The wealth management arm of UBS continues to be overweight US equities and US high-yield debt, arguing that in a world of diverging economic fortunes, the world’s largest economy is taking back its old role as driver for the world economy. It is also bullish about the dollar.

The wealth management arm of UBS continues to be overweight US equities and US high-yield debt, arguing that in a world of diverging economic fortunes, the world’s largest economy is taking back its old role as driver for the world economy. It is also bullish about the dollar.

The Zurich-listed firm, in a monthly note, said that it has made one tactical change to its portfolios by taking an overweight position in the Canadian dollar relative to an increased underweight position in the Swiss franc.

The thrust of the remarks in a monthly letter by Mark Haefele, global chief investment officer, was that while there are problems in the US economy, and a nagging concern about rising inequality in that nation, its policymakers have on balance chosen the right path over recent years, while in Europe, they have stumbled to get a clear sense of direction.

Haefele used the metaphor of movies to explain how the US economic story has taken a positive turn.

“If the US recovery were a Hollywood movie, its plotline has been a little like a `buddy movie’, with three friends coming together to achieve something remarkable. The Federal Reserve moved early and was persistent in providing monetary stimulus, the Department of the Treasury recapitalized banks in a timely manner, and the shale gas sector supported budget revenues while subsidizing industry through lower energy costs.”

“These factors have supported growth, earnings, and markets, and underpin our preference for US assets,” he continued.

“Yet, this recovery has not been a thrilling blockbuster with something for everyone, nor is it a stirring homage to a unique American exceptionalism; the US recovery has some complicated and concerning subplots that remain unresolved. Both government debt and the Fed balance-sheet have soared, leaving the US less room to maneuver in the event of a future downturn. Job creation seems strong, but is not concentrated in the areas that have contributed the most to the recovery. And we have seen a growing wealth imbalance between the `have-stocks’ and the `have-nots’, thanks to the sharp rally in financial assets relative to the performance of the economy.

As for the eurozone, Haefele said the currency bloc “needs a number of dominoes to fall if it wants to emulate the US formula for successful recovery”.

“First, it needs the credible policy action the US showed so early on. The European Central Bank stress-test results unveiled this month, which revealed no major capital shortfalls, were credible in our view. But market faith is hard to get. According to a recent Bloomberg poll, 51 per cent of respondents thought the test was not an accurate gauge of eurozone banks’ financial stability, and the banks have underperformed global equities by 8 per cent since the results were released,” he said.

He went on to state that Europe needs the lending cycle to start before the region can see a sustained improvement in earnings. Finally, we have seen structural improvements in Greece, Portugal, Ireland, and Spain. These countries are poised to be among the eurozone’s growth leaders in 2014. But the larger economies of France and Italy are still lagging behind – their unit labor costs have continued to increase even since the 2011 eurozone crisis. Parts of the eurozone will need to see structural improvements in competitiveness if we are to see a clear recovery story,” he said.

Japan
Commenting on the reflationary policies of Japan’s prime minister, Shinzo Abe, Haefele said “the credibility of fiscal policy and structural reform remains questionable”.

“The consumption-tax hike in April sent the country into its third recession since 2010, forcing Abe to postpone the second hike planned for 2015 and call a snap election. For now, the risk that the Japanese recovery story may test the audience’s patience yet again keeps us neutral on the market in our global portfolio,” he continued.

Canada and Switzerland
The UBS note said the “Canadian dollar has been under pressure in 2013 and so far in 2014, thanks to declining rates of inflation, and more recently falling oil prices. However, the Canadian labour market is strengthening, inflation is back to target, and, thanks to increasing exports, the trade balance has moved back into positive territory”.

Haefele said an interest rate rise in Canada is expected in the second half of next year.

Separately, he noted that the Swiss franc has recently appreciated to within touching distance of the Swiss National Bank’s 1.20 euro/Swiss franc floor, partly because of the favourable short-term deposit interest rate differential between the two currencies.

“From here, we believe that the floor is credible, at least over our tactical six-month investment horizon, and think the SNB will employ extra measures, including interventions or negative deposit rates if necessary, to defend the level,” his note added.