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Emerging market equities
Preference: overweight

UBS View
MSCI EM (27 June): 913 (last month: 907)
MSCI EM 6-month target: 1,000
• Currency weakness hurt emerging market (EM) equity performance in US-dollar terms year-to-date. We expect EM FX to appreciate against the USD from current levels over a six-month horizon.
• As expected, China has started to ease monetary policy. We believe there is also room to do more on the fiscal side, helping to support China's economic growth outlook for the second half of 2012 and into 2013. The 2Q GDP numbers are expected to represent the low point in the current cycle.
• Given the above, in our base case, we see scope for some multiple expansion for the MSCI EM Index, from the current 10.3x realized price-to-earnings ratio to closer to 11x over the next six months. We expect earnings growth of around 10% over the next 12 months.
• Within EM, we believe that Asia is best positioned for economic growth in the second half of 2012. In emerging Asia, we prefer China. In Latin America, we prefer Brazil and Mexico. Central and Eastern Europe remains the most vulnerable region, and we remain neutral on Russia.

Positive scenario
MSCI EM (6-month target): 1,190
• The outlook for the global economy improves, boosting EM's ability to grow more strongly in 2013. Stronger economic growth leads to earnings growth of 15%. Investor confidence improves, leading to a better P/E multiple of 12.5x trailing earnings. More cyclical Korea and Taiwan would benefit.

Negative scenario
MSCI EM (6-month target): 730
• Serious negative developments (e.g. a further deterioration of the Eurozone crisis, the US fiscal cliff, or a Chinese hard landing) hit trade and thus the economic prospects of emerging markets. In this case, we would expect a 25% decline in earnings. More defensive Malaysia would do better, whereas more cyclical Korea and Taiwan would underperform. We assume, however, that the market would also be expecting some recovery in earnings for 2013, helping the P/E multiple to recover to 9.5x trailing earnings.
Note: Scenarios refer to global economic scenarios (see slide 7)

What we're watching
Emerging market monetary policy
Why it matters
Investors are trying to figure out which emerging market central banks still have room to ease monetary policy and where rates may be heading up. Inflation data due for Russia (4–9 July), Brazil (7 July), China (9 July), Mexico (9 July), India (13 July), South Africa (18 July).

Oil prices & EM FX
Recent declines in oil prices are helping to reverse some of the inflationary impact of earlier rises, but the exchange rate matters, too.

Recommendations
Tactical (6 months)
• In Asia, we expect Chinese equities to benefit as the Chinese economy avoids a hard landing. In Latin America, we prefer Brazil and Mexico.

Strategic (1 to 2 years)
• Structural factors (e.g. stronger fiscal position, more favorable demographics) should continue to support stronger economic growth than in the developed economies.
• Strategically, we would advise a tilt in EM portfolios toward cash-rich and faster-growing Asia.

Emerging market country preferences
Current most preferred markets
Brazil
China
Mexico

Current least preferred markets
Hungary
Indonesia
Poland

We currently have a neutral view on the remaining emerging equity markets in the MSCI EM index.

UBS
For further information please contact CIO asset class specialist Costa Vayenas, costa.vayenas@ubs.com
Please see important disclaimer and disclosures at the end of the document.
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