EFTA01136756.pdf

From: US MO <[email protected]> To: Undisclosed recipients:; Subject: Eye on the Market, April 1, 2013: US vs EU Roulette Date: Mon, 01 Apr 2013 13:15:32 +0000 Attachments: 04-01-2013_-_EOTM_-_Roulette-pdf.zip !Mine-Images: image019.png; image004.png; image008.png; image009.png; image010.png; image°1 1 .png; image012.jpg; image013.png; image014.jpg Eye on the Market, April 1, 2013 (PDF is easier to read this week, particularly the Roulette wheel) Topics: American vs European Roulette, rising US equity markets and continued European underpeformance Compared to Europe, the US is running easier monetary and fiscal policy, and playing a game of American Roulette: gambling that eventual withdrawals will take place at a time of higher growth, and will thus be less disruptive. On fiscal policy, after the cyclical increase in tax receipts and decline in unemployment insurance, the US fiscal deficit is projected to be --5.5% by the end of 2013. Assuming the sequester remains in place and interest rates remain low, O3O projects a deficit of 3.7% for 2014 and 2.5% for 2015, with debt stabilizing at —75% of GDP. However, in 2015, mandatory entitlement spending and interest start to grow more rapidly. The US is tabling this issue to another day; US equity markets seem to like the idea. There is evidence that with the help of easy money, the US private sector is recovering. As shown below, household debt service has declined to 1990 levels, and the number of consumers using credit is rising again (from a low base). Modest payroll gains and fewer jobless claims have contributed to rising auto sales and consumer spending; this is a mild surprise given recent increases in payroll and income tax rates. Housing is on the mend (particularly in states wont-hit by the crisis), and inventories continue to decline. Home sales and home prices are rising in most locations, which are driving furniture and building supply sales. By the end of 2013, the % of Americans with underwater mortgages should decline below 20% from 35%+ at the peak. However, housing is improving off such a low base that the contribution to GDP from residential construction is only —0.5%. And while labor markets are getting better, they are not showing the substantial improvement the Fed cites as the criteria for ending its asset purchases. As a result, the Fed is adding to its 50 Trades of Grey ($2.5 trillion of US Treasury and Agency purchases and counting, measured in 10-year equivalents). We expect GDP growth of —2.5% by the end of the year. US household debt service Percent of consumers Increasing debt US vs. European employment Percentof disposable income balances (ex-student loans) Percent change, QoQ, saar 14.0% 4% 13.5% 44% •otyv 13.0% • 40% - 12.5% t ia. 12.0% 36% - 11.5% 32% • 11.0% 10.5% 28% . . . . . . •8% 1980 1990 2000 2010 2000 2002 2004 2006 2008 2010 2012 2007 2008 2009 2010 2011 2012 2013 Source: Federal Reserve Bowl. Source: FR6 of KC. Empirical Research Partners. Source: BLS, Eutostat. US initial jobless claims US auto sales Real Personal Consumption 4-week moving average, thousands Millions, sear Expenditures, 3-mo. % change-annualized 750 22 6% 20 4°o 650 • 18 200 550 • 10 0% 450 14 12 •2% 350 10 -4% 250 8 -6% 2005 2007 2009 2011 2013 2005 2007 2009 2011 2013 2005 2007 2009 2011 2013 Sou ce: DepostmentofLabor. Source: Autodata Source: BureauolEconomic Anabisis EFTA01136756  US housing inventory is steadily AZ. NV. FL & CA: Phoenix rising Fifty Trades of Grey: Fed purchases of declining, Million units Percentchange.YoY Treasuries and Agencies, % of total net 9- 80 20 supply issued On 10-yr equivalents, 6mma) Real estate owned (REO Real estate related 8 60 15 70% employment 7- 10 40 • 60% 6 5 Foreclosure 20 50% 05 4 0 40% 60+ days 3 -20 30% delinquent Building -10 2. 40 - permits • -15 20% Homes for sale -60 I- -20 . . . . . . . 10% 2000 2001 2003 2005 2006 2008 2010 2011 .so -25 0% Source: J.P. Morgan Securities Loan 1991 1995 1999 2003 2007 2011 2009 20 0 20 0 2 20 3 Performance. MBA. Source: BLS. Census. Empmai Reseal% Parings. Source Nomu a Securries .P. h organSec ribs. US business conditions are also improving, after pausing last fall during the elections and fiscal cliff debates. Spending on equipment and software is rising, and durable goods orders are headed in the right direction. Capacity utilization is almost back to normal, and the number of private establishments is growing, a sign that the US private sector has a pulse. Commercial real estate transactions are picking up, along with a revival in securitized lending through commercial real estate and C&I loans. US business spending on equipment Business spending: durable goods US production capacity utilization and software, Billions, Real 2005 USD orders, USD, bn, non-defense ex-aircraft Percent,Mal industry 1,200 - 70-i 85% 1.100 65 1.000 • 80% 900 - 60 800 • 75 700 - 55 :e n r # 600 • 70% • 50 500 V 400 45 65% 1995 1998 2001 2004 2007 2010 2006 2007 2008 2009 2010 2011 2012 2013 2005 2007 2009 2011 2013 Source. Bureau of Economic Analysis. Source Census Bureau. Source. Fed eralReserveBoard Number of private establishments Commercial real estate transaction Gross CLO and CMBS issuance Percentchange, YoY volume is rising, Billions. USD Billions. USD 3.0% 160 250 2.5% 140 20% 200 120 1.5% 100 • CMBS 150 1.0% 80 • CLO 0.5% 100 0.0% 60 -0.5% 40 50 • 1.0% 20 -1.5% 0 0 .Amli 2002 2004 2006 2008 2010 2012 ' 1 '02 '03 ' 4 '0 '0.6 '07 '08 '09 '10 '11 '12 02 03 04 05 06 07 08 09 10 11 12 Source: Bureau of Labor Statistics. Sou c e: Real Ca Rd Analyrcs. Source: Bridgewater. These are the improvements that rallying equity markets anticipated: as shown in the first below, PIE multiples on the S&P 500 rose over the last year despite falling earnings growth. Earnings expectations for 2013 have been falling across most sectors, and may weaken further before year-end; and the ratio of negative to positive earnings guidance is at its highest level in three years. Consequently, the latest positive economic news may be mostly a validation of the market's prior advance. While growth is still weak compared to prior recoveries, the recession that the Economic Cycle Research Institute was so sure about for 2012 never happened. We felt that 2012 and 2013 would be one of those anomalous years when equity markets would do better than what growth conditions alone would imply; this view still seems to be on track as the S&P 500 hits new highs. Better economic conditions may eventually drive households and corporations to reduce their cash holdings, which are still close to the highest levels on record. The Fed won't be making it easy for holders of cash: short-term policy rates may not rise until 2015-2016. Overall, no change to the benign view we outlined for US economics and markets in our 2013 Outlook. EFTA01136757  Multiples rising, earnings expectations falling Lots of cash. everywhere Forward RE ratio 2013 exp earnings growth, YoY Household and corporate cash balances, % of tangible assets 14.0x 13.0% 28 Expected2013 13.5x earnj2s growth 12.0% 13.0x 24 11.0% 12.5x 10.0% 12.0x 20 11.5x 9.0% 11.0x 8.0% 16 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 1952 1962 1972 1982 1992 2002 2012 Some: Bloomberg, Factset. Scarce: FederalReserve. Roulette: the European Version. The $13 billion bailout in Cyprus is small (in 2011, France and Germany made $80 billion of loans and grants to developing countries) and the situation is in many ways unique. However, the latest melodrama reinforces the inconsistent and chaotic nature of EU policy-making. Bondholders, equity investors, bank depositors and citizens of Europe are at risk of unpredictable outcomes as they play Eurozone Roulette. Here's where they might land on any given spin: Depositor confiscation and subordination: The EU eventually backed off, but the initial proposal for Cyprus involved a confiscatory tax on small and large Cyprus depositors, both foreign and domestic, with no loss to senior bond-holders (effectively subordinating the depositors). It was a shocking policy proposal in a region where confidence is everything: uninsured bank deposits range from 45% (Spain, Germany) to 80% (UK, Italy) of total bank deposits. Note: Laiki bank branches in the UK were not subject to deposit withdrawal restrictions, even though their branches in Cyprus were. Zero risk weight applied to sovereign bonds: Even after Greek bonds suffered principal losses, EU banks have the flexibility to use 0% risk weights on EU sovereign EFTA01136758 debt as per "IRB permanent partial use rules", regardless of the country's credit rating. Maastricht Ja/Nein!!!: From the inception of the Maastricht treaty in 1992 to 2008, there was not a single year when both France and Germany were in compliance with Maastricht debt and deficit targets. Today, Southern Europe is pushed to get in line ASAP. Loss of tax rate sovereignty: Throughout all the difficult negotiations and bailouts, Ireland was able to keep its 12.5% corporate tax rate despite pressure from the EU to raise it. No such luck for Cyprus, which is being forced to raise its corporate tax rate from 10%. As far as I know, homogenization of EU personal or corporate tax rates was never a condition for Eurozone membership. Changing protectionsfor senior bank bondholders: There is nothing wrong with bondholders, uninsured depositors or other creditors suffering losses when they are owed by insolvent banks whose asset values are insufficient to cover them. In Ireland however, a bailout was structured to avoid losses on some unguaranteed senior bank bonds which were subsequently repaid (a wealth transfer from Irish citizens to bondholders). In Cyprus, some senior bank bondholders are no longer protected. Tax Haven Designation: Germany's Federal Intelligence Service concluded last fall that an aid program for Cyprus would benefit certain Russian depositors with billions of dollars in deposits in Cyprus, and that "Cyprus is a gateway for money laundering activities in the EU". Fair enough; Cyprus is seen as a personal tax haven. But according to a US Congressional Research Service report in January 2013, tax havens cater to both individuals and corporations. One measure of a corporate tax haven is when foreign sourced profits are very large relative to GDP, such that in the words of the CRS, "profits in these countries do not appear to derivefrom economic motives related to productive inputs or markets, but rather reflect income easily transferred to low-tax jurisdictions". On this measure, Luxembourg leads the pack at 18% of GDP, 2x higher than Cyprus and 6x higher than Switzerland, Singapore and Panama. The degree, time and place of EU concern about tax havens can vary substantially. ECB asserts preferred creditor status: The ECB owned —50 billion Euros of Greek sovereign debt that was not restructured along with the private sector. Typically, preferred creditor status is reserved only for entities like the IMF and World Bank. Proposed bonus caps on stand-alone asset managementfirms and UCITSfunds (including regulated hedgefunds): Because their investment activities played such a large role in the EU sovereign debt crisis? Because they were beneficiaries of official sector deposit insurance and lots of ECB lending? I can't find evidence of either one happening, but maybe I am not looking hard enough. OK, enough about Cyprus. The bigger issue is that long-term growth conditions in Spain, Italy and France are as weak as they have been (other than during wartime) in over a century, as we first showed in October of last year and again last February. The chart below tells the story. While European sovereign debt spreads have rallied across the board, European bank lending to households and businesses is still declining, and the cost of small business loans in Italy and Spain is higher than both real and nominal growth. That may explain why European equity markets [a] are still trailing US counterparts (see table). As for Japan, we had a piece on March 18th that walked through why we believe its equity markets may keep rising this year despite economic data that is still pretty weak: some data is so bad (deflation actually worsened in February) that it may lead to a seismic shift in monetary and fiscal policy. On Emerging Market equities, this year's returns are a disappointment, although over most longer-term time horizons, they have generated better returns. EFTA01136759  Equity market returns by region Year to date 2007-2012 USS Local Cur USS Local Cur S&P 500 10.6% 10.6% 15% 15% MSCI Europe 2.8% 7.1% -5% -4% MSCI EMU -0.6% 2.4% -17% -17% Euro Stoxx -2.8% 0.0% -17% -17% MSCI Japan 11.8% 21.6% -22% -44% Nikkei 9.4% 19.5% -7% -33% MSCI EM -1.8% -0.7% 36% 39% Source: Bloonterg. Data as of March 28. 2013. Michael Cembalest J.P. Morgan Asset Management [a] There are two indices most often referred to as "European equities": the Eurostoxx 50 and the MSCI Europe index. They are quite different. From a constituency standpoint, there is only a 26% overlap in companies included due to the higher concentration and larger capitalization sizes in the Eurostoxx index. The other big difference is that the MSCI Europe index (which has outperformed in recent years) has very large exposures to the UK (34%) and Switzerland (14%), while the Eurostoxx has none. As such, the Eurostoxx is a better measure of the performance of Eurozone (EMU) equities, along with the MSCI EMU (European Monetary Union) index. Current long-term growth rates in France, Italy and Spain: That 19th Century Feeling Change in 7-year real GDP. percent, since 1820; WWI. WWII and Spanish Civil War excluded 60% World Wars: mobilization, destruction & rebuilding — France 50% — italy — Spain 40% 30% 20% 10% 0% -10% 1826 1838 1850 1862 1874 1886 1898 1910 1922 1934 1946 1958 1970 1982 1994 2006 Sources: eStabstica on WorldPopeditio,GDPandPer Capes GDP iverstyolGroningen: Conference Board. Bioombeig. Data as oilFebruery2013. See attached PDF for circled references to prior periods of long-term growth rates below zero. BLS Bureau of Labor Statistics CBO Congressional Budget Office C&1 Commercial & Industrial ECB European Central Bank FRB Federal Reserve Board UCITS Undertakings for the Collective Investment of Transferable Securities EFTA01136760 "Tar Havens: International Tax Avoidance and Evasion", US Congressional Research Service, Jane GraveIle, January 2013 IRS Circular 230 Disclosure: JPMorgan Chase & Co. and its affiliates do not provide tax advice. Accordingly. any discussion ofU.S. tar matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with JPMorgan Chase & Co. ofany ofthe matters addressed herein orfor the purpose ofavoiding U.S. tar- relatedpenalties. Note that J.P Morgan is not a licensed insurance provider. The material contained herein is intended as a general market commentary. Opinions expressed herein are those ofMichael Cembalest andmay differfrom those qfother J.P. Morgan employees and affiliates. This information in no way constitutes J.P. Morgan research and. hould not be treated as such. Further. the views expressed herein may differfrom that containedin J.P. Morgan research reports. The above summary4hicesiquotes/statistics have been obtainedfrom sources deemed to be reliable, but we do not guarantee their accuracy or completeness, any yield referenced is indicative and subject to change. Past performance is not a guarantee offuture results. References to the performance or character ofour ponfolias generally refer to our Balanced Model Portfolios constructedbylP Morgan. It is a proxylar client performance and may not represent actual transactions or investments in client accounts. The modelportfolio can he implemented arrays brokerage or managed accounts depending on the unique objectives ofeach client andis serviced through distinct legal entities licensedfor specific activities. Bank, trust and investment management services areprovided by JP Morgan Chase Bank, NA, and its affiliates. Securities are offered through J.P. Morgan Securities LLC (JPMS). Member NYSE, FINRA and SIPC. and its affiliates globallyas local legislation pennies. Securities products purchased or sold through JPMS are not insuredby the Federal Deposit Insurance Corporation ("FDIC,: are not deposits or other obligations rills bank or thrift affiliates and are not guaranteed by its bank or thrift affiliates: and are subject to investment risks, includingpossible loss ofthe principal invested. Not all investment ideas referenced are suitablefor all investors. Speak with your J.P. Morgan Representative concerning your personal situation. This material is not intended as an offer or solicitationfor the purchase or sale ofanyfinancialinstrument. Private Investments may engage in leveraging and other. peculative practices that may increase the risk of'investment loss, can be highly illiquid, are not required to provide periodic pricing or valuations to investors andmay invoke complex tar structures and delays in distributing important tax information. Typically such investment ideas can only be offered to suitable investors through a confidential offering memorandum whichfully describes all terms, conditions. and risks. High yield bonds are speculative non-investment grade bonds that have higher risk of'default or other adverse credit events which are appropriate for high-risk investors only. Investments in commodities carry greater volatility, than investments in traditional securities. There are additional risks associated with international investing and may not be suitable for all investors. This material is distributed with the understanding that J.P. Morgan is not rendering accounting. legal or tax advice. You should consult with your independent advisors concerning such matters. Bank plladucts and services are offered by JPMorgan Chase Bank, N.A. and its affiliates. Securities are offered by J.P. Morgan Securities LLC. member NYSE, FINRA and SIPC. and other affiliates globally as local legislation permits. In the United Kingdom, this material is approved by.I.P Morgan International Bank Limited (JPMIB) with the registered office located at 25 Bank Street, Canary Wharf. London Elf 5Je registered in England No. 03838766 and is authorised andregulated by the FinancialServices Authority. In addition, this material may be distributed by: JPMorgan Chase Bank N.A. (JPMCB) Paris branch, which is regulated by the French banking authorities Autorite de Combole Prudemiel and Autorite des Marches Financiers: J.P. Morgan (Suisse) SA, regulated by the Swiss Financial Market Supervisory Authority: JPMCB Bahrain branch, licensed as a conventional wholesale bank by the Central Bank ofBahrain (for professional clients only): JPMCB Dubai branch, regulated by the Dubai Financial Services Authority. In Hong Kong, this material is distributed by JPMorgan Chase Bank, N.A. (JPMCB) Hong Kong branch except to recipients having an account at JPMCB Singapore branch and where this material relates to a Collective Investment Scheme (other than privatefunds such as private equity and hedgefinds) in which case it is distributed by J.P. Morgan Securities (Asia Pacific) Limited (JPMSAPL). Both JPMCB Hong Kong branch andJPMSAPL are regulatedby the Hong Kong Monetary Authority. In Singapore, this material is distributed by JPMCB Singapore branch except to recipients having an account at JPMCB Singapore branch and where this material relates to a Collective Investment Scheme (other than privatefunds such as a private equity and hedgefunds) in which case it is distributed by J.P. Morgan (SEA.) Limited (JPMSEAL). Both JPMCB Singapore branch andJPMSEAL are regulatedby the Monetary Authority ofSingapore. With respect to countries in Latin America, the distribution ofthis material may be restrictedin certain jurisdictions. Receipt ofthis material does not constitute an offer or solicitation to any person in anyjurisdiction in which such offer or solicitation is not authorized or to any person to whom it would be unlawful to make such offer or solicitation. Each recipient ofthis presentation. and each agent thereof,' may disclose to anyperson. without limitation, the US income andfranchLve tax treatment and tax structure of the transactions described herein and may disclose all materials ofany kind (including opinions or other tar analyses)provided to each recipient insofar as the materials relate to a LS income orjkanchLve tax strategy provided to such recipient by JPMorgan Chase & Co. and its subsidiaries. Shouldyou have any questions regarding the information contained in this material or about J.P. Morgan products and. ervices. please contact your J.P. Morgan private banking representative. Additional information is available upon request. "J.P. Morgan" is the marketing namefor JPMorgan Chase & Co. Gaits subsidiaries and affiliates worldwide. This material may not be reproduced or circulated without J.P. Morgan.i authority. r)2013JPAlorgan Chase & Co.. All rights. reserved This email is confidential and subject to important disclaimers and conditions including on offers for the purchase or sale of securities, accuracy and completeness of information, viruses, confidentiality, legal privilege, and legal entity disclaimers, available at http://www.jpmorgan.com/pages/disclosures/email. EFTA01136761