WWRR Vol.2.017

Equities
Prepare for volatility. Volatility increases in
the latter stages of the economic cycle. Since
1990, the VIX index has averaged 22 in the
six months prior to the start of US recessions,
versus 18 during other periods in which the
economy is expanding.
Our main messages for equity
investors in 2019 are:
– Diversify globally. No single region offers
a uniquely compelling case. The US economy
remains strong, but with a price-toearnings
ratio of around 17x, valuations are
15% higher than the global average. Eurozone
and emerging market (EM) stocks
have lower valuations, but both regions are
more exposed to China’s slowdown. We
favor global diversification within equity
holdings, which should also help mitigate
volatility.
– Look for value and quality. We expect
US and EM value to outperform growth,
reversing their 2018 underperformance.
“Quality” companies, meanwhile, with
higher profitability, lower financial leverage,
and less earnings variability than average,
should withstand volatility better than the
overall market.
– Consider neglected sectors. Financials
could be set to outperform in the US and
China, thanks to rate rises and favorable
changes in regulations in the former, and to
economic stimulus in the latter. The US and
European energy sectors also offer value.
And we think oil prices will recover in early
2019 (see page 51).
Long-term outlook
Returns in the coming decade will be lower
than in the past decade. Higher interest rates
and relative labor scarcity will pressure margins.
The tech growth spurt will moderate.
Share buybacks will become more expensive
to finance.
Within our long-term outlook, several themes
stand out:
– US-focused investors should diversify.
US stocks have outpaced global equities by
around 50 percentage points over the past
seven years, returning a total of about
150% ver sus 100%. Over the next seven
years, we expect higher long-term returns
outside the US. US stocks trade in line with
their average trailing price-to-earnings (P/E)
ratio over the past 30 years, while the
global index is at a 20% discount.
– Emerging markets for the long term.
EM stocks face short-term headwinds, such
as a strong US dollar and rising US interest
rates. For more far-sighted investors, however,
valuations are appealing, with a trailing
P/E c.25% below the 30-year average.
– Japanese stocks have a good long-term
outlook. Japan is putting its history as a
market suffering from weak inflation and
poor corporate governance behind it. Still,
the index is valued at just 12x trailing earnings
– a 15% discount to global equities.
Investors could benefit even more by
holding unhedged positions in the market
(see page 48).
Year Ahead 2019 – UBS House View
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