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Equity styles

UBS view
Prefer mid caps in US, large caps in Europe
• We believe that medium-sized companies (mid caps) will outperform large caps in the US. US economic data is forecast to stabilize and then show moderate economic growth in the second half of 2012 and into 2013. The greater domestic sales exposure of US mid caps reduces the earnings risk coming from Europe.
• In Europe, we prefer companies with a large market capitalization (large caps) over ones with a small one (small caps) in the current very challenging economic environment. Small caps generate more sales in Continental Europe than large caps. Thus, they are more negatively affected by weak domestic demand. Small caps also have a more cyclical earnings exposure than large caps.
• Globally, high-quality dividend paying stocks promise to provide a real and stable income stream to investors in the current low-yield environment. Furthermore, they give exposure to the long-term potential of equity markets while tending to suffer less in declining markets.

Positive scenario
Prefer value, low quality and small caps
• Leading indicators continue to move higher, and risks related to the Eurozone debt crisis subside. In this case, add deep cyclical value (cheap price/book, price/earnings) regardless of the sector, with high beta and high leverage. In such an environment, small and mid-cap stocks should also perform well. A dividend strategy would be too defensive to outperform the market.

Negative scenario
Prefer quality and large caps
• The global economic picture deteriorates markedly. In this case, buy high-quality growth companies and large caps. Do not look for value opportunities, but be as defensive as possible with your equity exposure. Look to high-quality, dividend-paying stocks for yield.
Note: Scenarios refer to global economic scenarios (see slide 7).

What we're watching
Why it matters
Earnings revisions – see chart
(3-month moving average upgrades vs. downgrades)
Watch for signs of improvement in earnings revisions (aggregated from stock level). An improved earnings outlook would cause investors to add more risk – influencing our preferences among equity styles.
US and Eurozone PMIs
PMIs are important for earnings generation and preferences for value, growth and size. Key dates: Nov 2, PMI manufacturing Eurozone (final); Nov 1, US ISM manufacturing

Regional differentiation
• In the US, we prefer mid caps to large caps. Moderate economic growth should support their earnings generation.
• In the US, there are opportunities in value names that also show strong growth.
• Within Europe, we avoid small caps and instead rotate into large caps.

Strategic (1 to 2 years)
• We expect value strategies to outperform the European market over a multi-year time horizon.
• Mid-cap stocks provide attractive opportunities over the longer term.

Avoid small caps and favor large caps in Europe
DJ STOXX small over large and business confidence
[Chart showing performance trends from 2003 to 2012]
Large caps outperforming
Small cap over large cap — Eurozone business sentiment (rhs)

Source: Thomson Reuters, UBS, as of September 29, 2012
Note: Past performance is no indication for future returns.

UBS
For further information please contact CIO's asset class specialist Christopher Wright, christopher-zb.wright@ubs.com
Please see important disclaimer and disclosures at the end of the document.
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