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Japanese equities Preference: neutral Topix (24 Oct): 743 (last publication: 743) UBS view Topix (6-month target): 756 e We expect earnings growth of about 25% over the upcoming 12 months. A relatively high growth rate still reflects last year's sharp decline caused by two natural disasters. Still, the earnings recovery has disappointed so far. Earnings growth continues to slow down and is expected to move toward a more normal single-digit growth in 2013. ¢ The government started implementing its JPY 18 trillion recovery budget in Q4 2011; we expect it to boost GDP by 0.5-1.0% in FY2012, and about 0.5% in 2013. e However, we see only limited scope for an additional earnings boost from the local economic recovery. Slowing export markets also curtail the outlook. June quarter-earnings results revealed emerging market demand was below expectation, capping earnings growth. e We expect the TOPIX trailing P/E to drop to around 13.5x from 15.0x over the coming months, mainly due to the earnings recovery; this provides room for moderate price increases only. 4 Positive scenario Topix (6-month target): 970 ¢ Stronger global demand and stabilizing European markets lead to improved risk-taking. Falling risk aversion is likely to lead to a weaker yen, providing an additional increase in earnings. We expect 10-15% EPS growth in FY2013 and the TOPIX target is based on 16.0x trailing P/E. & Negative scenario Topix (6-month target): 575 ¢ Faltering global growth leads to weak exports, triggering negative earnings surprises. USD-JPY rate strengthening to below 75 and potential economic conflicts with China might serve as an additional drag on earnings. We would then expect the P/E ratio to contract to 13.0x and earnings to fall during the upcoming six months. Note: Scenarios refer to global economic scenarios (see slide 7) What we're watching Why it matters JPY and exports The exchange rate is an important factor for the Japanese equity market. Japan’s trade balance could be in deficit and may impact USD-JPY rates. Key date: Nov 21, Japanese trade balance BoJ’s monetary policy If the Bank of Japan makes additional commitments to its asset-purchase board meeting program, which is currently JPY 70 trillion in size, it would lead to a weaker yen, in our view. Key date: Oct 30, BoJ policy meeting 2 UBS Recommendations Tactical (6 months) e Japanese value stocks have under- performed growth stocks by more than 20% for the last four months. We see this as an overreaction to concerns on the slower global economy, and recommend picking some value stocks with high dividend yields. We prefer companies that are using cost- reduction initiatives to maintain price competitiveness during periods of yen strength. Strategic (1 to 2 years) A weaker USD-JPY rate may drive Japanese companies’ earnings recovery beyond a technical recovery from natural disasters. Japanese exporters and companies owning international operations would benefit from such a development. Japanese realized earnings likely to recover further going forward (6) 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 — Top 12m realized earnings per share Source: Thomson Reuters, UBS, as of October 22, 2012 N For further information please contact ClO asset class specialist Toru Ibayashi, toru.ibayashi@ubs.com jote: Past performance is not an indication of future returns. 18 Please see important disclaimer and disclosures at the end of the document. HOUSE_OVERSIGHT_025265