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UK equities
Preference: overweight

UBS View
FTSE 100 (27 June): 5,524 (last month: 5,266)
FTSE 100 (6-month target): 5,785

• We continue to like UK equities relative to global ones. An expected improvement in the global economy over the coming quarters should support UK companies as 70% of revenues are generated abroad.
• Energy is the largest sector of the UK market. While the oil price eased sharply over the past months, we expect it to stabilize in the second half of 2012. An attractive valuation of the energy sector at 6.5x trailing earnings provides some buffer for earnings volatility going forward.
• Profitability of UK banks is reasonable. They are less affected by the sovereign debt crisis than their Eurozone peers. While the recent easing of collateral requirements by the Bank of England is supportive in the short-term, the profitability of the domestic operations could be negatively affected by the implementation of the ring-fencing bank reform by 2015.
• UK equities’ P/E, at about 10.0x trailing, indicates attractive value relative to global equities. Based on our 12-month forward earnings growth estimate of about 5% and the P/E multiple slightly expanding to 10.3x, we expect UK equities to show good returns over the next six months.

Positive scenario
FTSE 100 (6-month target): 6,650
• Continued global growth and strong demand from emerging markets should support demand for commodities, helping the Materials and Energy sectors to lead the market higher. The market could re-rate to a P/E multiple of close to 12.0x, and we would expect earnings growth of 5–8% over 12 months.

Negative scenario
FTSE 100 (6-month target): 4,400
• A global recession drags UK earnings down by 15–20%. The market’s defensive characteristics would only partly offset its strong exposure to commodity-related sectors. We would expect the trailing P/E multiple to drop towards slightly below 9x.

Note: Scenarios refer to global economic scenarios (see slide 7)

Recommendations
Tactical (6 months)
• We like the Energy sector due to attractive valuations; Consumer Staples is another preferred sector Because of its defensive qualities.
• Approaching the end of the patent cliff should remove some uncertainty on the Healthcare sector and enable a re-rating.

Strategic (1 to 2 years)
• As commodity-related sectors, Energy and Materials should benefit from robust demand in emerging markets.
• The UK market's 4% dividend yield provides a good income stream.

UK market trades at a P/E-discount (based on realized earnings)
[Chart showing historical P/E data ranging from 0 to 35 between 1990 and 2012]
01.90 01.92 01.94 01.96 01.98 01.00 01.02 01.04 01.06 01.08 01.10 01.12
— FTSE 100 realized P/E — World realized P/E
Source: Thomson Reuters, UBS CIO, as of 21 June 2012
Note: Past performance is not an indication of future returns.

What we're watching Why it matters
Growth indicators Business survey indicators provide information on the economic development in the UK. Key date: 2 July, PMI manufacturing for June; 4 July, PMI services for June;
Commodity prices Energy and Materials together are about 30% of the UK market by market capitalization. Developments in commodity prices affect earnings estimates.
Policy action Loose monetary policy by the Bank of England (BoE) supports equities. Key date: 05 July, Bank of England policy meeting

UBS
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For further information please contact CIO asset class specialist Markus Irngartinger, markus.irngartinger@ubs.com
Please see important disclaimer and disclosures at the end of the document.
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