Nick Nelson Europe [email protected] Duncan Wooldridge Asia [email protected]

Karen Olney Europe [email protected] Scott Haslem Australia [email protected]

Neil Cherry UK [email protected] Tao Wang China [email protected]

George Vasic Canada [email protected]

Shoji Hirakawa Japan [email protected] George Bory Credit [email protected]

Niall MacLeod Asia x-Japan [email protected] Mansoor Mohi-Uddin Currency [email protected]

David Cassidy Australia [email protected] Michael Schumacher Rates [email protected]

John Tang China [email protected] Bhanu Baweja EM FICC [email protected]

Tomas Lajous Mexico [email protected]

David Jessop Global Head [email protected]

Berry Cox US [email protected]

U.S. Accounting

U.S. Economics Global Economics & Strategy

Larry Hatheway Chief Economist & Strategist

[email protected]

Global Equity Strategy

Global Emerging Markets Strategy

Regional Economics

Credit, Rates & Currency Strategy

Quantitative Strategy

U.S. Derivatives

U.S. Sector Heads

Regional Strategy

UBS Small Cap Sales & Trading

Stephen Roney TMT [email protected] Albert Aguiar Specialist [email protected]

Alphonso Diaz Health Care [email protected]

Kevin Mullane Financials/Consumer [email protected]

Richard Ryan Industrials [email protected]

Trading Sales


UBS 3

Table of Contents

Outlook

▪ Market Outlook ……...……………………………….………………..…………….. 4-5

▪ Fiscal Imbalances ...…………………..…………….…………….…..…………….. 6-7

▪ Tactical Review .…….……………………………………….……………………… 8-9

▪ Economic Outlook .…….…………………………………….……………………… 10-13

▪ Leading Indicators .…………………………………….……………………………. 14-15 Fundamentals

▪ Consensus Earnings Growth …..…….………………………….………..……….. 16-17

▪ Earnings — Revenue ….………………...…………………………………………. 18

▪ Earnings — Operating Margins ………..………………………………………….. 19

▪ Balance Sheets & Cash Flows .……………….…………………………………... 20-21

▪ Earnings Analysis ………………..………………….………………………………. 22-25

▪ M&A ……………………………..………………………..………………….……….. 26-27

▪ Dividends & Buybacks and Cash & Working Capital ..………………………..… 28-29 Market Leadership

▪ U.S. Equity & Sector Returns ….……………..……………………………………. 30-31

▪ Sector Recommendations...…………………..……………………………………. 32-35

▪ UBS Return Drivers — Summary….……..………..………...……………………. 36-37

▪ UBS Return Drivers — Revenue Growth & PEG ……………….………..……… 38-39

▪ UBS Return Drivers — Market Cap, Op Leverage & Valuation ..………………. 40-41

▪ Small vs. Large ……………………………………………………………………… 42-43

▪ Growth vs. Value ……………………………………………………………………. 44-45

▪ Fund Positions ………………………………………………………………………. 46-47 Valuation

▪ Investment Regimes ………………………..………………………………………. 48-49

▪ Russell 2000 …………………………………………………………………………. 50-51

▪ Russell 2000 Inter-Sector Relative Valuation ……………………………………. 52-53 Appendix

▪ UBS Return Drivers .…………….………………….………………..…………….. 54-55

▪ Inter-Sector Valuation ….………………….………………..……………………… 56-57 All data as of August 31, 2011 unless otherwise noted.

Highlights

• Market Outlook — Pages 4-5

• Earnings Analysis — Pages 22-25

• Sector Recommendations — Pages 32-35

• UBS Return Drivers — Pages 36-41

• Investment Regimes — Pages 48-49


UBS 4

Market Outlook

Outlook

Small Caps Down Big In August. In August, the Russell 2000 sold off by 8.7% into weak economic readings, rising double dip concerns, an increasingly tenuous European sovereign debt situation, and S&P’s downgrade of U.S. debt. Small caps underperformed large caps by almost 300bps. Cyclical sectors, including Energy, Discretionary, and Tech, were hit the hardest.

Volatility Should Remain Elevated. We believe that recent events have caused a contraction in underlying business and consumer activity. This should lead to very mixed economic readings over the next several weeks. Additionally, the situation in Europe continues to deteriorate. We expect volatility to remain elevated until incoming data begins to stabilize.

A Credit Shock Is the Biggest Risk. In our view, the biggest risk to the economy and small-cap stock performance is the potential for a global credit shock. While we continue to believe this is a low probability event, we are closely monitoring interbank lending markets. Over the near term, U.S. small-cap performance may be driven by the situation in Europe.

Slow Growth Not Recession. We believe that recent economic readings are more consistent with slow growth, not recession. Once it becomes clear that a recession will be avoided, we expect small cap stocks to rebound, potentially sharply.

Solid Earnings Results. Despite anemic GDP growth in the first half of the year, small companies reported very solid 2Q earnings results. With roughly 90% of the universe reported, Russell 2000 companies have posted year-over-year earnings growth of 33% (20% ex-Financials), with an aggregate earnings beat of 4.9% (4.8% ex-Financials).

Earnings Probably OK in 2H; 2012 Looks Like a Stretch. Company guidance has remained very conservative, and analysts have been modestly revising down 2H11 earnings expectations. As such, we expect modest earnings beats to continue over the next two quarters. However, 2012 expectations look stretched if GDP growth remains muted.

Attractive Valuations. At 16.7x, the Russell 2000 appears cheap relative to its five- and ten-year averages of 20.3x and 21.4x, respectively. The Russell 2000 is trading at a 46% premium to the Russell 1000, toward the high end of the historical range. However, the relative valuation appears reasonable, adjusting for easy comps.

We expect volatility to remain elevated into mixed economic readings and sovereign concerns

Over the near term, U.S. small caps may be driven by the situation in Europe

We believe a recession will be avoided, and companies will continue to surpass expectations in 2H11

However, 2012 bottom-up earnings forecasts appear stretched


UBS 5

Market Outlook

Leadership

A Cyclical Sector Bias. Based on our medium-term outlook, we have a cyclical bias. We’re overweight Tech, Industrials, Discretionary, and Health Care. We’re underweight Financials, and the most defensive areas, Staples, Telecom and Utilities. However, over the near-term, defensive sectors and characteristics could continue to outperform.

Overriding Investment Themes. Given investors’ longer-term growth concerns, we see three key investment themes playing out over the next several quarters:

All Eyes on Revenue Growth. On a sector-neutral basis, companies posting the highest revenue growth were winners during both the strong run from September to March and the more recent defensive rotation that began in April. We expect this to continue.

Buy Undervalued Earnings Growth. We also expect companies with the most attractive near-term PEG ratios to continue to outperform in the current environment.

A Robust M&A Cycle. We expect a significant pickup in deal activity as macro concerns fade, and companies look to buy growth and capture outsized deal synergies.

Risks

European Sovereign Debt. We believe that the biggest risk to U.S. small-caps is a credit disruption emanating from Europe.

Economic Weakness. Further deterioration in the economic outlook poses a serious threat to small caps. Recent weak economic readings are particularly concerning given limited policy responses in the event of a recession.

Negative Feedback Loop. In our view, there is the potential for a negative feedback loop to develop, consisting of (1) weakening economic fundamentals; (2) rising sovereign concerns and bank funding stress; (3) spikes in market volatility; and (4) a further contraction in underlying economic activity.

Note: In our charts and tables, we use either the S&P 600 or the Russell 2000 to represent the small-cap universe. Refer to the footnote beneath each exhibit to determine which index is being used.

Based on our medium-term outlook, we maintain a cyclical sector bias

We expect companies posting the highest top-line growth and those with the best PEG ratios to continue to outperform

There are significant risks to our relatively optimistic outlook


UBS 6

Fiscal Imbalances

Federal Budget Deficit (US$ Trillions)

0.5

1.4

1.3

1.4

1.1

0.7

0.5 0.50.6

0.6 0.60.7

0.7 0.7

08 09 10 11 12 13 14 15 16 17 18 19 20 21

Source: CBO, Haver and UBS

Federal Budget Breakdown

2011 2021

5% Interest 16%

18% Mandatory 13%

40% Entitlements 46%

14% Discretionary 9%

23% Security 17%

$3.5 Trillion

$5.9 Trillion

Source: Office of Management & Budget and UBS

The debt ceiling deal is a modest first step in addressing America’s fiscal imbalances

OMB projects that interest and entitlements will go from 45% of the budget to 62%… over 75% of tax receipts


UBS 7

Fiscal Imbalances

CDS Spreads

200

400

600

800

1000

1200

1400

1600

Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11

Portugal, Ireland & ► Greece CDS Basket

Source: Bloomberg and UBS Note: European CDS basket is the 5-day moving average of Portugal, Ireland and Greece CDS through Sept. 5, 2011

10-Year Spreads

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11

Italy - Germany▼

Spain - Germany▲

Source: Bloomberg and UBS

Portuguese, Irish, and Greek CDS spreads remain wide

Increased pressure on Italy and Spain as well


UBS 8

Tactical Review

Small Caps > 200-Day Moving Average

0%

20%

40%

60%

80%

100%

01/08 07/08 01/09 07/09 01/10 07/10 01/11 07/11

160

220

280

340

400

460S&P 600 ►

◄ % of Stocks > 200-Day MA

Source: Standard & Poor’s, FactSet and UBS Note: Data as of Sept. 2, 2011

Mutual Fund Flows (4-Wk Moving Avg.)

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

4/10 8/10 11/10 3/11 6/11

$B

◄ Small

◄ Large

Mid ▼

Source: Lipper and UBS

Small caps have room to run if economic data begins to stabilize

Small- and mid-cap flows have recently turned more negative


UBS 9

Tactical Review

Russell 2000 Implied vs. Realized Volatility (1M)

0

10

20

30

40

50

60

70

80

90

08 09 10 11

Realized Vol ▲

Implied Vol ▼

Source: CBOE, Russell and UBS Note: Data through Sept. 2, 2011

S&P 600 Industry Group Correlation (30D)

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

05 06 07 08 09 10 11

89%92%

Source: Standard & Poor’s, FactSet and UBS

Volatility has risen sharply

Stock correlations are very high, making alpha generation difficult


UBS 10

Economic Outlook

Russell 2000 vs. LEI

300

375

450

525

600

675

750

825

900

98 99 00 01 02 03 04 05 06 07 08 09 10 11

77

82

87

92

97

102

107

112

117

LEI ►

Russell◄ 2000

Source: Russell, Conference Board, Bloomberg and UBS

Small Cap Relative Performance vs. LEI

0.57

0.72

0.87

1.02

1.17

98 99 00 01 02 03 04 05 06 07 08 09 10 11

77

87

97

107

117

◄ Sm v Lg ▼

LEI ►


Small caps tend to trade in-line with the economic outlook

Small caps generally outperform when the economy is growing


UBS 11

Economic Outlook

Russell 2000 v. ISM New Orders

375

506

638

769

900

03 04 05 06 07 08 09 10

20

35

50

65

80

◄ Russell 2000

New Orders ►

Source: Russell, Institute for Supply Management, Bloomberg and UBS

U.S. Economic Surprise Index

-4

-3

-2

-1

0

1

2

3

06 07 08 09 10 11

> 0 represents Positive Surprise

< 0 represents Negative Surprise

Source: Bloomberg and UBS Global Economics Team

The key is whether or not economic indicators begin to signal a substantial slowdown or recession

Is the current environment like late 2006 or early 2008?

Economic data has recently started to surprise to the upside into lowered expectations


UBS 12

Economic Outlook

Interbank Lending Spreads

0

50

100

150

200

250

300

350

06 07 08 09 10 11

0

30

60

90

120

150

180

210

◄ TED Spread ▼

Euribor Spread ►

Source: Bloomberg and UBS Note: Data through Sept. 6, 2011

Baa Spread

150

250

350

450

550

650

06 07 08 09 10 11

Source: Moody’s, Bloomberg and UBS Note: Data through Sept. 6, 2011

Recessions are normally caused by credit contractions

European interbank spreads are showing signs of stress

The TED spread has recently risen, but remains at low levels

High quality corporate spreads have been relatively stable


UBS 13

Economic Outlook

ISM Manufacturing & Non-Manufacturing

98 00 02 04 06 08 10

35

40

45

50

55

60

>50 is Expansionary

<50 is Contractionary

◄ ISM Mfg

◄ ISM Non-Mfg

50.6

54.6

Source: Institute of Supply Chain Management, FactSet and UBS Note: ISM Mfg represents Aug. 2011

Weekly Unemployment Claims

90 92 94 96 98 00 02 04 06 08 10250

300

350

400

450

500

550

600

650

4-week avg. 410k

Source: US Department of Labor, FactSet and UBS

Recent economic data is consistent with slow growth, not recession, in our view


UBS 14

Leading Indicators

Small Business Optimism Index

80

85

90

95

100

105

110

01 02 03 04 05 06 07 08 09 10 11

Source: NFIB, Bloomberg and UBS Note: Data through July 2011

Small-Cap Cyclicals vs. Non-Cyclicals

1.35

1.43

1.51

1.59

1.67

1.75

Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11

3/31: 1.70

9/6: 1.44

6/17: 1.52

Source: Standard & Poor’s, Bloomberg and UBS Notes: Cyclicals represent and equal-weighted index of Discretionary, Tech, Industrials, Financials, Energy and Materials. Non-cyclicals represent an equal-weighted index of Health Care, Staples, Telecom and Utilities. Data through Sept. 6, 2011

Confidence is the key going forward

A reemergence of cyclical leadership would be a positive signal — we’re not there yet


UBS 15

Leading Indicators

10-Year Treasury Yield

1.9

2.2

2.5

2.8

3.1

3.4

3.7

4.0

1/10 4/10 7/10 10/10 1/11 4/11 7/11

4/11: 3.58

9/6: 1.97

6/24: 2.86

Source: Bloomberg and UBS Note: Data through Sept. 6, 2011

CRB US Spot Raw Industrials

450

500

550

600

650

1/10 4/10 7/10 10/10 1/11 4/11 7/11

4/12: 638

9/2: 571

Source: CRB, Reuters, Bloomberg and UBS Note: Data through Sept. 2, 2011

We attribute a majority of the move down in the 10-year yield to falling growth expectations

Industrial commodities may be stabilizing


UBS 16

Consensus Earnings Growth

Consensus Earnings Growth — Index Level 2011 Earnings Growth 2012 Earnings Growth

R2000 S&P 600 R2000 S&P 600Cyclicals

C. Discretionary 7.4 % 20.0 % 45.6 % 28.7 %Industrials 30.7 28.5 36.4 24.5Technology 11.2 11.2 25.0 17.4Energy 100+ 26.8 100+ 52.5Materials 48.8 23.5 27.0 25.7

Non-Cyclicals

C. Staples -3.3 9.2 72.7 22.7Health Care 100+ 3.2 100+ 19.9Telecom Svcs 71.6 -5.3 100+ 32.9Utilities -0.1 3.5 8.4 7.3

Index ex-Fin 40.6 15.6 45.0 23.4

Financials 100+ 35.4 46.5 34.4

Index 62.1 18.2 45.3 25.2 Source: Russell, Standard & Poor’s, Thomson Financial, Compustat, FactSet and UBS Note: Analysis based on constituents as of August 31, 2011. Analysis excludes FBP

Consensus Earnings Growth — Median Company 2011 Earnings Growth 2012 Earnings Growth

R2000 S&P 600 R2000 S&P 600Cyclicals

C. Discretionary 15.6 % 15.4 % 21.7 % 18.6 %Industrials 30.1 22.0 25.6 21.6Technology 16.9 15.8 21.2 17.3Energy 52.9 42.9 70.5 56.1Materials 19.4 16.5 21.5 19.5

Non-Cyclicals

C. Staples 14.1 10.1 17.3 15.8Health Care 10.7 10.7 18.9 15.8Telecom Svcs 0.4 -2.6 44.4 59.9Utilities 3.0 3.0 6.2 6.7

Index ex-Fin 17.8 14.6 22.6 18.3

Financials 23.3 17.8 20.6 22.0

Index 18.7 15.4 22.1 19.0 Source: Russell, Standard & Poor’s, Thomson Financial, Compustat, FactSet and UBS Note: Analysis based on constituents as of August 31, 2011. Analysis excludes FBP

Largely due to easy comps, Russell 2000 earnings growth is expected to be 62% in 2011 and 45% in 2012

Growth rates appear more reasonable looking at median estimates

Easy comps are distorting overall earnings growth estimates


UBS 17

Consensus Earnings Growth

S&P 600 Bottom-Up Consensus

10%

15%

20%

25%

30%

35%

01/10 04/10 07/10 10/10 01/11 04/11 07/11

2011 ▼

2012 ▼

Source: Standard & Poor’s, Compustat, Thomson Financial, FactSet and UBS

S&P 600 Forward PE vs. EPS

17

20

23

26

29

Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11

13.0

14.5

16.0

17.5

19.0

◄ Fwd EPS ▼

Fwd P/E ►

$28

14.1x


Analysts have been revising down 2011 earnings expectations

However, 2012 expectations have remained largely unchanged

Buy-side expectations have fallen much faster than sell-side forecasts


UBS 18

Earnings — Revenue

Revenue Growth vs. Nominal GDP Growth

-24%

-17%

-10%

-3%

4%

11%

18%

25%

00 01 02 03 04 05 06 07 08 09 10 11

-5%

-3%

-1%

1%

3%

5%

7%

9%

◄ Revenue

GDP ►

Y/Y Y/Y

Source: Standard & Poor’s, BEA, Compustat, FactSet and UBS Note: Analysis excludes Financials

Revenue Surprises — Small vs. Large

0.4

2.3

0.5

-0.1

0.4

2.6

-2.0

0.2

2.01.7 1.8

1.3

3.0 2.92.7

1.41.0

-0.9

2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11E

Large Caps

Small Caps

Source: Standard & Poor’s, Compustat, Thomson Financial and UBS Note: Analysis excludes Financials and certain other companies with missing data.

Small-cap revenue growth and nominal GDP are highly correlated

Top-line beats have been surprisingly strong over the past three quarters


UBS 19

Earnings — Operating Margins

Operating Margin vs. Capacity Utilization

4%

5%

6%

7%

8%

9%

10%

00 01 02 03 04 05 06 07 08 09 10 11

65

70

75

80

85

◄ Small-Cap Margins

Cap. Util. ►

8.9%

7.1%

4.8%

Source: Standard & Poor’s, Federal Reserve, Compustat, FactSet and UBS Note: Margins have been adjusted to reflect a trailing 4-quarter basis. Capacity Utilization shows quarterly averages

Current & Peak Operating Margins

58 8

57 7

9

52

89 9

12

9

5

1815 14

24

9 9 810 9

12 13

65

10

15

1113

12

8

21

26

17

2

6

13

Ene

rgy

Mat

eria

ls

Cap

Goo

ds

Com

m S

vcs

Tra

nspo

rts

Aut

os

Dur

able

s

Con

s S

vcs

Med

ia

Ret

ail

Foo

d R

etai

l

Foo

d B

ev

HH

Pro

d

HC

Svc

s

Pha

rma

Sof

twar

e

Har

dwar

e

Sem

is

Tel

ecom

Util

ities

Peak

2Q11

Peak 4Q01 1Q07 1Q98 4Q98 3Q07 3Q99 1Q06 4Q02 3Q04 3Q02 2Q06 3Q10 1Q07 2Q04 1Q03 2Q05 3Q00 4Q00 3Q04 3Q98

Source: Standard & Poor’s, Compustat, FactSet and UBS Note: Margins reflect a trailing 4-quarter basis. Peak quarter is listed below chart

Small-cap margins tend to mirror capacity utilization

We see margin expansion opportunities across the small-cap universe


UBS 20

Balance Sheets

Net Debt vs. Interest Coverage

10%

15%

20%

25%

30%

35%

40%

99 00 01 02 03 04 05 06 07 08 09 103.0x

4.0x

5.0x

6.0x

7.0x

8.0x

Interest Cov ►

Net Debt Ratio

deleveraging

6.3x

16.5%

Source: Standard & Poor’s, Compustat, FactSet and UBS Note: Analysis excludes Financials

Capex & R&D

7.0%

7.5%

8.0%

8.5%

9.0%

9.5%

01 02 03 04 05 06 07 08 09 10 113.0%

3.5%

4.0%

4.5%

5.0%

5.5%

R&D / Sales◄ (Rolling 12M)

Capex / Sales ► (Rolling 12M)

7.7%

3.6%


Small-cap balance sheets remain solid


UBS 21

Cash Flows

Free Cash Flow ($Bn) – Sources 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11

Net Income 1.3 3.5 2.6 3.9 4.0 4.6 4.4 4.5 4.6

Depreciation 4.4 4.4 4.4 4.3 4.2 4.3 4.4 4.5 4.1

Working Capital 2.9 0.6 1.0 (1.2) (2.2) (2.9) (0.9) (3.4) (1.6)

Other Op Items 3.4 2.7 3.8 1.6 2.4 2.5 3.1 1.1 1.5

CF From Ops 12.1 11.1 11.8 8.6 8.4 8.4 11.0 6.6 8.5

- Capex (net) 4.0 3.8 4.0 3.3 4.1 4.4 4.7 4.7 4.4

Free Cash Flow 8.1 7.3 7.8 5.3 4.3 4.1 6.4 1.9 4.1 Source: Standard & Poor’s, Compustat, FactSet and UBS Note: Universe excludes Financials

Companies focused on cash generation during the downturn

Working capital being replenished, but plenty of cash left over

Free Cash Flow ($Bn) – Uses 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11

Free Cash Flow 8.1 7.3 7.8 5.3 4.3 4.1 6.4 1.9 4.1

- Dividends 0.6 0.7 0.6 0.8 0.7 0.7 1.7 0.8 0.7

- Buybacks, net (0.8) (1.6) (0.6) (0.6) 0.6 0.6 (0.3) (0.7) 0.7

- Acquisitions, net 1.1 0.9 2.4 2.4 2.5 3.6 7.3 3.0 3.8

Debt Iss/(Repay) (4.4) (3.2) (2.5) (2.0) 0.1 2.7 4.8 0.7 2.2

L/T Investments (0.3) (0.7) (0.7) (0.4) (0.5) 0.3 (0.9) (0.3) (0.2)

Other Investing 0.4 0.2 (0.0) 0.6 0.5 (0.0) 0.4 (0.3) 0.3

Other Financing (0.1) (0.3) 1.4 0.0 (1.1) 0.2 (1.1) 0.4 (0.3)

Chg-Cash & ST Inv 2.7 3.3 3.6 1.0 (0.4) 2.3 0.9 (0.7) 0.9 Source: Standard & Poor’s, Compustat, FactSet and UBS Note: Universe excludes Financials

M&A activity has picked up. We expect this to continue

Dividends and buybacks should gradually increase as well


UBS 22

Earnings Analysis

Russell 2000 — Earnings Summary — 2Q11E Revenue Earnings

Growth Surprise Growth SurpriseRptd Total YoY (%) Pct (%) Beat Miss YoY (%) Pct (%) Beat Miss

Cyclicals ex-Finls 959 1068 15.7 2.6 558 297 29.4 4.9 572 347

Cons. Discretionary 238 269 6.3 1.2 122 82 23.0 10.5 140 90

Autos 18 18 20.4 5.3 11 5 51.7 10.9 8 10

Dur. & Apparel 49 56 0.9 1.6 33 15 <-100 <-100 31 17

Cons. Services 66 74 4.7 0.9 33 21 23.5 7.5 40 23

Media 31 38 6.8 4.2 13 12 >100 20.2 15 14

Retailing 74 83 5.7 -0.4 32 29 9.9 23.3 46 26

Industrials 250 278 15.6 2.0 154 75 23.1 7.3 152 85

Capital Goods 142 161 17.1 2.3 85 50 33.8 3.2 74 59

Services 70 79 12.4 1.9 44 17 36.7 9.1 48 20

Transportation 38 38 16.1 1.5 25 8 -1.2 15.0 30 6

Technology 313 334 14.1 1.4 190 84 16.2 6.0 202 98

Software 140 150 16.4 1.0 88 33 23.0 6.9 96 38

Hardware 104 115 13.1 1.8 64 33 14.6 3.0 60 41

Semiconductors 69 69 12.1 1.0 38 18 11.0 8.2 46 19

Energy 95 115 48.4 9.6 57 35 >100 -4.5 47 44

Materials 63 72 19.7 2.3 35 21 27.3 -5.2 31 30

Non-Cyclicals 352 397 9.9 1.7 189 127 -29.6 3.9 193 141

Cons. Staples 43 62 10.9 2.4 28 9 -29.7 -9.0 25 17

Food & Stpls Retail 9 15 9.5 1.9 7 1 75.8 >100 7 2

Food Bev. & Tob. 22 33 12.9 3.1 14 6 -59.7 -44.4 10 11

Hhld Products 12 14 12.1 2.1 7 2 16.1 9.6 8 4

Health Care 256 278 8.6 1.1 131 100 -29.9 83.2 139 102

Equip. & Services 131 137 9.0 0.4 66 50 21.2 6.0 72 47

Pharma/Biotech 125 141 6.1 6.7 65 50 -84.5 11.5 67 55

Telecom 21 23 12.1 0.4 9 8 <-100 <-100 9 10

Utilities 32 34 10.2 2.4 21 10 -21.1 -9.7 20 12

Russell 2000 ex-Finls 1311 1465 14.3 2.4 747 424 20.3 4.8 765 488

Financials 352 385 -28.2 0.7 201 118 82.9 5.1 206 130

Banks 164 177 5.6 2.5 91 53 >100 22.9 111 49

Diversified Finls 59 68 -68.6 -3.0 34 22 46.8 -7.2 34 22

Insurance 38 43 2.2 1.3 23 13 -53.8 -8.8 18 20

Real Estate 91 97 14.9 1.0 53 30 40.1 4.9 43 39

Russell 2000 1663 1850 8.6 2.2 948 542 33.3 4.9 971 618 Source: Russell, Compustat, Thomson Financial, FactSet and UBS Note: Analysis excludes companies with no analyst coverage or that are missing data in applicable databases. Results contain some UBS estimates


UBS 23

Earnings Analysis

S&P 600 — Earnings Summary — 2Q11E Revenue Earnings

Growth Surprise Growth SurpriseRptd Total YoY (%) Pct (%) Beat Miss YoY (%) Pct (%) Beat Miss

Cyclicals ex-Finls 360 382 17.4 2.8 205 105 16.8 3.9 224 121

Cons. Discretionary 100 107 6.9 2.4 55 28 7.1 10.5 64 32

Autos 5 5 2.8 0.3 2 2 -6.2 3.3 2 3

Dur. & Apparel 27 29 6.7 3.7 20 5 -5.2 10.8 18 8

Cons. Services 27 30 4.0 0.9 13 6 5.6 2.3 17 10

Media 3 3 19.0 16.3 2 1 >100 >100 2 1

Retailing 38 40 6.9 0.9 18 14 3.6 15.7 25 10

Industrials 83 90 13.2 1.4 47 25 16.5 4.6 50 27

Capital Goods 53 58 10.1 1.7 30 16 11.0 1.7 27 21

Services 22 24 11.7 0.8 12 6 35.6 7.9 15 6

Transportation 8 8 35.3 1.4 5 3 23.8 19.8 8 0

Technology 125 130 17.4 1.2 72 37 11.8 1.5 79 43

Software 45 46 19.2 0.0 27 11 -1.3 -0.1 31 14

Hardware 49 53 17.5 1.7 28 18 23.8 1.6 28 20

Semiconductors 31 31 14.2 0.8 17 8 12.4 2.8 20 9

Energy 19 21 61.2 10.1 13 5 70.1 5.7 12 6

Materials 33 34 17.7 1.6 18 10 17.8 -3.0 19 13

Non-Cyclicals 104 114 15.4 2.3 52 35 -11.2 -7.0 51 43

Cons. Staples 19 23 18.3 4.1 9 3 -24.0 -6.8 8 8

Food & Stpls Retail 3 5 19.6 7.2 2 0 50.1 28.3 2 1

Food Bev. & Tob. 11 13 19.7 2.7 7 1 -44.3 -21.0 5 4

Hhld Products 5 5 8.6 -0.7 0 2 -14.6 -5.6 1 3

Health Care 65 70 14.9 0.5 33 25 -7.7 -9.0 35 24

Equip. & Services 51 53 15.7 0.5 25 20 6.0 2.2 27 18

Pharma/Biotech 14 17 7.9 0.9 8 5 -82.3 -80.1 8 6

Telecom 7 7 10.7 1.0 2 3 -39.8 -20.3 1 5

Utilities 13 14 13.2 7.2 8 4 10.7 6.9 7 6

S&P 600 ex-Finls 464 496 17.0 2.7 257 140 9.9 1.5 275 164

Financials 100 102 8.2 1.1 56 26 33.1 3.2 52 40

Banks 41 41 3.6 1.4 22 11 >100 29.5 28 10

Diversified Finls 13 13 15.2 -0.4 6 6 24.0 -1.5 8 4

Insurance 16 17 8.8 1.8 10 3 -36.6 3.6 6 10

Real Estate 30 31 7.2 0.9 18 6 4.2 -10.4 10 16

S&P 600 564 598 16.3 2.6 313 166 14.2 1.9 327 204 Source: Standard & Poor’s, Compustat, Thomson Financial, FactSet and UBS Note: Analysis excludes companies with no analyst coverage or that are missing data in applicable databases. Results contain some UBS estimates


UBS 24

Earnings Analysis

Earnings Surprises — Small vs. Large

7

12

109

8

56 6

5

13

19

14

8

12

9

79

2

2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11E

Large Caps

Small Caps

Source: Standard & Poor’s, Compustat, Thomson Financial, FactSet and UBS Note: Analysis excludes Financials and certain other companies with missing data

Earnings Surprises — Cyclicals vs. Non-Cyclicals

18

21

19

7

15

8 8 8

45

12

3

9

5

14

6

10

-7

2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11E

Cyclicals

Non-Cyclicals

Source: Standard & Poor’s, Compustat, Thomson Financial, FactSet and UBS Note: Analysis excludes Financials and certain other companies with missing data

Large-cap beats have been higher in 2Q reports

Cyclical sectors posted much better results relative to expectations


UBS 25

Earnings Analysis

2Q11E Price Response – S&P 600 vs. S&P 500

Beats Misses Beats Misses

Bea

ts

4.20 -0.47 2.73

Bea

ts

0.86 -0.24 0.55

Mis

ses

-4.20 -6.25 -5.50

Mis

ses

-2.84 -4.64 -3.89

2.18 -4.11 0.27 -2.24

Small Cap Large Cap

Revenue Surprise Revenue Surprise

E

PS

Su

rpri

se

E

PS

Su

rpri

se

Source: Standard & Poor’s, Thomson Financial, FactSet and UBS

1Q11 Price Response – S&P 600 vs. S&P 500


Bea

ts

3.21 -0.87 2.11

Bea

ts

0.79 -0.60 0.30

Mis

ses

-2.96 -4.10 -3.49

Mis

ses

-1.46 -2.54 -2.04

1.73 -2.87 0.20 -1.29

E

PS

Su

rpri

se

Small Cap Large Cap


E

PS

Su

rpri

se


4Q10 Price Response – S&P 600 vs. S&P 500


Bea

ts

4.27 0.96 3.10

Bea

ts

1.49 -0.49 0.75

Mis

ses

-2.47 -3.30 -2.86

Mis

ses

-2.31 -2.48 -2.35

2.43 -1.18 0.81 -2.06

Small Cap Large Cap


E

PS

Su

rpri

se

E

PS

Su

rpri

se



UBS 26

M&A

Number of Deals – $250M to $2.5B

88108

190229

283

463444

549

637

329288291

414449

557550

289

232

390410

92 95 98 01 04 07 10

Source: Mergerstat, FactSet and UBS Note: 2011 estimated based on deals through July

Number of Deals – $250M and $2.5B

10

151512

15

2220

282926

22

2627

35

40

32

50

28

36

4042

3435

28

37

2830

24

32

41

02/09 05/09 08/09 11/09 02/10 05/10 08/10 11/10 02/11 05/11

Source: Mergerstat, FactSet and UBS Note: Data through July 2011

Deal activity picks up post recessions

We believe macro concerns have been holding back transaction volumes


UBS 27

M&A

Deals by Sector – 2010 and 2011 YTD 114 112

79

71 70 68

55

39

29

10

Fin Tech Discr H Care Ind En Mat Stpls Util Telcm

Source: Mergerstat, FactSet and UBS Note: Data through July 2011

Large vs. Small Operating Margins

4%

5%

6%

7%

8%

9%

10%

99 00 01 02 03 04 05 06 07 08 09 10

9%

10%

11%

12%

13%

14%

15%

◄ Small Caps ▲

Large Caps ►


Financials and Tech have seen the biggest pickup in deal activity

The difference between small- and large-cap margins is close to an all-time high

We believe that CEOs put more credence in cost synergies than potential revenue opportunities


UBS 28

Dividends & Buybacks

Payout Ratio

-25%

0%

25%

50%

75%

100%

125%

94 96 98 00 02 04 06 08 10

◄ Dividends + Buybacks

Dividends ▲

11%

43%

Source: Standard & Poor’s, Compustat, FactSet and UBS Note: Analysis excludes Financials and Utilities

Payout Ratios by Sector

4637

64

31 3040 38

127

9369 69

47

131

87

164

201

401

278

600 x-Fin &Util

Ind Discr Mat En Tech H Care Stpls Telcm

Peak

2Q11

PkQtr 4Q08 1Q08 3Q08 4Q00 4Q10 2Q02 3Q07 2Q06 3Q05

Source: Standard & Poor’s, Compustat, FactSet and UBS Note: Analysis excludes Financials and Utilities

Room to return cash across sectors

Total payout is way below prior peaks


UBS 29

Cash & Working Capital

Cash & Inventories (% Total Assets)

6%

9%

12%

15%

18%

00 01 02 03 04 05 06 07 08 09 10 11

Cash ►

◄ Inventories

12.2%

13.5%


Working Capital (% of Sales)

6%

7%

8%

9%

10%

99 00 01 02 03 04 05 06 07 08 09 10

7.1%


Working capital management has been stellar over the past few years

Cash balances remain high


UBS 30

U.S. Equity Returns

U.S. Equity Indices Index Aug-11 QTD YTD 1 Yr 3 Yr 5 Yr 7 Yr 10 Yr

R. 2000 (8.7) (12.0) (6.5) 22.2 0.8 1.5 5.5 5.8R. 2000 Value (8.8) (11.8) (8.5) 16.9 (0.6) (0.6) 4.3 6.5R. 2000 Growth (8.6) (12.1) (4.6) 27.5 2.1 3.6 6.6 4.9R. Mid-Cap (6.9) (10.3) (3.0) 21.3 2.9 3.0 7.0 7.2R. Mid-Cap Value (6.9) (10.2) (4.2) 17.5 2.0 1.4 6.4 7.5R. Mid-Cap Growth (6.8) (10.3) (1.7) 25.6 3.8 4.3 7.4 5.9R. 1000 (5.8) (7.8) (1.9) 19.1 0.8 1.1 4.0 3.2R. 1000 Value (6.2) (9.4) (4.0) 14.4 (1.4) (1.6) 3.0 3.4R. 1000 Growth (5.3) (6.2) 0.2 24.0 3.1 3.7 4.9 2.7S&P 600 (7.7) (10.6) (3.9) 24.4 2.1 2.7 6.4 7.0S&P 400 (7.1) (10.4) (2.7) 22.9 4.0 4.6 7.6 7.3S&P 500 (5.4) (7.4) (1.8) 18.5 0.5 0.8 3.5 2.7Dow (4.4) (6.5) 0.3 16.0 0.2 0.4 1.9 1.6Nasdaq (6.4) (7.0) (2.8) 22.0 2.9 3.4 5.0 3.6

Index Value 2010 2009 2008 2007 2006 2005 2004R. 2000 727 26.9 27.2 (33.8) (1.6) 18.4 4.6 18.3R. 2000 Value 956 24.5 20.6 (28.9) (9.8) 23.5 4.7 22.2R. 2000 Growth 419 29.1 34.5 (38.5) 7.0 13.3 4.2 14.3R. Mid-Cap 25.5 40.5 (41.5) 5.6 15.3 12.7 20.2R. Mid-Cap Value 24.8 34.2 (38.4) (1.4) 20.2 12.6 23.7R. Mid-Cap Growth 26.4 46.3 (44.3) 11.4 10.7 12.1 15.5R. 1000 16.1 28.4 (37.6) 5.8 15.5 6.3 11.4R. 1000 Value 15.5 19.7 (36.8) (0.2) 22.2 7.1 16.5R. 1000 Growth 16.7 37.2 (38.4) 11.8 9.1 5.3 6.3S&P 600 26.3 25.6 (31.1) (0.3) 15.1 7.7 22.6S&P 400 26.6 37.4 (36.2) 8.0 10.3 12.6 16.5S&P 500 1,219 15.1 26.5 (37.0) 5.5 15.8 4.9 10.9Dow 11,614 11.0 18.8 (33.8) 6.4 16.3 (0.6) 3.1Nasdaq 2,579 16.9 43.9 (40.5) 9.8 9.5 1.4 8.6

Source: Russell, Standard & Poor’s, Dow Jones, NASDAQ, FactSet and UBS Note: All returns include dividends except the Dow and NASDAQ


UBS 31

Sector Returns

Russell 2000 Sectors Index Aug-11 QTD YTD 1 Yr 3 Yr 5 Yr 7 Yr

Financials (6.9) (8.8) (8.1) 11.7 (3.8) (6.2) (0.9)

Technology (9.3) (16.6) (10.0) 23.4 6.2 4.1 6.7

Industrials (8.6) (12.5) (9.5) 22.6 (3.9) 2.0 7.3

Consumer Discret. (10.1) (12.8) (8.4) 23.4 5.0 0.0 2.1

Healthcare (8.9) (12.1) (0.6) 25.2 2.0 4.0 6.3

Energy (16.9) (14.4) (5.0) 41.1 (10.2) 0.8 11.8

Materials (9.0) (12.3) (7.5) 27.2 6.1 12.9 15.6

Utilities 2.2 0.5 9.5 21.8 8.1 5.8 8.4

Consumer Staples (3.2) (6.2) 4.4 23.9 9.2 7.9 9.9

Telecom Svcs. (8.2) (16.3) (1.1) 23.8 (3.3) (4.2) 3.5

Russell 2000 (8.7) (12.0) (6.5) 22.2 0.8 1.5 5.5

Index Weights 2010 2009 2008 2007 2006 2005

Financials 21.7 20.7 (1.4) (23.4) (19.6) 19.4 2.0

Technology 16.9 34.4 59.9 (43.8) 3.6 13.6 (1.9)

Industrials 15.5 29.7 13.9 (29.9) 6.2 22.0 9.4

Consumer Discret. 13.3 32.1 60.8 (47.6) (15.0) 14.6 (2.0)

Healthcare 12.5 17.2 22.6 (29.3) 13.6 8.6 5.5

Energy 7.0 33.3 41.0 (50.3) 14.3 16.5 47.3

Materials 4.9 34.0 60.9 (39.1) 26.3 41.5 4.5

Utilities 3.7 17.5 7.9 (11.0) (0.1) 26.4 0.7

Consumer Staples 3.6 19.7 23.7 (18.8) 4.2 29.1 (0.3)

Telecom Svcs. 1.0 11.6 24.1 (49.7) 3.5 40.7 2.0

Russell 2000 100.0 26.9 27.2 (33.8) (1.6) 18.4 4.6 Source: Russell, FactSet and UBS Note: All returns include dividends


UBS 32

Sector Recommendations

Overweight

Consumer Discretionary

We expect employment trends to gradually improve over the remainder of 2011, and expectations for the sector are low. Earnings results have been solid and valuations appear reasonable. We are most bullish on Media and companies exposed to higher-end consumer spending.

Industrials

Industrials is expected to deliver solid earnings growth over the next two years, supported by a modest economic reacceleration, as well as margin expansion. Analysts have underestimated operating leverage in recent quarters, a trend that should continue. In particular, we like Capital Goods companies exposed to later-cycle end markets.

Technology

In our view, Technology has become the most defensive cyclical sector. Notably, Tech carries roughly 25% of its assets in cash, which can be used to fund M&A activity, buybacks and dividend increases. While 2Q earnings results have been somewhat disappointing, we expect a reacceleration in 2H11.

Health Care

While 2Q results have been mixed, Health Care earnings trends have been strong over the past three quarters. Within the sector, we believe that larger companies will increasingly look to acquire small-cap names to achieve growth objectives. We note that the group does face longer-term profitability concerns given increased government intervention.

Market Weight

Energy

We believe that commodity prices and the Energy sector will benefit from an improving demand outlook. However, recent earnings results have been somewhat disappointing. Moreover, we expect energy prices to remain volatile over the next several quarters.

We’re most favorable toward Media and names exposed to high-end consumer spending

In our view, Tech has become the most defensive cyclical sector

We expect continued commodity price volatility


UBS 33


Market Weight (continued)

Materials

We expect Materials’ performance to remain closely tied to the outlook for the global economy and commodity prices, which could be volatile. We note that Materials’ undervaluation gap relative to the Energy has recently closed.

Underweight

Financials

We believe that many smaller banks remain undercapitalized, particularly relative to their larger peers, and that REITs will most likely underperform if interest rates rise. Moreover, new regulations could pose challenges to longer-term returns on capital and earnings growth. However, we note that the sector appears attractively valued on a normalized basis.

Consumer Staples

Consumer Staples could benefit from a defensive trade over the near term. Additionally, we continue to believe that the sector has strong secular growth prospects. However, we expect the sector to underperform as the 2H economic outlook gradually improves. Additionally, Staples appears somewhat expensive on a normalized basis.

Telecom

Telecom companies delivered disappointing earnings results in 2Q reports. Additionally, the group will most likely underperform if economic fundamentals reassert themselves and interest rates rise. Additionally, we believe that the group faces challenging competitive pressures over the long term.

Utilities

The Utilities sector is expected to post the lowest earnings growth of any sector over the next two years. Moreover, the sector faces a challenging pricing environment and may feel an outsized impact from increased regulations. However, the sector could outperform significantly if longer-term government bond yields continue to decline.

Many Banks will have to reinvest profits into their balance sheets rather than loan growth

Staples look expensive and cyclical sectors should have more earnings leverage


UBS 34


Consumer: Retailers vs. Food Retailers

0.25

0.35

0.45

0.55

0.65

0.75

0.85

0.95

00 01 02 03 04 05 06 07 08 09 10 11

81

86

91

96

101

106

111

116

LEI ►

◄ Retail vs. Food Retail

Source: Standard & Poor’s, FactSet, and UBS

Industrials: Capital Goods vs. Comm. Services

0.95

1.05

1.15

1.25

1.35

1.45

1.55

1.65

00 01 02 03 04 05 06 07 08 09 10 11

81

86

91

96

101

106

111

116

LEI ►

◄ Cap Goods vs. Comm Svcs


If a recession in avoided, Retailers could see significant outperformance

Currently, we favor Capital Goods companies with later-cycle end market exposure


UBS 35


Technology: Semis vs. Hardware

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

00 01 02 03 04 05 06 07 08 09 10 11

81

86

91

96

101

106

111

116

LEI ►

◄ Semis vs. Hardware


Financials: Loan Loss Reserves (% Assets)

0

1

2

3

4

5

84 86 88 90 92 94 96 98 00 02 04 06 08 10

◄ Banks with avg assets >$15B

Banks with avg assets <$1B ▲

Source: Federal Reserve, FRED database and UBS

We expect Semis to outperform if the economic outlook improves

Smaller banks are still building loan loss reserves


UBS 36

UBS Return Drivers

UBS Market Leadership Framework

Valuation

Earnings Fundamentals

Op Leverage

Non-Cyclicals

Cyclicals

I. Early Phase II. Middle Phase III. Late Phase

Volatility Quality

Source: UBS

Russell 2000 Cyclicals vs. Non-Cyclicals

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

03 04 05 06 07 08 09 10 11

89

93

97

101

105

109

113

117

LEI ►

▲◄ Cyclicals v Non-Cyclicals


Different investment characteristics are rewarded at each stage of the investment cycle

Cyclicals and Non-Cyclicals tend to trade in-line during the middle of the cycle


UBS 37

UBS Return Drivers

UBS Small Cap Return Drivers

3.8

-3.3-3.7 -1.3-2.8 0.21.4 1.5

Vol Op Lev Sm Cap PEG Ern Surp RevGrwth

Div Yld ROE

Apr 11 - Aug 11: Reemerging Concerns

Offense DefenseMiddle

2.51.8

1.2

4.7

2.5

4.3

-1.4-0.1

Op Lev Vol Sm Cap PEG Ern Surp RevGrwth

Div Yld ROE

Sept 10 - March 11: Entering the Middle Innings


3.8

-3.3-4.7 -1.9-1.42.1 1.9

3.0

Vol Sm Cap Op Lev PEG Earn Surp Div Yld Rev Gwth ROE

May 10 - Aug 10: Credit Concerns


-17.3-13.7-8.4-5.4

17.2

3.4

27.0 26.7

Vol Sm Cap Op Lev PEG Earn Surp Div Yld Rev Gwth ROE

Mar 09 - Apr 10: Junk Rally


Source: Standard & Poor’s, Compustat, Thomson Financial, Worldscope, FactSet and UBS

Initially, the recent defensive rotation was about slowing growth; now it’s primarily about credit concerns

Revenue Growth was a big winner during the market’s strong run from September to March

Credit concerns drove a defensive rotation last summer

The “junk” trade was on during the initial phases of the market rally

See Appendix for UBS Return Driver calculation methodology


UBS 38

UBS Return Drivers — Revenue Growth

Revenue Growth Return Driver

90

95

100

105

110

115

120

01 02 03 04 05 06 07 08 09 10 11

75

84

93

102

111

120

LEI ►

◄ Rev Growth ▼

March '09

Oct '02


Revenue Growth — Sector Performance

16.8

8.76.9 5.8 5.4 5.2

2.4 1.90.8

30.9

-2.4

STPL EN MAT FIN SP600 DISC HC UTIL TECH IND TLCM

Relative Outperformance

Relative Underperformance

Sep 10 - Aug 11


Companies producing the highest revenue growth have performed surprisingly well in recent months

Revenue Growth has been working broadly


UBS 39

UBS Return Drivers — PEG

PE to Growth (NTM) Return Driver

89

94

99

104

109

01 02 03 04 05 06 07 08 09 10 11

75

84

93

102

111

120

▲LEI ►

◄ PEG ▼

March '09


PE to Growth (NTM) — Sector Performance

9.08.3

7.3

3.32.8

2.1 1.7

0.7-2.8 -3.2

9.3

STPL EN MAT FIN SP600 DISC HC UTIL TECH IND TLCM

Relative Outperformance

Relative Underperformance

Sep 10 - Aug 11


PEG generally works in the middle innings of the cycle

PEG is working broadly as well



UBS 40

UBS Return Drivers — Cap & Op Leverage

Small Market Cap Return Driver

95

100

105

110

115

120

125

130

135

01 02 03 04 05 06 07 08 09 10 11

75

84

93

102

111

120

▼ LEI ►

◄ Small Market Cap


Operating Leverage Return Driver

95

100

105

110

115

120

01 02 03 04 05 06 07 08 09 10 11

75

84

93

102

111

120

▼ LEI ►

◄ Op Leverage


Cap is not a primary driver of returns in the middle innings of the cycle

Operating Leverage should continue to add value in cyclical sectors if recession is avoided


UBS 41

UBS Return Drivers — Valuation

Earnings Yield Return Driver

100

110

120

130

140

150

160

170

00 01 02 03 04 05 06 07 08 09 10


Dividend Yield Return Driver

95

100

105

110

115

120

00 01 02 03 04 05 06 07 08 09 10


Buying cheaper stocks tends to add value over time

Dividend Yield is a cyclical characteristic



UBS 42

Small vs. Large

Relative Performance – Russell 2000 vs. 1000

50

70

90

110

130

150

170

78 81 84 87 90 93 96 99 02 05 08

Source: Russell and UBS Note: Recessionary periods highlighted

Sector Weights R2000 R1000 Difference

Cyclicals 57.6 % 56.6 % 1.0 %

C. Discretionary 13.3 11.6 1.7

Industrials 15.5 10.7 4.8

Technology 16.9 18.2 -1.3

Materials 4.9 4.3 0.6

Energy 7.0 11.7 -4.8

Non-Cyclicals 20.8 28.7 -7.9

C. Staples 3.6 10.2 -6.6

Health Care 12.5 11.7 0.7

Telecom 1.0 3.0 -2.0

Utilities 3.7 3.8 -0.1

Index ex-Fin 78.3 85.2 -6.9

Financials 21.7 14.8 6.9

Index 100.0 100.0 0.0 Source: Russell, FactSet and UBS

We expect small caps to outpace large companies over the medium term


UBS 43

Small vs. Large

Relative P/E

0.7

0.9

1.1

1.3

1.5

1.7

1.9

00 01 02 03 04 05 06 07 08 09 10 11

Small CapsCheap

Small CapsExpensive

Source: Russell, Thomson Financial and UBS

Small vs. Large Cons. Earnings Estimates 2011 Earnings Growth 2012 Earnings Growth

R2000 R1000 R2000 R1000Cyclicals

C. Discretionary 7.4 % 17.7 % 45.6 % 14.6 %Industrials 30.7 18.2 36.4 19.3Technology 11.2 15.5 25.0 11.6Energy 100+ 36.0 100+ 12.8Materials 48.8 43.9 27.0 14.8

Non-Cyclicals

C. Staples -3.3 8.4 72.7 9.4Health Care 100+ 7.0 100+ 7.6Telecom Svcs 71.6 10.9 100+ 22.1Utilities -0.1 1.7 8.4 1.0

Index ex-Fin 40.6 17.5 45.0 12.1

Financials 100+ 14.0 46.5 33.7

Index 62.1 16.9 45.3 15.4 Source: Russell, Thomson Financial, FactSet and UBS Note: Analysis excludes FBP

Small caps’ relative valuation is near the high end of the historical range

We believe small caps’ premium is justified given higher expected earnings growth


UBS 44

Growth vs. Value

Relative Performance

10

30

50

70

90

110

130

150

78 81 84 87 90 93 96 99 02 05 08

Source: Russell and UBS

Sector Weights Growth Value Difference

Cyclicals 66.8 % 48.2 % 18.6 %

C. Discretionary 14.8 11.7 3.2

Industrials 16.0 15.0 1.1

Technology 22.7 11.0 11.8

Energy 8.8 5.2 3.6

Materials 4.4 5.4 -1.0

Non-Cyclicals 20.9 13.5 7.4

C. Staples 4.2 2.9 1.3

Health Care 19.6 5.3 14.2

Telecom 1.2 0.8 0.5

Utilities 0.1 7.3 -7.3

Index ex-Fin 92.0 64.6 27.4

Financials 8.0 35.4 -27.4

Index 100.0 100.0 0.0 Source: Russell, FactSet and UBS

We expect Growth to outperform Value

Technology is over 20% of Growth

Financials is over 35% of Value


UBS 45

Growth vs. Value

Relative P/E

0.5

1.0

1.5

2.0

2.5

3.0

3.5

90 92 94 96 98 00 02 04 06 08 10

Growth Cheap

Growth Expensive


Growth vs. Value Cons. Earnings Estimates 2011 Earnings Growth 2012 Earnings GrowthGrowth Value Growth Value

Cyclicals

C. Discretionary 22.0 % 1.2 % 23.5 % 68.9 %Industrials 42.6 22.8 29.8 43.9Technology 18.3 3.7 23.0 24.1Energy 100+ 100+ 100+ 100+Materials 74.5 32.4 22.8 27.3

Non-Cyclicals

C. Staples 70.5 -32.6 32.0 100+Health Care 85.7 3.0 100+ 95.0Telecom Svcs 72.7 44.5 100+ 100+Utilities 22.2 -0.9 18.6 8.4

Index ex-Fin 84.5 12.9 39.0 49.1

Financials 18.0 100+ 39.3 50.3

Index 75.5 44.9 39.0 49.5 Source: Russell, Thomson Financial, FactSet and UBS Note: Analysis excludes FBP

On a relative basis, Growth and Value P/Es are within historical norms

Earnings growth differentials are largely explained by easy comps


UBS 46

Fund Positions

Select Small-Cap Core Funds — Relative Sector Positions

4.13.7 3.4

1.1 0.9-6.9-1.9-1.6-1.3-0.9-0.7

En Mat Ind Other Stpls Telcm HCare Util Discr Tech Fin

Source: Lionshares, Russell, FactSet and UBS Note: Analysis is based on 2Q11 holdings data for six large small-cap core funds. 2Q11 holdings data for one of the funds is as of May 31, 2011

Select Small-Cap Core Funds — Top 10 OWs and UWs

Rel Weight Return (%)Ticker Company Name 2Q11 August YTDOverweightsASNA Ascena Retail Group Inc. 40 -12.1 7.6MANT ManTech International Corp. (Cl A) 31 -8.1 -9.3NUS Nu Skin Enterprises Inc. (Cl A) 29 12.7 39.8CATO Cato Corp. (Cl A) 26 -8.8 -7.4BKE Buckle Inc. 26 -11.1 4.3IGTE iGATE Corp. 26 -25.1 -43.0JDAS JDA Software Group Inc. 23 -5.5 -5.7CLC CLARCOR Inc. 22 5.6 8.5KCG Knight Capital Group Inc. (Cl A) 22 14.1 -6.4MMS Maximus Inc. 22 -4.2 12.8UnderweightsHS HealthSpring Inc. -25 -4.9 47.2NETL NetLogic Microsystems Inc. -22 -13.1 -4.4BRY Berry Petroleum Co. Cl A -22 -14.5 12.2ROSE Rosetta Resources Inc. -22 -11.2 22.1PMTC Parametric Technology Corp. -22 -13.4 -20.1DAN Dana Holding Corp. -21 -23.5 -25.9TEN Tenneco Inc. -21 -17.9 -20.3SIVB SVB Financial Group -20 -24.5 -13.1BMR BioMed Realty Trust Inc. -20 -6.8 -1.9MFA MFA Financial Inc. -20 0.0 -8.2

Source: Lionshares, Russell, FactSet and UBS Note: Analysis is based on 2Q11 holdings data for six large small-cap core funds. 2Q11 holdings data for one of the funds is as of May 31, 2011

Many Core managers are overweight commodity sensitive areas and underweight Financials


UBS 47

Fund Positions

Select Small-Cap Growth Funds — Relative Sector Weights

6.3

1.60.8 0.5 0.2 0.0 -3.6-2.8-1.6-1.30.0

Discr Fin En Util Other Telcm Mat Stpls Ind Hcare Tech

Source: Lionshares, Russell, FactSet and UBS Note: Analysis is based on 2Q11 holdings data for six large small-cap growth funds

Select Small-Cap Value Funds — Relative Sector Weights

7.5

4.6

2.7 2.60.9 0.8 0.4 -15.8-2.3-1.5-0.2

En Tech Ind Mat Hcare Stpls Other Discr Telcm Util Fin

Source: Lionshares, Russell, FactSet and UBS Note: Analysis is based on 2Q11 holdings data for six large small-cap value funds. 2Q11 holdings data for one of the funds is as of May 31, 2011

Many Growth managers are underweight Tech

Many Value managers are underweight Financials


UBS 48

Investment Regimes

Dow Jones Industrials — Super Cycle Log Scale

all or

nothing

10 20 30 40 50 60 70 80 90 00 104050

100

200300400500

1,000

2,0003,0004,0005,000

10,000

Source: Dow Jones, FactSet and UBS

S&P 500 E/P vs. Inflation (Disco Regime)

72 74 76 78 804

6

8

10

12

14

16

Inflation ►

Earnings Yield ▼

Source: Standard & Poor’s, Dept. of Labor, Thomson Financial, FactSet and UBS Note: Earnings Yield based on trailing earnings; CPI (+2%) is lagged by 3 months

In the 1970s “Disco Regime,” inflation was the primary driver of stock values

Equities experience prolonged booms or periods of anemic returns

These “investment regimes” hold the key to stock prices


UBS 49

Investment Regimes

S&P 500 E/P vs. 10 Yr Yield (Great Moderation)

82 84 86 88 90 92 94 96 984

6

8

10

12

14

16◄ Earnings Yield

10-year Yield ▲

Source: Federal Reserve, Standard & Poor’s, Thomson Financial, FactSet and UBS

S&P 500 E/P vs. Baa Yields (Millennium Regime)

5

6

7

8

9

10

04 05 06 07 08 09 10 11

Earnings Yield ►

▲ Baa Yield

P/E Anchored to Baa Bond Yields

Slower Growth

Recession Fears

g )er(i

pr

gk

pr

E

P 11

1

0

−++=

−=

rprf

Source: Moody’s, Standard & Poor’s, Thomson Financial, FactSet and UBS

During the “Great Moderation” the Fed Model explained returns

Stocks look attractively valued relative to bond equivalents

We believe long-term growth concerns will restrain multiple expansion


UBS 50

Russell 2000 Valuation

Russell 2000 — Forward P/E

8

12

16

20

24

28

32

36

40

00 01 02 03 04 05 06 07 08 09 10 11

Undervalued

Overvalued


Russell 2000 vs. Russell 1000 — Forward P/E

0.7

0.9

1.1

1.3

1.5

1.7

1.9

00 01 02 03 04 05 06 07 08 09 10 11

Small CapsCheap

Small CapsExpensive


Small caps are trading below historical averages on an absolute basis

Small caps look expensive on a relative basis


UBS 51

Russell 2000 Valuation

Russell 2000 – Price-to-Book

1.0

1.5

2.0

2.5

3.0

00 01 02 03 04 05 06 07 08 09 10 11

Undervalued

Overvalued

Source: Russell, Compustat, FactSet and UBS

Russell 2000 vs. Russell 1000 – Price-to-Book

0.4

0.5

0.6

0.7

0.8

0.9

1.0

00 01 02 03 04 05 06 07 08 09 10 11

Small CapsCheap

Small CapsExpensive

Source: Russell, Compustat, FactSet and UBS

The Russell 2000 appears reasonably valued on a price-to-book basis


UBS 52

Inter-Sector Relative Valuation

Industrials vs. Technology

-20

-15

-10

-5

0

5

10

15

20

94 96 98 00 02 04 06 08 10

P/E

Mu

ltip

le P

oin

ts

-20

-15

-10

-5

0

5

10

15

20

◄ Industrials

Technology ►

Overvalued

Undervalued

Source: Thomson Financial, Russell, FactSet and UBS

Consumer Discretionary vs. Financials

-20

-15

-10

-5

0

5

10

94 96 98 00 02 04 06 08 10

P/E

Mu

ltip

le P

oin

ts

-20

-15

-10

-5

0

5

10

◄ Discretionary

Financials ►

Overvalued

Undervalued


Industrials and Technology appear reasonably valued


UBS 53

Inter-Sector Relative Valuation

Energy vs. Materials

-25

-20

-15

-10

-5

0

5

10

15

20

94 96 98 00 02 04 06 08 10

P/E

Mu

ltip

le P

oin

ts

-25

-20

-15

-10

-5

0

5

10

15

20

◄ Energy

Materials ►

Overvalued

Undervalued


Health Care vs. Staples

-25

-20

-15

-10

-5

0

5

10

15

94 96 98 00 02 04 06 08 10

P/E

Mu

ltip

le P

oin

ts

-25

-20

-15

-10

-5

0

5

10

15

◄ Health Care

Staples ►

Overvalued

Undervalued


The divergence between Energy and Materials valuations has recently closed

Consumer Staples appears modestly overvalued

See Appendix for inter-sector relative valuation methodology


UBS 54

Appendix: UBS Return Drivers We define market leadership by specific stock characteristics, such as Size (small vs. large), Valuation (expensive vs. cheap), Growth, Momentum, and Volatility. We track fifteen such characteristics, which we have dubbed “UBS Return Drivers.”

UBS Return Drivers

Size (Capitalization) Price Volatility Revenue Surprise

Operating Leverage Financial Leverage Earnings Surprise

Fwd Earn Yld (E/P) Dividend Yield PEG Ratio

Earnings Growth Return on Equity Total Payout

Book Value Yld (B/P) Foreign Sales Revenue Growth

Source: UBS

Computation Each Return Driver is calculated as a hypothetical long/short portfolio built around a single quantitative decision variable. Our calculations assume monthly rebalancing and no transaction or borrowing costs. For each Return Driver, the computation process has four steps:

(1) Break Stocks into Industry Groups. While our Return Drivers are reported at the sector and index level, our process starts by breaking the S&P 600 into its 24 GICS industry groups.

S&P 600 GICS Sectors and Industry Groups

Source: Standard and Poor’s and UBS

(2) Rank Based on Return Drivers. Within each industry group, stocks are ranked from top to bottom by the Return Driver in question (e.g., highest to lowest price volatility). The list is then broken into three groups: top-third, middle-third, and bottom-third. Our calculations assume that the top-third of stocks are bought and the bottom-third of stocks are sold.

Ranking and Return Calculation Methodology

Top 1/3Buy (Top 1/3).Stock returns equal-weighted within industry group

Middle 1/3

Bottom 1/3Sell (Bottom 1/3).Stock returns equal-weighted within industry group

Source: UBS

Sectors Industry Groups

Energy Energy

Materials Materials

Industrials Capital Goods; Commercial & Professional Services; Transportation

Consumer Cyclicals Autos; Consumer Durables & Apparel; Consumer Services; Media; Retailing

Consumer Staples Food & Staples Retailing; Food Beverage & Tobacco; Household & Personal Products

Health Care Health Care Equipment & Services; Pharmaceuticals, Biotech & Life Sciences

Financials Banks; Diversified Financials; Insurance; Real Estate

Technology Software & Services; Hardware & Equipment; Semiconductors & Equipment

Telecom Telecommunication Services

Utilities Utilities


UBS 55

(3) Calculate Returns. Monthly returns are then calculated by subtracting the returns of the bottom-third (sells) from the top-third (buys). The result is then divided by two to put the outperformance in a long-only context. This analysis is done on an equal-weighted basis within each Industry Group.

Return Driver Calculation — Hypothetical Example Foreign Sales Calcualtion — Industry Group Example

Long: Highest Foreign Sales Stocks (Top 1/3) 9.8%Short: Lowest Foreign Sales Stocks (Bottom 1/3) 4.6%Difference 5.2%Divide by 2 ÷ 2Factor Result 2.6%

Source: UBS

(4) Aggregate Results. At the sector level, Returns Drivers are calculated as a weighted average of industry group returns based on S&P 600 index weights. S&P 600 index results are a weighted average of sector results. We also index monthly returns as a time series for further analysis.

GICS Sectors and Industry Groups — S&P 600

S&P 600

Sector Sector

Industry Group Industry Group

Cap-weighted result of Sector Average

Cap-weighted result of Industry Group Average

S&P 600

Sector Sector


S&P 600

Sector Sector


Cap-weighted result of Sector Average

Cap-weighted result of Industry Group Average

Source: Standard and Poor’s and UBS

(5) Analytics. There are several ways that UBS Return Drivers can be used in investment decision making. We have listed a few below:

Identify Winning Investment Characteristics. UBS Return Drivers identify which specific equity characteristics have outperformed and underperformed during a specific time period. This data is available at the industry group, sector, and index level. Additionally, investors can get a sense for the magnitude of outperformance or underperformance of Return Drivers relative to one another.

Track Historical Trends. In our analysis, we track the performance of each one of our Return Drivers over time. This allows us to identify the types of market environments in which each Return Driver tends to outperform or underperform.

Avoid Crowded Trades. Our work also helps identify over-loved and under-loved investment themes. For each UBS Return Driver, we track the valuation spread between the top-third of companies and the bottom-third of companies over time. As such, we can help identify points when particular portfolio tilts or trades appear to be “crowded” or “priced in.” Alternatively, we can also identify points when upside opportunities appear outsized.


UBS 56

Appendix: Inter-Sector Valuation The goal of our inter-sector valuation work is to gauge whether each Russell 2000 GICS sector is undervalued or overvalued relative to the overall market. Our analysis is based upon the historical valuation relationships between sectors. Importantly, we normalize sector valuations for three dynamics that could potentially provide spurious results, if not accounted for correctly:

Some sectors tend to be more expensive than others on a systematic basis (e.g., Tech consistently trades at a higher P/E than Financials).

The valuation dispersion between sectors is wide in some environments (e.g., the early-00s) and tight in others (e.g., 2010). In other words, a multiple point today is not necessarily the same as a multiple point yesterday.

Sector dynamics change over time. For example, Tech traded at a premium multiple in the late-90s and early-00s, but trades relatively inline with the market today.

Our inter-sector valuation work suggests that relative sector valuations are mean-reverting over medium-term time frames. As such, we view our inter-sector valuation rankings as a good starting point in determining sector recommendations. However, we note that sectors can stay cheap or expensive for multi-year time periods.

Ranking Overview In order to properly normalize inter-sector valuations over time, our analysis focuses on how many standard deviations away each sector’s P/E is from the market’s P/E. (For our fellow math geeks, this is known as cross-sectional standard deviation analysis.) We then put this calculation into a historical context on a sector-by-sector basis.

In the table below, we provide an overview of the calculations behind our inter-sector valuation rankings. On the following page, we walk though our calculations on a step-by-step basis.

Inter-Sector Valuation Ranking Overview — Hypothetical Example

(A) (B) (C=A-B) (D) (E=C/D) (F) (G=E-F) (H)Sector Market Premium Market Z Score Avg Z Net Z

Sector Fwd P/E Fwd P/E (Current) Std Dev (1) Current (Trail 36M) Current RankMaterials 13.54x 13.2x 0.3 1.4 0.2 1.1 -0.86 1Technology 13.13x 13.2x -0.1 1.4 -0.1 0.7 -0.80 2Financials 11.71x 13.2x -1.5 1.4 -1.1 -0.6 -0.47 3Energy 12.09x 13.2x -1.1 1.4 -0.8 -0.6 -0.15 4Health Care 12.19x 13.2x -1.0 1.4 -0.7 -0.9 0.15 5Cons. Staples 14.71x 13.2x 1.5 1.4 1.0 0.7 0.34 6Utilities 13.35x 13.2x 0.1 1.4 0.1 -0.4 0.47 7Cons. Discretionary 15.20x 13.2x 2.0 1.4 1.4 0.9 0.51 8Industrials 15.23x 13.2x 2.0 1.4 1.4 0.7 0.72 9Telecom 14.63x 13.2x 1.4 1.4 1.0 -0.1 1.13 10

(1) Represents the standard deviation of the Russell 2000’s Forward P/E Source: First Call, Russell and UBS


UBS 57

Step-by-Step Calculations (1) Aggregate P/Es and Standard Deviations (columns A, B and D). First, we calculate a forward P/E

for the market and all ten of its sectors, using consensus EPS estimates over the next twelve months. We also calculate the weighted average standard deviation of the market’s forward P/E.

(2) Calculate Z-Scores (column C). Next, we calculate a Z-Score for each sector. This expresses each sector’s P/E as a number of standard deviations away from the market’s P/E. This is calculated by subtracting the market’s P/E from each sector’s P/E and dividing the result by the weighted average standard deviation of the market’s forward P/E.

Z-Score Calculation

Market P/E

MarketSector

)P/E(P/EScore-Sector Z

σ−=

Source: UBS

(3) Put Current Valuations in Historical Context (columns E, F and G). A Net Z-Score is then calculated for each sector by comparing current Z-Scores to average Z-Scores over the prior 36 months. We perform our analysis on a rolling 36-month basis to account for secular changes in sector dynamics (e.g., new governmental regulations).

Net Z-Score — Valuation in Historical Terms

AverageMonth -36CurrentScore- Z Score- ZScore-Net Z minus=

Source: UBS

(4) Rank Sectors from Most to Least Expensive (column H). We then rank all ten sectors based upon their Net Z-Scores (i.e., how expensive or cheap each sector’s current Z-Score is in comparison to its historical average). Sectors with negative scores are cheap on a relative basis. Sectors with positive scores are expensive.

(5) Convert Net Z-Scores into Current P/E Multiple Points. To make the visual interpretation of our analysis easier to understand, we covert each sector’s historical Net Z-Scores into current P/E multiple points (cheap or expensive). This is done by multiplying the historical Net Z-Scores by the current weighted average standard deviation of the market’s forward P/E.

Health Care — Multiple Points Cheap / Expensive

-3

-2

-1

0

1

2

97 99 01 03 05 07 09

P/E

Mu

ltip

le P

oin

ts

Overvalued

Undervalued



UBS 58

Analyst Certification

Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers and were prepared in an independent manner, including with respect to UBS, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report.


UBS 59

Required Disclosures

This report has been prepared by UBS Securities LLC, an affiliate of UBS AG. UBS AG, its subsidiaries, branches and affiliates are referred to herein as UBS.

For information on the ways in which UBS manages conflicts and maintains independence of its research product; historical performance information; and certain additional disclosures concerning UBS research recommendations, please visit www.ubs.com/disclosures. The figures contained in performance charts refer to the past; past performance is not a reliable indicator of future results. Additional information will be made available upon request. UBS Securities Co. Limited is licensed to conduct securities investment consultancy businesses by the China Securities Regulatory Commission.

UBS Investment Research: Global Equity Rating Allocations

UBS 12-Month Rating Rating Category Coverage1 IB Services2

Buy Buy 54% 39%Neutral Hold/Neutral 39% 35%Sell Sell 7% 14%

UBS Short-Term Rating Rating Category Coverage3 IB Services4

Buy Buy less than 1% 33%Sell Sell less than 1% 25%

1:Percentage of companies under coverage globally within the 12-month rating category. 2:Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided within the past 12 months. 3:Percentage of companies under coverage globally within the Short-Term rating category. 4:Percentage of companies within the Short-Term rating category for which investment banking (IB) services were provided within the past 12 months. Source: UBS. Rating allocations are as of 30 June 2011. UBS Investment Research: Global Equity Rating Definitions

UBS 12-Month Rating Definition

Buy FSR is > 6% above the MRA. Neutral FSR is between -6% and 6% of the MRA. Sell FSR is > 6% below the MRA.

UBS Short-Term Rating Definition

Buy Buy: Stock price expected to rise within three months from the time the rating was assigned because of a specific catalyst or event.

Sell Sell: Stock price expected to fall within three months from the time the rating was assigned because of a specific catalyst or event.


UBS 60

KEY DEFINITIONS

Forecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12 months. Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not a forecast of, the equity risk premium). Under Review (UR) Stocks may be flagged as UR by the analyst, indicating that the stock's price target and/or rating are subject to possible change in the near term, usually in response to an event that may affect the investment case or valuation. Short-Term Ratings reflect the expected near-term (up to three months) performance of the stock and do not reflect any change in the fundamental view or investment case. Equity Price Targets have an investment horizon of 12 months.

EXCEPTIONS AND SPECIAL CASES

UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell: Negative on factors such as structure, management, performance record, discount. Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment Review Committee (IRC). Factors considered by the IRC include the stock's volatility and the credit spread of the respective company's debt. As a result, stocks deemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating. When such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece.

Research analysts contributing to this report who are employed by any non-US affiliate of UBS Securities LLC are not registered/qualified as research analysts with the NASD and NYSE and therefore are not subject to the restrictions contained in the NASD and NYSE rules on communications with a subject company, public appearances, and trading securities held by a research analyst account. The name of each affiliate and analyst employed by that affiliate contributing to this report, if any, follows.

UBS Securities LLC: Chip Miller, CFA; Jonathan Golub, CFA. Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report.


UBS 61

Global Disclaimer

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This report is for distribution only under such circumstances as may be permitted by applicable law. Nothing in this report constitutes a representation that any investment strategy or recommendation contained herein is suitable or appropriate to a recipient’s individual circumstances or otherwise constitutes a personal recommendation. It is published solely for information purposes, it does not constitute an advertisement and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments in any jurisdiction. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein, except with respect to information concerning UBS AG, its subsidiaries and affiliates, nor is it intended to be a complete statement or summary of the securities, markets or developments referred to in the report. UBS does not undertake that investors will obtain profits, nor will it share with investors any investment profits nor accept any liability for any investment losses. Investments involve risks and investors should exercise prudence in making their investment decisions. The report should not be regarded by recipients as a substitute for the exercise of their own judgement. Past performance is not necessarily a guide to future performance. The value of any investment or income may go down as well as up and you may not get back the full amount invested. Any opinions expressed in this report are subject to change without notice and may differ or be contrary to opinions expressed by other business areas or groups of UBS as a result of using different assumptions and criteria. Research will initiate, update and cease coverage solely at the discretion of UBS Investment Bank Research Management. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. The analyst(s) responsible for the preparation of this report may interact with trading desk personnel, sales personnel and other constituencies for the purpose of gathering, synthesizing and interpreting market information. UBS is under no obligation to update or keep current the information contained herein. UBS relies on information barriers to control the flow of information contained in one or more areas within UBS, into other areas, units, groups or affiliates of UBS. The compensation of the analyst who prepared this report is determined exclusively by research management and senior management (not including investment banking). Analyst compensation is not based on investment banking revenues, however, compensation may relate to the revenues of UBS Investment Bank as a whole, of which investment banking, sales and trading are a part.

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