DS9 Document EFTA01149274

• 1 • • J.P Morgan he J.P. Morgan View The endgame on EMU is approaching • Economics — Lower Japan growth drives global growth projections down to 2.5% for this year and next. EMU endgame is approaching as conditions are now so bad that core Europe is making proposals to tighten fiscal integration. • Portfolio strategy — Stay defensive and underweight equities. • Fixed Income — We go long duration in the Euro area, on peripheral turmoil and a more dovish ECB. • Equities — Mixed economic data and continued negative EMU headlines warrant a defensive stance. • Credit — We remain defensive and UW European vs. US credit. We move from underweight to marketweight in select Euro area senior bank debt. • Foreign exchange — Focus EUR shorts on JPY. • Commodities — In an environment of falling demand, we expect OPEC to cut production to maintain prices close to current levels. • Riskier asset classes — equities, commodities and credit — are weaker again this week. Bonds are up on the week, in particular in Europe on a worsening of North South tensions in the Euro area, and speculation of monetary easing. • We are tactically defensive, underweighting riskier assets on negative momen- tum in prices and economic growth expectations, and a lack of convincing policy options in the major economies. But any strategy must always be on the lookout for signs that conditions are reversing. As discussed here before, conditions for reversal must be based on better data, policies, value and positions: Economic data need to stop surprising on the downside; policies need to be put in place to reverse economic downside; the worst should be in the price: and investors should be short risky assets. These conditions are not yet in place — hence our defensiveness — but we need to keep monitoring than. • First, global activity data remain weaker than most are hoping to see, but their second derivative, the pace of weakening, is itself coming down. For most countries, data are in line with out much lowered projections. The exception is Japan, where we were forced to cut both H2 and next year. Much attention is on how the collapse in confidence and equities in August are affecting demand. The good news is that while demand has weakened, it is not breaking in a manner one would expect if global recession had started. Chinese and US sales are holding up, but the tech sector is weakening seriously, as evidenced by Taiwan exports and Japanese foreign orders. • Second, the sudden rise in recession risks are pulling policy makers into action. The question is: What can they do? EM policy makers have plenty of ammunition left, but inflation is not coming down fast enough yet to induce broadbased easing. In most cases, EM central banks have stopped tightening. We retain selective longs at the short end of their bond curves. Global Asset Allocation J.P.AAorgan Chase Bank NA, J.P. Morgan Securities Ltd. Sep 9, 2011 Jan Loeys' John Normand Nikolaos Panigirtzoglou Seamus Mac Gorain Matthew Lehmann YTD returns through Sep 8 %. equities are in lights, color. Gold =IMF= EMBIG US High Grade US Reid Vcome EM Local Bonds K — Global Gov Bonds— EM Corp. K US High Yield K GSCI TR K EN FX 0 Europe Fixed Income' US cash S&P500 K MSCA AC World' I MSCI EV' MSCI Europe. Topa' 0 20 95 S a n t e : yoga. Ellocelmg. Rekrns n USD. local tummy. - 11c4;ed inio USD. Eum Red Income is tea Ong al bre. US HG. HY. EMENG ad EM $ Cap en At ii at EM ELLIamS. The certifying analyst is indicated by an AC. See page 7 for analyst certification and important legal and regulatory disclosures. EFTA01149274 Global Asset Allocation The J.P. Morgan View J.P, Morgan • The US economy is teetering on the edge of recession. This will likely push the Fed into an Operation Twist to raise the duration of its SOMA portfolio later this month. We are not optimistic on its impact, gauging it at only 1Obp (see Terry Belton et al, Demystifying Operation Twist, Sep 9). President Obama proposed yesterday a larger than expected plan to lower taxes and raise spending. If fully implemented, it would add 2% to 2012 US growth, offsetting and postponing the 1.75% negative fiscal drag currently in our forecast. Given the polarization in Congress, it is highly unlikely that all of his proposals will become law, although some elements will likely pass. Our current US growth forecasts, which are at the bottom of the consensus, have as a base case that none of the proposals are adopted, and will be adjusted once we know more. • In Europe, the endgame on EMU is approaching fast. As discussed before, the survival of the common currency requires a common fiscal policy. Member states have been fighting this dramatic loss of fiscal sovereignty, and will surrender only if the alternative of a much more damaging EMU breakup is imminent. We have argued that conditions need to become a lot worse before EMU countries move to the needed joint management of funding and deficits. • And that is what we got this week. Conditions worsened badly (see below). Sarkozy and Merkel made clear weeks ago that a Eurobond is not feasible without more strict control of budgets than is possible today. On Monday, the Dutch PM and Minister of Finance proposed installing a fiscal Czar with the power to make countries exit EMU if they do break its budget rules. And yesterday, German Chancellor Merkel proposed in parliament a new EU Treaty to permit a common economic policy, deeper integration and more dependabil- ity. The pieces for the salvage of EMU are starting to fall into place, but a lot of progress needs to be made, with huge execution risks. Fixed income • The turmoil in the Euro area continues to escalate, pushing core European bonds higher, with German Bunds again hitting new yield lows. The triggers this week: prevarication by Italy and Greece, before each delivered substantial austerity proposals, uncertainty over the degree of private sector support for the Greek debt exchange, and the resignation today of the ECB Governing Council's German Chief Economist, Juergen Stark. • We remain defensive on the periphery. Today's resignation will renew ques- tions over divisions within the ECB on its bond buying program. Spain and Italy come to the market next week with issuance. And further ahead, the EFSF's €44Obn total capacity will be sorely tested to match the ECB's pace of bond purchases (€56bn in the first four weeks). Spain is our preferred UW. • The ECB changed tack by more than expected this week in response to the economic slowdown, declaring that inflation risks are now balanced (instead of to the upside). The likelihood of a near-term ease has increased substan- tially. That, and the peripheral turbulence, prompt us to go long duration in the Euro area, even at these very low yields. • We stay long duration in EM, (favour Indonesia, Malaysia, Thailand and Poland), but arc flat elsewhere in DM, including US Treasuries. The Treasury market remains focused on the additional stimulus expected from the FOMC meeting in two weeks. We estimate though that a moderate-sized active 2012 JPMorgan global GDP growth forecast vs. Global equities 3.8 IASC1 AC World 360 —PP 3.6 350 3.4 340 32 330 3.0 320 2.8 310 2.6 300 2.4 2012 JPM global GDP growth forecast 4-- Jan4 1 Mar-11 Matl Scume. JP. Min:A Gramm Ecceorria Consensus Eccearim fecemsls ae let regims and =Muss Pal .e ?seemed usng the same Siam ming USD GDP %yips thane Lae lx COI 0•11 Octal groat!, bean. 2011 global GDP growth forecasts: JPMorgan and Consensus 4.0 3.8 3.6 3.4 32 3.0 2.8 2.6 2.4 Jan-10 May-10 Sep-10 Jan-11 May-11 Seel' Scums ktfg:n Gramm Eccentrics Consensus Eccearim twecasts se ler regims and =Muss Pal .e weraged tang the same Si.. ming USD GDP %yip's Nose use lx COI eon Octal growth brat More details in ... Global Data Watch, Bruce Kasman and David Hensley Global Markets Outlook and Strategy. Jan boys. Bruce Kasman. el 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 Mowal et al. Flows and Liguickiy. Nikos Paniginzoglou el al. Sep 8, 2011 2 EFTA01149275 Global Asset Allocation The J.P. Morgan View J.P, Morgan Operation Twist program would reduce 10yr yields by only 10bp. See Terry Belton et al., Demystifying Operation Twist, Sep 9. US EASI US Economic Activity Surprise Index 40 Equities 30 • Mixed economic data and continued negative headlines from Europe's cover- 20 eign crisis warrants a defensive stance. Our US Economic Activity Surprise 10 Index remains in negative territory, as it has been for five straight months 0 (chart). We need to see this index moving to positive territory, and US data to .10 start surprising on the upside, for equities to sustain a recovery. .20 • Rule-based trading strategies tend to perform better in highly uncertain environments. These strategies point to the following recommendations: 1. A US equity sector trading model based on a combination of sector short interest, a contrarian indicator, and 11-month return momentum, suggests being long in US Energy and Materials vs. Financials and Staples (Flows & Liquidity, Apr 15). 2. Our Cyclical vs. Defensive global sector trading signal based on the monthly change in the global PMI currently recommends an UW in Cyclicals (Trading Cyclical vs Defensive sectors, Aug 2009). The global PMI has been declining for six straight months weighing on Cyclical sectors. 3. Our EM vs. DM equity signals based on relative IP growth and 2-month return momentum is currently neutral in EM (The EM vs Developed Markets equity allocation, Apr 2009). Relative IP growth favours EM but 2-month return momentum favours DM. 4. Our model for allocating between the US and Euro area equities currently suggests a long in S&P500 vs. MSCI EMU currency hedged (Panigirtzoglou et al., Trading the US vs Europe, June 24). Of the three signals, the perform- ance of global equities over the past 3 months and the change in the US-Euro PMI difference point to an UW of Euro area equities. They dominate the third signal, the change in the EURUSD over the past three months, which favours Euro area equities. Credit • Once again spreads were wider across the board this week. Europe continues to underperform the US and the gap between the CDX.IG and iTraxx Main, historically 10bp, reached an all-time wide of 58bp on Tuesday, or 36bp after adjusting for banking sector composition differences. As the Euro area will likely remain under stress near term, we buy protection in the iTraxx main vs. • However, our European strategists upgraded their recommendation on European bank senior debt to neutral this week. Whilst increasingly priced into spreads, they believe that issuance risks have been dampened by funding diversification via covered bonds, ECB support and balance sheet deleveraging (see Roberto Henriques et al, Reassessing Senior Unsecured Risk, Sep 8). They hold a preference for Irish and Portuguese senior debt • Our recent Credit Investor Survey shows little consensus as to where US HG spreads are headed; 33% expect tightening and 39% expect widening. Asset managers are bearish and hedge funds are bullish (see Eric Beinstein et al., 30 .40 Jan4)9 Jul.09 Jan-10 Jula Jan.11 Jull saute: ■ Maw US HG spreads during recessions JP Morgan JULI index spread over USTs (Barclays US Aggregate is used before 0112000). BP 600 500 400 300 200 100 0 73 79 85 92 98 04 11 Seen:. Mogan. Cwastnam COX IG vs. iTraxx Main Monthly spread levels since Jan 2007. Bp 250 200 150 100 50 0 Scow Boonbag More details in . EM Corporate Outlook and Strategy, Warren Mar et al. US Credit Markets Outlook and Strategy. Eric Beinstein el al. High Yield Credit Markets Weekly. Peter Acciavalli et al. European Credit Outlook & Strategy, Steven Dulake et al. Sep 9, 2011 3 EFTA01149276 Global Asset Allocation The J.P. Morgan View Credit Market Outlook & Strategy, Sep 9). However, their cash positions are J.P. Morgan FX weekly change vs USD building and they are trading up in credit quality. We tactically remain UW US 4% HG bonds although attractive valuations and growing cash positions may facilitate a rally medium-term. 0% .4% ■ • EMBIG spreads widened Ilbp to 380bp and CEMBI spreads widened 6bp to 425bp. We maintain that EM will outperform DM given strong economic fundamentals and policy room-to-manoeuvre. However, in keeping with our more bearish stance on credit and because EM is behaving akin to a high-beta sector, we overweight EM sovereigns vs. EM corporates. •8% Foreign Exchange •12% • The dollar is re-recoupling with stock markets and volatility, and thus threaten- ing to break the five-month ranges which DXY and trade-weighted indices have observed. HIA 2.0 remains a wildcard which could drive the dollar broadly higher, but this risk looks exaggerated. EUR/USD is clearly at risk from an ECB ease, conflict over the SMP following Stark's resignation and the usual sovereign stresses. But Obama's fiscal ease and possible QE 3 are important offsets. Outside EUR/USD, ranges on other currencies look intact. • SNB stole the spotlight by setting a floor for EUR/CHF which could affect other major currencies through the re-channelling of fiscal hedging. But why this might partly explain the accelerated break-down in EUR/USD, it doesn't make safe-havens of inherently cyclical currencies such as SEK, NOK, AUD and NZD. Moreover, the SNB's actions are not a playbook for the Bo). The SNB's actions stopped out our long CHF trades vs EUR, GBP and USD. We are cautiously monetising the SNB's floor for EUR/CHF by selling short-dated puts struck at the 1.20 floor, albeit recognising the long-term constraints and pressures on this peg. The portfolio remains defensively positioned in funding currencies, albeit exclusively now through yen. Hedge the risk of a further loss of confidence in the euro through EURZIPY rather than EUR/USD, while hold existing yen longs versus both USD and GBP. Commodities • As we pointed out last week, the oil market has proved resilient during the past month's turmoil in risky markets. Brent is up another 13% this week and is now almost back to where it was before the correction at the beginning of August. We expect prices to range trade around current levels right through to the middle of next year, though with considerable volatility. The resumption of Libyan production is unlikely in any material size until next year when we may also see an expansion of Iraqi exports. However, in a scenario of increased supply that is not met by adequate demand, our view is that OPEC will cut production in order to maintain prices above $100/bbl and protect their revenues. Our oil analysts report that early estimates of Middle East exports for August already show a decline of as much as 6% of the previous month's exports, perhaps reflecting the current economic slowdown. • This week's statement by the SNB that they will purchase "unlimited" quantities of foreign currency to maintain a floor for the EUR/CHF of 1.2 is a new bullish factor for gold. It has removed the CHF from the list of liquid hedges for the Euro area crisis. In addition, although the SNB is unlikely to use the cash it gets from selling CHF to buy gold, this may accentuate the recent trend of EM central banks diversifying their reserves into gold, thus boosting prices further. Sep 2011 4 USD CUR GBP JPY CHF CAD AUD TWI Sauce: J.P. ucepi More details in ... FX Markets Weekly. John Normand et al. Commodity Markets Outlook 8 Strategy. Cohn Fenton el al. OA Markets Monthly. Lawrence Eagles et al. Metals Review and Outlook Michael Jansen Global Metals Ouarterry. Michael Jansen EFTA01149277 Global Asset Allocation The J.P. Morgan View Interest rates Current Sep-11 Den.11 Man12 Jun.12 J. P Morgan YTD Return' United States Fed funds rate 0.125 0.125 0.125 0.125 0.125 10.year pens 1.92 2.05 2.60 2.80 3.00 8.3% Ewe area Safi rate 1.50 1.50 1.50 1.50 1.50 10.year yields 1.77 2.10 2.05 2.00 2.00 72% United Kingdom Repo rate 0.50 0.50 0.50 0.50 0.50 10.year yields 226 2.45 2.55 2.55 2.55 9.1% Japan Overnight call rate 0.10 0.05 0.05 0.05 0.05 10.year yields 1.00 0.90 0.95 1.05 1.10 1.6% GBI.EM hedged in S Yield • Global Diversified 625 6.90 5.0% Credit Markets Current Index YTD Return' US high grade (bp over UST) 207 JPMorgan US Index (JULI) i.swead 72% Euro high grade (bp over Euro gov) 300 iElow Euro Corporate Max 33% USD hgh yield (bp vs. UST) 735 JPMorgan Global Hgh Yield Index 32% Ewe high yield 02p over Euro goy) 850 iBoxx Euro HY Index .34% EMBIG 'to vs. UST) 370 EMBI Global 8.1% EM Corporates (29 vs. UST) 414 JPM EM Corporates (CEMBI) 4.8% Commodities Current Quarterly Averages 1103 1104 1201 1202 GSCI Index YTD Return' Brent (aid) 115.6 110.0 115.0 115.0 110.0 Energy 0.8% Gold (Sbz) 1815 1650 1800 1800 1750 Precious Metals 31.3% Copper (Vmetric ton) 8913 9750 10000 10250 9500 Industrial Metals 45% Corn (Sltu) Foreign Exchange 7.54 Current 7.20 6.90 7.10 Sep-11 Den.11 Mar.12 7.40 Jun.12 Agnouthee 0.6% 3m cash YTD Return' Index In USD EURUSD 1.41 1.45 1.45 1.48 1.48 EUR 53% USCUPY 77.3 76 75 74 73 JPY 5.1% GBPAJSD 1.60 1.63 1.59 1.66 1.68 GBP 3.4% USOBRL 1.66 1.58 1.6 1.6 1.65 BRL 5.3% USOCNY 6.40 6.35 6.3 6.2 6.10 CNY 22% USCIKRW 1072 1040 1070 1050 1020 KRW 7.1% USD/TRY 1.76 1.65 1.65 1.65 1.65 TRY .9.1% YTD Return 2011 Equities Current (local coy) Forecast US Sector Allocation' YTD Europe YTD Japan YTD EM YTD (S) S&P 1193 .5.5% 1475 Energy 4.2% 432% .10.1% 43.2% Nasdaq 2537 -5.9% Materials -10.4% .232% .18.2% -13.6% Topix 754 .16.9% Industrials •113% .22.5% •132% .20.6% FTSE 100 5319 -10.6% 5900 Discretionary 4.2% -17.7% -21.9% -1.1% MSCI Eurozone' 121 •243% 145 Staples 4.7% 4.0% 4.6% 13% MSCI Europe' 944 -19.7% 1100 Healthcare 4.4% .1.6% 4.1% -13.4% MSCI EM V 988 •14.5% 1300 Financials -222% •27.8% .25.7% 15.6% Brazil Bovespa 56607 -19.8% Information Tech. .6.4% -14.7% -28.0% •19.6% Hang Song 20048 .11.8% Telecommunications 4.3% 4.7% 4.4% 1A% Shanghai SE 2516 -11.4% levelerelums as of Sep 08.2011 Local oirrency except MSCI EM S UWities 8.0% -18.6% -40.0% -10.7% Overall .5.5% 49.7% 46.9% .143% Swot Bkorrbag Ceastearrt eEs Sbretvd a Pech J P Mogen eetroles Sep 9, 2011 5 EFTA01149278 Global Asset Allocation The J.P. Morgan View J. P Morgan Global Economic Outlook Summary Real GDP %Mr a year ago Real GDP sonar pre404 good saw Consumer prices %eir a yea, ago 2010 2011 2012 1011 2011 3011 4011 1012 2012 3012 4010 2011 4011 2012 The Americas United States 3.0 1.4 12 0.4 1.0 1.0 1.0 OS 1.5 2.5 1.2 33 32 1.3 Canada 3.2 2.2 22 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 5.8 15 3.4 3.1 2.6 4.3 4.4 6.7 6.8 72 7.3 kgentid 9.2 7.0 4.8 11.7 5.0 6.0 3.0 4.0 6.0 4.0 11.0 11.0 11.0 13.0 Brazi 7.5 3.4 3.8 5.0 3.1 2,3 3.9 43 4.1 3.5 5.6 6.6 6.5 5.7 Chile 5.2 6.5 43 6.4 5.7 3 2.5 5.0 4.5 4.3 2.5 3.3 4.0 3.6 Colombia 4.3 5.3 4.0 7.7 6.0 3.5 1.5 42 4.7 5.2 2.7 3.0 3S 3.1 Ecuador 3.6 6.0 3.0 7.3 3./ 2.0 1.0 2.0 3.5 4.0 3.4 4.1 3.9 3.6 Mexico 5.4 4.0 2S 2.4 4.5 52 2.6 -15 3.7 4.9 4.2 33 34 3.6 Peru 8.8 6.3 5.0 6.9 4.5 2.5 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 11,5 3.0 3.0 5.0 6.5 27.3 24.6 29.0 33.6 AslaPacifIc Japan 4.0 -0.31 2,5 1 -3.71 4.1 1 7.0 351 2.01 1.71 15 1 -0.3 -0.4 -02 -0.7 Australia 2.7 1.4 T 3.5 1 -3.4 T 4.81 12 1 221 4.1 3.4 T 4.8 2.7 3.6 3.8 3.2 New Zealand 1.7 2.8 42 3.4 4.2 4.5 3.7 3S 4.3 5.5 4.0 53 32 2.4 Asia ex Japan 9.1 7.2 7.0 8.9 5.3 6.1 1 6.8 72 7.5 7.6 4.9 5.7 4.9 4.5 China 10.3 8.9 8S 8.9 7.0 15 8.5 8.7 8.9 9.0 4.7 5.7 4.6 4.3 Hong Kong 7.0 5.2 4.0 13.0 -2.0 1.5 35 5.5 5.6 4.5 2.7 52 5.1 4.3 India 8.5 7.6 8S 8.3 7.6 7.5 7.1 8.6 9.0 9.5 9.2 9.1 8.7 7.8 Indonesia 6.1 6.4 62 6.8 5.4 EL 62 62 6.2 6.2 6.3 5.9 4.5 5.6 Korea 6.2 4.0 42 5.4 3.6 T g I 4.0 4.0 4.5 4.5 3.6 42 3.7 t 3.1 Malaysia 7.2 4.2 3.6 5.5 3.2 1.0 3S 4.0 4.1 4.0 2.0 3.3 2.8 2.4 Philippines 7.6 4.6 1 5.2 1 7.8 2.4 Q,41 511 4.9 4.9 5.3 3.5 5.0 4.6 3.3 Singapore 14.5 5.1 1 3.81 27.2 -6.5 OM 1 3.2 1 4.5 6.1 7.0 4.0 4.7 4.6 T 3.01 Taiwan 10.9 5.0 3.8 14.6 0.9 j5 3.8 42 4.7 4.8 1.1 1.6 22 2.0 Thailand AfrIcaMiddle East 7.8 3.1 3.6 8.1 -0.8 2.0 45 4.5 4.0 4.0 2.9 4.1 3.7 3.6 Israel 4.8 4.3 2.9 4.7 3.3 2.4 12 0.8 3.2 6.1 2.5 4.1 2.8 2.3 South Africa Europe 2.8 3.3 2.7 4.5 1.3 3.3 2.9 2.3 2.6 2.9 3.5 4.6 5.8 5.1 Euro area 1.7 1.6 0.9 3.11 0.61 0.0 0.5 1.0 1.0 1.5 2.0 2.8 2.5 1.4 Germany 3.6 28 1.3 5.5 0.5 0.5 1.0 1.5 1.5 2.0 1.6 2.5 22 1.2 France 1.4 1.6 13 3.6 0.0 15 1.0 IS 15 2.0 1.9 22 2.1 13 Italy 1.2 0.6 0.6 0.51 1.2 t -0.5 0.0 0.5 1.0 1.5 2.0 2.9 2.8 1.8 Norway 2.1 2.3 1.8 1.9 4.1 2,0 1.0 15 2.0 2.0 2.2 1.4 14 1.4 Sweden 5.4 4.4 1.6 3.2 3.9 A 1.0 IS 1.5 2.0 1.9 2.9 2.71 1.61 United Kingdom 1.4 1.0 1.4 1.9 0.7 t5 1.0 1.0 OS 4.0 3.4 4.4 4.7 2.8 Emerging Europe 4.5 3.6 3.0 3.6 1.2 1 LA 22 4.0 3.8 3.8 6.6 7.1 6.0 5.2 Bulgaria 0.2 as 2.7 Czech Republic 2.3 2.0 1.6 3.51 031 0.3 0.8 1.3 1.8 2.0 2.1 1.8 2.1 2.8 Hungary 1.2 1.5 13 1.2 -021 La 1.0 1.0 1.5 1.8 4.4 4.0 3.8 3.1 Poland 3.8 3.8 3.0 4.5 4.5 2.0 25 2.8 2.8 3.0 2.9 4.6 4.0 2.5 Romania -13 12 1.0 7.9 82 4.0 3.5 Russia 4.0 3.4 3.5 3.7 0.4 1.1 2.0 5.0 4.7 4.5 8.2 9.6 7.4 6.5 Turkey 8.9 5.6 33 7.4 5.9 6.8 6.1 Global 3.9 2.51 2.5 1 2.61 1.5 1 2.4 221 221 2.61 3.21 2.7 3.7 3.4 2.4 Developed markets 2.6 1.3 1 1.4 1 0.91 Q.61 1.6 121 1.1 1 1.41 2.2 1.5 21 2.6 13 Emergiig markets Space JP. /.1:rgan 7.3 5.7 53 7.2 4.1 4.6 5.0 5.4 5.9 6.1 5.6 62 53 I 5.3 Sep 9.2011 6 EFTA01149279 Global Asset Allocation The J.P. 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