J.P. Morgan

J.P. Morgan The J.P. Morgan View Still too many banana peels Global Asset Allocation J.P.Morgan Chase Bank NA, J.P. Morgan Securities Ltd. Sep 30, 2011 • Economics — Further cuts to growth forecasts, this time in Japan and EM Jan LoeysAc Europe. US Q3 is tracking a 1.5% pace. We retain the view that Europe is sliding into recession. John Normand • Portfolio strategy — Riskier markets are trying to rebound as many active managers are short. We find it too early to go long risk, as there remain too many banana peels in front of us, on which risk assets can slip. Nikolaos Panigirtzoglou • Fixed Income — Falling growth projections remain bullish for bonds. • Equities — 2012 Eurostoxx50 dividends provide an attractive return to risk Seamus Mac Gorain • Credit — EU recession forecasts justify staying defensive. • Foreign exchange— Be long WY vs EUR and GBP. On the USD, we prefer to buy it against NOK. Matthew Lehmann • Commodities — We close our outright longs in copper, corn and wheat but we remain long gold and a basket of EM driven against a basket of US driven commodities. • Risk markets rallied early this week, and bond yields rebounded strongly, as some of the feared event risks in Europe did not materialise. But they then lost ground again later in the week as investors have no confidence that underlying conditions in the world have improved. YTD returns through Sep 29 %. equities are in liclher colour. Gold • We retain a defensive posture, underweighting risky assets, as (( ) the Euro area is far from creating the fiscal solidarity and discipline needed to resolve US Fixed Income US High Grade its sovereign funding crisis — even as it is now at least talking about these more openly— and likely requires a renewed crisis before its takes these Global Gov Bonds- actions; (2) whatever the outcome of the EMU debt crisis, Western Europe is likely now already sliding into recession; (3) the US is probably not in reces- EMBIG EM Local Bonds- sion yet, but Congress seems too divided to prevent the main risk of recession coming from the massive fiscal tightening, that is on the books for 2012; and Europe Fixed Income' US cash (4) Japan and Asia are now also weakening and will thus not be able to turn around the US and European economies. US High Yield EMS Corp. • Investors are heavily undenveight European assets as they see a significant risk that EMU members are unable to combine resources to battle their self- inflicted debt crisis. The required degree of fiscal integration implies surrender- ing much of their cherished national sovereignty and will not be taken in a EM FX SW500 l= GSCI TR single yea-or-nay vote. It can only come about through a long set of decisions and actions over the coming year by all the EMU member states. Each such decision constitutes a banana peel on which Europe could slip in its journey for a full resolution to the euro crisis. The best that can be said about the last MSCI AC Wald' Topic I= MSCI Eutcper II MSCI EM few days is that nobody slipped on this week's bag of bananas. But there . • remains quite a few in front of us. .20 45 40 4 0 5 10 15 Some: AP. Mown ISbcelscrg. Rekrns I' USD. Ural earercy. - 14:4;ed rip USD rum Rad Income is beta Owal • Over the next few weeks, we expect few major actions, although still half a dozen EU countries have to ratify the EFSF enlargement. The decision on the next Greek package has been pushed out to later in October to give Greece The certifying analyst is indicated by an AC. See page 7 for analyst certification and important legal and regulatory disclosures. lades. US HG. NY. DABIG EM scrap ate JP1i ittes. Be RH Elias & www.morganmarkets.com EFTA01169186 Global Asset Allocation The J.P. Morgan View J.P. Morgan more time to meet the fiscal criteria. And the muted leveraging up of the EFSF can only be openly discussed once all EU countries have ratified the EFSF enlargement. Funding conditions in the Euro area improved this week with two uncovered bond issues by banks, which will likely be followed by more, especially as we expect the ECB to buy bank covered bonds again (see this week's Flows & • Near-term funding conditions might improve in the euro area, but a true rebound requires both a TARP-like recapitalization of European banks and a massive increase in EFSF firepower beyond the €440bn now voted on by EU parliaments. It is good to see that both of these options are now more openly discussed in Europe, but it is our sense that the Euro Area truly needs a knife on its throat before it takes the needed decisions. A near-term fading of the crisis is thus more likely to lead to further procrastination by EU decision makers. Even with some form of a resolution to the euro crisis, it will likely involve further fiscal tightening and is thus unlikely prevent the recession that our economists believe is just about to start in the Euro area. We thus retain that view that conditions have to become worse before they get better, and hold on to EU asset underweights. • US economic data on the margin improved slightly this week, but the overall set tracks a Q3 GDP growth pace of only 1.5%. This is better than our forecast of 1.0%, but below consensus of 1.9%. More importantly, the major threat to the US economy —from next year's unwinding of fiscal stimulus measures — remains on the horizon. It is only reversed if Congress and the Administration agree on a combination of near-term stimulus extension and longer-term fiscal tightening. We see little sign of impending compromise and thus remain pessimistic here. • Until recently, there was hope that continued growth in EM and the V-shaped rebound in Japan would soften the blow from fiscal tightening in Europe and the US. Recently data make us a lot less optimistic. Weaker IP, PMIs, and consumption forced us to take 0.3% and 0.6%, respectively, out of this and next year's growth in Japan. Our EM growth projections for 2012 have been cut by 0.9% to 5.1% over recent months, this week through downgrades of growth in EM Europe. Fixed income • Yields on government debt are up this week, in line with the modest rebound in the prices of riskier asset classes. Our defensive posture on riskier asset classes implies a near -term bullish bias on bonds. But we are not ecstatic about them, as risk is not balanced in their favour. If the US and Europe fall into recession, then Bunds and USTs will rally further, quite likely by another 30-ish basis points. But if such a recession is avoided and the Euro area puts together a convincing plan to tackle its debt crisis, then both these bond yield curves can easily rise by 100bp. Hence, we feel better outright shorting equities than being long duration in bonds. • EMU government bonds spreads have come in nicely this week on tons of rumours of plans to leverage the EFSF and recapitalise the banks. These plans are all smoke and no fire yet, and we thus stay defensive on the EMU periph- ery. 2012 JPMorgan global GDP growth forecast vs. Global equities Ja -11 May-11 Jul.11 Seal' Sarte JP. ktrga-, Gratnsus Ecrorrtm. Corcxvs Eco-crrtm. Iciensis re Ir tegcns rd ocunres t a1 A awngto Lnng the :tele S got rain? USD GOP wells thr.vte se b cut can gtt.al growth tee= 2011 global GDP growth f orecasts:JPMorg an and Consensus 4.0 3.8 3.6 3.4 3.2 3.0 2.8 2.6 2.4 Joni° May-10 Sep-10 Jan-11 May-II Sep-11 Sturcc JP. Abizrk Camases Eccrorries. Cerewnsus Emmert; faecal, :we lea regent and =rows Pal we averaged Long the same Stew rang USD GDP weirs dial we use to cur own Vaal growth beast. More details in ... Global Data Watch. Bruce Kasman and David Hensley Global Markets Outlook and Strategy. Jan !says. Bruce Kasman. el al. US Fixed Income Markets. Terry Belton and Srini Ramaswamy Global Fixed Income Markets, Pavan Wadbwa and Fabio Bassi Emerging Markets Outlook and Strategy. Joyce Chang Key trades and risk: Emerging Market Equity Strategy. Adrian Mcwal et al. Rows and Liquidly. Nikos Paniginzoglou el al. Sep 30,2011 2 EFTA01169187 Global Asset Allocation The J.P. Morgan View J.P, Morgan Equities • Equities rebounded this week but they remain in the middle of the narrow range held since the beginning of August. On the two fronts that continue to trouble investors — policy action in Europe and the prospect of a recession — the signals we received this week continued to be rather mixed. • While the rise in our EASI — US Economic Activity Surprise Index — into positive territory suggests that US economic data have stopped surprising on the downside, economic data outside the US keep disappointing. In terms of policy action, on the positive side, the ECB is expected to cut its policy rate next week, including the re-introduction of 1-year repos and the resumption of its covered bond program. But impending policy actions regarding Greece, bank recapitalizations and leveraging the EFSF are clouded by uncertainty. • We keep a defensive stance favouring large-cap defensive stocks in the US. We remain cautious in Europe. Our model for allocating between the US and Euro area equities continua to suggest holding a long in S&P500 vs. MSCI EMU currency hedged (Panigirtzoglou et al., Trading the US vs Eumpe, June 24). In Europe, we believe that buying dividend futures —2012 Eurostoxx50 dividends — provides an attractive return to risk . The prospect of a reces- sion in the Euro area does not meaningfully shift our positive stance on 2012 dividends, since they are paid out of 2011 earnings which are nearly 3/4 accrued. See Peng Cheng, European Equity Derivatives Strategy, Sep 28. • We remain ovenveight DAX vs. Eurostoxx50. The main motivation is German growth outperformance vs. the rest of the Euro area. 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. Within EM, we continue to underweight BRICs and focus our exposure on ASEAN coun- tries. Investors remain sceptical about BRICs and are concerned about overheating and corporate governance. Credit • A calmer week in credit markets than some of late. US bond and CDS spreads continued their upward bleed, ending slightly wider on the week. Volatility remains elevated, however, with the VIX sitting a mere 1.5 points of the YTD high of 43 it registered last month. • European credit tightened a little, although JPM economists revised their forecasts to reflect a mild European recession starting this quarter. Some positive steps have been made on the EU policy front, however, with Germa- ny's approval of an expansion of the EFSF yesterday. • In Emerging Markets, last week's 70bp gapping of the CEMBI Broad was its worst performance since September 2008. Poor liquidity and weak sponsorship are seen as the biggest challenges in this market. Our strategists believe that redemption risk has increased and that investors are building cash balances to maintain liquidity (see Warren Mar et al., Emerging Markets Corporate Strategy, Sep 28). We remain wholly defensive EM corporate credit. Foreign Exchange • Next week the ECB will almost certainly cut the refi rate (50bp baseline) and the Bank of England could restart asset purchases (£50bn initially), and at least More details in ... EM Corporate Outlook and Strategy, Warren Mar et al. US Credit Markets Outlook and Strategy. Eric 8einstein el al. High Yield Credit Markets Weekly. Peter Acciavalli el al. European Credit Outlook & Strategy, Steven Dulake el al. Sep 30,2011 3 EFTA01169188 Global Asset Allocation The J.P. Morgan View J.P. Morgan two other central banks should relaunch easing cycles by month-end — Norway on Oct 19, and Sweden on Oct 27. There are abundant precedents for why this outcome could extend the dollar's summer rally into the fall, but also a good technical argument for thinking these moves will be smaller than usual. The USD-bullish case reflects the well-established tendency of currencies to respond to narrowing rate spreads, even when the country cutting will remain the higher yielder indefinitely. Even the global high-yielder Brazil succumbed to this phenomenon since rate cuts surprised an investor base which was still long the currency. • But after a summer of deleveraging, the technical backdrop for G-I0 currencies is the opposite of the emerging markets easers entering this growth slump and easing cycle. Currency funds and CTAs are not just long of dollars; they hold their largest USD longs Many recession's starting point, such as late 2000 and 2007. What applies for the whole applies to the parts. Euro shorts are close to record large in absolute terms, and twice as large as they were entering the 2008 easing cycle. Sterling positions were long entering the 2001 and 2007 easing cycles and are now, as in euro, approaching record shorts. • This unusual skew limits currency declines in October more than it can prevent them, since there are still huge uncertainties about how large and lengthy these easing cycles will be. Hence the decision to re-enter short EUR/ WY and GBP/JPY this week after taking profits mid-month. Execute through options to limit short-term market-to-market on Bank of Japan intervention, and to position for only modest declines in the crosses. We are also long USD/NOK to position for contagion from the EM local bond and stock unwind. Commodities • Commodities are slightly down this week having stabilised somewhat following last week's sharp correction. Our economists have now sharply revised down their Japanese 2012 growth forecast, which in addition to last week's forecast of a recession in the Euro area means that DM demand is unlikely to improve anytime soon. Our commodity strategist, Colin Fenton, was stopped out of his outright long copper, corn and wheat positions but he retains a long position in gold as well as a relative value position, which is long commodities where supply is tight and marginal demand comes from EM and short commodities ►inked to US consumption. For long term investors we recommend opening an outright long in the Dec 13 copper future which we believe to be priced too low given our expectation of a supply/demand deficit in 2012 (see Trade opportunities for long•tenn investors, Sep 27). • At the time of writing, Brent prices are at their lowest since February and since last week, the discount between spot and the first futures contract has almost halved. The coming Euro area recession raises notable downside risks to demand from Europe but at the same time, demand in Asia continues to be strong. This is evident from the spread between Brent and Dubai crudes. which is at its lowest since the beginning of the year, as strong Asian demand pushes up Dubai prices relative to Brent. We remain of the view that this demand from Asia coupled with ongoing supply issues in the North Sea and OPEC production cuts will support global oil prices, but risks are now biased to the downside. FX weekly change vs USD 4% - 2% - 0.6 4% - •6% - •8% - USD EUR GBP ,WY CHF CAD AUD 1YA sauce:■ u•lln More details in ... FX Markets Weekly. John Normand et al. Commodity Markets Outlook & Strategy. Colin Fenton et al. Oil Markets MontMy. Lawrence Eagles et al. Metals Review and Outlook Michael Jansen Global Metals Ouatteny. Michael Jansen Sep 30, 2011 4 EFTA01169189 Global Asset Allocation The J.P. Morgan View J.P. Morgan Interest rates Current Sep-11 Dec-11 Mar-12 Jun-12 YID Return' Urged States Fed funds rate 0.125 0.125 0.125 0.125 0.125 IC-year yields 1.91 2.05 2.60 2.80 3.00 8.7% Euro area Refi rale 1.50 1.00 1.00 1.00 1.00 10-year yields 1.89 2.10 2.05 2.00 2.00 7.1% United Kingdom Repo rale 0.50 0.50 0.50 0.50 0.50 10-year yields 2.43 2 45 2.55 2.55 2.55 9.7% Japan Overnight cal rate 0.10 0.05 0.05 0.05 0.05 10-year yields 1.02 0.90 0.95 1.05 1.10 1.9% GBI-EM hedged in $ Yield • Global Diversified 6.65 6.90 3.4% Credit Markets Current Index YTD Return' US high grade (bp over UST) 242 JPMorgan US Index (JULI) i-spread 5.8% Euro high grade (bp over Euro ow) 318 Boor Euro Corporate Index 2.9% USD high yield (bp vs. UST) 812 JPMorgan Global High Yield Index 0.1% Euro high yield (bp over Euro gov) 935 Bon Euro HY Index -6.4% EMBIG (bp vs. UST) 462 EMBI Global 3.4% EM Corporates (bp vs. UST) 513 JPM EM Corporales (CEMBQ -1.4% Commodities Current Quarterly Averages 1103 1104 1201 1202 GSCI Index YID Return' Brent ($/bbll 102.4 110.0 115.0 115.0 110.0 Energy .5.2% Gold (Sitz) 1624 1650 1800 1800 1750 Precious Metals 13.3% Copper (S/metric ton) 7210 9750 10000 10250 9500 Industrial Metals Com (lBu) Foreign Exchange 5.93 Current 7.20 6.90 7.10 Sep-I1 Dec-11 Mar-12 7.40 Jun-12 Agriculture -12.2% 3m cash YTD Return Index In USD EURUSD 1.34 1.38 1.38 1.40 1.42 EUR 2.9% USCVJPY 77.1 75 74 73 72 JPY 5.8% GBPAISD 1.56 1.59 1.58 1.58 1.60 GBP 1.0% USDBRL 1.88 1.70 1.70 1.70 1.70 BRL -4.7% USD/CNY 6.38 6.30 6.20 6.10 6.00 CNY 1.6% USDKRW 1178 1070 1050 1020 1010 KRW -1.7% USD/TRY 1.86 1.65 1.65 1.65 1.65 TRY -13.0% no Return Equities Current (local eey) US Sector Allocation ' YTD Europe YTD Japan YTD EM YTD ($) S&P 1141 -7.9% Energy .8.9% -10.6% 43% 41.2% Nasdaq 2437 7.6% Materials At% -27A% -16.6% -25.7% Top& 761 -13.4% Industrials -11.8% •20.7% -13.2% -30.0% FTSE 100 5128 -10.6% Discretionary .3.0% .152% -18.1% .9.3% MSCI &ozone' 125 -18.8% Staples 4.6% .2.6% 4.9% 4.8% MSCI ELrope' 960 -15.2% Healthcare 3.8% 2.6% .2.3% 492% MSCI EM 894 .20.4% Financials -22.4% -22.6% .20.7% -25.0% Brazil Bovespa 52017 -24.9% Information Tech. 41% .11.2% -25.9% .20.4% Hang Sang 17592 -21.4% Telecommunications AA% 4.6% -4.2% .5.1% Shanghai SE 2359 -16.0% 'Levelstreturns as of Sep 29.2011 Local currency except MSCI EM $ Utilities 12.0% .10.3% -43.3% 49.6% Overall •72% 452% -134% -204% Sarre: Bkorrber; Dalasteara SE& Standard a Pooh Sankt& J.P Masan 15111911.1 Sep 30,2011 EFTA01169190 Global Asset Allocation The J.P. Morgan View J. P Morgan Global Economic Outlook Summary Real GDP %oar vital' ago Real GDP %over previous period. saa, Consumer prices %ever avearacp 2010 2011 2012 1Q11 2011 3011 4011 1Q12 2Q12 3012 4010 2011 4Q11 2012 The Americas United States 3.0 1.6? 131 0.4 131 Lit 1.0 0.5 1.5 2S 12 33 32 1.4 Canada 3.2 2.2 2.2 3.6 -0.4 1.8 2.4 2.6 2.6 2.4 2.3 3.4 2.6 1.6 Latin America 6.0 4.3 3.5 5.6 4.1 3.4 3.1 2S 4 4.24 4.4 6.7 6.7 7.2 72 Argentina 9.2 7.0 4.8 13.1 10.2 g 3.0 4.0 6.0 4.0 11.0 9.7 11.0 13.0 Brazil 7.5 3.4 3.8 5.0 3.1 21 3.9 43 4.1 3S 5.6 6.6 6.7 5.3 Chile 5.2 6.5 4.5 6.4 5.7 g 2.5 5.0 4.5 4.3 2.5 3.3 4.0 3.6 Colombia 4.3 5.3 3.74 2.9 8.5 3,5 1.5 3.0 4 4.0 4 5.04 2.7 3.0 3.5 3.1 Ecuador 3.6 6.0 3.0 7.3 3.0 2.0 1.0 2.0 3.5 4.0 3.4 4.1 3.9 3.6 Mexico 5.4 4.0 2.5 2.4 45 2 2.6 -1.5 3.7 49 4.2 3.3 3.4 3.6 Peru 8.8 6.3 4.5 4 6.9 4.5 a 3.0 7.0 5.3 5.3 2.1 3.1 3.6 3.0 Venezuela -1.5 3.5 3.0 14.7 -3.2 ji 3.0 3.0 5.0 6.5 27.3 24.6 29.0 33.6 AstalPacilic Japan 4.0 -0.64 1.94 -17 -2.1 314 2.04 1.84 1S4 134 -03 -0.4 -0.2 -0.7 Australia 2.7 1.4 3.5 -3.4 4.8 2.1 2.2 4.1 3.4 4.8 2.7 3.6 3.8 3.2 New ZeaLard 1.7 2.0 3.8 3.5 0.4 a 4.1 3.9 3.9 5.6 4.0 5.3 3.2 2.4 Asia ex Japan 9.1 7.2 7.0 8.9 53 5.91 6.81 72 7.41 7.54 4.9 5.7 4.9 4.5 China 103 8.9 8.5 8.9 7.0 7.5 85 8.7 89 9.0 4.7 5.7 4.6 43 Hong Kong 7.0 5.2 4.0 13.0 -2.0 3.5 5.5 5.6 4.5 2.7 5.2 5.1 4.3 Ind a 8.5 7.6 8.5 8.3 7.6 7.5 7.1 8.6 9.0 9S 9.2 9.1 8.7 7.8 Indonesia 6.1 6.4 6.2 6.8 5.4 g 6.2 62 62 62 6.3 5.9 4.5 5.6 Korea 6.2 3.94 4.04 5.4 3.6 1§4 4.211 4.0 4A4 4.04 3.6 4.2 3.7 3.1 Malaysia 7.2 4.2 3.3 5.5 3.2 1.0 3.2 3.6 3.6 3.6 2.0 3.3 2.8 2.4 Philippines 7.6 4.3 4.8 7.8 2.4 41 5.3 4.9 4.9 53 3.5 5.0 4.6 3.3 Singapore 14.5 5.1 3.8 27.2 -6.5 DI 3.2 4.5 6.1 7.0 4.0 4.7 5.6? 4.01 ... Taiwan 10.9 5.0 3.8 14.6 0,9 Li 3.8 42 4.7 4.8 1.1 1.6 22 2.0 Thailand 7.8 3.1 3.3 8.1 -0.8 a 3.5 4.0 3.8 3.8 2.9 4.1 3.7 3.6 Africalliddle East Israel 4.8 4.3 2.9 4.7 3.5 2.4 1.2 0.8 32 6.1 2.5 4.1 2.8 2.3 South Africa 2.8 3.1 2.54 4.5 1.3 LQ 394 2.3 2.6 284 3S 4.6 5.8 5.1 Europe Euro area 1.7 1.6 -0.5 3.1 0.6 Q5 -0.5 -1.0 -1.5 0.0 2.0 2.8 28? 1.7 Germany 3.6 2.8 0.2 55 05 15 -OS 0.0 -OS 05 1.6 2.5 2S? 1.51 France 1.4 1.6 -0.1 3.71 0.0 jj 0.0 -0.5 -1.0 OS 1.9 2.2 2.41 1.4 Italy 1.2 0.5 -1.2 0.5 1.2 -1.0 -1.5 -1.5 -2.5 -0.5 2.0 2.9 3S? 25 Homy 2.1 2.2 0.7 1.9 4.1 I.5 OS 0.0 0.0 1.0 2.2 1A 1.3 12 Sweden 5.4 4.1 0.4 3.1 3.6 2,0 0.0 -OS -0.5 0.5 1.9 2.9 2.6 1.3 United Kingdom 1.4 1.0 0.8 1.9 0.7 1.5 1.0 0.5 -1.0 2S 3.4 4.4 4.9 2.8 Emerging Europe 4.5 3.8 2.5 4 3.6 1.2 _201 1.3 4 3.1 4 3.0 4 3.8 6.6 7.1 6.0 5.2 Bulgaria 0.2 2.8 2.44 Czech Republic 2.3 2.0 1.0 4 3.5 0.3 Q.51 -0.38 0.3 4 1.3 4 2.51 2.1 1.8 1.8 4 2.5 4 Hungary 1.2 1.41 0.94 12 -0.2 Q31 0.0 4 0.0 4 1.0 4 1.5 4 4.4 4.0 3.8 421 Poland 3.8 3.8 2.74 4.5 4.5 2_51 2.04 2.04 254 3.0 2.9 4.6 3.94 2.5 Romania -13 1.2 0.84 ... 7.9 8.2 4.0 3.5 Russia 4.0 3.4 3.0 4 3.7 0.4 a t 1.0 4 4.0 4 3.5 4 4.5 8.2 9.6 7.4 6.5 Turkey 9.0 6.3 2.7 7.4 5.9 6.7 6.0 Global 3.9 2.5 2.0 4 2.6 1_61 2.5 1.8 4 1.61 1.8 4 2.7 4 2.7 3.7 3.5 2.4 Developed markets 2.6 1.3 0.84 0.9 0.7 t 1.7 0.74 0.31 0.4 1.54 13 2.7 2.7 1.41 Emerging markets 7.3 5.7 5.1 4 7.1 4.3 4.5 4.9 4 52 4 5.8 4 6.0 4 5.6 6.2 5.7 5.3 Smote JP. 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