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Equity Strategy
Mislav Matejka, CFA
AC
(44-20) 7325-5242mislav.matejka@jpmorgan.com
Emmanuel Cau, CFA
(44-20) 7325-1684emmanuel.b.cau@jpmorgan.comJ.P. Morgan Securities Ltd.
See the end pages of this presentation for analyst certificationand important disclosures.
J.P. Morgan does and seeks to do business with companies coveredin its research reports. As a result, investors should be awarethat the firm mayhave a conflict of interest that could affect the objectivity ofthis report. Investors should consider this report as only a single factor in making their investment decision.
European Equity Research
2
nd
August 2010
 
Key calls
We are positive on equities as:
1. Macro momentum has peaked, but our work indicates that historically equities have continued to advanceover the next 12 months post these peaks. There are similaritiesto ’04 in terms of market volatility during thetransition from lead indicators peaking towards greater clarity regarding the sustainability of recovery.Slowdown in manufacturing is clear, but beyond profit taking at sector level, our 
ISM framework
does notwork as a sell signal for the overall market at this stage.
2. Our 
 Yield curve framework
is still giving a positive signal. Despite last quarter’s flattening, the curve is stillin the top 10% of record steep observations. To get around the problem of zero short rates, we found that the
10y-30y year spread was also a strong indicator of recessions.
Right now it is near record steep, apositive. Historically, it took 29 months between the peak in curve steepness and the next recession.
3.
Interbankstress has reduced markedly
, peripheral bond yields and CDS spreads have moderated.
4.
Profits are on the upturn,
although 2H surprises are likely to slow significantly.
5. Rotation away from inventory rebuild and fiscal support towards
increasing evidence of sustainability of recovery in private demand (capex, labour market, smaller businesses)
.
6.
DM inflation risks minimal
, allowing central banks to remain accommodative for longer, countering theheadwind from fiscal consolidation.
7.
Equity valuations undemanding
in absolute terms and vsother asset classes.
In terms of market catalysts, we think that:1. The fact that a number of key events are now behind us could act to reduce the tail risk that markets arepricing in going forward. US financial regulatory bill was passed, stress tests are behind us, there is moreclarity on Basel3, July was the peak month of Spanish refinancing. The underlying problem is not going away,but at least the hurdles for next few quarters are getting easier.2. Chinese policymakers are turning more market friendly as CPI peaks and economic momentum slows.
Key risks
: “Double dip”near term. We see the five-year outlook to be far worse than the 12-month one.
 
2
 
Key trades and themes
Regional:
1
.
Re-enter EM vsDM exposure:
we started the year OW DM vsEM on the back of adverse EM growth –inflation tradeoff, but two months ago reversed it.
2.
OW Europe vsUS:
European activity is resilient vsthe US; the region is underweight in globalportfolios and attractively priced.
3.
Reducing OW DaxvsEurostoxx50:
OW Germany was our key regional trade this year, but we see itas a crowded call now.
Sectorwise:
Stay OW Cyclicals
 
vsDefensives
-despite their strong outperformance ytd.
Rotate out of crowded, outperforming, expensive cyclicals(
Cap. Goods
downgraded on 27
th
July), asmanufacturing momentum is slowing.
Better risk/reward among non-consensus cheaper cyclical laggards (
Banks/Mining
).
Key longs: Banks, Mining, IT, Discretionary.
Key shorts: Utilities, Pharma
 
.
Themes:
M&A to pick up:
our key theme for 2010 due to strong balance sheets and record low credit yields (seeour 21st June report for details).
Dividend comeback:
we think the recent GE, AAL etc. dividend news is significant; we expect continuedpositive news flow on this front (see our 29th June report for more details).
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