EFTA01171763.pdf

J.P.Morgan Global Asset Allocation J.P.Morgan Chase Bank NA, J.P. Morgan Securities Ltd. Nov 18, 2011 he J.P. Morgan View EMU now more clearly in a liquidity crisis, affecting all Jan LoeysAc • Economics — Q4 GDP growth in US raised to 3%, even as Q3 was probably only 2%. We reduce UK 2012 growth from 0.8% to 0.5%, with a mini-recession in HI. John Normand • Portfolio strategy — Near -term volatility as EMU plays poker. • Fixed Income — Economic momentum favours UK gilts overJGBs. Nikolaos Panigirtzoglou • Equities — Continue to focus on country trades favouring Germany and BRICs. • Credit — Senior French bank bonds vs. OATS look attractive in very good, Seamus Mac Gorain and very bad, states of the world. • Foreign exchange — We remain short EURIJPY through options to hedge adverse outcomes in Europe. Matthew Lehmann • Commodities — We raise our WTI forecast to reflect our view that the Brent- WTI spread should narrow to only $4/bbl by the end of next year. Leo Evans • Markets remain extremely volatile and continue to react to the latest political statements out of Europe on who will or will not, or should or should not, do what to resolve the Euro sovereign debt crisis. Economic data in the rest of the YTD returns through Nov17 world, and especially the US, were supportive for risk markets, but were %. wire are in lighter colour. outshouted by the political chaos in Europe, leaving riskier assets signifi- Gold cantly down over the week. US High Grade • US activity data continue to impress, relative to subdued expectations, and are EMBIG bringing our forecast for Q4 up to 3%, even as we downside Q3 to only 2%. US Fixed Income The average for H2 stays at 2.5%, much better than the 1% pace we projected Global Gov Bonds- only two months ago. This good news improves the glide path of the economy into 2012, but itself does not eliminate the downside risk due to the EM Local Bonds" expiring of a number of fiscal stimulus measures at the end of this year. There US High Yield remains no sign of compromise in Washington on the 2012 budget nor on the EMS Corp. Supercommittee's effort to reduce the 10-year out deficit by $1.5 trillion. One GSCI 1R could hope that both sides know the nation needs clarity and will compromise US cash at the last minute, but time is running out. Monday should bring news from the Supercommittee. Europe Fixed Income' S&P500 • Elsewhere, we see further evidence that slower growth this year is now EM FX starting to bring headline inflation down. By our forecast, global headline MSCI AC Work!' inflation should fall from 3.6% oya this quarter to 2.4% oya in 6 months' lime. MSCA O Our latest Inflation Expectations Survey (Garayo and Chordia, Nov 11) revealed that investors have raised their probability of deflation over 2 of the MSCI Europe' next 5 years by 5% to 10% in the US and 15% in the Euro Area (EA). For the Topix EA. this equals their probability of high inflation (>4%). .20 '0 20 30 SWIM: AP. Maga E0xeloscg. Pans n USD. 'Lea/ • Falling inflation and inflation expectations should provide both support to mercy. - He.:1;ed USD. Ewe Red Income is boa Cueral consumers and comfort to central bankers that they should be thinking about lit. US HG. HY. EMIG ad EM SCtep are WM Sx% EU FICHELManS. providing greater stimulus, through rate cuts in EM and quantitative easing in the major developed markets. The Bank of England is in the midst of raising its The certifying analyst is indicated by an Mr. See page 7 for analyst certification and important legal and regulatory disclosures. EFTA01171763 Global Asset Allocation The J.P. Morgan View J.P,Morgan Asset Purchase Facility from £200bn to £275bn by February, but we expect it to decide at some point to raise it to £425bn in 2012. In the US, we see close to even odds that the Fed will move to QE3 next year. And in the Euro area, rising deflation fears should reduce some of the area's reluctance to use the ECB balance sheet to purchase debt of sovereigns with liquidity problems. • The Euro area remains at the core ofinvestor concerns. Auctions by Belgium and Spain were not well received and caused their bond markets to back up and underperform the rest of the EA. Periphery bonds as a whole backed up, but in a novel development this week, not only did we see Dutch and Finnish bond spreads rise dramatically, but the German government bond market itself sold off, despite rallies in the US, UK and Japan. Anybody still arguing that spread widening in the EA is due to rising solvency risk and not a liquidity crisis needs to think again. A self-fulfilling run on governments can affect each and every euro bond market, even Germany. • This run on government debt requires a lender of last resort, not just for banks, but also for sovereigns. The creditor EMU member countries have been reluctant to approve an enlargement of the EFSF, or to support the ECB providing this function for sovereigns as they do not want to lend to debtor EMU member countries that they believe are not making sufficient efforts to redress their fiscal excesses. One can consider the chaos of statements and opinions around this issue as a poker game where neither side wants to show its cards. Germany clearly has the best hand at the moment, but wants to make sure that borrowing member countries provide enough commitment to fiscal austerity and growth stimulus before unleashing further liquidity support. That at least is the benign view, with the more pessimistic one being that positions are well entrenched, inflexible, and thus unable to come to the compromises that are needed to salvage the monetary union. • This author is taking the benign view, that credit member countries have the power and willingness to exchange further support for borrowing member countries in exchange for greater fiscal austerity. But the game is not over and it will take some time for this to become obvious. The market will remain in the dark for some time and thus under pressure. Fixed income • The gathering EMU storm has begun to engulf the very core, with even fiscally upstanding Finland and the Netherlands seeing their spreads lurch wider by midweek, before retracing. Credible fiscal consolidation and supply- side reforms in the periphery are necessary for a long-term solution, but cannot stem the liquidity crisis. Thus, the path of least resistance is to wider spreads, and a further flattening of intra-EMU credit curves, absent more concerted official action (e.g. EFSF leverage via ECB liquidity support). • Economic newsflow has sometimes taken a back seat to the EMU drama in recent months, with Treasuries rallying this week despite further encouraging activity data. Yet economic momentum, as measured by changes in unemploy- ment rates, has historically been a strong signal both for duration timing within bond markets, and for cross-market allocation (see our Investment Strategy No. 67, Using unemployment to trade bonds, 16 November). Cur- rently this signal favours UK gilts over JGBs. Indeed, gilts are supported by a dovish Bank of England, with this week's Inflation Report prompting us to Nov IS, 2011 2 EFTA01171764 Global Asset Allocation The J.P. Morgan View J.P,Morgan raise our QE forecast to a cumulative £425bn (£150bn more than the BoE's MSCI EM vs. World current target), or a little over a quarter of GDP. Retain* tout relum index based on MSCI World, sector indices Equities 240 • Equity markets retrenched in November but they remain well above the 220 beginning of October lows. The MSCI AC World index is still 8% above the October low and has retraced a third of the Aug-Oct downmove. While we 200 recognize the risks stemming from the Euro debt crisis, we are reluctant to 180 abandon our positive stance. Excessive pessimism and bearish positions among investors, continue to create an asymmetric outlook for equity markets, 160 with bearish news creating limited downside and positive news more pro- 140 nounced rebounds. As we highlight in Flows& Liquidity, positions remain low, supporting further equity rallies in the absence of big negative news. 120 100 • We continue to believe in the importance of having peripheral hedges in an 2006 2006 2007 2008 2009 2010 2011 equity portfolio. Overweighting DAX vs.Eurostorm50 is such a hedge. This Scum: 0:Wren% J. P. Magni trade posted a gain in September, October and November. Although this trade can operate as a hedge, it is also motivated by the growth outperformance of Germany vs. the rest of the Euro area. This theme is still in place as 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. • The shift in EM policy priorities from inflation to growth is favouring an overweight in EM vs DM equities. The shift is more pronounced in BRICs, including China. Asa result, we overweight BRICs withinEM to an over- weight within EM (long MSCI BRICs vs MSCI EM). BRICs have been underperforming steadily since the end of 2009, mostly due to overheating and tightening fears. These fears are gradually fading. Credit • With policies, politicians and increasingly EU membership subject to change, spreads are bleeding wider as the European storm rumbles on. A slew of German bank downgrades earlier in the week set the tone and the iTraxx Senior Financials stands at 300bp, up from 206bp before the EU summit and 35bp on the week. • In this environment where extreme scenarios should be considered, we look for tactical opportunities which pay off if tail events in either direction materialize. Ten year Senior French bank bonds are trading at a spread of 100-200bp to France. A significant deterioration of the crisis, putting nationalisation on the cards, would see a convergence of sovereign and bank risks, making a long in toy French banks bonds vs. OATS profitable. Conversely,if funding conditions improve significantly, spreads will also compress making this an attractive, positive carry play. lilore details in ... • Our European strategists published their 2012 outlook this week. They favour EM Corporate Outlook and Strategy. Warren Mar el al. long risk in iTraxx senior financiaLs vs. bank equity on looming capital LIS Credit Markets Outlook and Strategy, Eric Beinstein et at injections to the banking system and short cyclical vs. non-cyclical euro credit on the likelihood of an EU recession. US data continued to improve on ggh Yield Credo Markets Weekly, Peter Acciavani et al. the whole but US credit is far from immune to a more bearish EU sentiment. Our European Creotit Outlook & Strategy. Steven Dulake et al. US HG strategists however reiterated the impressive strength of US HG credit Emerging Markets Cross Product Strategy Weekly, Eric metrics this week (see Eric Beinstein and team, High Grade Credit Beinstein el al. Fundamentals, today). Revenue growth, EBITDA and free cash flow were all Nov 18, 2011 3 EFTA01171765 Global Asset Allocation J.P.Morgan The J.P. Morgan View strong in 3Q11, profit margins remain at a near decade high and leverage FX weekly change vs USD 1% - continues to decline. I Foreign Exchange 0% • The dollar is up versus every currency but the yen this week in classic deleveraging fashion. Anxieties about peripheral Europe remain the driver, but we take some comfort from an emerging pattern: ECB bond buying which pushes peripheral yields lower has tended to be dollar-negative versus all currencies including the euro. This trend will run counter to some investors' expectations that ECB bond purchases are necessarily currency-negative, so should sink the euro. We disagree. Debt monetisation is currency-negative .2% - 0I when it raises inflation expectations and lowers real yields. This impact can .3% be particularly severe for countries which are capital importers like the US, USD EUR GBP ,WY CHF CAD AUD which is why QE1 in 2009 was so USD-negative. 1Vil Seine: J.P. Worn • In Europe's case, even a trillion euros of debt monetisation is unlikely to lift inflation expectations during a recession. More importantly, QE will diffuse default risk, which is the main bearish force for the euro now. Of course no amount of QE will matter if governments fail to implement structural reform, which is why the actions of the new Monti government in Italy and the new Spanish government likely to emerge through Sunday elections will be key for EUR/USD too over the next few months. We remain short EUR/JPY through options to hedge an adverse outcome. • USD/JPY has now given back 75% of its gains from the October 31 Bank of Japan intervention, a move which confirms our view that the BoJ cannot peg the yen as the SNB did the Swiss franc. No doubt intervention is a recurring feature of currency markets where no one welcomes a strong currency, but some central banks are clearly more constrained that others. Any BoJ interven- tion is a buying opportunity for the yen. Commodities • Commodity markets are down around I% this week as all commodities fell in tandem with other risky markets. Gold was one of the worst performers this week down around 3%. We remain bullish gold as there are strong fundamen- tal drivers of higher prices from here. Gold demand in Q3 grew strongly. driven by Chinese consumers and EM central banks. We expect this trend of increas- ing EM demand to continue and to underpin higher gold prices going forward. • One notable change in oil market dynamics that occurred this week was the announcement that a pipeline between the US Midwest, where WTI is priced, and the Gulf Coast will be reversed. This is significant because it will help to alleviate the bottleneck that had built up at the WTI pricing point, which had depressed WTI relative to world oil prices (i.e. Brent). The announcement More details In ... itself resulted in the spread between Brent and WTI prices narrowing by over $3/bbl. Assuming the pipeline owners gain regulatory approval, the reversal FX Markets Weekly. John Normand et at. should take place in Q2 2012. We highlighted in August that the very wide Commodity Markets Outlook & Strategy. Cohn spread between Brent and WTI was enough of an incentive for market Fenton el al. participants to find ways to move oil out of the US Midwest that would have been too expensive under normal conditions (see Oil Market Weekly: Brent 04 Markets Monthly. Lawrence Eagles et al. and WTI Forecasts and Risks, Eagles et al., Aug 25). We now raise our WTI Metals Review and Outlook. Michael Jansen forecasts to reflect this new development which means we now expect the Global Metals Ouarterly. Michael Jansen Brent-WTI spread to narrow to only tab] by the end of next year. from $10/ bbl currently. Nov 1&2011 4 EFTA01171766 Global Asset Allocation .1.1? Morgan The J.P. Morgan View Interest rates Current Dec•11 Mar-12 Jun-12 Sep-12 YTD Return' United States Fed funds rate 0.125 0.125 0.125 0.125 0.125 10.year yields 2.02 2.25 2.50 2.50 2.50 9.3% Euro area Ref rate 1.25 1.00 1.00 1.00 1.00 10.year yields 1.97 1.75 200 2.10 2.15 8.4% United Kngdom Repo rate 0.50 0.50 0.50 0.50 0.50 10-year yields 225 2.45 2.45 2.55 2.65 14.5% Japan Overnight call rate 0.05 0.05 0.05 0.05 0.05 10.year yields 0.95 0.85 1.00 1.10 1.10 2.1% GBI-EM hedged in S Yield • Global Diversified 633 6.70 4.3% Credit Markets Current Index YTD Return' US high grade Ibp over UST) 240 JPMorgan JULI Poi-folio Spread to Treasury 7.4% Euro high grade (bp over Euro gov) 229 iBoxx Euro Corporate Index 0.6% USD high yield (bp vs. UST) 741 JPMorgan Global Huh Yield Index STW 4.7% Euro Ngh yield (bp over Euro gov) 805 iBoxx Euro HY Index -3.0% EMBIG tbp vs. UST) 411 EMBI Global 7.6% EM Corporates (bp vs. UST) 454 JPM EM Corporates (CEMBI) 3.6% Ounterly Averages Commodities Current 1104 1201 1202 1203 GSC1Index YTD Return' Brent (Sbbl) 107.9 115.0 120.0 120.0 125.0 Energy 6.5% Gold IS.foz) 1724 2150 1925 1875 1850 Preoous Metals 20.6% Copper ("Metric ton) 7518 7250 8250 8500 9250 Industrial Metals -21.5% Corn (Saw 6.13 6.40 6.70 7.00 6.80 Agriculture 17.3% 3m cash YTD Return' Foreign Exchange Current Dec-11 Mar-12 Jun-12 Sep-12 Index In USD EURrUSD 1.35 1.38 1.38 1.40 1.42 EUR 2.2% USIWY 76.9 75 74 73 72 JPY 5.6% GBP/USD 138 1.59 138 1.58 1.60 GBP 1.9% USD'BRL 1.78 1.80 1.80 1.80 1.80 BBL 0.3% USDJCNY 6.36 6.30 620 6.10 6.00 CNY 2.6% USIYKRW 1139 1090 1090 1060 1030 KR? 2.3% USCUTRY 1.83 1.78 1.82 1.80 1.75 TRY -10.4% YTD Return US Europe Japan EM Equities Current (local ccy) Sector Allocation ' YTD YTD YTD YTD (S) S&P 1220 -12% Energy 22% 1.0% •2.5% •112% Nasdaq 2583 -2.0% Materials • 11.7% .23.0% .24.7% •19.9% Topix 720 -18.1% Industrials A.7% •139% .25.7% FTSE 100 5363 .6.0% Disaebonanr 23% -12.4% .23.1% -4.9% MSCI Eurozone* 127 -16.9% Stages 7.6% 1.8% 2.5% -1.2% MSCI Europe' 994 .11.8% Healthcare 6.3% 4.8% -9.7% .21.5% MSCI EM 952 -15.1% Financials .21.2% .27.3% .25.7% -22.0% Brazil Bovespa 56944 .17.8% Information Tech. 2.4% -5.4% .26.2% -133% Hang Sang 18491 -18.0% Telecommunications 02% -1.7% 22% 4.1% Shanghai SE 2417 .14.6% Mites 13.3% •13.3% -47.0% -132% *Levelstrelums as of Nov 17.2011 Overall -1.2% -11.8% -18.1% 45.1% Local currency except MSCI EM Scutt. BkorrEel Dalasteam. IBES, Studird a Pcaes Senion. JP Megan ea trales Nov 18.2011 EFTA01171767  Global Asset Allocation The J.P. Morgan View J.PMorgan Global Economic Outlook Summary Real GDP Real GDP Consumer prices %e.t altar ago %ow previous period. oar %opt a tea, ago 2010 2011 2012 1011 2011 3011 4011 1012 2012 3012 2011 4011 2012 4012 The Americas Unied States 3.0 1.8 1.8 1. 0.4 1.3 2.5 al T 0.5 1.5 25 3.3 3.3 1.5 12 Canada 3.2 2.31 2.1 1 3.6 -0.4 ag T 1.71 2.1 1 2.6 2.31 3.4 2.6 1.6 1.7 Latin America 6.0 4.1 3.01 53 T 4.1 1 13 1 2.0 1.6 4.8 4.9 6.7 7.2 6.4 6.2 Argentina 9.2 7.0 1.01 13.1 10.2 a 2.0 0.0 6.0 4.0 9.7 11.0 10.0 9.0 Brazi 75 3.0 3.1 5.0 3.1 0.4 13 2.9 5.0 53 6.6 6.7 52 52 Chile 5.2 6.5 4.0 5.8 1 5.31 2.6 1 2.5 3.5 4.5 5.0 3.3 3.6 3.6 3.4 Colombia 4.3 5.3 3.7 2.9 8.5 15 1.5 3.0 4.0 5.0 3.0 3.9 3.0 2.9 Ecuador 3.6 6.5 1 3.0 7.1 9.1 aT 1.0 2.0 3.0 1 3.01 4.1 5.5 1 5.3 1 4.6 1 Mexico 5.4 4.0 2.5 2.4 4.5 5.7 2.6 -1.7 4.1 4.8 3.3 3.2 3.5 3.5 Pew 8.8 6.7 4.5 7.3 T 4.6 T 3.7 2.7 4.5 5.0 62 3.1 4.0 3.6 2.7 Venezuela -1.5 3.8 t 4.0 16.0 7 -4.1 1 6.81 3.0 1 6.0 6.0 4.0 24.6 28.6 26.7 25.3 Asiaacifk Japan 4.11 -0.2 t 2.17 -2.77 -1.31 6.0 131 2A7 1.5 13 -0.4 -0.1 -OS t 415 Australia 2.7 1.4 3.5 -3.4 4.8 2.1 2.2 4.1 3.4 4.8 3.6 3.8 3.2 3.3 New Zealand 1.7 2.3 2.8 3.5 0.4 5.7 2.4 -02 6.5 3.7 5.3 2.9 2.2 2.5 Asia ex Japan 9.1 7.01 6.4 9.0 52 6.0 I 5.1 1 6.7 6.9 1 7.1 5.7 4.9 1 4.01 4.01 China 10.4 9.0 8.3 9.0 7.9 7.9 LI 82 82 8.9 5.7 4.8 1 3.6 1 341 Hong Kong 7.0 5.0 3.0 13.0 -1.6 0.4 1.5 35 4.0 5.5 5.2 5.2 4.3 4.5 IndrJ 8.5 7.4 7.7 8.3 12 7.3 7.0 6.9 7.3 85 8.9 8.6 7.6 7.8 Indonesia 6.1 6.3 5.2 6.8 5.4 6.2 5.5 5.0 4.5 5.0 5.9 3.2 3.6 4.0 Korea 6.2 3.8 3.8 5.4 3.6 3.0 4.2 3.0 4.0 4.0 4.2 3.7 3.1 3.5 Malaysia 7.2 4.0 1.5 6.7 1 2.1 1 5.8 I IQ 1.0 1.0 2.0 3.3 2.4 1.5 1.3 Philippines 7.6 4.1 4.0 7.8 2.4 4.1 2.4 2.4 7A 5.3 5.0 4.9 3.9 4.0 Singapore 14.5 4.8 1.5 27.2 -6.5 A -3.9 2.0 6.1 6.1 4.7 5.6 4.0 2.8 Taiwan 10.9 4.4 3.0 14.5 0.6 -1.1 2,5 3.5 43 4.6 1.6 0.9 1 0.71 2.4 Thailand 7.8 1.01 1.5 1 8.1 -0.8 1.8 -25.01 20.0 11.0 1 0.5 1 4.1 3.5 3.9 15 AtrIcaUlddle East Israel 4.8 4.3 2.9 4.71 3.51 3.41 1.3 0.8 32 6.1 4.1 2.8 2.3 2.5 South AHca 2.8 3.1 2.7 4.5 1.3 3.9 2.3 2.6 2.8 4.6 6.2 6.4 6.1 Europe Euro area 1.8 1.6 -0.71 3.1 0.7 091 -IA -1.5 -1.5 -03 2.8 2.9 1.9 T 1.5 Germany 3.6 3.2 1 0.4 T 5.5 1.1 T 3.0 -0.5 -0.3 -0.3 05 2.5 2.7 1.7 1.3 France 1.4 1.6 -0.2 3.8 T -0.2 1 1.5 La -0.8 -0.8 OS 2.2 2.5 ? 1.71 1.3 Italy 1.2 0.5 -1.6 0.5 1.2 14 .5 -2.0 -25 -25 -1.0 2.9 3.8 2.81 1.7 Noway 2.1 2.2 0.7 1.9 4.1 1.5 0.5 0.0 0.0 1.0 IA 1.1 1.2 13 Sweden 5.4 4.1 0.4 3.1 3.6 a 0.0 -0.5 -0.5 0.5 2.9 25 1.1 1.1 linked Kingdom 1.8 091 0.5 1 1.6 0.4 2.0 M1 0.01 -1.5 1 25 4.4 4.6 1 2.61 1.9 Emerging Europe 4.5 4.1 1 2.4 3.6 1.4 [ 3.5 1 1.0 2.7 2.7 321 7.1 6.2 5.6 5.7 Bulgaria 0.2 2.2 1 2S t Czech Republic 2.3 2.0 0.6 3.5 0.3 0.01 -0.3 0.0 0.8 2.0 1.8 1.8 2.5 2.8 Human! 1.2 1ST 0.5 2.07 0.81 2.01 0i 0.0 0.8 IS 4.0 3.7 4A 5.1 Poland 3.8 4.0 2.7 4.5 4.5 A 2.0 2.0 25 3.0 4.6 3.9 2.5 2.7 Romania -1.3 1.5 0.8 8.2 4.0 3.5 35 Russia 4.0 3.6 3.0 3.5 1 0.71 3.51 Et 4.0 35 4.01 9.6 7.1 6.3 7.3 TuMey 9.0 7.0 2.2 5.9 8.3 7.8 6.0 Global 4.0 2.6 2.0 2.71 Jr 3.0 I 1.9 1 131 1.7 2.6 3.7 3.6 2.4 2.2 Developed madels 2.7 1ST IA T 1.1 T 0_81 2.31 121 0.1 0.4 1.41 2.7 2.8 1.5 T 12 Emerging markets 7.3 5.7 4.7 7.2 4,5 4.71 3.6 1 4.7 5.5 T 5.9 6.1 5.7 4.91 4,9 Space JP. /.1,y„ Nov It 2011 6 EFTA01171768 Global Asset Allocation The J.P. 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