This report has been prepared by UBS AG. Please see important disclaimers and ­disclosures­at­the­end­of­the document.­

UBS House ViewMonthly Letter 14 January 2021

Chief­Investment­Office­GWMInvestment Research

Equity excess?

Some elements of the current rally are consistent with bubbles according to our framework. We­see­pockets­of­speculation,­but the broader equity market is not­in­a­bubble,­in­our­view.

Bond bubble?

By­some­measures,­bond­markets can be described as a bubble. But central banks have almost unlimited capacity to maintain their policies.

Irrational exuberance?

The cryptocurrency markets are exhibiting­signs­of­excessive­speculation and the IPO/SPAC markets are the hottest in two decades.­But­these­markets­do not yet pose a broader systemic risk.

Asset allocation

We­retain­a­pro-risk­stance.­We move­our­preference­for­UK equities­back­to­neutral­after­their recent good performance and­shift­focus­toward­emerg-ing market stocks.

Sparkles and bubblesI have some gray hairs. I am glad there are people in this world who lovingly call them­“sparkles.”­If­you­have­sparkles,­too,­then­you­have­also­lived­through­some­market bubbles. The experience that brought about those sparkles has taught me that­market­environments­that­feature­cheap­financing,­easy­access­to­investments,­the­incentive­to­engage­in­speculative­activity,­and­a­technological­or­political­“spark” tend to lead to bubbles. These conditions exist today.

Bond prices are so elevated that a quarter of all global bonds are trading with nega-tive­interest­rates.­Tesla­now­has­a­market­cap­bigger­than­all­major­listed­auto-makers­in­Europe,­Japan,­and­the­US­combined.­The­US­IPO­market­is­the­hottest­in more­than­two­decades,­with­first-day­performance­averaging­40%.­Tapping­into­investor­demand­for­new­listings,­special-purpose­acquisition­companies­(SPACs)­raised­more­than­USD 70bn­in­2020,­more­than­the­entire­prior­decade­combined.­Bitcoin almost quadrupled in just three months.

Last­year,­we­noted­that­ultra-low­interest­rates­and­government­stimulus­would­push investors toward accepting the idea that “There Is No Alternative” to equities. This­idea­is­now­more­widely­accepted,­and­is­leading­to­individual­speculative­bub-bles.­But­with­new­fiscal­stimulus­being­added­to­already­accommodative­monetary­policy,­we­think­the­equity­market­overall­still­looks­appealing­relative­to­bonds.­We­therefore­retain­a­pro-risk­stance.­

That­said,­we­focus­equity­exposure­away­from­some­of­2020’s­winners­(particularly­US­mega-caps),­and­toward­lesser­valued­emerging­market­stocks.­We­also­move­our­preference­for­UK­equities­back­to­neutral­after­their­good­recent­performance.­Within­fixed­income,­in­the­context­of­continued­low­yields,­we­like­hard-currency­emerging­market­sovereign­bonds­and,­for­investors­based­outside­the­US,­Asia­high­yield­credit.­For­long-term­growth,­we­continue­to­see­the­best­current­oppor-tunities­in­a­diversified­exposure­to­companies­positioned­in­5G,­fintech,­greentech,­healthtech,­and­within­private­markets.­

My­sparkles­also­taught­me­that­trees­don’t­grow­to­the­sky,­and­in­the­months­ahead­we­will­need­to­pay­particular­attention­to­risks­of­a­monetary­policy­reversal,­rising­equity­valuations,­and­the­rate­of­the­post-pandemic­recovery.­

Mark HaefeleChief­Investment­OfficerGlobal­Wealth­Management

Follow me on LinkedInlinkedin.com/in/markhaefele

Follow me on Twittertwitter.com/UBS_CIO

Sparkles and bubbles

2January 2021 – UBS House View Monthly Letter

Equities Government bonds Cryptocurrencies IPOs and SPACs

Are prices high relative to traditional measures?

Yes. Equity valuations are high based on P/E ratios.

Yes. Financial repression has pushed bond prices above fair value implied by expected­growth­and inflation.­

Yes. Traditional metrics are not­applicable,­but­a­fourfold increase in three months looks excessive.

Yes in terms of the size of first-day­IPO­price­rises­and­the amount of capital raised by SPACs.

Are prices discounting future rapid price appreciation?

No. Valuations can be ­justified­in­the­context­of bond­yields.­Long-term­return expectations are low.

No. Few­investors,­includ-ing­central­banks,­own­government bonds in the expectation­of­rising­prices.

Yes. Speculation appears to be playing an important role in rising prices.

Yes. First-day­IPO­performance is the highest in around two decades.

Are purchases being financed by high leverage?

No. Margin lending is ­currently lower­than­ historical norms.

Yes. Central bank balance sheets grew by USD 8 tril-lion­in­2020.

No. High levels of volatility mean­leverage­is­difficult­to employ.

No. IPOs are generally not funded by leverage.

Are buyers or companies making forward purchases?

Yes. Call option volumes are elevated.

Yes. Central banks have made forward purchase commitments.

Yes. The entire market is an­effective­“forward­purchase.”

Yes. SPACs­are­an­effective­“forward purchase” on a future investment opportunity.

Have new participants entered the market?

Yes, as seen from new account openings on digi-tal platforms and increased share­of­capital­flows­from­retail investors.

Yes. Central banks now own more of the govern-ment bond market; the Fed­owns­24%­of­US Trea-suries,­up­from­9% in­2009.

Yes. New wallet growth indicates increased participation.

Yes. SPAC sponsors now include politicians and celebrities.

Is there broad bullish sentiment?

Yes.­The­bull-bear­spread­of investor sentiment from the American Association of Individual Investors (AAII)­is­more­than­twice­the­average­(19­vs.­8­on­average­since­1990).

No. Consensus expects yields to rise.

Yes. Cryptocurrency investors almost uniformly expect higher prices or user adoption.

Yes. SPACs raised a record volume of new funds in 2020.

Does tightening risk popping the bubble?

Yes. Higher bond yields or interest­rates­would­make valuations look less appealing.

No. Central banks them-selves control the path of the­bubble.­Inflation­looks­far­off.

Yes. Higher interest rates may­not­be­meaningful,­ but regulation or taxation is a potential risk.

Yes. Higher yields would likely reduce the appeal of growth­stocks,­which­make­up­a­high­share­of­the IPO­and SPAC markets.

Source: UBS

In­the­remainder­of­this­letter,­we­address­some­of­the­key­questions­we­have­been­asked­about­bubbles­in­today’s­markets.­Only­one­year­ago,­when­markets­were­starting­to­crash,­investors­faced­a­seemingly­different­set­of­challenges­than­today.­Yet­by­dealing­with­their­emotions,­diversifying,­and­keeping­a­watchful­eye,­inves-tors can successfully protect and grow their wealth.

Where­do­you­see­bubbles­today?

The­presence­of­sufficient­oxygen,­heat,­and­fuel—the­“fire­triangle”—combined­with­a­spark,­will­trigger­a­fire.­In­Boom and Bust: A Global History of Financial Bubbles,­authors­William­Quinn­and­John­D.­Turner­argue­that­a­similar­principle­applies­to­financial­markets.­Sufficient­marketability,­access­to­credit,­and­willing-ness­to­engage­in­speculative­activity,­combined­with­technological­or­political­“sparks,”­are­preconditions­that­tend­to­trigger­market­bubbles.

Today,­all­of­the­bubble­preconditions­are­in­place.­Financing­costs­are­at­record­lows,­new­participants­are­being­drawn­into­markets,­and­the­combination­of­high­accu-mulated savings and low prospective returns on traditional assets create both the means­and­the­desire­to­engage­in­speculative­activity.­At­the­same­time,­accelerated­digitalization­has­generated­a­compelling­narrative­about­technological­change,­while elevated debt levels create the political imperative to support asset markets.

Today,­all­of­the­preconditions­for­bubbles to emerge are in place.

Sparkles and bubbles

3January 2021 – UBS House View Monthly Letter

So we should expect to see some bubbles emerging. Identifying bubbles while they are­occurring­is­notoriously­challenging.­However,­drawing­on­attempts­by­eco-nomic­historian­Charles­Kindleberger­and­by­Bridgewater­Associates’­Ray­Dalio­to­put­a­rational­framework­around­irrational­exuberance,­we­list­in­the­table­above­a­number of features of historic bubbles and attempt to apply them to various assets today.

In­short,­we­do­not­think­equities­as­a­whole­are­in­a­bubble,­although­we­see­signs­of­irrational­exuberance­in­the­crypotcurrency­markets,­and­note­that­IPO­and­SPAC­markets look hot. Government bonds can be considered to be in a bubble by many metrics,­though­this­bubble­is­unlikely­to­“pop,”­given­that­it­is­supported­by­policy-makers themselves.

Are equities in a bubble?

There­are­reasons­for­concern,­but­we­do­not­believe­that­equities­as­a­whole­are­in­a bubble.

The­21%­return­on­US­equities­and­16%­return­on­global­equities­in­2020­have­left­stocks­looking­expensive­on­price-to-earnings­ratio­(P/E)­metrics.­The­S&P 500­trades­on­a­forward­P/E­of­22.5x­and­the­Nasdaq­at­33.5x.­Since­1880,­the­US­market’s­cyclically­adjusted­P/E­(CAPE)­has­only­been­higher­in­1929­and­1999–2000,­prior­to­stock market crashes.

There are also elements of the rally that are consistent with bubbles according to our framework. The rally has coincided with new participants entering the market: Platforms­like­Robinhood,­which­added­more­than­3­million­users­in­2020,­have­contributed to broadening the accessibility of stocks. Retail investors now account for­a­full­20%­of­US­equity­order­flow,­up­from­just­10%­in­2010,­and­roughly­equivalent­to­flows­from­banks,­hedge­funds,­and­long-only­funds­combined.

Even though there are reasons for concern,­we­do­not­believe­equities as a whole are in a bubble.

New participants are entering the market.

80x

70x

60x

50x

40x

30x

20x

10x

0x1989 1997 2005 2013 2021

Nasdaq forward P/EFigure 1

Source: Refinitiv Datastream, as of 6 January 2021

25x

23x

21x

19x

17x

15x

13x

11x

9x

7x

5x1985 1991 1997 2003 2009 2015 2021

S&P 500 forward P/EFigure 2

Average since 1985

Source: Refinitiv Datastream, as of 6 January 2021

Sparkles and bubbles

4January 2021 – UBS House View Monthly Letter

2010 2013 2016 2019 2020

US equity order flows, by sourceFigure 3

Source: Bloomberg, UBS, as of January 2021

Market makers / High-frequency traders Banks Quant funds Hedge funds Long-only funds

10.1%

11.3%

12.1%

7.5%

8.7%

50.3%

13.0%

11.0%

13.4%

11.2%

10.3%

41.1%

15.0%

12.0%

13.2%

14.5%2.0%

43.3%

14.9%

9.7%

13.4%

16.7%

6.0%

39.3%

19.5%

6.4%9.0%

15.9%

5.8%

43.4%

Retail

Options activity and the growth in the SPAC market also suggest a willingness to “buy forward.” Average trading in call options has more than doubled over the course­of­2020,­and­put-to-call­ratios­are­indicative­of­prevailing­bullish­sentiment.­This­is­also­backed­up­by­equity­flows.­Global­equities­recorded­USD 46.4­billion­of weekly­inflows­in­the­week­ending­16­December,­exceeding­a­prior­record­of­USD 45­billion,­which­itself­was­only­set­on­11­November.­As­of­11­January,­net­inflows­into­equities­over­the­past­three­months­had­reached­USD­213­billion.­

However,­although­these­signals­bear­monitoring,­we­do­not­think­that­equities­as­a whole­are­in­a­bubble.

First,­although­leverage­can­increase­rapidly,­it­remains­contained­for­now.­Persis-tently­high­levels­of­equity­market­volatility­through­2020­have­helped­prevent­hedge­funds­and­risk­parity­funds­from­adding­leverage­through­the­rally,­although­recently­there­have­been­indications­that­leverage­is­rising.­Meanwhile,­margin­debt­relative­to the­S&P­500­market­cap­is­at­lower­levels­then­the­norm­for­much­of­the­past decade.

Options activity and the growth in the­SPAC­market­also­suggest­a willingness­to­“buy­forward.”­

Call option volumes, in thousands, 20-day moving average

Figure 4

Source: Bloomberg, UBS, as of 11 January 2021

25,000

20,000

15,000

10,000

5,000

0

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

CBOE weekly equity put-to-call option volume ratio

Figure 5

Source: Bloomberg, UBS, as of 11 January 2021

1.15

0.95

0.75

0.55

0.35

12.2

019

02.2

020

04.2

020

06.2

020

08.2

020

10.2

020

12.2

020

Sparkles and bubbles

5January 2021 – UBS House View Monthly Letter

Margin debt as a % ofS&P 500 market cap

Figure 6

Source: Bloomberg, UBS, as of 11 January 2021

4.0%

3.5%

3.0%

2.5%

2.0%

1.5%

1.0%1997 2000 2003 2006 2009 2012 2015 2018 2021

Implied equity leverage of risk parity funds

Figure 7

SPXT10TE Index 50D moving average

100D moving average

Average

200D moving average

Source: Bloomberg, UBS, as of 11 January 2021

1.6

1.4

1.2

1.0

0.8

0.6

0.4

0.2

02017 2018 2019 2020 2021

Second,­we­can­point­to­large­parts­of­the­market­that­are­not­expensively­valued­by­historical­comparison.­For­example,­stripping­out­the­FAAMNG­stocks­(Facebook,­Amazon,­Apple,­Microsoft,­Netflix,­and­Google),­the­S&P­500­only­rose­6%­last­year.

Excluding­IT­and­the­IT-related­parts­of­consumer­discretionary­the­forward­P/E­for­global­stocks­drops­from­20.2x­to­17.7x.­On­a­cyclically­adjusted­basis,­P/E­ratios­are­close­to,­or­below,­long-term­averages­in­all­major­markets­except­for­the­US,­where­valuations­have­been­skewed­higher­by­mega-cap­tech­stocks.

Finally,­valuations­of­equity­indexes­look­more­reasonable­if­we­consider­the­back-drop­of­low­interest­rates.­Nobel­laureate­Robert­Shiller’s­“excess­CAPE­yield”­implies­a­forward-looking­excess­return­of­equities­over­bonds­of­around­3.8%,­consistent­with­long-term­averages.­An­equity­risk­premium­(ERP)­approach,­com-paring­equity­earnings­yields­with­benchmark­yields,­shows­similar­results,­with­stocks looking cheap relative to bonds.

Of­course,­collapsing­bubbles­can,­in­the­right­circumstances,­drive­broader­eco-nomic weakness and impact the equity market even if the market itself is not in a bubble.­However,­the­parts­of­the­market­that­may­be­experiencing­bubbles­today­(such­as­cryptocurrencies)­do­not­appear­to­be­highly­interconnected­with­the­finan-cial­system­and­are­not­particularly­capital-­or­labor-intensive.­This­should­limit­the­broader­economic­fallout­and­impact­on­corporate­earnings­more­broadly,­in­the­event of any individual bubbles collapsing.

Stripping­out­the­rally­in­mega-cap­tech­stocks,­the­S&P 500­only­rose­6%­in­2020.

Valuations of equity indexes look more reasonable if we consider the backdrop of low interest rates.

Sparkles and bubbles

6January 2021 – UBS House View Monthly Letter

Are government bonds in a bubble?

Talk­of­a­bond­bubble­is­hardly­new:­Yields­on­10-year­US­yields­have­been­in­a­­secular­downtrend­since­the­early­1980s.­But­with­central­banks­around­the­world­printing­more­than­USD­8­trillion­in­2020­to­support­economic­recovery,­fears­of­a bond­market­bubble­are­rising.­

By­some­measures,­the­current­setup­can­be­described­as­a­bubble:­It­involves­new­market­participants­(in­the­form­of­central­banks),­leverage­(of­central­bank­balance­sheets),­an­element­of­speculation­(that­the­easing­will­work),­forward­commit-ments,­and­prices­that­are­at­record­highs.­But­whereas­other­bubbles­are­prone­to­collapsing­because­of­a­sudden­shift­in­buyers’­sentiment,­a­lack­of­new­funds,­or­changes­in­regulation,­central­banks­have­almost­unlimited­capacity­to­maintain­their­policies,­if­they­see­fit.­

So­the­question­becomes:­When­will­central­banks,­and­most­importantly­the­Federal­Reserve,­take­away­the­punchbowl?­We­currently­do­not­see­conditions­that­could­change­their­minds­about­keeping­monetary­policy­ultra-loose­over­our­medium-term investment horizon:

–­ Inflation is not a threat.­After­the­global­financial­crisis,­the­Fed­did­not­hit­its­­inflation­target­sustainably­even­after­a­decade-long­expansion,­and­the­COVID-19­pandemic­has­now­delivered­an­additional­severe­disinflationary­shock.­Given­­elevated­unemployment­and­ample­spare­capacity,­a­prolonged­rise­in­inflation­is­likely­to­be­years­off.­

–­ The Fed’s reaction function has changed, even if inflation rises.­In­the­past,­the­Fed­acted­under­the­assumption­that­inflation­has­momentum­and­that,­in­order­to­prevent­an­undesired­overshooting,­it­needed­to­hike­proactively­in­advance­of­inflation­rising­to­target.­But­the­Fed­has­now­shifted­to­an­average­inflation­target­approach,­meaning­it­will­deliberately­wait­until­inflation­is­overshooting­2%­before hiking rates. Fiscal policymakers are also committed to running the econ-omy “hot” to support the recovery.

We­currently­do­not­see­conditions that could change central­banks’­minds­about­keeping­monetary­policy­­ultra-loose­over­our­medium-term­investment horizon.

Excess CAPE yield and annualized subsequent 10-year total excess return

Figure 8

Excess CAPE yield

Subsequent 10-year excess return

Excess CAPE yield is calculated by taking the cyclically adjusted earnings for the S&P 500 divided by its price, and then subtracting the 10-year Treasury yield

Source: R. Shiller, UBS, as of 11 January 2021

30%

25%

20%

15%

10%

5%

0%

–5%

–10%

1881

1891

1901

1911

1921

1931

1941

1951

1961

1971

1981

1991

2001

2011

1920

19321982 2009

19493.8%

Equity risk premium, median since 1960

Figure 9

Median since 1960

Source: Factset, UBS, as of 11 January 2021

8%

6%

4%

2%

0%

–2%

–4%

–6%1950 1960 1970 1980 1990 2000 2010 2020

Stocks cheapvs bonds

Stocks expensivevs bonds

Sparkles and bubbles

7January 2021 – UBS House View Monthly Letter

–­ The yield curve is unlikely to steepen much further. One of the main arguments for steeper­curves­is­the­increased­bond­issuance­required­to­fund­the­deficit.­But­there is no empirical evidence from the past several decades to support the idea that greater supply leads to higher yields in the US. Increasing debt means peak Fed­funds­continues­to­move­lower­each­cycle—last­cycle’s­equilibrium­appeared­to­be­about­1.6%.­And­the­appointment­of­former­Fed­chair­Janet­Yellen­as­US Treasury­Secretary­could­also­suggest­increased­willingness­to­use­fiscal­stimu-lus in combination with easy monetary policy.

By­design,­policymakers­have­chosen­to­make­safe­assets­expensive,­and­risky­assets­relatively­appealing.­This­may­lead­to­higher­valuations­relative­to­history,­but­there­are reasons to believe this policy environment may persist for years.

Are cryptocurrencies a bubble?

Recently,­the­UK’s­financial­regulator,­the­Financial­Conduct­Authority,­warned­that­cryptocurrency­investors­should­be­prepared­to­accept­total­loss.­With­the­weekly­volatility­in­Bitcoin­exceeding­that­of­the­annual­volatility­in­stocks,­we­think­inves-tors looking to protect and grow their wealth over the long term should maintain discipline and exercise extreme caution on cryptocurrency speculation. Read more in our­recent­publication on Bitcoin.

Given­the­absence­of­cash­flows­or­widespread­use­cases­for­cryptocurrencies,­valu-ing­these­assets­in­a­traditional­way­is­challenging.­Indeed,­one­could­view­crypto-currencies­as­an­effective­“forward­purchase”­(one­of­the­hallmarks­of­a­bubble)­on­future­use­cases­being­developed.­Yet­whatever­these­uses­might­be,­it­would­seem­improbable that they could have changed so dramatically as to drive a fourfold increase in price in just three months.

Publicly­available­data­from­blockchain.com,­the­world’s­leading­Bitcoin­wallet­pro-vider,­shows­1­million­new­wallets­were­created­in­the­past­three­months,­as­many­as were­created­in­the­prior­year,­meaning­that­new­users­appear­to­have­been­attracted­by­rising­prices.­It­also­shows­a­significant­increase­in­the­number­of­addresses­used­(roughly­equivalent­to­daily­users),­likely­indicative­of­an­increase­in­speculative­trading­activity.­While­still­in­its­infancy,­the­open­interest­in­the­Bitcoin­futures­market­has­also­increased­more­than­threefold­since­October.­All this,­and­with­95%­of­coins­held­by­just­2.5%­of­addresses­(note­that­one­user­can­also­have­multiple­addresses),­the­potential­for­price­“squeezes”­should­also­be evident.

Of­course,­finding­signs­of­speculation­and­timing­a­collapse­are­different­things.­In the­past,­regulatory­fears­have­contributed­to­declines­in­cryptocurrency­prices.­Prices­have­also­fallen­sharply­without­an­obvious­catalyst­(for­example,­the­69%­drop­following­the­December­2017­bubble).­But­the­history­of­bubbles­should­teach­us­that­they­can­also­inflate­further­and­for­longer­than­seems­plausible.­Changes­in the­way­assets­are­perceived­can­also­mean­that­bubbles­may­never­fully­deflate,­and­this­could­hold­true­for­cryptocurrencies,­too.­Remember­that­gold­has­been­described­as­the­world’s­oldest­bubble.­

That­said,­with­prices­currently­likely­being­driven­more­by­speculation­than­funda-mentals,­investors­looking­to­protect­and­grow­their­wealth­should­exercise­extreme caution.

By­design,­policymakers­have­chosen to make safe assets expensive,­and­risky­assets­relatively appealing. There are reasons to believe this policy environment may persist for years.

We­think­inves­tors­looking­to­protect and grow their wealth over the long term should maintain disci pline and exercise extreme caution on cryptocurrency speculation.

Sparkles and bubbles

8January 2021 – UBS House View Monthly Letter

Do the hot IPO and SPAC markets pose a risk?

Since­few­will­invest­in­every­new­IPO­and­SPAC,­it­is­hard­to­talk­about­the­valua-tion of the IPO and SPAC markets. But even if sentiment changed and the IPO and SPAC­markets­cooled,­we­don’t­think­they­are­currently­big­enough­to­have­sys-temic­consequences.­In­the­US,­a­record­of­over­USD­65­billion­was­raised­in­IPOs­in­2020­(plus­more­than­70­billion­in­SPACs),­with­average­first-day­returns­around­40%­(AirBnB,­for­example,­jumped­113%­on­day­1).­The Chinese­IPO­market­was­even­hotter,­with­around­USD­100­billion­raised­and­first-day­returns­for­China-domiciled­IPOs­close­to­80%.­Reminders­of­the­dotcom­era­are­clear.

Even if sentiment changed and the­IPO­and­SPAC­markets­cooled,­we­don’t­think­they­are­currently­big enough to have systemic consequences.

Bitcoin price, in USDFigure 10

Source: Bloomberg, UBS, as of 11 January 2021

45,000

40,000

35,000

30,000

25,000

20,000

15,000

10,000

5,000

02010 2012 2014 2016 2018 2020

Open interest in CME Bitcoin futures contracts, in USD mn

Figure 11

Source: CME, JPMorgan, UBS, as of 31 December 2020

2,400

2,100

1,800

1,500

1,200

900

600

300

001.2019 07.2019 01.2020 07.2020 01.2021

Total number of unique blockchain.com wallets created

Figure 12

70,000,000

60,000,000

50,000,000

40,000,000

30,000,000

20,000,000

10,000,000

001.2018 07.2018 07.2019 07.2020

Source: Blockchain com, UBS, as of 11 January 2021

Total number of unique addresses used

Figure 13

Source: Blockchain com, UBS, as of 11 January 2021

1,200,000

1,000,000

800,000

600,000

400,000

200,000

0

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

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2021

Sparkles and bubbles

9January 2021 – UBS House View Monthly Letter

US SPAC capital raised (USD bn, lhs)

Number of deals (rhs)

Source: SPAC Insider, UBS, as of January 2021

US SPAC capital raised and number of deals

Figure 15

80 250

200

150

100

50

0

70

60

50

40

30

20

10

080 85 90 95 00 05 10 15

Source: Jay Ritter, Bloomberg, IPOScoop, UBS, as of 1 December 2020

Average US IPO first-day return, in %

Figure 14

80

70

60

50

40

30

20

10

080 85 90 95 00 05 10 15 20

39%

Yet the total money invested in IPOs is negligible in the context of the overall equity market. A crash in the IPO market might destroy several hundred billion dollars in total­wealth,­compared­with­a­USD­34­trillion­total­market­cap­for­US­equities.­Lim-ited leverage used to make these investments also means the systemic risk is low.

Second,­financial­bubbles­are­costly­for­an­economy­if­they­entail­a­significant­mis-allocation of capital to unproductive investments. But with the current batch of IPOs focused­on­relatively­capital-light­businesses,­and­with­the­roughly­USD­65­billion­raised­in­2020­equivalent­to­just­over­0.25%­of­US­GDP,­even­if­capital­is­being­mis-allocated,­it­doesn’t­appear­to­be­particularly­large­in­scale.

Finally,­frothy­IPO­prices­would­be­a­larger­concern­if­they­were­indicative­of­a­buildup­of­excesses­in­the­overall­equity­market.­But­as­discussed­earlier,­we­do­not­think that equity markets as a whole are in a bubble.

How should I think about investing in a speculative environment?

1) Face your fear of missing out (“FOMO”).­We­chose­to­take­the­bubble­ques-tion­on­directly­in­this­letter­not­to­scare­investors­out­of­equities,­but­to­help­create­better­conversations­around­the­emotional­side­of­investing.­With­certain­assets­soaring,­there­are­temptations­to­try­and­hitch­a­ride.­But­getting­rich­and­staying­rich­require­different­attitudes­to­fear­and­greed.­In­a­speculative­environment,­investors looking to protect and grow their wealth over the long term will need to remain disciplined. Our Liquidity. Longevity. Legacy.* approach to wealth manage-ment­should­help­investors­right-size­risky­investments­and­keep­their­portfolios­aligned­with­their­financial­goals.­

2) Think beyond the bubbles. One reason that bubbles can be so deceptive is that­there­is­often­a­grain­of­truth­behind­their­narratives.­The­dotcom­bubble,­for­example,­correctly­anticipated­the­impact­of­the­internet.­Many­of­the­narratives­linked­to­today’s­bubbles­may­also­prove­to­be­correct.­Investors­may­be­able­to­capture some upside but reduce the risk associated with bubbles by identifying the narrative,­yet­investing­in­a­more­diversified­way.­Today,­investor­excitement­about­

With­certain­assets­soaring,­there­are temptations to try and hitch a ride. But getting rich and staying rich­require­different­attitudes­to­fear and greed.

*­Timeframes­may­vary.­Strategies­are­subject­to­individual­client­goals,­objectives­and­suitability.­This­approach­is­not­a­promise­or­guarantee­that­wealth,­or­any­financial­results,­can­or­will­be­achieved.

Sparkles and bubbles

10January 2021 – UBS House View Monthly Letter

fintech,­industry­disruptors,­and­green­technology­is­contributing­to­individual­asset­price­bubbles.­But­when­investing­in­them­is­done­in­a­diversified­way,­we­think­each of these themes represent attractive opportunities for the decade ahead.

3) Invest around the bubbles.­Some­assets­do­look­expensive,­and­may­even­be­“in­a­bubble.”­But­this­clearly­does­not­apply­to­every­single­listed­equity.­We­con-tinue­to­see­attractive­opportunities­among­more­cyclical­companies,­sectors,­and­markets­as­the­post-pandemic­recovery­gains­ground.­We­maintain­a­preference­for­global­small-­and­mid-caps,­and­this­month­we­shift­our­preference­for­global­equi-ties­to­focus­on­emerging­market­stocks,­which­are­cheaper­and­should­benefit­from­a global economic recovery. This is consistent with the “Diversify for the Next Leg” message discussed in our Year Ahead outlook.

Key scenarios and asset class impact

Upside Central Downside

Investment ideas Top ideas 1.­ Position­for­a­weaker­dollar­2.­ Invest­in­“The­Next­Big­

Thing”­(5G,­fintech,­­healthtech,­greentech,)

1.­ Go­cyclical­for­the­recovery­(including­EM­equities)

2.­ Hunt­for­yield­(including­dividends­and­credit)

3. Buy into sustainability4.­ Diversify­into­private­markets

1.­ Protect­against­the­downside­(using­gold,­dynamic­allocation­strategies,­long­duration,­and­option­structures)

2.­ Ease­into­markets

Scenario Description Developed­countries’­GDP­returns­to­pre-pandemic­levels­by­end-2021

Central banks stay accommoda-tive,­but­start­to­consider­tight-ening­in­late­2021­or­early­2022

Discretionary­fiscal­impulse­con-tinues to support the economy.

Lower real rates and a weaker dollar boost global growth over the­next­12­months

Vaccine­rollout­accelerates.­Suffi-cient part of the key risk group are­vaccinated­in­1Q.

A partial rollback of existing trade­tariffs­raises­global­growth

Developed­countries’­GDP­returns­to­pre-pandemic­levels­in 2022

Central banks stay accommodative

Real rates remain low and stable over­the­next­12­months

Fiscal impulse fades moderately and­gradually,­as­governments­adapt to economic recovery

Recurring­COVID-19­waves­are­likely, but­limited­public­fear­and restrictions­fade­gradually­with­sufficient­vaccinations­by­mid-2021

Global trade policy is more nuanced and the US takes a targeted approach

Developed­countries’­GDP­returns­to­pre-pandemic­levels­in­2023­or later

Diminishing­fiscal­impulse­is­unable to compensate for economic weakness

Initially,­monetary­policy­is­supportive,­but­eventually­tapers­as­inflation­rises­(bad­tapering)

Vaccine­availability­is­delayed,­or­vaccines­show­lower­efficacy­than­initially thought

Heightened public fear of COVID-19­and­strict­restrictions­on business activity keep recurring­throughout­2021

Growth is hurt by renewed global trade­tensions

An­asset­price­bubble­inflating­then bursting

Asset class impact

(targets­for­December 2021)

Spot*

S&P 500 3,794 4,300 4,000 3,200

Euro Stoxx 50 3,612 4,100 3,800 3,000

MSCI EM 1,350 1,600 1,450 1,050

SMI 10,875 12,000 11,300 9,500

USD IG spread** 67 50bps­/­+1.5% 80bps­/­+1% 200bps­/­–3%

USD HY spread** 382 320bps­/­+6% 400bps­/­+4.5% 700bps­/­–10.5%

EMBIG spread** 349 280bps­/­+9.5% 340bps­/­+6,5% 550bps­/­–7%

EUR USD 1.22 1.32­ 1.27­ 1.22

Gold 1,843 USD­1,500–1,600/oz­ USD­1,800/oz­ USD­2,000–2,100/oz­

*­­ Spot­prices­as­of­12­January­2021**­During­periods­of­market­stress,­credit­bid-offer­spreads­tend­to­widen­and­result­in­larger­ranges.­Percentage­changes­refer­to­expected­

total return­(t.r.)­for­the­indicated­spread­levels­

Note:­asset­class­targets­above­refer­to­the­respective­macro­scenarios.­Individual­asset­prices­can­be­influenced­by­factors­not­reflected­in­the macro­scenarios

Source:­UBS,­as­of­January­2021

Sparkles and bubbles

11January 2021 – UBS House View Monthly Letter

4) Be prepared to ride the waves. One risk with the presence of bubbles is that fear­of­collapse­leads­investors­to­forgo­opportunities,­and­structural­shifts­often­look­like­bubbles­in­their­early­stages.­For­example,­Apple­stock­has­risen­six­times­since­this article declared it was a bubble,­Amazon­stock­has­risen­tenfold­since­this pro-nouncement,­and­even­the­broad­S&P 500­has­more­than­doubled­since­these com-ments­were­made.­Provided­investors­diversify­well­and­keep­a­long-term­view,­we­think­it­will­pay­to­remain­invested­in­a­diversified­portfolio­of­stocks.­With­interest­rates­set­to stay­low­for­an­extended­period,­sitting­in­cash­out­of­fear­of­being­caught in a collapsing bubble is likely to be more costly than being invested over the long­term,­in­our­view.

Top investment ideas for the year and decade ahead

Go cyclical for the recoveryWe­see­further­upside­for­equities,­particularly­those­with­exposure­to­a­cyclical­recovery.­At­this­time­we­like­global­small-caps,­and­have­added­a­preference­for­financials­in­the­Eurozone,­given­their­low­valuations­and­solid­earnings­prospects.­Regionally,­we­continue­to­see­better­relative­performance­prospects­outside­the­US.­That­said,­after­a­strong­performance­that­narrowed­the­UK­market’s­valuation­discount­to­global­equities,­we­have­closed­our­preference­for­UK­stocks.

We­have­shifted­our­preference­toward­emerging­markets,­where­we­see­valuations­as­more­attractive­than­global­stocks.­In­Asia,­we­have­a­preference­for­Chinese­equi-ties,­given­strong­EPS­trends,­reduced­domestic­and­international­policy­uncertain-ties,­and­supportive­monetary­policy.­Within­the­Chinese­tech­space,­while­the­bipo-lar­technology­race­should­continue­between­the­US­and­China,­unilateral­actions­like delisting are less likely under the new US administration. In an extreme scenario of­delisting,­affected­stocks­might­experience­sharp­corrections­(15–20%)­as­a­knee-jerk­reaction,­but­focus­should­eventually­shift­back­to­medium-­to­long-term­funda-mentals.­In­our­view,­recent­share­price­corrections­have­discounted­most­of­the­con-cerns over tighter regulation of the Chinese internet space.

Position for a weaker dollarWe­retain­our­view­for­further­US­dollar­weakness­in­2021.­We­think­that­as­the­recovery­gathers­pace,­driven­by­vaccine­rollouts,­more­cyclical­currencies­(euro,­the British­pound,­select­oil-linked­currencies)­have­upside­potential.­We­expect­a­corresponding­decline­in­demand­for­safe-haven­assets,­such­as­the­US­dollar. Invest in “The Next Big Thing”The next decade will likely reward investing in the companies using technology to ­disrupt­other­sectors.­We­expect­“The­Next­Big­Thing”—market­segments­where­over the­next­decade­earnings­could­triple­due­to­a­large­potential­market­(over­USD 200bn),­a­disruptive­catalyst­to­spur­growth,­and­a­cyclical­catalyst­to­kick-start­things­in­2021—to­materialize­from­the­5G­rollout,­fintech,­healthtech,­or­greentech.­

Hunt for yieldThe­Fed­continues­to­anchor­short-term­rates­close­to­zero.­In­our­base­case,­policy­rates­remain­unchanged­for­several­years,­facilitated­by­a­slow­acceleration­in­infla-tion­expectations.­While­we­expect­economic­normalization­to­put­some­upward­pressure­on­long-term­rates,­we­expect­increases­to­remain­modest.­We­still­favor­opportunities­in­the­riskier­end­of­the­bond­market,­including­USD-denominated­emerging­market­sovereign­bonds­and,­for­investors­based­outside­the­US,­Asian­high­yield­credit.­We­think­there­is­room­for­further,­albeit­limited,­spread­compres-sion,­and­yields­remain­attractive­at­4.8%­and­7.2%­respectively.­We­also­continue­to­recommend­considering­alternative­strategies­to­boost­income,­including­selling­still-elevated­volatility­and­employing­leverage­if­appropriate.

One risk with the presence of bubbles is that fear of collapse leads investors to forgo opportunities,­and­structural­shifts­often­look­like­bubbles­in­their­early stages.

We­see­further­upside­for­equities,­particularly those with exposure to a cyclical recovery.

We­retain­our­view­for­further­US dollar­weakness­in­2021­and­prefer more cyclical currencies.

While­we­expect­economic­normalization to put some upward pressure­on­long-term­rates,­we­expect increases to remain modest.

Sparkles and bubbles

12January 2021 – UBS House View Monthly Letter

Buy into sustainabilitySustainable investing remains our preferred solution for clients looking to invest globally.­Governments,­businesses,­and­individuals­are­driving­a­shift­toward­sustain-able­investment,­and­many­of­the­highest-growth­opportunities­in­the­decade­ahead­are­set­to­be­sustainability-linked,­such­as­greentech.­In­a­post-pandemic­world,­we­believe­companies­that­reduce­their­environmental­footprint,­strengthen­their­supply-chain­relationships,­and­embrace­diversity­are­likely­to­benefit.­

Diversify into private marketsWe­expect­returns­on­traditional­assets­to­be­lower­in­the­coming­decade.­In­this­context,­private­markets,­which­come­with­a­distinct­set­of­opportunities­and­risks,­may­offer­an­effective­way­to­enhance­portfolio­returns­and­diversification.­The­asset­class­has­historically­generated­higher­returns­than­listed­markets,­although­it­requires­committing­over­a­longer-term­investment­horizon.­The­current­economic­environment—one­shaped­by­the­negative­economic­fallout­of­the­pandemic,­low­interest­rates,­and­rapid­technological­change—offers­a­broad­range­of­opportunities­for­private­market­managers,­including­investing­in­dislocations,­enhanced­yield,­and­long-term­growth.

Mark HaefeleChief­Investment­OfficerGlobal­Wealth­Management

Many­of­the­highest-growth­opportunities in the decade ahead are­set­to­be­sustainability-linked,­such as greentech.

Private­markets,­although­not­without­risk,­may­offer­an­effective­way­to­enhance­portfolio­returns­and­diversification­in­the­decade ahead.

UBS Investor Forum InsightsAt­this­month’s­Investor­Forum,­participants­discussed­the­outlook­for­­fiscal­and­monetary­policy­as­governments­continue­to­wrestle­with­the­economic­effects­of­the­COVID-19­pandemic.­

–­ Participants­agreed­that­central­banks­had­little­incentive­to­start­taper-ing policy support over the coming year. The Federal Reserve is expected­to­be­the­first­developed­market­central­bank­to­start­taper-ing,­but­only­in­2022.­

–­ With­the­Democrats­achieving­a­sweep­of­the­White­House­and­Con-gress,­participants­agreed­that­further­large-scale­fiscal­support­was­on­the­way­in­the­US.­But­there­was­a­sense­that­President-elect­Joe­Biden­will­still­struggle­to­win­sufficient­support­for­large-scale­spending­on­green projects.

–­ Overall,­the­combination­of­continued­policy­support­and­recovering­corporate­earnings­meant­that­participants­maintained­a­broad­risk-on­stance.

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13January 2021 – UBS House View Monthly Letter

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Investing­ in­ structured­ investments­ involves­ significant­ risks.­ For­ a­ detailed­discussion­of­ the­ risks­ involved­ in­ investing­ in­ any­particular­structured­ investment,­you­must­read­the­relevant­offering­materials­ for­ that­ investment.­Structured­ investments­are­unsecured obligations of a particular issuer with returns linked to the performance of an underlying asset. Depending on the terms of­the­investment,­investors­could­lose­all­or­a­substantial­portion­of­their­investment­based­on­the­performance­of­the­underlying­asset. Investors could also lose their entire investment if the issuer becomes insolvent. UBS Financial Services Inc. does not guarantee

14January 2021 – UBS House View Monthly Letter

in­any­way­the­obligations­or­the­financial­condition­of­any­issuer­or­the­accuracy­of­any­financial­information­provided­by­any­issuer. Structured investments are not traditional investments and investing in a structured investment is not equivalent to investing directly­in­the­underlying­asset.­Structured­investments­may­have­limited­or­no­liquidity,­and­investors­should­be­prepared­to­hold­their­investment­to­maturity.­The­return­of­structured­investments­may­be­limited­by­a­maximum­gain,­participation­rate­or­other­feature.­Structured­investments­may­include­call­features­and,­if­a­structured­investment­is­called­early,­investors­would­not­earn­any further return and may not be able to reinvest in similar investments with similar terms. Structured investments include costs and fees which are generally embedded in the price of the investment. The tax treatment of a structured investment may be complex­and­may­differ­from­a­direct­ investment­ in­the­underlying­asset.­UBS­Financial­Services­ Inc.­and­ its­employees­do­not­provide tax advice. Investors should consult their own tax advisor about their own tax situation before investing in any securities.

Important Information About Sustainable Investing Strategies: Sustainable investing strategies aim to consider and incorporate­ environmental,­ social­ and­governance­ (ESG)­ factors­ into­ investment­process­ and­portfolio­ construction.­ Strategies­across­geographies­and­styles­approach­ESG­analysis­and­incorporate­the­findings­in­a­variety­of­ways.­Incorporating­ESG­factors­or­Sustainable­Investing­considerations­may­inhibit­the­portfolio­manager’s­ability­to­participate­in­certain­investment­opportunities­that otherwise would be consistent with its investment objective and other principal investment strategies. The returns on a portfolio­consisting­primarily­of­sustainable­investments­may­be­lower­or­higher­than­portfolios­where­ESG­factors,­exclusions,­or­other­sustainability­issues­are­not­considered­by­the­portfolio­manager,­and­the­investment­opportunities­available­to­such­portfolios­may­differ.­Companies­may­not­necessarily­meet­high­performance­standards­on­all­aspects­of­ESG­or­sustainable­investing­issues;­there­ is­also­no­guarantee­ that­any­company­will­meet­expectations­ in­connection­with­corporate­ responsibility,­ sustainability,­and / or­impact­performance.

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