EFTA00598000.pdf

J.P. Morgan Global Asset Allocation Chase Bank NA, Morgan Securities Ltd. Jul 29, 2011 The M. Morgan View Where can you hide? Jan LoeysAc • Economics — A very weak US HI GDP, combined with forecast cuts for India (1.212) 834.5874 and Taiwan, brings our 2011 global growth forecast to 2.8%, which is below the historic average of 3%. John Normand • Portfolio strategy —The falling credit quality of public sectors in Europe (44.20) 7325-5222 and the US is inducing capital to move away as far as possible, to the credit and currencies of smaller DMs, EM, and to commodities. Even Japan is Nikolaos Panigirtzoglou gaining, as its fiscal problems are longer term, its economy is rebounding, and (46.20) 7777-0386 it is so far from Europe and the US. • Fixed Income — Be long duration in EM and in euros (Bunds), under- Seamus Mac Gorain weighting the EMU broad periphery. (44.20) 7777-2906 • Equities — Reporting season is less encouraging in Europe. So far 40% of DJStoxx 600 companies are beating estimates, compared to 78% in S&P500. Matthew Lehmann • Credit — EM and HY remain preferred as they are furthest removed from the (44-20) 7777-1830 crisis in public sector debt. • Foreign exchange — EUR and USD are competing on which is worse. EUR/ USD thus in a range. We stay positive on the G6 and EM, as well as JPY. • Commodities —Gold is the best performing commodity this year. Stay long on flows, momentum and lacklustre economies. YTD returns through Jul 28 %. equities are in lighter Colour. • Equities lurched down again, undoing last week's gains, on the deadlock in Saki Washington. A very weak US GDP report, renewed spread widening in the US High Yield EMU periphery, and some lukewarm earnings reports did not help, but the Emen uninspiring picture in Washington surely trumped it all. Safer, still AAA-rated SKI TR government debt rallied strongly, while credit is largely unchanged this week, and commodities are down 1%. EMS Cap. EM FX • What is likely to happen now and how do you deal with it? Both these ques- US High Grade tions have a near-term and more medium term angle. Over the next week, our SW500 base case remains that Congress will agree to some lifting of the debt ceiling, US Fixed Income but the probability is growing rapidly that we will either get a small hike in the ceiling that buys Treasury just a few months worth of spending, or that Aug 2 EM Local Bonds" passes without any hike in the ceiling at all. The Administration has refused so Gbbal Gov Bonds" far to state what bills get paid first. Our assumption is that coupons and bond MSGI AC work? 0 maturities will get top priority, to avoid a default, and that the government will US cash initially use extra cash and sell liquid assets to pay salaries, social security and medicare. Even excluding its gold reserves — which it would be loath to sell - Europe Fixed Income' - the Federal Government has some S670bn in student loans, TARP assets, IAKI Europe' 0 MBS and foreign cash that it could try to monetize, carrying it to year end, MSG EM' even without a higher debt ceiling. Such a fire-sale would be disruptive and is Topix = unlikely to yield good prices, but the ability to avoid a default and government • -s o S 10 15 shut-down is there. Sainte: Mips. Megan Rekrns n USD. •Local wilency. - 14:kpd ado USD. Etna Fled Intim is tea Omal • Even with a hike in the debt ceiling, we believe it quite likely that the US bin. US HG. Hi. EMIG ad EMS Corp.,MI its 1141 nasal/halt government will lose its AAA rating in coming months. That is because on The certifying analyst is indicated by an AC. See page 7 for analyst certification and important legal and regulatory disclosures. EFTA00598000 Global Asset Allocation The Morgan View J.P.Morgan any compromise between the two sides in Congress, US government debt will 2011 global GDP growth forecasts: JPMorgan and continue to grow faster than GDP for years to come, and growth is set to Consensus remain anaemic. Fiscal policy in 2012-13 will be at its tightest levels in decades, 3.9 even without extra spending cuts coming from any agreement to lift the debt ceiling. 3.7 3.5 • Even as we see no chance of an outright US default next month, the failure to lift the debt ceiling would be highly disruptive, and will have hard-to-foresee 3.3 market implications. This is because most investors are very uncertain on how 3.1 to react The old 'flight-to-quality" trade into US Treasuries clearly makes much less sense now. We are already seeing large outflows from UST-only 2.9 money market funds into bank deposits, exactly the reverse of what we saw 2.7 post Lehman. Given how much world bond and money markets have relied on Jan-10 May-10 Sep-10 Jan-11 May-11 the absolute safety and liquidity of US Treasuries, the shenanigans in Wash- Scum:. Morgan Consensus Ece-orrim Oases Ecenacrid ington are throwing buckets full of sand in the plumbing of the fixed income basis se le regal rd wades hal we astragal sung the markets. This means reduced liquidity, and as yet undetected disruptions. same Sitar ming USD GOP mitts didre La is. Oar Oen grad grovel incest • How does one invest in a world where the global benchmark— US Treasur- 2012 global GDP growth forecasts: JPMorgan and ies — is not perfectly safe anymore? Many market participants feel lost as Consensus their models require the existence a risk-free asset. Given the lack of something safer than USTs, the US market will either just stick with USTs as the risk-free 3.7 assets, or switch to the European practice that uses swaps instead. Our sister publication — Flows & Liquidity — this week brings together our thinking 3.6 on the direct impact of a US downgrade. In a nutshell, we do not see much pressure among bond managers to sell USTs as few have AAA mandates, and 3.5 those with average rating targets would sell other assets. There is likely to be more pressure on money market funds, not from their managers, but from their 3.4 end investors. • More broadly, the weakening credit quality of major government debt markets 3.3 will accelerate an asset allocation away from these weaker credits. The asset Jan-11 Marl May-11 Jul-II Saute: 'Asa Comas Eat Consensus Ecarics classes and regions furthest removed from where the sovereign debt storm is foals me Is. regions and combos dal .e averaged sung the raging — Europe and the US — will benefit the most. This means that USD, same Slew sing USD GDP weirs dal we to Is. all eon Vail growth brat GBP and EUR will weaken further against EMand other DM currencies (the smaller developed). Even Japan is gaining, as its fiscal problems are longer term, its economy is rebounding, and it is so far from Europe and the US. One might think that such credit concerns should similarly hurt US and EU bonds and equities versus the rest of the world, but this logic does not work well. High public sector debt leads to fiscal tightening, low growth and thus easier monetary policy, which boosts bond prices. The weaker currencies and low More details In ... wage growth of these countries by themselves support earnings growth of Global Data Watch. Bruce Kasman and David Hensley their companies who frequently operate on a multinational basis. It is worth overweighting the exporters in the US and Europe. Global Markets Outlook and Strategy. Jan !says. Bruce Kasman. el al. • The circus in Washington and Brussels has taken some attention away from US Fixed Income Markets. Terry Belton and Stini economic data. Until today's US GDP report, activity data were largely in line Ramaswamy with expectations (lowered over past months). But the overall lowering of the Global Fixed Income A4arkets, Pavan Wadlma and Fabio US GDP profile over recent years — a 5.1% contraction during the recession, Bassi and only 5% growth since then — reinforce the malaise around the medium- Emerging Markets Outlook and Strategy. Joyce Chang term US growth outlook. We retain a 2.5% projection for Q3 in the US, but accept a downside risk bias around it. Key trades and risk: Emerging Market Equity Strategy. Adrian Mcwal et al. Flom and Liguithry. Nikos Paniginzoglou el al. Jul 29, 2011 2 EFTA00598001 Global Asset Allocation J.P.Morgan The Morgan View Fixed income and credit US EASI Index Balance of positive minus negative US economic • Bonds rallied strongly around the world on the US debt crisis and weaker US surprises. growth data. Over the longer-term, a US public sector debt and deficits are 40 bearish for USTs. But nearer term, these depress growth and equities, and 30 make any monetary tightening unlikely in coming years. Most investors have 20 no safer alternative to US Treasuries, and will push yields down on an equity 10 sell off, and vice versa. We are bullish volatility in USTs, but have no duration 0 positions on. •10 • In Europe, we move to long duration and underweight the periphery. Most of •20 Europe is going on vacation this weekend, but that will not prevent further •30 funding pressures for the periphery. EU authorities feel they went massively 40 out of their way to satisfy bond investors, and are very disappointed they got •50 only 24 hours of peace. Investors (most in Europe itself) remain unconvinced Jan 10 May 10 Sep 10 Jan 11 May 11 as the EMU member states remain very far from taking joint responsibility for Same.. Yoi9w their fiscal affairs. A unitedEMU stands fall, but divided it will fall. • Credit markets roll up and down with equity markets, but are showing much less volatility and beta to stocks than normal. This suggests that both positions and supply are light. As with other markets, credits most removed from the government debt crisis in the US and Europe will do best. We keep a preference forHY andEM. Equities The rise in government risk spooked equity markets this week. The impasse in debt ceiling negotiations, a high chance of a US rating downgrade and a sharp rise in Italian and Spanish spreads have all created a negative mix for risky markets. But not everything was negative this week. The rise in our US Economic Activity Surprise Activity to positive territory for the first time in almost five months highlights that a capitulation in expectations has already taken place and that it is becoming easier for activity indicators to beat consensus expectations. In our view, this positive message is not cancelled by the disappointment today in the rather backward looking Q2 US GDP report. We thus keep a positive overall stance favouring Cyclical and Commodity sectors. A recovery in global manufacturing is the part of the economic picture we are more confident about. Industrials, Technology and Materials are the sectors most sensitive to manufacturing. Materials remain the US sector with the highest short interest. The US reporting season is coming in better than expected but the magnitude of positive surprises shrank this week. With 302 companies of the S&P500 index having reported so far, the average EPS beat (vs. expectation at the beginning of the reporting month) is 3.7, slightly below the average of previous reporting seasons. Top-line revenues are also beating by an average 1.9% so far, suggesting that US companies arc able to generate decent top More details in ... line growth even in a low GDP growth environment. EM Corporate Outlook and Strategy, Warren Mar el al. • But the reporting season is less encouraging in Europe. So far 40% compa- US Credit Markets Outlook and Strategy. Eric Beinstein et al. nies are beating estimates in Europe within the DJStoxx 600 index, as compared High Yield Credit Markets Weekly. Peler Acaavalli el al. to 78% in the US. This supports our model driven recommendation to OW US European Credit Outlook & Strategy. Steven Dulake et al. vs. Euro area equities — see Panigirtzoglou ct al., Trading the US vs Europe June 24. Jul 29,2011 3 EFTA00598002 Global Asset Allocation J.P.Morgan The Morgan View Foreign Exchange FX weekly change vs USD Despite enormous uncertainties around European and US fiscal policy, the 4% dollar is unchanged trade-weighted this week. The surprise is that many cyclical currencies (commodity FX and EM), which have most to lose from an 3% unimpressive Washington effort, are stronger on the week, and vol premia remain within this year's range. Only short-dated vols evidence stress 2% through their inverted term structure between 1 and 2 week maturities, but then only for a handful of markets such as EUR/USD and EUR/CHF. These 1% patterns suggest some complacency that Aug 2 will pass as a non-event. 0% This pricing seems at odds with the important of next week's decision. Even excluding the extreme scenario of a technical default, Aug 2 will leave four .1% questions unanswered: (I) will an unambitious package trigger an immediate USD EUR GBP JPY CHF CAD AUD downgrade; (2) is a downgrade a vol event for currencies; (3) will fiscal TWI tightening depress US growth as much as it has peripheral Europe's/Urs; and sane: • Atian (4) has Washington's budget process permanently damaged the dollar? "Probably" seems the most reasonable answer to most of these questions, which is why ranges on most currencies but JPY and CHF should persist for another month. Despite events in Spain today (credit watch, early elections), EUR/USD still looks set to remain in the 1.40s. Fiscal issues are enough to inspire reserve manager bids for the currency, even if the majority of private investors see the currency as a clear sell. We've held no directional risk for three weeks, on a view that cyclical and policy offsets would keep markets in a range. Cyclically, Japan's resurgence and impressive US earnings coincide with mixed activity data from Emerging Asia and sluggishness from the US and Europe. Policywise, Europe's great intentions announced at last week's summit face an implementation lag, as well as several unanswered questions from the Washington debate. We will stick with a no-touches for another week to monetise the ranges on USD/CAD, AUD/USD, EUR/GBP and EUR/GBP. Commodities Commodities fell in tandem with other risky assets this week, with losses largely driven by energy. Gold managed to maintain its winning streak with another 1.5% gain and industrial metals outperformed, up around 1%. Copper is supported by the ongoing strike at the world's largest copper mine in Chile, which shows no signs of abating. Gold continues to see strong demand via ETFs with a further $1.2bn inflow this week. The lack of a hike in the US debt ceiling is no doubt supporting gold as investors look for an alternative to the usual safe haven of US Treasuries. The deleterious fiscal situation in both the US and Europe coupled with weaker economic data keep us bullish gold. More details in ... Yesterday, our natural gas analyst lowered his forecast for US gas consider- ably from $5.13 to $4.43 for 2011 and from $5.40 to $4.95 for 2012 (see FX Markets Weekly. John Nomand et at.. Natural Gas Monthly, Scott Speaker, July 28, 2011). In order to comply with Commodity Markets Outlook 8 Strategy. Cohn emissions guidelines, utilities in the US will start to shift to gas-fired power Fenton el al. generators over the coming years but the current level of domestic produc- Oil Markets Monthly. Lawrence Eagles et al. tion growth should easily be able to cope with this increase in demand. Further development of the infrastructure needed to deliver the gas and Metals Review and Outlook Michael Jansen increasing supply means prices will stay below $5/MMBTu over the next Global Metals Ouatteny. Michael Jansen year. Jul 20, 2011 4 EFTA00598003 Global Asset Allocation The Morgan View J.P.Morgan Interest rates Current Sep41 Dec41 Mar-12 Jun42 YTD Return' United States Fed funds rate 0.125 0.125 0.125 0.125 0.125 10-year yields 2.83 3.25 3.50 3.70 3.80 3.5% Euro area Refi rate 1.50 1.50 1.50 1.75 2.00 10-year yields 2.54 2.90 3.10 3.30 3.50 2.3% United Kingdom Repo rate 0.50 0.50 0.50 0.75 1.00 10-year yields 2.86 3.25 3.40 3.60 3.90 4.4% Japan Overnight cal rate 0.10 0.05 0.05 0.05 0.05 10-year yields 1.08 1.10 1.30 1.35 1.40 1.0% GBI-EM hedged in $ Yield Global Diverged 6.79 7.10 22% Credit Markets Current Index YTD Return' US high grade (bp over UST) 149 JPMorgan US Index (JUU) i-spread 5.0% Euro high grade (bp over Euro ow) 183 iBoxx Euro Corporate Index 0.8% USD high yield (bp vs. UST) 567 JPMcogan Global High Yield Index 7.0% Euro high yield (hp over Euro gov) 596 iBoxx Euro HY Index 3.1% EMBIG (bp vs. UST) 299 EMBI Global 6.7% EM Corporates (bp vs. UST) 313 JPM EM Corporates (CEMBI) 5.3% Ouarterry Averages Commodities Current 1103 1104 1201 1202 GSCI Index YTD Return' Brent ($/bbi) 116.7 110.0 115.0 120.0 120.0 Energy 9.5% Gold (Stz) 1624 1650 1800 1800 1750 Precious Metals 13.2% Copper (Welk ton) 9794 9750 10000 10250 9500 Industrial Metals 2.2% Corn ($43u) 6.68 7.20 6.90 7.10 7.40 Agriculture -4.0% 3m cash YTD Return' Foreign Exchange Current Sep-11 Dec-11 Mar-12 index In USD EURNSD t44 1.45 1.48 1.48 EUR 7.4% USDUPY 77.1 79 78 78 JPY 4.4% G8PMSD 1.64 1.59 1.64 1.66 GBP 5.0% USDERL 1.55 1.58 1.6 1.62 BRL 10.8% USD/CNY 6.44 6.35 6.3 6.2 CNY 1.3% USDKRW 1054 1040 1070 1050 KRW 9.2% USD/TRY 1.69 1.57 1.6 1.57 TRY -5.0% YTD Return 2011 US Europe Japan EM Equities Current (local ccy) Forecast Sector Allocation' YTD YTD YTD YTD (S) 1297 4.2% 1475 Energy 13.5% 22% 11.8% 5.0% Nasdaq 2766 4.8% Materials 1.4% -5.3% -4.1% 1.1% Topix 841 -5.2% Industrials 1.0% -5.0% 1.1% 3.5% FTSE 100 5815 0.5% 6600 Discretionary 7.3% 22% -4.5% 11.9% MSCtEurozone' 153 -1.0% 181 Stiles 7.0% 12% 3.9% 6.7% MSCI Europe' 1117 -1.7% 1310 Healthcare 10.0% 82% -2.2% -3.0% MSCI EM 8' 1145 1.3% 1300 Financials -6.3% .5.1% -10.1% 1.7% Braze Bovespa 58683 -15.3% Information Tech. 4.6% 2.8% -13.5% -4.6% Hang Se® 22440 -0.6% Telecommunications L4% 1.3% 6.4% 53% Shanghai SE 2702 -3.8% Utilities 9.1% .1.6% -41.2% 2.1% •Levels/relums as of Jul 28.2011 Overall 42% 4.7% 42% 1.3% Local currency except 1ASCI EM S Sane: Bkavhce Dalasteara SES, Stinivd &Pooes Pi a pan ,!fidlt: Jul 20, 2011 5 EFTA00598004 Global Asset Allocation J. P Morgan The e Morgan View Global Economic Outlook Summary Real GDP Real GDP Consumer prices %veer a ref ago % otc previous period. sae' %oar a ref ago 2010 2011 2012 1011 2011 3011 4011 1012 2012 3012 4010 2011 4011 2012 The Americas United States 3.01 1.81 2.7 0.41 1.31 21 3.0 2.0 3.0 3S 1.2 3.3 3.0 1.4 Canada 3.2 2.8 2.6 3.9 IS 2.4 2.7 2.9 2.7 2.6 2.3 3.2 2.6 1.6 Lan America 6.0 4.6 3.9 5.8 a& 4.7 3.8 3.6 4.0 3.4 6.7 6.8 7.2 7.3 Argentina 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 Brazil 75 4.0 3.8 5.4 4.7 32 3.7 4D 3.5 3.5 5.6 62 6.5 5.7 Chile 5.2 6.5 4.5 5.4 6.0 5.5 3.5 4.5 4.5 4.3 2.5 3.4 4.5 4.0 Colombia 4.3 4.9 4.0 7.7 3.7 4.2 4.5 3.5 4.0 2.7 3.1 3.4 3.0 Ecuador 3.6 4.5 3.5 7.3 2.5 1.5 1.0 3.5 3.5 3.5 3.4 4.1 3.9 3.6 Mexico 5.4 4.5 3.8 2.1 2.1 7.5 4.0 23 4.0 2.0 4.2 3.3 3.4 3.6 Peru 8.8 6.6 5.5 6.6 4.9 3.0 8.0 6.0 5.0 5.0 2.1 2.9 2.8 3.0 Venezuela -1.7 3.5 3.0 14.1 Pi 4.5 3.0 3.0 5.0 6.5 27.3 24.4 29.0 316 AskiPaclfic Japan 4.0 -0.4 3.5 -15 -30 6.0 6.5 3.5 3.0 2.0 0.1 0.2 0.2 0.1 Australia 2.7 1.6 4.6 -4.7 5.2 4.41 5.5 4.6 3.11 4.8 2.7 3.6? 3.8 3.2 New Zealard 1.7 2.2 3.7 3.4 a 3.5 3.7 35 4.6 3S 4.0 5.2 3.3 2.5 Asia ex Japan 9.1 7.3 7.41 9.0 in 6.81 7.71 7.61 7.61 7.5? 4.9 5.7 4.6 4.2 10.3 9.1 9.0 8.9 7.0 L 9.5 9.3 9.1 8.9 4.7 5.7 4.1 3.8 Hong Kong 7.0 5.2 4.6 11.7 434 2.5 5.01 5.81 5.8 4.5 2.8 5.1 5.11 4.31 India 8.5 7.61 8.51 Si 7.61 7.51 7.11 8b4 9.01 951 9.2 9.1? 8.7 7.8 Indonesia 6.1 6.3 6.0 6.9 4S 6.5 6.0 6.0 55 6.5 6.3 5.9 4.5 5.6 Korea 6.2 4.2 41 5.4 3.4? g 4 6.0 4.0 4.5 4S 3.6 4.2 4 3.5 2.7 Malaysia 7.2 3.6 4.3 5.7 :2,5 2.5 5.0 5S 4S 4.3 2.0 3.3 2.8 2.4 Philippines 7.6 4.7 5.5 7.8 a 7.4 6.1 52 52 5.3 3.0 4.8 4.9 3.1 Singapore 14.5 5.2 t 4.3 4 22.5 -4.7 ? 5.3 4.14 4.9 5.3 4.9 4.0 4.7 3.8 t 2.7 Taiwan 10.9 5.04 4.11 19.0 3.6? Li 1 591 52 5.0 4S 1.1 1.6 2.2 2.0 Thailand 7.8 3.1 4.1 8.4 ,2,0 2.0 4.5 5.0 52 4.5 2.9 4.1 3.7 3.6 AtrIcaUlddle East Israel 4.7 4.5 4.0 4.6 a 4.2 4.5 45 4.0 4.0 2.5 4.1 4.0 3.4 South Africa 2.8 3.61 3.71 4.8 2.1 3.6 4 3.5 4 3.61 4.1 1 4.4 t 3.5 4.6 5.8 5.1 Europe Euro area 1.7 1.9 1.8 3.4 1.5 05 1.8 22 2.0 2.0 2.0 2.8 2.5 4 1.6 Germany 3.5 3.4 t 2.1 t 6.1 2.0 1.0 2.5 ? 2.5 2.0 2.0 1.6 2.5 2.4 t 1.51 France 1.4 1.91 1.91 18 0.11 1.0 2.5 ? 2.0 2.0 2.0 1.9 2.2 2.2 1.4 Italy 1.2 0.91 1.3? 0.5 1_81 0.0 1.31 1St 1.5 IS 2.0 2.9 2.41 1.41 Moony 2.1 2.6 2.8 2.4 4.0 2.5 2.5 3.0 2.8 2.8 2.2 1.4 1.6 1.6 Sweden 5.4 4.51 2.71 321 3.9? L5 2.5 3.0 2.8 2.8 1.9 2.9 2.9 2.6 United Kingdom 1.4 12? 2.4 1.9 0.7? 2.0 2.5 25 25 3.0 3.4 4.44 4.84 3.0 Emerging Europe 4.5 4.3 4.31 4.5 1.8 3.9 5.5 4.8 4.3 4.1 6.6 7.2 6.4 1 5.5 1 Bulgaria . 0.2 3.5 4.0 Czech Republic 2.3 2.7 3.0 3.6 2 3.0 3.0 3.5 3.5 3.5 2.1 1.9 2.5 3.3 Hungary 1.2 2.6 2.7 2.8 20 2.0 3.0 3.0 2.5 2S 4.4 4.0 3.9 3.3 Poland 3.8 4.2 3.8 4.1 4.0 4.0 4.5 3.5 3.5 3.5 2.9 4.6 4.1 2.7 Romania -1.3 2.0 4.0 7.9 8.6 5.7 53 Russia 4.0 4.5 5.0 5.1 Q, 4.2 6.5 5.7 5.0 4.5 8.2 9.51 7.74 6.91 Tudev 8.9 5.6 4.3 7.4 6.0 7.1 5.9 Global 3.9 2.81 3.41 2.71 1.7 4 3.2 3.9 3.41 331 3.0 2.7 3.7 3.41 2.5 Developed markets 2.6 ? 1.6 4 2.5 1.01 0.9 1 23 3.0 2.4 2.6 2.8 1.6 2.8 2.6 1.5 Emerging markets 7.3 6.0 5.9 7.4 4bt 5.71 6.21 6.1 1 6.1 1 5.9 ? 5.6 6.2 5.6 5.2 Swrte Morgal Jul 29. 2011 6 EFTA00598005 Global Asset Allocation The e Morgan View 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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