J.P Morgan

J.P Morgan he J.P. Morgan View The paradox of austerity • Asset Allocation — The shallowness of the correction in risk assets and the lack of a convincing reason to go short will likely pull investors back in, creating further upside over coming months. • Economics — Data are tracking a mild deceleration of global growth in Q2, driven by excess inventories. Solid consumption data are telling us this slowdown should be temporary and are setting us up for better growth in H2. • Fixed Income — Flat duration, bearish on Euro area peripherals. • Equities — The reporting season is delivering significant positive surprises in both the US and Europe. • Credit — We move to marketweight EMS sovereigns overall although NEXGEM sovereigns offer a good investment opportunity. Foreign exchange — BoJ easing should keep USD/JPY in low 80s. • Commodities —Central bank buying still supporting gold. • Risk markets rebounded this week on continued good US earnings, a sup- portive FOMC, and an OK Italian bond auction. The dollar eased modestly in line with its safe-asset image, while bonds are largely unchanged. Global equities remain about 2% below their YTD peak in March. Given the news flow this week, which contained a lot of political fireworks from Europe and an upside surprise on US claims, one would have expected risk markets to have traded lower this week. We like to interpret the upmove as supporting our view that the main driver of this year's rally in credit and equities will not be a surplus of good news, but a lack of enough bad news relative to the risks that already priced into markets. To put this into Finance jargon, risk is high, but risk premia are even higher. • This strategy depends on the Value force which we know does not work reliably from week to week, but has to be assessed on a 3.12 month basis. A lot of more tactical players have covered their longs in risk assets recently, on event risk in Europe, and so have many of our product strategists. We under- stand the reasoning, but also find that most investors retain a positive me- dium-term view on equities and credit and will thus be looking for point to re- enter the market. Our medium-term strategy, therefore, stays long risk. • The prevalence of defensive positions — in cash and safe debt — are largely due to concerns about US growth, a fiscal gridlock at year end (the so-called "fiscal cliff'), military conflict in the Middle East, the Chinese economy, and Europe. We judge that the sum total of these risks has become less acute, even as it is too much to say that they are fading away. The US continues to The certifying analyst is indicated by an AC. See page 7 for analyst certification and important legal and regulatory disclosures. Global Asset Allocation J.P. Morgan Chase Bank NA, J.P. Morgan Securities Ltd. Apr 27, 2012 Jan LoeysAc John Normand Nikolaos Panigirtzoglou Seamus Mac Gorain Matthew Lehmann Leo Evans YTO returns through Apr 26 14. equities are in lighter colour. Topa' S&P500 MSCI AC World' MSCI Eke EM S Corp. US High Yield EMBIG EM FX Gold IMMO MSCI Europe I GSCI TR MIMI US High Grade MI EM Local Bonds" j US Fixed Income El Global Gov Bonds- • Europe Fixed Income' • US cash I 0 ICI IS Some: J.P. Maim. Sbaran. Ratan ii USD teal curter,. "Hedged at: USD. En Ned Income a Itow Omni Het. US MG.WE/33/G and EMS Cap ale JP/A oda& E/A nth Eli/hint www.morganmarkets.com EFTA01176400 Global Asset Allocation The J.P. Morgan View J.P, Morgan be in a stable 2-handle growth path with little volatility. Q I came in a bit weaker than we thought last week, but better than we thought a month ago. There will be no information about what compromise the two sides of the US aisle will make late this year to prevent a fiscal crisis or recession until after the elec- tions. The risk of a worse slowdown in China is receding with each passing data release. And risk of a new war in the Middle East this year is similarly rapidly fading, as evidenced by the recent fall in oil prices. That leaves Europe. The European political news is showing strong resistance, in both periphery and core, to more austerity. This is not mere short-sighted complacency, but a conviction that austerity is not working and may even be counterproductive. At the country level, signs that a government is slacking on its austerity commitments tend to push its debt and equity prices down. But evidence that EMU wide austerity is depressing its economic activity are also a negative. This is of course nothing other than the Paradox of Thrift, the economic application of what is known as the Fallacy of Composition in logic. What is right and good for the individual — to save more — is not necessarily right and good for the group — a recession. You can't have your cake (austerity) and eat it too (growth). The experience of non-EMU countries (US, UK, Japan) is instructive on how markets will and should react to austerity. The US and Japan are clearly showing even less fiscal discipline than Spain or Italy, while the UK is show- ing more, in our view. But the US and Japanese economy are growing and their equity markets have produced double-digit returns YTD. The UK economy, in contrast, is flat on its back and its equity market is barely up on the year. But each of their government bond markets has performed better than the euro periphery as their central banks are active buyers of their debt. If you have your own central bank, then equity markets do not like excessive austerity. • To judge euro asset prices, we do not merely look at whether countries are serious in pursuing austerity. Instead, we look at evidence that EMU members are working together and coordinating fiscal policies and funding, whether towards more or less austerity. A go-it-alone strategy by individual member countries away from their fiscal commitments, is a clear negative. Ago-it- together strategy by member countries towards a growth strategy and away from pure austerity should be a positive for euro assets if it is combined with more cooperation on funding. We do not see it is a negative that there is a heated discussion, and disagreements on austerity in Europe.This is what should happen and is happening among parties in the same country. By Washington standards, the spat between Merkel and Hollande is genteel. Maybe this debate is simply evidence that the Euro Area is growing into a political unit, exactly what is needed to make EMU work. Fixed income • Bonds edged a little higher, with German and Australian benchmarks record- ing new all-time yield lows, in a week of data disappointments. Intra-EMU spreads held in despite a wobble both at the start of the week, on the fall of the Dutch government, and its end, on the Spanish downgrade. We maintain a bearish outlook on peripheral bonds, with the slowing of bank buying leaving the balance of supply and demand precarious. • One factor supporting bonds even at these low yields has been strong buying from bond mutual funds, which even based on incomplete data posted the Apr27,2012 2012 global GDP growth forecasts: JP/slorgan and Consensus 4.0 3.5 3.0 2.5 2.0 I5 Ja .11 Apr•I I .411 Oct.11 Jan.12 Appl2 Saute J.P /.4ovin.Caneraus Ecarxmcs.Cansensus Emexnes Ixecasts are fa, MOMS all conies HIS roe areeard usig he ,are lea rehg USD GDP stia•ts tal se use kr DJ cran gbbal 'oath 'crawl. More details In ... Global Data Watch. Bruce Kasman and David Hensley Global Markets Outlook and Strategy. Jan Loeys. Bruce Kasman. et al. US Fixed Income Markets. Terry Belton and Srini Ramaswamy Global Fixed Income Markets. Pavan Wadhwa and Fabio Bassi Emerging Markets Outlook and Strategy. Joyce Chang Key trades and risk: Emerging Market Equity Strategy. Adrian Mowat et al. Flows and Liquidity. Nikos Paniginzoglou et al. 2 EFTA01176401 Global Asset Allocation The J.P. Morgan View J.P, Morgan strongest inflows since 2010 in Ql. Flows into both bond and equity funds are strongly related to past returns, and with capital gains on bonds surely limited from here, this source of bond demand seems likely to slow over the rest of the year. • Euro money market rates fell on the week, so much so that they now imply a reasonable likelihood that the ECB will cut not just its main policy (refs) rate, but also its deposit rate, which sets a floor for unsecured rates. We think any such move is more likely to come this summer than next year and so recom- mend euro money market steepeners (see GEMS Derivatives, Wadhwa and Bassi). We remain flat duration overall, with weakish data, supportive central banks, and Euro area jitters counterbalancing the low level of yields. Equities • Equities are up on the week despite negative macro/political news. The reporting season is becoming an important catalyst in both the US and Europe, something we and our clients had underestimated a few weeks ago. • With more than half of the S&P500 companies having reported so far, 75% have beaten expectations and the S&P500 Q1 EPS is up 8% vs. bottom-up analysts' expectation at the beginning of the month (based on Bloomberg data). The $1.5-$2 surprise in the Q1 S&P500 EPS creates upside to our 2012 EPS forecast of €106.4 according to our US Equity Strategist Tom Lee. • We have a similar but less impressive picture in Europe. Mislay Matejka, our European Equity Strategist, calculates that from the 124 companies of the DJStoxx600 index that have reported so far. 54% have beaten expectations with an average EPS beat of 4%. As we argued before, in absolute terms, there is little reason to celebrate, especially in Europe where yoy EPS growth is coming in at •7%. But this weakness, the result of very weak growth in Europe, is well telegraphed. • The large divergence between yoy EPS growth for the S&P500 (+8% yoy) vs. DJStoxx (-7% yoy) is another metric that supports our OW in US equi- ties. In other words, both the absolute performance of the Q1 reporting season (yoy growth) and the relative performance vs. expectations (EPS surprise) look a lot better for the US compared to European equities. • EM equities continued to underperform their DM counterparts this month. We remain neutral tactically in our model portfolio. EM equities are hostage to the Chinese growth story and there are no catalysts yet to resolve this story. However, for investors wanting to take a stance on EM, we would recommend a long EM vs. DM position. We expect Chinese growth to gradually bottom out in coming months and the MSCI EMS index is currently trading at the low end of its historical range vs. MSCI World$. Credit • US High-grade credit has been in a stasis over the past two weeks, showing remarkably low volatility around current spread levels. It has traded in a 2bp range since Apr 10 (200-202bp), even as 3-4bp were shaved off Treasury yields and equities rallied 3% over this period. Clearly weaker economic data on the one hand, which pushed down Treasury yields, are being offset by a positive earnings season, which is highlighting the strength of corporate credit metrics, on the other. US HY which is far less sensitive to Treasury yields, has been More details in ... EM Corporate Outlook and Strategy. Warren liar el al. US Croat Markets Outlook and Strategy, Eric Bernstein et at. High Yield Credit Markers Weekly, Peter Acciavagi et at. European Credit Outlook & Strategy. Steven Dulake et al. Emerging Markets Cross Product Strategy Weeldy. Eric Beinstein el al. Apr27,2012 3 EFTA01176402 Global Asset Allocation The J.P. Morgan View J.P. Morgan enjoying some of earnings upside registered by equities, tightening by almost 20bp and returning 1% during this time-frame. • In EM we downgrade the EMBIG to market weight, as the coming period of political stress in the Euro area is likely to keep risk markets nervous and sentiment, as highlighted by our IMF/World Bank Spring meetings in Wash- ington, is less sanguine towards the asset class. Next Generation sovereigns (NEXGEM), which make-up less than 9% ortheEMBIG by market cap, appear to offer the best investment opportunities heading into YE (See Joyce Chang. Highlights from the IMF/World Bank Spring Meetings, Apr 24). Foreign Exchange Strange for a week in which shocks abounded — French elections, Dutch coalition collapse, Spanish downgrade, UK re-entered recession — the dollar is down versus all currencies but ARS and INR; the broad indices (DXY, JPMQUSD) hit their weakest levels in a month; and FX volatility has fallen to a new four-year low (9.3% on VXY Global). The greenback's range versus the euro isn't so surprising given that pervasive pessimism has lead to near- record euro shorts. The causes of dollar weakness versus the rest of the world are less obvious but neither have these currency moves been very large — the trade-weighted dollar remains within the ranges its has traced for three months as most of the low-intensity regional dramas offset one another. • Is risk mispriced? Yes, but only by about I vol on VXY Global, which is half of the undershoot witnessed before last summer's deleveraging and a fourth of the pre-Lehman bubble. Also, this year FX carry has underperformed even the higher, predicted level of FX vol, probably because most FX high-yielders are commodity exporters, so too exposed to China's slowdown. This gap between vol performance and carry trade returns does not exist in other asset classes such as credit, which suggests that China has been a constraint unique to FX. Europe still poses a risk of higher vol, but even controlling for a bounce in VXY, FX carry still has scope to catch up if Chinese data over the next two weeks continue the transition from bad to stable which began in April. This dynamic favours modest moves higher in commodity FX, though still within recent ranges. • The Bank of Japan delivered more asset purchases than expected but failed to increase its inflation target, which should make investors question whether it is as serious about delivering currency weakness as others such as the Swiss National Bank or Central Bank of Brazil. With the Bank of Japan having taken a detour on the road to Damascus — assuming it ever intended to make that journey — USD/JPY should keep to the low 80s. An uptrend still requires a hawkish Fed or a meaningfully higher oil price, neither of which this global economic stagnation can support. Commodities • Commodities rose on the week, in tandem with higher equities, with energy, agriculture and metals all gaining. That included a tick up in gold, to the middle of its recent range. Central bank buying is an important factor underlying our bullish view on gold, and this week the IMF reported that a number of central banks, including Russia's and Mexico's, took advantage of lower prices to add to their gold holdings in March (see Michael Jansen, Base and Precious Metals Daily). Also supportive of gold is that speculative positions, as measured by the CFTC, are at the bottom end of their range of the past few years. We stay long gold. Apr27, 2012 FX weekly change vs USD 1.0% 05% 0.0% -0.5% -1.0% 4.5% USD JPY EUR GBP CHF CAD AUD TWI Setrce:J.P. Wpm 1 . I More details in ... FX Markets Weekly. John Normand at al. Commodity Markets Outlook & Strategy. Cohn Fenton et al. 04 Markets Monthly. Lawrence Eagles et al. Metals Rewew and Outlook. Michael Jansen Global Metals &latterly. Michael Jansen 4 EFTA01176403 Global Asset Allocation The J.P. Morgan View J. P Morgan Interest rates Current Jun-12 Sep-12 Dec-12 Mar-13 YTD Return* United Slates Fed fundsrate 0.125 0.125 0.125 0.125 0.125 10.year yields 1.94 2.40 2.50 2.50 2.50 0.0% Euro area Ref rate 1.00 1.00 1.00 1.00 1.00 10.year yields 1.70 1.80 2.00 2.00 2.00 1.2% United Kngdom Repo rate 0.50 0.50 0.50 0.50 0.50 10.year ykelds 2.13 2.55 2.55 2.40 2.40 13% Japan Overnight call rate 0.05 0.05 0.05 0.05 0.05 10.year yields 0.89 1.15 1.05 1.05 1.15 0.7% GBI-EM hedged in $ Yield • Global Diversified 629 6.30 2.6% Credit Markets Current Index YTD Return* US high grade (bp over UST) 202 JPMorgan JULI Podolto Spread to Treasury 3.1% Euro high grade (bp over Euro gov) 269 iBoxx Euro Corporate Index 3.7% USD high yield (bp vs. UST) 639 JPMorgan Global High Yield Index 57W 6.1% Euro high yield (bp over Euro gov) 868 iBoxx Euro HY Index 11.1% EMBIG (bp vs. UST) 351 EMBI Global 6.3% EM Corporates (bp vs. UST) 396 JPM EM Corporates (CEMBI) 6.6% Commodities Current Ouarterly Avenges 1202 1203 1204 1301 GSCI Index YTD Return' Brent (Sbbl) 119 112 120 125 125 Energy 7.0% Gold IS.C2) 1665 1825 1900 1925 1850 Precous Metals 5.6% Copper ("Metric ton) 8454 8500 8875 9000 8750 Industrial Metals 5.5% Corn ("Bu) Foreign Exchange 627 Current 6.70 6.50 6.60 Jun12 Sep.12 Dec-12 Mar-13 Agriculture -1.5% 3m cash YTD Return' Index In USD EUR+USD 1.33 1.34 1.36 1.36 1.36 EUR 2.6% USDJPY 80.5 86 84 83 82 JPY 4.7% GBP/USD 1.63 1.61 1.62 1.62 1.62 GBP 4.7% USDBRL 1.89 1.84 1.82 1.80 1.80 BRL 1.8% USDICNY 6.31 6.20 620 6.10 6.10 CNY 0.6% USDKRW 1135 1120 1100 1090 1090 KRVI 2.3% USCUTRY 1.76 1.80 1.77 1.75 1.70 TRY 10.0% YTD Return Equities Current (local ccy) US Europe Sector Allocation ' YTD YTD Japan YTD EM YTD ($) S&P 1403 12.3% Energy 2.4% -1.5% 3.0% 8.5% Nasdaq 3068 17.4% Materials 10.6% 102% 9.4% 7.8% Topix 804 11.6% Industrials 10.4% 9.0% 11.4% 13.4% FTSE 100 5777 5.1% Discretionary 16.5% 16.0% 18.8% 12.7% MSCI Eurozone' 136 4.4% Staples 6.2% 6A% 13.3% 13.6% MSCI Europe' 1064 5.2% Healthcare 8.7% 3.4% 5.6% 13.1% SAKI EM 1016 11.6% Financials 19.9% 6.7% 23.5% 12.0% Brant Bovespa 61974 9.2% Information Tech. 20.2% 7.7% 12.5% 18.7% Hang Seng 20741 13.9% Telecommunications 6.4% -6.6% .2.1% 7.5% Shanghai SE 2396 9.3% 'Levels returns as of Apr 26, 2012 Local currency except MSCI EM UtilAies .0.3% .1.3% 2.3% 8.8% Overall 12.3% 5.2% 11.6% 11.6% Sane Bantam, Dantean. BE.S.Bendard & Pals Seneca JP. Merge, elriltf. Apr 27,2012 EFTA01176404 Global Asset Allocation The J.P. Morgan View J. P Morgan Global Economic Outlook Summary Real GDP %env a yea- 293 Real GDP %o,er patio 65 WOO. Saa Consumer prices crier a yea- age 2011 2012 2013 4011 1012 2012 3012 4012 1013 2013 4011 2012 4012 2013 The Americas United States 1.7 2.41 22 3.0 2.21 n 3.0 2.0 1.5 2.3 3.3 2.1 1 191 1.6 Canada 2.5 2.3 2.5 1.8 2.1 2.6 2.3 2.4 2.7 2.4 2.7 1.7 1.7 2.0 Latin America 4.3 3.8 4.0 2.4 3/ 5.1 4.3 4.1 4.4 3.8 1.2 6.4 6.3 6.9 Argentina 8.9 4.5 4.0 32 0.0 5.5 6.5 5.0 3.0 4.0 9.6 10.0 10.0 11.0 Brazil 2.9 3.1 4.5 1.3 2.6 5.7 5.5 5.7 4.5 4.5 6.7 Si 5.1 53 Chile 6.0 5.0 4.5 82 5.1 4.9 4.6 4.7 4.5 4.4 4.0 4.2 3.9 3.4 Colombia 5.9 5.0 5.0 5.4 4,5 4.9 4.1 3.0 5.1 6.0 3.9 3.6 3.3 3.0 Ecuador 7.8 4.0 4.0 4.1 2.0 3.5 4.0 4.0 4.0 4.0 5.5 5.3 4.7 4.7 Mexico 3.9 3.8 3.5 1.1 Li 3.9 2.0 3.2 4.9 2.8 3.5 4.2 4.0 3.8 Peru 6.9 5.5 7.0 2.8 52 5.8 6.2 7.3 8.0 8.0 4.5 3.9 3.1 3.0 Venezuela 4.2 4.0 1.0 3.5 LQ 6.0 4.0 -3.0 0.0 0.0 28.5 23.9 23.4 31.1 Asktfacific Japan -0.7 2.0 12 -0.7 28 2.0 IA 1.2 1.0 12 -0.3 0.1 0.1 -0.1 Australia 2.0 3.0 3.3 1.7 3,1 1.9 3.7 4.1 4.5 2.0 3.1 2.5 3.3 3.0 New Zealand 1.4 2.9 2.7 1.4 Ad 2.1 3.7 3.0 0.9 3.4 1.8 1.2 2.5 2.7 Asia ex Japan 7.0 6.5 7.1 4.6 0,2 6.7 7.1 1 7.3 1 7.0 7.0 4.9 3.9 4.4 4.9 China 9.2 8.2 9.1 8.8 6.8 1.8 9.5 10.0 9.1 8.1 4.6 3.3 3.6 4.6 Hong Kong 5.0 2.8 42 1.6 3.0 4.0 5.5 6.0 3.0 3.5 5.7 4.5 3.6 3.2 1.0 7.1 72 3.8 13.0 5.5 6.3 6.5 6.1 7.5 8.4 7.8 8.2 8.5 Indonesia 6.5 5.3 5.5 9.9 5.0 5.0 4.5 5.0 5.5 5.5 4.1 3.9 7.4 7.3 Korea 3.6 3.3 4.0 1.3 3.71 4.0 4.5 4.01 4.0 4.0 4.0 3.0 3.5 3.8 Malaysia 5.1 3.9 32 4.8 5.0 2.0 2.0 2.5 4.0 4.5 3.2 2.6 2.2 1.8 Philippines 3.7 4.3 4.8 35 4.3 4.9 5.7 4.9 4.5 4.5 4.7 3.9 4.0 4.0 Singapore 4.9 3.7 4.0 -2.5 3.3 6.6 3.2 2.0 4.5 4.5 5.5 4.6 3.4 2.8 Taiwan 4.0 3.31 491 -0.6 5,0 1 4.8 5.0 1 5.3 1 4.5 4.6 IA 1.3 1.7 12 Thailand 0.1 5.1 3.5 -36.4 45.D 20.0 2.0 0.5 5.0 6.5 4.0 3.7 3.5 3.2 AtrIcaUlddle East Israel 4.8 2.9 4.4 32 0.8 3.2 6.1 7.4 4.5 2.8 2.5 2.3 2.5 2.1 South Allit3 3.1 2.7 3.6 32 2.3 2.6 2.8 3.2 3.8 3.5 6.1 6.0 6.2 5.9 Europe Euro area 1.5 -0.4 0.4 -12 -0.5 -0.8 -0.5 0.3 0.5 0.5 2.9 2.4 2.2 1.7 Germany 3.1 0.6 1.4 -0.7 0.3 1.0 0.8 1.3 1.5 1.5 2.6 2.3 2.1 1.7 France 1.7 0.3 0.7 0.6 0,0 0.0 0.3 0.5 0.8 1.0 2.6 2.6 2.3 1.9 'tab/ 0.5 -1.9 -0.7 -2.6 2.5 -2.5 -1.5 -1.0 -0.5 -0.5 3.7 3.6 4.0 3.6 Nanny 2.7 1A 1.8 23 ID 0.0 1.0 1.0 2.0 2.5 0.9 0.9 1.4 1.7 Sweden 4.0 -0.3 1.7 -4.4 AD -0.5 0.5 1.0 2.0 2.3 2.3 1.1 1.1 1.5 United Kingdom 0.7 0.1 1 1.9 -12 -091 jQ 2.5 15 2.0 2.0 45 3.0 3.0 2.1 Emerging Europe 4.8 2.8 3.5 4.6 1.2 1.4 3.0 3.1 3.5 3.2 6.4 5.0 5.5 6.1 Bulgaria 1.7 1.5 25 ... ... ... ... ... ... ... Czech Republic 1.7 -0.2 1.7 -0.5 -0.8 -1.0 1.1 2.3 3.3 -1.3 2.4 2.7 2.9 2.5 Hungary 1.7 0.5 15 12 4.3 0.3 1.0 1.5 1.5 2.0 4.1 5.8 5.9 3.8 Poland 4.3 3.2 3.0 4.5 2.8 2.0 2.5 3.0 3.0 3.0 4.6 3.9 3.5 2.8 Romania 2.5 0.8 2.7 -0.8 -1.2 -1.5 0.8 2.4 2.5 3.0 3.4 3.3 4.4 4.0 Russia 4.3 3.7 3.7 6.4 1.5 2.0 4.0 3.5 4.0 4.0 6.8 3.9 6.1 6.8 Turley 8.5 2.5 4.5 9.2 9.0 6.8 8.8 Global 2.6 2.3 2.6 1.5 2.41 2.2 2.61 2.5 2.5 2.6 3.6 2.71 2.71 2.7 Developed roadies 1.3 1.2 1 15 0.6 1_21 1.0 1.5 1.3 1.3 1.5 2.8 2.0 1.8 1 1.6 Emerging markets 5.8 5.0 5.6 4.0 5.8 7 5.3 5.7 5.8 1 5.7 5.5 5.7 4.8 5.1 5.6 1 A.P. Morgan Apr27,2012 6 EFTA01176405 Global Asset Allocation The J.F. 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