Watchword for investing next year is "caution,' according to the Swiss bank. There's a recovery in the works for the world's recession-plagued developed economies in the second half of 2009, but -- barring a kick-start from some of the aggressive fiscal and monetary policy actions already taken or soon to unfold -- it's likely to be a mild one. As a result, UBS Wealth Management is urging a guarded approach to investing in the New Year.

UBS' 2009 "UBS global outlook" study, subtitled "Proceed with caution," identifies potential opportunities and obstacles for investors as the global economy continues to atrophy for another six to eight months.

For the first half of 2009, UBS sees the world's developed economies sliding further into recession -- with the U.S. in for its worst slump in 25 years -- and emerging markets keeping to a slow-growth path. As a result, UBS concludes that risk in financial markets will remain high next year, especially in view of its expectation that corporate earnings are in for a drubbing.

Go lightly

But, given sharp declines in the value of "risky assets" like real estate, stocks and commodities, much of the bad news to come may already have been priced in, says UBS. Still, with an eventual recovery in mind, the Zurich-based bank urges that investors can't "simply pick up where they left off once the economy begins to recover." Rather, they should look to "portfolio diversification, a defensive investment stance, and taking calculated risks as a means to achieve above-market performance."

The report's outlook for stocks is cautious, but it also takes note of "strong valuation signals" in stock markets, especially in Europe. UBS recommends that investors who can tolerate volatility, and who have a long-term view, focus on sectors where earnings contraction is likely to be muted -- areas such as healthcare, consumer staples and telecommunications.

Though UBS sees China, India, Brazil and Russia avoiding outright recession in 2009, it expects business activity in those countries to decrease with the result that the valuation discount to global equities within emerging-market equities won't be especially compelling. Within emerging-market bonds, the report advises investors to avoid sub-investment-grade sovereign issuers and to maintain diversity among the highest rated investment-grade issuers.

UBS sees the greatest risk for bonds denominated in U.S. dollars and Japanese yen. Financial market performance during 2009 will likely depend heavily on the effectiveness of "reflationary" policies to mitigate the economic slowdown. Though deep recessions are usually good for government bonds, lending to states could look a lot less attractive as some countries grow obese with debt. And because short-term rates are already very low in the U.S .and Japan, fiscal policy will have to do more of the heavy lifting to stimulate growth in those economies.

Given its guarded outlook, UBS also warns against strong exposure to the U.S. dollar after its recent sharp appreciation. The yen and the Swiss franc could come under pressure as well -- the yen because the outlook on Japan's economy is bleak; the Swiss franc because its home market is so dependent on financial services.

Earlier this week, the National Bureau of Economic Research said the U.S. has been in recession since December 2007. -FWR

Purchase reproduction rights to this article.