J.P. Morgan

J.P. Morgan The J.P. Morgan View Signal versus noise • Asset Allocation — Near-term momentum is negative for risk markets, but we find the signal from medium-term drivers more reliable and thus stay with our long risk assets for coming months. • Economics—Fall in Global All-Industry PMI eliminates upside risks on growth, but is consistent with 2.2% global growth projection we have for Q2. Loss of US job momentum implies Q2 may come in closer to 2%. • Fixed Income— End of BoE's QE next week a headwind for gilts. • Equities — OW US vs. Euro area equities, DAX vs Eurostoxx50 and MSCI EM Asia vs. MSCI EM. • Credit — Keep the focus on US credit. • Foreign exchange — Remain risk neutral and focused on earning carry in cyclical currencies with low vol and non-threatening valuations (Scandinavia) while simultaneously selling upside on stretched commodity currencies. • Commodities — Neutral outlook favours spread trades over next 3 months. • Equity markets this week gave back all their gains of the previous week and have now fallen back to the low end of the range they have held over the past 10 weeks. Commodities and bonds yields continue to fall from the year highs seen in March. The dollar is up against most currencies This week fall's in risk prices, and the rally in bonds and the dollar, had for once little to do with Europe where periphery, yields are down nicely. Instead, we are seeing a number of economic data releases, punctuated by today's US payrolls report, that show fading momentum into the second quarter. The magnitude of the negative surprises are not yet large enough to force downgrades of growth forecasts. Our global 2012 projection does slip back to the 2.2% forecast we held all through Q I, but this is largely a rounding issue caused by last week's US Q1 cut and this week downgrade of Taiwan. Market attention has focused on weaker PMIs across the world and US jobs data. Our April Global Manufacturing PMI edged back to the January level and is thus really unchanged this year. Our Global Services PMI, in contrast, fell 3 points, pushing our All-Industry PMI down 2 points and back to its November level. By themselves, these data are consistent with our 2.2% global growth forecast for Q2. They leave us with balanced risk on global growth, even as the drop eliminates the upside risk bias we had before this month. • Similarly, the weaker US jobs data are signalling a loss of momentum into Q2 and make it more likely that US Q2 will come closer to 2% flat, compared with our 2.5% projection. At the start of the year, we expected average monthly jobs growth at 200,000. The first few months came in well above this, while the shortfall over the past 2 months brings the YTD mean exactly to 200,000. From 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 Lid. May 4, 2012 Jan LoeysAc (1-212) 834-5874 jan.loeys@jornorgansom John Normand (44-20) 7325-5222 [email protected] Nikolaos Panigirtzoglou (44-20) 7777-0386 [email protected] Seamus Mac Gorain (44-20) 7777-2906 [email protected] Matthew Lehmann (44-20) 7777-1830 [email protected] Leo Evans (44-20) 7742-2537 [email protected] YTD returns through May 3 14, equities are in lighter colour. StP500 I MSCI EM Topa I msci AC Wade EMBIG US High Yield EMSCorp. EM FX MSCI Europe' = Gold ~I US HO Grade EM Local Bends— GSCI TR MI US Fixed Income • Global Gov Bends— • Europe Fixed Income' 1 US cash II 0 5 10 15 SOttte J.P Want 8betiben Rei.me H uS0 trod nanny. "Heidei n» USO Eu» Feed Ircane e Itom Oeral frt. US Ha HY. USG and EMS Cap am JPM »<km EM FX t; ELM, MS www.morganmarkets.com EFTA01176677 Global Asset Allocation The J.P. Morgan View J.P. Morgan this point, there seems little to worry about, but we need to monitor activity data over the next month to check for a more meaningfull slide in momentum. With economic drivers of spending. such as borrowing costs, gas prices, prices, lending standards, and profit margins, to name a few, not showing any deterioration and if anything modestly improving, we see no reason yet to get overly negative. • The difficulty we all have on how to react to recent data prints relative to fundamentals and more medium-term trends is known as the signal versus noise issue: Are recent swoons in data and prices just noise around a more reliable trend, or are they the first sign that this trend is reversing? The answer must be that it depends on the strength of the new information relative to the medium-term forces. For that, we rely on our economists to sift through the data and on empirical evidence on what information over what "lookback" has most signal value. On the former, the stability of the 2012 forecasts, and the lack of any clear deterioration of global economic drivers — Europe excepted — induce us to "underreact" to recent activity data. For markets, we have found that 6-month momentum on market returns is a lot more reliable than following the last 1.2 months. On this basis, cash should remain the weakest asset class over coming months, keeping us long risk assets. Euro micro sense, and macro non-sense. Europe remains a risk and irritant to markets. We will not review elections and weaker activity data here. Instead, we like to make the single point that much of the Euro area's problems appear self-inflicted and can be reversed, but only in Europe. In a nutshell, Europe appears to have reacted to its sovereign crisis with actions that make eminent sense at a micro level, but are disasters on a macro level. Demanding that countries should be responsible for their own debt; should not rely on other counties to repay their debt; should cut spending when their debt is too high; and should force their banks to have enough capital makes enormous sense, as that is what we demand from individuals and companies. But such rules have the perverse effect of making conditions worse when applied to all EMU member counties and banks at the same time. They destroy growth, bank lending, and the market for safe government debt all at the same time, in our view. A strategy to exit its crisis needs to focus on growth, recapitalizating the bank (Euro-TARP?), and make government debt into a desirable asset class again. Fixed income • Bonds rallied on the week. German Bunds are still on a tear, hitting all-time yield lows again. We remain flat duration. We do expect yields to increase from these very low levels over the next few months, but weakish economic data and Euro area uncertainties (including this weekend's elections) make us reluctant to position for this at present. • Instead we focus risk on exploiting a range of monetary policy crosscurrents. In the UK, we expect no further easing this year, with persistent inflation having prompted the BoE's typically dovish Posen to withdraw his vote for more QE last month. That deterioration in the supply-demand imbalance argues for some gilt underperformance. We position for this by adding 10- year gilt swap spread narrowers, with spreads at the wide end of their recent range. 2012 global GDP growth forecasts: JPMorgan and Consensus 4.0 3.5 3.0 - 2.5 - 2.0 - JPM Consensus 1.5 Jan-11 Apr•11 Jul-11 0ct•11 Jan•12 Apr-12 Saute. JP. Phrgort Ccmensus Ecorgmes.Camenus Eccomes kaniSrE of Vol AVM. ye Will*. IM -e 00co301 un-° to saw Sles rain USD GCP otitis WI n use lx o.r von gtbal Tooth !awed. 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 Sdni Ramaswanly Globe/ Fixed Income Markets. Pavan Wadhwa and Fabio Bassi Emerging Markets Outlook and Strategy. Joyce Chang Key trades and Ask: Emerging Market Equity Strategy. Adrian Mont et al. Flows and Liquidity. Nikos Panigirtzoglou et al. • We see upside risks to money market rates in both the UK and the US. In the May 4,2012 2 EFTA01176678 Global Asset Allocation The J.P. Morgan View J.P, Morgan UK, very weak growth would seem to rule out hikes in the near term, but we think the money market curve should steepen to incorporate a greater risk of a hiking cycle, say two years ahead. In the US, although the most likely course is for the FOMC to remain on hold through 2014, we think money market rates do not sufficiently reflect the significant tail risk that the unemployment rate falls much faster than expected. sparking an earlier hiking cycle. Equities • What are ow main calls in equities? OW US vs. Euro area equities: as we argued last week, the large divergence between yoy EPS growth for the S&P500 (+8% yoy) vs. DJStoxx (-7% yoy) supports ow OW in US equities. Both the absolute performance of the Q1 reporting season (yoy growth) and the relative performance vs. expectations (EPS surprise) were stronger in US relative to European equities. • OW DAX vs. Eurostorooc50: This trade has performed well in both bullish and bearish environments. Although this position works well as a hedge against Euro risk, the main motivation is German growth outperformance. This theme is still in place as healthier German balance sheets — both private and public — allow the country to escape the painful adjustments that other Euro area countries have to make. German exports are cushioned by their large exposure to EM, even if a Euro area recession materialises. The period that this trade did badly was last August when the short sale ban forced sellers to use the DAX to express a negative view on Euro area equities. • OW in MSCI EMAsia$ vs MSCI EMS:A better Chinese PMI raises confidence that the Chinese economy is in the process of bottoming out. The growth picture in EM Asia x China is also improving (see Daily Economic Briefing, David Hensley, May 2). It is encouraging that EM Asia equities outperformed in April. Admittedly, this is an exposure that may not perform immediately. There is perhaps more upside in the summer as we expect that around July/August, two to three months before leadership change in China, a large FAI spending program will be announced. Credit • Spreads were moving tighter coming into today, with US HG breaking out of the 2bp range it has held in recent weeks, and double-digit tightening seen in higher-beta sectors. But today's disappointing US job data hit risk markets and a lot of last week's gains could be undone. On a positive note, retail fund flows looked stronger this week, with US HY seeing a solid inflow (above $1bn), having dropped off somewhat since February. Strong US HG flows continue unabated, as do EM hard currency flows. • We published our trade recommendations in GMOS this week, with a general theme balancing towards US-based assets. As one of our preferred assets on a medium-term horizon. US HY has been outperforming US HG over the last few months, which is likely a function of three factors. I) Defaults staying low. We keep our 1.5% forecast for 2012, relative to the 4% historical average. 2) The HG index is more exposed to Europe due to a higher weight of European issuers, as well as the more global nature of HG companies. 3) Financials have a much lower weight in the HY space, and they remain at the center of global concerns going forward. See today's CMOS for more details as well as a discussion about recent divergences in credit-related price trends. More details in ... EM Corporate Outlook and Strategy, Warren Mar et al. US Credit Markets Outlook and Strategy. Eric Beinstein et al. H.gh Yield Credit Markets Week/y. Peter Acciavatti et al. European Credit Outlook B Strategy. Steven Dulake et al. Emerging Markets Cross Product Strategy Weekly. Eric Bensten et al. May0,2012 3 EFTA01176679 Global Asset Allocation The J.P. Morgan View J.P, Morgan Foreign Exchange • The EUR/USD looks surprisingly indifferent to this weekend's French and Greek elections. The current level of EUR/USD is consistent with basic models linking the spot rate to US-European rate differentials and sovereign spreads, and the options market shows no extreme bid for euro puts at either the I-week tenor or the 1-month horizon. • This pricing is consistent with a view that pre-election campaign rhetoric may be quite pitched but post-election policymaking will not be so contentious. In France, there is little substantive difference in fiscal policy under Hollande versus Sarkozy, since both endorse a balanced budget — Hollande by 2017, Sarkozy by 2016. And while Hollande says he rejects the fiscal compact, in fact, he has simply argued for a growth pact to accompany it. Germany. Italy and Spain also endorse a growth pact, provided it is geared towards structural reform and public investment (financed through the European Investment Bank) rather than through deficit spending to fund public sector pay rises or pensions (the old, discredited European model). The more material risk to the Europe under Hollande could come if this new President fails to implement structural reform to raise trend growth, since weak growth undermines France's creditworthiness. • Greek elections are more of a wildcard since both mainstream parties— New Democracy and Pasok — poll so low that more extreme elements may enter the new governing coalition. An even more fragmented, feckless government would raise tensions with the troika and runs the risk that Europe suspends the Greek financing program out of frustration with missed fiscal targets. Talk of expelling Greece from EMU would then resurface, even though this avenue is not legally permissible. Commodities • Conunoditiessaw broad-based declines, with oil (down around 6%) leading the way. The weakish tone to activity data, especially in Europe, has weighed on commodities as much as other risky assets. More broadly, oil has been challenged by the combination of strong supply (including from rapid progress in rebuilding Libyan and Iraqi output), and weaker demand due to refinery maintenance. Our expectation of stronger oil demand as the year goes on underlies our outlook for higher prices in H2. • The spread between Brent and WTI crude oil has narrowed significantly over the past month. The Brent-WTI spread can be thought of as a proxy for the cost of moving surplus oil from Cushing, where WTI is priced, to the Gulf Coast. The reversal of the Seaway pipeline later this month will allow oil to flow south out of Cushing, and should narrow the spread from its current level of $15/bbl towards $6/bbl over time, reflecting the lower cost of transporting oil via the pipeline rather than by rail or barge. See last Monday's Oil Market Weekly, Eagles et al.. • Our overall commodity outlook remains neutral, and so favours spread trades in the near term. Today's Commodity Market Outlook and Strategy (Colin Fenton) examines how commodity spreading strategies have performed since 1970, depending on the month, inflation environment and weather. For May. this analysis suggests owning natural gas, crude oil and corn, against sales in gasoline, wheat, and cattle. FX weekly change vs USD 2.0% 1.0% 0.0% -1.0% - -2.0% — -3.0% — USD JPY EUR GBP CHF CAD AUD TWI Save,. J P Yawn More details in ... FX Markets Weekly. John Normand of at Commodity Markets Outlook & Strategy. Cohn Fenton et al. Oil Markets Monthly. Lawrence Eagles et al. Metals Review and Outlook, Michael Jansen Global Metals Quarterty. Michael Jansen May4,2012 4 EFTA01176680 Global Asset Allocation The J.P. Morgan View Interest rates Current Jun.12 Sep-12 Dec-12 Mar-13 J.P, Morgan YTD Return* United States Fed funds rate 0.125 0.125 0.125 0.125 0.125 10-year yields 1.88 2.40 2.50 2.50 2.50 02% Euro area Refi rate 1.00 1.00 1.00 1.00 1.00 10-year yields 1.58 1.50 2.00 2_00 2.00 1.6% United Kingdom Repo rate 0.50 0.50 0.50 0.50 0.50 10-year yields 2.00 2.55 2.55 2.40 2.40 1.1% Japan Overnight call rate 0.05 0.05 0.05 0.05 0.05 10-year yields 0.88 1.15 1.05 1.05 1.15 0.9% GBI-EM hedged in S Yield . Global Diversfied 6.25 6.30 3.0% Credit Markets Current Index YTD Return' US high grade (bp over UST) 197 JP/Aorgan JULI Portia Spread to Treasury 3.7% Euro high grade (bp over Euro gov) 262 iBenor Euro Corporate Index 4.3% USD high yield (bp vs. UST) 622 JP/Amgen Global High Yield Index STW 7.0% Euro high yield (hp over Euro gov) 852 ifilcou Euro HY Index 12.2% EMBIG (bp vs. UST) 344 EMBI Global 7.5% EM Corporates gx) vs. UST) 386 JPM EM Corporates (CEMBI) 7.4% Commodities Current Quarterly Averages 1202 1203 1204 1301 GSCI Index YTD Return* Brent (VDU) 113 112 120 125 125 Energy 7.8% Gold (Slot) 1644 1825 1900 1925 1850 Precious Metals 5.8% Copper (S/metric ton) 8285 8500 8875 9000 8750 Industrial Metals 6.7% Corn {Silk) Foreign Exchange 6.20 Current 6.70 6.50 6.60 Jun-12 Sep-12 Dec-12 Mar-13 Agriculture 0.0% 3m cash YID Return' Index in USD EURIUSD 1.31 1.34 1.36 1.36 1.36 EUR 2.0% USDHPY 79.9 78 80 78 80 JPY 42% GBP/USD 1.62 1.61 1.62 1.62 1.62 GBP 4.9% USD/BRL 1.92 1.90 1.90 1.90 1.90 BRL 0.7% USD/CNY 6.31 6.20 6.20 6.10 6.10 CNY 01% USCHKRW 1132 1120 1100 1090 1090 Km 3.0% USD/TRY 1.76 1.80 1.77 1.75 1.70 TRY 10.4% YTD Return Equities Current (local ccy) US Europe Sector Allocation Y11) YID Japan YTD EM YTD (S) SEP 1372 9.8% Energy 1.1% -2.1% 2.9% 8.8% Nasdaq 2964 13.5% Matenats 8.9% 9.9% 7.4% 7.2% Toplx 793 10.0% Industrials 9.6% 9.3% 8.1% 14.7% FTSE 100 5655 2.9% Discrebonary 17.9% 182% 151% 14.2% MSCI Eurozone 134 3.8% Staples 6.5% 7.1% 12.0% 12.9% hISCI Europe' 1062 5.3% Healthcare 8.6% 4.7% 4.9% 13.8% MSCI EM 5' 1024 12.6% Financials 184% 5.5% 19.2% 12.6% Brazil Bovespa 60831 7.2% Inbrmaton Tech. 18.4% 6.6% 9.0% 22.2% Hang Seng 21086 14.6% Teleccinmunications 8.1% -7.1% -2.5% 11.0% Shanghai SE 2452 10.9% *Levelsfretums as of May 03, 2012 Local currency except MSCI EM S Names -0.3% -2.0% 0.3% 8.7% Overall 9.8% 5.3% 10.0% 12.6% S0VONB100Mterg. UMW. tIES. Slalc1314 8 Pan SOW* .1 P WWI OkrANS May 4, 2012 5 EFTA01176681 Global Asset Allocation The J.P. Morgan View J. P Morgan Global Economic Outlook Summary Real GDP %Crier a yea ay) Real GDP S orec recess mad. saar Consumer prices S Crier a year ago 2011 2012 2013 4Q11 1Q12 2012 3012 4012 1Q13 2Q13 4011 2012 4012 2Q13 The Americas United States 1.7 2.4 22 3.0 2.2 2.5 3.0 2.0 1.5 2.3 3.3 2.1 1.8 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 Latn America 4.3 3.8 4.0 2.4 12 4.6 4 4.4 t 4.1 4.4 3.8 1.2 6.4 6.2 4 6.9 Argentina Brazil Chile 8.9 2.9 6.0 4.5 3.1 5.0 4.0 4.5 4.5 32 1.3 82 0.0 2.6 5.1 5.5 4.5 4 4.9 6.5 5.7t 4.6 5.0 5.7 4.7 3.0 4.5 4.5 4.0 4.5 4.4 9.6 6.7 4.0 10.0 0.01 4.2 10.0 0.01 3.9 11.0 5.3 3.4 Colombia 5.9 5.0 5.0 5.4 4.5 4.9 4.1 3.0 5.7 6.0 3.9 3.6 3.3 3.0 Ecuadcr 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 41 Mexico 3.9 3.8 35 11 1.1 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 12 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 6.0 6.0 4.0 -3.0 0.0 0.0 28.5 23.9 23.4 31.7 AsimPacific Japan -0.7 2.0 13 -01 2.8 2.0 1A 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 1A 2.9 21 1.4 5.1 2.1 3.7 3.0 0.9 3.4 1.8 1.2 2.5 2.1 Asia ex Japan China Haig Kong 7.0 9.2 5.0 6.44 8.2 2.8 7.1 9.1 42 4.6 8.8 1.2 4 _801 6.8 LO 6.7 LB 4.0 7.2 t 9.5 5.5 7.3 10.0 6.0 7.0 9.1 3.0 7.0 81 3.5 4.9 4.6 5.7 3.9 3.3 4.4 4 4.34 3.6 3.5 4 4.81 4.6 3.4 t India 7.0 7.1 7.3 3.8 t31) 5.5 6.3 6.5 6.7 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 3.7 4.0 4.5 4.0 4.0 4.0 4.0 2.6 4 2.9 4 3.5 4 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 3.5 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 0,0 6.6 3.2 2.0 4.5 4.5 5.5 4.6 3.4 2.8 Taiwan 4.0 2.44 5.0t ],04 4.8 6.5 t 5.8t 4.5 4.6 1.4 1.3 1.7 12 Thailand Africa/Middle East 0.1 5.1 3.5 -36.4 45.0 20.0 2.0 0.5 5.0 6.5 4.0 3.7 3.5 3.2 Israel 4.8 2.9 4.4 32 10 3.2 6.1 7.4 4.5 2.8 2.5 2.3 2.5 2.1 South Africa Europe 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 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 03 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 Italy 0.5 -t9 -0.7 -2.6 .25 -2.5 -1.5 -1.0 -0.5 3.7 3.6 4.0 3.6 Norway 2.7 1.4 1.8 25 0.0 0.0 1.0 1.0 2.0 25 0.9 0.9 1.4 11 Sweden 4.0 -0.3 1/ -4.4 &,0 -0.5 0.5 1.0 2.0 2.3 2.3 1.1 1.1 1.5 United Kingdom 0.7 0.1 1.9 -12 -0.8 -1.0 2.5 1.5 2.0 2.0 4.6 3.0 3.0 2.7 Emerging Europe 4.8 2.8 3.4 4 4.6 1.2 1.4 3.0 3.1 3.3 4 3.1 4 6.4 5.0 5.5 6.1 Bulgaria 1.7 1.5 2.5 Czech Republic 1.7 -0.2 0.9 1 -0.5 AB -1.0 1.0 4 2.2 4 1.1 1 -I.7 4 2.4 2.7 2.9 2.5 Hungary 1.7 0.5 13 12 A1.0 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 a 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 Turkey 8.5 2.5 43 9.2 9.0 6.8 8.8 Global 2.6 2.2 1 2.6 1.5 2.4 2.2 2.7 t 2.5 2.4 1 2.6 3.6 2.7 2.7 2.7 Devebped markets 1.3 1.2 13 0.6 t2 1.0 1.5 1.3 1.3 15 2.8 2.0 1.8 1.6 Emerging markets 5.8 5.0 5.6 4.0 U 4 5.2 4 5.7 5.8 5.7 5.5 5.7 4/ 4 5.0 4 5.6 Scutt: LP kbrign May 4,2012 6 EFTA01176682 Global Asset Allocation The J.P. 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