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UBS investor’s guideWealth Management Research25 February 2011

More price pain ahead for food and energy

Interview “Europe cannot continue in the old way” John Bruton, former Irish Prime MinisterMarket outlook Political risks roar into view

UBS investor’s guide 25 February 2011 3

News in briefEditorial

For our weekly market outllook, please see UBS Weekly Guide. It features a focus article with in-depth thematic commentary, the week’s most important economic/market indicators and an overview of market perform-ance and WMR investment strategy.

ContentsNews in brief .............................3

Focus .......................................4-6

Interview ................................7-9

Asset allocation ..................10-11

Economy .............................12-15

Equity market .....................16-27

Bond market .......................28-29

Currencies ...........................30-31

Commodities ......................32-33

Emerging markets ..............34-35

Market scenarios .....................36

This report has been prepared by UBS AG and UBS Financial Services Inc.

Analyst certifi cation and required disclosures begin on page 37.

UBS does and seeks to do business with companies covered in its research re-ports. As a result, investors should be aware that the fi rm may have a confl ict of interest that could aff ect the objectiv-ity of this report. Investors should con-sider this report as only a single factor in making their investment decision.

UBSFS accepts responsibility for the con-tents of this report. US persons who re-ceive this report and wish to eff ect any transactions in any security discussed in this report should do so with UBSFS and not UBS AG.

Dear readers,

All eyes are on the dramatic events unfolding in the Middle East and North Africa (MENA). The root causes behind this wave of defi ance washing over entrenched, autocratic regimes are many and complex. But one com-mon trigger is certainly the rising prices for commodities in general and food in particular. And we think this fac-tor is not yet ready to disappear.

In this month’s Focus article, Dominic Schnider examines the forces behind the recent surges in energy and agri-cultural commodities. He concludes that to dampen de-mand and spur new supply, prices need to rise still more. Moreover, the turmoil in MENA can have the unwel-come eff ect of exacerbating other price increases, espe-cially for oil. Hence, we may be nearing a vicious circle.

The events in MENA have pushed the European sover-eign debt crisis to the back burner for now. Some pun-dits are even sounding an all-clear signal, but we are not among them. Several political milestones over the next couple of months could revive stresses in the Eurozone. The Irish elections on 25 February are one of those po-tential triggers. We are pleased to off er readers the in-sights of the Honorable John Bruton, former Taoiseach (prime minister, in Old Irish) and EU president, on the upcoming Irish vote as well as his assessment of the Eu-rozone’s prospects, which are topics he knows well.

Andreas HoefertChief Economist

Central bankersBundesbank President’s resignation could aff ect Eurozone crisis resolutionGerman central bank (Bundesbank) President Axel Weber announced his resignation by the end of April. Weber had been the front-runner to succeed Jean-Claude Trichet as President of the European Central Bank (ECB) by the end of this year. Weber has been an outspoken critic of ECB support for crisis-ridden countries, fear-ing that the bank’s overriding goal of price sta-bility could eventually be compromised. We-ber’s departure rules him out for the top job at the ECB and is signifi cant for two reasons. Firstly, he was the German government’s fa-vorite to head the ECB. With an infl ation-averse German at the helm of the ECB, the

government hoped to win back support from conservative voters who worry that Germany could be dragged into a transfer union. With Weber now gone, the German government’s room for maneuver at EU crisis summits is lim-ited. Chancellor Angela Merkel may now be forced to adopt a less compromising stance re-garding the indebted countries at the periph-ery. Secondly, there is now a risk that with We-ber’s departure, peripheral countries may expect the future ECB to continue to contain market pressures by intervening in bond mar-kets, leading them to withdraw from unpopu-lar austerity measures and possibly causing the Eurozone to again teeter on the brink of crisis in the future.

The UBS Research Focus “The Eurozone: Lost in transition” looks at the question of how the euro dilemma could be re-solved. Since the disturbances in North Africa erupted, things have calmed down with regard to the problems of the com-

mon European currency. That is certainly not to say that they have gone away. Weaker and stronger states are no closer economically than they were before, and tensions within the Eurozone remain. Politi-cians have been concentrating almost exclusively on combat-ing the crisis and limiting the damage caused. But this does not go far enough, as the debt crises are just symptoms of much deeper structural prob-lems in the eurozone.

Reducing government debt on its own will not be suf-fi cient over the longer term. There are only two ways to re-move the fundamental weak-nesses in the way the currency union has been constructed: further integration towards fi s-cal union, or a redimensioning

of the Eurozone.In other words, either the

individual states will have to cede enormous sovereign rights to the center, or some countries (be it the weaker or the stronger) will leave the cur-rency union. It is a matter of choosing the lesser of two evils, and no politician is pre-pared to make this choice just yet. Crisis management will therefore be the order of the day for the foreseeable future. In the long term, however, the Eurozone needs to be funda-mentally restructured, other-wise it will remain a source of trouble.

Eurozone – a currency area with structural weaknessesThe Eurozone at the crossroads: integrate or resize?The difficult choice between two visions of Europe

The Eurozone: Lost in transition

UBS research focusWealth Management ResearchFebruary 2011

New UBS Research Focus

The Eurozone: Lost in transition

4 UBS investor’s guide 25 February 2011

Focus


Focus

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Source: Bloomberg, UBS WMR

1960 1965 1975 1980 19851970 1990 1995 2000 2010

Price index of agricultural commoditiesPrice index of agricultural commodities in real terms (deflated by US CPI)

More price pain ahead for food and energy

Food and energy prices continue to make headlines around the world. Prices for several agricultural commodities have doubled while coal and crude oil prices have risen steadily. We think even higher prices will be required to ensure true demand rationing and give producers maximum incentive to increase supplies.

Dominic Schnider, Analyst, UBS AG

and the desire to increase strategic domestic inventories are, in our opinion, doing more harm than good – resulting in higher prices.

Substantial investments in production capacities are needed to ensure suffi cient supply cushions in food and energy. In the meantime, we think demand rationing is imperative to pre-vent further deterioration in two important indi-cators, inventories and spare capacities. This means short-term pain for consumers because demand rationing can only be achieved via higher commodity prices. This is especially rele-vant for emerging markets, where a large share of household income is used for food and energy items.

From good to catastrophic in one go The weather did not cooperate in 2010 and it continues to cause problems this year, aff ecting a wide range of commodities. A severe drought and wildfi res sharply cut Russia’s wheat exports, from 18.6mn tons in 2009/10 to just 4mn tons expected in 2010/11. With wheat prices soar-ing, the spillover to other grains was instantane-ous and in short order negative news fl ow fanned market anxieties.

Lower corn yield estimates in the second half of 2010 and the outlook for a 3% shortfall

in supply versus demand then paved the way for corn prices to take off , in our view. Farm acre-age expansions for soybeans in the US, Brazil and Argentina kept prices rather shielded at fi rst. However, with la Niña thought to be caus-ing a severe drought in Argentina and excessive rainfall in Southeast Asia and Australia, higher prices were assured. The expectation that Ar-gentina’s 54.5mn ton soybean crop would drop by 10% or more unsettled markets even further.

Additional pressure came from the palm oil market, which is likely to be undersupplied. With demand for edible oils in China and India growing by 6% p.a. over the last fi ve years, moderate production increases are not enough. Sharp swings in weather patterns have also af-fected the quality of harvests, limiting their use for feed purposes and reducing export sales. Supply shortfalls have not just impacted the grains. Cotton, sugar and coff ee are also strug-gling with insuffi cient supply and are unable to improve their structurally low global stock-to-use ratios.

Devastating fl oods in Australia sent coal prices soaring, once again exposing China and India’s increasing import dependence on coal. Emerging Asia’s growth is fueled by coal. The region should consume an estimated 63% of global coal demand in 2011 and should account for 90% of global demand growth in the sea-borne market.

Crude oil has been aff ected indirectly: not by the weather, but by recent political and social unrest in Africa and the Middle East, which has sparked OPEC related supply concerns. On the demand side, upward revisions in oil demand by key energy-related institutes made clear that the world needs OPEC more than ever. With the risk of OPEC’s spare capacity sliding to critical levels, below 5% of global demand, crude oil prices in Europe and Asia above USD 100/bbl are becom-ing the norm. Due to rising crude oil inventories in the US, US prices (WTI) have lagged behind, delivering temporarily an impressive USD 20/bbl spread to Brent crude.

To ease short-term tightness and move demand into the future, many forward curves fl attened or started to be downward sloped, of-fering consumers and investors a large discount to spot prices. Less economic growth would also help to ease price pressure, but which country wants to make that an explicit policy goal?

Where prices go from here We expect prices for agricultural commodities to advance further, especially in the short term. With supply concerns in South America and risks that China again needs to import large quantities of grains, export demand should remain high for the US, the world’s most impor-tant grain exporter.

To prevent US inventories from falling to record low levels, some demand drivers must give way. For example, corn demand for ethanol production and China’s soybean imports need to ebb. This will only happen if corn and soy-bean prices rise by another 15% to 20%, mak-ing ethanol and soybean oil production uneco-nomical.

With regard to wheat, policy-linked re-stocking and export limitations could squeeze high-quality wheat supplies, with similar price implications. Meanwhile, inadequate invento-

Long-term development of agricultural pricesNominal and real prices, standardized index 1960 = 100

The heat is on for central bankers and politi-cians in emerging markets. Infl ation concerns have reemerged and are threatening to top the price pressures seen at the onset of the fi nancial crisis. As it was three years ago, the focus is on food and energy prices, while core infl ation has remained tame.

In some countries, rising commodity prices have helped fuel recent social unrest, with some very dramatic consequences in the Middle East. The remedies needed to stabilize or reduce pric-es are not as easy to implement as they may appear. Ever-growing global demand has made food prices highly sensitive to weather-related supply shocks, for example. Meanwhile, export restrictions by some key producing countries


Focus Interview


ries and a poor crop in Brazil could see coff ee prices climb to multi-decade highs as well. De-mand seems better met in sugar and cotton, where we see no further price gains over the coming 12 months.

Prices are likely to trend higher for thermal and coking coal, beyond fl ood-related export limitations by Australia and Indonesia. Coal imports by China and India should grow at a he y 25% per year over the next two years, allowing prices to end this year 15% higher than present levels. To meet the estimated 2 mpbd growth in global oil demand for each of the next two years, OPEC is likely to tolerate a price level above USD 100/bbl. Given indications that OPEC’s production capabilities are compromised due to political unrest, we believe oil can easily command an additional USD 20/bbl price pre-mium.

While the appreciation pace in food and en-ergy prices should slow compared to recent months, consumers will still need a higher share of their income for agricultural and energy com-modities in the years ahead. That said, we do not share the Malthusian view of insuffi cient food supply as productivity gains are still feasi-ble. Nevertheless, land reforms, better seed

quality, more fertilizer use and the spread of genetically modifi ed crops will require time and money. For capital to fi nd its way into the agri-cultural sector, profi t margins need to match returns in other fast-growing economic sectors, especially in emerging markets.

Recommendations We recommend long positions in corn, wheat, soybeans and coff ee, targeting a 20% return potential in the coming 6-12 months. Since sup-ply can change swi ly with changing weather, investing in agricultural commodities should be viewed from a tactical perspective. Regarding crude oil and other energy commodities, new positions in WTI make sense to us if prices trade closer to USD 85/bbl. At these levels, a price in-crease into the range of USD 100/bbl to USD 120/bbl would compensate investors suffi ciently for forward curve-related investment costs and price volatility. A 15% higher coal price from present levels should allow coal-related compa-nies to perform well.

In Europe, we cannot continue in the old way

Few observers are better placed to comment on recent European history than John Bruton. As Prime Minister of Ireland during the 1990s, he witnessed the birth of the currency union. Ireland has been at the heart of the European story ever since, in triumph and in tragedy. Ahead of the Irish general election, he shares his insights with UBS Senior Economist Brian O’Reilly on the future of Europe and Ireland.

Interview: Brian O’Reilly, Economist, UBS AG

Ask almost any economist about the future of the Eurozone and they would say that it’s doomed in its current form. But virtually every politician says it can’t fail. Who’s right here? Will we see a break-up of the Eurozone, or will this crisis lead to greater integration.I think the politicians are right because the politi-cians make the decisions, whereas economists frequently spend their time explaining decisions a er they’ve happened. But I think the European Union project was in some danger, particularly the euro, maybe two years ago. In Germany there was quite an amount of hostility to the bail-out of Greece. But I think as people in Germany have dug deeper into analyzing the euro, they are increasingly seeing that it has been very good for Germany too. It has given Germany a realistic

exchange rate upon which it can continue with its export-led growth model.If the German mark were re-established, the risk is that the exchange rate for that mark, as long as there were free capital movements, would shoot up to a point, destroying the competitive-ness of German exports. Another big fear in Germany, of course, is that of infl ation. I think German opinion is increasingly moving back in favor of the euro and the danger that existed a year or so ago is receding.

We’ve seen the market take some confi -dence that European leaders will be able to ring-fence this crisis. Ahead of this meeting in Helsinki next month do you think we’ll see further steps to help resolve the debt crisis?I think we will see signifi cant steps taken at these meetings. I was in Germany this week and, from informal conversations I’ve had, I was struck by the extent to which Germany is quietly thinking through all of these various problems in Europe. For Germany to accept any greater bur-dens, the German electorate has to be con-vinced that the source of the problem is being dealt with in the longer term and that realistic steps are being taken and that there are realistic controls.

Mr. John Bruton served as Irish Prime Minister (Taoiseach) from 1994-1997, and helped transform the Irish economy into the “Celtic Tiger.” Until recently he served as Ambassa-dor of the European Union to the United States (2004-2009) and played a pivotal role in developing Ireland’s relations with the European Union.

Lingering infl ation fears in emerging marketsHigher infl ation in several emerging markets has fanned fears of sharply rising interest rates, tighter fi scal policies and, ultimately, lower eco-nomic growth. Although infl ation may rise fur-ther in the months ahead, we think infl ationary pressure will ease in the second half of 2011. The prices of emerging market bonds denomi-nated in USD are not directly aff ected by infl a-tion in emerging markets. Rather, it is infl ation in the US that can drive their yields higher. For these markets, we expect yields to increase only gradually in the months ahead. We continue to see attractive opportunities in selected USD-de-nominated bonds, especially those with some-what shorter durations.Higher energy prices

tend to be supportive of bonds from oil and gas exporting countries like Malaysia, Mexico, Rus-sia, Venezuela, and several Gulf countries. Com-modity prices are also important to assess the credit risk of emerging market corporate bonds, although the links are sometimes less clear. We currently prefer sovereign bonds from Malaysia, Mexico, and Russia, while we think Venezuelan bonds are too risky. For more information and updates, see the most recent Emerging Market Bonds: Sovereign Bond Issuer Update.

Michael Bolliger, Analyst, UBS AG


Interview


Interview

What has to happen next to make Europe work? We increasingly hear that Germany will push for greater fi scal integration; are we still at too early a stage for greater integration?As early as 1971, we had the Werner Report, which proposed steps towards the establish-ment of the euro. It didn’t happen because of the oil crisis, but the Werner Report proposed quite intrusive controls on national budgets and spending policies as part of what would be nec-essary to sustain a single currency. So the meas-ures we’re now contemplating have already been contemplated and deemed to be neces-sary right from the beginning.

But what happened was that while the political leaders were prepared to accept the idea of a single currency, they were not pre-pared to accept the intrusion in the individual national budget-making processes that have been considered by the economists to be essen-tial. So, bridging that gap between economic theory and political practice is still unresolved, but I do think we’re going to see quite a bit of progress at the meetings in March, as a result of the crisis. We know now that we cannot con-tinue in the old way.

Focusing now on the Irish elections the latest polls indicate that we will see a change of power in Ireland. Fianna Fáil appear to be slipping further, and Fine Gael rising. What do you expect in the general election?I think we’re actually seeing a cataclysmic decline in the support for a dominant party in Irish political life since 1932, the Fianna Fáil. The polls are showing they’ll be as low as 15%. This has brought the Fine Gael party, which has tra-ditionally been the second party in Ireland, into the position of being the biggest party. A likely outcome, I think, is that Fine Gael will form a coalition with the Labor party. If it does, this coalition will have a huge majority in the house.

The big imponderable, however, is the way

in which this new government will be able to operate due to the constraints imposed by the EU/IMF program. We’ve never had such restric-tions on what the government can and cannot do in Ireland since independence. This could make life either more diffi cult or easier for the government, in the sense that it will make cer-tain decisions for which it will be able to blame the EU and the IMF rather than take full respon-sibility itself. There are, of course, downsides to that.

In the event of a coalition, can the parties work together or will we see political gridlock, risking that the necessary adjustments to the economy won’t be made?I think there’s no possibility that the necessary adjustments won’t be made, because the EU/IMF program is so tight. It will be so intrusive that any government will have to implement a major program of adjustment, and all they will be able to do is argue about the details, about shi ing the emphasis from one tax to another, while raising the same amount, but not disput-ing the amount to be raised. That will be the way the government will have to operate, because if the EU/IMF support line was to be withdrawn, the country would fi nd itself in a very precarious situation. Will there be internal tension? Yes. Will there be tension between the government and the IMF and EU? Yes. But will the program be implemented? The answer is also yes.

Fine Gael has suggested that, if elected, they could seek to restructure the non-guaranteed portion of senior bank debt. What does the future of the Irish banking sector hold, particularly in relation to any investors still invested, or intending to invest, in Irish banks?Well, as we know, there are proposals for re-structuring the banks, and in the case of new bond holders there would be some provision for

burden-sharing. Retrospectively changing the conditions of a bond, particularly of a senior bond, is unlikely. Now, from a moral point of view, there might be a strong argument for this in the sense that it would be fairer to taxpayers, but from a respectful contract point of view, there are quite considerable diffi culties in this.

For Ireland, respect for its international obligations is probably more important than it is for most countries because we are more open to the global economy. Exports represent 90% of our GDP because we have so much foreign direct investment in Ireland and continue to attract it. In fact, last year was one of the best years ever for foreign direct investment in Ireland, despite the diffi culties.

Bear in mind, of course, that one of the rea-sons for the EU/IMF assistance to Ireland was precisely to prevent the sort of contagion and loss of confi dence in banks that might occur if Ireland were to take this course. And I imagine that the European Union would have something to say if there was to be serious contemplation of any action along these lines, certainly in the absence of a comprehensive safety net for other peripheral countries being in place.

The debt crisis has boosted anti-European sentiment, and not just in the peripheral nations. Would you expect the newly elected government to lobby Europe to reduce the interest rate on emergency loans to Ireland, and can they succeed?I think it is possible that some reduction in the interest rate could be negotiated, but not for Ireland alone. There may also be other creative ideas brought forward to provide support for countries, but on a more market-oriented basis rather than simply in the form of a centrally pro-vided loan or a centrally organized write-down of liabilities. There might be some market-ori-ented mechanism considered, but this is I think very much at an early stage of consideration.

Economic data out of Ireland in recent months has been extremely positive. Is it too soon to call the end of the crisis in Ireland, and longer-term, if you were to construct a road map for Ireland to get its economy back on track, what would that entail?I think it is too soon to call an end to the crisis in Ireland because we’ve had EUR 6bn in cuts al-ready this year, and we have to have another 3bn each year for the following three years. That’s 9bn more of austerity that has to be undertaken, so that’s going to have a dampen-ing eff ect on domestic demand. But encourag-ingly we’re seeing very buoyant export growth in the service, manufacturing and agricultural sectors.

Ireland is also a very entrepreneurial society, with a young population; well-educated, out-ward-looking, fl exible. Flexible also in accepting reductions in living standards in the short term to deal with a longer-term problem. So Ireland is a country that has tremendous potential but I think it will take three or four years for this to work itself out.


Asset Allocation


Asset Allocation

Political risk roars into viewA wave of revolution from North Africa to the Middle East has triggered fears of rising oil prices. With markets on edge, we think setbacks in equity markets are possible in the near term and recommend taking a more measured approach toward emerging markets for the time being.

Mark Andersen, Strategist, UBS AG Stephen R. Freedman, Strategist, UBS Financial Services Inc.

Since last autumn, as the economic outlook gradually improved globally, equity markets have boomed. And, for once, the main winners were in developed markets. Investor sentiment was warmed by record order intakes and a re-newed willingness to hire, developments that should lead the global economy back to sustain-able health.

Comfort was also provided by relatively tame infl ation in the developed world and a low-interest-rate environment that will only

gradually fade. Thus, most indicators suggested continued support for equities. However, the re-cent surge in geopolitical concerns now risks distracting markets from the solid economic news, and could lead equities to pullback over the coming months before resuming their up-ward trend.

Geopolitical risks to the foreWhat appeared to be a small spark in Tunisia ignited a revolutionary fi restorm throughout the

Middle East and North Africa (MENA) region since mid-January. The price of oil spiked when the turmoil reached Libya, and that was enough to stir up worries in the developed global fi nan-cial markets. The concerns center on a sharply rising oil price, which could dampen growth in the developed world, although, we believe, only to a moderate degree at this stage. Usually, po-litical risks create buying opportunities, but, for the moment, we would exercise some caution and market selectivity on equities.

Emerging market equities under pressure for now but attractive longer termThe convulsive events in MENA have reminded investors that political risks should not be ignored when investing in less developed countries. As this lesson coincides with tightening monetary policy and rising infl ation fears in many emerging economies, emerging market equities could re-main under pressure in the near term.

At this stage, core infl ation is rising only at a modest pace; food prices are the main concern. The emerging consumer feels the pain of rising food and energy prices and interest rates, so consump-tion could face headwinds in coming months.

These concerns are real, and valid, but should not obscure the bigger picture: Investors should not loose sight of the longer-term appeal of developing economies. Among other factors, demographic advantages and productivity gains favor the continued fl ow of resources and invest-ment towards these areas in the years ahead, in our view. Although the right timing is diffi cult to predict, we believe their underperformance is starting to create a buying opportunity.

Alternatives to government bondsGovernment bonds might enjoy a brief revival during this wave of political turmoil – but we argue this should be seen primarily as an oppor-tunity to sell. The credit quality of developed market government bonds continues to weak-en; interest rate hikes are slowly but surely mov-ing closer, US quantitative easing is drawing to an end, and fund fl ows have turned solidly neg-

ative. The latter is particularly noteworthy a er bond funds attracted heavy infl ows during 2010.

Better alternatives for bond investors can be found in the corporate bond space and in emerging markets, especially those bonds de-nominated in the USD or EUR, or issued in a lo-cal currency with a preference for Asia. Despite rising infl ation and interest rates, we think solid balance sheets should continue to support cor-porate and emerging bond investors.

Extended asset allocation

Asset class Tactical view* Comment

US equities + Solid earnings growth and ongoing phase of positive economic sur-prises are expected to persist a while longer. This currently off sets valu-ations, which are less attractive than abroad.

Non-US developed market equities

n Valuations more attractive than US, especially in Europe. However, lower growth potential and fi scal concerns in the Eurozone and Japan suggest more cautious stance.

Emerging market (EM) equities

+ Strong valuation, earnings growth and fi scal fundamentals are partly off -set by the risk of further food price infl ation and monetary tightening.

US fi xed income – Dollar fundamentals are poor, but this is already largely refl ected in ex-change rates against other major currencies.

Non-US fi xed income

– Extremely low yields and overvalued yen make Japanese debt unattrac-tive. European sovereign debt concerns remain a risk for the euro.

Cash (USD) n Low yields create high opportunity costs for holding cash.

Commodities n While we expect commodity prices to rise further this year, negative roll yields (resulting from contango term structure of futures prices) should signifi cantly trim total returns.

Source: UBS WMR and Investment Solutions, as of 23 February 2011. *See Scale for Investment Strategy in the Appendix for an explanation. For more information, please read the most recent US Investment Strategy Guide.

Where next for the Arab world?Events in Tunisia and Egypt have struck an unexpectedly strong chord. However, the process of change in the Arab world is only just beginning and the future of the region remains open. The best-case scenario would be political change with no dangerous power vacuum. The worst would be civil unrest, as may yet be the case in Libya.

As there is almost no political pluralism in Arab countries, the political transition will mainly be steered by the moderate forces of the ruling class. This has the advantage of ensuring economic stability and reassuring the markets. The drawback is that accept-ance of the old-new leadership may not be broad enough, and the situation could remain unstable for some time.

What could the possible changes be for the markets in the region? In political terms some liberalization can be expected, such as freer elections, rights of assembly and free-dom of expression. In business and economic life, it is likely to become easier to enter a profession and acquire property, and there could be some privatization of government companies and a reduction in subsidies. This could lead to a situation comparable to that of Turkey. Under these conditions, once the reforms have taken place, frontier markets would be more attractive places to invest in equities, bonds and other asset classes.


Economy US


Economy US

We continue to expect visible real GDP growth acceleration in 1H11, driven by a boost to personal income from the recent extension of the Bush tax cuts. However, the surge in oil prices due to the political turmoil in the Middle East and Africa and the fast-ap-proaching US government debt ceiling have raised the downside risk to our forecast. In the worst case, these risks could dent US growth signifi cantly. In our scenario, they clearly tilt the risk to our growth outlook to the downside.

Thomas Berner, Analyst, UBS Financial Services Inc.

Further growth acceleration is challenged

Real GDP growth acceler-ated from 2.6% in 3Q10 to 3.2% q/q annualized in 4Q10. The acceleration was driven by consump-tion, and we think there is more to come. The tax bill of late 2010 will boost personal disposable in-come visibly in 1Q11 as withholding taxes are low-

ered. We estimate that real disposable income will grow by almost 5% q/q annualized in 1Q11, compared with a long-term trend of 3.5% and

a recent trend of about 2%. The boost to in-come growth will likely show up almost entirely in higher consumption growth, as historically only a very small portion of tax cuts have been saved in the US. Historical evidence suggests that up to 90% of tax cuts get spent in the US. Moreover, the spending lag tends to be very short. Consequently, expect a boost to real con-sumption growth in both 1Q11 and 2Q11. Spe-cifi cally, we forecast real consumption growth of 5% and 4.5% q/q annualized in 1Q11 and 2Q11, a er 4.4% in 4Q10 and 2.4% in 3Q10.

Two risks have grown in magnitude and probability that clearly highlight the downside

risk to our current growth scenario. First, the po-litical turmoil in the Middle East and North Africa (MENA) has led to a spike in the price of oil, which at the time of writing has almost reached 100 USD/barrel. Our commodity team continues to expect a price of 100 USD/bl in 12 months but has raised the trading range to 85-120 USD/bl to account for further spikes. Clearly, an increase in energy prices curtails US consumer purchasing power and thus highlights the downside risk to our growth scenario. We estimate that a one-time permanent increase in the price of oil of 10% curtails real consumption by about 0.4% a er 12 months. Applying this blindly, the price of oil would have to rise to about 170 USD/bl to bring about a US recession given our 2011 real consumption growth forecast of 3.9%. In the real world, economic forces typically don’t un-ravel linearly. Therefore, a lower oil price would already create quite some damage to the growth picture. However, our simple calculation shows that there is still room before we will need to get extremely worried about a serious growth decel-eration.

The second risk haunting our growth picture is the US government debt ceiling at USD 14.29 trillion. Given the current run rate of federal out-

lays the debt ceiling could already be reached by early April. If the US Congress does not approve an increase in the debt ceiling, the Treasury will be hard-pressed to make ends meet. While it can draw down the cash held at the Fed (currently at about USD 80bn) and the cash held in the sup-plementary fi nancing account, also at the Fed (currently at about USD 175bn), it would soon therea er run into serious cash fl ow issues. In a second step, the Treasury has options that frees up cash and thus lowers its borrowing needs. Ac-cording to the Government Accountability Offi ce (GAO) at present these actions could amount to about USD 155bn in lower borrowing needs per month. However, in eight months in 2010 the monthly federal outlays surpassed this amount. Thus, it would likely be very diffi cult for the Treas-ury to manage the situation. The immediate up-shot could be a technical default of the US gov-ernment and/or missed payments of federal programs such as Social Security and Medicare. We don’t expect the problem to escalate to this level, as we think that eventually Congress will raise the debt ceiling. But with investors already skittish about the value of US Treasuries and the USD there seems to be very little room for mis-takes.

02468

10121416

1994 1998 2002 2006 2010

US federal government debt US government debt ceiling

US federal debt to hit the ceiling soonUS federal government debt and debt ceiling, in USD trillions


US economic forecasts (see latest WMR Forecast Tables for additional US and global forecasts)

*year-end level

Source: Datastream, UBS WMR, as of 22 February 2011

About These Forecasts: In developing the forecasts set forth above, WMR economists worked in collaboration with economists employed by UBS Investment Research (INV). INV is published by UBS Investment Bank. Forecasts and estimates are current only as of the date of this publica-tion and may change without notice.

in % 2007 2008 2009 2010F 2011F 2012F

Real GDP (y/y) 1.9 0.0 -2.6 2.9 3.3 2.7

CPI (y/y) 2.9 3.8 -0.3 1.6 1.8 2.1

Core CPI (y/y) 2.3 2.3 1.7 1.0 1.2 1.6

Unemployment rate 4.6 5.8 9.3 9.6 8.9 8.7

Fed funds rate* 4.25 0.25 0.20 0.10 0.25 1.75

Sentiment points to growth accelerationUS consumer sentiment (index level), real consumption (% y/y)


(4)

(2)

0

2

4

6

1998 2002 2006 2010

0

20

40

60

80

100

120

US real consumption (lhs)

University of Michigan expectations index (rhs)

Conference Board expectations index (rhs)

UBS investor’s guide 25 February 2011 15 14 UBS investor’s guide 25 February 2011

Interest rates2010 22.02.11 6 M2 12 M2

United States 3m 0.3 0.3 0.4 0.6

10y 3.3 3.5 4.0 4.3

Japan 3m 0.2 0.2 0.3 0.4

10y 1.1 1.3 1.3 1.5

Eurozone 3m 0.9 1.0 1.0 1.5

10y 3.0 3.1 3.5 3.8

UK 3m 0.8 0.8 0.8 1.0

10y 3.4 3.7 4.3 4.5

Switzerland 3m 0.2 0.2 0.6 1.1

10y 1.7 1.9 2.3 2.3

Exchange rates 22.02.11 3 M2 6 M2 12 M2 PPP3

EURUSD 1.3532 1.35 1.35 1.39 1.25

GBPUSD 1.6139 1.60 1.60 1.66 1.67

USDJPY 83.16 85 85 89 86

USDCHF 0.9453 0.96 0.96 0.96 1.15

EURCHF 1.2797 1.30 1.30 1.33 1.45

GBPCHF 1.5257 1.54 1.54 1.59 1.92

US leading the pack

Reported GDP fi gures for 4Q 2010 again showed that the recovery remains uneven. The US economy grew at 3.2% (annualized), com-pared to timid expansion in the Eurozone and contractions in the UK and Japan. Most market participants stressed the impact of events such as unusually cold weather, fading government stimulus and strikes (in France) to explain the weaker readings outside the US. We expect the American economy to continue to lead the re-covery in the developed world on the back of its fi scal stimulus, although we believe the recovery will gain momentum outside the US. Purchasing manager indices are near multi-year highs, pointing to a continued robust expansion in the US and Europe. In the meantime, infl ation has

picked up as higher food and energy prices feed through core and non-core infl ation fi gures. The Federal Open Market Committee minutes in the US nevertheless revealed the Fed has only mar-ginally increased its infl ation forecast, while the European Central Bank also communicated no signifi cant change in its policy outlook.

Europe will experience a key month ahead, as the Eurozone pursues a better solution to its structural crisis. Outside the US, Japan and Europe, the developing economies continue with their strong economic expansion and are battling infl ation with interest rate hikes.

EurozoneInfl ation increased to an annualized 2.4% in January, well above the European Central Bank (ECB) target of 2.0% due to rising commodity prices. The most recent ECB conference revealed that the ECB stands ready to raise interest rates if price stability is in danger. On the other hand, current rates were considered to be appropriate. Speculation regarding the future monetary stance has increased a er the prime candi-date to succeed Mr. Trichet (Head of ECB) – Bundesbank Head Axel Weber – resigned as of April 2011.

JapanFourth-quarter GDP contracted 0.3% q/q (annualized 1.1%), down for the fi rst time in fi ve quarters. The major drag was private consumption, which squeezed GDP growth by 0.4 ppt due to the hangover eff ect of the expiration of the government?s eco-car subsidies at the end of September. Never-theless, the latest data on industrial output signal that the so patch is ending this quarter, mainly driven by a re-acceleration in exports. Indeed, the Bank of Japan up-graded its assessment on the current eco-nomic conditions at the policy board meet-ing earlier this month, although the monetary policy was kept unchanged.

UKNew and somewhat unanticipated data continues to be reported. January retail sales increased by 1.9% m/m (nearly four times consensus) and excluding petrol by 1.6% (eight times consensus). Somewhat surprising data given a January VAT hike, although the previous two months’ data were revised downwards. The three-month rate was modest but positive.

Meanwhile, government fi nances for January were in surplus by over GBP 5bn against expectations of being fl at. All in all it seems to be a bad time to be a forecaster; better to be patient and perhaps a little op-timistic.

Asia Latest export data in Asia ex-Japan (AxJ) showed external demand remains robust in 2011. Seasonally-adjusted export growth in AxJ countries rose 4-14% m/m in January, with the exception of India which recorded a sequential contraction. The level of AxJ exports is now near 20% higher than the pre-crisis peak. Stronger recovery in the de-veloped world would boost AxJ growth but exert additional price pressure in the region, whereon rate hikes will pick up. Indonesia has belatedly started hiking rates, the fi rst time since the crisis. Other countries like China and India have been tightening for months.

Economy GlobalEconomy Global

¹ UBS WMR Forecasts, as of 22 February 2011.² Purchasing Power ParitySources: Reuters EcoWin, Thomson Reuters, IMF, UBS WMRAbout these forecasts: In developing the forecasts set forth above, WMR economists worked in collaboration with economists employed by UBS Investment Research (INV). INV is published by UBS Investment Bank. Forecasts and estimates are current only as of the date of this publication and may change without notice.

UBS macroeconomic forecastsin %

Real GDP growth in % Inflation in %

2010F1 2011F1 2012F1 2010F1 2011F1 2012F1

USA 2.9 3.3 2.7 1.6 1.8 2.1

Brazil 7.8 5.4 5.1 5.9 5.8 4.8

India 9.0 8.0 8.6 12.5 6.9 7.3

Canada 2.9 2.3 2.7 1.8 2.6 2.4

Japan 4.0 1.5 2.1 –0.7 –0.3 0.4

Germany 3.5 2.3 2.0 1.1 2.0 1.6

France 1.6 1.9 1.9 1.7 1.6 1.5

Mexico 5.2 4.3 3.5 4.4 4.0 3.7

UK 1.8 2.3 2.2 3.2 2.8 1.9

Eurozone 1.8 1.9 1.9 1.6 2.2 2.0

Switzerland 2.7 2.3 2.1 0.7 0.9 1.7

Australia 2.6 3.2 3.9 2.8 2.8 2.9

China 10.3 9.6 9.0 3.3 4.8 4.0

Asia ex Jp/Cn/In 5.3 4.3 4.3 2.7 3.2 3.2


Below are excerpts from our US Equity Sector monthly reports which, along with updates, are lo-cated in the Equity section of the Online Services Research website. For sector strategy, see the most recent Investment Strategy Guide.

Healthcare

Not all healthcare stocks are equal

In spite of good cash fl ow generation and some highly attractive dividend yields, many health-care stocks are unlikely to outperform again this year, in our opinion. There are a number of rea-sons for large-cap healthcare underperform-ance, reasons that don’t appear to be going away anytime soon. Lead among them is their sheer size, especially given the maturation of product lines, relative lack of signifi cantly new product introductions and a far more demand-ing and cost-conscious customer base. These companies aren’t currently without growth; however, such large companies will fi nd it diffi -cult (if not impossible) to achieve the growth of years past, given the signifi cant headwinds they face over the next decade. So where does one invest for performance in 2011? In our opinion, the best places in healthcare to invest are those companies with innovative new products, espe-cially those that improve patient outcomes, or those companies positioned to lower healthcare costs, such as generic drug companies. We think managed care organizations will fare much bet-ter than many investors had feared for 2011 af-ter new government mandates established the minimum portion of insurance premiums that an insurer must now pay out for member healthcare costs. Commercial insurers’ perform-ance could be among the best in 2011.

.Jerome BrimeyerAnalyst, UBS Financial Services Inc.

High Conviction Calls

Celgene Corp. Outperform

Teva Pharmaceuticals Outperform

Utilities

Interest rate headwindsWe rate the utility sector moderate under-weight. With the economy now more clearly in a sustainable expansion, we believe interest rates will continue to have an upward bias, cre-ating headwinds for the regulated industry group. Investors in regulated utilities are o en attracted to the group’s dividend yields. If inter-est rates are rising due to higher infl ation expec-tations, as they are now, investors usually de-mand a higher dividend yield to compensate for the rise in infl ation. This tends to lead to utility sector underperformance relative to the broader equity market.

In the unregulated power sector, we believe the fundamentals are bottoming as a result of an improving macroeconomic outlook and less downward pressure on natural gas prices. We expect power markets to begin to tighten as de-mand grows in line with the economy and older, less effi cient coal plants are retired. In addition, there is a strong correlation between natural gas prices and power prices because natural gas-fi red power plants are the marginal producers of electricity in the US. While we are not bullish on natural gas prices in the near term, we do be-lieve that the downward pressure on prices is likely coming to an end.

David LefkowitzAnalyst, UBS Financial Services Inc.


AES Outperform

ITC Holdings Corp Outperform

NextEra Energy Outperform

Equity market US

At a glanceThe economic outlook for the US in the fi rst half of 2011 is well supported by fi scal and monetary policy measures. We forecast US earnings growth of about 12% in 2011, as strong economic growth implies robust revenue growth for US companies. Solid US earnings should ultimately carry US equities higher, reinforcing our positive stance.

Economic recovery drives company earnings Rebounding US domestic demand supports company earnings growth and should carry US equities higher.

Markus Irngartinger, Strategist, UBS AG; Stefanie Scholtysik, Analyst, UBS AG

Support for the US economy continues una-bated. Fiscal and monetary policy measures are both aimed at improving economic growth. While these policy measures are not sustaina-ble in the long run, they will stimulate domes-tic demand, especially in the fi rst two quarters of the year. Following 2.6% real GDP growth in 3Q 2010 and 3.2% in 4Q 2010, our econo-mists look for a further acceleration in 1Q 2011 to 4.2%. For the time being, we believe strong-er economic data will attract infl ows into US equities.

Earnings growth mainly driven by rising revenues As US companies generate 70% of sales at home and only 30% abroad, stronger economic

growth implies higher revenues for US compa-nies. We expect revenue growth, rather than margin expansion, to be the driver behind earn-ings advances in the US this year. Profi t margins have already recovered their previous highs of summer 2007. The sharp recovery in US profi t margins clearly refl ects the cost-cutting eff orts of US companies. The layoff s of about 8 million people during the crisis reduced wage costs, which make up about two-thirds of fi xed costs. Going forward, we expect the US labor market to gradually recover. We think it is revenue growth, rather than cost-cutting and profi t mar-gin expansion, that will drive earnings growth in 2011. We forecast US company earnings to advance 12% in 2011.

Economic recovery drives company earningsIndustrial production index and realized earnings

105

95

85

100

90

65707580

95

85

75

55

65

45

35

25

Source: Bloomberg

1992 1996 2000 2004 2008 2012

US ind. production (lhs)US realized EPS (rhs)

Equity market US sectors





Consumer discretionary

Higher January sales, but costs may stifl e profi ts

Year-to-date, the Consumer Discretionary index outperformed the S&P 500 index by 6.4 basis points. We remain cautious on Consumer Dis-cretionary sector. We forecast modest consumer spending growth in 2011. However, our view is the increased input costs approaching compa-nies’ supply chains may cause less operating profi t leverage than last year.

Retail spending started the year positively despite terrible winter weather that plagued most of the US throughout January. The increases in input costs may challenge corporations’ abili-ties to grow profi ts on top of very strong 2010 results. The incremental costs may cause compa-nies to test higher prices, which may lead to low-er demand. The Producers’ Price Index (y/y) rose .8% in January 2011, higher than the previous six-month average of .5% and twelve-month av-erage of .3%.

The one sub-sector we recommend investing in is the Autos & Auto Components industry group. Our main thesis on the group is our view that new vehicle sales stabilized and are recover-ing out of the trough. We anticipate seeing a fur-ther recovery in sales for the next two to three years.

Alexandra MahoneyAnalyst, UBS Financial Services Inc.


Comcast Outperform

Dana Holdings Outperform

Dollar General Outperform

Lear Corp Outperform

Magna International Outperform

Starbucks Outperform

Starwood Hotels & Resorts Outperform

Information technology

Going Mobile

Each February the World Mobile Congress takes place in Barcelona. Unlike past shows, this was an exclamation point proclaiming the shi to mobile technologies. The newswires were clogged with smartphones and tablet an-nouncements as the industry attempts to catch up with Apple’s trend-setting products. Apple does not even attend this event but that didn’t stop the iPhone 4 from winning the award for Best Mobile Device.

All market capitalization groups have per-formed well over the last month and on at YTD basis: tech stocks with market values over USD 50 bn are up 4.2% and 11.1% respectively; those between USD 10 bn and USD 49 bn are up 5.6% and 8.5% respectively; and tech stocks under USD 10bn are up 5.5% and 11.7% re-spectively. These results have generally outper-formed the S&P 500 over the last month and on a YTD basis.

We remain of the opinion that “big cap technology” needs robust GDP growth to con-sistently outperform. Consequently, our focus continues to be on stocks whose product cycles and/or share gains are of suffi cient impact to overcome the inertia of a low-growth economy. Much of our emphasis is tied to the growth in mobility and we expect that will likely remain true for most of 2011.

Bob FaulknerAnalyst, UBS Financial Services Inc.


Cypress Semiconductor Outperform

Qualcomm Underperform

Financials

Good results in 4Q 2010, but investors looking for growth

Our equity strategy group maintains a neutral weighting for Financials overall, but a moderate overweight for the Diversifi ed Financials subsector and a moderate underweight for the REIT subsec-tor. Banks posted a generally good fourth quarter, with over 70% in our coverage universe beating consensus estimates based on lower net charge-off s, reserve release and some signs of loan growth. Several prominent mergers were announced that helped boost valuations of regional banks. Howev-er, we do not believe that big merger premiums will become commonplace. We continue to prefer the larger banks to the regional banks. At this point, the additional benefi t to valuations from improving credit has diminished while revenue growth should still be challenging in 2011.

Our insurance sector view is based on attrac-tive valuations, strong balance sheets, and solid capital positions. We prefer the life insurers over P&C insurers as they have more positive catalysts. We would avoid growth companies that face chal-lenging headwinds that are not fully refl ected in valuations. Asset managers have benefi ted from rising equity markets and improved fl ows. Ex-changes have experienced higher trading volumes.

Although REIT valuations are off their peak, we continue to maintain our cautious stance on the REITs as we do not believe FFO & AFFO multi-ples, dividend yields and implied cap rates off er an attractive risk/reward profi le. We reiterate our “quality focus” thesis with a clear bias toward well-capitalized REITs with defensible, high-quality assets and strong management.

Michael Dion, CFA, Dean Ungar, CFA, Jonathan Woloshin, CFAAnalysts, UBS Financial Services Inc.


Ameriprise Financial Outperform

Camden Properties Outperform

Metlife Outperform

Piedmont Office Realty Underperform

US Bancorp Outperform

Wells Fargo Outperform

Industrials

Anticipated sector sales and earnings growth above S&P 500

Rather than looking at the Industrials sector’s strong 2010 performance, it is more instructive for investors to focus on the inferences and im-plications that can be drawn the forecasts for 2011. In the near term, the consensus estimates for the fi rst quarter call for S&P Industrial sector sales growth to modestly outpace the S&P 500, 6% versus 5%. More telling are the compara-tive consensus estimates for earnings, which call for the Industrials to grow 27%, almost double the 14% forecast for the market as a whole. Full year 2011 estimates are similar, but not as dra-matic. Industrials’ are forecasted to outgrow the S&P 16% to 13%, while sales are expected to grow at a slower pace, 6% to 8%. These es-timates translate to an operating leverage that favors the Industrials vs. the overall market.

Andrew SutphinAnalyst, UBS Financial Services Inc.


3M Co. Outperform

Cooper Industries Outperform

Danaher Outperform

FedEx Outperform

Illinois Tool Works Outperform

Roper Industries Outperform

United Technologies Outperform





Consumer Staples

Positive view of Consumer Staples

Our equity strategy group recommends a mod-erate overweight allocation for US Consumer Staples. Overall, the fundamental outlook ap-pears sound, despite a disappointing earnings season for a number of companies in the sector. Earnings growth should improve as the year un-folds, and we view the sector’s relative valuation as undemanding. Our top picks continue to re-fl ect our bias toward consumer packaged goods companies with emerging markets exposure, and our view that leading brands are best poised to grow in developed and emerging markets. We look for companies with successful produc-tivity or cost savings initiatives which can fund investments to drive future growth. Taken to-gether, these attributes should contribute to a company’s ability to post upside to earnings ex-pectations. Other important considerations in-clude management quality, fi nancial fl exibility, solid dividend yields, and attractive valuation. Among consumer packaged goods companies, we see the most appealing opportunities in household products/cosmetics and beverage stocks, refl ecting their generally higher weight-ing in international markets.

Sally DesslochAnalyst, UBS Financial Services Inc.


Coca-Cola Outperform

Energy

Middle East tensions bring volatility

Oil prices have been volatile, as events in the Middle East have continued to unfold. While the situation in Egypt appears improved, civil unrest has spread to other Middle Eastern nations, and concerns over the potential disruption of pro-duction and transportation routes oil supplies have continued to escalate. At USD 95/bbl, the price for West Texas Intermediate crude oil is at its highest level since October 2008. While it is uncertain whether oil price strength will be pro-longed, the upward pressure has been support-ive for the stock prices of oil producers.

The primary risk to rapidly rising oil prices is the potential that higher energy costs could slow worldwide economic growth. A decrease in economic activity would reduce oil demand, and oil prices could collapse. Looking back at 2008, oil prices moved sharply downward though the second half of the year, reaching USD 37/bbl by mid-December, over USD 100/bbl from the highs reached in June. We will be watchful for signs of economic stress if oil prices continue to climb; and we would be particularly wary if West Texas Intermediate were to reach USD 110/bbl. However, for now, we maintain our preference for oil-levered producers over natural gas producers.

Nicole DeckerAnalyst, UBS Financial Services Inc.


Andarko Petroleum Outperform

Devon Energy Outperform

Halliburton Outperform

Hess Outperform

Schlumberger Outperform

Telecommunications

Telecom: meager return outlook, but we like some subsectorsYear-to-date and over the last month the tele-com sector has underperformed the S&P 500 Index by 7% and 1.3%, respectively, on a total return basis. We expect telecom sector returns to be modest in coming months due to slowing wireless subscriber growth and a still only slowly recovering wireline segment. We, however, continue to fi nd opportunities in select subsec-tors. These include Wireless Towers, which should benefi t from strong new device and data plan adoptions and network buildouts/upgrades that could result in stronger revenues than the market expects. For example, we think Sprint’s strong 4Q2010 postpaid subscriber growth could drive stronger deployment of equipment on towers and signifi cantly stronger than in the 2009-2010 period. In addition, T-Mobile may be deploying equipment (adding lease amend-ments) at a more rapid pace than expected by the market as it builds out in rural areas and continues the upgrade of its third-generation network. Additional support for tower leasing revenues could come from Clearwire obtaining additional funding.

George LambertsonAnalyst, UBS Financial Services Inc.


American Tower Outperform

CenturyLink Outperform

Materials

Sector earnings aspirations appear predicated on price and leverage

While the S&P Materials sector’s 6.4% total re-turn outpaced the 3.7% posted by the S&P 500 since our last report (25 January), the year-to-date performance for the Materials sector ap-pears to be losing some steam. Since the turn of the year, the 3.7% total return of the Materials sector lagged the 5.9% gain recorded by the S&P 500. The answer may be found in the 4Q10 results thus far reported. Although the Materials sector saw its 4Q10 sales grow 13% compared to the S&P 500’s 8%, the consensus estimates were lo y for the Materials sector as 63% of the reporting companies beat sales expectations versus 68% for the S&P 500. Similarly, the Ma-terials sector saw its earnings growth of 51% far exceed the 35% of the S&P 500. However, only 64% of the reporting companies within the Materials sector exceeded consensus earnings expectations versus 70% of the S&P. Expecta-tions for 1Q11E and 2011E sales and earnings growth suggest a substantial portion of the Ma-terials sector above market earnings growth will be fueled by increased prices and operating lev-erage. Clearly, this will be our focal point as the present quarter progresses.

Andrew SutphinAnalyst, UBS Financial Services Inc.


Alcoa Underperform

Celanese Corp Outperform

Dow Chemical Outperform

Potash of Saskatchewan Outperform

Praxair Outperform


Equity market US and globalEquity market US and global

Source: FactSet, Thomson Financial and UBS WMR. Prices and performance as of 22 February 2011. Since inception, the U.S. Top 25 Stock List has included 123 stock recommendations, of which 75 advanced and 48 declined while on the list. See the Appendix for important information regard-ing performance calculations. For a detailed discussion of the methodology underlying the U.S. Top 25 Stock List and updates to the list, please see the most recent U.S. Top 25 Stock List.Stocks which are only covered by UBS Investment Research are annotated as such with a “+” sign. UBS Investment Research is part of UBS Invest-ment Bank (the UBS business group that includes, among others, UBS Securities LLC).** 2006 data include the total return from the list’s inception on 18 January 2006.

Source: FactSet, Thomson Financial and UBS WMR. Prices and performance as of 22 February 2011. Since inception, the ADR Top List has included 42 stock recommendations, of which 28 advanced and 14 declined while on the list. See the Appendix for important information regarding performance calculations. For a detailed discussion of the methodology underlying the ADR Top List and updates to the list, please see the most recent ADR Top List.For additional information, see Education Note: Understanding ADRs, 29 Nov. 2007. Stocks are covered by UBS Investment Research. UBS Invest-ment Research is part of UBS Investment Bank (the UBS business group that includes, among others, UBS Securities LLC).** 2009 data include the total return from the list’s inception on 26 October 2009.

Recommendation list Data as of 22 February 2011

Company Ticker Sector Price

Adobe Systems Inc. ADBE Technology $33.74

Ameriprise Financial Inc. AMP Financials $63.13

Analog Devices Inc. ADI Technology $40.06

Apple Inc. AAPL Technology $338.61

Bank of America Corp. BAC Financials $14.18

Coca-Cola Co. KO Consumer Staples $63.76

Colgate-Palmolive Co. CL Consumer Staples $78.60

Cypress Semiconductor Corp. CY Technology $21.10

Dow Chemical DOW Materials $37.16

FedEx Corp. FDX Industrials $93.29

General Mills Inc. GIS Consumer Staples $36.76

Halliburton Co. HAL Energy $46.60

Hess Corp. HES Energy $80.76

Hewlett-Packard Co. HPQ Technology $48.23

Illinois Tool Works Inc. ITW Industrials $53.34

IntercontinentalExchange Inc. ICE Financials $122.29

Interpublic Group Of Cos. IPG Consumer Discr. $11.90

Lear Corp. LEA Consumer Discr. $109.94

McKesson Corp. MCK Health Care $78.51

MetLife Inc. MET Financials $46.27

National Grid PLC (ADR) + NGG Utilities $45.60

Schlumberger Ltd. SLB Energy $92.91

Teva TEVA Health Care $51.11

Thermo Fisher Scientifi c Inc. + TMO Health Care $56.15

U.S. Bancorp USB Financials $27.69

PerformanceSince inception on 18 January 2006

Period Top 25 S&P 500

Since inception 26.6% 14.0%

2011 year-to-date 6.2% 4.9%

2010 9.7% 15.1%

2009 29.5% 26.5%

2008 -39.9% -37.0%

2007 20.6% 5.5%

2006** 15.8% 12.4%

Recommendation list Data as of 22 February 2011

Company Ticker Sector Price

ABB ABB Industrials $23.64

Anheuser-Busch InBev BUD Consumer Staples $54.51

Banco Santander Brasil BSBR Financials $11.89

Bank of Nova Scotia BNS Financials $60.19

Barrick Gold ABX Materials $51.52

BHP Billiton BHP Materials $92.11

British American Tobacco BTI Consumer Staples $78.89

Cenovus Energy CVE Energy $37.60

China Life Insurance LFC Financials $56.35

ENI E Energy $46.68

Honda Motor HMC Consumer Discr. $42.79

HSBC Holdings HBC Financials $56.04

ING ING Financials $12.33

Lloyds Banking Group LYG Financials $4.22

Magna International MGA Consumer Discr. $56.95

National Grid NGG Utilities $45.60

Nestle NSRGY Consumer Staples $55.92

Nexen NXY Energy $24.87

Novartis NVS Health Care $56.94

Repsol YPF REP Energy $32.07

Rio Tinto RTP Materials $69.38

SAP SAP Technology $59.24

Talisman Energy TLM Energy $24.21

Telefonica TEF Telecom $24.57

Teva Pharmaceutical TEVA Health Care $51.11

Veolia Environnement VE Utilities $32.25

Yanzhou Coal Mining YZC Energy $28.58

PerformanceSince inception on 26 October 2009

Period ADR List S&P ADR Index

Since inception 13.5% 14.7%

2011 year-to-date 3.3% 4.4%

2010 7.2% 7.5%

2009** 2.5% 2.2%

U.S. top 25 stock list ADR (American depository receipt) top list


Equity market US and globalEquity market US and global

Dividend ruler stocksOver the past 100 years, dividends have contributed nearly half of the total return from US equity markets. We believe investors will likely be more attracted to stocks where they are “paid to wait.” The Dividend Ruler Stocks screen for companies that off er a reasonable current dividend yield and have a strong track record of dividend growth. Dividend growth is important since it not only showcases the ability of the current management, but provides some infl ation protection for investors who receive an income stream that grows over time.

Source: FactSet, Thomson Financial and UBS WMR. Prices as of 18 February 2011 and performance as of 22 February 2011. Since inception, the Dividend Ruler Stock list has included 200 stock recommendations, of which 138 advanced and 62 declined while on the list. See the Appendix for important information regarding performance calculations. For a detailed discussion of the methodology underlying the Dividend Ruler Stock list and updates to the list, please see the most recent “Dividend Ruler Stock list“ report.Stocks which are only covered by UBS Investment Research are annotated as such with a “+” sign. UBS Investment Research is part of UBS Invest-ment Bank (the UBS business group that includes, among others, UBS Securities LLC).** 2003 data include the total return from the list’s inception on 17 October 2003.

Q-GARP (quality growth at a reasonable price)The Q-GARP stock list provides investors with stocks that we believe should be included in a well-balanced portfolio to take advantage of the fundamental and cyclical trends that are likely to favor true secular growth stocks in the current market environment. We believe these companies off er attractive valuations relative to their high levels of sustainable growth, relative margin stability, and high profi tability. In our view, at this stage of the recovery, the risk-reward trade-off favors higher-quality stocks.

Source: FactSet, Thomson Financial and UBS WMR. Prices and performance as of 22 February 2011. Since inception, the Q-GARP stock list has included 89 stock recommendations, of which 53 advanced and 36 declined while on the list. See the Appendix for important information regarding performance calculations. For a detailed discussion of the methodology underlying the Q-GARP stock list and updates to the list, please see the most recent “The world according to Q-GARP” report.Stocks which are only covered by UBS Investment Research are annotated as such with a “+” sign. UBS Investment Research is part of UBS Investment Bank (the UBS business group that includes, among others, UBS Securities LLC).** 2007 data include the total return from the list’s inception on 31 May 2007

Recommendation List Data as of 22 February 2011

Company Ticker Price

3M MMM $92.00

Adobe Systems ADBE $33.74

AFLAC AFL $57.96

AmerisourceBergen ABC $37.40

Apple AAPL $338.61

Bed Bath & Beyond BBBY $48.98

Coach COH $56.36

Coca-Cola KO $63.76

Colgate-Palmolive CL $78.60

Danaher DHR $50.47

Darden Restaurants DRI $48.51

Exxon Mobil XOM $85.44

General Mills GIS $36.76

Home Depot HD $38.09

Illinois Tool Works ITW $53.34

Medtronic MDT $40.21

Microso MSFT $26.59

NIKE NKE $87.23

PepsiCo PEP $63.15

Procter & Gamble PG $64.07

Rockwell Collins COL $64.58

Staples SPLS $21.20

Starbucks SBUX $32.77

United Parcel Service UPS $74.61

United Technologies UTX $83.56

Walgreen WAG $42.18

PerformanceSince inception on 31 May 2007

Period Q-GARP S&P 500

Since inception 14.8% -6.7%

2011 year-to-date 3.4% 4.9%

2010 17.2% 15.1%

2009 28.3% 26.5%

2008 -27.7% -37.0%

2007** 2.1% -3.0%

Domestic companies Data as of 18 February 2011

Company Ticker Dividend yield Price

3M MMM 2.4% $92.96

AFLAC AFL 2.1% $59.08

Air Products & Chemicals APD 2.1% $94.96

Boeing BA 2.4% $73.04

Coca-Cola KO 2.9% $64.55

Colgate-Palmolive CL 2.7% $78.42

ExxonMobil XOM 2.1% $84.50

General Mills GIS 3.0% $36.10

Home Depot HD 2.6% $38.48

Illinois Tool Works ITW 2.5% $54.90

Johnson & Johnson JNJ 3.6% $61.11

Medtronic Inc. MDT 2.2% $41.27

NextEra Energy NEE 4.0% $54.59

Northeast Utilities NU 3.3% $33.44

PepsiCo PEP 3.0% $63.41

Praxair PX 2.0% $99.09

Procter & Gamble PG 3.0% $64.30

Raytheon RTN 2.9% $52.16

United Parcel Service UPS 2.8% $76.47

United Technologies UTX 2.0% $85.01

International companies Data as of 18 February 2011

Company Ticker Dividend yield Price

AstraZeneca Plc + AZN 5.2% $49.38

British American Tobacco + BTI 4.3% $80.43

National Grid + NGG 6.7% $46.65

Nestle + NSRGY 3.5% $54.92

Novartis + NVS 4.1% $57.31

Ntt Docomo + DCM 3.3% $18.93

Pearson + PSO 3.5% $17.19

Roche Holding + RHHBY 4.8% $36.37

Tesco + TSCDY 3.3% $19.94

Total + TOT 5.3% $59.74

Unilever + UL 3.9% $29.56

Veolia Environnement + VE 5.1% $33.12

Performance of Deividend Ruler Stocks Since inception on 17 October 2003

Period Div. ruler S&P 500 S&P Global 1200

Since inception 94.6% 46.7% 69.1%

2011 year-to-date 3.5% 4.9% 4.5%

2010 10.9% 15.1% 11.9%

2009 23.2% 26.5% 31.7%

2008 -23.8% -37.0% -40.1%

2007 5.6% 5.5% 10.2%

2006 22.8% 15.8% 21.5%

2005 5.3% 4.9% 10.2%

2004 23.4% 10.9% 14.9%

2003** 7.2% 7.4% 8.1%


Equity market Technical analysisEquity market Technical analysis

Trends help determine what type of market persists (bull or bear market). Once this is established, then trades are made accordingly. A problem arises, however, because trends can occur over many time horizons and can actually give

diff erent messages. So which trends do you look at? All of them.

Jon Beck, Technical Strategist, UBS Financial Services Inc.Peter Lee, Chief Technical Strategist, UBS Financial Services Inc.

Following trends is at the heart of technical analysis. In fact, a technician will make trading/investing decisions based on the direction of the trend. However, it gets tricky as trends can vary, spanning many years to just a few days or even minutes. In fact, confl icting messages o en oc-cur, confusing the investment decision. One of the key tenets of technical analysis is that the longer-term trends will override shorter-term trends. Therefore, when we analyze a chart, we prefer to start by looking back as far as possible to determine what the long-term/secular trend is. This helps to give us a broad overview of the terrain that we are attempting to navigate and lets you know that “you are here.” We then

zoom in, looking at shorter-term charts to make tactical timing decisions. This is the type of road-map that we try to draw out when providing our investment advice.

Below is the course that we are following for the US Equities market, via the S&P 500. Secular Trend (8-20 years) – Long-term sideways Trading Range market

March 2009 is the mid-point of a long-term secular trading range market that began in March 2000. We expect another 5-10 years of sideways trading before the start of the next secular bull market in the US. In the next few years, we believe SPX will likely be confi ned to a wide trading range between 800 +/- 50 on the downside and 1,450 +/- 50 on the upside. We estimate the mid-point of this secular trading range or the equilibrium level will be near 1,125.

Primary Trend (1-3 years) – Entering 2nd half of Cyclical Recovery / Cyclical Bull Rally

March 2009 also marked the start of an-other Cyclical Bull trend. We are now approach-ing the second year of the March 2009 market bottom. This suggests the easy part of the rally is behind us. Nonetheless, we expect the current Cyclical Bull trend will be sustained into this year. The back half of a recovery/cyclical bull phase is o en denoted by stock selectivity or

commonly referred to as a “stock picker’s” mar-ket. US stock markets tend to be challenging during the fi rst two years of a US presidential cycle (2012-2013).

Intermediate Trend (3-12 months) – Mid-term Year bottom / Cyclical Bull will mature

Breakout above 1,130-1,150 (September 2010) negated a 1-year head/shoulders top pat-tern. In the process, it also validated a 4-month head/shoulders bottom formation and estab-lished an important mid-term election year cycli-cal low (July 2010). We maintain our 2011 pro-jection of 1,348-1,362 possibly as early as the 1st half of 2011. However, SPX can overshoot to 1,440-1,450 under ideal market conditions. Nonetheless, we expect the cyclical bull rally will begin to mature later in the year.

Short-term Trend (1 week-3 months) – Cyclical Bull continues / Modest correction

Strong momentum from last year carried over to the beginning of the new year produc-ing gains of 3.06% for January. Based on the January indicator, this bodes well for the rest of the year. Although we believe the cyclical bull will reach our 2011 projection of 1,348-1,362

Trends – Knowing the direction of the market

S&P 500 – Shorter-term Outlook (1-3 months)Well defined Uptrend Channel since Jul/Aug 2010

Source: Bloomberg and UBS WMR-A (prices as of 22 February 2011)

S&P 500 DJIA NASDAQ 10-Yr. Treasury (%)

Support 1290-1300 11800-11825 2675-2725 3.25%

1260-1270 11250-11450 2535-2600 2.90-3.00%

Resistance 1350-1360 12375-12500 2861 3.75%

1400 12750-12900 3000-3120 4.01%

Technical levels

Source: UBS WMR as of 22 February 2011

(1st half) and as high as 1,440-1,450 (2nd half). Our optimistic projections coincide with the May 2008 peak just before the onset of the Lehman/credit collapse as well as the projection based on the 2010 breakout above 1,219-1,227 during late-2010. Modest corrections of the magnitude of 5%-7% can be expected at any time. Febru-ary is not a seasonally strong month, ranking as the 2nd worst month of the year, with average losses of -0.26% in 1929-2010. We believe cor-rections will be contained as long as SPX holds onto prior key breakout near 1,220-1,240. 1,130-1,150 remains pivotal intermediate-term support. A deeper correction of 10%-15% or more is possible towards the 2nd half a er SPX achieves our price targets.

In summary, technical analysis involves rec-ognizing chart patterns, price momentum, mar-ket psychology, and trends, among others. In this Investor’s Guide, we took a brief look at trends. Trends need to be analyzed over a number of time periods to provide the most useful information. Looking at one in isolation can be misleading, especially when secular and cyclical forces converge. At these points, one must respect the longer-term trend, unless prov-en otherwise.

1000

1050

1100

1150

1200

1250

1300

1350

1400

Jul Aug Sep Oct Nov Dec Jan Feb


Bond market Municipal bonds

State and local budgets will address unfunded pension liabilities as Utah recently has. More states will adopt programs like Utah’s.

Joseph Krist, Analyst, UBS Financial Services Inc.

In recent months, we have postulated that state and local governments will need to address their unfunded pension liabilities by adopting over-due reforms to current retirement programs. Defi ned benefi t programs will be gradually abandoned in favor of hybrid programs more like those adopted by the private sector for their employees. The transition is likely to occur over a period of years and will be adopted more quickly in some states than others.

For those states looking for a roadmap, Utah just provided one. The Beehive State has replaced its defi ned benefi t program with a new program similar to a conventional 401(k) plan for new employees. The legislation’s sponsor, Senator Dan Liljenquist, was motivated by a de-cline in the state’s pension funding ratio due to market volatility in late 2008 and early 2009. The state employed a 7.75% discount (assumed investment) rate to calculate its pension liabili-ties. Based on information provided by the Utah retirement system, a 6% return over the next 25 years (vs. 7.75%) would trigger a USD14.4 bn future unfunded liability.

Rather than rely on improved market per-formance to provide such a return and restore the funding ratio, legislators voted to introduce

Utah pension reform

a new program to limit its future liability. Utah will contribute 10% of each worker’s salary (12% for public safety workers and fi refi ghters) to a retirement account in the employee’s name. Employees are not permitted to borrow from the retirement account and are subject to cer-tain investment parameters. They can opt out of the program entirely, in which case the state simply contributes the 10% to the individual’s traditional 401(k) plan. Existing employees are unaff ected by the change as the state constitu-tion prohibits any radical changes to the retire-ment plans of existing employees, absent an overriding fi scal emergency.

State contributions under the new plan are generous by private sector standards but serve the best interest of the state’s taxpayers by limit-ing the obligation to the current year’s payment. The state’s obligation is fi xed annually – for new employees – and not subject to change due to poor investment returns, greater life expectancy, or more years of service for the average employ-ee. The new program may encourage individu-als to enter government service later in their careers for a shorter tenure; the system is no longer constructed in such a way as to encour-age individuals to join the government payroll in relative youth and remain there for 30 years to enhance their pension benefi ts. We believe more states will adopt similar programs.

Bond market Credit sectors

The companies we cover within basic industries are basically doing very well. Most carry high levels of liquidity on their balance sheets, and their debt ma-turities look manageable. Revenues have increased, cash fl ow generation is strong, and credit metrics have improved. Pricing

conditions for most commodities remain posi-tive, supported by an acceleration of economic activity in the developed world, and the conse-quent rise in demand, as well as by structural constraints in new supply coming on stream.

Large global mining companies boast the strongest credit metrics within the sector, while the recovery in US chemical producers is becom-ing more evident. We note that US chemical companies appear to have relevant competitive advantages relative to their global competitors in today’s pricing environment. While most glo-bal producers use naphtha, a derivative from expensive crude oil as a major feedstock, US chemical companies rely mostly on ethane, which is a derivative from relatively depressed natural gas.

We remain cautious on the aluminum sec-tor on the back of our rather bearish view for that particular metal. However, the ongoing drought in China and its potential impact on hydro-electric generation, and on energy-inten-sive aluminum production, may prove an impor-tant upside risk. Likely restrictions in aluminum production may translate into draw-downs from global inventories. If that were to occur, a nor-malization of production and restocking, when and if the drought eases, could provide support

for higher prices.The risk of the emergence of possible un-

foreseen events that could derail the current vir-tuous cycle should not be underestimated. However, it seems that concerns about periph-eral Europe feeding into risk aversion have eased, and the situation in Egypt, and its poten-tial impact on vessel traffi c through the Suez Canal, now appears under control. Unless a ma-jor negative surprise, we would expect the posi-tive trend to extend into 2011.

In the short term, we are still concerned with persistent low yields potentially triggering leveraged mergers and acquisitions (M&A), and/or tempting managements to use debt to boost shareholders’ returns, both of which could re-sult in weaker fundamentals to the detriment of bondholders. Longer term, we remain con-cerned with the sector’s growing reliance on China as the ultimate end user, or driver of pric-es, as well as with rising infl ation in emerging markets.

Donald McLauchlan, Analyst, UBS Financial Services, Inc.

Basic industries – basically sound

Credit Sector reports and our Corporate Bond Valuation Reports are located in the Credit section of the Online Services Re-search website.


Currencies


Currency pairs

GPBUSD British pound per US dollar

EURUSD Euro per US dollar

AUDUSD Australian dollar per US dollar

USDJPY US dollar per Japanese yen

Source: Thomson Reuters, UBS WMR

Forward

Forecast

Volatility Range

Volatility Range

100

95

90

75

80

85

Jun 11 Oct 11 Feb 12 Jun 12Jun 10Feb 10 Oct 10 Feb 11

2.5

1.9

1.5

2.3

2.1

1.7

1.3

Source: Bloomberg

1982 1986 1990 1994 1998 2002 2006 2010

EURCHFPPP EURCHF

The AUDUSD traded within a range of 0.98 – 1.02 since the start of 2011. We expect strong China demand for Australia com-modity exports to support the AUD, but near-term upside in the AUDUSD would be constrained by global risk aversion, on the back of ongoing Middle-East tensions.

The Bank of England is challenged by rising infl ation, which will eventually compel the BoE to tighten monetary policy, supporting the pound versus the US dollar. At the same time, political tensions in North Africa sup-port the US dollar versus the pound. We expect GBPUSD to remain in a 1.63 to 1.53 range.

Franc refl ects security and growth

When the global economy is rocked by turmoil, the franc appreciates. This has been the case since the end of World War II and will not change any time soon. Switzerland is politically and economically stable even when many other countries have major problems. The same seems to apply in reverse, too: when the global econo-my is booming, the Swiss franc weakens. The last time we saw a strong global economy com-bined with a weak franc was in the heyday of the carry trade between 2005 and 2008, when risk-hungry investors borrowed francs and systematically pushed the currency down.

UBS Wealth Management Research (WMR) expects the Swiss franc to remain expensive for years to come. Stable fi nances at public institu-tions, high household and corporate savings and a dynamic economy are prized by interna-tional investors facing a diffi cult environment. They see the franc as an ideal investment that

may not off er much of a yield but provides a high degree of security. For Swiss companies, and exporters in particular, the currency strength is a challenge.

The Swiss franc is massively overvalued at present. The exchange rate against the euro has reached the highest level of overvaluation UBS WMR has ever measured on its purchasing power parity model (see chart). Even so, the probability of weakness is slim. In our view, there is an increased likelihood that the Swiss National Bank will raise rates if the currency breaks through 1.00 to the dollar or 1.40 against the euro. This would make the franc even more attractive and push it up again.

Whichever way they look at it, Swiss inves-tors and exporters have to come up with strate-gies to deal with the strong franc. We feel it is important for Swiss exporters to protect them-selves against possible further appreciation without giving up the possibility of benefi ting from it. Options or warrants are essential tools to insure against extreme fl uctuations. Recent months have shown that the franc weakens slightly whenever things normalize a little on the international stage. If things hot up again, inves-tors promptly buy francs again on a large scale. And once the storm has broken, it is hard to fi nd shelter.

Thomas Flury, Analyst, UBS AG


Forward

Forecast

Volatility Range

Volatility Range

1.8

1.7

1.6

1.5

1.4



Forward Forecast

Volatility Range

Volatility Range

1.15

1.10

1.05

1.00

0.95

0.90

0.85

0.80



Forward

Forecast

Volatility Range

Volatility Range

1.60

1.50

1.40

1.30

1.20


We expect EURUSD to remain range-bound, between 1.30 and 1.40. Tensions in North Africa and the Middle East are supportive for the USD, but we think its rise is capped by the Fed’s quantitative easing measures. Strong growth in Germany supports the euro, as it raises rate hike expectations for the ECB.

USDJPY lies in a range of 80 to 90. Some indicators show strong growth. Chances are small, however, that growth would lead to infl ation and consequently to central bank hikes. Therefore we would buy USD versus JPY at dips towards 80.

Swiss franc is massively overvalued


Commodities


Commodities

US natural gas

Silver

Gold

Coff ee

22.02.2011USD 3.93/mmbtu

22.02.2011USD 1401/oz

22.02.2011USD 2.75/lb

Forecast3 months

Forecast3 months

Forecast3 months

Forecast9–12 months



22.02.2011USD 32.9/oz

Forecast3 months


US natural gas prices peaked at USD 4.8/mmbtu in January, steadily declining there-a er toward USD 3.8/mmbtu in February. The weak price environment refl ects robust production growth, which was able to off -set price-supportive weather conditions. Effi ciency gains and lower breakeven costs have motivated drilling activity, keeping the market well supplied. We think depressed prices are needed to balance supply and demand. That said, price dips to USD 3.6/mmbtu and below should be low enough to make tactical long positions attractive.

A er an 8% correction in January, as spec-ulative accounts closed some long posi-tions, prices recovered towards USD 1400/oz. The events in the Middle East are a fac-tor. We also see support for gold from neg-ative real interest rates, infl ation concerns and currency uncertainties, which should increase fi nancial demand during 2011. We expect growing demand from India and especially from China, where fi rm economic growth and rising wages allow demand to grow structurally. We keep our 12-month target unchanged at USD 1650/oz.

Silver prices breached last year’s highs on renewed investment demand. A backward-ated forward curve and falling inventories indicate an undersupplied market. This, and an improved economic outlook for the developed world, have been enough to revive investors’ attention a er the sell-off towards USD 26.5/oz in January. Despite this apparent shortage, we believe that the underlying supply-demand balance should not warrant silver outperforming gold. Hence, we think only moves below USD 26/oz should be used to build long positions.

Coff ee prices are up about 14% since the beginning of the year, driven by tight supply and strong demand. Inventories at international coff ee exchanges fell to 1.6mn bags (multi-year lows) and farmers are still holding back stocks in anticipation of further price gains. Moreover, the 2011/12 crop year for Brazilian Arabica is entering an off -year, lowering output. Given this backdrop and the unsustainable inventories at exchanges, we expect prices to move above USD 3/lb in the coming months.

Global industrial metal demand

Values are standardized to 100

130

115

105

95

125120

110

100

90

Source: WBMS, UBS WMR

2005 2006 20082007 2009 2010 2011

LeadNickel

TinZinc

AluminiumCopper

Industrial metals demand to challenge supply

In 2010 industrial metal performance rose 20%, measured by the Dow Jones UBS Industrial Met-als index. We believe 2011 to be another year in which metal prices will rise. Double-digit returns for the sector are foreseen, though lower than last year.

Accelerating global economic growth will underpin demand for industrial metals in 2011. Global consumption of industrial metals sur-passed pre-crisis highs already in late 2010. With demand from the developed world contributing solidly to consumption growth and China’s demand growth swelling again a er a so patch, global demand should advance strongly. This will challenge supply on the cost and output side dur-ing coming quarters. Any disruption of supply will thus be a catalyst for higher prices.

Copper is our top individual pick for long positions. Higher Chinese import demand in coming quarters and limited supply additions as well as delayed mining projects should keep the market undersupplied by more than 500kt in

2011. We think prices could move towards USD 11,500/mt this year. Zinc is our second-most preferred metal. A pick-up in galvanized steel production from China and the outlook of aging mines should allow prices to advance. Initially we expect mounting exchange inventories to top out. With a lack of ores and concentrates to supply growth in 2012 and onwards, we see a risk of undersupply to the market. To ensure suf-fi cient mine investments, we expect price moves above USD 3000/mt.

Other base metal prices should also gain traction. The supply side in aluminum, lead and nickel is better situated to cope with higher de-mand. But even here mounting energy prices – for coal in particular – have supported prices fi rmly. Risk stems from an excessive rise in crude oil and energy prices, which could slow eco-nomic activity and therefore demand for indus-trial metals.

Dominic Schnider, Analyst, UBS AG

Arrows indicate whether the commodity is expected to strengthen, weaken or trend sideways.


Emerging markets


Emerging markets

BrazilLatest infl ation fi gures showed that com-pared to a month ago, prices in Brazil increased by more than one percent. Primar ily, the acceleration of infl ation was driven by higher producer prices. As food prices continue to rise, producers of food products and industrial goods (which in-clude the infl ation in the prices of cotton and tobacco) start to increase the prices of their products. Based on these dynamics, it seems likely that infl ationary pressure will increase in the months ahead. Therefore, we expect a further tightening of monetary and fi scal policies.

IndiaA er resilient high growth in 2010, we expect a moderation in 2011. Recent indus-trial output data has been on the weak side. Time series data remains very volatile, however. Headline infl ation showed signs of easing, but high local and global food and commodity prices and supply side bot-tlenecks could generate surprises ahead. Infl ation lingers. We expect it to come down only gradually. Meanwhile, we ex-pect the Reserve Bank of India to hike the repo and reverse repo rates by 25bps each to contain rising infl ationary expectations when it meets next on 17 March.

RussiaThe Russian economy is currently fueled by the high oil price, itself li ed by the unrest in the Middle East and fears of further con-tagion. This also supports the Russian rou-ble versus both the euro and the US dollar, but there are limits to rouble strength. The Russian central bank, wary of the still shaky economic recovery, does not want the rou-ble to become much stronger and is thus intervening in the currency market. For the same reason, the central bank is currently postponing interest rate hikes, but these will need to be realized in coming months to move real rates into positive territory.

ChinaChina’s consumer price index (CPI) rose 4.9% y/y in January from 4.6% in Decem-ber, below market consensus of 5.4%. Food prices are again the main driver. Non-food infl ation also reached a decade high, suggesting broad-based price pressure. The impact of CPI basket re-weighting should be largely neutral to headline infl ation this year. While a smaller food weighting can reduce the volatility of a CPI, rising non-food prices, in particular housing costs, would be amplifi ed. We think infl ation will remain elevated and peak in 2Q11. We look for at least two rate hikes this year, both of which are likely to come in 1H11.

Source: Bloomberg, UBS WMR, as of 21 February 2011

0 2 4 6 8 10 12 14 16RussiaTurkey

HungaryPoland

South AfricaIndonesia

ChinaIndia

PhilippinesMalaysia

BrazilChile

ColombiaMexico

Peru

Food infl ation – large diff erences between countries Annual food price inflation in emerging markets, in %

Driven by higher food and energy prices, rising infl ation in several emerging markets has increased concerns about interest rate hikes, tighter fi scal policies and, ultimately, lower economic growth.

Although food and energy prices may increase somewhat in the months ahead, we think infl ation in most emerging markets should remain contained. For one thing, pressure on food prices appears to be easing in several mar-kets, and most emerging market central banks already began tightening their monetary poli-cies a while ago. Hence, a er peaking in the fi rst half of 2011, we think infl ation rates will moderate in the second half of the year. Once concerns about infl ation start to ease later this year, investors will likely feel reassured about the solid longer-term growth prospects of many emerging economies. First and foremost, this should benefi t emerging market equities, especially in Asia, where markets have under-

performed in recent months. Investors are therefore well-advised to follow infl ation trends carefully.

Of course, there are risks to this benign sce-nario. Infl ation might trend higher in some mar-kets and the central banks might have to tighten their policies more signifi cantly. Looking at labor market utilization, monetary policy, and infl a-tion trends, we think risks for this are currently somewhat higher in Brazil, Turkey, Indonesia, and the Philippines, as well as in India, although to a lesser extent. We currently recommend investors reduce their equity exposure in India and Indonesia.

It is important to note that the prices of emerging market bonds denominated in USD are not directly aff ected by infl ation in emerging markets. Rather, it is infl ation in the US that can drive the yields of these bonds higher. Although we expect yields to gradually increase in the US, we continue to see attractive opportunities in selected US dollar-denominated emerging mar-ket bonds, especially for bonds with somewhat shorter durations.

Michael Bolliger, Analyst, UBS AG

Infl ation’s shadow stalks emerging markets

Investors should be aware that Emerging Market assets are subject to, amongst others, potential risks linked to currency volatility, abrupt changes in the cost of capital and the economic growth outlook, as well as regulatory and socio–political risk, interest rate risk and higher credit risk. Assets can sometimes be very illiquid and liquid-ity conditions can abruptly worsen. WMR generally recommends only those securities it believes have been registered under Federal U.S. registration rules (Section 12 of the Securities Exchange Act of 1934) and individual State registration rules (commonly known as “Blue Sky” laws). Prospective investors should be aware that to the extent permitted under US law, WMR may from time to time recommend bonds that are not registered under US or State securities laws. These bonds may be issued in jurisdictions where the level of required disclosures to be made by issuers is not as frequent or complete as that required by US laws.For more background see the WMR Education Notes, “Investing in Emerging Markets (Part 1): Equities,” 27 August 2007, “Emerging Market Bonds: Understanding Emerging Market Bonds,” 12 August 2009 and “Emerging Markets Bonds: Understanding Sovereign Risk,” 17 December 2009. Clients interested in gaining exposure to emerging markets sovereign USD bonds may either buy a diversified fund of such bonds (preferably an actively managed portfolio of such bonds), or they may wish to select bonds from specific countries.Investors interested in holding bonds for a longer period are advised to select the bonds of those sovereigns with the highest credit ratings (in the investment–grade band). Such an approach should minimize the risk that an investor could end up holding bonds on which the sovereign has defaulted. Sub–investment grade bonds are recommended only for clients that have a higher risk profile and who seek to hold higher-yielding bonds for only shorter periods.


Market scenarios

High Growth

Low Growth

Negative Growth

Goldilocks Supercycle

Deflation Stagflation

High Negative Inflation

Low Inflation Inflation

High Growth

Low Growth

Negative Growth





High Growth

Low Growth

Negative Growth





High Growth

Low Growth

Negative Growth





60%

Globally economic indicators continue showing signs of strength, especially in the US. While a moderate recovery remains our baseline scenario, we have further increased our likelihood assess-ment of a strong recovery to 25%. We have also increased the likelihood of a stagfl ation scenario, given rising food prices and the potential impact on oil of political instability in the Middle East. A renewed defl ationary downturn appears unlikely at this stage.

Brian Rose, PhD, Strategist, UBS Financial Services Inc.Stephen R. Freedman, PhD, CFA, Strategist, UBS Financial Services Inc.

Moderate Recovery

5%

RenewedDownturn

25%

Strong Recovery

10%Stagfl ation

• The global economy remains on an increas-ingly self-sustaining but unspectacular ex-pansion course.

• Rapid growth in the emerging markets helps to sustain global aggregate demand.

• The recovery in developed countries is more subdued than in prior cycles because of deleveraging pressures on the consumer and the fi nancial sector.

• The abundant slack in the US economy keeps infl ationary pressures from building up despite easy monetary policy. Food price infl ation abates during the second half of 2011.

• High profi t margins and low interest rates encourage a surge in investment spending.

• Improvements in the labor market and in credit conditions allow a more dynamic consumer recovery.

• Global GDP growth exceeds 4.5% in 2011.

• Loose monetary policy boosts commod-ity prices without helping the economy, setting an infl ationary process in motion. Political instability in the Middle East leads to more signifi cant spike in crude oil prices than expected.

• Rising price levels and weak growth pros-pects poses signifi cant challenges to most fi nancial assets.

• The fragile recovery in the developed econ-omies stalls as fi scal consolidation creates additional headwinds.

• Most countries suff er at least one quarter of negative growth as consumers cut back on spending.

• Falling commodity prices and a rise in ex-cess capacities lead to negative consumer price infl ation (defl ation).

Down from 65%

Up from 20%

Up from 5%

Down from 10%

Disclosures

Analysts provide a relative rating, which is based on the stock’s total return potential against the total estimated return of theappropriate sector benchmark over the next 12 months.

Industry Sector Relative Stock View

Outperform (OUT) Expected to outperform the sector benchmark over the next 12 months.Marketperform (MKT) Expected to perform in line with the sector benchmark over the next 12 months.Underperform (UND) Expected to underperform the sector benchmark over the next 12 months.Under review: Upon special events that require further analysis, the stock rating may be flagged as “Under review” by theanalyst. Suspended: If data is not valid anymore, the stock rating may be flagged as “Suspended” by the analyst.Restricted: Issuing of research on a company by WMR can be restricted due to legal, regulatory, contractual or best business-practice obligations which are normally caused by UBS Investment Bank's involvement in an investment banking transaction inregard to the concerned company.

Stock Recommendation System

Analyst CertificationEach research analyst primarily responsible for the content of this research report, in whole or in part, certifies that withrespect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his orher personal views about those securities or issuers; and (2) no part of his or her compensation was, is, or will be, directly orindirectly, related to the specific recommendations or views expressed by that research analyst in the research report. For a complete set of Required Disclosures relating to the companies that are the subject of this report, please mail a requestto UBS Wealth Management Research Business Management, 1285 Avenue of the Americas, 13th Floor, New York, NY10019.

Required disclosures

Statement of riskStock and bond market returns are difficult to forecast because of fluctuations in the economy, investor psychology, geopoliticalconditions and other important variables.

Scale for Investment Strategy charts

Symbol Description/ Symbol Description/Definition Definition

+ moderate – moderateoverweight vs. underweight vs.

benchmark benchmark

++ overweight vs. – – underweight vs.benchmark benchmark

+++ strong – – – strongoverweight vs. underweight vs.

benchmark benchmark

n neutral, i.e.,on benchmark

Source: UBS WMR

High Conviction Calls Sector analysts are required to have at least one "high conviction" outperform or underperform callfor each sector they cover. Analysts have discretion over the selection of a recommendation as high conviction and thegrounds for selection (e.g., greatest upside/downside to price target, most/least compelling investment case, etc.). The basisfor each high conviction call is set forth in any research report identifying a recommendation as such.

Sector bellwethers, or stocks that are of high importance or relevance to the sector, that are not placed on either the outper-form or underperform list (i.e., are not expected to either outperform or underperform the sector benchmark) will be classifiedas marketperform. Additionally, when stocks that are not deemed to be of high importance or relevance to the sector are notexpected to outperform or underperform the sector benchmark, they will simply be removed from the lists and will not beassigned a WMR rating.

The overweight and underweight recommendations repre-sent tactical deviations that can be applied to any appropri-ate benchmark portfolio allocation. They reflect WMR’sshort– to medium–term assessment of market opportunitiesand risks in the respective asset classes and market seg-ments. The benchmark allocation is not specified here. Itshould be chosen in line with the risk profile of the investor.

For more information, please read the most recent USInvestment Strategy Guide.


Disclosures Disclosures

UBS Financial Services Inc. Technical Research Dept.: Definitions and DistributionUBS Financial Definition and Criteria CorrespondingServices Rating Rating

CategoryBullish Well–defined, reliable uptrend, an increase in the rate Buy

of change (or strong momentum) and confirming technical indicators

Mod. Bullish Positive overall trend, momentum and confirming Buytechnical indicators

Neutral Trading range trend, a flat rate of change and Neutral/Holdconfirming technical indicators

Mod. Bearish Weakened trend, momentum and confirming Selltechnical indicators

Bearish Negative trend, momentum and confirming Selltechnical indicators

N/A Not enough historical data to make an evaluation N/A

For information on the ways in which UBS manages conflicts and maintains independence of its research product; historical performanceinformation; and certain additional disclosures concerning UBS research recommendations, please visit www.ubs.com/disclosures.

Global Equity Rating AllocationsUBS 12–Month Rating Rating Category Coverage1 IB Services2

Buy Buy 49% 40%Neutral Hold/Neutral 42% 35%Sell Sell 8% 21%1Percentage of companies under coverage globally within the 12–month rating category.2Percentage of companies within the 12–month rating category for which investment banking (IB) services were provided within the past 12 months.Source: UBS. Rating allocations as of 31 December 2010.

Global Equity Rating DefinitionsUBS 12–Month Rating DefinitionBuy FSR is > 6% above the MRA.Neutral FSR is between –6% and 6% of the MRA.Sell FSR is > 6% below the MRA.KEY DEFINITIONSForecast 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 topossible change in the near term, usually in response to an event that may affect the investment case or valuation.

EXCEPTIONS AND SPECIAL CASESCore 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 exceptionsapply, they will be identified in the Companies Mentioned or Company Disclosure table in the relevant research piece.

UBS Investment Research

The indicated performance for Dividend Ruler Stocks, Quality Growth at a Reasonable Price, U.S. Top 25 Stock List and ADR Top List isbased on capital appreciation plus dividends of an equal weight portfolio, but does not include transaction costs, such as commissions,fees, margin interest and interest charges. Actual transactions adjusted for such transaction costs will result in reduced total returns.

Prices of stocks used in performance calculations generally reflect closing prices one trading day after the addition or deletion toensure that changes to the list are announced in a manner that allows clients to match the list's performance. For ADR Top List, wewill typically publish changes to the list after the close and prices used for performance calculation purposes are the closing prices onthe following trading day after the date on the published report. In cases where we publish the ADR Top List in the morning prior tothe New York Stock Exchange open, as was the case for our initial report on 26 October 2009, we will use the closing price of thedate on the report for performance calculation purposes, which still reflects one full day of trading after the publication of the report.

A complete record of all the recommendations upon which the performance calculations are based is available from UBS FinancialServices Inc. upon written request. Past performance is not an indication of future results.

Performance

Other Important DisclosuresIn certain countries UBS AG is referred to as UBS SA. This publication is for our clients’ information only and is not intended as an offer, or a solici-tation of an offer, to buy or sell any investment or other specific product. It does not constitute a personal recommendation or take into accountthe particular investment objectives, financial situation and needs of any specific recipient. We recommend that recipients take financial and/or taxadvice as to the implications of investing in any of the products mentioned herein. We do not provide tax advice. The analysis contained herein isbased on numerous assumptions. Different assumptions could result in materially different results. Other than disclosures relating to UBS AG, its sub-sidiaries and affiliates, all information expressed in this document were obtained from sources believed to be reliable and in good faith, but no rep-resentation or warranty, express or implied, is made as to its accuracy or completeness. All information and opinions are current only as of the dateof this report, and are subject to change without notice. This publication is not intended to be a complete statement or summary of the securities,markets or developments referred to in the report.

Opinions may differ or be contrary to those expressed by other business areas or groups of UBS AG, its subsidiaries and affiliates. UBS WealthManagement Research (UBS WMR) is written by Wealth Management & Swiss Bank and Wealth Management Americas. UBS InvestmentResearch is written by UBS Investment Bank. The research process of UBS WMR is independent of UBS Investment Research. As a consequenceresearch methodologies applied and assumptions made by UBS WMR and UBS Investment Research may differ, for example, in terms of invest-ment horizon, model assumptions, and valuation methods. Therefore investment recommendations independently provided by the two UBS researchorganizations can be different.

The analyst(s) responsible for the preparation of this report may interact with trading desk personnel, sales personnel and other constituencies forthe purpose of gathering, synthesizing and interpreting market information. The compensation of the analyst(s) who prepared this report is deter-mined exclusively by research management and senior management (not including investment banking). Analyst compensation is not based oninvestment banking revenues, however, compensation may relate to the revenues of UBS as a whole, of which investment banking, sales and trad-ing are a part.

At any time UBS AG, its subsidiaries and affiliates (or employees thereof) may make investment decisions that are inconsistent with the opinionsexpressed in this publication, may have long or short positions in or act as principal or agent in, the securities (or derivatives thereof) of an issueridentified in this publication, or provide advisory or other services to the issuer or to a company connected with an issuer. Some investments maynot be readily realizable since the market in the securities is illiquid and therefore valuing the investment and identifying the risk to which you areexposed may be difficult to quantify. UBS relies on information barriers to control the flow of information contained in one or more areas withinUBS, into other areas, units, groups or affiliates of UBS. Some investments may be subject to sudden and large falls in value and on realization youmay receive back less than you invested or may be required to pay more. Changes in foreign currency exchange rates may have an adverse effecton the price, value or income of an investment. Past performance of an investment is not a guide to its future performance. Additional informationwill be made available upon request.

All Rights Reserved. This document may not be reproduced or copies circulated without prior written authority of UBS or a subsidiary of UBS. UBSexpressly prohibits the distribution and transfer of this document to third parties for any reason. UBS will not be liable for any claims or lawsuits fromany third parties arising from the use or distribution of this document. This report is for distribution only under such circumstances as may be per-mitted by applicable law. The securities described herein may not be eligible for sale in all jurisdictions or to all categories of investors.

Australia: Distributed by UBS Wealth Management Australia Ltd (Holder of Australian Financial Services Licence No. 231127), Chifley Tower, 2Chifley Square, Sydney, New South Wales, NSW 2000. Bahamas: This publication is distributed to private clients of UBS (Bahamas) Ltd and is notintended for distribution to persons designated as a Bahamian citizen or resident under the Bahamas Exchange Control Regulations. Canada: InCanada, this publication is distributed to clients of UBS Wealth Management Canada by UBS Investment Management Canada Inc.. Dubai: Researchis issued by UBS AG Dubai Branch within the DIFC, is intended for professional clients only and is not for onward distribution within the United ArabEmirates. France: This publication is distributed by UBS (France) S.A., French «société anonyme» with share capital of € 125.726.944, 69, boulevardHaussmann F–75008 Paris, R.C.S. Paris B 421 255 670, to its clients and prospects. UBS (France) S.A. is a provider of investment services duly author-ized according to the terms of the «Code Monétaire et Financier», regulated by French banking and financial authorities as the «Banque de France»and the «Autorité des Marchés Financiers». Germany: The issuer under German Law is UBS Deutschland AG, Stephanstrasse 14–16, 60313Frankfurt am Main. UBS Deutschland AG is authorized and regulated by the «Bundesanstalt für Finanzdienstleistungsaufsicht». Hong Kong: Thispublication is distributed to clients of UBS AG Hong Kong Branch by UBS AG Hong Kong Branch, a licensed bank under the Hong Kong BankingOrdinance and a registered institution under the Securities and Futures Ordinance. Indonesia: This research or publication is not intended and notprepared for purposes of public offering of securities under the Indonesian Capital Market Law and its implementing regulations. Securities men-tioned in this material have not been, and will not be, registered under the Indonesian Capital Market Law and regulations. Italy: This publicationis distributed to the clients of UBS (Italia) S.p.A., via del vecchio politecnico 3 – Milano, an Italian bank duly authorized by Bank of Italy to the pro-vision of financial services and supervised by «Consob» and Bank of Italy. Jersey: UBS AG, Jersey Branch is regulated by the Jersey Financial ServicesCommission to carry on investment business and trust company business under the Financial Services (Jersey) Law 1998 (as amended) and to carryon banking business under the Banking Business (Jersey) Law 1991 (as amended). Luxembourg/Austria: This publication is not intended to con-stitute a public offer under Luxembourg/Austrian law, but might be made available for information purposes to clients of UBS (Luxembourg) S.A./UBS(Luxembourg) S.A. Niederlassung Österreich, a regulated bank under the supervision of the «Commission de Surveillance du Secteur Financier»(CSSF), to which this publication has not been submitted for approval. Singapore: Please contact UBS AG Singapore branch, an exempt financialadviser under the Singapore Financial Advisers Act (Cap. 110) and a wholesale bank licensed under the Singapore Banking Act (Cap. 19) regulatedby the Monetary Authority of Singapore, in respect of any matters arising from, or in connection with, the analysis or report. Spain: This publica-tion is distributed to clients of UBS Bank, S.A. by UBS Bank, S.A., a bank registered with the Bank of Spain. UAE: This research report is not intendedto constitute an offer, sale or delivery of shares or other securities under the laws of the United Arab Emirates (UAE). The contents of this reporthave not been and will not be approved by any authority in the United Arab Emirates including the UAE Central Bank or Dubai Financial Authorities,the Emirates Securities and Commodities Authority, the Dubai Financial Market, the Abu Dhabi Securities market or any other UAE exchange. UK:Approved by UBS AG, authorised and regulated in the UK by the Financial Services Authority. A member of the London Stock Exchange. This pub-lication is distributed to private clients of UBS London in the UK. Where products or services are provided from outside the UK they will not be cov-ered by the UK regulatory regime or the Financial Services Compensation Scheme. USA: Distributed to US persons by UBS Financial Services Inc., asubsidiary of UBS AG. UBS Securities LLC is a subsidiary of UBS AG and an affiliate of UBS Financial Services Inc. UBS Financial Services Inc. acceptsresponsibility for the content of a report prepared by a non–US affiliate when it distributes reports to US persons. All transactions by a US person inthe securities mentioned in this report should be effected through a US–registered broker dealer affiliated with UBS, and not through a non–US affil-iate.

© 2011. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.

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