JP Morgan Global Markets Outlook and Strategy

Global Asset Allocation
March 7, 2012
Global Markets Outlook and Strategy
The economy Our 2012 global growth forecast remains at an anaemic 2.2%, but PMIs are suggesting mild upside risk. Asset Allocation We remain long equities, EM and credit against safer assets. Of the six drivers of the rally, two are now closer to neutral (positions and risk perceptions), and one has gained (momentum). We analyse the impact of high relative supply of safe assets, cash and govt debt, and conclude equities and credit need to rally some 6% over the coming 12 months just to keep pace with rising cash and govt debt outstanding. The portfolio now includes hedges against oil and inflation. Long-only ETF portfolio We recommend a higher allocation to equities (48%) than bonds (42%). In equities, focus exposure on ETFs that give exposure to DAX, BRICs, US Preferred stocks and among sectors to Technology/Industrials/Energy. In bonds, focus exposure on US HY corporate bond and US TIPS ETFs. Fixed income We hold modest tactical shorts in DM, and select longs in EM local markets, Poland and South Africa. Position for tighter Euro area peripheral spreads, wider inflation breakevens, and a steeper AUD front-end curve. Credit We lower our allocation to outright longs in US HY, US HG and EMBIG, and take more risk on less directional trades on relative price convergence and relative carry-to-risk: Long iTraxx XO vs. CDX.HY, an overweight in EU HY vs. EM $ Sovereigns, and long CDX.HY vs. LCDX. Equities Both the macro and the position support have faded. We keep a positive stance overweighting Cyclical sectors, but we hedge via a long in equity volatility via J.P. Morgans Macro Hedge Index and an OW in the Energy sector. The search for yield should support higher-yielding stocks. Currencies The first signs of currencies delinking from the global risk trade provide opportunities for country-specific exposures. We are therefore long NOK vs. USD, and EUR vs. GBP and NZD. Commodities Seasonally weaker demand over the coming months should see oil prices give back some of their recent gains. We stay long gold on further buying by central banks and retail in EM.
Jan LoeysAC
(1-212) 834-5874 jan.loeys@jpmorgan.com J.P.Morgan Chase Bank NA
Bruce Kasman
(1-212) 834-5515 bruce.c.kasman@jpmorgan.com J.P.Morgan Chase Bank NA
John Normand
(44-20) 7325-5222 john.normand@jpmorgan.com J.P. Morgan Securities Ltd.
Nikolaos Panigirtzoglou
(44-20) 7777-0386 nikolaos.panigirtzoglou@jpmorgan.com J.P. Morgan Securities Ltd.
Seamus Mac Gorain

(44-20) 7777-2906 seamus.macgorain@jpmorgan.com J.P. Morgan Securities Ltd.
Matthew Lehmann
(44-20) 7777-1830 matthew.m.lehmann@jpmorgan.com J.P. Morgan Securities Ltd.
Leo Evans
(44-20) 7742-2537 leonard.a.evans@jpmorgan.com J.P. Morgan Securities Ltd.
Contents
Economic Outlook Market Forecasts Global Market Strategy Long-only ETF portfolio FX Strategy Fixed Income Strategy Credit Strategy Equity Strategy Commodity Strategy 2 6 7 15 17 21 24 26 29
The certifying analyst is indicated by an AC. See page 31 for analyst certification and important legal and regulatory disclosures.
www.morganmarkets.com
JPMorgan Chase Bank David Hensley (1-212) 834-5516 david.hensley@jpmorgan.com Carlton Strong (1-212) 834-5612 carlton.m.strong@jpmorgan.com
Economic Research Global Markets Outlook and Strategy March 7, 2012
Global Economic Outlook Summary

Real GDP
% over a year ago
Real GDP
% over previous period, saar
Consumer prices
% over a year ago
2011 The Americas United States Canada Latin America Argentina Brazil Chile Colombia Ecuador Mexico Peru Venezuela Asia/Pacific Japan Australia New Zealand Asia ex Japan China Hong Kong India Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand Africa/Middle East Israel South Africa Europe Euro area Germany France Italy Norway Sweden United Kingdom Emerging Europe Bulgaria Czech Republic Hungary Poland Romania Russia Turkey Global Developed markets Emerging markets Memo: Global PPP weighted 1.7 2.5 4.3 9.2 2.8 6.3 5.8 8.0 3.9 6.9 4.2 -0.9 1.9 1.7 7.0 9.2 5.0 7.0 6.5 3.6 5.1 3.7 4.9 4.0 0.1 4.8 3.1 1.5 3.1 1.7 0.4 2.7 4.0 0.8 4.7 1.7 1.7 1.7 4.3 2.5 4.3 8.2 2.6 1.3 5.8 3.5
2012 2.3 2.3 3.6 4.5 3.1 4.5 4.5 4.0 3.3 5.0 4.0 1.4 3.1 2.5 6.5 8.4 2.8 7.3 5.2 3.3 3.9 4.3 2.3 2.8 5.1 2.9 2.7 -0.4 0.7 0.1 -1.8 1.4 -0.3 0.8 2.7 1.5 0.5 0.5 3.2 0.8 3.5 2.5 2.2 1.2 5.0 3.2
2013 2.2 2.5 4.0 4.0 4.5 4.8 5.0 4.0 3.5 7.0 1.0 1.3 3.2 2.9 7.2 9.1 4.2 8.0 5.4 4.0 3.2 4.8 3.7 5.1 3.5 4.4 3.6 0.3 1.3 0.3 -0.7 1.8 1.7 1.9 3.5 2.5 1.7 1.5 3.0 2.7 3.7 4.5 2.6 1.5 5.6 3.6
3Q11 1.8 4.2 3.1 4.5 -0.2 2.6 7.1 7.1 5.1 5.3 6.7 7.0 3.9 3.2 6.3 8.4 0.4 7.5 5.9 3.3 6.1 3.4 2.0 -0.2 3.4 3.8 1.7 0.2 2.3 1.3 -0.7 3.1 3.5 2.2 3.5 -0.3 1.6 4.1 7.4 3.5 2.9 2.2 5.0 3.6
4Q11 3.0 1.8 2.3 6.5 1.5 3.0 3.7 1.0 1.7 2.8 3.5 -2.3 1.8 2.9 5.0 9.2 1.6 5.5 9.9 1.4 4.8 3.5 -2.5 -0.6 -36.4 3.2 3.2 -1.1 -0.7 0.9 -2.9 2.5 -4.4 -0.8 4.9 -1.2 1.2 4.5 -0.8 7.0 1.5 0.5 4.3 2.5
1Q12 2.0 2.1 2.9 0.0 2.6 5.0 4.2 2.0 2.5 4.0 6.0 2.2 2.8 1.0 7.3 7.2 3.0 7.7 5.0 3.0 5.0 4.3 4.9 3.3 45.0 0.8 2.3 0.0 1.0 0.0 -2.0 0.0 -0.5 2.0 2.2 0.0 -0.3 2.8 -1.2 3.0 2.4 1.3 5.2 3.3
2Q12 2.5 2.6 5.5 5.5 5.7 5.0 4.5 3.5 5.5 5.0 6.0 1.6 2.9 4.4 6.9 7.8 4.0 7.2 4.5 4.0 2.0 4.9 6.6 4.8 20.0 3.2 2.6 -1.5 0.0 -1.0 -2.5 0.0 -0.5 -1.0 1.2 0.8 0.3 2.0 -1.5 1.5 2.1 0.8 5.5 3.1
3Q12 3.0 2.3 3.9 6.5 5.5 6.0 3.5 4.0 0.6 6.5 4.0 1.2 3.5 2.4 7.4 9.5 5.5 7.7 5.0 4.5 2.0 5.7 2.0 5.8 2.0 6.1 2.8 -0.3 1.0 0.0 -1.5 1.0 0.5 2.5 2.5 2.0 1.0 2.5 0.8 3.0 2.7 1.6 5.6 3.7
4Q12 2.0 2.4 3.5 5.0 5.7 6.0 3.0 4.0 1.0 7.6 -3.0 1.0 3.7 1.8 7.7 10.0 6.0 8.0 5.0 5.0 2.5 4.9 1.2 6.5 0.5 7.4 3.2 0.3 1.0 0.0 -1.0 1.0 1.0 1.5 3.7 2.0 1.5 3.0 2.4 4.5 2.5 1.3 5.9 3.7
1Q13 1.5 2.7 4.4 3.0 4.5 4.5 5.5 4.0 5.0 8.0 0.0 1.2 3.3 1.0 7.3 9.1 3.0 8.3 5.5 4.0 4.0 4.5 4.5 4.5 5.0 4.5 3.8 0.5 1.5 0.5 -0.5 2.0 2.0 2.0 3.3 1.5 1.5 3.0 2.5 4.0 2.5 1.3 5.8 3.7
4Q11 3.3 2.7 7.2 9.5 6.7 4.0 3.9 5.5 3.5 4.5 28.5 -0.3 3.8 2.9 5.0 4.6 5.7 9.0 4.1 4.0 3.2 4.7 5.5 1.4 4.0 2.5 6.1 2.9 2.6 2.6 3.7 0.9 2.3 4.6 6.3 2.4 4.1 4.6 3.4 6.8 9.0 3.6 2.8 5.8 4.1
2Q12 1.9 1.7 6.8 10.0 5.1 3.6 3.6 5.3 4.2 3.3 29.1 -0.2 3.2 2.2 4.1 3.0 4.5 8.5 8.0 3.4 1.5 3.9 4.3 1.3 2.8 2.3 6.0 2.1 2.0 2.0 2.7 0.9 1.1 2.5 4.9 2.7 5.3 3.3 3.3 4.4 8.1 2.6 1.8 4.9 3.2
4Q12 1.5 1.7 6.8 11.0 5.1 3.4 3.3 4.7 4.0 2.4 30.3 -0.1 3.3 2.5 4.1 3.1 3.6 7.8 9.1 3.5 1.3 4.0 3.2 1.7 1.4 2.5 6.2 1.9 1.9 1.7 3.0 1.4 1.1 2.0 5.4 2.9 5.4 3.3 4.4 6.3 6.2 2.5 1.5 5.0 3.1
2Q13 1.4 2.0 7.3 11.0 5.3 3.2 3.0 4.7 3.8 3.0 36.5 -0.2 3.0 2.7 4.4 3.9 3.2 7.6 9.2 3.5 1.4 4.0 3.0 1.2 1.4 2.1 5.9 1.6 1.6 1.4 2.7 1.7 1.5 1.8 5.9 2.5 3.5 2.9 4.0 6.8 7.9 2.5 1.4 5.4 3.1
Note: For some emerging economies, 2011-2013 quarterly forecasts are not available and/or seasonally adjusted GDP data are estimated by J.P. Morgan. Bold denotes changes from last edition of Global Markets Outlook and Strategy, with arrows showing the direction of changes. Underline indicates beginning of J.P. Morgan forecasts. Source: J.P. Morgan
JPMorgan Chase Bank Bruce Kasman (1-212) 834-5515 bruce.c.kasman@jpmorgan.com David Hensley (1-212) 834-5516 david.hensley@jpmorgan.com Joseph Lupton (1-212) 834-5735 joseph.p.lupton@jpmorgan.com
Economic Outlook
Still looking for a sub-par 2.2% annualized gain in
global GDP in 1H12, but risks are shifting.
Chart 1: Global PMI and GDP

DI, sa
61 58 55 52 49 46 43 98 00 02 04 06 08 10 12
Source: J.P. Morgan
%q/q, saar (1Q12 fcst boxed)

All-industry PMI 6 4 2 0 -2
Aggressive policy actions have trimmed downside tail

risks, most importantly in Europe.
Manufacturing bounce is underway and our global PMI

is pointing to 1%-point stronger global GDP growth.
GDP=-21.4 + 0.45*PMI R-sq=0.71
Real GDP
Oil has become the largest near-term downside risk,

but a sluggish consumer in the US is also a concern.
Signs of global lift tempered by oil risk

Since the start of the year, our baseline view has been that the deceleration in global economic activity into the turn of the year would continue in the first half of this year. This outlook has been premised on the belief that the Euro area crisis would be contained but that sufficient damage had been done to push the region into a mild recession and pull the UK to a halt; that the US would decelerate to a 2.2% annualized pace in 1H11 after an inventory-induced jump in 4Q11 returns to more modest final demand growth; and that China would continue to struggle with its real estate adjustment and post a weak 7.5% annualized gain in the first half. Aside from an upward revision to the lift from reconstruction efforts in Japan, our global outlook has not changed much from the last GMOS. We expect global GDP to expand at a 2.2% annualized pace in 1H11, 0.2%-point stronger than in last months GMOS and roughly the same pace set in the second half of last year. These relatively small changes, however, mask bigger movements beneath the surface. First, activity in the manufacturing sector is lifting sharply after contracting outright 3% annualized in the 3 months through November last year, the weakest showing since the global financial crisis. The latest data from Asia reinforce this view. Coupled with a boomy 8.6% gain in the US, global manufacturing output looks set to post a robust 5% annualized gain in the three months through January. To be sure, growth is being boosted temporarily as the damaging effects of Thai flooding fade. The underlying pace is better captured by our global PMI, which is tracking closer to a 2% pace of global IP growth. Still, with last weeks February reading, the manufacturing PMI has increased for three consecutive months and as such confirms an important momentum shift in the global industrial cycle. The second dynamic underway beneath the forecast is a trimming of downside tail risks in response to aggressive policy actions around the world. The ECB has pumped roughly
500bn of net liquidity into the banking sector with its two LTROs, effectively short circuiting a more disruptive credit crunch that had been building last quarter. Also, a credible effort is underway to expand the liquidity hospital to a size that could potentially admit the likes of Spain and/ or Italy. While medium- and longer-term challenges remain, and further writedownsthis time on official sector debtare likely for Greece, the region has stepped away from the brink as the crisis moves to a presumably more manageable chronic stage. At the same time, the extension of low for long through 2014 by the Fed along with additional QE from the BoE and a surprising commitment by the BoJ to target a 1% inflation rate have added to the sense in which G-4 central banks remain intent on backstopping the recovery as fiscal authorities struggle with the timing surrounding their own deleveraging process. In the EM, easing in Chinaalbeit targeted and nothing like in 2009is expected to set the stage for a sharp acceleration in activity later this year. A similar call is set for Brazil, where we continue expect the selic rate to fall to 9.25%.
Global PMIs pose near-term upside risk

The trimming of downside risks to our global outlook is being complemented by our global business surveys, which are underscoring upside risk to our forecast for global GDP to expand 2.2% annualized this quarter. The January-February average of our all-industry PMI output index (a weighted average of manufacturing and services) is now tracking 3.4% global GDP growth. To be sure, the standard error of this relationship is sizable, at 1.4%-point. Still, the upside is broadly based across countries, with the largest discrepancies found in the US, UK, Japan, and Brazil. A smaller, though still positive gap also exists for China. The Euro area forecast is very close to what is implied by the PMI. In addition to its breadth, the lack of any evidence for positive serial correlation in the global PMIs prediction errors of late gives validity to the risk.
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JPMorgan Chase Bank Bruce Kasman (1-212) 834-5515 bruce.c.kasman@jpmorgan.com David Hensley (1-212) 834-5516 david.hensley@jpmorgan.com Joseph Lupton (1-212) 834-5735 joseph.p.lupton@jpmorgan.com
Chart 2: Oil price and retail sales volumes, global

%3m/3m change (fcst assumes $123/bbl)
-30 -15 0 15 30 45 02 03 04 Real retail sales 05 06 07 08 09 10 11 12 Crude oil price
%3m/3m, saar
10 8 6 4 2 0 -2 -4
roughly 10% rise since the start of this year. Although some of this increase reflects shifting expectations about economic growth, the latest move up also likely reflects concerns surrounding a possible oil embargo on Iran. In response to Irans nuclear ambitions, the US and European Union have agreed to impose a set of aggressive sanctions on Iran. In addition to the European plans to curb imports starting in May (roughly 500kbd), the US will impose sanctions, due to take effect at the end of March, that would deny access to the US payments system to anyone that does not show an effort to reduce trading activities with Iran. Companies have begun curtailing trading activities with Iran and there is precautionary stockbuilding in advance of a more adverse scenario. With roughly 16mbd shipped through the Strait of Hormuz, military action that temporarily disrupts flows would produce a material oil price shock. Our analysis suggests that each 1mbd removal of oil supply (sustained for a full year) would raise oil prices by 26% and reduce global GDP by 0.5%-pt. Libyan production is coming on line faster than anticipated and the Saudis suggest they will compensate European countries for Iranian oil as sanctions against Iran take effect. However, recent events illustrates why the oil marketand thus our global economic outlookremains closely linked to Middle Eastern supply risks.
Source: J.P. Morgan
To be sure, recent positive surprises in the January and February PMIs already have had an impact on our 1Q GDP growth estimate. In late January, our 1Q global GDP forecast stood at 1.7%. Since that time, we have raised 1Q forecasts in the Euro area, the UK, Japan, and numerous EM Asian economies. The PMIs played a role in motivating many of these revisions. Put differently, the discrepancy between the PMIs prediction and our own GDP forecast would be 1.7%points, or well over one standard error, had we not already been making GDP revisions. Notably, one place where the upside risk was quite largethe Euro areais where the largest 1Q revision has occurred in recent weeks. One forecast that has not been changed in response to positive PMI surprises is the US. Our US team has access to more timely and accurate expenditure data compared with any other country, and has maintained that 1Q growth will be subpar due to weak growth in consumer spending and a fall-off from last quarters contribution of inventory building. Although we tend to view the PMIs and GDP growth contemporaneously, it is possible that the current, 1Q strength of the PMIs is signaling upside risk for 2Q12. In the US, for example, a host of supply-side indicatorsincluding the ISM surveys, IP, and hours workedpoint to strong GDP growth that seems unlikely to be realized this quarter. If these indicators continue to impress, we may come to believe that they are signaling a much better GDP growth outcome for 2Q12. Alternatively, the stretch of soft expenditure growth could induce a downshift in production and employment growth, much as happened in 1H11.
A cautious eye on the global consumer

In assessing the contours of lift we are keenly focused on the global consumer. The foundation for the turn in global industry was laid last summer by the pickup in consumption as shocks related to commodity price increases and the Tohoku earthquake faded. The restoration of household purchasing power and a rebound in global auto demand helped firms align inventories closer to desired levels. It also provided a pleasant surprise countering growing recession concerns. However, this foundation for lift appears to have weakened in recent months. Following a 5% annualized gain in global retail sales volume from July-October, increases since appear to have slowed to a crawl. The fundamentals for global spending to grow solidly are in place as labor markets continue to improve and confidence is rebounding. Consistent with this view, global auto sales were strong in January and are on track to record another solid gain in February. The combination of rising oil prices and a stall by consumers into the new year concentrates risks on the US but there are good reasons to think that US household spending will rebound. Recent US weakness is concentrated in utilities (related to mild weather) and an unusual dive in gasoline consumptiondevelopments not indicative of underlying trends. There is also positive news in the sustained strength in durable spending (with auto sales barreling further ahead in February), a rise in consumer confidence, and signs that the household saving rate has been broadly stable for more than a year. Against this backdrop, the mantra give them income and they will spend looks to be the right one for forecasting US consumer spending this year. If this weeks labor market forecast is right, it will market the first 4-month period of above-200k on payrolls since the recovery started.
Oil has become a key downside risk

The forecast is not without its downside risks, however. Clearly, events in the Euro area can flare up at any time, as they did last year. Also, the Lunar New Year has made data tracking in Asia very difficult and thus increases uncertainty about our call for a soft landing in China. But the most visible risk at present is the potential for a sharp spike in oil prices. The price of Brent crude oil has moved above $120/bbl for the first time since early May of last year, reflecting a
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JPMorgan Chase Bank David Hensley (1-212) 834-5516 david.hensley@jpmorgan.com Michael Mulhall (1-212) 834-9123 michael.r.mulhall@jpmorgan.com
Central Bank Watch

Official rate Global excluding US Developed Emerging Latin America CEEMEA EM Asia The Americas United States Canada Brazil Mexico Chile Colombia Peru Europe/Africa Euro area Refi rate United Kingdom Bank rate Czech Republic 2-wk repo Hungary Israel Poland Romania Russia South Africa Turkey Asia/Pacific Australia New Zealand Japan Hong Kong China Korea Indonesia India Malaysia Philippines Thailand
1
Current
Chg since
1 1
rate (%pa) 05-07 avg Peak Trough 2.09 2.88 0.58 6.16 7.46 6.07 5.71 1.31 -223 -146 -278 -89 -367 -12 -14 -408 -430 -269 -490 -342 38 -199 24 -191 -189 -444 -160 -19 -174 -6 -300 N/A -265 -439 -58 -164 -482 -15 -542 48 -85 -412 164 -22 -307 -75 -63 -292 -236 -363 -181 -625 -271 -124 -470 -513 -350 -925 -525 -325 -475 -225 -320 -325 -525 -300 -400 -300 -200 -475 N/A -650 -600 -130 -300 -575 -47 -625 -91 -200 -700 -50 -50 -350 -200 -175 45 61 5 144 134 211 143 26 0 75 175 0 450 225 300 37 0 0 0 175 200 100 0 N/A 0 575 54 125 0 0 0 125 125 0 375 100 0 175 63
Last change
Next meeting
Forecast next change
Forecast (%pa) Mar 12 Jun 12 Sep 12 Dec 12 Mar 13 2.08 2.86 0.58 6.11 7.22 6.05 5.71 1.28 1.97 2.70 0.50 5.94 6.83 5.76 5.67 1.22 0.125 1.00 9.25 4.50 4.50 5.50 3.75 1.60 0.75 0.50 0.75 7.00 2.25 4.50 5.25 5.25 5.50 10.00 3.51 4.25 2.50 0.05 0.50 6.56 3.25 5.75 8.25 3.00 4.00 3.00 1.875 1.95 2.68 0.50 5.88 6.83 5.51 5.67 1.22 0.125 1.00 9.25 4.50 4.50 5.50 3.75 1.56 0.75 0.50 0.75 6.50 2.25 4.25 5.25 5.25 5.50 9.00 3.51 4.25 2.75 0.05 0.50 6.56 3.25 5.75 8.25 3.00 4.00 3.00 1.875 1.97 2.70 0.50 5.93 6.83 5.46 5.80 1.22 0.125 1.00 9.25 4.50 4.50 5.50 3.75 1.55 0.75 0.50 0.75 6.00 2.25 4.00 5.25 5.25 5.50 9.00 3.58 4.25 3.00 0.05 0.50 6.81 3.25 5.75 8.25 3.00 4.00 3.00 1.875 1.99 2.73 0.51 5.97 6.83 5.61 5.80 1.24 0.125 1.25 9.25 4.50 4.50 5.50 3.75 1.57 0.75 0.50 0.75 6.00 3.00 4.00 5.50 5.50 5.50 9.00 3.58 4.25 3.25 0.05 0.50 6.81 3.25 5.75 8.25 3.00 4.00 3.00 1.875
Fed funds O/N rate SELIC O/N Repo rate Disc rate Repo rate Reference
0.125 1.00 10.50 4.50 5.00 5.25 4.25 1.83 1.00 0.50 0.75 7.00 2.50 4.50 5.50 5.25 5.50 11.50 3.53
16 Dec 08 (-87.5bp) 8 Sep 10 (+25bp) 18 Jan 12 (-50bp) 17 Jul 09 (-25bp) 12 Jan 12 (-25bp) 24 Feb 12 (+25bp) 12 May 11 (+25bp)
13 Mar 12 8 Mar 12 7 Mar 12 16 Mar 12 15 Mar 12 8 Mar 12
On hold On hold 7 Mar 12 (-50bp) On hold 15 Mar 12 (-25bp) Apr 12 (-25bp)
0.125 1.00 10.00 4.50 4.75 5.50 4.25 1.82
23 Mar 12 23 Mar 12 (+25bp)
8 Dec 11 (-25bp) 5 Mar 09 (-50bp) 6 May 10 (-25bp) 20 Dec 11 (+50bp) 23 Jan 12 (-25bp) 8 Jun 11 (+25bp) 2 Feb 12 (-25bp) 14 Sep 11 (-25bp) 18 Nov 10 (-50bp) 21 Feb 12 (-100bp)
8 Mar 12 8 Mar 12 29 Mar 12 27 Mar 12 26 Mar 12 4 Apr 12 29 Mar 12 Mar 12 29 Mar 12 27 Mar 12
Jun 12 (-25bp) On hold On hold 3Q 12 (-50bp) Mar 12 (-25bp) 3Q 12 (-25bp) 29 Mar 12 (-25bp) 1Q 13 (+25bp) On hold May 12
1.00 0.50 0.75 7.00 2.25 4.50 5.25 5.25 5.50 11.50 3.53
2-wk dep Base rate 7-day interv Base rate Repo rate Repo rate 1-wk repo
Cash rate Cash rate O/N call rate Disc. wndw 1-yr working Base rate BI rate Repo rate O/N rate Rev repo 1-day repo Official disc.
4.25 2.50 0.05 0.50 6.56 3.25 5.75 8.50 3.00 4.00 3.00 1.875
6 Dec 11 (-25bp) 10 Mar 11 (-50bp) 5 Oct 10 (-5bp) 17 Dec 08 (-100bp) 6 Jul 11 (+25bp) 10 Jun 11 (+25bp) 9 Feb 12 (-25bp) 25 Oct 11 (+25bp) 5 May 11 (+25bp) 1 Mar 12 (-25bp) 25 Jan 12 (-25bp) 30 Jun 11 (+12.5bp)
3 Apr 12 8 Mar 12 13 Mar 12 14 Mar 12 8 Mar 12 8 Mar 12 15 Mar 12 9 Mar 12 19 Apr 12 21 Mar 12 Mar 12
2Q 13 (+25bp) 3Q 12 (+25bp) On hold On hold 4Q 12 (+25bp) On hold 2Q 13 (+25bp) 2Q 12 (-25bp) On hold On hold On hold 3Q 13 (+12.5bp)
4.25 2.50 0.05 0.50 6.56 3.25 5.75 8.50 3.00 4.00 3.00 1.875
Taiwan
1. Peak refers to highest rate between 2007-08, trough refers to lowest from 2009-present Bold denotes move since last GMOS and forecast changes. Aggregates are GDP-weighted averages. Source: J.P. Morgan
Global Asset Allocation Global Markets Outlook and Strategy March 7, 2012
Market Forecasts
Interest rates
United States Euro area United Kingdom Japan GBI-EM hedged in $ Fed funds rate 10-year yields Refi rate 10-year yields Repo rate 10-year yields Overnight call rate 10-year yields Yield - Global Diversified Current 0.125 1.97 1.00 1.77 0.50 2.14 0.05 0.98 6.35 Current 199 258 647 832 353 391 Index JPMorgan JULI Porfolio Spread to Treasury iBoxx Euro Corporate Index JPMorgan Global High Yield Index STW iBoxx Euro HY Index EMBI Global JPM EM Corporates (CEMBI) Quarterly Averages Mar-12 0.125 2.50 0.75 2.15 0.50 2.25 0.05 1.15 Jun-12 0.125 2.50 0.75 2.00 0.50 2.10 0.05 1.05 Sep-12 0.125 2.50 0.75 1.95 0.50 2.10 0.05 1.05 Dec-12 0.125 2.50 0.75 1.90 0.50 2.10 0.05 1.15 6.30 0.2% 1.9% YTD Return* 2.9% 3.8% 4.5% 10.9% 5.0% 5.9% -1.0% 0.3% -0.1% YTD Return*
Credit Markets
US high grade (bp over UST) Euro high grade (bp over Euro gov) USD high yield (bp vs. UST) Euro high yield (bp over Euro gov) EMBIG (bp vs. UST) EM Corporates (bp vs. UST)
Commodities
Brent ($/bbl) Gold ($/oz) Copper ($/metric ton) Corn ($/Bu)
Current 124 1684 8287 6.38
12Q1 115 1725 8000 6.70
12Q2 112 1825 8500 7.00
12Q3 120 1900 8875 6.80
12Q4 125 1925 9000 6.30
GSCI Index Energy Precious Metals Industrial Metals Agriculture
YTD Return* 11.6% 9.7% 12.6% 2.0%
Foreign Exchange
EUR/USD USD/JPY GBP/USD USD/BRL USD/CNY USD/KRW USD/TRY
YTD Return
Current 1.34 81.2 1.57 1.76 6.31 1125 1.78
Mar-12 1.30 76 1.55 1.75 6.45 1210 1.75
Jun-12 1.34 76 1.57 1.77 6.35 1080 1.75
Sep-12 1.36 74 1.58 1.78 6.30 1070 1.70
Dec-12 1.38 72 1.60 1.80 6.10 1090 1.65
3m cash YTD Return* index in USD EUR JPY GBP BRL CNY KRW TRY 1.5% -4.6% 1.6% 7.8% 0.3% 3.1% 7.0%
US
Europe YTD 5.6% 15.4% 12.8% 17.3% 3.2% 1.4% 17.4% 11.8% -2.6% 3.9% 9.7%
Japan
YTD 10.2% 14.5% 14.9% 23.1% 7.2% 6.0% 28.7% 13.0% 1.1% 8.9% 13.5%
EM
YTD ($) 22.4% 20.1% 22.7% 13.1% 10.4% 13.6% 19.6% 19.5% 7.3% 16.4% 17.8%
Equities
S&P Nasdaq Topix FTSE 100 MSCI Eurozone* MSCI Europe* MSCI EM $* Brazil Bovespa Hang Seng Shanghai SE
Current 1353 2934 823 5791 141 1086 1041 65729 20628 2395
(local ccy) 10.5% 15.3% 13.5% 7.6% 12.2% 9.7% 17.8% 18.8% 12.6% 8.8%
Sector Allocation *
Energy Materials Industrials Discretionary Staples Healthcare Financials Information Tech. Telecommunications Utilities Overall
YTD 8.4% 12.0% 10.3% 11.7% 1.8% 4.9% 14.9% 16.4% 1.2% -2.7% 10.5%
*Levels/returns as of Mar 06, 2012 Local currency except MSCI EM $
Source: Bloomberg, Datastream, IBES, Standard & Poors Services, J.P. Morgan estimates
6
J.P. Morgan Chase Bank NA Jan LoeysAC (1-212) 834-5874 jan.loeys@jpmorgan.com
Global Market Strategy

Our portfolio remains comfortably long equities and
credit against safer asset classes.
The GMOS strategy and model portfolio

GMOS focuses on cross market, tactical asset allocation across bonds, currencies, emerging markets, credit, equities and commodities. Recommendations are presented in the form of a model portfolio. Strategies focus on a medium-term investment horizon, and deal with asset classes rather than relative value across securities, which are presented by our many sister publications. Any intra-month updates to our strategies are published in the weekly The J.P. Morgan View. We endeavour consistency with our economists and sector strategists, but may have gaps due to differences in timing, investment horizons and hedging. We express trades only in three sizes: small, medium and large, and denote these with one, two and three stars (, and ). For performance measurement, they constitute, $5 million, $10 million and $20 million in value-at-risk.
Of the six drivers of the rally, momentum has

strengthened as volatility has come down.
Defensive positions and falling risk perceptions are now

much closer to neutral as drivers of the rally. Economic forecast momentum remains only slightly positive.
The value driver has lost a bit of its edge as a positive,

but remains strong given the still wide spread to cash and government yields.
We add a new driver of the rally, taken from the

massive excess supply of safe versus risky assets. World equities and credit needs to gain 6% in value this year just to keep up its market share against cash and government bonds.
Chart 1: 2012 J.P. Morgan global GDP growth forecast: J.P. Morgan vs. consensus
% 3.8
The portfolio now includes an OW in energy stocks,

and longs in VIX, and inflation as hedges against the main risks threatening asset reflation. The long risk strategy continued to perform well in February with most riskier asset classes repeating their price gains from January. March is starting dangerously with Tuesday of this week delivering the biggest 1-day loss in equities since November, rudely interrupting the almost straight-line rally of the past three months. This weeks correction took place without a lot of fundamental news, though, aside from nervousness around the Greek restructuring, and thus suggests it reflects largely short-term profit taking. Our overall portfolio strategy remains long risk assets against safer ones cash and government debt. And we continue to add non- or less-directional sectoral and regional relative value allocations to reduce the risk-beta of our portfolio. From this month on, we include also positions that we consider hedges against the directionality of the portfolio. What are the drivers of the long risk position? They are 1. Economic growth: forecasts are showing little momentum, but global PMIs suggest modest upside. 2. Value: still high risk premia, even if lower than last year. 3. Risk perceptions have come down, but can fall more. 4. Momentum on returns and vol is strengthening. 5. Positions: not as defensive anymore, but far from stretched. 6. Massive supply of safe assets versus a little or negative issuance of risky assets.
3.4 3.0 2.6 2.2
Consensus
JPM
1.8 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12
Source: J.P. Morgan, Consensus Economics. Consensus Economics forecasts are for regions and countries that we averaged using the same 5-year rolling USD GDP weights that we use for our own global growth forecast.
Our global growth forecasts for 2012 are unchanged over the past month and are only 0.1% higher than they were six months ago (Chart 1). By now, our projections are flat on consensus. However, global PMIs, which in the past have been the best signal on near-term growth momentum, by themselves are more consistent with about 1% global Q1 growth than our or consensus bottom-up country forecasts (see also pp. 3-4). While hinting at upside, the bullish case for risk assets does not get that much support from economic momentum. Value: Each day a market rallies, it becomes more expensive against longer-term fundamentals. But the longterm deviation means that is at the core of high risk premia in the world, remains fully in place the zero nominal yield on cash and zero real yield on safe government debt in
7
the G4, relative to significantly higher credit and earnings yields. On an outright basis, there is no great value in credit and equities as both HG and HY yields are near or at historic lows, and earnings yields on equities are near historic means. But comparisons with past valuation levels are not of the greatest relevance as investors can only buy what is in store today. Relative value among currently available IRRs is thus the only metric that matters and on this basis, credit and equities remain very cheap against cash and government debt. Risk perceptions have greatly improved over the past three months as Europe sidestepped each of the traps it could have fallen into; US Congress was able to show better compromise on tax alleviation than it displayed before the market fall in August last year; and China has so far maintained its growth pace despite a dramatic contraction in its housing industry. Over the next 1-2 months, risk perceptions will likely not fall as dramatically as they have so far this year, quite likely as market participants have already downgraded the risk of imminent trouble from Europe or the US. And the risk from military conflict around Iran and thus to oil prices has risen. Risk of conflict seems low for Q2, but should rise into Q3. However, every day that we pass without accidents, and every day we move further away from the financial crisis is a day that medium-term risk perception will fade further. Overall, fading risk perception is thus from here only a small contributor to the bullish case for risk assets. Momentum, in contrast, is not weakening, and has become stronger. For asset allocation, we have found that 6 months is the most reliable lookback period, providing the best trade-off between getting in too early and too late into a new trend. Six-month rolling returns on all risky asset classes are now solidly positive and they are coming in with less and less volatility. Defensive positioning among many market participants was a very important driver for our decision in early December to get back into the risk asset class. By now, much of the tactical underweights of risk assets have likely been covered, and converted into mildly overweight positions. Macro hedge funds resisted the first part of the rally, but have since joined the fray (see Charts 1 and 2 in Equity Strategy section). But looking also at still low leverage indicators, it does not feel as if hedge funds are yet fully committed to the rally. Relative supply is a last reason to remain long risk assets, but arguably one of the strongest ones. The main way that end investors can adjust the overall risk exposure of their portfolios is through the relative allocation to safer
8
Chart 2: 2012 YTD returns

%, equities are in lighter colour.
Topix* MSCI EM* MSCI AC World* GSCI TR Gold S&P500 MSCI Europe* EM FX US High Yield EM $ Corp. EMBIG US High Grade EM Local Bonds** Global Gov Bonds** US Fixed Income Europe Fixed Income* US cash
0 4 8 12 16
Source: J.P. Morgan, Bloomberg. Returns in USD except: (H) is hedged into USD, (U) is unhedged in dollars and (LC) is local currency. US HG, HY, EMBIG and EM $ Corp are JPM indices. EM FX is ELMI+ in $.
Chart 3: Global outstandings of bonds, equities, and cash

Feb 12. Govt is the GBI-global index + US MBS and munis + global linkers from the Barcap Multiverse. Equities are the Datastream World equity index. Cash is M2 across the 16 largest countries.
EQUITIES, 43tr
CASH, 59tr
CREDIT, 12tr GOVT, 28tr

Source: J.P. Morgan, Datastream
Chart 4: 2011 USD Change in global stock of equities, bonds and cash
Change in market value in 2011 adjusted for FX and price changes. Govt is the GBI-global index + US MBS and munis + global linkers from the Barcap Multiverse. Equities are the Datastream World equity index. Cash is M2 across the 16 largest countries. $tr 6
5 4 3 2 1 0 CASH
Source: J.P. Morgan, Datastream
GOVT
CREDIT
EQUITIES
versus riskier assets. Chart 3 shows the current portfolio allocation for the global investors, who represent the sum of all investors in the world. We do not adjust for double counting here caused by some intermediaries, such as banks that both issue bonds and hold them. Of $152 trillion in outstandings, only $55 trillion consists of riskier asset classes equities and corporate bonds. Chart 4 shows the relative net supply (issuance) of these assets during 2011. Last year, $6.6 trillion was supplied to the market in the form of cash and government bonds, while less than one eighth of that ($0.8 trillion) was issued in the form of equity and credit. For 2012, we think the relative supply of these assets will be of a similar order of magnitude, although the supply of safer assets will likely be slightly less overwhelming i.e., less than 8 times the supply of riskier assets. QE by major central banks implies continued heavy printing of money. Government deficits are shrinking only slowly. Our analysts expect conventional net supply of G10 government bonds to shrink from $2,051bn last year to $1,711bn this year (Salford and Chordia, Global government issuance 2012, Jan 11). Matching these changes, our US credit strategists expect net issuance of US high-grade bonds to shrink this year to $90bn, from $225bn last year (Eric Beinstein, Credit Market Outlook and Strategy, Feb 24, p. 30). Last year saw $0.3bn of equity net issuance, consisting of about $1tr in IPOs and rights issuance and about $640bn in buybacks. We have no forecasts here, but think it is reasonable to expect similar net issuance of equities this year. Bringing these forecasts together, the new supply of cash and government debt will continue to be orders of magnitude larger than that of equity and credit. The implication of the heavy relative supply of safe versus risky assets is that, all else constant, the increasing scarcity of riskier assets should make them more valuable. If nothing else changes, then end investors will want to keep the risk exposure of their portfolio unchanged. When the supply of safe assets increases relative to riskier assets, then investors have to bid up the price of the riskier assets to keep them at an unchanged allocation versus safe assets. Assuming for the moment the same relative supplies as last year, as a percent of outstandings, then the world value of equities and corporate bonds has to appreciate by 6% over the next year just for them to keep up their portfolio share for the global investor. In sum, of the six factors supporting a long risk portfolio, one has gained (momentum); two remain largely unchanged and strong (Value and relative supply); two have weakened
to almost neutral (defensive positions and falling risk perceptions); and one remains only slightly positive (economic momentum). It is hard to add up these different factors, but our qualitative assessment says we should stay solidly long risk assets. When momentum builds in markets, one should always be on the outlook for adverse events that can change the markets direction. Investors should try to hedge part of the main risks through options or side positions, when such hedges are affordable. We will start with this month including smaller hedge positions against the main adverse events that we can identify and where we think the cost is manageable. Such hedges are ideally done with options, which we will pursue in the future. The most important risk into Q3 is likely a military conflict with Iran over its nuclear program. We thus include in our portfolio an OW in energy stocks, and a long the US equity vol index, the VIX, through the J.P. Morgan Macro Hedge Index. The main long-term risk is that the liquidity machine that is driving asset price reflation stops and is reversed due to a rise in inflation and/or inflation expectations. The large remaining output gap in the world suggests this risk is far away. But the running inflation rate is well above what a simple output gap model would suggest. In addition, central banks and economies are becoming ever more dependent on further QE injections, and may become too confident that these will not create inflation. Market participants have put on inflation hedges after the first QE efforts, but these have not paid off as inflation expectations have remained remarkably stable. We include in our portfolio a long position in both UK and US break-evens, and continue to hold a long in gold. As we have tried in past months, we continue to include positions that we believe have little directionality to risk markets. These include most bonds positions, but in particular those based on our rule-based strategies that can be followed in our Investment Strategies series. A combination of carry and reversal now suggests receiving in 10 years in euros and dollars against CHF and AUD. In equities, these systemic rules using momentum and positions remain long Utilities and Discretionary against Financials and Staples. In credit, they suggest overweighting EU against US HY in CDS, while relative value indicates being long CDX HY against LCDX (loans). In commodities, we go long WTI against Brent futures as the price gap has widened too much.
GMOS performance
Investors who held our recommended positions gained 42bps since last GMOS, on 82bp of ex ante annualized risk, largely due to a bullish position on risk. The largest gains came from longs in US equities, and broad-based credit longs, with US high-yield standing out. Fixed income benefited from cross-country trades, including cross-market shorts in Australia. FX gains were broad-based, with the biggest gain on longs in NOK. Commodities however posted a loss, due to a long in gold.
Performance (cumulative return, basis points)
since last GMOS (1 Feb) Total Equities Bonds Credit Currency Commodity Cross-asset 42 8 7 10 8 -3 12 YTD 88 41 6 15 10 -4 19
J.P. Morgan model portfolio performance

quarterly performance*, bp, not annualized
300 250 200 150 100 50 0 -50 -100 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

* The GMOS performance reported is calculated as of closing on the date of the GMOS publication. Any necessary adjustment for market movements today will be made in the following GMOS, reflected in the YTD GMOS performance. Source: J.P. Morgan
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Trades and overall risk allocation

Overall risk allocation
$mn risk capital on y-axis, directional risk contributions to the portfolio in light grey bars
The GMOS model portfolio

The overall risk, or value at risk, is the annualised standard deviation of the set of trades in each asset class, in $mn. We aim for an average VaR of $100mn over the year, undershooting when we see fewer tactical opportunities in the coming month, and overshooting when we see more. The directional risk, or beta to the market, in each asset class is this total VaR times the correlation of these trades with the market portfolio. The latter means MSCI World in equities, GBI, MBS and Pfandbriefe in Fixed Income, Barcap Multiverse minus the FI benchmark in credit, GSCI in commodities, and DXY in FX.
120 100 80 60 40 20 0
FX Co mm od ity Cr os sas se t om e ies Cr ed To Eq uit He dg Inc
-20
Cross Asset Positions

$mn risk capital on x-axis
Fix
ed
es
tal
it
Trade rationale
Price momentum, value, and the high relative supply (flood) of cash and gov't debt are the main drivers of our overweight in equities, and EM FX against cash and safe gov't debt. Economic momentum is a small positive while positions and risk perception are now closer to neutral.
Long MSCI AC WORLD vs GBI
Long EM FX $mn
10
15
20
Source: J.P. Morgan
Hedges
These trades may be repeated from other sections if there is a fundamental rationale along with the trade being a good hedge. This does not mean the trade size has been doubled. $mn risk capital on x-axis
Trade rationale
Long US & UK 5yr Breakeven Long Equity Volatility Overweight Energy
We will start, this month, including smaller hedge positions against the main adverse events that we can identify, and where we think the cost is manageable. The most important risk into Q3 is likely a military conflict with Iran over its nuclear program. We thus include in our portfolio an OW energy position in equities, and one that is long the US equity vol index, the VIX, through the JPMorgan Macro Hedge Index. We are also long breakevens in the US and UK as well as being long gold to protect against any rise in inflation expectations.
Long Gold
Source: J.P. Morgan
10
15
$mn
20
11
Equity Strategy
Trade rationale
Directional trades
Long MSCI AC World
Momentum, the search for yield and asset reflation should support equities. Convertible bonds will benefit from both the rally in equities and credit.
5 10 15 20 $mn
Long US Convertible Bonds
Country / regional trades
OW MSCI EM$ vs MSCI World$
2-month momentum favoures overweighting EM vs. DM equities. Growth outperformance in Germany and a hedge against any escalation in the Euro area crisis.
OW Dax vs. Eurostoxx
OW SP500 vs. MSCI AC World
Growth outperformance in the US and a hedge against any escalation in the Euro area crisis.
OW MSCI Brics vs. MSCI EM 5 10 15 $mn 20
A more pronounced policy reversal in BRIC countries relative to the rest of EM.
Sector / style trades

Sector momentum & position strategy OW Cyclicals vs Defensives JPM sustainable yield basket vs. EuroStoxx 600 OW S&P preferred stock vs. S&P500 Source: J.P. Morgan
Long utilities and consumer discretionary vs. financials and consumer staples on positions and momentum.
The 2-month change in the global PMI is still positive.
The search for yields should benefit high dividend yielding and preferred stocks.
10
15
20
12
Fixed Income Strategy

Trade rationale
Directional trades
Long South Africa 30y
Due to recent relative underperformance and a supportive budget On falling credit and inflation risk premia, and supportive positions Bonds have not reflected the lessening in tail risk so far this year. Attractive valuations given our inflation forecast, and a hedge for higher oil prices. On the view that the LTRO-fuelled domestic bid can cause peripherals to rally a little further.
0 5 10 15 $mn 20
Long 10YR Poland
Short GBI
Long UK 5yr Breakeven
Long 3Y Spain
Country trades
Long EUR & USD vs AUD & CHF 10y Swap
Based on combined carry and reversal signals.
Curve trades
AUD money market curve steepener 0
Source: J.P. Morgan
10
15
20
With roughly trend growth in prospect, RBA looks unlikely to ease further this year
5 10 15 20
$mn
FX Strategy
Trade rationale
NOK vs USD
Positioning on global growth and continued, demand-driven increases in the oil price.
EUR vs NZD
Hedge for a destabilising spike in the oil price. GBP is at risk from the substantial compression of euro zone credit risk.
0 5 10 $mn 15
EUR vs GBP
Source: J.P. Morgan
13
Credit Strategy
Trade rationale
Directional trades
Long Risk iTraxx Snr Fins
We remain bullish on credit in light of the recent grab for yield, driven by the massive liquidity injections of the LTROs.
OW EMBIG vs USTs
OW US HG credit
OW US HY credit
10
15
$mn
20
Relative Value
Long Risk CDX.HY vs LCDX
OW EU HY vs EM $ Sovereigns
But by scaling back our longs, we take more risk on less directional trades based on relative price convergence and relative carry-to-risk: Long iTraxx XO vs CDX.HY, an overweight in EU HY vs. EM $ Sovereigns, and long CDX.HY vs. LCDX.
OW EU HY vs US HY
Source: J.P. Morgan
10
15
$mn
20
Commodity Strategy
Trade rationale
We remain bullish gold on further buying by EM central banks and EM retail as well as still positive 12-month price momentum.
Long Gold
Long Dec12 WTI vs Dec12 Brent 0

Source: J.P. Morgan
10
15
20
A pipeline reversal later in the year should alleviate the bottleneck that has built up at the WTI pricing point and help reconnect WTI to world oil markets, i.e. Brent.
14
J.P. Morgan Securities Ltd. Nikolaos PanigirtzoglouAC (44-20) 7777-0386 nikolaos.panigirtzoglou@jpmorgan.com
Long-only ETF portfolio

We recommend a modestly higher allocation to equities (48%) than bonds (42%). This compares to neutral or market-cap weights of 43% and 47%, respectively. In equities, focus exposure on DAX, BRICs, US Preferred stocks and Technology/Industrials/Energy among sectors. In bonds, focus exposure on US HY corporate bond and US TIPS ETFs. Overweight gold (7.5%) vs cash (2.5%). This compares to neutral weights of 5% for both. Gold is benefiting from strong EM demand and cleaner positions. Equities continued to outperform bonds. We continue to recommend a higher allocation to equities than bonds, but only modest, by 5%. This modest overweight is justified as both the macro and investor positioning support for risky assets have faded. Indeed, our US Economic Activity Surprise Index is negative. And various position indicators suggest that investors equity exposures continued to rise and perhaps around 50%-75% of the position retrenchment seen between April and September last year has been reversed so far. To protect ourselves against a potential re-escalation of the Euro debt crisis, we continue to OW US equities within our equity portfolio. Within Europe we focus on Germany due to more favourable financial conditions and higher exposure to exporters. Within EM, we focus on BRICs as the latter are benefiting from a more pronounced policy shift from inflation fighting towards supporting growth. Sectorally we prefer to focus on Cyclical sectors and high dividends/income stocks. The 2-month change in the global manufacturing PMI still favours Cyclical sectors. ETFs that track the Technology and Industrial sectors are our preferred Cyclical exposures. The search for yield should allow higher-yielding stocks to outperform. US preferred stocks offer a dividend yield of 6% vs. 2% for the S&P500. Supply limits the downside for oil prices and the Energy sector. Buy ETFs which track the Alerian MLP Index. This index combines exposure to the Energy sector with a dividend yield of close to 5%. Fears that the steady expansion of central balance sheets and the rise in money supply breed inflation problems for the future, justify focus on inflation linked bonds. As a result we overweight ETFs that invest in US TIPS. In addition, the search for yield justifies an OW in HY corporate bonds within the bond ETF universe.
In this section we construct a long-only portfolio among the biggest and most liquid ETFs by incorporating our tactical views across asset classes. This is different from the other GMOS sections where the focus is on long-short trade ideas, many of which are not accessible to long-only investors. Similar to the other GMOS sections, the sizes of these long-only ETF trades are mostly a reflection of our confidence and do not take into account the correlations between the different asset classes. Our long-only portfolio selects among the 100 biggest ETFs by AUM. These include government bonds, HG and HY corporate bonds, commodities and equities of different countries, regions and sectors. Table 2 shows the indices tracked by the 100 biggest ETFs along with the AUM. Our allocation is a two step process. In the first step we decide the overall allocation among main asset classes, i.e. bonds, equities, commodities and cash. The starting point or neutral allocations is currently 43% equities, 47% bonds (based on market capitalizations), 5% commodities and 5% cash. Deviations from the neutral allocation of 5% denote low confidence, of 10% denote medium confidence and of 20% denote high confidence. In the second step, within the equity or the bond portfolio, we construct an equally weighted portfolio of the equity or bond ETFs based on the regions/countries/sectors we feel more confident about, as explained in the other GMOS sections. Our overall allocation is shown in Table 1.
Table1: Our preferred portfolio
Weights in %. In this publication we do not recommend any specific ETF. We rather recommend exposure to indices tracked by ETFs.
Equity funds S&P US Preferred Stock Index DAX MSCI BRAZIL FTSE/XINHUA CHINA 25 Alerian MLP Energy Index S&P500 Technology Sector S&P500 Industrial Sector Bond funds US TIPS US HY Corporate bonds US Aggregate Index Commodity funds Gold Cash
Source: J.P. Morgan
Allocation Neutral Strategy 48% 43% 6.9% 0.2% OW US/ OW High DY Stocks 6.9% 1.5% OW DAX 6.9% 1.4% OW BRICs 6.9% 3.8% OW BRICs 6.9% 5.7% OW Energy/OW High DY Stocks 6.9% 4.2% OW Cyclical sectors 6.9% 5.7% OW Cyclical sectors 42% 47% 14.0% 2.0% OW inflation linkers 14.0% 2.6% OW HY credit 14.0% Broad Bond Index exposure 7.5% 2.5% 5% 5% OW Gold UW cash
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Table 2: Indices tracked by the 100 biggest ETFs along with the total AUM invested in these ETFs
Equity index S&P 500 Index MSCI Emerging Markets Index MSCI EAFE Index Nasdaq 100 Index DAX Index MSCI US Broad Market Index S&P Mid Cap 400 Index Nikkei 225 Index Topix Index Russell 2000 Index Russell 1000 Growth Index DJ Eurostoxx 50 Index DJ Industrial Average Index Russell 1000 Value Index Hang Seng Index MSCI Brazil Index MSCI REIT Index (Div Yld 3.3%) DJ Select Dividend Index (Div Yld 3.3%) Mergent Dividend Achievers Select Index (Div Yld 2.0%) S&P HY Dividend Aristocrats Index (Div Yld 3.1%) S&P IT Select Sector Index Amex Gold Miners Index MSCI Us Prime Market 750 Index S&P 500 Energy Sector Index S&P Small Cap 600 Index US Utilities Select Sector Index (Div Yld 3.9%) FTSE/Xinhua China A50 Index S&P 500 Growth Index Russell 1000 Index FTSE/Xinhua China 25 Index MSCI Us Prime Market Growth Index Russell Mid Cap Index FTSE All-World Ex-Us Index US Financial Select Sector Index DAX Global Agribusiness Index Mexbol Index S&P Consumer Staples Select Sector Index MSCI Japan Index FTSE 100 Index MSCI Canada Index S&P 500 Value Index Russell 2000 Value Index US Health Care Select Sector Index MSCI Us Small Cap 1750 Index Swiss Market Index S&P Industrial Select Sector Index Alerian MLP Index (Div Yld 4.8%) Russell 2000 Growth Index MSCI US Mid Cap 450 Index TSEC Taiwan 50 Index MSCI World Index S&P 100 Index MSCI Pacific Ex-Japan Index Russell 3000 Index MSCI South Korea Index SSE50 Index DJ U.S. Real Estate Index CAC 40 Index Bond index Barclays Us Aggregate Index Barclays Us Treasury Inflation Notes Index iBoxx $ Liquid IG Index iBoxx $ Liquid HY Index Barclays 1-3Yr Treasury Index Barclays Brothers HY Very Liquid Index Barclays 1-3Yr U.S. Credit Index S&P U.S. Preferred Stock Index (Div Yld 6.1%) Barclays 1-5Yr Govt/Credit Index Barclays 20+ Yr Treasury Index Barclays 7-10Yr Treasury Index Barclays Intermediate US Credit Index Barclays US MBS Index iBoxx Liquid Corporates Index JPMorgan EMBI Global Core Index Commodity Gold Silver Commodity Index Source: J.P. Morgan. Note: AUM as of Feb 29, 2012 16 AUM ($bln) 137.2 93.0 45.5 29.2 23.0 20.5 19.5 16.5 15.9 14.9 14.8 13.9 12.3 11.8 10.5 10.3 9.8 9.7 9.5 8.7 8.6 8.5 8.5 8.1 7.3 7.2 6.7 6.6 6.6 6.5 6.3 6.3 6.2 6.2 6.0 5.7 5.6 5.3 5.3 4.7 4.3 4.3 4.0 3.9 3.7 3.7 3.7 3.7 3.4 3.4 3.4 3.4 3.3 3.3 3.3 3.2 3.1 3.1 AUM ($bln) 29.1 22.6 18.0 12.3 10.9 9.8 9.2 7.6 7.5 6.2 4.7 4.6 4.2 3.7 3.6 AUM ($bln) 162.3 9.7 5.7 Exchange NYSE/ASX/London/Frankfurt NYSE/ASX/London/Frankfurt NYSE/ASX NASDAQ Frankfurt NYSE NYSE/ASX Osaka/Tokyo Tokyo NYSE/ASX NYSE EN Paris/Frankfurt NYSE NYSE Hong Kong NYSE NYSE NYSE NYSE NYSE NYSE NYSE NYSE NYSE NYSE/ASX NYSE Hong Kong NYSE NYSE NYSE/ASX NYSE NYSE NYSE NYSE NYSE Mexico NYSE NYSE/ASX London NYSE NYSE NYSE NYSE NYSE SIX Swiss Ex NYSE NYSE NYSE NYSE Taiwan London/Frankfurt CBOE NYSE NYSE NYSE/ASX Shanghai NYSE EN Paris Exchange NYSE NYSE NYSE NYSE NYSE NYSE NYSE NYSE NYSE NYSE NYSE NYSE NYSE London/Frankfurt NYSE Exchange NYSE/London/Tokyo/SIX Swiss/Frankfurt NYSE NYSE Region USA/EMEA USA/EMEA USA USA EMEA USA USA APAC APAC USA USA EMEA USA USA APAC USA USA USA USA USA USA USA USA USA USA USA APAC USA USA USA USA USA USA USA USA LATAM USA USA EMEA USA USA USA USA USA EMEA USA USA USA USA APAC EMEA USA USA USA USA APAC USA EMEA Region USA USA USA USA USA USA USA USA USA USA USA USA USA EMEA USA Region USA/APAC/EMEA USA USA Asset Class Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Equity Asset Class Debt Debt Debt Debt Debt Debt Debt Debt Debt Debt Debt Debt Debt Debt Debt Asset Class Cmdty Cmdty Cmdty Sub Sector US EM EAFE/Europe US Germany US US Japan Japan US US Europe US US HK Brazil US US US US US US US US US US China US US China US US Global ex-US US Global Mexico US Japan US Canada US US US US Switzerland US US US US Taiwan Global US AUS, HK, NZ, SG US South Korea China US France Sub region US US US US US US US US US US US US US Europe EM Sub Sector Gold Silver Diversified
J.P. Morgan Securities Ltd. Paul MeggyesiAC (44-20) 7859-6714 paul.meggyesi@jpmorgan.com
Global FX Strategy Global Markets Outlook and Strategy March 7, 2012
FX Strategy
The correlation between G10 exchange rates and risk
markets continues to weaken, reflecting the lessening in systemic risk and the resultant re-emergence of currency-specific factors as drivers of exchange rates (i.e. interest rates, terms of trade). This decorrelation is likely to result in more tactical trade opportunities in coming weeks.
Chart 1: The average beta between G10 currencies and equity markets has fallen sharply, indicating that local stories are more influential now that systemic Euro area risk has dissipated
Average beta from pair-wise regressions of G10 FX/USD against the S&P500. Daily returns, 1-month rolling window. A positive beta indicates that the G10 currencies on average appreciate vs USD when equities rally, and vice versa
0.6 0.5 0.4 0.3 0.2 0.1 0.0 -0.1 -0.2 -0.3 -0.4 Apr-02
Source: J.P. Morgan
Our long euro basket has suffered over the past

week whereas we had emphasised the currency positive impact of reduced credit stress, the market has reacted to the interest-rate negative consequences of the ECB's second LTRO.
Reduce euro longs in recognition of the currencys

impaired interest rate support (take profits on EUR/USD) but stay long EUR/NZD as a hedge to a supply-driven spike in the oil price and short EUR/GBP just ahead of its stop.
Apr-04
Apr-06
Apr-08
Apr-10
Chart 2: Equity betas have fallen for many currencies, not only EUR
Betas from 1-month, pair wise regressions of G10 FX/USD against the S&P500.
Stay short USD/NOK as a core trade on global growth

and continued, demand-driven increases in the oil price. The dollar may be spared QE3 but it is hard to see the dollar recovering on a trend basis without the realistic prospect of Fed tightening. The dollar is not morphing into an investment currency.
0.6 0.5 0.4 0.3 0.2 0.1 0.0 -0.1 -0.2 -0.3 -0.4 Nov-11
Source: J.P. Morgan
Closed trades: Take profits on long EUR/USD. Stay short USD/NOK, long EUR/NZD and long
EUR/GBP, all in cash. Hold a USD/JPY 1x2 put spread (this is now a very cheap anti-risk hedge). For anybody, and that surely is everybody, who has despaired of the debilitating tyranny of the 'risk-on, risk-off' paradigm, whereby a view on virtually all currencies boiled down to a single view on the prospects for risk, the last few weeks have offered the tantalising prospect of exchange rates starting to move once more on independent, countryspecific factors. Charts 1 and 2 highlight how the unusually tight linkage between exchange rates and equity markets has loosened in recent weeks following the removal, or at least reduction, in euro-centric systemic tail risk, not to mention the increase in global economic momentum. Yen depreciation is the most striking but by no means only example of an idiosyncratic move: 1) Petro-currencies continue to reap the benefits of terms of trade gains (this remains a low volatility, and hence benign, run-up in the oil price); 2) the euro, contrary to our expectation, has struggled in the immediate aftermath of the second LTRO as the negative impact of additional liquidity on short-term interest rates has overpowered the positive benefits from a
CAD AUD Dec-11 Jan-12
EUR NZD Feb-12
further reduction in euro credit risk; 3) dollar-bloc currencies have benefited from meaningful improvements in front-end interest rate support (chart 3), reflecting leverage to the US (Canada) and a still robust domestic economy which in the absence of a Euro area collapse is unlikely to warrant further monetary easing (Australia). Of these trends we have been on the right side of oil for quite a few weeks (a sizeable basket long in NOK which we scaled back last week to a sole position in USD/NOK) but on the wrong side of the euro this week. In hindsight we underestimated the impact which the second injection of three year liquidity would have on front-end rate spreads, or at least the significance which the FX market would attach to this shift in rate differentials rather than the more positive
17
ramifications for the euro of the significant reduction in credit risk (10Y BTP yields have slumped by 55bp this week). We are scaling back euro longs this week, in recognition of this move in rates, but suspect that the euro should find its feet next week should the ECB fail to cut interest rates whilst simultaneously downplaying the prospects for LTRO v3.0 (as Chancellor Merkel emphatically did today, adding key political support to the Bundesbank President who himself has aired deep misgivings about the LTRO strategy). Hence we are staying long of EUR/GBP and EUR/NZD this week even while taking profits on EUR/USD. EUR/NZD can also be seen as a defensive hedge to any form of disruptive spike in oil prices that starts to adversely impact our NOK exposure. As for the dollar generally, our strong inclination is still to regard this as a funding rather than investment currency. Acceleration in US growth is a necessary but by no means sufficient condition for a trend recovery in the dollar. The key remains with Fed policy the dollar doubtless took some encouragement from Bernankes Congressional testimony this week, which omitted any discussion of future policy easing, but policy tightening remains a dim and distant prospect. Without the prospect of higher policy rates for a good two years, it is hard to see how a deficit and debtor currency can sustain a meaningful appreciation (chart 4). Tactically the dollar might get another boost should next week's labor data reveal another meaningful drop in the unemployment rate but we are not convinced that there is sufficient upside to justify buying the dollar.
Chart 3: Interest rate differentials remember those? The fading of systemic risk means that more traditional fundamentals such as rate spreads have a greater chance of influencing exchange rates. The euro needs the ECB not to cut next week in order to stabilise
2Y swap rates, change over 1-week and 1-month
40 35 30 25 20 15 10 5 0 -5 -10 -15 EUR JPY USD CHF GBP SEK NOK CAD NZD AUD
Source: J.P. Morgan
1 week
1 month
Chart 4: The dollar may be spared QE3 but a further recovery in USD TWI still requires an implausible reappraisal of short-term rate expectations. It takes a 25bp rise in 2Y swaps to lift USD by 2.75%.
100 USD TWI 95 90 85 US-G10 2Y spread 2 1.5 1 0.5 0 -0.5 -1 80 75 70 Jan-06 -1.5 -2 -2.5 -3 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12
Trades Take profits on long EUR/USD. Stay long euro vs

GBP and NZD The euro was undermined this week by the contrast between the ECB, which was eager to pump an extra EUR 300bn of liquidity into the banking system, and the Fed, which increasingly is reluctant to countenance further stimulus of its own (chart 5). The ECB's liquidity injection may not be dislodging inflation Euro area expectations but it has nonetheless weakened the euro through the more the direct channel of softer front-end rate spreads (chart 3). We certainly under-appreciated this effect but are reluctant to embrace a view that the ECB actions have condemned the euro to a life as the G10s chief funding currency. We are locking in (reduced) profits on a long EUR/USD position initiated the other side of the Greek bail-out but keep long euro exposure versus sterling and kiwi dollar. The ECB meeting next week is key for the currency a rate cut or any nod towards further long-term liquidity injections would be punished by the market. Conversely, steady rates and an attempt to dispel speculation of further LTROs should
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Source: J.P. Morgan
help to steady the ship. As for EUR/GBP, we still believe that GBP is at risk from the substantial compression of euro zone credit risk. Foreign investors were renewed buyers of Gilts in January but this does not disprove the hypothesis that as a safe haven currency GBP is vulnerable from capital outflows as credit risk recedes. In addition, the market is strangely indifferent to the reality of the BoEs QE, which as a percent of GDP is larger than the ECBs two LTRO operations (chart 6). Take profits on long EUR/USD. Bought Jan 27 at 1.3120. Closed at +0.8%. Stay long EUR/NZD bought Feb 24 at 1.6050, marked at -1.3%
Stay long EUR/GBP. Bought Feb 24 at 0.8480, now worth -1.8%.
Stay short USD/NOK

Last week we cut back our NOK exposure on the basis that the higher the oil price goes, the closer it gets to the inflexion point beyond which investors start to worry about the implicit tax on economic growth and consequently shy away from cyclical assets, including petro-currencies. We argued that this threshold was still some 5-10% away, so kept a residual NOK long vs USD. That the oil price has cooled by a few dollars this week should if anything be read as supportive for the current levels of NOK as even petro-currencies can have too much of a good thing. Stay short USD/NOK sold Feb 13 at 5.7210. Marked at 1.9%.
Chart 5: The ECBs LTRO injected additional liquidity worth around 3% of Euro area GDP. While we have emphasised its positive impact on the euro through a reduction of credit risk, the market is putting more emphasis on the negative impact through nominal interest rate differentials. The euro needs Draghi to downplay the prospects of LTRO v 3.0, otherwise this weeks sell-off could well extend.
1.60 1.55 1.50 1.45 1.40 1.35 1.30 1.25 1.20 Jan-08 -15% Jan-09 Jan-10 Jan-11 Jan-12 -10% -5% EUR/USD Fed-ECB balance sheet, % GDP 0%
Hold USD/JPY 1x2 put spread

The market has embraced with enthusiasm the triple themes of structural current account compression, more aggressive BoJ easing, and funding currency status, to the extent that the yen is now highly oversold on virtually all crosses. This undervaluation should start to support the yen, especially as the Treasury market remains firmly within its range parameters and year-end repatriation flows remain within the pipeline. And even if an independent recovery in the yen fails to materialise, this trade can still be seen as a cheap hedge to the possibility that risk markets succumb to fatigue. Hold a 6-mo 76-72.50 USD put/JPY call spread in 1x2 notional. Cost 0.15%, worth 0.13%.
Source: National central banks; J.P. Morgan
Chart 6: The market may be obsessed by ECB balance sheet expansion but it remains curiously apathetic about the BoEs QE. The scale of the BoEs asset purchases since October exceeds the new cash injected by the ECBs two LTROs. Relative balance sheet expansion is now supportive of EUR/GBP
EUR/GBP 0.95 BoE-ECB balance sheet, % GDP 0.0% -2.0% 0.9 -4.0% 0.85 -6.0% -8.0% 0.8 -10.0% 0.75 Jan-08 -12.0% Jan-09 Jan-10 Jan-11 Jan-12
Source: National central banks; J.P. Morgan
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J.P. Morgan Securities Ltd. John NormandAC (44-20) 7325-5222 john.normand@jpmorgan.com Paul MeggyesiAC (44-20) 7859-6714 paul.meggyesi@jpmorgan.com
J.P. Morgan FX Forecasts vs. Forwards & Consensus

Exchange rates rates vs. Exchange vs. U.S dollar U.S. dollar Current Majors EUR JPY GBP AUD CAD NZD JPM USD index DX Y Mar 7 1.31 80.8 1.57 1.06 1.00 0.82 81.3 79.8 Mar 12 1.30 76 1.55 1.06 1.00 0.80 80.7 79.8 Jun 12 1.34 76 1.57 1.08 0.98 0.82 79.3 78.0 Sep 12 1.36 74 1.58 1.10 0.96 0.84 78.9 76.7 Dec 12 1.38 72 1.60 1.08 0.98 0.82 79.2 75.7 JPM forecast gain/loss vs Dec-12* forward rate 4.9% 11.7% 1.7% 5.6% 2.9% 2.4% Consensus** 7.2% 8.3% 2.3% 6.4% 2.7% 2.1% Actual change in local FX vs USD Past 1m o 0.0% -5.2% -0.6% -1.6% -0.6% -1.9% 1.3% 0.9% YTD 1.3% -4.8% 1.2% 3.4% 2.0% 5.2% -1.5% -0.5% Past 12m os -5.6% 2.4% -2.7% 4.6% -3.0% 10.5% 2.1% 3.8%
Europe, Middle East & Africa CHF ILS SEK NOK CZK PLN HUF RUB TRY ZAR Am ericas ARS BRL CLP COP MX N PEN VEF LACI Asia CNY HKD IDR INR KRW MYR PHP SGD TWD THB ADXY EMCI Exchange rates vs Euro JPY GBP CHF SEK NOK CZK PLN HUF RON TRY RUB 106 0.835 1.21 8.91 7.44 24.85 4.16 296 4.36 2.35 39.06 99 0.840 1.21 8.90 7.70 24.50 4.15 290 4.37 2.28 38.94 102 0.855 1.21 8.95 7.65 24.50 4.12 290 4.40 2.35 39.17 101 0.860 1.20 8.90 7.60 24.50 4.10 285 4.35 2.31 40.03 99 0.865 1.20 8.80 7.55 24.30 4.10 285 4.35 2.28 40.66 6.5% -3.1% 0.2% 2.5% 0.0% 2.5% 4.7% 7.7% 2.1% 9.4% 0.2% 1.0% -4.6% 4.3% 0.6% 0.2% 2.7% 1.6% 3.2% -0.8% 0.1% -1.8% 0.92 3.81 6.79 5.67 18.93 3.17 225 29.75 1.79 7.66 4.34 1.77 493 1781 12.67 2.68 4.29 110.1 6.31 7.76 9118 50.3 1125 3.03 42.92 1.26 29.54 30.78 117.0 98.7 0.93 3.75 6.85 5.92 18.85 3.19 223 29.96 1.75 7.40 4.50 1.75 530 1950 12.80 2.75 4.30 108.8 6.25 7.76 8950 48.0 1120 3.00 42.00 1.23 29.25 30.75 116.6 99.2 0.90 3.70 6.68 5.71 18.28 3.07 216 29.23 1.75 7.60 4.60 1.77 510 2000 13.20 2.80 4.30 107.3 6.20 7.75 8900 47.0 1080 2.97 41.50 1.21 29.75 30.25 119.6 99.9 0.88 3.65 6.54 5.59 18.01 3.01 210 29.43 1.70 7.70 4.80 1.78 490 1950 12.80 2.75 4.30 108.5 6.20 7.75 9250 50.0 1070 3.00 43.00 1.24 31.25 30.50 121.1 100.0 0.87 3.65 6.38 5.47 17.61 2.97 207 29.46 1.65 7.70 4.90 1.80 480 1900 12.00 2.72 4.30 110.8 6.10 7.75 9480 48.0 1090 2.98 42.50 1.23 31.50 30.75 121.1 101.91 3.4% 0.1% 0.5% 10.2% 4.7% 3.1% 2.0% 2.3% -6.9% 1.4% 0.4% 0.4% -7.0% 1.5% -0.9% 0.5% -1.4% -0.1% -7.1% -1.7% 5.1% 5.5% 7.5% 4.9% 7.5% 9.8% 12.9% 5.1% 14.8% 3.8% 1.7% 3.6% 5.9% -3.8% 10.9% -1.0% -0.1% 11.9% 3.3% 7.9% 7.5% 10.1% 9.0% 10.6% 5.3% 7.3% 1.0% 1.0% -2.2% 3.9% -1.4% 6.5% 0.4% 11.7% 0.1% -2.4% -1.0% 2.6% 0.4% 0.2% -1.0% 1.2% -1.6% -1.4% 0.0% -2.5% -2.7% 0.4% -2.4% 0.5% 0.0% -1.9% 0.0% -0.1% -1.4% -2.4% -0.4% -0.3% -0.8% -1.0% 0.1% 0.6% -0.4% -1.0% 2.2% 0.0% 1.4% 5.4% 4.3% 8.6% 7.9% 8.0% 5.8% 5.7% -0.8% 5.5% 5.4% 8.9% 7.4% 0.8% 0.0% 5.4% -0.2% 0.1% -0.5% 5.5% 2.5% 4.6% 2.2% 2.8% 2.5% 2.5% 1.6% 5.8% 1.9% -6.1% -6.3% -1.5% -7.8% -10.0% -13.0% -5.0% -11.1% -10.2% -7.1% -6.5% -3.6% 6.0% -7.5% 3.5% 0.0% -5.2% 4.1% 0.3% -3.6% -10.3% -0.6% 0.1% 1.3% 0.5% -0.5% -1.4% 0.2% -5.6%
Actual change in local FX vs EUR -5.2% -0.6% 0.1% -1.0% 2.6% 0.4% 0.2% -1.0% -0.2% -1.6% 1.2% -6.0% -0.2% 1.0% 0.0% 4.0% 3.0% 7.2% 6.6% -0.7% 4.4% 6.8% 8.4% 3.1% 7.9% -0.7% 4.3% -2.3% -4.7% -7.8% -3.8% -5.8% 0.6%
indicates rev ision resulting in stronger local FX , indicates rev ision resulting in w eaker local FX * Negativ e indicates JPM more bullish on USD than consensus,** Consensus Economics Publication: Foreign Exchange Consensus Forecasts Feb 2012 Source: J.P.Morgan Source: J.P. Morgan
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J.P. Morgan Securities Ltd. Seamus Mac GorainAC (44-20) 7777-2906 seamus.macgorain@jpmorgan.com
Fixed Income Strategy

We are modestly bearish on duration in DM, as
bonds have not reflected the lessening in tail risk so far this year.
Hold select longs in EM local markets, focussing on

South Africa and Poland.
As discussed on p. 7, GMOS focuses on global tactical asset allocation. In this section, we focus on medium-term asset allocation across G10 and EM rates markets. More short-term and detailed recommendations are presented in our sister publications, US Fixed Income Weekly, Global Fixed Income Markets Weekly, Emerging Markets Outlook and Strategy, and EM Top Trade Ideas.
Chart 1: Three-month high-low range of DM 10-year yields
Per cent, average of 3-month high-low range for 10-year US Treasuries, German Bunds and UK gilts. 2
Position for steeper AUD money market curve,

higher inflation breakevens, and tighter Euro area peripheral spreads.
Tight ranges for outright yields highlight the

importance of cross-market signals in generating market-neutral returns. We hold duration longs in EUR and USD 10yr swaps vs AUD and CHF, on combined carry and reversal signals. Bonds are about flat on the month. The strongest start to a year for global equities since 1998, even after this weeks setback, has left bonds largely unmoved, and maintaining the tightest ranges in recent times (Chart 1). This is the third time in the past few years that bonds have not followed a sharp equity rally (Chart 2). The 2010 bond-equity divergence, sparked by the onset of QE2, was resolved by a sharp backup in yields towards the end of the year. But after the 2009 divergence, also fuelled in part by easier monetary policy, bonds held their gains. We think bonds offer little value to investors with longterm time horizons. For example, 5-year USD swap rates, five years ahead, are a shade above 3% (and at similar levels in EUR and GBP). By comparison, the FOMCs expectation of the Fed Funds rate in the longer run is 4-4.5% nominal, or 2-2.5% real. Thus, even before accounting for Libor-OIS spreads and term premia, at face value the forward curve prices a considerable likelihood of prolonged Japan-like stagnation. Our tactical view on duration is modestly bearish, reflecting the fact that bonds have not reflected the lessening in tail risks so far this year, especially in Europe. Even so, we do not expect a sharp near-term move higher in yields, with monetary policy remaining so supportive. Quite apart from flooring short-term yields, central banks have been pushing down longer-term rates explicitly via QE, while low short-term rates encourage investors to extend duration in search of carry, to the same effect. Underlying our mildly bearish duration view is the expectation that Euro area concerns will remain on the back burner for the immediate future. Spains increase in
1.75 1.5 1.25 1 0.75 0.5 0.25 0 90 92 94 96 98 00 02 04 06 08 10 12
Source: Bloomberg, J.P. Morgan
Chart 2: Global equities vs government bond yields

Index Per cent
400 350 300 250 200 150 09

Source: Bloomberg, J.P. Morgan
3.25 MSCI World (LHS) 3 2.75 2.5 2.25 GBI Global yield (RHS) 2 1.75 10 11 12
its deficit forecast to 5.8%, with the previous 4.4% target unrealistic against the backdrop of economic contraction and a big deficit miss last year, highlights that the regions structural problems will take a long time to resolve. But for the near term, the balm of LTRO-fuelled domestic bank demand should support the periphery, biasing intra-EMU spreads tighter.
21
Indeed, after taking roughly a net 114bn of borrowing from the first LTRO, Spanish and Italian banks bought close to 70bn of domestic government debt in December and January alone. We think that Spanish and Italian banks also accounted for around half the net new borrowing in the second LTRO (i.e. a net 80bn each). The solid foreign demand for peripheral bank debt issuance this year also testifies to the thawing in financing conditions (Chart 3). Even at this late stage, the Greek PSI remains uncertain. We expect participation to be high enough to push through the PSI, but low enough that collective action clauses are invoked to apply the restructuring to holdouts (see Pavan Wadhwa, Handicapping potential outcomes of the Greek debt restructuring, 6 Mar).
Chart 3: Foreign buying of peripheral bank debt

Per cent of book taken by foreign buyers for a range of 2012 issues, bonds ordered left to right by pricing date 100%
80% 60% 40% 20% 0% Santander Intesa Sabadell BBVA Caixa Intesa MPS Unicredit BPE
Source: Bloomberg, J.P.Morgan
Small duration short in DM (), select longs in EM

local bonds (South Africa, Poland) () As discussed above, we have a mildly bearish outlook on DM duration. EM local bonds have backed up a little from near-record low yields, thus underperforming DM over the past month (Chart 4). Foreign inflows into EM bonds have picked up this year, after a lull in late 2011, but are heavily tilted towards hard currency rather than local currency bonds (Chart 5). The thrust of monetary policy remains supportive, though higher EM currencies and oil prices reduce the room to ease at the margin. We stay selectively long in EM local markets (and thus also OW vs DM). Focus longs on Poland (on falling credit and inflation risk premia) and South Africa (on recent relative underperformance, and a supportive budget). See Mike Trounce, EMEA EM :Local Market Strategy, 5 March, for details.
Chart 4: EM and DM government yields
Per cent 7.5
3.25 EM local bonds (LHS) DM government bonds (RHS)
2.75
6.5
2.25
6 Jan-10
Source: J.P.Morgan
1.75 Jul-10 Jan-11 Jul-11 Jan-12
Chart 5: Monthly flows into EM bond funds

$bn. See Trang Nguyen and Laura Bierer, EM fixed income flows weekly, for details
Position for a steeper AUD money market curve ()

AUD short rates have been rising over the past month, since the RBA surprised the market by not easing. We look for the money market curve to continue to disinvert, with the RBA requiring a material softening in the outlook to ease further, and thus likely to remain on hold for the rest of the year, despite this weeks surprisingly weak GDP print. See Sally Auld, The Antipodean Strategist, for details.
8 6 4 2 0 -2 -4 -6 08
Source: EPFR, J.P.Morgan
Hard currency Local currency
OW Euro area peripheral via 3yr Spain CDS ()

We are biased to a further narrowing of credit and liquidity premia in the Euro area, though the very strong rally in recent months has diminished the upside significantly. We recommend selling protection on Spain (with CDS spreads having lagged the narrowing in cash),
22
09
10
11
12
and also expect two-year swap spreads to narrow, reflecting the unprecedented excess liquidity in the money market.
Chart 6: Cumulative return of reversal and carry strategies

Index, 1995 = 100 600
Long UK 5yr inflation breakevens ()

We are broadly positive on breakevens, consistent with a bullish view on risk, and bearish view on duration, but also because of the tail risk of an oil price spike, as Middle East tensions remain high. Hold longs in UK 5yr breakevens, whose valuation looks attractive against our inflation forecast.
500 400 300 200 100 0 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Source: J.P. Morgan
Combined Reversal
Carry
Long duration in 10yr EUR and USD swaps vs short

in 10yr CHF and AUD swaps, on combined carry and reversal signals () Range-trading markets highlight the importance of crossmarket strategies in generating market-neutral returns. One such strategy which has been consistently profitable (including over the past year) is cross-market carry: overweighting markets with steep curves against those with flat curves (see Nikolaos Panigirtzoglou, A crossmarket bond carry strategy, March 2006). Another consistent pattern in cross-market bond returns is that markets which have underperformed recently tend to outperform subsequently, as some cross-market divergences reflect temporary factors such as issuance, positioning, or short-lived economic divergences. One way to take advantage of this pattern is to overweight markets whose curves have steepened most over the recent past, against those whose curves have flattened most. That avoids positioning for mean reversion when large moves in long-term yields are matched by similar movements in short-term yields, suggesting that monetary policy fundementals are behind the move, and so that it is more likely to persist. (That is less so, however, when movements in short rates are very limited, as in the G-4 at present). Combining the carry and reversal signals would historically have produced a risk to return of 1.2, net of transactions costs, across 10-year DM swaps (Chart 6). At present, the combined signal argues for duration longs in EUR and USD vs shorts in AUD and CHF.
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J.P. Morgan Securities Ltd. Leo EvansAC (44-20) 7742-2537 leonard.a.evans@jpmorgan.com
Credit Strategy
We lower our allocation to outright longs, US HY,
US HG and EMBIG, and take more risk on less directional trades that look to exploit relative value on either a carry-to-risk, or price convergence, basis.
Chart 1: Februarys Total Returns

The black bars are Februarys returns, the dark blue bars are Januarys returns and light blue bars are the historical average return for February. %
7 6 5 4 3 2 1 0 EU High Yield EM $ Sov. US High Yield EM $ Corp. EU High Grade US High Grade
We add a rule based, co-integration strategy for

trading EU HY vs. US HY via CDS. The strategy currently suggests to be long risk iTraxx XO vs. CDX.HY.
We overweight EU HY corporate bonds vs. EM $

Sovereigns on more attractive carry-to-risk. EU HY credit offers twice the expected income for a lower volatility of realized returns.
Source: J.P. Morgan, Bloomberg, Markit
We open a long position in CDX.HY vs. LCDX as

we believe the recent overperformance of LCDX is overdone. Spreads continued to move tighter through February and a grab for yield has clearly taken place across fixed income and credit markets. Similar to January, the risk-on mood has benefited the higher beta sectors in credit: European HY, EM $ Sovereigns and US HY did particularly well (Chart 1). The major driving force has of course been a dramatic reduction in perceptions about systemic/tail risk via the LTROs which has given investors both the confidence, and need, to adjust their holdings towards these higher yielding assets. Our move from a medium-beta risk profile in January to a full risk-on (high-beta) stance last month saw good gains in the credit portfolio. We remain bullish as the aforementioned credit-supportive forces are still firmly in place, but choose to scale back the amount of risk in our outright directional trades, and add some relative value overlays, given that a significant spread compression has already taken place. These new trades are based on relative price convergence and relative carry-to-risk. Relative price convergence: we add Euro HY vs. US HY in CDS based on the results of a statistically motivated co-integration trading rule. We also add US HY vs. US HY Loans in CDS, where we look for the recent underperformance of CDX.HY vs LCDFX to correct. Relative carry-to-risk: Euro HY vs. EM $ Sovereigns, as suggested by our carry-to-risk metric (Chart 2). Carry-to-risk gives a measure of the expected return per unit of realized risk for a sector and thus highlights the most attractive sectors for income.
24
Chart 2: Carry-to-Risk in Credit

Spread - expected credit loss / 12-month vol. of excess returns. Credit losses are defined as S&Ps rating transition probability, from the average rating of the index to default, multiplied by 1 - 40% recovery. Excess returns are defined relative to similar duration governement bonds.
1.25 1.00 0.75 0.50 0.25 0.00 EU HY US HG US HY EM $ Corp. EU HG EM $ Sov.
Source: J.P. Morgan, Bloomberg
Chart 3: Future US HY upgrades likely to outnumber downgrades

Moodys + S&Ps downgrade watchlist additions / Moodys + S&Ps upgrade watchlist additions. Data is quarterly.
3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Mar-02
Sep-04
Mar-07
Sep-09
Mar-12
J.P. Morgan Securities Ltd. Leo Evans AC (44-20) 7742-2537 leonard.a.evans@jpmorgan.com
Directional Trades Overweight in US HY vs. USTs ()

50 basis points of tightening through February meant solid gains for this trade, and HY demand remains an important theme in risk markets on the back of three months of inflows. Going forward, the key metrics we track 1) trailing default rates (1.9%) 2) corporate credit metrics and 3) watchlist ratios (a measure of future rating actions) are all looking healthy. The latter measure is pushing towards the decade-long lows recorded in 1Q11 (Chart 3). US HY is also one of the more attractive sectors on a carry-to-risk basis (Chart 2) and we stay overweight.
Chart 4: Rule based strategy suggests long EU vs US HY via CDS

The blue lines are the one-standard-deviation confidence interval on the level of the iTraxx XO based on CDX.HY. The strategy goes long iTraxx XO vs. CDX.HY if the iTraxx spread is greater than the model implied spread and short if it is below it. Bp
1300 1100 900 700 500 300 100 Aug-06
CDX.HY Implied Spread
iTraxx XO Spread
Overweight in EMBIG vs. USTs ()

As we suggested last month, EM $ Sovereigns had been lagging the credit rally due to heavy issuance in January, but the asset class made up ground through February as we anticipated (Chart 1). The pace of the rally in EM assets has waned this week, but we believe a bullish stance is still warranted. Policy support remains accommodative and technicals have been improving. EM bond funds have seen 9.9bn of inflows YTD, 86% of which have been to hard currency funds.
Feb-08
Aug-09
Feb-11
Overweight in US HG vs. USTs ()

HG spreads fell 20bp in February despite heavy supply of $90bn, testament to the strong demand for the asset class. Credit fundamentals remain solid, although some deterioration occurred to revenue growth in 4Q11. Importantly though, interest expense is stable as companies are replacing higher coupon debt with newly issued lower coupons and we look for spreads to tighten towards our 175bp spread target.
are likely short-lived and profitable to bet against. We test a monthly strategy that uses rolling 2-year regressions to give a one standard-deviation confidence band for the level of iTraxx XO based on the level of the CDX.HY. The strategy goes long (short) if iTraxx XO is above (below) the bands and holds the position until it falls back within them (Chart 4). Since 2003, the strategy has traded 10 times, held a position for an average of 2 months, given a mean holding period return of 1.5%, a success ratio of 67% and an information ratio of 0.8. The signal currently suggests long risk in iTraxx XO vs. CDX.HY
Open: Long risk CDX.HY vs. LCDX (2:1 ratio) on

relative price convergence () CDX.HY has underperformed LCDX recently, with CDX.HY trading about 46bp wider, and LCDX 19bp tighter, since Feb 23. The usual trading relationship is 1bp to 0.7bp, suggesting LCDX is about 35bp too tight. This trade is positive on both carry and slide, and benefits in the case of default of a reference entity in the LCDX that is not in the CDX.HY.
Sell protection on iTraxx Senior Financials ()

The positive impact of term liquidity provided via LTRO II keeps us OW Senior Financials, as Euro banks have likely used ECB funds to retire some of their existing liabilities, a bullish force for senior debt.
Sector Trades Open long risk in iTraxx XO vs. CDX.HY on relative

price convergence () Historically EU vs. US HY has exhibited a negative beta to credit markets as US HY was the more volatile market. This trend reversed in 2011 as concerns about Europe drove risky asset prices down, and European HY credit down more so. The subsequent risk-on mood has seen Euro HY significantly outperform YTD. Given that these assets have historically exhibited strong co-integration in the CDS space, deviations from a historical relationship
Open Overweight EU HY corporate bonds vs. EMBIG

on relative carry-to-risk () On a carry-to-risk basis, EU HY (including financials) is the most attractive sector and EM $ sovereigns is the least attractive. EU HY offers twice the expected income (7.2% vs. 3.4%) for a lower volatility of realized returns (6.6% vs. 8.9%). On a volatility-weighted basis, this trade is positive carry.
25
Equity Strategy
Both the macro and the position support have faded.
We keep a positive stance, but we hedge via longs in equity volatility.
Chart 1: Macro HF beta to equities

21-day rolling beta of HFRX Macro HF beta index vs. S&P500
0.8 Macro HF: beta to S&P500 0.6 0.4 0.2 0.0 -0.2 -0.4 Jan-10
Our PMI signal, i.e. the 2-month change in the

Global Manufacturing PMI overall index, is still pointing to an overweight in Cyclical vs. Defensive sectors.
We continue to like the longer theme of OW high

dividend yield stocks. The search for yield should allow higher-yielding stocks to outperform. In the US, OW S&P US preferred stock vs. S&P500 index. In Europe, OW the J.P. Morgan European Sustainable Yield Basket vs. STOXX Europe 600.
Jun-10
Nov-10
Apr-11
Sep-11
Feb-12
Source: Datastream, J.P. Morgan
As hedges, we introduce an OW in the Energy sector

via the Alerian MLP index and a long in equity volatility via J.P. Morgans Macro Hedge Index. The equity rally continues. The S&P500 hit a new postcrisis high of 1374 last week. The macro support has somewhat faded due to negative surprises in US economic data. Indeed, our US Economic Activity Surprise Index is negative. But globally, the macro picture is better and our PMI signal, i.e. the 2-month change in the Global Manufacturing PMI overall index, is still pointing to an overweight in Cyclical vs. Defensive sectors (see REVISITING: Using the Global PMI as trading signal, N. Panigirtzoglou, Jan 12). The position factor is also fading. Most position indicators suggest that investors equity exposures continued to rise and perhaps around 50%-75% of the position retrenchment seen between April and September last year has been reversed so far (Charts 1 and 2). The rise in oil prices has started raising concerns, though, as investors remember the negative impact that the spike in oil prices had on the real economy a year ago. The 15% rise in oil prices over the past few months is not yet comparable to the more than 50% rise seen between Sep 2010 and Mar 2011, but an escalation of Iran tensions is a serious risk worth hedging. So while we keep most of our trades and a bullish bias in our portfolio, to protect our portfolio for example from higher oil prices or potential re-escalation of the Euro debt crisis, we introduce two hedges:
Chart 2: CFTC spec position indicator

Net spec position is USD amount of long positions minus short positions across a range of futures contracts; including commodities, equities, bonds and currencies. The net positions are aggregated and scaled by open interest. The chart shows this scaled difference between net positions in risky minus safe haven assets. 0.5
0.4 0.3 0.2 0.1 0.0 -0.1 -0.2 Jun-06
Mar-07 Dec-07 Sep-08 Jun-09
Mar-10 Dec-10 Sep-11
1) Overweight Energy () The Energy sector has provided a good hedge to last years spike in oil prices. In our sectoral recommendations, we prefer to combine Energy sector exposure with high dividends via the Alerian MLP Energy Index. This index tracks the performance of the 50 most prominent Energy Master Limited Partnerships. Like REITs, these companies enjoy tax advantages and typically distribute most of their earnings as dividends. As a result the Alerian MLP Index offers a dividend yield of 5%. 2) Longs in equity volatility () The problem with simple long VIX strategies is that they have a negative carry which over time becomes problematic. A way to avoid this
26
negative carry is to hedge via the J.P. Morgan Macro Hedge Index (JPMZMHUS Index). This index picks up premium through its short exposure to the 1st month along the VIX futures curve, yet allows for tail risk protection through its long position in the 2nd month. It takes off the short leg opportunistically and systematically.
Chart 3: MSCI BRICs vs. MSCI EM

Relative total return index based on MSCI $ indices
105 100 95
DIRECTIONAL TRADES Keep long in MSCI AC World ()

See discussion in the cross asset section.
90 85 80 Dec-07
MSCI BRIC vs. MSCI EM total return index
Keep long in US Convertible Bonds ()

Convertible bonds posted another gain in February. We stay long as US Convertible bonds are still at the bottom of the 2-year range vs. the S&P500. Convertible bonds are hybrid instruments with debt and equity-like features. As an asset class they benefit from both the rally in equities and credit. But their low beta to equities means that they are more suited for investors who have no strong directional view on equities or appetite to take pure equity risk, and instead look at investing in bond-like equities, i.e. midway between equities and bonds.
Oct-08
Aug-09
Jun-10
Apr-11
Feb-12
Chart 4: MSCI World Cyclicals vs. non-Cyclicals

Relative total return index based on MSCI World$ sector indices.
65 60
Global PMI
150
130
REGIONAL ALLOCATION OW DAX vs. Eurostoxx50 ()

This trade continued to print money with DAX outperforming Eurostoxx50 by more than 6% YTD. The lifting of the short sale ban in bank stocks in France, Italy, Spain and Belgium is helping this trade not only by making it easier to implement directly, but also by removing the incentive to use the DAX as a selling vehicle during periods of stress. The main reason it underperformed by so much last August was the introduction of the short sale ban which forced sellers to use the DAX to express a negative view on Euro area equities.The escalation of the euro debt crisis remains a serious risk for 2012, reminding us of the importance of having peripheral hedges in an equity portfolio. Overweighting DAX vs. Eurostoxx50 is such a hedge. Although this trade works well as a hedge against Euro peripheral risk, the main motivation for this trade is 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. German exports are cushioned by their large exposure to EM, even if a recession materialises.
55 50 45 40 35 98 00 02 04 06 08 10 12 Global Cyclicals vs. NonCyclicals 90 110
70
inflows into EM equity fund flows in January/February vs. outflows in December and November. YTD EM equity funds have seen inflows of $21bn vs. outflows of $34bn in 2011. Positive flow momentum, coupled with still positive 2month return momentum, keeps us with an OW in MSCI EM vs. MSCI World.
OW in MSCI BRICs$ vs MSCI EM$ ()

The shift in EM policy priorities from inflation to growth is more pronounced in BRICs, including China. BRICs have been underperforming steadily since the end of 2009, mostly due to overheating and tightening fears. These fears are gradually fading creating a support for BRICs (Chart 3).
OW S&P500 vs. MSCI AC World currency hedged () OW in MSCI EM$ vs MSCI World$ ()
Investors are returning to EM equities as shown by US equities were the clear winners among regions in 2011, outperforming MSCI AC World by almost 9% in local
27
currency terms. As we explained before, this was driven by economic and earnings growth outperformance in the US. This year the S&P500 is up by 6.8%, only marginally below the MSCI AC World local index (+7.2). So most of the underformance in US equities YTD in common currency terms is currency driven, i.e. stems from the decline in the dollar. While the higher beta of Euro area and EM equities makes this trade unattractive in a bullish environment, we believe that the risk return/tradeoff is still better for US equities. The Euro debt crisis will likely linger, creating more downside for European economies and equities. We also believe this trade is a good hedge to a potential market disruption from a re-escalation of the euro debt crisis.
Our colleagues in European Quant Strategy (D. Silvestrini and M. Dion) are recommending a basket of high and sustainable dividend yield stocks, i.e. stocks with high DY, modest and stable payout ratios, and debt/equity ratios under 100%. The J.P. Morgan European Sustainable Yield Basket (JPDEUSYB <Index>) contains European stocks with sustainable dividends according to the above filters and an average forecast yield of 4.7%.
Combining positions with momentum to trade US

equity sectors. Be long in Utilities, Discretionary vs. Financials and Staples () We introduced in Flows & Liquidity Apr 15 a US equity sector trading model based on a combination of sector short interest, a contrarian indicator, and 11-month return momentum. The short interest strategy OWs the sector with the highest short interest, and UWs the sector with the lowest short interest. This means being long Discretionary vs. Staples. A momentum strategy on US equity sectors, which OW the sector with the highest return and UW the sector with the lowest return over the past 11 months, is currently long Utilities and short Financials.
SECTORAL ALLOCATION Keep OW in Cyclical versus Defensive sectors ()

The latest reading in the global manufacturing PMI points to a positive stance in Cyclical vs Defensive sectors (see REVISITING: Using the Global PMI as trading signal, N. Panigirtzoglou, Jan 12). The 2-month change in the global manufacturing PMI is the signal we follow to trade Cyclical vs Defensive equity sectors. As Chart 4 shows Cyclicals have recaptured half of the retrenchment that occurred between March and November last year. So there is room for further outperformance.
OW High DY stocks. In the US, OW S&P US

preferred stock vs. S&P500 index. In Europe, OW the J.P. Morgan European Sustainable Yield Basket vs. STOXX Europe 600 () We continue to like the longer theme of OW high dividend yield stocks. Such stocks greatly outperformed last year, but they are lagging this year as equity managers have moved into higher-beta growth stocks that pay little in dividends. With our bullish view on equities not based on economic growth and instead on asset reflation and the search for yield, we think that investors this year will again focus on yield and should thus permit higher-yielding stocks to outperform. US Preferred stocks offer much higher income, 6.9% vs 2.2% for the S&P500. The outperformance of US preferred stocks over the past month suggests this trade can also perform in a bullish environment.
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J.P. Morgan Securities Ltd. Matthew LehmannAC (44-20) 7777-1830 matthew.m.lehmann@jpmorgan.com J.P. Morgan Chase Bank, NA Colin P. Fenton (1-212) 834-5648 colin.p.fenton@jpmorgan.com
Commodity Strategy
Oil led commodities higher in February as supply
issues combined with low inventories and OPEC spare capacity were exacerbated by the risk of a conflict between Israel and Iran.
Chart 1: S&P GSCI 2011 total returns and forecasts for 2012
% total return.
GSCI Energy GSCI GSCI Prec. Mtls. GSCI Livestock GSCI Ind. Mtls GSCI Agriculture -5%
Oil prices should come down seasonally with the

arrival of spring.
Open a long Dec-12 WTI vs. Dec-12 Brent trade as

the spread should narrow to $4/bbl by year end from $11/bbl currently.
We remain bullish gold on further buying by EM

central banks and EM retail as well as still positive 12-month price momentum.
YTD total return 12 month forecast 0% 5% 10% 15%
Agriculture prices should fall through the year helping

support pro-growth policies in EM but there are upside risks to prices in Q3. Commodities rallied 6.5% in February led higher by oil which was up over 8%. Recent strength in the oil market reflects four things: low inventories, low OPEC spare capacity, supply problems across a range of producer countries and stronger than expected demand due to a cold snap across Europe and Asia. This was then exacerbated by an increase in geopolitical risk from Israel and Iran. Looking forward, we expect oil demand to decline seasonally with the arrival of spring, which should pull prices lower before they rebound along with the global economy in Q2. Production issues in the North Sea have now subsided but outages remain in Yemen, Syria, Sudan, China and Canada. This lost supply makes up around 1% of total world oil production. However, warmer weather has caused demand for oil products to start to wane, hurting refinery margins and even causing some credit-constrained refiners to temporarily reduce production, which has weakened crude oil demand further. The potential for a strike by Israel on Iran is a risk worth watching. We are not military or diplomatic experts and thus we make no attempt to forecast when or how such an event may occur. Instead, we focus on the likely impact on commodity prices. Table 1 shows the performance of a range of major commodities during past oil supply shocks. Apart from oil, gold has been the best performing commodity having posted a positive return in each of the six supply shocks. Agriculture has produced a positive return on average but less consistently than gold. And base metals, unsurprisingly given their link to global economic growth, have performed the worst historically.
Chart 2: OECD crude oil inventories

Mn bbl 1,110 1,090 1,070 1,050 1,030 1,010 990 970 950 Jan-05 Jul-06 Jan-08 Jul-09 Jan-11
Source: J.P. Morgan commodities research
Table 1: Commodities during oil shocks

Spot price change during trough-to-peak oil price rises during oil supply shocks. Until 1983 oil prices are Arabian gulf Arab light crude spot prices. After 1983 oil prices are WTI spot prices.
Oil shock Arab-Israeli War/OPEC embargo Iranian revolution Iran-Iraq War First Gulf War Second Gulf War Arab Spring Median
Oil 279% 78% 88% 36% 24% 83%
Gold 50% 29% 5% 10% 15% 22%
Agriculture Base metals 11% 25% 22% -3% -6% 4% 7% N/A 23% -19% -10% 3% -4% -4%
105% 119%
For investors who do wish to hedge a serious supply disruption from Iran, we believe owning out-of-the-money calls on Brent would be the most effective trade. In such a scenario, prices would likely only briefly peak somewhere between $160/bbl and $180/bbl before a significant policy response would bring prices back down sharply (see
29
J.P. Morgan Securities Ltd. Matthew LehmannAC (44-20) 7777-1830 matthew.m.lehmann@jpmorgan.com J.P. Morgan Chase Bank, NA Colin P. Fenton (1-212) 834-5648 colin.p.fenton@jpmorgan.com
Commodity Memento, Feb 23, Colin Fenton). This means that an option position, which would also benefit from the likely spike in volatility, would be a more efficient hedge than a pure long via futures. As we have discussed previously (see J.P.Morgan View, 18 Nov, 2011), a pipeline between the US Midwest, where WTI is priced, and the US Gulf Coast should be reversed later this year. 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). In November, the announcement itself resulted in the spread between Brent and WTI prices narrowing to around $8/bbl from the peak of $27/bbl previously. It has since widened to around $17/bbl currently as the timing of the pipeline reversal as been pushed out to Q3 from Q2. There is also concern that increased supply from Canada and the US midwest may end up being too much for the pipeline to handle, leading to further inventory building at Cushing. We think this is unlikely and expect the spread to narrow to only $4/bbl by the end of the year. We thus open a long Dec-12 WTI vs Dec-12 Brent trade in futures. The spread between the two December contracts is currently $11/bbl, implying an almost three-fold gain over the next nine months. This trade also has a low correlation to risky assets as its drivers are independent of the drivers of risk premia in equities, credit and other commodities. Gold has fallen almost 4% since the end of January although most of this came following Fed chairman Ben Bernankes testimony to congress. The Fed chairman gave no indication of any further QE in the US given the state of the economy is not currently bad enough to warrant it. We remain bullish gold. With the second LTRO, the ECB has joined the other G4 central banks in a notable expansion of its balance sheet. This action revives the potential for inflation further down the road and should support demand for the yellow metal. In China, the government is making efforts to improve access to the gold market throughout the country. EM central banks, who have relatively small gold reserves compared to their DM counterparts, also appear likely to increase their holdings. We expect average prices to reach $1925/oz by the end of 2012. Another reason to stay long gold is momentum. A simple monthly strategy that goes long gold when the 12-month price momentum is positive and short gold when it is negative has produced an annualised excess return of 10% since 1971 with a success rate of 59% (Chart 3). This
30
Chart 3: Gold price momentum trading rule

A strategy that goes long gold when the 12-month price return is positive and short when it is negative. Excess return index 6000 Strategy Passive RTN: 10% 3% 5000 VOL: 20% 20% IR: 0.5 0.17 4000 Success rate: 59% 49% 3000
2000 1000 0
12-month momentum strategy
Passive long gold
71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11
compares to simply being long gold which produced an annualised 3% return and a success rate of 49%. Both strategies have 20% annualised volatility over the period. This echoes the work of Ribeiro et al. in Momentum in Commodities, Sep 06, who found that 12-month momentum is a profitable signal for trading commodities. Currently the gold strategy suggests a long position in gold as the 12-month price momentum is still positive. Agriculture was slightly up in February but has essentially been in a range so far this year and remains some 20% down from its Q1 2011 peak. This is positive for the global economy through lower inflation, especially in emerging markets as it allows policy makers there to make the shift from fighting inflation to supporting growth. Our agriculture outlook for this year is relatively benign and we expect the sector to finish the year lower than it started. We do believe there is some upside risk to prices in Q3 as current USDA corn yield forecasts appear somewhat optimistic compared to estimates by our commodity research team. High protein wheat is also vulnerable to a price spike given increased Chinese demand. Bread is becoming more popular in China as the population becomes wealthier leading to higher imports of the higher protein wheat needed to make bread. The Chinese government has incentivised the planting of higher protein varieties of wheat but not necessarily the higher quality varieties. Thus, a further increase in consumption would necessitate imports (see Agriculture Weekly, Jonah Waxman, 2 Mar 2012).
Allocations Long Dec-12 WTI vs. Dec-12 Brent ()

See discussion above.
Long Gold ()
See discussion above.
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: (1) 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 analysts 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. Explanation of Ratings: Ratings System: J.P. Morgan uses the following sector/issuer portfolio weightings: Overweight (over the next three months, the recommended risk position is expected to outperform the relevant index, sector, or benchmark), Neutral (over the next three months, the recommended risk position is expected to perform in line with the relevant index, sector, or benchmark), and Underweight (over the next three months, the recommended risk position is expected to underperform the relevant index, sector, or benchmark). J.P. Morgans Emerging Market research uses a rating of Marketweight, which is equivalent to a Neutral rating. Valuation & Methodology: In J.P. Morgans credit research, we assign a rating to each issuer (Overweight, Underweight or Neutral) based on our credit view of the issuer and the relative value of its securities, taking into account the ratings assigned to the issuer by credit rating agencies and the market prices for the issuers securities. 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32

JP Morgan Global Markets Outlook and Strategy

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JP Morgan Global Markets Outlook and Strategy

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Global Asset Allocation

Global Markets Outlook and Strategy

Seamus Mac Gorain

Economic Research Global Markets Outlook and Strategy March 7, 2012

Global Economic Outlook Summary

Economic Research Global Markets Outlook and Strategy March 7, 2012

Chart 1: Global PMI and GDP

%q/q, saar (1Q12 fcst boxed)

Aggressive policy actions have trimmed downside tail

Manufacturing bounce is underway and our global PMI

GDP=-21.4 + 0.45*PMI R-sq=0.71

Oil has become the largest near-term downside risk,

Signs of global lift tempered by oil risk

Global PMIs pose near-term upside risk

Economic Research Global Markets Outlook and Strategy March 7, 2012

Chart 2: Oil price and retail sales volumes, global

Source: J.P. Morgan

A cautious eye on the global consumer

Oil has become a key downside risk

Economic Research Global Markets Outlook and Strategy March 7, 2012

Central Bank Watch

Forecast next change

13 Mar 12 8 Mar 12 7 Mar 12 16 Mar 12 15 Mar 12 8 Mar 12

On hold On hold 7 Mar 12 (-50bp) On hold 15 Mar 12 (-25bp) Apr 12 (-25bp)

0.125 1.00 10.00 4.50 4.75 5.50 4.25 1.82

23 Mar 12 23 Mar 12 (+25bp)

Current 124 1684 8287 6.38

12Q1 115 1725 8000 6.70

12Q2 112 1825 8500 7.00

12Q3 120 1900 8875 6.80

12Q4 125 1925 9000 6.30

GSCI Index Energy Precious Metals Industrial Metals Agriculture

YTD Return* 11.6% 9.7% 12.6% 2.0%

Current 1.34 81.2 1.57 1.76 6.31 1125 1.78

Mar-12 1.30 76 1.55 1.75 6.45 1210 1.75

Jun-12 1.34 76 1.57 1.77 6.35 1080 1.75

Sep-12 1.36 74 1.58 1.78 6.30 1070 1.70

Dec-12 1.38 72 1.60 1.80 6.10 1090 1.65

*Levels/returns as of Mar 06, 2012 Local currency except MSCI EM $

J.P. Morgan Chase Bank NA Jan LoeysAC (1-212) 834-5874 jan.loeys@jpmorgan.com

Global Market Strategy

The GMOS strategy and model portfolio

Of the six drivers of the rally, momentum has

Defensive positions and falling risk perceptions are now

The value driver has lost a bit of its edge as a positive,

We add a new driver of the rally, taken from the

The portfolio now includes an OW in energy stocks,

3.4 3.0 2.6 2.2

J.P. Morgan Chase Bank NA Jan LoeysAC (1-212) 834-5874 jan.loeys@jpmorgan.com

Chart 2: 2012 YTD returns

Chart 3: Global outstandings of bonds, equities, and cash

CREDIT, 12tr GOVT, 28tr

J.P. Morgan Chase Bank NA Jan LoeysAC (1-212) 834-5874 jan.loeys@jpmorgan.com

J.P. Morgan Chase Bank NA Jan LoeysAC (1-212) 834-5874 jan.loeys@jpmorgan.com

J.P. Morgan model portfolio performance

300 250 200 150 100 50 0 -50 -100 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Trades and overall risk allocation

The GMOS model portfolio

Cross Asset Positions

Long MSCI AC WORLD vs GBI

Source: J.P. Morgan

Long US & UK 5yr Breakeven Long Equity Volatility Overweight Energy