J.P. Morgan market commentary on US recovery and Spain borrowing needs (April 9, 2012)

Eye on the Market | april 9, 2012 J.P Morgan Q&A on the USA, with a watchful eye on the risk of giant man-eating plants; Spain Our view for 2012 was that economic and equity market conditions in the US and Asia ex-Japan would be better than in Europe. So far, that view is on track. Spain in particular is in difficult shape (see page 5); its banks and government may have to borrow 1.5 trillion Euros over the next 12 months while in recession. Both the ECB and EU will need to keep the spigot open to prevent Spain from becoming a bigger problem. This week, some Q&A on the US recovery, flows into bonds and stocks, profits and P/E multiples, municipal bonds, and the long-term US fiscal situation. The Fed appears to be saying that no additional monetary easing is needed unless the economy worsens further. Are there any signs that the US recovery is becoming self-reinforcing? Durable goods consumption, equipment & software spending, vehicle sales, bank loans to companies, manufacturing payrolls (even after Friday’s disappointing report) and housing stats (building permits, multifamily housing starts) have improved over the last few months. While delinquency rates are in better shape (credit card delinquencies are back to 2007 levels), household credit growth is still weak. However, homebuilders are seeing stronger demand, and nationwide remodeling continues to rise. We see opportunities in retailing and building products companies that may benefit from a continuation in these trends. Publicly-held builders reporting stronger demand Residential remodeling index Percent change, YoY in latest fiscal quarter Number of homes, millions, 3-month moving average 40% 33 New Backlog 65; Orders of Orders 6.4 4 | 20% 29 10% 27 2.5 0% 2.3 -10% °” Lennar KBHome Toll Hovnanian DR Horton NVR Pultegroup 2001 2008 2008 200% e008 ann .. Source: BuildFax. Empirical Research Partners. Source: Corporate Reports. Empirical Research Partners. Has the data really been that good? I heard better US economic data has a lot to do with the weather. Parts of the US experienced the warmest March in recorded history. Measured from December to February, the winter was the 4" warmest on record. I don’t think there are reliable models to estimate the impact of demand being pulled forward, so we will have to see how consumer spending, housing and payrolls behave in the months ahead. As our Chief Economist Michael Vaknin reminds me, other distortions come from the “catch-up” effect from Japan’s tsunami. As shown below, some strength in auto sales came from pent-up demand for Japanese cars, a process which now seems complete. US auto sales in the wake of Fukushima It looks like pent-up demand for Japanese cars has MoM change in SAAR auto sales, millions of units caught up, SAAR million units 1.0 10 0.5 0.0 -0.5 mJapan -1.0 mUS+Other -1.5 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 2009 2010 2011 2012 Source: BEA/Wards, DB, J.P. Morgan Private Bank. Box indicates impact Source: DB, J.P. Morgan Private Bank. Shadings indicate Cash for of Japanese earthquake. Clunkers and Japanese earthquake, respectively. So where does that leave the US payroll and growth picture? The weakness in the payroll report was almost entirely concentrated in retailing. Net of distortions and seasonal adjustments, it looks like payroll growth is running at 150-175k per month, and GDP growth is running at a 2.25% trend pace, both below prior recoveries. While 2.25% is a barn-burner compared to Europe, it only corresponds to a modest improvement in employment. That’s why 2013 US fiscal policy is so important: this is not a recovery that can withstand much tighter fiscal conditions. 1 HOUSE_OVERSIGHT_025242