waiting on the fed - urner barry · waiting on the fed april 2015. 1 an ... and crude oil prices...
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CIO Wealth Management ResearchTom McLoughlin
Fixed Income Investments in an Uncertain WorldWaiting on the Fed
April 2015
1
An uncertain world …
Uneveneconomic
growth
Divergent monetary policies
Competing labor forces
Inconsistentfiscal policies
Geopolitical tensions
Increased volatility
Source: UBS CIO WMR, as of April 2015 1
2
The big picture: the Fed is keenly aware of the fact that …
Global growth remains uneven
Monetary policies around the world are diverging
Geopolitical risks are on the rise in the Eurozone, Russia, and the Middle East
Currency values are moving in different directions, and
Demand for labor is evolving as the economy is buffeted by technological change
Source: UBS CIO WMR, as of April 2015 2
Let's take a closer look at the last item a little more closely …
3
Technology adoption is faster
Source: Citigroup Global Perspectives, UBS CIO WMR, as of April 2015 3
Time to reach 50 million users
Telephone
TV
Internet
Angry birds
Radio
75 years
38 years
3.5 years
13 years
4 years
35 days
4
Triggering some creative destruction
Source: Brynjolfsson and McAfee, The Second Machine Age, UBS CIO WMR, as of April 2015 4
2004 2008
Music sales on physical media
In music …
800M units$12.3B in sales
400M units$7.4B in sales
5
In books …
Creative destruction
Source: Brynjolfsson and McAfee, The Second Machine Age, UBS CIO WMR, as of April 2015 5
Amazon.com2,000,000 titles
Barnes & Noble NYC Flagship store : 40,000
titles
6
Creative destruction
Source: Brynjolfsson and McAfee, The Second Machine Age, UBS CIO WMR, as of April 2015 6
In photography …
Through 2014, there were 3.5 trillion photographs taken since the first image was captured in Paris in 1838
10% of that total were taken in the last 12 months
Eastman Kodak employed 145,300 employees and had a market share of 90% at its peak
The company invented the digital camera in 1975 but shelved the idea
Today 2.5 billion people have the capability of taking digital photographs and Kodak is a shadow of its former self
7Source: UBS CIO WMR, as of April 2015 7
Intellectual property
• Patents• Copyrights
Efficiency
• Automation – auto assembly• Self service – airline check-
in• Mobility – RFID, airline bag
tags
Business model
• User generated content− Yelp, Trip Advisor
• On-line delivery of services− Amazon.com
Economic Drivers in an Era of Accelerating Technological Change
8
Creating winners and losers
Source: Citigroup Global Perspectives, UBS CIO WMR, as of April 2015 8
1990 2015Big 3 Automakers Big 3 Tech Companies
Employees: 1.2 million
Market Cap: $36B
Employees: 137,000
Market Cap: $1.3T
9
Are we measuring economic activity properly?
Source: Brynjolfsson and McAfee, The Second Machine Age, UBS CIO WMR, as of April 2015 9
QuestionHow much would you pay (or more accurately, would have paid) for services now available for free on the Internet?
AnswerIn a McKinsey survey, the answer was: $50 per month or an estimated $35 billion annually.
10
Squeezing the middle class and altering labor demand
Source: UBS CIO WMR, as of April 2015 10
In high demandEngineersPlumbersElectriciansDentistsGardeners
In less demandBookkeepersBank tellersBilling clerksTelephone operatorsAssembly line workers
11
Factors driving rates in the United States
• Unemployment rate falls• Private sector job creation
• Subdued inflation• The flight to safety• A strengthening dollar• ECB engages in QE• Portfolio rebalancing• Harsh winter slows growth
Source: UBS CIO WMR, as of April 2015 11
12Source: Bloomberg, UBS CIO WMR, as of 31 March 2015
A low inflation rate encourages patience by the Fed
12
13
North American oil productionIn 1,000 barrels per day
Crude remains under pressureWTI crude price
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
1990 1995 2000 2005 2010 20150
20
40
60
80
100
120
140
160
2000 2003 2006 2009 2012 2015
And crude oil prices decline, a net positive for the US
Source: Bloomberg, UBS CIO WMR, as of 8 April 2015 13
14
5
6
7
8
9
10
11
12
13
Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 1.0
1.5
2.0
2.5
3.0
3.5
600
800
1000
1200
1400
1600
Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15
RTS index (lhs)Source: Bloomberg, UBS CIO WMR, as of 8 April 2015
But alters the outlook for the Eurozone, Russia, and Middle East
Great default looms, exit risk moderate but risingGreek 10-year government bond yield
Russian equity market and the rubleHistorical levels
14
15
Meanwhile, while central bank assets have increased …
Total assets of global central banks$ in billions
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
2005 2007 2009 2011 2013 2015
PBoC ECB Fed BoJ
Source: Bloomberg, UBS CIO WMR, as of 8 April 2015 15
16
… global monetary policies are now diverging
Source: UBS Investment Research, UBS CIO WMR, as of 31 March 2015 16
17
Payrolls have continued to trend higher despite the recent dataUS non-farm payrolls
(1000)
(800)
(600)
(400)
(200)
0
200
400
600
2008 2009 2010 2011 2012 2013 2014 2015
Non farm payrolls 12 month moving average
Source: Bloomberg, UBS CIO WMR, as of 8 April 2015
The economic expansion in the US appears durable …
17
18
Government bond yield curves
(0.5)
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3M 6M 1Y 2Y 3Y 5Y 7Y 10Y 30Y
US Germany Japan Italy
… and puts the Fed is on path towards normalization
Source: Bloomberg, UBS CIO WMR, as of 8 April 2015 18
19
0.0
0.5
1.0
1.5
2.0
2.5
3.0
0 5 10 15 20 25 30
Yiel
d to
mat
urity
(%)
Maturity (years)
Spot Fwd (3mo) Fwd (6mo) Fwd (9mo) Fwd (1yr)
… leaving the front end of the curve more exposed …
Source: UBS CIO WMR, as of 20 March 2015 19
20
1yr forward curve today vs. spot curve on 9/5/2013
… as investors expect the Treasury curve to flatten
0
0.5
1
1.5
2
2.5
3
3.5
4
2yr 5yr 10yr 30yr
Yiel
d to
mat
urity
(%)
Maturity (years)9/5/2013 3/25/2016
Source: UBS CIO WMR, as of 26 March 2015 20
21
Total return by fixed income sector
Total ReturnIn %
Source: BofAML, Bloomberg, UBS CIO WMR, as of 6 April 2015
-10% -5% 0% 5% 10% 15% 20%
Treasuries
TIPs
Agencies
Investment Grade
High Yield
Preferreds
Emerging Markets
Build America Bonds
Munis
Taxable FI Agg
S&P 500
2015 YTD TR 2014 TR
21
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Yields have continued to trend lower
0
2
4
6
8
10
12
1980 1985 1990 1995 2000 2005 2010 2015
Source: Bloomberg, UBS CIO WMR, as of 8 April 2015
10 year Treasury yieldsAverage yield per year, in %
23
Biggest challenge: where to find income?
(1)
0
1
2
3
4
5
6
7
Source: BofAML, UBS CIO WMR, as of 6 April 2015
Yield-to-worstYield, in percent
24
The zero rate policy fuels higher volatility …
1.42.43.44.45.46.47.48.49.410.411.412.413.4
50
100
150
200
250
Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15
MOVE Index MOVE Index AVG 10-Year Treas Vol 10-Year Vol Avg
Pre-Crisis Post Crisis
The number of times volatility has risen above the average has been greater post crisis
Source: Bloomberg, UBS CIO WMR, as of 9 February 2015 24
Volatility levels and Average over the past 12 years
25
… but the next tightening cycle should be more gradual
Source: Bloomberg, UBS CIO WMR, as of 7 April 2015
Inflation rate is more subdued than in past
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
-3
-2
-1
0
1
2
3
4
5
6
7
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Tightening cycles CPI YOY Avg. Fed tightening cycle inflation rate
25
26
… and a slower rise in rates should boost fixed income returns
Total return of various fixed income spread product during the actual dates of tightening using 1,2, and 3 year projections with rising rates and fed funds
-4
0
4
8
12
16
20
1994 Hikes 1999 Hikes 2004 Hikes Proj. 1yr Proj.2yr Proj. 3yr
US Treas IG Corp HY Invest MBS Preferred
Source: UBS CIO WMR, as of 20 March 2015 26
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Our Outlook: "Will, Won't, Might"
Source: UBS CIO WMR, as of 31 March 2015
• Will happen
− Global growth continues, led mainly by developed economies− The Fed tightens gradually while other central banks ease− The US dollar strengthen just a little more – then trades in a narrow range − European equities get a boost from a lower euro
• Won't happen− Inflation becomes a global problem− The Federal Reserve tightens monetary policy too soon, too much, too fast − The S&P 500 delivers better than average returns without volatility
• Might happen− Structural reforms in EM lead to better earnings outlook & investor sentiment− Long-term interest rates don't budge even if Fed raises the short end− European economic growth accelerates, providing support to the euro
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Preferred investment views
Please see important disclaimer and disclosures at the end of the document.
Recent upgrades Recent downgrades
• USD
• Government bonds ()• US high yield• US investment grade• Mortgage IOs • US senior loans• Beyond benchmark fixed income
investing
Most preferred Least preferred
• US small caps• Eurozone• The rising Millennials• E-Commerce• US capex• Cancer therapeutics
• Emerging Markets ()• UK ()
Equities
Fixed income
Foreign exchange• EUR
Cash
Alternative investments
Portfolio weightings
Source: WMA Asset Allocation Committee (AAC) and UBS CIO WMR, as of 23 April 2015
Note: Portfolio weightings are for USD-based moderate risk profile, taxable account For portfolio weights related to other risk profiles please see the flagship publication UBS House View.
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Source: UBS CIO WMR
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Important Information
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Disclaimer
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