J.P.Morgan

J.P.Morgan Global Asset Allocation 07 September 2012 The J.P. Morgan View Can the risk rally last? • Asset allocation — Following our re-entry into long US equities vs cash last week, we have further upgraded our risk exposure by being long both equities and credit versus cash and government debt Given the overnight announcement of Chinese infrastructure spending, even if not all new, we cover our underweight in Chinese equities and in industrial metals and reverse the short in commodity FX. • Economics — World growth is in a bottoming process, but at well below potential with a return to trend only projected by the middle of next year. Policy casing is restarting in the US, UK, Euro area with monetary policy, and in China with both monetary and fiscal policy. • Fixed Income — Position an ECB policy though Spanish curve flatteners, and Fed QE3 through long end Treasury steepeners. Equities — We take profit on our BRIC underweight within EM. • Credit — We go further up in yield and down in quality in our credit portfolio. Currencies — Close defensive trades and go long commodity FX vs Europe. • Commodities — The newly announced Chinese stimulus makes us take profits on our OW energy vs. base metals trade. We stay long energy on Middle East risk. ECB President Mario Draghi's promise yesterday to provide a backstop to EMU members with funding problems, by using Outright Monetary "kg Transactions (OMTs) to keep risk premia low, induced a massive rally in periphery bonds and global equities. Even a weak US jobs report could not rain on this parade. And all this without him actually spending any money as no i country yet meets his conditions cleanly. Both US and German equity indices reached new cycle highs. While consistent with our long-risk strategy, these new highs do force us to ask whether the good times for risk assets can last We think the positive environment for risk assets can and will last over the next 3-6 months. And this is not because of a strong economy, as we foresee below potential global growth over the next year and are below consensus expectations. Overall, we continue to see data that signal that world growth is in a bottoming process. With most countries having now reported, global GDP looks to have expanded at a tepid 1.9% pace in 2Q12, l.3%-point below what would simply be trend. On the back of weak gains in consumer and business spending at mid-year, global IP growth has come to a stand-still. And while things appear to have bottomed with some signals of improvement in consumer spending in July, the soft trajectory of both spending and production through June is expected to hold global GDP growth to another tepid quarter of just 2%. See page 7 for analyst certification and important disclosures. Global Asset Allocation JPMorgan these Sank NA John Normand J.P. Morgan Securities plc Nikolaos Panigirtzoglou J.P. Morgan Securities plc Seamus Mac Gorain J.P. Morgan Securities plc J.P. Morgan Securities plc Leo Evans J.P. Morgan Securities plc YID returns through Sep 6 % equities are in tighter color. S8P500 EM BIG EM $ Corp. MSCI Europe MSCI AC Wald' US High Yield Gold US High Grade Europe Fixed Inc' MSCI EM' EM Local Bonds" EM FX GSCI TR US Faced Income Global Gov Bonds" US cash Topic 6 0 Source: J.P. Morgan. Bbornberg. See bbe taxon page 2 for clesaipeon. www.morganmarkets.com EFTA01181150 Jan Loewe I-21218345874 Global Asset Allocation The J.P. Morgan View 07 September 2012 • More important to us as positive drivers of risk markets are coming policy stimulus measures, price momentum, and the continuing but more medium-term forces of asset reflation and high risk premia. • On policy, we expect further QE announcements by the Fed next week, and the UK MPC later this year. The ECB confirmation and clarification yesterday that it will use its balance sheet to depress risk premia for EMU members in an EFSF support program likewise increases confidence that policy makers stand ready to support growth. The overnight Chinese announcement of infrastructure spending worth 2% of GDP may not all be new money, but likely signals a renewed commitment to provide support. We similarly expect a supplementary budget from Korea next week. • The impact of further policy easing does not make us immediately upgrade economic growth projections, but it does not make us more bullish on risk markets. That is because we see the main impact of policy on asset prices via risk premia and liquidity. The ECB's new OMT policy will not spend any money next week. It is merely a promise to buy short-dated debt, if a country applies for help and meets conditions. As with other policy measures, it largely works by providing insurance, and thus reduces tail risk. With still high sky-high risk premia on equities and periphery debt and less so on credit, it supports risk assets without making us more bullish on growth. • The second, and in our view, equally important aspect of actual liquidity injections from QE is that they increase the supply of cash in the market, which will likely be redeployed into better yielding financial assets. This is the force we keep referring to, ad nauseam, as asset reflation. "Don't fight the Fed" is an old adage in the market, and applies doubly when other central banks pursue the same kind of monetary expansion. It keeps us short cash and long financial assets, overweighting the riskier ones (equities and credit) as they should gain most from asset reflation. Fixed income • Core yields are much higher on the week, with the ECB trumping today's soft US Employment Report. ECB President Draghi signaled again that the new "OMT" program, with no set limit on bond purchases of up to three years' maturity, should have a much more persistent impact on yields than its predecessor, the SMP. There remains considerable uncertainty as to when bond buying will begin, not least because the ECB's request for the IMF to be involved in setting the related conditionality will likely make Spain all the more reluctant to sign up. • Peripheral bonds have already enjoyed a dizzying rally since July. From here, we favor 2- to-5-year curve flatteners in Spain. If the ECB succeeds in anchoring front end bonds, 5-year yields should compress towards the short end. On the other hand, any disappointment on ECB purchases would be most keenly felt at the front end. • Today's payroll print makes QE3 all the more likely at next week's FOMC meeting. We think that should steepen the long end of the Treasury curve, in line with past QE announcements. We are neutral overall on duration, but have a medium-term bearish stance on Treasuries, and think short yields are too low in the UK, compared to Germany. • Just how much all these unconventional central bank measures will affect inflation remains a keen topic of discussion, and our 10th J.P.Morgan Inflation Expectations Survey includes a question on the impact of the ECB's J.P.Morgan 2012 global GDP growth forecasts: JPMorgan and Consensus 4.5 4.0 3.5 3.0 2.5 2.0 Ja -11 May-11 Sep-11 Jan-12 May-12 Some: .P Morgan. Consensus Economics Consensus Economics Icrecesi are for agars and countries that we aivaged uurg the same 5- ear toting USD GDP wecnts dine use Ice cue urn gOnsi growth forecast 2013 global GDP growth forecasts: JPMorgan and Consensus 3.5 - 3.0 - 2.5 Jan-12 Apr-12 Jul-12 Sane: J.P. Morgan. Consensus ECCO3MiCS, Consensus Economics forecasts are for reports and coulees that we averaged using the same 5-year rolIng USO GDP we .% that we use for our Iran gbbal growth forecast Consensus JPil 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 Panigirtzoglou et al. Description of YTD Chart on front page: Returns in USD. local Currency. s•Hedged into USD. Euro Fixed Income is iBoxx Overall Index. US HG. HY. EMBIG and EMS Corp are JPhl indices. EM FX is ELMI. In S. 2 EFTA01181151 Jan Loeys (1-2121834-5870 Global Asset Allocation The J.P. Morgan View 07 September 2012 new program. Please help us gauge prospects for inflation by completing the survey on https://www.surveymonkey.com/s/September20I2InflationSurvey. Equities • Equity markets responded strongly to this week's ECB's press conference with the S&P500 and other DM indices reaching new post-Lehman highs. We argued last week that policy response is essential for the equity rally to continue into September and this policy response appears to be coming through nicely. • Positive announcements were not only confined to Europe this week. China announced large projects, totaling close to 2% of GDP, triggering the biggest rally in Chinese stocks in almost eight months. These policy announcements prompt us to take profit on our BRIC underweight within EM, i.e. our long in MSCI EM against MSCI BRIC. • Next week's FOMC meeting appears set to announce a new round of QE adding to the policy chorus. • Our preferred region is the US. The outperformance of US economic indicators is the main reason. The JPM US Economic Activity Surprise Index (EAS1) has risen to positive territory last week, for the first time in six months. In contrast, EM economies continue to print weak economic data. Macro data are also weak in Europe, but European equities are still benefiting from underweights that are not yet fully covered by investors. Credit • Spreads tightened across the board this week, as markets received the ECB's bond buying plan — one that combines capacity with conditionality — as a positive step forward. Higher beta sectors outperformed, but the degree of spread tightening was surprising, given that apart from the role of the IMF, Mr Draghi revealed relatively little new information about the contours of the OMT. • With global growth likely in the process of bottoming out, in GMOS yesterday we outlined our down-in-quality strategy. We do not have a strong regional bias, given that central banks are easing monetary policy globally, but today's weak US payroll numbers will have raised expectation of QE3 at next week's FOMC meting, and should provide a boost to US CMBS, one of the core longs of our portfolio this month. • There was an uptick in defaults in August, with S3bn of high-yield bonds and institutional loans defaulting, the second highest month YTD. However, the continued focus on refinancing amid buoyant primary markets should keep longer-term defaults well anchored. In the US, we forecast a 2% or lower default rate for the next two years (see Peter Acciavatti and team, Default Monitor). Foreign Exchange • With yesterday's pledge to "remove the tail risk of Europe", the ECB has triggered a series of hedge unwinds across global markets. FX vols have fallen to a 5-year low (basis VXY), EUR/CHF has posted a 2-sigma rally, EUR/USD skews are flattening aggressively, European sovereign CDS are approaching 2012 tights and the dollar is collapsing. It might be a stretch to call the ECB's strategy a game changer when remaking EMU remains a multi- year game and when Spain and Italy are likely too proud to get on the pitch. J.P.Morgan More details in ... US Credit Markets Outlook and Strategy. Eric &Inman el at. High Yield Credit Markets Weekly. Peter Acciavaiti et al. European Credit Outlook & Strategy. Steven Oulake et at. Emerging Markers Cross Product Strategy Weekly, Eric Beinstein er a EFTA01181152 Jan Loeys t-21218345874 Global Asset Allocation The J.P. Morgan View 07 September 2012 Still, we view the bank's tail-risk emphasis is a short-term boon for carry trades which rely on vol suppression to deliver returns. FX weekly change in USD • Whether to fund in euros or dollars depends on how much further EUR/USD P.0% can rally. We suspect not much more given Spanish and Italian aversion to the EFSF plus ECB rate cuts next month. The EUR/USD year-end target is 1.0% therefore unchanged at 1.24. The corresponding EUR/GBP target is 0.79 and I EUR/JPY 97) Some will probably counter that politics plus future ECB rate cuts justify a much weaker euro, but we believe that view ignores the 0.0% likelihood of Fed QE this fall. Also unconvincing is the normative argument that the euro will trend lower because currency depreciation will restore 40% competitiveness. This is true -- in the same way that yen depreciation will generate Japanese inflation -- but irrelevant, in ow view. Unless the ECB cuts rates as it buys bonds, it will likely be difficult to offset the region's decent SD balance of payments profile (small current surplus) in the same way that the U TWI JPY EUR GBP CHF CAD AUD Bank of Japan struggles to weaken the yen while Japan still runs an external Sara IR./Ragan surplus. • The more material change in view is that the majority of euro crosses (EUR vs commodity FX, Scandies, Latam, and Asia) are topping out after a summer rally, even if their decline may be limited to a few percent due to the mediocrity of global growth. Close defensive trades (short commodity FX) and open trades that benefit from less event risk in Europe. Take profits on short AUD/USD, short AUD/NZD, long NOK/SEK and long USD/SEK, and buy commodity FX vs Europe, expressed through NZD/SEK given the overvaluation of the Swedish currency. Commodities • Commodities are more or less unchanged on the week with base metals rallying some 4%, offsetting a fall in energy. We went OW energy vs. base metals at the beginning of June on the argument that global manufacturing, especially in China, was slowing and that supply issues would support oil (GMOS, Jun 7). Since then, the GSCI energy index has made 15% compared to only 0.5% for the GSCI industrial metals index (excess return). Last night, the Chinese authorities announced significant stimulus via further infrastructure investment to the tune of around 1.7% of Chinese GDP. It is not yet clear how much of this is simply existing stimulus repackaged but it is enough for us to take profit on this trade. We keep the long leg as the steeply inverted Brent forward curve suggests oil markets remain tight and geopolitical risk in the Middle East appears unlikely to decline anytime soon. • Gold is up 10% over the last two months and is perhaps an indication that the market anticipates further QE. The ECB's new OMTs should significantly expand their balance sheet once they start buying peripheral debt and we also expect both the Fed and the BoE to do the same over the coming months. This should create bullish conditions for gold and we stay long. J.P.Morgan More details in ... FX Markets Weekly. John Normand et al. Commodity Markets Outlook & Strategy. Cohn Fenton et al. Oil Markets Monthly, Fenton et al. Daily Metals Note. Fenton et al. Agriculture Weekly, Dietz et al. 4 EFTA01181153 Jan Loeys 1-212) 834-5874 Interest rates Global Asset Allocation The J.P. Morgan View 07 September 2012 Current Sep•12 Dec-12 Mar-13 Jun-13 J.P.Morgan YTD Return* United States Fed funds rate 0.125 0.125 0.125 0.125 0.125 1.62 1.75 2.00 2.00 2.00 10-year yields 2.1% Euro area Rea rate 0.75 0.75 0.50 0.50 0.50 1.52 1.00 0.90 1.00 1.20 10-year yields 2.5% United Kingdom Repo rate 0.50 0.50 0.50 0.50 0.50 1.68 1.40 1.45 1.55 1.65 10-year yields 2.9% Japan Overnight call rate 0.05 0.05 0.05 0.05 0.05 0.82 0.85 0.95 0.95 0.95 10-year yields 1.7% GBI•EM hedged in S Yield • Global &worsted 5.85 6.00 5.7% Credit Markets Current Index YTD Return' US high grade (bp over UST) Euro high grade (bp over Euro gay) USD high yetd (bp vs. UST) Euro high yield (bp over Euro goy) EMBIG (bp vs. UST) EM Corporates (bp vs. UST) 186 212 iBoxx Euro Corporate Index 590 JPMorgan Global High Yield Index 51W 822 JPMergan JUU Porta° Spread to Treasury 7.4% 71% iBoxx Euro HY Index 16.4% 13.8% 11.9% 304 371 JPM EM Corporates (CEMBI) EMBI Global Commodities Current Ouarterty Averages 1203 1204 1301 1302 GSCI Index YTD Return' Brent (SibbI) Goa (Sloz) Copper (S/metric tat) Corn (SBu) 114 95 100 105 95 Energy 1739 1655 1725 1750 1775 Precious Metals 5.0% 12% 7693 8000 8300 8500 8700 Industrial Metals -5.6% 8.04 8.25 8.25 8.00 7.75 Agriculture 23.5% Foreign Exchange Current Sep.12 Dec.12 Mar.13 Jun-13 3m cash YTD Return' Index In USD EURRJSD 1.26 1.24 1.24 1.25 1.25 EUR -1.6% USCUPY 79.0 78 78 80 80 JPY 2.4% GBP/USD 1.59 1.59 1.58 1.58 1.58 GBP 3.7% USDBRL 2.03 2.00 1.98 1.95 1.95 8RL -3.0% USD/CNY 6.34 6.33 6.30 6.30 6.25 CNY 0.5% USDKRW 1134 1150 1150 1090 1090 KRW 3.5% USD/TRY 1.81 1.82 1.80 1.75 1.75 TRY 10.7% YTD Return Equities Current (local coy) Sector Allocation * US YTD Europe YTD Japan YTD EM YID (5) SM3 1436 15.6% Energy 5.1% 1.1% -15.3% -0.5% Nasdaq 3130 20.2% Materials 9.6% 6.8% -16.3% -3.4% Topix 735 0.0% I n d u s 10.5% 12.7% -4.2% 5.5% FTSE 100 5795 7.3% s a e t o n a r y 20.3% 22.1% 52% 5.6% MSCI Eurozone' 145 14.7% Staples 12.7% 15.4% 12.9% 12.1% MSCI Europe' 1107 11.8% Healthcare 15.5% 16.0% 9.4% 22.0% MSCI EM 5' 950 6.4% Frianciats 20.6% 16.0% 14.5% 8.9% Brazil Bovespa 57774 4.4% Information Tech. 23.0% 11.4% -10.9% 12.2% Hang Seng 19209 8.0% Telecomnunica0ons 23.9% 2.2% 6.6% 11.3% Shanghai SE 2052 'Levelstretums as of Sep 06.2012 Local currency except MSCI EM S Some: J.P. klorgan -6.7% Utilities 4 2 % 7.4% -23.6% 5.9% Overall 15.6% 11.8% 0.0% 6.4% 5 EFTA01181154 Jen Loop 1-2121834-5874 Global Asset Allocation The J.P. morgen view 07 September 2012 Global Economic Outlook Summary JPMorgan Real GDP % ow a year ago Real GDP !,rr crex orevroos penal. soar Consumer prices mar a year ago 2011 2012 2013 1O12 2O12 3O12 4O12 1O13 2O13 3O13 4O11 2O12 4O12 2O13 The Americas United States 1.8 2.2 2.0 2.0 1.7 15 2.0 1.5 2.3 2.5 3.3 1.9 2.1 2.3 Canada 2.4 2.0 2.11 1.8 1.8 1.91 2.0 2.11 2.11 2.21 2.7 1.6 2.4 2.0 Lath America 4.2 2.8 3.7 2.9 1.9 4.2 3.8 3.5 3.8 3.9 7.2 6.0 6.2 t 7.0 Argentina 8.9 3.3 2.2 3.6 4.5 8.0 6.0 0.0 1.5 0.5 9.6 10.0 10.0 11.0 Brazil 2.7 1.4 4.11 0.5 1.6 4.8 4.6 3.8 4.0 4.3 6.7 5.0 5.2 5.2 Chile 6.0 5.0 4.5 5.1 7.1 2.0 4.0 4.6 4.7 4.4 4.0 3.1 2.5 3.1 Colornbe 5.9 3.5 4.5 1.2t 2A4 2.84 3.44 5.0 6.0 6.0 3.9 3.6t 3.3 t 3.2 Ecuador 7.8 4.0 4.0 2.8 3.5 4.0 4.0 4.0 4.0 5.0 5.5 5.1 4.2 4.4 Mexico 3.9 3.6 3.5 4.9 3.5 2,2 3.0 4.4 3.7 3.3 3.5 3.9 4.2 3.6 Peru 6.9 6.0 7.0 8.3 1 6.0 t 5.5 6.0 8.0 8.0 7.0 4.5 4.1 3.1 1 2.8 Uruguay 5.7 3.5 4.0 11.65 &,5 28.0 -10.3 13.5 -11.0 25.0 8.3 8.0 7.6 7.2 Venezuela Age/Pacific 4.2 5.0 0.0 10.1 0.6 3.5 -3.0 -3.0 0.0 3.0 28.5 22.3 23.4 37.3 Japan -0.7 2.5 0.9 5.5 1.4 4 0.5 1.0 1.2 1.3 -0.3 0.2 0.1 -0.1 Australia 2.1 3.5 1 2.5 5.6 1 2.6 1 1.5 1 1.8 1 3.8 1 2.5 1 1.8 3.1 1.2 1 1.7 1 2.7 New Zealand 1.3 2.5 2.8 4.7 04 3.3 3.0 2.3 3.4 3.2 1.8 1.1 2.5 2.8 Asia ex Japan 7.4 6.2 6.6 7.3 5.71 5.9 6.4 6.8 6.9 7.1 4.9 3.9 3.5 1 4.0 China 9.2 7.7 8.5 6.8 6.9 40 8.5 8.7 8.7 8.7 4.6 2.9 2.6 t 3.7 Hong Kong 5.0 1.2 3.2 2.4 -0.4 2,Q 2.5 3.5 3.5 5.0 5.7 4.2 2.5 2.7 India 6.5 5.6 6.0 6.1 5.3 5/ 5.0 5.8 6.0 6.8 8.4 10.1 9.8 9.0 Indonesia 6.5 5.0 3.7 4.6 6.2 IQ 3.0 3.5 4.5 5.0 4.1 4.5 3.9 2.2 Korea 3.6 2.44 3.3 3.5 1.1 2.0 3.5 3.5 3.5 4.0 4.0 2.4 1.9 3.1 Malaysia 5.1 4.7 2.9 5.8 5.9 25 1.5 2.0 3.0 3.5 3.2 1.7 1.1 1.2 Phifccmes 3.8 5.3 3.5 12.6 0.9 1/ 1.2 4.5 4.5 4.5 4.7 2.9 2.3 2.3 Singapore 4.9 2.1 3.4 9.5 -0.7 0.8 4.1 4.1 4.1 4.1 5.5 5.3 3.4 2.4 Taiwan 4.0 1.1 19 1.5 3.5 La 3.8 4.5 4.6 4.8 1.4 1.7 2.1 1.8 Thailand AfrIca/Middle East 0.1 5.8 2.7 50.8 13.9 2.0 2.0 1.5 2.0 2.0 4.0 2.5 1.3 1.1 Israel 4.8 t 3.0 t 4.4 3.0 t 2.04 a 2.8 4.9 6.1 6.1 2.5 1.6 1.3 1.5 South Africa Europe 3.1 2.6 1 3.21 2.7 3.2 23 1 2.41 3.81 3.2 3.6 t 6.1 5.7 5.5 5.6 Euro area 1.5 -0.51 0.2 •0.11 -0.7 -1.0 -0.5 0.5 0.5 1.0 2.9 2.5 2.5 1.9 Germany 3.1 1.0 1.2 2.0 1.1 0.3 0.5 1.5 1.5 1.8 2.6 2.1 1.9 1.6 France 1.7 0.1 0.6 0.1 -0.2 -0.3 0.0 0.8 1.0 1.3 2.6 2.3 2.3 1.7 Italy 0.5 -2.3 -1.0 -3.3 .2.9 :2.5 -1.5 .0.8 -0.5 0.0 3.7 3.6 3.4 2.5 Spain 0.4 -1.5 -0.9 -1.3 -1.7 -2.8 -2.0 -0.5 0.5 0.5 2.7 1.9 3.2 2.6 United Kingdom 0.8 -0.4 1.5 -1.3 -1.8 2.0 0.5 1.5 2.0 2.5 4.6 2.8 2.7 2.6 Emerging Europe 4.8 2.7 3.0 1 2.4 t 1.3 1.3 1 2.2 1 3.1 3.1 3.6 t 6.4 5.0 5.8 5.8 Bulgaria 1.7 1.0 2.5 Czech Remick 1.7 -1.1 0.9 -3.1 -0.8 x,24 -1.3 4 2.1 t 1.01 4.3 t 2.4 3.4 2.9 24 Hungary 1.6 -1.2 0.8 -3.51 -0.91 -0.5 0.5 1.0 1.5 1.8 4.1 5.5 5.5 3.3 Poland 4.3 2.4 2.1 2.4 1.6 12 1.6 1.8 2.4 3.5 4.6 4.0 3.7 2.6 Romania 2.5 0.6 1 0.9 1 0.6 1 2.1 1 j ig 4 0.8 1 1.2 1 -0.4 1 3.2 1 3.4 1.9 4.4 4.2 Russia 4.3 3.6 3.4 3.7 1.5 2.0 3.0 4.0 4.0 3.7 6.8 3.9 6.7 7.4 Turkey 8.5 2.8 4.1 1 ... 9.2 9.4 6.5 5.9 Global 3.0 2.5 2.7 3.1 1.9 2.0 2.4 2.7 2.9 3.2 3.8 2.8 2.9 3.0 Developed markets 1.3 1.2 1 1.2 1.8 V 0.5 0.9 t 1.2 1.5 1.8 2.7 1.8 2.0 1.8 Emerging markets 6.1 4.7 5.3 5.4 4,14 4.74 5.1 4 5.4 5.51 5.8 t 5.7 4.6 4.5 5.0 Source: t Morgan 1 6 EFTA01181155 Jan Loeys (t-2121834-5874 Disclosures Global Asset Allocation The J.P. Morgan View 07 September 2012 J.P.Morgan Analyst Certification: The research analyst(s) denoted by an "AC" on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an "AC' on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that (I) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. 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