DS9 Document EFTA01148765

• • J. P Morgan he J.P. Morgan View How can risk markets rally in an ugly world? Global Asset Allocation J.P.AAorgan Chase Bank NA, J.P. Morgan Securities Ltd. Nov 11, 2011 • Economics - US data keep supporting a 2.5% pace in H2. Jan LoeysA.- • Portfolio strategy — Heavy ovenveights in cash, that pays no yield, and less acute risks on US growth and Chinese inflation keep us overweight risk assets John Normand • Fixed Income — We close tactical shorts in long end Treasuries, and keep only a value-based short in 2-year Germany. Nikolaos Panigirtzoglou • Equities — Both US and European companies have beaten Q3 EPS consensus by 4% on average. • Credit — We keep a preference for long US vs. European credit. Seamus Mac Gorain • Foreign exchange — Large-scale ECB bond buying should not be a negative for the euro. But we keep hedges by being long JPY. • Commodities — We close the short leg of our EM Asia vs. US relative trade and double up on the long leg. Be long brent, gasoil, gold, sugar, corn and wheat. Matthew Lehmann Leo Evans • After a quite volatile week, risk markets are net up on the week, and safe bonds are down, though by amounts that could be reversed in minutes. Let's just call it range trading, therefore. The great majority of institutional investors YTD returns through Nov 10 we see remain quite sceptical about risk assets as the politics of fiscal consoli- dation in a slow-growth world continue to be quite ugly. And the Euro Area is %. equities are in lighter colour. little closer to agreement on measures to stop their debt crisis, while now more openly debating whether it is better to just shrink the currency union. Gold US High Grade O EMBIG O How is it possible for risk markets to gain in a world with so much risk, unknowns, volatility, disequlibria, and pure political ineptitude? One answer is to look at the main problem that end investors face — where do I get a return? US Fixed Income C Global Gov Bonds" The top chart on p. 2 shows that the yields on global cash and bonds remain near all-time lows. After tax and inflation, these yields are negative. Equity yields — earnings yields plus inflation— are, in contrast, high by historic standards, but obviously require you to buy a very volatile asset. The last month saw very significant inflows into equity, high-yield, and muni mutual funds, much of which we believe is driven by the dire returns on safe assets. EM Local Bonds" O US High Yield O EM $ Corp. GSCI TR 0 SW500 US cash • Even more important than the low value of safe assets is that concerns about the world are starting to edge down, in a very up-and-down fashion, from the end-is-nigh sentiment that prevailed this summer. Fear of a US economy stalling has receded, but has not gone away, as H2 growth is rebounding to Europe Fixed Income' EM FX MSG AC World' I=I about 2.5%, from less than I% in HI. This week alone, trade, claims and confidence all surprised on the positive side. That said, there remains no sign of compromise in Washington on deficit reduction for next year nor for the MSCI EM' O MSCI Europe' O Toper' next decade. 40 40 0 10 V.1 90 Smote: AP. Mown Ettriberg. Pans n USD. 'Leal • In China, the continued fall in inflation, and move to monetary easing are earercy. - Naked do USD. Eum Fixed ti nv is Wm Dana greatly reducing fears of a hard landing. This induced us a few weeks ago to Index. US HG. HY. D.191G rd EM SCtxp are At Sect Eli Fite ELM. in S. The certifying analyst is indicated by an AC. See page 7 for analyst certification and important legal and regulatory disclosures. www.morganmarkets.com EFTA01148765 Global Asset Allocation The J.P. Morgan View J.P. Morgan go overweight on EM equities. On the negative side of the ledger, the massive floods in Thailand will have a similar supply-chain effect as the Japanese tsunami in March, though only some 40% of its impact (see Global IP hit by Thai floods, Hensley and Lupton in today's GDW). The floods should take 2.25% off global industrial growth this quarter, translating into a 0.5% cut in global GDP growth. As with Japan, we should expect this loss to be recouped in HI of next year. Markets should be able to see through this IP decline. • The Euro area remains at the core of investor concerns, and rightly so. Last month's EU summit commitments had both a carrot and a stick — fiscal solidarity (funding) and fiscal discipline (austerity) — but needed to have a lot of blanks filled in. This week saw little progress on the carrot, but more on the stick. Greece now has a new PM who was a "Euro technocrat", and Italy seems set to get one next week. Both should give the EMU creditor nations better confidence that austerity conditions of financial support will actually be implemented. But debitor nations cannot live on austerity alone, as their economies are entering recession, depressing tax revenues even as tax rates are being raised. • The Euro area thus needs to urgently make progress on creating a lender of last resort function that can exert overwehelming funding power to stop the widening run on EMU governments. Austerity by itself has limited power in stopping this run on government debt. The EFSF remains too small, underde- veloped. and not well thought out to provide the shock-and-awe that de- pressed bond investors need. The IMF seems to be coming closer to getting involved but itself has a challenge answering the question why it needs to provide funding for a region that has almost no external deficit.The ECB is limited by its no-bailout clause to follow the Fed and other central banks in moving to a full QE for the Euro area. We think that ultimately the Euro area will step away from the break-up abyss and will rely on a combination of much larger IMF, EMS, ECB liquidity support, quite likely with the ECB providing extra funding to one or both of the other two. Fixed income • Largely unchanged US Treasury and German Bund yields hardly tell the story of another turbulent week in the Euro area. France and Austria underperformed, on concerns about their AAA ratings, but more damaging was the I% round-trip in Italian yields. The heightened volatility and reduced liquidity of Italian bonds raise questions about both market access in the short term, and the longer-term demand for Italian debt. Indeed, our economists now see an EU-IMF support package for Italy as increasingly likely (See Nicola Mai, Italy edges towards the IMF, I I Nov). With discussion of EMU breakup increasing, it is striking that this year's underperformance of Italian BTPs vs German Bunds already rivals that seen in the 1990s, when the position in- cluded currency risk (see chart). • We stay flat overall on the periphery. The turmoil in Italian bonds bodes ill, but the new government expected next week may steady the ship for a time. We close tactical shorts and steepeners in long end Treasuries, with poorly- received supply now out of the way, and keep only a value-based short in 2yr Gemrany. • Our latest Inflation Expectations Survey (J. Garayo and A. Chordia, out today) Expected return on a global portfolio of fixed income. equities. and cash 16 14 12 10 8 6 4 89 92 95 98 01 04 07 10 Equities Sturm: JP. Mxgr. The especkel rekm on Ugh is oWend a the teed co Pe JP.Morgan Gel Octal cash n*x fed ern de/doped rafts* filed ircane see lie J.P.Menvel GABi pea rd Ne elpeeed relLm m conks is the 'ambled Odd cede Dalasliern ecdd it dus free toe redng reeked Octal tritalen Global portfolio weighting of fixed Income, equities, and cash % of total portfolos: J.P. Morgan estimates from Oct 2011 45% Cash 40% 35% 30% 25% 20% 89 92 95 98 01 04 07 10 Outstanding: Estim. 31 Oct Average Gap Cash $58 41.1% 37.3% 3.8% Equity $40 28.4% 32.4% -4.0% Bonds $43 30.5% 30.3% 0.2% Total $141tr Gauze: J.P Megan. BM DaqinCOTI1 Gebel rl a Foxed by re van of to Octal ctrereste dcbl sect:ties reporled by GIS alt JP. kbroan's EMBIG rdto re warn debt Fa MACS. se used the Odadrean weld CqJty Gtrtel CM" is 51 agiregted 1.12 (sr dose ;racy el 1121 el &mixed rd deodecie ceueies. Nov 11, 2011 2 EFTA01148766 Global Asset Allocation The J.P. Morgan View J.P. Morgan points to slightly lower expectations since July. The looming recession has led to a reappraisal of tail risks in the Euro area, with survey respondents now seeing deflation as equally likely as high inflation (>4%). By contrast, high inflation remains the overwhelming tail risk in the US and especially the UK. Long 30yr UK breakevens, at historically attractive levels, is our favoured inflation trade. Equities • Equities rebounded this week, helped by optimism from political changes in Greece and Italy. Excessive pessimism and bearish positions among investors, continue to create an asymetric outlook for equity markets, with bearish news creating limited downside and positive news more pronounced re- bounds. As we highlight in Flows&Liquidity, positions remain low, support- ing further equity rallies in the absence of big negative news. • The reporting season is adding to positive momentum. More importantly, profit margins appear to have expanded over the past year. S&P500 EPS grew 16% YoY in Q3, vs 11% for Sales-per-Share. The size of the EPS surprise has been higher in Europe, 4% for DJStoxx600 vs 3% for the S&P500. • We continue to believe in the importance of having peripheral hedges in an equity portfolio. Overweighting DAX vs. Eurostoxx.50 is such a hedge. This trade posted a gain in both September and October. Although this trade can operate as a hedge, it is also motivated by the growth outperformance of Germany vs. the rest of the Euro area. This theme is still in place as healthier balance sheets (both private and public) in Germany allow the country to escape the painful adjustments that other Euro area countries have to make. Credit • Attention this week shifted to Italy and political turmoil in Europe remains a central theme in credit performance. The wave of optimism that brought about October's rally has seemingly abated and spreads across the board finished net up on the week. Still, US economic numbers have turned the corner and we continue to see value in US vs. European credit. • Our US and European strategists both published client surveys this week. US investors are typically bearish on the direction of spreads: 41% expect spreads to widen this month vs. 20% last month. 25% expect to see tightening vs. 63% last month. 71% of US investors reported being underweight Euro- pean issuers. • In Europe, investors maintained credit overweights but cut back positions in lower rated credit. Our strategists also asked where clients saw the biggest risk of dissapointment going forward. Topping the list were EFSF leverage and Greek PSI, for which the respondents forecast a mean acceptance rate of 68%. Foreign Exchange • By now almost everyone outside of the ECB and the German government contends that massive debt monetization will be required to manage Europe's sovereign funding crisis. Most would also argue that this process will be hugely euro-negative. At this stage in the inflation and global rate cycle, however, it isn't clear that large-scale asset purchases would be so destruc- Return of 10yr Italy vs 10yr German goverment bond lyr rolling total return. per cent. Measured in Deutschemark pre•1999 i.e. inducing FX risk 60% 40% 20% 0% •20% 40% 89 91 92 94 96 98 00 02 04 06 08 10 Sane J.P.14:egan More details in ... EM Corporate Outlook and Strategy. Warren Mar el al. US Creoll Markets Outlook and Strategy, Eric Beinstein et al. High Yeti Credit Markers Weekly, Peter Acciavalti et al. European Crack Ourlook & Strategy. Steven Dulake et al. Emerging Markets Cross Product Strategy Weekly, Eric Beinstein el al. Nov11,2011 3 EFTA01148767 Global Asset Allocation The J.P. Morgan View J.P, Morgan live. If QE undermines currencies through higher inflation or inflation expecta- tions, the 2012 recession is a much more auspicious time for debt monetization currency-wise than the Fed and Bank of England's first attempts at QE in 2009. • The evidence around QE's currency effect is mixed. The US's QE experience ran from March 2009 to June 2011 and was textbook across all variables. Inflation expectations oscillated around 2.25%, nominal rate expectations declined versus the rest of the world, real yields fell to zero and the dollar declined trade-weighted. The UK's experience was less consistent. Inflation expectations averaged 3%, nominal rate expectations trended lower, real rates fell to zero, but trade-weighted sterling traced a range. Perhaps sterling's stability simply reflected Europe's disarray: Were it not for recurring sovereign stress, sterling might have responded to the declining level of real yields. • The implication for the ECB is that QE shouldn't undermine currency stability unless real yields fall relative to other countries. That could happen in 2012 only if Euro area inflation outpaces other countries', and if bond pur- chases push nominal rates much lower than elsewhere. Both will be hard to achieve next year when commodity inflation is muted and other central banks pursuing QE (UK) or considering it (US). For the next year, even a doubling of ECB purchases is probably consistent with euro stability. The more material question is what amount is consistent with European political harmony, since the governments of most of Europe's AAA countries share the ECB's anti- monetization philosophy. These countries sound resolutely opposed to further QE now, but their stance may soften if the revamped EFSF fails to launch. With European sovereigns still without a clear source of guaranteed funding, we retain hedges against another financing squeeze through shorts in EUR/JPY,USDIJPY andGBP/JPY. Commodities • In a volatile week, commodities are up around 1% helped by oil markets which offset declines in base metals and agriculture. Yesterday, our commod- ity strategist Colin Fenton took profit on the short leg of his EM Asia vs. US commodity basket and recommended that investors double up on the long leg. This means being outright long Brent, gasoil, gold, sugar, corn and wheat. The recent rotation of the WTI futures curve into backwardation (downward sloping) coupled with drawdowns in crude oil product inventories show markets are tight and give us confidence in our bullish view (see Commodity Mementos: Exit Commodity Bear Basket - Buy Gas Vol, C. Fenton, Nov 10). • In contrast to crude markets, base metals still give us some cause for concern that downside risks to the global economy have not gone away. Both copper and steel prices have fallen sharply and remain depressed. We thus advise that investors hedge the above bullish exposure. The long gold position should do well if either the European or US political situation worsens but we also recommend buying 10% OTM puts on US natural gas in the Mar-12, Apr- 12 and May-12 contracts. These trades should do well if US IP unexpectedly falls or if the Deficit Supercommittee fails and political gridlock worsens in the US. The gas puts would also benefit from a warm winter or if permits to drill for gas in the US Outer Continental Shelf are given out aggressively. We also recommend buying Calendar 2015 straddles in NYM natural gas, or variance swaps on that calendar strip. FX w ekly change vs USD 2% 1% 0% -1% .2% USD EUR GBP JPY CHF CAD AUD TWI Soute:1P Maw More details in ... FX Markets Weekly. John Normand et at. Commodity Markets Outlook & Strategy. Cohn Fenton et al. 0)1 Markets Monthly. Lawrence Eagles et al. Metals Revmaw and Outlook. Michael Jansen Global Metals °toiletry. Michael Jansen Nov 11,2011 4 EFTA01148768 Global Asset Allocation The J.P. Morgan View Interest rates Current Dec-11 Mar-12 Jun-12 Sep-12 J.P. Morgan YTD Return' United Slates Fed fundsrate 0.125 0.125 0.125 0.125 0.125 10.year yields 2.C6 2.25 2.50 2.50 2.50 8.8% Euro area Reg rate 125 1.00 1.00 1.00 1.00 10-year Oda 1.89 1.75 2.00 2.10 2.15 9.1% United Kingdom Repo rate 0.50 0.50 0.50 0.50 0.50 10.year yields 2.29 2.45 2.45 2.55 2.65 14.4% Japan Overnight call rate 0.05 0.05 0.05 0.05 0.05 10.year yields 0.97 0.85 1.00 1.10 1.10 2.1% GBI-EM hedged in S Yiekl • Global Diversified 6.45 6.70 4.7% Credit Markets Current Index YTD Return' US high grade (bp Over UST) 223 JPMorgan JULI Porfolio Spread to Treasury 8.2% Euro high grade (bp over Euro gov) 226 iBoxx Euro Corporate Index 1.7% USD high yield (bp vs. UST) 726 JPMorgan Glottal High Yield Index STW 5.2% Euro high yield (bp over Euro gov) 812 iBoxx Euro HY Index .2.4% EMBIG tbp vs. UST) 395 EMBI Global 8.3% EM Corporates (bp vs. UST) 439 JPM EM Corporates (GEMS!) 4.0% Commodities Current Quarterly Averages 1104 1201 1202 1203 GSCI Index YTD Return' Brent (SIbl) 114.2 115.0 120.0 120.0 125.0 Energy 7.5% Gold aux) 1787 2150 1925 1875 1850 Preoous Metals 23.3% Copper (Vmetrie ton) 7457 7250 8250 8500 9250 Industrial Metals -21.5% Corn '5Bu' Foreign Exchange 6.38 Current 6.40 6.70 7.00 6.80 Dec-11 Mar-12 Jun.12 Sep-12 Agriculture -14.1% 3m cash YTD Return' Index In USD EUR(USD 1.38 1.38 1.38 1.40 1.42 EUR 2.7% USDOPY 77.2 75 74 73 72 JPY 4.9% GBP/USD 1.61 1.59 1.58 1.58 1.60 GBP 2.5% USDBRL 1.74 1.80 180 1.80 1.80 SRL 0.5% USD/CNY 6.34 6.30 620 6.10 6.00 CNY 2.7% USDKRW 1127 I CSC 1090 i C60 1030 HAW 1.9% USD/TRY 137 1.78 1.82 1.80 1.75 TRY -9.7% Equities YTD Return Current (local ccy) Sector Allocation US YTD Europe YTD Japan YID EM YTD (S) S&P 1265 2.4% Energy 5.4% 0.2% -1.3% -11.5% Nasdaq 2683 1.9% Matenals .8.3% -21.6% 23.6% -19.5% Topix 729 .17.0% Industrials .3.8% -19.2% -14.6% -25.8% FTSE 100 5545 3.0% 0scrolionary 4.0% -10.9% 22.8% -4.2% MSGIEurozone' 129 -16.0% Staples 8.1% 0.9% 2.2% MSCI Europe' 998 .11.5% Hea thcare 8.2% 3.2% -8.3% 20.3% MSCI EM S' 954 -15.0% Financials -17.9% -25.7% 25.7% -20.6% Brant Bovespa 58543 .15.5% Informal on Tech. 3.4% -5.7% 264% •15.7% Hang Seng 19137 -19.0% Telecommunications 2.0% -2.0% 2.8% .259E Shanghai SE 2481 'Levels/mums as of Nov 10.2011 Local amency except MSCI EM .13.3% Wales 14.9% -13.0% .47.7% -12.7% Overall 2.4% -113% -17.0% -15.0% Sarre: el:amber% OW:dna WS Standard a Pout SeniCOS. J P Masan 15111911.1 Nov 11, 2011 EFTA01148769 Global Asset Allocation The J.P. Morgan View J. P Morgan Global Economic Outlook Summary Real GDP over a year ago Real GDP % over premous perod. saw Consumer prices % aver a year ago 2010 2011 2012 1011 2Q11 3011 4011 1012 2012 3012 2011 4011 2012 4012 The Americas United Slates 3.0 1.8 1.7 0.4 13 25 25 0.5 1.5 2.5 3.3 3.31 1.51 12 Canada 3.2 2.2 2.2 3.6 -0.4 1.8 2.4 2.6 2.6 2.4 3.4 2.6 1.6 1.7 Latin America 6.0 4.1 1 3.1 $ 5.6 421 2.91 2.01 1.6 481 4.9 7 6.7 7.2 6.41 6.2 Argentina Brazil Chile 9.2 7.5 5.2 7.0 1 3.01 6.5 3.0 13.1 3.11 5.0 4.0 6.4 102 3.1 5.7 AO 1 35 2.0 1.31 2.5 0.0 2.91 3.5 6.0 5.0 t 4.5 4.0 531 5.0 9.7 6.6 3.3 11.0 6.7 3.6 10.0 5.3 3.6 10.0 5.2 3.4 Colombia 4.3 5.3 3.7 2.9 8.5 3., 1.5 3.0 4.0 5.0 3.0 3.9 3.0 2.9 Ecuador 3.6 6.0 3.0 7.11 9.11 2.0 1.0 2.0 3.5 4.0 4.1 3.9 3.6 3.5 Mexico 5.4 4.0 2.5 2.4 4.5 5.7 2.6 -1.7 4.1 4.8 3.3 3.2 3.5 35 Peru 8.8 6.7 1 4.5 6.9 45 _371 2.71 4.5 5.0 6.2 3.1 4.0 3.6 2.7 Venezuela -15 35 4.01 14.7 -32 3,p t 4.0 7 6.0 7 6.0 7 48 1 24.6 28.61 26.71 25.3 As Ialla c If ic Japan 4.0 -0.6 1.9 -3.7 -21 55 2.0 1.8 15 1.3 -0.4 -01 -0.7 -05 Australia 2.7 1.4 3.5 -3.4 4.8 21 2.2 4.1 3.4 4.8 3.6 3.8 3.2 3.3 New Zealand 1.7 2.31 2.81 3.5 0.4 5.7 7 2.41 -021 6.5 7 3.71 5.3 2.91 221 2-5 Asia ex Japan 9.1 7.1 6.4 1 9.0 5.7 5.9 5.51 6.7 6.5 7.1 5.7 5.0 1 4.1 1 4.1 China 10.4 9.0 8.3 9.0 7.9 7.9 8.0 8.2 8.2 8.9 5.7 4.9 3.8 3.5 Hong Kong 7.0 5.0 3.0 1 13.0 -1.61 0.41 1.51 3.5 1 4.0 1 5.5 5.2 5.2 43 4.5 India 8.5 7.4 7.7 8.3 7.7 73 7.0 6.9 7.3 8.5 8.9 8.6 7.6 7.8 Indonesia 6.1 6.3 5.2 6.8 5.4 62 5.5 5.0 4.5 5.0 5.9 3.21 3.61 4.0 1 Korea 6.2 3.8 3.8 1 5.4 3.6 3.0 4.2 3.0 1 4.0 4.0 42 3.7 3.1 3.5 Malaysia 7.2 4.0 1.5 5.5 32 _201 0.01 1.01 1.0 1 2.0 7 3.3 2.4 1 1.5 1 131 Phkfines 7.6 4.1 4.0 7.8 2.4 4.1 2.4 2.4 7.4 5.3 5.0 4.9 7 3.91 4.0 Singapore 14.5 4.81 1.5 27.2 -65 1.6 -3.9 2.0 6.1 6.1 4.7 5.6 4.0 2.8 Taiwan 10.9 4.4 3.0 14.5 0.6 -1.1 2.5 3.5 4.3 4.6 1.6 2.2 2.0 2.4 Thailand AlricallIddle East 7.8 1.91 2.21 8.1 -0.8 LI -15.01 20.0 1 1.0 1 1.3 4.1 3.51 3.91 3.5 1 Israel 4.8 4.3 2.9 4.8 3.7 M di 1.31 0.8 3.2 6.1 4.1 2.8 2.3 2.5 South Africa Europe 2.8 3.1 2.7 4.5 1.3 1.0 3.9 23 2.6 1 2.81 4.6 6.2 6.4 6.1 Euro area 1.8 1.61 -0.6 3.1 0.7 121 -1.0 -1.5 -1.5 -0.3 2.8 2.9 1.81 1.4 Germany France Italy 3.6 1.4 1.2 3.0 1.61 0.51 0.3 5.5 -0.21 3.7 -1.61 0.5 05 0.0 12 1._Q g 1 -051 -0.5 -1.0 -2.0 -0.3 -0.8 -2.5 -0.3 -0.8 -25 0.5 0.5 -1.0 2.5 22 2.9 2.7 I. 2.4 7 3.8 1.7 7 1S 7 2.7 1.3 1.2 7 1.7 Norway 2.1 2.2 0.7 1.9 4.1 Lk 05 0.0 0.0 1.0 1.4 1.1 1.2 1.3 Sweden 5.4 4.1 0.4 3.1 3.6 2.0 0.0 -0.5 -0.5 0.5 2.9 2.5 1.1 1.1 United Kingdom 1.8 1.0 0.8 1.6 0.4 2.0 1.0 0.5 -1.0 2.5 4.4 4.9 2.8 1.8 Emerging Europe 4.5 4.1 1 2.41 3.6 12 251 1.0 1 2.71 2.71 3.5l 7.1 6.2 5.61 5.7 Bulgaria 0.2 2.8 2.4 Czech Republic 2.3 2.0 0.6 3.5 0.3 0.3 -0.3 0.0 0.8 2.0 1.8 1.8 2.5 2.8 Hungary 1.2 1.2 0.5 1.2 -02 0.0 -0.3 0.0 0.8 1.5 4.0 3.7 4.4 5.1 Poland 3.8 4.0 2.7 4.5 45 a 2.0 2.0 2.5 3.0 4.6 3.9 2.5 2.7 Romania -13 1.5 0.8 82 4.0 35 3.5 Russia 4.0 3.6 3.0 3.7 0.4 2.8 1.0 4.0 3.5 4.5 9.6 7.1 7 6.3 7 731 Turkey 9.0 7.01 2.2 1 ... 5.9 8.3 7.8 6.0 Global 4.0 2.6 2.0 2.6 1.7 2.91 1.81 1.4 1.7 2.6 3.7 3.6 2.4 2.2 Developed markets 2.7 1.4 0.9 1 0.9 al 24 1 11 0.1 1 0.4 1.5 2.7 2.8 T 1.4 12 Emerging markets 7.3 5.7 4.71 7.2 43 4.41 3.81 4.7 5.4 7 5.9 6.1 5.7 1 5.01 491 Space JP. kixgan Nov 11.2011 6 EFTA01148770 Global Asset Allocation The J.P. 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