Eye on the Market I

Eye on the Market I June 30, 2011 J.P. Morgan The Five Stages of Greece. We are putting the finishing touches on a piece on U.S. commercial real estate, which will come out next week. Heading into the weekend, a brief note on Europe. In almost every client meeting, I am asked "what's going to happen in Greece?". The best way to answer that question is by using the Kflbler-Ross model, the Five Stages of Grief, adapted for Greece. This model defines the process as Denial, Anger, Bargaining, Depression and Acceptance. Manifestations of this process appear below, personified by representatives of European governments, central banks and regulatory bodies. Axel Weber's journey from the top to the bottom of the table is illustrative of the epiphanies people (and markets) have had to face. The Five Stages of Greece Stage DENIAL Date 12/28/2009 "We don't need the IMF: it is illegal in Europe to finance budget deficits using the kind of central bank funds which are at the IMFs disposal" Manifestation Articulated by Bundesbank President Axel Weber 01/29/2010 "Greece will not default. In the euro area, default does not exist." EU Monetary Affairs Commiss loner Joaquin A km nia ANGER 02/26/2010 "Its an attack on the euro zone by certain other interests, political or financial. We are being targeted, particularly with an ulterior motive or agenda. " 02/26/2010 "Attacks by investors and the hostility shown by some sectors of the British and U.S. press amount to collusion. None of what is happening. including editorials in some foreign media with their apocalyptic comnrntaries, is happening by chance or innocently" 03/01/2010 - We have to strengthen the primacy of politics. We have to be able to stop financial markets. We have instruments of torture in the basement. We will display them if it becomes necessary" Greece Prime Minister Papandreou Spanish Transport Minister Jose Blanco Jean Claude Juncker. Eurogroup head BARGAINING 06/21/2011 "We believe that the private sector could play a role in helping Greece, provided that it doesn't result in a credit event or default. Of course. it should be done in agreement with the European Central Bank." European Commission president Jose Manuel Banoso Ing'RFNSION U6/20/2011 arc difficult, the reform fatigue is visible in the streets of Athens. Madrid and elsewhere. and so is the support fatigue in some of our member states" 06/23/2011 "The most serious threat to financial stability in the EU stems from the interplay between the vulnerabilities of public finances in certain EU member states and the banking system. There are potential contagion effects across the union and beyond" ...Risk signals for financial stability in the euro area are flashing "red" as the debt crisis threatens to infect banks. Olli Rehn. EC Commissioner for Economic/Financial Affairs Jean Claude Trichet.EO3 President ACCEPTANCE 05/08/2011 "Ireland will never repay the (250bn it has borrowed from the EU and IMF. Unnamed Irish Fine Gael senior government insiders have admitted — but we will not default until our Minister, to the Irish Mail -EU partners agree we have no choice. A senior minister last night told the Irish Mallon Sunday that the Cabinet expects our crippling debts to be restructured within three years. However. Fine Gael is pinning its hopes on the EU being forced by outside events, such as the collapse of the Greek economy. into a realisation that Ireland cannot hope to pay off the debt mountain accumulated by our rogue banks." 06/27/2011 "There are, unfortunately, only very limited options: Ether a default or partial Former Bundesbank President haircuts or a guarantee for the outstanding amount of Greek debt.... At some Axel Weber point you've got to cut your losses and restart the system". The latest deal for Greece, based on a French proposal, is another chapter in the "Bargaining" stage: it maintains the fiction that Greece's debts will be repaid at Par, and does little to address the crumbling economic and social situation in Greece, rising deposit outflows out of Greek banks and the possible exhaustion of their eligible collateral to post at the ECB, and collapsing Greek imports and exports. The plan is mostly designed to continue transfers from the EU taxpayers and the IMF to French and German banks, and buy some time (perhaps a year or so). 1 EFTA01069682 Eye on the Market June 30, 2011 J.P.Morgan Here's another timeline of where I think we are in Greece: at the latter stages of the "let's keep lending more money and rolling existing exposures and hope it gets better" phase of the Mexican sovereign debt crisis in the 1980's. I expect the latest deal to be the last one before the eventual (and inevitable) restructuring of Greek debt. Mexico's lost decade: kicking the can down the road makes it bigger Public sector external debt/GDP 65% 60% 55% 50% 45% 40% 35% 30% 25% 20% 15 1982 1983 1984 1985 1986 Source: Mexico Ministry ot Finance and Public Credit. Rescheduling r New money operations 1987 1988 1989 YOU ARE HERE 1990 Some good news: Japan is rebounding rapidly from the earthquake. Manufacturing surveys have recovered 93% of the decline in March, and there has been a significant easing of supply-chain disruptions. Industrial production rose 5.7% (month over month) in May, with similar gains expected for June and July in production and exports. Retail sales are less than 2% below pm-quake levels. In our March 15, 2011 Eye on the Market ("Matter over Mind", we reviewed the history of the 1995 Kobe earthquake, and topics like the recovery in Confederate farm output after the Civil War, and the recovery in Japanese industrial production and German exports from 1946 to 1954. Our conclusion: countries with higher income, higher educational attainment, greater openness, more complete financial systems, better developed supply chains and decentralized governments can recover quickly from natural and man-made disasters. The theory is working out in practice in Japan. In the rest of non-Japan Asia, industrial production continues to climb, with Malaysia as the only country whose production is still below pm-crisis (2007) levels. Michael Cembalest Chief Investment Officer The material contained herein is intended as a general marker conzmentary. Opinions expressed herein are those of Michael Cembalest and may differ from those of other J.P. Morgan employees and affiliates. This information in no way constitutes J.P. Morgan research and should nor be treated as such. Further. the views expressed herein may differ front that contained in J.P. Morgan research reports. 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