Macro outlook Macro outlook In the meantime, China is signaling the relaxation of zero- We see commodities as attractive both on an outright COVID-19 measures, even in the face of elevated case counts. In basis and for the hedging role they serve in multi-asset our view, this suggests a commitment to such a shift in policy, portfolios. Already low inventories can continue to shrink in which should allow for a boost in consumption. The process is an environment of slowing growth so long as supply remains unlikely to play out in a straight line, but the direction of travel constrained – as is the case across most key commodity seems pretty clear, to us. Our confidence that the bottom is markets. Securing sufficient access to energy is not a problem in for China is fortified since these adjustments to COVID-19 that will be solved at the end of this winter – and may policy are taking place in tandem with the most comprehensive grow more intense as Chinese demand increases if mobility support for the property sector to date. A rebounding China restrictions are removed. In addition, commodities have a may provide a needed boost as developed economies slow, but track record of strong performance during months when will also likely lead to higher commodity prices. This too may stocks and bonds suffer meaningful declines. make it difficult for the Fed and other central banks to back off too quickly. In currencies, we believe we have moved from a strong, trending US dollar to more of a rangebound trade in USD. Asset allocation Our catalysts for a broad turn in the dollar are for the Fed to Macro and cross-asset volatility are unlikely to fade away along stop hiking interest rates, China’s zero-COVID-19 policy to with the calendar year. And the distribution of outcomes end, and energy pressures in Europe stemming from Russia’s remains much wider than investors became accustomed to in invasion of Ukraine to subside. None of these have fully the previous cycle. Our focus is therefore on positioning over happened yet, but all three appear to be getting closer. the coming months as opposed to the coming year, and we A more rangebound dollar coupled with a global economy are ready to pivot as the business cycle evolves. that is still growing, but slowing, could provide a very positive backdrop for high carry, commodity-linked currencies. The Fed vs. the US labor market Chart 2 – Top 40% of earners account for 60% of spending Going into 2023, we expect global equities at an index level We prefer the Brazilian real and Mexican peso. To best understand US economic dynamics, it is necessary to 9% to remain range-bound. They will likely be capped to the break down the US labor market into lower and higher income upside by the Fed’s desire to keep financial conditions from cohorts. Lower wage employees, who are disproportionately easing too much. However, we expect some cushion on the Chart 3 – S&P 500 margins tend to be positively correlated with employed in the service sector, are experiencing very strong 38% 13% 0-20% (lowest earners) downside from a resilient economy and rebounding China. jobs, spending growth wage growth (Chart 1). This is happening in large part 20-40% because higher income workers still have a lot of excess The relative value opportunity set across global equities % 40-60% 30 savings, which they are ready and more than willing to spend appears fertile. Financials and energy are our preferred 25 in the service sector². While high earners have a lower marginal 17% 60-80% sectors. This is because we believe cyclically-oriented 20 propensity to consume (that is, they spend a smaller percentage 80-100% (top earners) positions should perform if what appears to be overstated 15 of their income compared to lower earners), they also account pessimism on global growth fades in the face of resilient 10 for the lion’s share of total consumption (Chart 2). economic data. Activity surprising to the upside and a higher- 5 23% for-longer rate outlook should benefit value stocks relative 0 to growth, in our view – particularly as profit estimates for -5 Chart 1 – US income growth is strongest among the lowest earners Source: UBS-AM, Macrobond. Data as of January 1, 2021. United States, BLS, Con- inexpensive companies are holding up well relative to their -10 sumer Expenditure Survey, Expenditures, Total Average Annual Expenditures, Total, pricier peers. On a regional basis, Japan is buoyed by a rare Quintiles of Income Before Taxes, USD -15 % combination of accommodative monetary and fiscal stimulus. -20 8 It is the Fed’s job to cool this situation down, and make sure ‘00 ‘02 ‘04 ‘06 ‘08 ’10 ’12 ’14 ’16 ‘18 ‘20 ’22 it doesn’t turn into a wage-price spiral. The Fed’s tightening We are neutral on government bonds. The Fed is likely to US Job Growth YoY US Consumption YoY 7 S&P average margins ex commodities 6 of financial conditions has meant some progress in slowing be slow in ending or reversing its hiking cycle as long as the aggregate labor income, cooling the housing market and US labor market bends but does not break, while signs that Source: UBS-AM, Macrobond. Data as of October 31, 2022 5 bringing down goods consumption. But the service spending overall inflation has peaked may reduce the odds of over- 4 dynamics mentioned above are unique to this COVID-19- tightening. However, price pressures are likely to remain driven cycle and arguably tougher to break. We believe this stubbornly high – a side effect of a US labor market that 3 means the US economy (and earnings) probably don’t fall off refuses to crack. China’s reopening should fuel a pick-up 2 as sharply as many are projecting, and, however, also the Fed in domestic oil demand, offsetting some of the downward 1 will need to keep rates higher for longer. pressure on inflation from goods prices. In US and European 1997 2002 2007 2012 2017 2022 credit,, investment grade bond yields look increasingly First Wage Quartile Second Wage Quartile attractive as a balance between a potentially resilient Third Wage Quartile Fourth Wage Quartile economy and more range-bound government bond yields. Source: Macrobond, Atlanta Federal Reserve. Data as of October 1, 2022 ² https://www.chicagofed.org/publications/working-papers/2020/2020-15 4 5