European Equity Research 2nd August 2010

Equity Strategy

Mislav Matejka, CFA AC (44-20) 7325-5242 mislav.matejka@jpmorgan.com

Emmanuel Cau, CFA (44-20) 7325-1684 emmanuel.b.cau@jpmorgan.com J.P. Morgan Securities Ltd.

See the end pages of this presentation for analyst certification and important disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Key calls
We are positive on equities as: 1. Macro momentum has peaked, but our work indicates that historically equities have continued to advance over the next 12 months post these peaks. There are similarities to ’04 in terms of market volatility during the transition from lead indicators peaking towards greater clarity regarding the sustainability of recovery. Slowdown in manufacturing is clear, but beyond profit taking at sector level, our ISM framework does not work as a sell signal for the overall market at this stage. 2. Our Yield curve framework is still giving a positive signal. Despite last quarter’s flattening, the curve is still in the top 10% of record steep observations. To get around the problem of zero short rates, we found that the 10y-30y year spread was also a strong indicator of recessions. Right now it is near record steep, a positive. Historically, it took 29 months between the peak in curve steepness and the next recession. 3. Interbank stress has reduced markedly, peripheral bond yields and CDS spreads have moderated. 4. Profits are on the upturn, although 2H surprises are likely to slow significantly. 5. Rotation away from inventory rebuild and fiscal support towards increasing evidence of sustainability of recovery in private demand (capex, labour market, smaller businesses). 6. DM inflation risks minimal, allowing central banks to remain accommodative for longer, countering the headwind from fiscal consolidation. 7. Equity valuations undemanding in absolute terms and vs other asset classes. In terms of market catalysts, we think that: 1. The fact that a number of key events are now behind us could act to reduce the tail risk that markets are pricing in going forward. US financial regulatory bill was passed, stress tests are behind us, there is more clarity on Basel3, July was the peak month of Spanish refinancing. The underlying problem is not going away, but at least the hurdles for next few quarters are getting easier. 2. Chinese policymakers are turning more market friendly as CPI peaks and economic momentum slows. Key risks: “Double dip” near term. We see the five-year outlook to be far worse than the 12-month one.
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Key trades and themes
Regional: 1. Re-enter EM vs DM exposure: we started the year OW DM vs EM on the back of adverse EM growth – inflation tradeoff, but two months ago reversed it. 2. OW Europe vs US: European activity is resilient vs the US; the region is underweight in global portfolios and attractively priced. 3. Reducing OW Dax vs Eurostoxx50: OW Germany was our key regional trade this year, but we see it as a crowded call now. Sectorwise: Stay OW Cyclicals vs Defensives - despite their strong outperformance ytd. Rotate out of crowded, outperforming, expensive cyclicals (Cap. Goods downgraded on 27th July), as manufacturing momentum is slowing. Better risk/reward among non-consensus cheaper cyclical laggards (Banks/Mining). Key longs: Banks, Mining, IT, Discretionary. Key shorts: Utilities, Pharma. Themes: M&A to pick up: our key theme for 2010 due to strong balance sheets and record low credit yields (see our 21st June report for details). Dividend comeback: we think the recent GE, AAL etc. dividend news is significant; we expect continued positive news flow on this front (see our 29th June report for more details).

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Morgan Eurozone composite PMI 65 60 55 50 45 40 35 30 98 99 00 01 02 03 04 05 06 07 08 09 10 80 75 70 65 60 55 50 45 40 35 30 48 ISM and recessions 52 56 60 64 68 72 76 80 84 88 92 96 00 04 08 E u ro area P M I c om p os ite US recessions ISM manufacturing Source: J. driven by the slowing in manufacturing activity Global manufacturing PMI 60 55 50 45 40 35 30 98 99 00 01 02 03 04 05 06 07 08 09 10 Global Manufacturing PMI Source: J.P.P.Macro momentum is peaking. albeit from elevated levels. Morgan Source: Datastream. NBER 4 . driven by manufacturing slowdown The macro momentum is peaking.1 .

9 61.0% 0.0% 24.4% 0.Peak in macro momentum does not mean equities need to fall The pushback we frequently hear from clients is: “ If you were using bottoming out in ISM and the improvement in its 2nd derivative as a reason to buy stocks last year.1% 14.1% -13.2% 6.8% 5.7% 17.1% 4.2 58.1% 19. Morgan.2% 2.1% 1.4% -0.1% 5.0% 7.4 69.5% 0.6% 3.7% -16.3% 4.9% 9.2 64.9% 100% 100% 75% +12m 26.8% 7.2% -2.7% 3.6% 26.5 68.2% -6.9 59.1 +1m 0.9% 37% +6M 20.5% 0.7% -3.9% 4.4% 7.5 62.5% 3.8% -4.3% -12.2% 9.9% 0.2% 0.5% -1.2% 4.6% 3.7 60.1% -21.3% 9.9% -6. the peak in lead indicators didn’t work as a sell signal at the market level Equity performance after ISM peak S&P500 perf ISM peak Jul 50 Aug 52 May 55 May 59 Dec 61 Mar 65 Apr 68 Jan 73 Feb 76 Jul 78 Nov 80 Dec 83 Dec 87 ISM 77.0% 3. why are you not using the peaking in ISM and a rollover in macro momentum as a signal to sell?” Historically.5 63.8% 0.8% 6.5% -8.5% 1.2% 5.0% 13.8% -12.5% 3.4% 12.4 57.3 60.0 72.2% -3.0% 21.4% -0.2% 4.9% -1.5% 2.2% 3.6 60.6 61.9% 1.9% 4.8% 3.7% -6.1 61.5% -5.3% 1.1% -0.7% -0.P.7% -11.3% 2.8% -3.1% 1.2% -2.4% 12.7% 4.7% 1.0% -0. J.9% 68% +12M 24. *% of time performance is positive 5 .1% 1.2% 3.6% 5.1% 1.2 69.7% -9.8% 4.7% 14.4% 88% S&P500 performance +3m +6m +9m 9.1% -7.9 58.9% 75% Sep 91 Oct 94 Jul 97 Nov 99 Jun 02 May 04 Average Median Hit ratio Feb 50 Dec 54 Oct 58 Aug 61 Feb 72 Feb 76 Jul 83 Dec 03 Average Median Hit ratio Source: Datastream Source: Datastream.1% 7.1 53.5% -7.8 62.2 64.5% 68% Forward S&P500 perf when ISM goes above 60 ISM 60.1% 10.8% 2.5 63.7% 5.6% 0.3% 6.4% 8.6 61.9% 20.3% 2.0 54.1% -4.4% 2.6% 0.3% 0.5% -1.4 +3M 8.4% -2.4% 7.0% 3.2% 17.1% -0.0% 12.8% 2.7 58.3% 2.5 60.4% 1.

ISM during the last cycle Lead indicators almost always tended to peak within 1.Looking at the past cycle. MSCI Europe fell by 8% between March and August ‘04 However. ultimately this was a good buying opportunity as equities moved much higher over the next few years Typical ISM move during recovery vs.4. but equities continued to advance most of the time In the last cycle ISM peaked in May 2004 at 61. latest 65 1800 May-04 ISM peak Jun-07 MSCI Europe peak (+65%) 65 1600 60 55 1400 50 1200 45 1000 40 800 35 600 03 04 05 06 MSCI Europe 07 ISM (rhs) 08 30 Source: Datastream. ISM peaked in 2004 but equities continued to rally for another three years MSCI Europe vs.5 years of an upcycle starting. just a bit more than a year after the market trough. MSCI Typical ISM and S&P500 moves during recovery 65 145 140 60 60 135 130 125 55 55 50 50 45 120 115 45 40 110 105 100 35 40 30 gh 4m 2m 6m 8m m m m m m m m m m m m m m m 30 32 34 18 ou 14 10 12 16 26 20 22 24 28 36 35 gh 4m 6m 2m 8m m m m m m m m m m m m m 10 12 14 16 18 20 22 24 26 28 30 m ou 36 32 34 m 95 Tr Av erage ISM ISM s inc e Dec -08 Tr Av erage ISM Av erage S&P500 (rhs ) Source: Datastream Source: Datastream 6 . The peaking in the ISM was coincident with shortterm market volatility.

2% 1.7% 1.1% 2.7% 14.8% +12m 19. Morgan 7 .8% 8. It doesn't pay to sell stocks in 30-40 range of ISM.7% 6.2% 3.4% Forward S&P500 perf in different ISM ranges average S&P500 Fwd return +3m 10.9% 10.9% 1.1% 7.9% 3.9% 27.4% 1.3% Source: Datastream.6% 5.8% 6.4% 0.0% 4.3% 10.3% -4.6% 23. given the next 3.9% 1.8% 8. J.0% 18.P.7% +6m 23. but strength of signal is relatively weak The current ISM level does not mean outright “sell” % of time equities go up in different ISM ranges Hit ratio S&P500 Fwd return ISM range 25-30 30-35 35-40 40-45 45-50 50-55 55-60 60-65 65-70 70-75 75-80 % of time 0.5% 0.5% 4.3% 10. equities tended to fall on the majority of occasions when the ISM started in the 65-75 range.2% 1.3% 23. J.1% 7.3% -5.P.1% 1.5% 22. 6 and 12 months’ equity performance is likely to be strong.3% 23.1% 4. This was one of the key catalysts to enter beta in Q1 ‘09 Looking at the other side of the coin. but not a good SELL indicator Last year the key call was not to ignore the “2nd derivative”. Morgan Source: Datastream.6% 28.4% 0.0% 0.5% 18.5% -6.1% 1.5% 18.4% 0.0% 0.5% 4.ISM framework – Great BUY indicator.7% -0.6% 28.7% 8.6% 5.5% 5.4% +3m 100% 67% 74% 64% 57% 67% 65% 58% 50% 0% 100% +6m 100% 92% 84% 63% 64% 69% 71% 62% 57% 33% 100% +12m 100% 100% 100% 68% 70% 73% 67% 67% 47% 33% 100% ISM range 25-30 30-35 35-40 40-45 45-50 50-55 55-60 60-65 65-70 70-75 75-80 % of time 0.8% 8.

5 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 US recessions US 30-10y Source: Datastream.0 0.5 0.0 -0.2 .0 -1.Fed funds) Source: Datastream. but it is at a record steep now.What is the Yield curve really saying? Still constructive DM yield curves have flattened.5 -1. US recessions vs shape of the yield curve 4 75 70 65 60 1 55 0 50 -1 45 -2 40 35 30 55 57 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 3 2 -3 -4 NBER dated recessions Yield curv e (10y r . but are still near record steep in the historical context Yield curve steepness peaks on average 2. 10y-30y spread behaved similar to 10y-3m spread.5 Start of Recessions Apr-60 Dec-69 Nov-73 Jan-80 Jul-81 Jul-90 Mar-01 Dec-07 Difference (# months) 21 25 29 52 10 33 21 43 29 27 1.5 years before the start of a recession Pushback of zero short-term rates. *latest 8 . NBER Timing of recessions and peak of the yield curve Peak of the yield curve Jul-58 Nov-67 Jun-71 Sep-75 Sep-80 Oct-87 Jun-99 May-04 Average Median Source: Datastream. NBER 10Y-30Y spread and US recessions 1. inverting ahead of every recession.

equities continued to rise 73% of the time after the yield curve peaked The current level of the yield curve is consistent with 10-15% annualized equity return Flattening/falling yields supports defensives and steepening/rising yields supports cyclicals Yield curve investment clock 10 Year Rising 1.F e d fu n d s ) Source: Datastream 12m S&P500 perf* from different levels of the yield curve -1 0 % -3 / -2 -2 / -1 -1 / 0 Y ie ld c u rv e +0/1 +1/2 s te e p +2/3 +3 / 4 Source: Datastream.*average since 1955 S & P 5 0 0 + 1 2 m p e rf 9 . 1 % 15% 14% 10% 10% 8% 5% 6% 12m fwd S&P500 perf following the peak of the yield curve 5 4 3 2 1 1% 0 -1 -2 -3 -4 -5 55 57 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 -2 9 % -3 0 % -1 3 % -2 0 % -5 % -8 % 0% 15% 8% 7% 30% 26% 19% 14% 5% 30% 34% 34% 40% 20% 10% -1 0 % -4 0 % S & P 5 0 0 + 1 2 m p e rf (rh s ) Y ie ld c u r v e ( 1 0 y r . Utilities) 10 Year Falling 4. Recovery Strong OW: Cyclicals (esp. Overheating Modest OW Defensives (esp Telecoms) OW Financials Modest UW Cyclicals (esp Resources) -1 0 % -6 / -5 -5 / -4 -4 / -3 in v e rte d -5 % -5 % 5% 3% 2% 0% -0 .Yield curve and equity market direction The start of yield curve flattening is not an indicator of a poor equity performance ahead In the past 50 years. using US/European sectors and US 10-2year yield curve Source: Datastream. Slowdown Strong OW Defensives (esp Staples and Pharma) UW Financials Strong UW Cyclicals (esp Industrials & Discretionary) 3. Utilities) 2. Resources) 10-2 Steepening OW Financials (esp Banks) Strong UW Defensives (esp. Expansion Modest OW Cyclicals 10-2 Flattening (esp Industrials & Media) UW Financials (esp Banks) Modest UW Defensives (esp Telecom.

3 .Libor – OIS spread: Spread between 3-month Libor and overnight swap rate Bloomberg ticker: . but still way off the ‘08 levels Interbank market .Monitoring the stress in funding markets – the pace of deterioration is slowing Signs of bank funding stress elevated.LIBOROIS F index Peaked at 364 bps in October ‘08 LIBOR-OIS spread 2007-to-date 400 350 35 40 LIBOR-OIS spread year-to-date 300 30 250 200 150 100 50 0 07 08 Libor-OIS spread 09 10 25 20 15 10 5 Jan-10 Feb-10 Mar-10 Apr-10 Libor-OIS spread May -10 Jun-10 Jul-10 Source: Bloomberg Source: Bloomberg 10 .

Euro Swap spread Spread between two-year German bond yield and two-year swap rate Bloomberg ticker: EUSS2 crncy Peaked at 126 bps in October ‘08 Euro swap spread 2007-to-date 140 Euro swap spread year-to-date 90 85 120 80 75 70 65 100 80 60 60 55 50 45 40 20 0 07 08 09 Euro sw ap spread 2YR 10 40 Jan-10 Feb-10 Mar-10 Apr-10 May -10 Jun-10 Jul-10 Euro sw ap spread 2YR Source: Bloomberg Source: Bloomberg 11 .

0 4.0 3.0 07 08 09 Ted spread 10 TED spread year-to-date 0.TED spread Spread between 3m T-Bills and 3m LIBOR Bloomberg ticker: TEDSP index Peaked at 463 bps in October ‘08 TED spread 2007-to-date 5.0 0.30 0.5 0.10 Jan-10 Feb-10 Mar-10 Apr-10 May -10 Jun-10 Jul-10 Ted spread Source: Bloomberg Source: Bloomberg 12 .25 0.0 1.5 1.45 0.50 0.5 2.35 0.0 2.55 0.40 0.15 0.5 3.20 0.5 4.

P. but significantly below ‘08 wides US and Euro corporate high grade spreads 2008-to-date 600 500 400 300 200 100 Jan-08 May -08 Sep-08 Jan-09 May -09 Sep-09 Jan-10 May -10 370 320 270 220 170 120 70 US and Euro corporate high grade spreads year-to-date 170 160 150 140 130 120 110 100 Jan-10 Feb-10 Mar-10 Apr-10 May -10 Jun-10 Jul-10 130 110 90 70 190 170 150 US corporates high grade spreads Source: J. Morgan Euro corporate high y ield spreads (rhs) US corporates high y ield spreads Source: J. Morgan Euro corporate high grade spreads (rhs) US corporates high grade spreads Source: J. Morgan Euro corporate high y ield spreads (rhs) 13 .Corporate credit spreads Volatile.P.P.P. Morgan Euro corporate high grade spreads (rhs) US and Euro corporate high yield spreads 2008-to-date 2100 1900 1700 1500 1300 1100 900 700 500 Jan-08 May -08 Sep-08 Jan-09 May -09 Sep-09 Jan-10 May -10 1900 1700 1500 1300 1100 900 700 500 300 800 750 700 650 600 550 500 US and Euro corporate high yield spreads year-to-date 570 520 470 420 370 320 Feb-10 Mar-10 Apr-10 May -10 Jun-10 Jul-10 Jan-10 US corporates high y ield spreads Source: J.

0 00 01 02 03 04 05 06 07 08 09 10 U S indus trials c orporate high grade y ield Source: J.5 5.0 3.5 6.P.0 5.0 While the spreads are widening.5 7. but ‘05 8. Morgan Eurozone corporate High Grade yield (%) 7.0 8. the total yield on HG corporate bonds in Europe is near record lows.5 4.0 4.5 8.5 6. Morgan Source: J.0 99 00 01 02 03 04 05 06 07 08 09 10 4.5 3.P.Credit yields near record low US corporate High Grade yield (%) 9.5 4.5 5.5 5.5 UK corporate High Grade yield (%) 99 00 01 02 03 04 05 06 07 08 09 10 Euro industrials co rpo rate high grade yield U K c orporate high grade y ield Source: J.0 6. Morgan 14 .5 7.0 6.P.5 5. thanks to the rally in government bonds Not ’07-’08 backdrop.0 7.5 6.0 5.0 6.0 7.0 7.0 4.

3 3.6 1.3 0.4 1.0 3.1 3.4 7th May 12.6 3.5 3.1 2.3 5.2 5.1 7th May 17.3 1.8 Move since 7/05 (bps) -742 0 -304 -104 -54 45 -2 14 -16 46 41 36 -18 Ytd Move (bps) 625 0 160 31 23 -51 -24 8 -59 -14 -42 -45 -51 Move in 10yr government bond yields (%) 10 Y BY GREECE IRELAND PORTUGAL SPAIN ITALY UK BELGIUM AUSTRIA US FRANCE FINLAND NETHERLAND GERMANY Current 10.0 1.8 3.5 0. “credible and committed buyer of last resort” Most of the Southern European yields have moved off their 7th May peak due to ECB action Move in 5yr CDS spreads 5 Yr CDS GREECE PORTUGAL IRELAND SPAIN ITALY BELGIUM AUSTRIA FRANCE UK NETHERLAND GERMANY US FINLAND Current 697 225 208 177 133 92 75 62 56 39 36 34 24 Year Start 283 92 158 114 109 54 84 32 83 32 26 38 28 7th May 939 440 263 251 230 106 85 78 100 53 57 43 30 Move since 7/05 (bps) -242 -215 -55 -74 -96 -13 -11 -16 -44 -14 -22 -9 -6 Ytd Move (bps) 413 133 50 64 24 38 -9 30 -27 7 9 -4 -4 Source: Datastream up to 27th July Move in 2yr government bond yields (%) 2 Yr BY GREECE IRELAND PORTUGAL SPAIN ITALY FINLAND UK AUSTRIA BELGIUM NETHERLAND FRANCE GERMANY US Current 10.6 3.7 Move since 7/05 (bps) -194 -61 -110 -31 -35 -18 -19 -17 -38 -11 -11 -10 5 Ytd Move (bps) 450 42 116 15 -7 -52 -38 -57 -79 -55 -60 -60 -62 Source: Datastream up to 27th July Source: Datastream up to 27th July 15 .6 Year Start 3.9 1.5 0.0 2.9 0. the more they should fall as it gets incrementally harder to meet the fiscal obligations Circuit breaker is needed.1 0.4 3.9 1.0 0.3 4.8 3.2 1.9 4.7 2.7 3.4 3.3 1.5 0.3 3.6 3.3 0.5 1.0 4.1 3.7 3.9 0.0 3.7 1.9 3.7 1.0 1.8 4.1 3.0 3.5 3.0 3.8 4.8 1.3 3.1 3.0 1.1 1.1 3.5 1.4 4.9 2.The movement in bond yields and sovereign CDS spreads Self fulfilling prophecy: the more bonds fall.7 1.7 3.2 5.0 2.7 6.8 Year Start 5.1 3.1 0.8 1.2 4.7 1.8 6.

J. yield curve shape. but size of surprises to slow in 2H Macro momentum vs earnings surprises Most of the leading indicators that we follow for earnings suggest further growth ahead The trends in IFO. but 2H is likely to witness a rollover 40 30 20 10 0 -10 -20 -30 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 80% 60% 40% 20% 0% -20% -40% -60% S &P 500 P os itiv e / N egativ e EPS s urpris es % y oy ISM % y oy (rhs ) Source: Bloomberg. adv 13m) IFO (%y oy . rhs) Source: Datastream. rhs) -4% -6% -60% -40% IFO vs European profits 8% 6% 40% 60% 25% 20% 15% 10% 5% 0% 0% -5% 4% 20% 2% 0% -2% -20% -10% -15% -20% -25% 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 Europe trailing earnings (%y oy . margin proxy etc. are bullish for near term profits.Earnings remain a support. assuming July ISM at 52 US profit margins proxy* vs corporate profits 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% 51 53 55 57 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 US corporate profits %y oy USA prox y for profit margins (%y oy . * GDP deflator – Unit labor cost Source: Datastream 16 .P. BEA.4 . Morgan.

Morgan 17 .EPS integer continues to move higher.P.2 0 0 2 a v e r a g e c u r r e n t y e a r E P S e s tim a te s 2 0 0 3 . Cyclicals showed the bulk of upgrades 115 Typical EPS trajectory ’88-’02 vs ’03-’06 In the last cycle analysts were behind the curve 110 105 100 95 YTD change in 12m Fwd sector EPS forecasts S e m ic o n A u t o m o b ile M e t& M in C h e m ic a ls B anks C o n s D u r a b le s T ra n s p o rt C ap G oods R e t a ilin g HPC H o t e ls .0 6 a v e r a g e c u r r e n t y e a r E P S e s tim a te s Source: IBES Europe EPS +ve to –ve revisions 40% 20% 0% -20% -40% -60% -80% 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Europe +v e to -v e EPS rev isions Source: IBES. R e s t& L e is E u ro p e Food B ev& Tob F o o d D ru g R e t S o ftw a re D iv F in R e a l E s ta te E n e rg y M e d ia H e a lt h c a r e In s u ra n c e T e le c o m s C ons M at U tilitie s T e c h H a rd w a re Source: IBES up to 27th July 90 85 80 Jan F eb M ar Apr M ay Jun Jul Aug Sep Oct N ov Dec 138% 87% 48% 25% 22% 21% 20% 19% 16% 14% 14% 13% 10% 10% 10% 9% 9% 8% 8% 7% 1% 1% -2 % -3 % -1 5 % 1 9 8 8 . Dominated by Cyclicals European earnings integer moved up by 13% ytd. J.

8% 1.7% -0.6% 35.rs) European EBIT/Sales 14% 13% 12% 11% 10% 9% 8% 7% 99 00 01 02 03 04 05 06 07 08 09 10 11 European P&L decomposition As % of Sales Staff costs COGS excl staff costs SGA costs Other expenses EBITDA Depreciation EBIT Interest Other income Pretax Income Taxes Minority. IBES 18 .6% 1. MSCI.6% 8.0% 8. %y oy ) Source: Datastream.1% 31.4% 9.6% 0.1% 10.5% 2. Morgan Source: Datastream.9% EBIT/Sales Europe IBES forecasts Source: Datastream.6% 0.4% 2.0% 17.7% 6.7% 34.6% 52. despite steep volume falls Corporate restructuring.0% 12.1% 7.5% 4.2% 2009 16.2% 6.Profit margins troughing at relatively high level.1% 18.1% 9.5% 11. FX tailwind Europe vs US 12m Fwd earnings vs EUR/USD Margins are troughing at relatively high levels in 2009.9% 2006 15.9% 13.5% 2.8% 1.6% 0.6% 13.5% 8.0% 5.P.0% 10. top-line diversification.0% 52.5% 52.9% 2004 15.2% 6.0% 13.0% 1.9% 3. J.6% 2.1% 8.6% 0.0% 13.2% 14.0% 6.1% -0.1% 4.1% 11.5% 2.8% 6.7% -0.1% 13. Worldscope.4% 0.7% 2007 14.4% 3.2% 5.9% 15.6% 2005 15.4% 51.9% 17.8% 3.9% 34.5% 53.1% 6.0% 1.7% 3.2% 6.6% 12.9% 37.3% 11.1% 0.2% 51.2% 6.1% 19.9% 3.9% 12.8% -0.0% -0.0% 0.2% 6.2% 34.5% 1.4% 8. lower interest costs and taxes have contributed to margins holding up The weakening Euro is acting as a tailwind to European vs US profitability trends 40% 30% 20% 10% 0% -10% -20% -30% -40% 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 -30% -20% -10% 0% 10% 20% 30% Europe F w d earnings rel to U S (ex -F inancials.6% 13.1% 1. etc Net Income Taxes as % of pretax income EBIT / Sales Net income / Sales 2003 16.3% 6.8% 0.6% 5. disctd. IBES EU R /U SD (%y oy . rhs.0% 17.3% 10.4% 1.7% 10.6% 3.4% 0.1% 2008 14.1% 12.7% 2.2% 1.6% 12.3% 51.5% 3.0% 15.1% 5.9% 33.4% 5.9% 10.1% 14. aggressive cost control.8% 7.1% 3.

where positive news flow was mostly margin related. of cos reported 160/288 11/21 18/36 36/54 16/26 9/20 9/22 25/62 15/18 9/14 12/15 EPS surprise 6% -5% 6% 28% 24% 1% -2% 16% -3% 5% -2% Sales surprise 6% 15% 1% 1% 3% 0% 3% 9% 1% 4% 6% 19 . IBES. Morgan Summary of the US Q2 reporting season % cos beating EPS % reported estimates 61% 77% 62% 71% 81% 68% 82% 85% 43% 88% 48% 89% 69% 77% 73% 83% 61% 61% 33% 67% 31% 55% % cos beating Sales estimates 62% 48% 60% 70% 74% 26% 60% 70% 70% 0% 55% Summary of the European Q2 reporting season % cos beating EPS % reported estimates 56% 59% 52% 64% 50% 50% 67% 58% 62% 69% 45% 56% 41% 67% 40% 60% 83% 73% 64% 67% 80% 33% % cos beating Sales estimates 70% 64% 56% 69% 73% 70% 100% 68% 71% 100% 58% S&P500 Energy Materials Industrials Discretionary Staples Healthcare Financials IT Telecoms Utilities Source: Bloomberg No. Q3 and Q4 ‘09. the majority of corporates in both the US and Europe have surprised consensus revenue projections for Q1 and Q2 15% 8% 13% 10% 7% 9% 10% 5% 0% -1% -5% -10% -15% -12% -9% -13% -15% -12% -10% -20% 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10e DJStox x 600 Sales grow th (%y oy ) DJStox x 600 ex -Financials Sales grow th (%y oy ) Source: Bloomberg. J. of cos reported 301/497 24/39 25/31 46/56 34/80 19/40 35/51 58/80 46/76 3/9 11/35 EPS surprise 10% 9% 7% 9% 21% 2% 4% 26% 4% 3% 3% Sales surprise 0% -6% 1% 0% 3% 0% 0% 7% 2% 0% -3% DJStoxx600 Energy Materials Industrials Discretionary Staples Healthcare Financials IT Telecoms Utilities Source: Bloomberg No.Moving away from “low quality” beats European revenue growth The Q2 reporting season has delivered strong results. above street estimates on both the top line and bottom line Unlike Q2.P.

but we believe operational leverage could be substantial Earnings rebound has historically been proportional to the size of the fall US and European consensus EPS growth forecasts Europe '11e vs peak -4% -13% 1% 2% 2% 29% 34% -31% -6% 1% -11% US '11e vs peak 18% -21% 8% 1% 49% 22% 21% -12% 54% -18% 3% MSCI Europe EPS fall and rebound around past recessions 100% 2003 90% 80% 70% 1993 1976 60% 50% 40% 30% 1982 20% 10% 0% -48% -46% -44% -42% -40% -38% -36% -34% -32% -30% X MSCI Europe EPS fall Peak to Trough Source: Datastream. IBES 20 . % yoy as of 27th July X S&P500 operating EPS fall Peak to Trough Source: Datastream. but achievable Y +24m MSCI Europe EPS growth from the trough Y +24m S&P500 operating EPS growth from the trough ’10 and ’11 expectations appear aggressive at face value.’10-’11 hurdle rate appears challenging. IBES 2009 '08 Market Energy Materials Industrials Discretionary Staples Healthcare Financials IT Telecoms Utilities -24% 19% 4% -9% -26% 8% 11% -70% -3% 12% 3% '09e -20% -47% -58% -32% -54% -9% 10% 49% -48% -2% -7% '10e 33% 34% 80% 37% 115% 10% 11% 56% 59% 1% -4% '11e 18% 20% 30% 20% 25% 11% 6% 28% 27% 4% 3% '08 -31% 24% -11% -1% -23% 1% 10% -151% 11% -3% -1% '09e 1% -54% -47% -29% 18% 4% 2% -5% -28% -3% '10e 34% 41% 68% 19% 40% 8% 7% 45% 1% 2% '11e 16% 21% 25% 18% 18% 8% 9% 30% 11% 14% 4% S&P500 EPS fall and rebound around past recessions 2001 100% 80% 60% 2009 1991 1983 1958 1949 1981 -60% -50% -40% -30% -20% -10% 0% 1975 1953 40% 20% 0% -20% 1961 1970 Source: IBES.

sa) Source: BEA.Real GDP vs ‘08 peak => new high achieved at global level in Q2 ‘10 When will GDP regain past peak US real GDP is expected to surpass its past peak in Q3 ’10. Morgan estimates 21 . For Europe.% Fall in US Real GDP during past recessions Global R eal GDP index (2005=100. this should happen by the end of 2011 / start of 2012 Historically. rather than 3-4% Region Global US UK Euro Area Germany France Japan EM Source: J. Morgan estimates ‘08 Peak 08Q2 08Q2 08Q1 08Q1 08Q1 08Q1 08Q1 08Q3 Expected/Reached new High 10Q2 10Q3 12Q1 12Q1 12Q1 11Q1 12Q1 09Q3 US real GDP rebound in the past cycles 9 Y .P.P. Blue Chip forecasts Source: J.% Gain in US real GDP during the first year of past recoveries 8 7 6 5 1970 4 current 3 2 1 0 0 -1 -2 -3 -4 -5 95 120 Global real GDP projections 1948-49 1960-61 1981-82 1957-58 1953-54 1973-75 115 110 1980 105 1990-91 2001 100 05 06 07 08 09 10 J PM forecasts 11 X . the size of GDP loss was proportional to the size of rebound => suggesting US real GDP should be growing 67%.

potential growth.Profit margins in the long-term context Investors are sceptical about the magnitude of potential margin recovery We think margins will cyclically rebound. supporting valuation multiples Longer-term margins will depend on inflation. etc 1950-60s displayed structurally high margins (although still cyclical) against a backdrop of low inflation. NBER Recessions US Corporate profits as a % of GDP 22 . rhs) Source: Datastream. Some of these conditions might hold again European RoE vs GDP growth 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 6% 4% 2% 0% -2% -4% -6% -8% 14% 13% 12% 11% 10% 9% 8% 7% 6% US NIPA profit margins 47 50 53 56 59 62 65 68 71 74 77 80 83 86 89 92 95 98 01 04 07 10 Europe RoE Source: Datastream Europe GDP (%y oy . low risk-free rates and low wage growth.

to which both US and Europe are significantly leveraged. BEA Source: NBER.0% 12% 14% Domestic non-financial margins 2.0% 1.5% 0.0% 47 50 53 56 59 62 65 68 71 74 77 80 83 86 89 92 95 98 01 04 07 10 Recessions US Domestic financial corporate profits as a % of GDP Source: NBER.0% 47 50 53 56 59 62 65 68 71 74 77 80 83 86 89 92 95 98 01 04 07 10 8% 6% 4% 2% 47 50 53 56 59 62 65 68 71 74 77 80 83 86 89 92 95 98 01 04 07 10 Recessions US Foreign profits as a % of GDP Recessions US Domestic non financial corporate profits as a % of GDP Source: NBER.5% 1.5% 3.0% 2.5% 3.0% 1.0% 3.5% 1.0% 0.NIPA profit margin breakdown Financials margins likely to be structurally under pressure. but short term they are supported by steep yield curves EM margins.0% 0.5% 2.5% 0. need not structurally weaken Domestic non-financial margins are not stretched US domestic financial margins 4.5% 10% 2. BEA Foreign profit as a share of GDP 3. BEA 23 .

Morgan US GDP forecast 2009. is coming to an end J.0 0 -1 -2 -3 -0.6 1.0 -7.3 -0.6 1Q 2.6 Fiscal thrust and private final sales %oya GDP 2009 2010e 2011e Fiscal thrust (+ is stimulative) 2009 2010e 2011e Inventory contribution 2009 2010e 2011e Underlying private final sales 2009 2010e 2011e Source: J.8 -0.3 -0.2 0.5 4.8 2.4 2.4 2.8 -19. %q/q.4 2.2 0.5 -5.1 -1. smaller businesses The fiscal drag is likely to subtract an average of 1-1/4%-pt from GDP growth over the next six quarters and to become more significant from Q1 ’11 onwards Inventory rebuild and the acceleration in production.2 -1.1 EMU -4.7 1.8 2.1 1.1 35.0 0.1 37. saar 3Q 2.3 0.6 0.0 41.1 -1.8 0.5 3.0 3Q 3.3 -0.0 -4.5 2.5 2.Fiscal drag and an end to inventory rebuild vs. consumer.0 2011.9 0.1 42.5 4Q 3.7 1.9 2011E Source: J.9 1.0 2.2 1.9 4.7 1.3 0.6 1.0 UK -4.1 39.6 2.5 2.1 2Q 2.5 7. which typically lasted four quarters.2 -0.4 -1.2 -0.P.7 5.8 0.5 Source: J.9 2010.5 .5 0.70 4. Morgan economic research.P.P.1 37.P. saar 4Q real GDP final sales* Inventories* Inventories ** IP 5.6 4.2 0.8 1.1 -0. Morgan estimates *as a contribution to GDP growth **change in absolute level of inventories (ch $bn. 4 3.5 -2.6 3.7 3. %q/q.2 2.6 -1. % chg.1 -5. Morgan economic research DM -3.5 US -2.0 1Q 2.8 1.5 2. chained $2000) Estimated contribution of fiscal policy to US GDP growth 4 3 2 1 0. saar 24 .4 2009E 2010E -2.8 0.2 0.9 4.2 6. %q/q.6 -1.6 2.7 -0.1 Japan -5.0 -2.1 3.0 2.0 -1.1 3.2 0.6 2.6 4.4 -5. the improving private demand – capex.4 0.2 -0. saar 2Q 2.9 41.1 -2.3 -1.5 3.5 2.6 -0.3 1.9 2.3 3.3 2.

7 -11.3 -4.2 -3. 2009) UK US Japan Stability and Growth Program deficit Euro area Germany France Italy Spain Netherlands Belgium Austria Greece Ireland Finland Portugal Slovakia Slovenia Luxembourg Cyprus Malta -3.7 72.9 0.6 -14.6 -6.7 -1. manageable at EMU level Putting Eurozone sovereign concerns into perspective.2 -9.3 -11.5 1.5 -0.4 -0.3 -3.1 Fiscal positions (%GDP.8 3.8 Primary deficit -3.2 -7.1 -0.0 -3.6 Cyc adj Primary Balance -1.8 0.5 0.6 Deficit (Eurostat) -6.4 -6.3 0.6 53.7 -8.8 0.1 2.0 1.9 0.6 -0.8 2012e 1.5 -12.5 1.5 -5.1 2.5 -12.0 76.5 -0. 2009) Fiscal Balance Euro area -6.4 -13.7 73.2 60.9 1.9 -1. UK or Japan Primary budget position and debt (%GDP.8 -5.9 -3.9 96.5 1.7 -5.2 -3.4 189.0 -3.8 53.9 -5.0 -2. Morgan economic research 2010e -0.1 -0.7 -5.4 0.P.1 0.7 1.6 3.0 Gross debt 78.3 2. Morgan economic research Fiscal thrust across the Euro area Source: J.4 -4.9 83.P.2 -3.4 1.7 -8. Morgan economic research 25 .7 55.2 -0.2 -9.2 77.3 0.3 -1.3 1.7 66.5 56.3 -11.7 -6.8 0.3 -7.3 -6.9 0.8 0.2 9.6 -9.2 -5.1 -0.5 Source: J.1 -3.7 -2.1 Euro area Germany France Italy Spain Netherlands Belgium Austria Greece Ireland Finland Portugal Source: J.8 1. the primary deficit for Eurozone as a whole is no worse than those for the US.5 -10.8 -8.6 -5.6 0.2 1.3 -2.0 44.1 -7.3 -12.4 2.0 -6.2 -1.9 -5.0 96.8 Gross debt 78.4 -6.3 Net debt 51.6 -8.6 Cycl-adj primary position -1.7 35.3 -6.5 -3.9 -6.7 1.9 14.1 0.4 2011e 1.7 -1.The size of the needed fiscal consolidation.9 -10.5 -5.1 64.6 115.4 -3.2 0.8 35.2 0.3 -0.6 -9.7 -0.P.5 115.5 1.3 -6.2 69.3 -5.7 Primary balance -3.

5 7.2 39.3 5.1% Greece 8.5% Perf Rel to MSCI Europe ($) 7.7% 2.5 30.2 10.3 6.1% 1.8% 1.5% 4.0 3.9 9.1% Source: National central banks.0 24.9% -6.6 58.1 3.7 7.6% 2.0 0.4% -10.5 7.7% 22. though Previous fiscal adjustments* in EMU The size of proposed Greek fiscal adjustment is ranking the top of historical achievements.4 1.0 39.4 10.2 1.0 0.5% 444.2% 90.9 21. maturity and redemption schedule 10-year Bond yield (%) Average in 90-ies Spain Italy Portugal Greece Ireland Total Source: J.1 47.3 1.1 0.0 0.3% 9.0% Ireland 5.6 6.0 65.0 1.8% Abs Perf (LC) 82.7 83.2 8.2 3. Morgan Fixed income research Source: J. * largest three-year moves in cyclically adjusted primary balances Government debt cost.5 6.0 81.4% 10.9% 44.7 4.8 7.6% -29.Periphery facing a Herculean task.0 5.3 1.4% 0.4 0.9% 0.1% 5.1% 0.0 20.5% 38.0% 3.9 7.4 7.8% 10.6% 35.0 Sep-10 5.2% 18.2% Share of Eurozone GDP Belgium Germany Portugal Netherlands Greece Ireland Italy Finland Spain Austria France Average Median 4% 29% 2% 6% 2% 2% 16% 2% 10% 3% 21% Largest move % pts of GDP 8.4 6.6 26 .7% -68. at 12-13% of GDP Refinancing schedule to ease in H2 ECB funding as % of total bank assets EMU Dec-08 Dec-09 Jun-10 Change 2.4 12.4% 2.0% 31.2 1.7 6.2% -38.9 Latest 4.2% 17.P.7% 0.7% 0.2% 116.6% 5.9% -0.4% -6.4% 12.5% Italy 1.9 Jun-10 8.6 0.4 12.5% -15.6 19.6 7.9% 1. Bloomberg Avg debt maturity (years) 6.5% Spain 2. bonds (principal plus interest) and bills Aug-10 6.3% 9.7% 2.6% 396.2 Nov-10 5.9 21.5% 2.3% 338.9% 1.6% 5.9 5.5 2.4% -22.5 6.0 2Q11 22.1 1Q11 18.9 Date 1982-84 1996-98 1982-84 1996-98 1992-94 1982-84 1991-93 1998-00 1994-96 1995-97 1994-96 Real GDP Avg Annual Growth 1.2 7.8 6.5% Portugal 2.6% 0. Morgan Fixed income research.6% -13.3% 19.1 3.0 2.8% -73.1% 0.3 Dec-10 4.0% 3.P.1% 2.1 1.1% 17.2 Jul-10 29.7 0.8% 41.5 86.3% 20.1% 1.1 122.8 45.8 12.8 51.0 2.4 6.5% Perf Rel to MSCI Europe (LC) 4.6 Redemption schedule €bn.5 7. ECB aggregate MFI balance sheet.0 119.1 4Q11 23. J.0 61.8 3.P.0 6. Morgan economic research.3 1.9 2.1 3Q11 25.7 Oct-10 7.5% 7.6% 0.4 0.8 55.2% 7.9% 107.1 0.3 58.1% 3.3% 20.6 0.0 0.

P. cash deficit and annual fiscal balance Spanish govt.P. Morgan economic research Source: J. Morgan economic research Portuguese govt. cash deficit and annual fiscal balance Source: J.P.Tracking the fiscal adjustment in the Euro area: So far so good The monthly budget data through June are now available for Greece and Spain It appears that public finances are on track to reach the respective government objectives of fiscal consolidation for this year Greek govt. cash deficit and annual fiscal balance Source: J. Morgan economic research 27 .

2 19.2 PMI Manufacturing Unemploymen Employment t Rate 54.8 8.7 41. Germany.2 4.9 54.8 9.5 53.7 59.2 42.8 51.9 56.0 7.1 10. Austria.2 Germany Netherlands EMU France Austria Italy Ireland Spain Greece Source: Datastream EMU manufacturing PMI breakdown 65 60 55 50 45 40 35 30 25 Jan-08 Apr-08 EMU Jul-08 Oct-08 Jan-09 France Apr-09 Jul-09 Greece Oct-09 Italy Jan-10 Ireland Apr-10 Jul-10 Spain 10 0 -1 0 -2 0 -3 0 -4 0 -5 0 -6 0 -7 0 -8 0 EMU consumer confidence breakdown J a n -0 8 A p r-0 8 J u l-0 8 O c t-0 8 J a n -0 9 A p r-0 9 J u l-0 9 O c t-0 9 J a n -1 0 A p r-1 0 J u l-1 0 Germany EM U G e rm a n y F ra n c e G re e c e Ita ly S p a in Source: Datastream Source: Datastream 28 .Recovery so far: Eurozone is not the odd one out Majority of macro indicators for June and July remained robust in Europe Within Eurozone.7 47.0 54.0 45.7 10.8 4.9 12.3 51.1 52.3 51.2 55.9 46. while Greece. sa 61. Netherlands and France appear in relatively stronger positions. Spain and Ireland are weaker Only Greece is “double dipping so far” Manufacturing and employment indicators in EMU Share in Euro Area GDP 29% 6% 100% 21% 3% 16% 2% 10% 2% PMI Manufacturing Overall.1 49.

2 -1. in contrast to Blue Chip forecast for 2010 which stands at 1% FX tailwind to offset fiscal tightening in periphery US ISM vs Eurozone PMI 65 60 55 50 45 40 35 30 97 98 99 00 01 02 03 EMU PMI Source: Markit.8 1.0 0.0 1.6 2012e 1. Morgan estimates 1.2 -0. consistent with 3% real GDP growth.0 US vs Eurozone consumer confidence 5 0 -5 -10 -15 -20 -25 -30 -35 -40 04 05 06 07 08 09 10 US ISM US Conference Board index .P.1 -4.4 0.2 1.8 2011e 1.5 1. the European data in this upcycle has been robust so far Eurozone composite output PMI index printed 56.7 1.7 in July.4 2.P.8 -0.6 1.4 1. However.0 1.consumer confidence indicator (rhs) Source: Conference Board.2 -4. European Commission 29 .2 1.8 2.0 2.3 -0.3 2.FX boost and resilient macro momentum to counter austerity packages The economic underperformance of Europe in the early stages of an upturn has been a regular feature of past recoveries.consumer confidence EU surv ey . Morgan real GDP projections (%yoy) 2010e Euro area Germany France Italy Spain Greece Portugal Ireland Source: J. ISM 160 140 120 100 80 60 40 20 0 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 J.

brought forw ard 3 quarters) Source: Datastream US non residential capex (%y oy . rhs) Source: Datastream 30 .net% tightening (adv 3q.Drivers of final demand – a) Remain bullish on capex We continue to see the key leading indicators of corporate spend: 1) change in bank lending standards. rs) Source: Datastream. as supportive of stronger capex However. we have recently closed our long standing OW Capital Goods call (since Feb ’09) as we believe it is a crowded trade Lending standards vs non-residential capex -40 -20 0 20 40 60 80 100 91 93 95 97 99 01 03 05 07 09 11 15% 10% 5% 0% -5% -10% -15% -20% -25% US bank lending standards . rhs) US capacity utilization (%y oy . 2) turn in the profit cycle and 3) the momentum in utilisation rates. from equity market perspective.brought forw ard 2 quarters) US non residential capex (%y oy . rhs) US corporate profits vs non-residential capex 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 06 09 -25% -5% -15% 5% 0% -5% -10% -15% US capacity utilization vs non-residential capex 35% 25% 15% 15% 10% 5% 35% 25% 15% 5% -5% -15% -25% 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 US corporate profits (%y oy . Federal Reserve US non residential capex (%y oy .

0% 21. dividends/buybacks and capex. This bodes well for M&A. ex-financials and companies with short record US capex as a share of GDP 20% 19% 18% 17% 16% 15% 14% 13% 12% 11% 47 49 51 53 55 57 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 Priv ate fix ed inv estment % of GDP av erage Eurozone capex as a share of GDP 23. Unlike the trough of the last cycle. *bottom-up aggregated.P.0% 18. when corporate balance sheets were under pressure. but actual capex levels are also at record lows. Morgan Source: Eurostat 31 .5% 22.0% 19.5% 20.5% 19.Starting point favourable.5% 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Eurozone Nominal gross fix ed inv estment % of GDP av erage Source: J. 700 18% 600 16% 500 14% 400 12% 300 10% 200 8% 100 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 6% M SC I Europe ex -F inanc ials C as h on Balanc e s heet (€bn) M SC I Europe ex -F inanc ials C as h / M ark et c ap (rhs ) Source: Worldscope. capex share of GDP record low.0% 22. corporate balance sheets cash rich Cash* on MSCI Europe* balance sheets The pushback is the low utilisation rate.0% 20. the cash on balance sheets is at record highs at present.5% 21.

Private payrolls in positive territory for six months in a row. Latest indicators are mixed. 3. Challenger/Manpower surveys constructive US non-farm private payrolls (‘000s) 600 400 200 0 -200 -400 -600 -800 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 70 65 60 55 50 45 40 35 30 25 20 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 US Retail sales vs unemployment rate 20% -40% 15% -20% 10% 0% 5% 20% 0% 40% -5% 60% -10% -15% 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 R etail s ales . Jobless claims are stuck in a range at 460k. rhs . ISM Employment index at 57.8 (near 40-year highs). Productivity surge calls for stronger hiring. but on balance point up: 1. 000s) Source: Datastream Source: Datastream ISM m anufac turing s urv ey .we believe 500k is breakeven for +ve payrolls. 4. rs ) unem ploy m ent rate forec as ts 80% Source: JP Morgan. 5.total. the key condition for sustainable consumption growth is improvement in the labour market. 2. Datastream ISM employment component US non-farm private payrolls (1m ch. s a % y oy C iv ilian unem ploy m ent rate. s a (% y oy .em ploy m ent 32 .Drivers of final demand – b) Consumer needs to see further improvement in labour markets Ultimately.

“Jobless” recovery?
US total hours worked, start of expansions

We contrast the movement in hours worked and jobless claims to past recoveries, split into “strong” (1975 & 1983) and “weak” (1992 & 2002) labour recoveries The trajectory of hours worked and jobless claims momentum remains consistent with the path of historical “strong labour recoveries”

% 3m , s aar 10 S tro n g re c o v e rie s

5 C u rre n t 0

-5

"J o b le s s " re c o v e rie s

-1 0 t= 0 +3 +6 +9 +1 2 M o n th s s in c e e n d o f re c e s s io n , t = 0 re p re s e n ts e n d o f re c e s s io n

Source: J.P Morgan

US jobless claims, start of expansions
3m prior to end of recession=100 110

100

M ild recov ery

90

80 C urrent 70 Strong recov ery

60 -3 0 3 6 M onths (0 = end of recession) 9 12

Source: J.P. Morgan

33

European labour markets are improving
The size of labour market adjustment in Eurozone was substantial, but there is a clear improvement in European labour market indicators evident The latest employment PMI reading at 50.9 is higher than in ’03, ’04 or ’05, higher than at any point during the first three years of past cyclical upswings
Eurozone employment PMI
60

55 50

45 40

35 30 98 99 00 01 02 03 04 05 06 07 08 09 10

EM U PM I m anufac turing s urv ey - em ploy m ent

Source: JP Morgan, Datastream

UK ILO & Claimant Count
300

Euro area unemployment change
800 600 400 200

200

100

0

0 -200 -400
03 04 05 06 07 08 09 10

-100

-200

00

01

02

03

04

05

06

07

08

09

10

ILO 3m C h in 3m m a, thous ands
Source: Eurostat

U K C laim ant C ount 3m C h in 3m m a, thous ands
Source: Eurostat

Euro Area Unemploy ment sa, m/m ch

Euro Area Unemploy ment sa, m/m ch in 3mma

34

c) Recovery broadening to smaller businesses
Contrary to the consensus view that smaller companies will not see a recovery because they are cut off from access to credit, small cap surveys in all parts of the world have been on an uptrend
Shoko-Chukin small firms’ business sentiment index
50 45 40 35 30 25 20 May -08 Sep-08 Jan-09 May -09 Sep-09 Jan-10 May -10

Shoko-Chukin small firms' business sentiment index
Source: J.P. Morgan

US Small Business Confidence
94 92 90 88 86 84 82 80 J an-08 M ay -08 Sep-08 J an-09 M ay -09 Sep-09 J an-10 M ay -10

German VDMA machinery orders
80% 60% 40% 20% 0% -20% -40% -60% -80% 00 01 02 03 04 05 06 07 08 09 10

N F IB Sm all Bus ines s O ptim is m Index

Germany Plant & Machinery Orders YoY
Source: Bloomberg

Source: Bloomberg

35

Delinquencies peaking
Good correlation between macro momentum and delinquencies, suggesting delinquencies are falling in absolute terms now The turn in the credit cycle is the big positive for banks’ profitability

US residential mortgage delinquencies vs jobless claims
50% 40% 30% 20% 20% 10% 0% -10% -20% 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 0% -20% -40% 80% 60% 40%

US commercial loan delinquencies vs IP
10% 5% 0% -5% -10% -15% 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 US IP (y oy %) JPM IP forecast US Delinquency Rates - Commercial and Industrial Loans (y oy %, rs, rhs)
Source: Datastream, J.P. Morgan

-60% -40% -20% 0% 20% 40% 60% 80% 100% 120% 140% 160%

U S res idential m ortgage delinquenc ies (%y oy )

U S jobles s c laim s (%y oy , rhs )

Source: Datastream

36

China backdrop – growth redistributes - policy tightening to slow
Chinese growth slowing and rebalancing, but not expecting a hard landing Chinese inflation to peak in Q3 and to allow policymakers to relax the tightening process
China inflation
10% 8% 6% 4% 2% 0% -2% -4% 00 01 02 03 04 05 06 07 08 Forecast 09 10 11

China CPI %y oy

Source: Datastream, J.P. Morgan estimates

China GDP growth and contribution breakdown
12% 10% 8% 6% 4% 2% 0% -2% -4% -3.9% -6% 2009 Real GDP 2010e Consumption % Inv estment Net trade 2011e 0.8% 4.4% 4.6% 5.3% 4.7% 4.5% 8.7% 8.1% 10.8% 9.4%

Chinese interest rates
4.0 3.5 3.0 2.5
0.3%

2.0 1.5 1.0 J a n -1 0 F e b -1 0 M a r-1 0 A p r-1 0 M a y -1 0 J u n -1 0 J u l-1 0

Source: J.P. Morgan economic research Source: Bloomberg

C H IN A IN T E R B A N K R E P O 7 D

37

6 . after more than two years.0 1. This time around the output gaps are even more extreme Some pickup in inflation expectations would be welcome for Eurozone given the low recent inflation readings Euro area vs German core inflation 2. DM central banks to remain accommodative for longer Historically. J.0 0.5 07 08 Germany core CPI %y oy 09 Eurozone core CPI %y oy 10 Source: Eurostat US output gap 600 US median CPI 5 400 4 200 0 3 -2 0 0 2 -4 0 0 -6 0 0 1 -8 0 0 0 -1 0 0 0 49 51 53 55 57 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 M e d ia n C P I (% y o y ) J P M a n d C B O fo re c a s ts U S O u tp u t G a p Source: Datastream. J. Morgan 38 .P.P.5 2.Inflation risk limited. core CPI would bottom out only with a long lag following the trough in activity. on average.5 1. Morgan estimates Source: Datastream.

% dev of output from potential. Morgan CPI Serv ices Inflation %y oy Slack one y ear ahead. Morgan 39 .5 3. rhs Source: J.5 1.5 2.0 97 98 99 00 01 02 03 04 05 06 07 08 09 10 0 -1 -2 -3 -4 CPI.5 CPI services vs JPM composite slack 2 1 2 0 -2 -4 04 05 06 07 08 09 CPI Serv ices. %oy a Source: J. and move to 1.5% yoy run rate by the end of this year UK core vs headline inflation 6% 5% 4% 3% 2% 1% 0% 2007 2008 U K headline C PI %y oy 2009 U K c ore C PI % y oy 2010 Source: ONS Core services vs goods inflation 6 4 4. UK inflation remained uncomfortably high We expect UK inflation to peak out right now.0 4.0 1.P. %oy a 10 3.0 5. Eurozone and Japanese inflation remains on a firm downtrend.UK Inflation bucks the trend While US. Goods Ex Food and Energy .0 2.P.

since 1971 Source: Datastream. *re-based to 100 on the day before the 1st hike.Timing of Fed exit: way too early to position for it Non-farm payrolls at times of Fed hikes (‘000) JPM expecting start of policy normalisation in Q4 2011 Equities have fallen every single time in the aftermath However. the equity uptrend has resumed following the initial weakness End of recession Apr-58 Feb-61 Nov-70 Mar-75 Jul-80 Nov-82 Mar-91 Nov-01 Average Median Source: Datastream Payrolls -274 -127 -110 -270 -263 -124 -160 -292 -203 -212 1st Fed Hike Jul-58 Nov-61 Jul-71 Aug-77 Oct-80 Mar-84 Feb-94 Jun-04 Payrolls 125 222 63 238 280 275 201 81 186 212 # mths positive payrolls 1 7 5 26 3 7 24 10 10 7 S&P500 performance around the first hike 105 103 101 99 97 95 93 91 89 87 85 1st hike -12M -10M -8M -6M -4M -2M +10M +12M +2M +4M +6M +8M 85 90 95 100 105 110 S&P500 maximum fall following the first hike 1s t hik e 30 d 1971 60 d 1977 90 d 1980 120 d 150 d 1984 180 d 1994 210 d 2004 1s t hik e Av erage S&P500* M edian S&P500* Source: Datastream. *re-based to 100 on the day before the 1st hike 40 .

8 0. The starting leverage is excessive.N onfinancial s ector debt . credit growth not needed early in recovery Distinction between Stock and Flow of credit.8 1. sa (%y oy ) Source: Nationwide Source: Federal Reserve 41 .4 1. BOE Corporate credit growth vs recessions 20% UK House prices 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% -20% 15% 10% 5% 0% -5% 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 R ecessions U S flow of funds .6 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 UK HH Debt / Income ratio US HH Debt / Income ratio France and Germany av erage HH Debt / Income ratio (rhs) Source: ECB.2 1.6 1.0 0.“Money illusion” to show up again.0 1. but it might not prevent the cyclical response to liquidity injection Economic participants to artificially feel better off again Actual credit expansion not needed in the early stages of recovery Household leverage 2.corporate business (%y oy ) 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Nationw ide house price index .

Looking at 2004 pause Using the last recovery as an example. Subsequently.9 Jan-04 Apr-04 Fed Funds rate Jul-04 US 10Y bond y ield (rhs) Oct-04 3.8 3. the initial equity gains were largely made from March ’03 to Jan ’04.8x fwd P/E 4.0 23 21 19 17 15 13 11 2.5 1.1 4. IBES Source: Datastream 42 .8 Feb-04 13.1 0.6 June-10 10.5 5.6 MSCI Europe 12m Fw d P/E Source: Datastream. MSCI.0 9 7 5 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 1.9 4. in 2005 the equity advance resumed MSCI Europe in 2003-04 1100 1050 1000 950 900 850 800 750 700 650 Dec-02 M ar-03 Jun-03 Sep-03 Dec-03 Mar-04 Jun-04 Sep-04 Dec-04 MSCI Europe up 51% MSCI Europe down 8% MSCI Europe Source: Datastream Valuations in 2004 vs current 25 Fed funds rate and bond yields in 2004 2.7 4.4 1.8x fwd P/E 1. with MSCI Europe up almost 50%.3 2. equities were flat for the ensuing 7 months However.3 4.2 1.

MSCI Source: Datastream. on a number of metrics stocks are still at or below historical fair value 25 23 21 19 17 15 13 11 9 7 5 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 median 04 05 06 07 08 09 10 MSCI Europe 12m Fw d P/E Source: Datastream.7 1. MSCI.0 3.8 1. MSCI M S C I E u ro p e P ric e to S a le s 43 .5 0.0 2.5 4.5 1.4 1.8 0.0 1.5 0.6 0.7 0.0 0.0 0.9 1. Despite strong re-rating in 2009.4 0.9 0.2 1.3 MSCI Europe P/Sales MSCI Europe P/Book median 96 97 98 99 00 01 02 03 04 05 06 m e d ia n 07 08 09 10 Source: Datastream.5 3.7 – Near-term valuations: at or below fair value MSCI Europe 12m Fwd P/E The first stage of equity rebound is driven by multiple expansion.3 1.1 1. IBES MSCI Europe P/Book 4.0 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 1.6 1.5 1.5 2.

6 3.6 2.0% 3.5 4.5 Stdev 10 +1.2 -1.0% 1.9 -1.0% 4.0% 99 00 01 02 03 04 05 06 Div idend Yield Gap 24m m a DY Gap Equities expensive Equities cheap 07 08 09 -1.2 -1. Morgan Dividend yield vs corporate bond yield (%) Dividend yield Utilities Telecom Energy Chemicals Staples Real Estate Technology Building Materials Capital Goods Transport Autos Source: Datastream.6 Difference 2.5 -2.0% 2.8 3.5 -1.0% 3.0% 99 00 01 02 03 04 05 06 07 08 09 -1.0 3.3 2.0% 4.0% -1. Morgan Eurozone HG corporate yield minus dividend yield 6.1 -0.0% 1.P.0% -2.P.1 -2.0% 0.7 2.0% -4.0% -1.4 -2.7 5.3 2.Yield gaps attractive: could drive asset allocation shift to stocks European dividend yield gap European equities still trade at the largest DY vs bond yield spreads since March 2003 The drive for yield compression could push stocks to re-rate further 5.3 2.1 -1.0% 0.5 3.1 -1.8 Corp Div idend Yield Gap Source: J.3 1.2 -1.0% -3.2 -2.0% High grade yield 3.2 0.9 2.7 3.9 6.9 2.P.6 3.5 2.5 Stdev 44 .5 -1.8 LT average -0.0 4.0% 2.8 -3.8 -1. J.5 Stdev 10 5.0% -2.3 0.6 3.3 -1.5 Stdev Source: J. Morgan 24mma DY Gap +1.3 -0.1 3.1 2.

J. valuations remained “cheap” for a long time in the aftermath of structural bear markets Risks to the “ultimate carry trade”: lower potential growth rates. our medium term (2-3 years) outlook is much more cautious Using S&P500 10-year rolling earnings (at 49$) and historical average P/E since 1900 (at 18. Using the P/E average since 1945 (20x) gives fair value at 1000. Morgan Source: Federal Reserve 45 . protectionism. structurally weaker labour markets. regulation. gives S&P500 fair value at 900. and P/E since 1980 (24x) gives fair value at 1175. fiscal consolidation.ratio Source: Datastream. de-leveraging of consumer. Historically. no capital deepening etc S&P500 cyclically adjusted P/E 60 50 40 30 20 10 0 00 05 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 00 05 10 S&P500 cy clically adjusted P/E Av erage 200% 180% 160% 140% 120% 100% 80% 60% 40% 20% 0% 45 47 49 51 53 55 57 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 US non-financial corporates Equities/net worth average S&P500 Q . rise of real interest rates. deflation.P. Shiller data.Longer-term equity outlook: much more muted While our tactical (6-9 month rolling horizon) view remains bullish.5x).

0 1.5 4.5 2. and could be seen as the “blue sky” scenario MSCI Europe EPS integer vs trend 5.7 11.0 4. and assuming the average P/E that equities traded on peak EPS.2 11.8 12. this is not taking into account the structural drags present now.0 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 Europe earnings log Source: Datastream. The subsequent EPS peaks averaged 76% above the prior peaks. MSCI 205.3 6.7 5.2 117. we arrive at 100% upside from here over the next 4-5 years Clearly.5 34. taking 7.3 11.6 11. MSCI EPS cycles and P/E at the time of peak EPS Peak date May-70 Nov-74 Oct-80 Jan-90 May-01 Jan-08 Average Peak EPS integer 7.5 5. the upside could still be significant We have seen five EPS cycles over the past 40 years in Europe.9 9.3 Trend next peak? in 2015 Source: Datastream.7 7.If we have full cycle.8 17.5 1.0 3.5 P/E 11.0 % above past peak na 63% 49% 99% 99% 69% 76% time taken to new high/years n/a 4.5 7.6 6.0 2.5 3.6 19.9 69.5 years in between the peaks Assuming earnings in this upcycle follow the same dynamic.3 11.6 76% 46 .

MSCI 47 .0 0.2 1. However.5 0.7 0.4 90 91 92 93 94 95 96 97 98 99 00 01 av erage 02 03 04 05 06 07 08 09 10 EM vs DM equity performance 140 135 130 125 120 115 110 105 100 95 Jan-09 Apr-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 MSCI EM 12m Fwd P/E rel to MSCI DM +1stdev -1stdev MSCI EM v s DM Source: Datastream.1 1.3 1.8 0.9 0. MSCI Source: Datastream. from tightening towards being more market friendly EM vs DM valuations 1. we reversed this call recently as we see a potential change in Chinese policy stance in particular.Regional calls: re-entering EM vs DM We started 2010 cautious on EM vs DM exposure as we saw adverse Growth – Inflation tradeoff developing in EM this year.6 0.

4 Div 12m Yield Fw d P/E 3.7 0.3 3.0 3.7 2.7% 1.2 1.9 0.0 1.5 3.3 2.9 0.4 2.3 1.9 1.9 0.1 3.2 2.7 2.3 13.2% 2.4 0.5% 14.7 0.8% 4.1 1.8% 1.9 1.4% 10.Restaurants&Leisure Food & Drug Retailing Food Beverage & Tobacco Household Products Healthcare Banks Diversified Financials Insurance Real Estate Software and Services Technology Hardware Sem icon & Sem icon Equip Telecom s Utilities P/Book 1.8 1.6% 12.7 2.2% 12.8 1.9 2.OW Europe vs the US We prefer European equities vs the US as we view them as under owned and relatively attractively priced In addition.6 1.3 1.8 0.5% 13.0 10.5 2. RHS) 48 .3 15.6 6.8% 13.4 3.5 2.9 9.8% 10.6 6. IBES up to 28th July Source: Datastream MSCI Europe rel to US (%y oy ) US$ to Euro (%y oy .5% 34.5% 12.5% 2.3 P/Book 1.1 9.6% Europe vs US vs Bond Yields spread 0.2 1.2 A p r-1 0 M a y -1 0 J u n -1 0 U S .6 2.7 2.3% 5.1 2.4 13.6% 1.7% 9.0 2.2 1.1 2.2% 12.1 14.9 3.7% 12.7 3.5 0.1 0.0 0.6% 2.7 8.2 1.9 3.1% 1.9 10.4 4.8% 14.4% 2.8 15.2% 2.5 11.1% 1.7 2.9 2.4 2.4 1.3 2.3 1.5 1.2 14.3% 2.2% 0.0 2. MSCI.5% 10.8 3.7% 4.6 0.3% 15.0 4.9 3.8% 3.1 1.1 1.G e rm a n 1 0 y b o n d y ie ld J u l-1 0 Market Energy Chem icals Construction Materials Metals & Mining Capital Goods Transport Autom obile Consum er Durables Media Retailing Hotels.5 3.9 2.2 5.7 17.4 2.8% 37.2 US Div Yield 2.0 1.5 6.7 2.6 1.4 17.4 2.3 12.5 12.7 10.9 13.7 1.2% 13.6 13.2% 0.3 14.9% 10.1% 0.5 12.7% 10.3% 2.4% 15.4% 13.1 8.9 11.2 0.5% 15.3 0.4% 17.1% 3.7 2.3% 2.7% 2.4% 10.6 3.1% 2.3 Source: Datastream European vs US equities and EUR/USD 40% 30% 20% -20% 10% 0% -10% -20% 30% -30% -40% 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 40% 50% -10% 0% 10% 20% -50% -40% -30% Source: Datastream. European macro backdrop is proving to be rather resilient and interbank market stress is easing Europe vs US valuations Europe 12m Fwd P/E 10.8 8.4 3.0 3.0 2.4% 14.3% 1.

reducing our preference for Dax vs Eurostoxx German equities strongly outperformed the rest of Europe this year.6 -1.P.7 -7.3 1. since March ’09 and March ‘03 25% 20% 115 30% 20% 15% 10% 5% 110 10% 0% -10% 0% -5% -10% -15% -20% 105 100 -20% 95 -30% 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 -25% 90 tro u g h +1 m +2 m +3 m +4 m +5 m +6 m +7m +8 m +9 m +1 0 m +1 1 m +1 2 m +13m +1 4 m +1 5 m +1 6 m Da x re l to E u rs to x x (T R ) in 2 0 0 3 Da x re l to E u ro s to x x (T R ) in 2 0 0 9 DAX rel to EM U (T R . We think that this will continue on a two-year view. rhs ) Source: Datastream.58 1.8 -0.8 -8.56 Dax vs Euro zone and IFO 120 Dax vs Europe.3 1.6 1.Within Europe. but also that it is a crowded trade in the short term.7 -4.2 -1.4 -6. and could suffer some reversals 2008 Chinese and German total exports 2008 exports (U$ trillion) China Germany Source: Datastream Cyclically-adjusted primary budget position (%GDP) 2009 Euro area Germany France Italy Spain Netherlands Greece Source: J.4 1. re-based to 100 on 12 March ‘03 and 09 March ‘09 Source: Datastream 49 .5 -3. Morgan estimates 2010e -2.1 -0.2 -1. % y oy ) IF O (% y oy .

0 36.2 27.2 2.4 22.7 1.1 0.4 2.9 3.1 1.2 2.8 0.8 1.0 15.1 2. P/Book since 1980.8 % to median 18% 13% -30% 13% -43% -11% -16% -2% -19% -3% -10% 1% 3% -28% -26% -8% 11% 64% -7% 39% 12% -20% 4% 5% -16% -9% -7% Last 14.6 11.8 14.1 1.3 15.1 2.5 % to median 0% -4% -33% -3% -31% -31% 5% -11% -27% 21% 34% 19% 17% -10% -11% 27% 73% 56% -3% 49% 32% 42% 8% 70% -8% -1% -6% Europe Energy Chemicals Cons Mat Metals&Mining Capital Goods Transport Automobile Cons Durables Media Retailing Hotels.0 1.4 17.5 17.2 3.2 2.9 11.5 1.0 Median 12.5 1.5 13.7 16.6 1.3 9.8 0.8 19.3 17.0 15.9 1.8 2.7 2.4 13.0 0.6 1.3 12.1 11.2 1.1 1. vs Def.2 11.4 12.4 18.8 8.6 0.7 29.5 0.5 22.3 1.2 12.5 8. At cob 27th July 2010.3 0.9 35.5 14.0 0.3 2.7 12.2 14.6 10.8 0. 12m Fwd P/E and two-year out P/E since 1995.9 12.0 2.3 17.9 2.8 0.9 8.2 11.9 9.8 2.5 1.5 17.Sector valuations: Europe Valuations favour Defensives European sector valuations vs history 12m Fwd P/E Last 10.5 12.1 21.7 1.9 P/book Median 1.8 8.7 13.8 0.8 14.7 1.2 13.2 2.2 9.3 2.1 25.1 15.3 27.7 12.4 13.0 3.Rest&Leis Food&Drug Ret Food Bev&Tob HPC Healthcare Banks Insurance Real Estate Software&Svs TechHardware Semicon Telecoms Utilities Cyclicals Defensives Cyc.7 17.1 13.1 20.2 9.9 0.0 1.1 11.3 14.0 3.5 28.6 1.4 1.3 16.6 19.97 % to median 22% 60% 1% 1% 35% 4% -6% -1% -12% 45% 11% 13% 21% 4% 24% 77% 4% 38% 29% 64% 37% 50% 42% 28% 18% 31% -13% Last 1.7 17.9 26.3 20.1 12.9 15.6 0.7 8.7 21.4 0.4 10.6 Median 1.7 1.7 10.6 10.7 24.5 25.4 0.6 1.1 1.1 1.1 1.0 10.3 19.5 13.8 19.4 1.1 17.1 2.1 2.8 1.2 18.9 Cycle-adj P/E Median 21.2 13.3 23.3 27.9 1.1 11.1 17.4 0.9 15.3 0.3 0.3 13.4 2.8 1.6 13.3 11.6 0.2 1.1 0.9 % to median 30% 83% 5% 16% 52% 9% 6% 7% -11% 38% 11% 12% 22% 4% 22% 63% 26% 53% 37% 47% 41% 51% 37% 29% 23% 29% -6% 12m Fwd P/Sales Last 1.6 35.8 17.7 13.2 14.7 2.4 12.4 1.0 2.7 0.6 16.8 14.6 1.7 2.6 10.8 15.2 29.6 12.8 1.8 0. Source: Datastream.5 12.08 Median 13.8 13.1 13.3 15.7 15.3 22.3 6.0 1.5 1. MSCI.5 2.0 13.2 0.7 2.9 25.8 12.5 1.5 10.5 0.6 0.5 19.7 21.5 14.5 2.1 12.9 10.9 11.3 0.9 20.2 11.5 2.6 9.5 12.1 9.2 15. IBES.1 14.0 7.1 1.2 2.2 14.5 8.2 11.0 9.4 14.3 24.5 2.9 2.2 13.3 7. Cycle-adjusted P/E since 1983.4 1.1 14.8 1.5 0.9 0.7 22.7 11.8 15.9 20.9 11. P/Sales since 2000 50 .0 2.3 1.3 14.6 9.5 11.7 12.0 22.3 13.7 0.4 20.8 10.3 1.7 8.2 1.0 15.8 10.1 2.2 0.9 1.5 24.8 17.6 1.6 1.1 10.5 11.9 1.8 % to median 45% 45% -21% 38% -6% 23% 35% 10% 23% 81% 22% 56% 44% -8% -1% 41% 61% 276% 129% 35% 134% -9% 41% 34% 17% 28% -11% 2-year out P/E Last 9.5 22.

9 1. 12m Fwd P/E and two-year out P/E since 1995.6 0.7 12.2 22. Cycle-adjusted P/E since 1983.7 2.1 1.9 2.97 Cycle-adj P/E Median 19.7 0.7 1.0 10.5 24.7 14.7 18.7 12.3 1.0 16.6 9.1 0.0 10.7 2.2 2.5 6.3 2.5 12.5 14.2 1.9 10.9 1.2 17.0 % to median 41% 105% -5% 75% 13% 38% -51% 34% 35% 10% 25% 7% 11% 65% 17% 55% 30% -2% 44% 7% 40% 27% 13% 12m Fwd P/Sales % to Last Median median 1.0 23.9 10.5 11.6 20.3 20.9 14.1 13.6 0.1 12.3 0.5 -7% 69% 5% 30% 85% 10% 25% -47% -20% 66% 74% 51% 4% 4% 67% 10% -8% 12% -21% UK Energy Chemicals Cons Mat Metals&Mining Capital Goods Transport Automobile Cons Durables Media Retailing Hotels.1 15.3 1.6 8.2 3.4 24.1 16.0 9.7 23.7 3.9 2.0 1.6 14.3 1.7 0.5 0.6 6.6 29.8 8.0 3.7 11.5 14.0 12.4 11.0 0.0 1.3 12.4 2.0 2.5 9.7 3.4 12.3 0.6 1.4 3.8 12.3 0.5 2.3 18.0 11.8 17.5 14.6 12.6 18.8 P/book Median 2.9 0.6 11.4 2.3 13.4 19.9 1.0 13.1 15.7 16.0 6.6 -26% 0.1 1.9 13.0 29.6 10.5 1.8 16.7 15.0 68.2 1.2 1.Sector valuations: UK Valuations favour Defensives UK sector valuations vs history 12m Fwd P/E Last 9.5 11.8 2.9 1.3 1.7 10.3 14% 0.9 8.5 7.0 14.4 12.3 2.8 26.8 5.1 13.2 2.1 22.4 11.0 10.0 16.7 10.8 0.7 12. Source: Datastream.3 8% 1.2 14.8 7.8 17.4 2.7 15.7 22.0 12.6 3.8 1.7 2.0 2.6 0.5 12.9 20.8 2.3 0.5 0.6 20.4 9.1 3.9 15.5 9.0 1.8 2.1 1.9 9.4 1.5 5.4 19.6 1.6 0.99 % to median 37% 42% -40% 73% -27% 10% 47% 97% -50% 30% 97% 31% 13% -15% -12% 43% 147% 200% 115% 7% -23% -42% 46% -7% 14% 11% 2% 2-year out P/E Last 8.4 22.6 % to median 14% 14% -47% 12% -32% 13% -6% -26% -35% -3% 33% 1% 22% -12% -16% 7% 34% 27% -19% 1% 41% -40% 42% -21% -23% 5% -28% Last 14.9 0.7 0.7 27.1 1.0 17.4 0.6 12.4 11.8 20.8 12.2 16.0 12.7 7.1 16.0 9.7 8.3 1.9 1.0 29.5 51.6 19.5 1.2 7.8 24.3 20.3 16.8 15.9 Median 12.8 13.8 24.4 1.0 10.4 2.6 4.0 2.8 2. At cob 27th July 2010.2 39.5 0.9 6.2 8.8 0.1 8.9 4.Rest&Leis Food&Drug Ret Food Bev&Tob HPC Healthcare Banks Insurance Real Estate Software&Svs TechHardware Semicon Telecoms Utilities Cyclicals Defensives Cyc.7 14.5 1.7 22.9 21.3 15.8 11.93 Median 13.5 3.9 17.7 10.5 2.4 11.5 1.5 13.0 1. P/Book since 1980.4 12.5 0.7 0.0 14.0 9.2 1.97 % to median 31% 75% -15% 64% 17% 8% -57% 35% 37% 13% 27% 7% 18% 82% -9% 37% 26% 6% 50% 8% 45% 40% 6% Last 1.5 14.0 31.4 2.5 13.1 15.4 0.7 2.9 11.3 5.4 2.1 10.8 12. vs Def.0 26.4 9.4 0.8 3. MSCI.0 24.4 1.4 2.3 5.8 17. IBES.4 42% 2.0 14.6 15.5 8.1 3.7 20.4 15.3 2. P/Sales since 2000 51 .

40 10 5 10 0 95 90 J an F eb M ar Apr M ay J un J ul E M U F in an c ia ls 20 1 0e E P S E M U C y c lic als 2 01 0 e E P S E M U De fen s iv e s 20 1 0e E P S 52 Source: IBES . MSCI. For Eurozone only.9 0. the 2010 consensus EPS integer for Cyclicals has been revised up by 10% ytd.9 1.1 1.3 1.6 1. While the valuation angle is not outright supportive for Cyclicals. IBES 2010 consensus sector EPS estimates 11 5 Performance Sep-09 to current 9% 2% 6% current 12.5 1.4 1. IBES Cyclicals vs Defensives valuations and performance 12m Fwd P/E Sep-09 Cyclicals Defensives Cyclicals/Defensives Source: Datastream.8 0. MSCI. we think these will be tolerated as long as EPS momentum is on the clear uptrend.Stick with Cyclicals Cyclical valuations remain elevated compared to Defensives in the historical context.7 0. although they have improved significantly vs their most stretched level. Cyclicals relative to Defensives fwd P/E 1.5 11.6 95 96 97 98 99 00 01 02 03 04 av erage 05 06 07 +1s tdev 08 09 -1s tdev 10 Europe C y c lic als 12m F w d P/E rel to Defens iv es Source: Datastream.08 11 0 16.6 11. seen in September ’09.2 1.0 0. but has been downgraded for Defensives by 1%.

9% 7.3 10% 19% 19% 14.9 11.8% 8.0% -0.4% -5.7 17.4% 0.4 14.7 10. IBES.5 10% 19% 19% 12.4 13.0% -8.3 15.9% 7.0% -0.7% 9% 2% Source: Datastream.7% 4.6% -2.1% 1.5 19.4 7% 14% 14% 17.9 9.9 13.5 10.5 13.1 10.1 8.3% -3.5% 4.4% -3. Cyclicals appear to consistently offer double the upside of Defensives current 12m Fwd P/E Europe Energy Chemicals Cons Mat Met&Min Cap Goods Transport Automobile Cons Durables Media Retailing Hotels.2% -7.5 18% 35% 140% 8.8 8.4 4% 9% 21% 12.3 13.5% 4.7% 17.7% -11.Exploring the potential EPS driven upside Potential cyclical upside at sector level The potential cyclical upside? P/E multiples staying put or derating to 04-06 levels Assuming various EPS scenarios.5 12.0% 8.2 11.0% 28.2 6% 14% 14% 11.9 4% 7% 7% 10.9 10.7 17.1 9. MSCI.3 9% 15% 15% 15.1 9% 19% 26% 11.1 6% 13% 13% 9.7 21.8% -17.3 -14% -7% -3% 12.1 14.8 11.4% 20.3 14.3% 11.3 12.5% -19.5% 29.9 13.9% -8.4 10.1 10% 19% 23% 8.1% 10. as at 28th July 2010 53 .2 12.8% 8.9 17% 27% 87% 13.8 15.1% 14.4 9.6 2004-06 median 12m Fwd P/E 12.4 17.6 21.8% -3.1 6% 12% 17% 13.7 12% 17% 17% 10.7% 11.5 11.7% 11.3 12% 20% 32% 13.9 3% 11% 11% 13.6 13.2 11% 21% 21% 13.5 8% 17% 17% 12.4 13% 20% 22% 13.4 12.5 13.0 10.9% 2.8 11.8% 14.9 Price upside assuming 12m Fwd Lowest EPS 2012e Past Peak P/E as of Jun.EPS EPS 2011 11.4% -8.Rest&Leis Food Drug Ret Food Bev&Tob HPC Healthcare Banks Div Fin Insurance Real Estate Software Tech Hardware Semicon Telecoms Utilities Cyclicals Defensives 10.1 12% 21% 21% 8.2 14.8% -3.2% -19.5 13.3 13.8 3% 5% 5% 15.3 13.7% 3% -4% Perf since Sep-09 0.9 13.0% 1.1% 8.6% 15.0% -8.0 3% 6% 11% 10.7 8.5% 8.5 12.0% 11.6 5% 10% 13% Ytd perf -2.4% -5.6 11.4 14.9 10% 33% 33% 13.7% 3.4 11% 24% 38% 9.6% -12.4% -13.7 16.2 14.8 23.8 22% 42% 42% 9.3 15.9% 8.9 14.

8 10.3 14.3 P/Book 2. low P/B.88 2. MSCI.6 12.0 1.6 13.8 13.6 12.9% 3.4% 4.48 0.47 0.51 0.8% 3.39 ND/Equity 0.8 1.5 1.8 1.60 0.5% 3.1% 2.42 ND/Equity 0.8% Div Yield 3.4% 5.44 ND/Equity 0.9 2.3 1.5 1.17 1. -ve EPS revisions and relatively more leveraged names 1H of this year saw EPS momentum and quality as the key factors Factors that have worked for European outperformers 2010 Q3 Quintile 1 Quintile 2 Quintile 3 Quintile 4 Quintile 5 2010 Q2 Quintile 1 Quintile 2 Quintile 3 Quintile 4 Quintile 5 2010 Q1 Quintile 1 Quintile 2 Quintile 3 Quintile 4 Quintile 5 2009 Q4 Quintile 1 Quintile 2 Quintile 3 Quintile 4 Quintile 5 2009 Q3 Quintile 1 Quintile 2 Quintile 3 Quintile 4 Quintile 5 2009 Q2 Quintile 1 Quintile 2 Quintile 3 Quintile 4 Quintile 5 Rel perf 10% 3% -1% -4% -9% Rel perf 20% 11% 4% -2% -11% Rel perf 17% 8% 2% -3% -12% Rel perf 15% 6% 0% -7% -16% Rel perf 22% 7% 0% -7% -17% Rel perf 34% 14% 4% -4% -13% MV weight 18% 16% 20% 21% 22% MV weight 17% 23% 18% 20% 19% MV weight 13% 16% 21% 29% 21% MV weight 19% 27% 23% 15% 14% MV weight 14% 17% 22% 24% 22% MV weight 13% 13% 24% 22% 29% ND/Equity 0.9 12.1% 3. The initial out-performers can be characterized as the biggest fallers over the past two years.5% 3. data is 12 months forward IBES estimates 54 .0% 3.5% 4.41 0.1 12.7 13.Drivers of stock selection: value starting to outperform most recently The “low quality” has outperformed in the initial stages of the rally. performance relative to sector.46 0.6 2.27 0.0% Div Yield 4.43 0.0% 3.2 1.40 ND/Equity 0.1 10.1% 3.6 1.2 1.9 15. IBES.7 1. smaller caps.P.6 P/E 14.1% Source: J.26 0.1 14.49 0.36 0.9 1.26 ND/Equity 0. within all sectors.8 P/E 7.33 0.9 12.4 P/E 10.41 0.8 13.0 1.7 1.2 P/Book 0.31 0.5 P/Book 0.28 0.7 P/E 16.9 1.7% 2.90 1.9 1.1% 3.8 P/Book 0.2% Div Yield 2.4 Div Yield 3% 4% 4% 3% 3% Div Yield 2.5 15. Cyclicals.15 0.26 0.6% 4.3 P/E 14. Defensives and Financials.4 1. Morgan.8 1.4% Div Yield 2.5% 3.54 0.30 0.10 P/Book 2.1 9.77 1.58 0.42 0.56 0.67 0.3 12. low ROE.2 13.9 13.3 P/Book 1.0 1.44 0.5% 2.6 10.1 12.2% 4.7 13.5% 3.5 12.42 %ch EPS 1% 1% 1% 0% 0% %ch EPS 15% 10% 10% 4% 2% %ch EPS 10% 7% 5% 4% 0% %ch EPS 11% 5% 4% 1% 0% %ch EPS 2% 1% 3% 0% -3% %ch EPS -9% -4% -4% -2% 0% RoE 10% 12% 14% 15% 16% RoE 16% 14% 11% 12% 10% RoE 12% 13% 13% 13% 11% RoE 15% 14% 13% 11% 9% RoE 8% 10% 13% 14% 16% RoE 9% 11% 14% 14% 14% P/E 10.9% 3.8 11. low P/E.

5 7.60 0. stronger profit margins and lower leverage than at the similar stage of the past cycle) Cost of financing is near record low Valuations and FX favour European targets (and UK vs continent) in cross-border deals Improving equity market leads to M&A M&A activity vs equity performance 200% 150% 100% 50% 0% -5 0 % -1 0 0 % 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 50% 40% 30% 20% 10% 0% -1 0 % -2 0 % -3 0 % -4 0 % -5 0 % E u ro p e a n De a l V a lu e ($ m ) % y o y 6 m m a M S C I E u ro p e % y o y 6 m m a (rh s ) Source: Datastream.55 0.5 5.70 0. Bloomberg European net debt to equity 0. MSCI.P.35 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 7.0 3. Morgan.40 0.75 0.50 0.0 6.80 0.5 4.45 0.2010 Theme: M&A activity to pick up Corporates are in a strong position (16% of market cap in cash.0 4.5 3. * all maturities 55 .5 6.0 5.0 99 Euro area corporate high grade yield* 00 01 02 03 04 05 06 07 08 09 10 Europe ex -Financials Net Debt/Equity Source: Worldscope Euro corporate high grade y ield Source: J.65 0.

3% 41.9% 61.6% 40.5% 40. Cyclicals and Financials 55 50 45 40 35 30 25 20 15 10 5 0 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 MSCI Europe dividend per share MSCI Europe Div idend per share Source: Datastream.1% 2012e DPS upside 5.8% 37.1% 33.9% 39.9% 46.9% 44.2% 58.7% 27.1% - 40% 20% Energy Materials Industrials 0% -20% Discretionary Staples Health Care -40% -60% 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 Financials IT Telecoms Utilities Source: IBES MSCI Europe DPS (%y oy ) M SCI Europe EPS (%y oy ) Source: Datastream.4% 37. i.1% 2012e 41.2% 42.2% 71.3% 6. MSCI European EPS and DPS growth 60% Dividend upside potential at sector level Payout ratio 04-'07 average Europe 43. MSCI 56 .5% 4.3% 37.4% 36.8% 33.e.2010 Theme: Dividends to start growing again Corporate balance sheets are in a strong position The earnings cycle is on the up and has historically been coincident with the dividend cycle Financials sector profitability is picking up We advise positioning in areas where dividends are likely to grow the most.5% 26.1% 45.3% 44.4% 61.9% 23.0% 14.

Prices and Valuations as of COB 29th July. or you can contact the covering analyst or your J. We remain OW on the cyclical growth story. 2010 Please see the most recent company-specific research published by J. UCG now trades at 0. we think Givaudan's superior fundamentals deserve a premium rating Q1 sales bodes well for Nestle to sustain volume growth and EBIT margins expansion. Our basic premise of Cyclical recovery & structural uplift remain in place. we remain Overweight on ASML 2Q results solid. multiple positive medium and long term catalysts for ABI. increase to the share buyback (though widely speculated) and positive Brilinta FDA AdCom could drive the share price up in our view. 5% upgrade to FY'10 EPS guidance. stronger Krona rather than Euro) . Rio Tinto remains compelling from a cashflow and valuation perspective.P.1 E 1.2 E 44.0 SF 3.0 £ -26% -1% -8% -6% OW OW OW OW Steel price momentum to underpin margins on 3Q.7x P/NAV11E. MT NA RIO LN XTA LN AAL LN 23. Further impressive evidence on Holiday Inn re-launch is an important tailwind in the recovery of hotel cycle Good strategy on digital channels with ITV2. Significant improvement in the intrinsic business model. We expect platinum business to move down the cost curve.2 E 334.5 £ 10. J. exposure to Emerging Markets. VOD LN KPN NA TEL NO 150. We think the 37% discount to book value and 7% discount to NAV are simply too wide. which has cleanest generation fleet in the UK and a fast growing energy services business. ROG VX NOVN VX AZN LN 136.0 E 2. remaining a counterparty of choice with strong cash flow generation and high gearing to a recovery in the credit cycle. valuation is hugely supportive in our view.7 SF 53. Strong Q2 numbers.0 NK 38.& 4. Novartis has a strong pipeline with several potential blockbuster candidates and the long term outlook remains underappreciated by the market.4 E 92.4 E 86. best in class operational management and a strong growth pipeline. and there is significant excess capital.P. We continue to see hidden value within Vodafone's portfolio.e.5 E -13% 2% 7% OW OW OW Strong gross margins development. We remain overweight ahead of 3 key triggers i) public certification of Brazilian pre-salt resource ii) resolution to the 'tax dispute' with Khazak govt iii) development sanction for QC LNG by year end 2010.P.0 £ 2.1 E 23. Operational leverage could offer medium term upside. Strong growth from Q1 has continued into Q2. but guidance upgrade and buyback announcements are positives along with cheap valuations make the stock an OW in our view ALU FP ASML NA SAP GR 2.morganmarkets. headcount reduction & procurement.107. We believe BarCap will remain the main earnings driver. Capacity to exceed AB cost synergies target to 2. Cost cutting and shareholder returns remain best in class. With high teens EPS growth and a potential cash return. scope for higher dividend payments on the back of better FCF guidance. Positive catalysts are continued exploration successes in NCS & recovery in European gas demand. IBES.6 E 93. Morgan representative 57 . The stock is underpriced in our view since the peer adjusted loss in market value exceeds our worst case liability estimate by more than 15Bn $. reduction of fixed costs. KPN will emerge with its core attractions (earnings growth. application and enterprise margin stronger than expected and services segment was also strong The company reported 17. Software & rel Svs are expected to grow at 6-8% with management optimistic that customers continue to invest for growth. and improvement in commercial vehicles margins and sales performance are the core reasons to remain overweight on MAN. BBVA is s solid option with Europe given its i) above average profitability ii) solid capital position highlighted in Bank of Spain's stress test iii) attractive international exposure through Mexico/Latam. reflecting under pricing by the market.Top Picks Name Energy BP BG Group Statoil TOTAL Materials ArcelorMittal Rio Tinto Xstrata Anglo American Industrials Siemens Schneider BAE Systems Man Philips Discretionary Daimler LVMH Intercontinental Hotels ITV JCDecaux Staples Anheuser Busch Inbev Carrefour BAT Givaudan Nestle Healthcare Roche Novartis Astrazeneca Financials Credit Suisse BNP Paribas UniCredit Societe Generale BBVA HSBC Swiss Re Ageas Barclays IT Alcatel Lucent ASML SAP Telecoms Vodafone KPN Telenor Utilities Centrica CNA LN 306.9 E 11% 17% 24% 2% 17% OW OW OW N OW Truck margins seem to be on an upward trend markets. After significant decline in the stock price following sovereign risk concerns. Also the possibility of cash utilization at year-end could support the stock Upbeat comments at NYU lodging conference.7 E 3. with free cashflow yield expected to exceed 16% based on our forecasts in FY 2011 and PER of 5. BNP Paribas is well positioned for growth.5 E 656.level rating in 2011 as a major catalyst.3 SF 51. Recent approval for Sandoz Generic in US to have positive impact. Strong 1H'10 to lay ground for upgrades. EPS has held better than feared and we consider Rating to be the key for perf. The self-help theory also still has legs with operational performance likely to be strong through H2. Total appears poised to deliver strong production growth in 2010 and the recovery in its downstream earnings is also a plus. The group posted solid set of results with a better earnings mix. There are numerous areas of conservatism in the Ageas book value.289.0 £ 961.3x.com. Further. The story still has some way to run at this stage. Post April jitters. also expected swing in earnings from lower provisions due to run-off and improvement of HFC. CSGN VX BNP FP UCG IM GLE FP BBVA SM HSBA LN RUKN VX AGS BB BARC LN 47. Ticker Price YTD perf Rating JPM view Source: Datastream.4 E 320. Also.5 SF 51. guidance more confident. improved pension funding status.0 £ 126. Strong oil price leverage and benefits from currency safe haven status (i.0 SF 2.1 E 24. Morgan. Cyclical & Structural optimism remains.25Bn$ from ZBB.5 £ 1.4 E -31% -10% -13% -15% OW OW N N Q2 results in line with consensus with strong cash generation.013.1 £ -7% -4% -4% -9% -18% -7% -4% -17% 21% OW OW OW OW N OW OW OW N Continues to tick the right boxes: i) attractive business mix ii) strong capital position iii) less impact from IB regulatory proposals than peers iv) excellent and stable management team In our view. MSCI. Relative to consensus.0 £ 1.1 £ 70. EBIT margins ahead of expectations.197.6 £ 19. MT remains top pick given its operating leverage to rising steel prices and it competitive advantage in raw materials. We see return to an AA. Also considering the ongoing provisioning improvement. Largest cost cutting guidance in media. Shift from balance sheet repair to earnings progression. valuation) Q2 results were mixed. Solid underlying growth of continuing business should put to rest concerns about a significant slowdown in the sales growth.8x 2011E P/NAV Barclays remains our favorite domestic UK bank. Innovation and mix improvements remain at the heart of the strategy rather than just volumes growth. Clear scope for a higher PE multiple in due course Topline momentum to continue. we remain overweight especially on valuation. higher EM exposure and ~30% exposure to late cyclicals should support growth relative to the sector in H2 2011 and beyond. Near term expectations on earnings for Philips have risen materially but the company seems to be on track to deliver while the valuations remain undemanding. likely to be replicated in the forthcoming Q2 reporting season.4 E 16% 6% -11% 29% 13% OW OW OW OW N We remain overweight on Siemens on a combination of attractive relative valuations and good earnings momentum. Research is available at http://www.355. UK advertising market to recover in '10 and grow by 4. Soc Gen can generate E8 per share in the long term in our view. and growth due to contracts won in 08 & 09 SIE GR SU FP BA/ LN MAN GR PHIA NA 74. in our view.0 £ 53. we reiterate our OW rating Ageas remains ver undervalued in our opinion at 60% of BV.032. With the under-capacity in DRAM & overall lack of capacity in semi market unlikely to end in 2H10.7 £ 9% OW Centrica remains our top pick in UK Utilities.0 NK 5% -10% 15% OW OW OW Macro driven recovery should support evolutionary improvements in growth. ABI BB CA FP BATS LN GIVN VX NESN VX 40. We also note that the book value is highly tangible (no DAC) Trading on 0. Superior top-line growth potential based on an improved portfolio.7 E 10.3 £ 48. Morgan for an analysis of valuation methodology and risks on companies recommended in this report. our PBT is still 7% ahead of Bloomberg average.3.0 £ -22% -10% 13% OW OW N Strong sales performance across the board. Growth drivers to start to re-emerge with strong sales in Programmes (Eurofighter and JFS) and International (Saudi Exports) to become more visible.7 SF 12% 4% 9% 16% 3% OW NA OW OW OW The background to the industry remains extremely supportive. DAI GR MC FP IHG LN ITV LN DEC FP 41.5% qoq growth in 2Q and a guidance of 10% qoq gr in 3Q'10. s/holder returns.9 E 35.541.3% leading to increased revenues in TV JCDecaux remains top preference because of the structural growth potential of the outdoor industry. BP/ LN BG/ LN STL NO FP FP 413.5 E 35. We expect Xstrata to continue best performance amongst big four based on exposure to favored commodities. Nestle is top pick amongst pan-European Food Producers since it is better placed to pass on the rising raw material costs in 2H'10 Long term value.4 E 2. also new line of efficient engines in Mercedes could lead to a better price/mix and a positive surprise from Mercedes LVMH has the potential to post significant growth on tougher comps than peers with a strong operating leverage.

GL. GAMESA CORPN. (XET) VOESTALPINE QIAGEN (XET) RED ELECTRICA CORPN.FSE. TECHNIP JCDECAUX PHILIPS ELTN. CABLE & WIRELESS WWD.1) AEGON RAIFFEISEN INTL.DE GPHYQ.CORP.GROUP XSTRATA SCHRODERS ROYAL DUTCH SHELL B BALFOUR BEATTY RECKITT BENCKISER GROUP BAE SYSTEMS ROYAL DUTCH SHELL A(LON) BRITISH LAND CARNIVAL COBHAM WHITBREAD TESCO HSBC HDG.-VERT. DAIMLER (XET) IBERIA ACERINOX 'R' ARCELORMITTAL RAUTARUUKKI 'K' RENAULT TF1 (TV.Stocks that derated the most since recent peak.BK. (ORD $0.TEGC.PORTUGUES 'R' VEOLIA ENVIRONNEMENT AGEAS (EX-FORTIS) INFINEON TECHS.50) INVESTEC BG GROUP LAND SECURITIES GROUP GLAXOSMITHKLINE JOHNSON MATTHEY MARKS & SPENCER GROUP KINGFISHER NEXT SERCO GROUP MORRISON(WM)SPMKTS. IBES 58 .HLDG. Country UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK UK Sector FINANCIALS MATERIALS ENERGY DISCRETIONARY DISCRETIONARY MATERIALS MATERIALS TELECOMS INDUSTRIALS MATERIALS FINANCIALS MATERIALS MATERIALS MATERIALS HEALTH CARE DISCRETIONARY FINANCIALS MATERIALS FINANCIALS ENERGY INDUSTRIALS STAPLES INDUSTRIALS ENERGY FINANCIALS DISCRETIONARY INDUSTRIALS DISCRETIONARY STAPLES FINANCIALS FINANCIALS ENERGY FINANCIALS HEALTH CARE MATERIALS DISCRETIONARY DISCRETIONARY DISCRETIONARY INDUSTRIALS STAPLES Price move since Mkt Peak -22% -26% -3% -22% -30% -12% -26% -26% -7% -14% -5% -14% -23% -12% -21% -17% -14% -19% -10% -11% -17% -9% -16% -10% -3% -14% -13% -9% -11% -7% -8% -10% -9% -11% -3% -8% -7% -5% -11% -9% Stock PIRELLI GROUPE EUROTUNNEL DEUTSCHE LUFTHANSA (XET) STMICROELECTRONICS (PAR) UPM-KYMMENE CIE. WOLSELEY RIO TINTO PRUDENTIAL ANGLO AMERICAN KAZAKHMYS BHP BILLITON SMITH & NEPHEW HOME RETAIL GROUP LONDON STOCK EX. despite +ve EPS trend intact MSCI Eurozone and UK stocks with the biggest P/E de-rating since 15th April to 28th June Fall in 12 Mth Fwd PE since Mkt Peak -84% -38% -35% -32% -29% -29% -25% -25% -24% -23% -22% -22% -20% -20% -19% -19% -18% -18% -17% -17% -16% -16% -15% -14% -14% -14% -14% -14% -13% -13% -13% -13% -13% -12% -12% -12% -11% -11% -11% -11% 12 Mth Fwd EPS move since Mkt Peak 22% 24% 48% 24% 3% 21% 3% 0% 22% 16% 24% 13% 0% 12% 1% 0% 1% 3% 6% 11% 1% 6% 0% 8% 10% 3% 1% 8% 2% 12% 8% 3% 2% 1% 8% 5% 4% 6% 3% 2% Fall in 12 12 Mth Fwd Mth Fwd Price move EPS move PE since since Mkt since Mkt Mkt Peak Peak Peak -91% 10% 11% -55% -25% 50% -50% -4% 87% -47% -18% 52% -41% 5% 87% -39% -32% 13% -38% 13% 87% -35% -2% 67% -34% -12% 34% -33% -29% 4% -33% -11% 35% -32% -1% 44% -31% -14% 34% -30% -13% 21% -30% -6% 34% -29% -29% 0% -29% -21% 10% -29% -24% 3% -29% -30% 1% -29% -18% 13% -28% -22% 9% -28% -11% 24% -28% 15% 64% -28% -21% 6% -27% 10% 57% -27% -5% 28% -26% -4% 31% -26% -21% 6% -26% -3% 11% -26% -15% 12% -25% -17% 0% -25% -22% 1% -25% -21% 6% -24% -1% 32% -24% -20% 12% -24% -20% 4% -23% -16% 5% -22% -18% 7% -22% -9% 19% -21% -3% 25% Stock RESOLUTION LONMIN TULLOW OIL ITV THOMAS COOK GROUP VEDANTA RESOURCES EURASIAN NATRES. ERAMET SBM OFFSHORE IPSEN TELECINCO OUTOKUMPU 'A' NESTE OIL BMW (XET) HOCHTIEF (XET) EXOR ORD ASML HOLDING UMICORE MEDIASET SOCIETE GENERALE OMV BANCO COMR. MSCI.KONINKLIJKE Country ITALY FRANCE GERMANY FRANCE FINLAND FRANCE GERMANY SPAIN SPAIN FRANCE FINLAND FRANCE FRANCE NETHERLANDS AUSTRIA SPAIN FRANCE NETHERLANDS FRANCE SPAIN FINLAND FINLAND GERMANY GERMANY ITALY NETHERLANDS BELGIUM ITALY FRANCE AUSTRIA PORTUGAL FRANCE BELGIUM GERMANY AUSTRIA GERMANY SPAIN FRANCE FRANCE NETHERLANDS Sector DISCRETIONARY INDUSTRIALS INDUSTRIALS IT MATERIALS ENERGY DISCRETIONARY INDUSTRIALS MATERIALS MATERIALS MATERIALS DISCRETIONARY DISCRETIONARY FINANCIALS FINANCIALS INDUSTRIALS MATERIALS ENERGY HEALTH CARE DISCRETIONARY MATERIALS ENERGY DISCRETIONARY INDUSTRIALS FINANCIALS IT MATERIALS DISCRETIONARY FINANCIALS ENERGY FINANCIALS UTILITIES FINANCIALS IT MATERIALS HEALTH CARE UTILITIES ENERGY DISCRETIONARY INDUSTRIALS Source: Datastream.

ASTRAZENECA DAIMLER (XET) NATIONAL GRID SMITH & NEPHEW NOVARTIS 'R' GLAXOSMITHKLINE HUSQVARNA 'B' WOLTERS KLUWER COBHAM UCB AEGON SWISS RE 'R' CRH CINTRA PUBLICIS GROUPE CREDIT SUISSE 'R' ZODIAC TATE & LYLE Ticker DELB BB FME GR TOMK LN PSON LN SYST VX AH NA SMIN LN IHG LN AZN LN DAI GR NG/ LN SN/ LN NOVN VX GSK LN HUSQB SS COB LN UCB BB AGN NA RUKN VX CRH ID CIN SM PUB FP CSGN VX ZC FP TATE LN Sector CONSUMER STAPLES HEALTH CARE INDUSTRIALS CONSUMER DISCRETIONARY HEALTH CARE CONSUMER STAPLES INDUSTRIALS CONSUMER DISCRETIONARY HEALTH CARE CONSUMER DISCRETIONARY UTILITIES HEALTH CARE HEALTH CARE CONSUMER DISCRETIONARY HEALTH CARE CONSUMER DISCRETIONARY INDUSTRIALS HEALTH CARE FINANCIALS FINANCIALS MATERIALS INDUSTRIALS CONSUMER DISCRETIONARY FINANCIALS INDUSTRIALS CONSUMER STAPLES % U$ sales 72% 71% 65% 64% 64% 60% 59% 54% 51% 50% 58% 49% 48% 48% 47% 47% 46% 46% 46% 45% 45% 45% 45% 42% 42% 42% 40% BAE SYSTEMS ASSA ABLOY 'B' SAGE GROUP UBS 'R' NOBEL BIOCARE INVENSYS ROLLS-ROYCE GROUP SYNGENTA BP PORSCHE PREF. SMITHS GROUP ICTL.GP.CARE TOMKINS PEARSON SYNTHES AHOLD KON.HTLS. Bloomberg Name Ticker BA/ LN ASSAB SS SGE LN UBSN VX NOBE VX ISYS LN RR/ LN SYNN VX BP/ LN POR3 GR SAN FP ML FP ELUXB SS ICI LN ACX SM ADS GR GIVN VX SWMA SS DGE LN DSY FP NESN VX LG FP SSABA SS IBLA SM Sector INDUSTRIALS HEALTH CARE INDUSTRIALS INFORMATION TECHNOLOGY FINANCIALS HEALTH CARE INDUSTRIALS INDUSTRIALS MATERIALS ENERGY CONSUMER DISCRETIONARY HEALTH CARE CONSUMER DISCRETIONARY CONSUMER DISCRETIONARY MATERIALS MATERIALS CONSUMER DISCRETIONARY MATERIALS CONSUMER STAPLES CONSUMER STAPLES INFORMATION TECHNOLOGY CONSUMER STAPLES MATERIALS MATERIALS INDUSTRIALS UTILITIES % U$ sales 39% 40% 39% 39% 38% 37% 36% 36% 36% 36% 35% 35% 35% 34% 33% 33% 33% 32% 31% 31% 31% 31% 30% 30% 30% 30% 30% ROCHE HOLDINGS GSH. ROG VX UNITED BUSINESS MEDIA UBM LN WLSNC NA CONSUMER DISCRETIONARY NOVOB DC HEALTH CARE INTERNATIONAL POWER IPR LN 59 . ACERINOX 'R' ADIDAS (XET) NOVO NORDISK 'B' GIVAUDAN 'N' SWEDISH MATCH DIAGEO DASSAULT SYSTEMES NESTLE 'R' LAFARGE SSAB 'A' IBERIA Source: Datastream.INDS.European stocks: US$ exposure We advise to position portfolios for USD strength and positive DM growth surprise European stocks with >30% revenues U$ denominated Name DELHAIZE FRESENIUS MED. (XET) SANOFI-AVENTIS MICHELIN ELECTROLUX 'B' IMPERIAL CHM. Worldscope.

35 0.48 -0.47 0.51 0.63 0.5 0.32 Materials WACKER CHEMIE EURASIAN NATRES.3 0.6 0.52 0.31 0.42 0.GP. as long as they are moving up for the “right reasons” European sectors correl to 10Y bond yields Cyclicals Discretionary Industrials IT Materials Defensives Staples Healthcare Telecom Utilities Cyclicals vs Defensives Financials Energy Source: Datastream.36 -0.35 0.39 0.69 0.4 0.32 0.33 0.48 0.3 0.45 0.13 0.43 0. since 1995 Stocks + correlation with bond yields Industrials ALFA LAVAL PRYSMIAN SANDVIK RENEWABLE ENERGY GAMESA SKF 'B' SIEMENS (XET) MAN (XET) ABB 'R' VESTAS WINDSYSTEMS ADP GEA GROUP INVENSYS ATLAS COPCO ADECCO ATLAS COPCO PHILIPS SCANIA 'B' SCHNEIDER ELECTRIC HOCHTIEF METSO VOLVO KONE Discretionary THE SWATCH GROUP CHRISTIAN DIOR LVMH HUSQVARNA BURBERRY GROUP FIAT ICTL.39 0. THYSSENKRUPP LONMIN SSAB 'A' SSAB 'B' XSTRATA ANGLO AMERICAN BHP BILLITON ANTOFAGASTA VEDANTA OUTOKUMPU VOESTALPINE NORSK HYDRO FRESNILLO JOHNSON MATTHEY ERAMET RIO TINTO KAZAKHMYS UMICORE HOLCIM 'R' STORA ENSO HEIDELBERGCEMENT ARCELORMITTAL RAUTARUUKKI AKZO NOBEL Correl to 10Y Bdy 0.07 -0.4 0.47 0.33 0.33 0.19 0.44 0.48 -0.46 0.4 0.51 0.62 0.46 0.37 0.3 Correl to 10Y Bdy 0.3 0.43 0. since 1995 60 .4 0.53 0.38 0.46 0. MSCI.58 0.05 0.35 0.55 -0.3 0.60 0.46 -0.49 0.31 0.41 0.47 0.European stocks correlation to bond yields Cyclical sectors display the highest positive correlation to bond yields.67 0.52 0.61 0. MSCI.32 0.62 -0.66 0.38 0.52 0.4 0.46 0.18 -0.45 -0.3 US 10y BDY German 10y BDY 0.32 0.HTLS.34 0.00 Source: Datastream.3 Tech ASML HOLDING STMICROELECTRONICS Correl to 10Y Bdy 0.53 0. Correl to 10Y Bdy 0.37 0.22 0.33 0.48 0.17 -0.22 -0.54 0.48 0.37 0.

3 -0 .2 -0 .2 1 .0 1 .3 -0 .1 -0 .6 -0 .8 2 . MSCI.6 -0 .3 0 .1 0 .3 1 .European stocks: operational leverage screen We screen for the cyclical stocks that suffered the largest derating this year.5 1 .4 1 .1 1 .4 1 .3 3 .4 -0 .8 3 .1 0 .1 -0 .C O R M A T E R IA L S A C T E L IO N HEALTH CARE K + S (X E T ) M A T E R IA L S T O M K IN S IN D U S T R IA L S Z A R D O Y A O T IS IN D U S T R IA L S S K A N S K A 'B ' IN D U S T R IA L S N O V A R T I S 'R ' HEALTH CARE STR AU M AN N H LD G .1 -0 .3 -0 .1 8 .9 ND E q u ity 0 .5 0 .6 1 .6 3 .3 1 .1 1 .3 1 .0 -0 .8 1 .0 0 .0 0 .4 1 .0 0 .1 -0 .1 0 .1 -0 . HEALTH CARE IN V E N S Y S IN D U S T R IA L S S H IR E HEALTH CARE G E B E R I T 'R ' IN D U S T R IA L S A B B 'R ' IN D U S T R IA L S M 6 -M E T R O P O L E T V C O N S U M E R D IS C ALFA LAVAL IN D U S T R IA L S BAE SYSTEM S IN D U S T R IA L S E L E C T R O L U X 'B ' C O N S U M E R D IS C B E IE R S D O R F (X E T ) CO NSUM ER STAP IN D IT E X C O N S U M E R D IS C B IO M E R IE U X HEALTH CARE P U M A R U D O L F D A S S L E RC O N S U M E R D IS C W A C K E R C H E M IE (X E T ) M A T E R IA L S BALFO U R BEATTY IN D U S T R IA L S SO NO VA N HEALTH CARE L 'O R E A L CO NSUM ER STAP S I K A 'B ' M A T E R IA L S N O K IA N R E N K A A T C O N S U M E R D IS C N E S T L E 'R ' CO NSUM ER STAP H E N N E S & M A U R I T Z 'B ' C O N S U M E R D I S C H E R M E S IN T L .1 -0 .1 RoE 22% 32% 36% 17% 21% 21% 23% 21% 18% 90% 15% 18% 22% 33% 26% 24% 18% 20% 22% 28% 20% 17% 26% 18% 17% 18% 18% 23% 16% 18% 17% 20% 41% 18% 18% 31% 16% 61 . C O N S U M E R D IS C IC A P F IN A N C IA L S K O N E 'B ' IN D U S T R IA L S LVM H C O N S U M E R D IS C Source: Datastream. IBES Y td P E C hange -5 5 % -5 1 % -4 3 % -4 2 % -4 1 % -3 3 % -3 2 % -3 1 % -2 9 % -2 3 % -2 0 % -1 9 % -1 6 % -1 6 % -1 5 % -1 5 % -1 4 % -1 4 % -1 4 % -1 2 % -1 1 % -1 1 % -1 0 % -9 % -8 % -7 % -7 % -6 % -6 % -5 % -4 % -4 % -4 % -4 % -3 % -2 % -1 % Y td E P S C hange 93% 72% 43% 25% 34% 38% 3% 39% 60% 6% 18% 11% 1% 12% 27% 11% 13% 10% 22% 5% 20% 10% 17% 11% 7% 9% 2% 11% 12% 29% 29% 9% 14% 17% 1% 18% 21% O p e ra tio n a l L e v e ra g e 1 .0 -0 .1 0 .1 -0 .1 1 .1 1 .5 -0 .8 1 .2 3 .0 -0 .4 0 .0 0 .5 0 .5 -0 .0 4 .5 2 .2 1 .5 1 .6 2 .1 -0 .8 -0 .5 2 .4 1 .4 -0 .5 1 .2 7 .7 0 .8 1 .6 -0 . display low leverage and high ROE Operational leverage screen N am e S e c to r R IO T IN T O M A T E R IA L S B H P B IL L IT O N M A T E R IA L S T E L E C IN C O C O N S U M E R D IS C KAZAKHM YS M A T E R IA L S ANTO FAG ASTA M A T E R IA L S E U R A S IA N N A T R E S .7 1 .7 2 .1 2 .2 2 .

02 14.MAERSK 'B' SANDVIK UPM-KYMMENE INVESTOR 'B' CONTINENTAL (XET) ASML HOLDING RESOLUTION TF1 (TV.62 14.7 2.565.6 13.8 10.15 9.5 2.26 34.48 56.4 69.50 10.84 14.9 6.396.534.0 2.0 5.071.027.70 15.310.490.252.52 19.17 15.046.09 15.796.61 10.372. ATLAS COPCO 'A' Mkt Cap (E) 12 Mth Fwd PE 6.5 2.MTG 'B' 71 PIRELLI 72 BIC 73 NORDEA BANK 74 DANSKE BANK 75 DEXIA 76 SKANSKA 'B' 77 ADECCO 'R' 78 STANDARD LIFE 79 DSV 'B' 80 RANDSTAD HOLDING Mkt Cap (E) 12 Mth Fwd PE 13.371.859.9 5.00 17.360.5 2.081.436.FSE.08 10.9 5.2 10.597.79 18.18 12.0 6.813.575.37 13.173.7 4.289. 51 CIMENTOS DE PORTL.158.98 15.433.8 12.4 5.611.3 5.5 2.583.5 5.HLDG.1) INFINEON TECHS.7 2.532.1 10.95 17.5 1.3 10. (XET) 42 ALFA LAVAL 43 NESTE OIL 44 TOMKINS 45 WARTSILA 46 LVMH 47 HOLMEN 'B' 48 MAN (XET) 49 TELE2 'B' 50 HERMES INTL.340.08 16. (XET) KESKO 'B' RENAULT EXOR ORD AKZO NOBEL ACERINOX 'R' TELECOM ITALIA RAIFFEISEN INTL.7 3.71 11.2 7.7 5.98 11.SGPS 52 SKF 'B' 53 JCDECAUX 54 THALES 55 SCA 'B' 56 TULLOW OIL 57 SCHNEIDER ELECTRIC 58 EDP RENOVAVEIS 59 UNICREDIT 60 KONE 'B' 61 WACKER CHEMIE (XET) 62 AGEAS (EX-FORTIS) 63 SIEMENS (XET) 64 BUREAU VERITAS 65 HUSQVARNA 'B' 66 RANDGOLD RESOURCES 67 ADIDAS (XET) 68 TERNA 69 STMICROELECTRONICS (PAR) 70 MODERN TIMES GP.8 5.5 3.52 13.472.GP.69 30.91 24.75 17.91 29.06 16.8 5.0 7.74 14.371.13 9.63 18.7 7.00 11.8 9.671.7 3. as at 28th July 2010 62 .29 13.8 24.1 13.77 6.74 15.2 2.506.673.165.1 5.98 44.26 10.0 4.2 13.600.80 12. IBES.205.48 13.96 29.995.054.04 11.38 19.92 9.64 11.47 12.797.18 13.739.099.938.75 Ytd Perf (%) -7% 82% -50% 1% -14% -12% 9% 17% 26% 23% 29% 58% 38% 59% 28% 11% 42% -7% 8% 46% 22% -4% -18% 33% 18% 34% 11% 33% 3% -26% -3% 34% 29% -4% 9% -2% -7% -8% -10% 24% YTD EPS -1m Price Perf -1m Chg in 12 Mth Fwd Ch(%) (%) EPS (%) Rank Name -3% -60% -50% 729% 154% 209% 400% 364% 128% 147% 105% 200% 227% 51% 0% 191% 126% 92% 125% 118% 113% 290% 163% 193% 41% 583% 114% 25% 58% 9% 191% 54% 15% 13% 4% 7% -5% -7% 7% 15% 3% 8% 1% 9% 4% 1% -1% -4% 8% 17% -2% 22% 16% 9% 9% -3% -6% 0% 6% 10% 3% 1% 11% 2% 8% 7% 4% 2% 1% 6% 5% 1% 104% 100% 60% 50% 50% 40% 35% 35% 33% 31% 30% 30% 25% 25% 24% 23% 23% 22% 20% 20% 20% 18% 17% 14% 13% 13% 13% 12% 12% 11% 11% 11% 11% 10% 10% 10% 10% 9% 9% 9% 41 VOLKSWAGEN PREF.4 8.83 10.791.9 2.0 5.8 1.4 3.9 3.679.32 10.138.04 8.3 7.83 11.631.587.616.724.70 15.069.54 13.3 10.52 17.47 9.68 20.8 13.28 15.9 2.4 23.4 14.085.3 45.773.1 10.0 2.489.08 17.871.720.945.5 13.49 12.001.57 14.2 8. RENEWABLE ENERGY PEUGEOT GROUPE EUROTUNNEL ALCATEL-LUCENT DEUTSCHE LUFTHANSA (XET) COMMERZBANK (XET) BRITISH AIRWAYS SWEDBANK 'A' STORA ENSO 'R' SCANIA 'B' IBERIA VOLVO 'B' BMW (XET) DAIMLER (XET) TUI (XET) RAUTARUUKKI 'K' ITV LLOYDS BANKING GROUP SEB 'A' FIAT BANCO COMR.63 52.79 11.363.00 Ytd Perf (%) 20% 23% -1% 79% 46% 18% 9% 34% 25% 38% -27% 22% 16% -25% 20% 5% 7% -29% -4% 19% 10% -17% 19% 28% 3% 21% 10% 6% -1% 37% 18% 16% 7% 15% -10% 9% 2% 0% 6% 3% YTD EPS -1m Price Perf -1m Chg in 12 Mth Fwd Ch(%) (%) EPS (%) 46% 40% 35% 100% 19% 29% 14% 61% 38% 25% 7% 60% 116% -20% 20% 113% 37% -5% 20% 25% 14% -5% 44% 15% 22% 68% 17% 18% 307% 48% 24% 15% 40% 130% -38% 33% 49% 5% 11% 50% 3% 9% -1% 32% 6% -1% -4% 5% 9% 16% 2% -3% -2% -2% 13% 17% 0% -6% 11% 6% 8% 13% 0% 2% 2% -15% 1% 6% -7% 2% 4% -6% 9% 11% 22% 5% -3% 10% 6% 5% 8% 8% 8% 8% 8% 7% 7% 7% 7% 7% 7% 7% 7% 7% 6% 6% 6% 6% 6% 6% 6% 6% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% Source: Datastream.667.357.6 5.7 4.96 14.BK.1 30.363.660.253.60 14.5 11.426.0 2.57 10.50 12.487.014.196.2 11.683.53 26.0 3.03 34.05 36.4 2.587.9 5.82 10.62 17.2 56.MSCI Europe constituents that showed largest EPS upgrades in the past month European stocks that showed outright EPS upgrades in the past month Name ORKLA ROYAL BANK OF SCTL.2 11.7 6.729.9 34.9 4.13 15.3 44.182.1 4.8 6.689.9 5.108.766.91 13.3 8.9 6.7 6.683.266.40 16.8 41.851.PORTUGUES 'R' A P MOLLER .19 11.5 3.13 10.019.141.08 15.868.03 194.66 8.583.

having upgraded the sector to OW in Feb ‘09 OW Capital goods is the most crowded trade at present and the sector price relative is at 15-year high Manufacturing momentum is rolling over and consensus is already implying record high margins for the sector Capital Goods relative to Europe 1.95 0. IBES 63 .rhs) EBIT/Sales C apital Goods IBES forecasts Source: Datastream. Morgan estimates Source: Datastream. J. Morgan estimates Capital goods EPS momentum vs IP 40% 30% 20% 10% 0% -10% -20% -30% -40% 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 8% 6% 4% 2% 0% -2% -4% -6% -8% 6% 5% 4% 8% 7% 10% 9% Capital goods EBIT margins 99 00 01 02 03 04 05 06 07 08 09 10 11 12 Industrials fw d earnings (%6mom) Europe IP(%6mom.80 0.P.70 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 C a p g d s (S X N P ) re l to E u ro p e (S X X P ) Source: Datastream.10 1.75 0.05 1. J.3mma.90 0.85 0.15 1.INDUSTRIALS: NEUTRAL Downgraded Capital Goods to N on 27th July We closed our long running bullish view on Capital Goods on 27th July.P.00 0.

8 0. valuations are rich Pricing lags the activity and is likely to get incrementally worse for Capital Goods Capital goods relative performance has decoupled significantly from bond yields Stretched valuations have been tolerated for some time. but might be seen as more challenging a hurdle in the backdrop of peaking of macro momentum Capital goods pricing relative and volume growth 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Germ an m ac hinery orders (%y oy . IBES 64 .1 1. 3m m a) EM U C apital Goods PPI relativ e (%y oy .INDUSTRIALS: NEUTRAL Pricing will get weaker.6 95 96 97 98 99 00 01 02 03 04 05 06 +1stdev 07 08 09 -1stdev 10 Capital Goods 12mth Fw d P/E rel av erage Industrials rel (%6mom) German 10y Bdy %6mom (rhs) Source: Datastream.3 1.7 0. rhs .2 1.4 1. MSCI. 21m lag) -4% -6% -8% 2% 0% -2% 8% 6% 4% Source: Eurostat Industrials relative and German 10-year bund yield 20% 15% 10% 5% 0% -5% -10% -15% -20% 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 40% 30% 20% 10% 0% -10% -20% -30% -40% Capital Goods 12m Fwd P/E relative 1.0 0.9 0. MSCI Source: Datastream.

4 -0. IBES 65 .8 0.0 2.5 3. rhs ) Source: Datastream. rs ) Source: Datastream. MSCI.8 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 1.0 0.6 -0.5 0.FINANCIALS: OVERWEIGHT Cyclical positives to prevail vs current credit dislocation Sector is still a consensus short. adv 12m .6 0.2 0 -0.0 1. in our view Credit cycle at the inflection point Regulatory uncertainty is easing 75% 50% 25% 0% -25% -50% 89 91 93 95 97 99 01 03 05 07 09 UK banks relative and mortgage applications 150% 100% 50% 0% -50% -100% UK Banks rel to market (%y oy ) Source: Datastream Mortgage approv als (%y oy .P ro v is io n s / to ta l lo a n s c h o y a E u ro p e B a n k s O p e ra tin g in c o m e % y o y (rh s .5 2. Worldscope European Bank s +v e to -v e EPS rev is ions relativ e Euroz one Yield c urv e (10y .5 E u ro p e .2y .2 -0. rhs) European bank provisioning vs profitability 100 80 60 40 0% 20 20% 0 -2 0 -4 0 97 98 99 00 01 02 03 04 05 06 07 08 09 40% 60% 80% -8 0 % -6 0 % -4 0 % -2 0 % European banks EPS revisions vs shape of the yield curve 0.0 -0.4 0.

7 0.8 3.9 13.7 3.3 0.8 3.4 10.7 6.2 2.6 2.9 3.5 3.1 9.0 1.4 0.7 0.0 3.9 0.7 0.1 2.4 2.BANKS: OVERWEIGHT.7 11.2 2.8 0.6 2.3 4.9 9.7 3.6 2.0 5.4 Price/PrePrice/Preprovision provision operating operating 12 Mth Fwd profit 2010E profit 2011E PE Germany Commerzbank Deutsche Bank Deutsche Postbank Nordics Danske Bank DNB SEB Swedbank CEEMEA Erste Raiffeisen KBC Greece Agricultural Bank of Greece Alpha Bank Bank of Cyprus Eurobank EFG Bank of Piraeus Benelux Dexia Portugal BCP BES BPI Europe 5.6 0.1 3.6 3.3 10.6 3.1 3.5 3. Pre-provision valuations attractive European banks pre-provision P/E and P/Book Price/PrePrice/Preprovision provision operating operating 12 Mth Fwd profit 2010E profit 2011E PE UK Barclays HSBC Lloyds TSB Royal Bank of Scotland France BNP Paribas CASA Societe Generale Ireland Allied Irish Banks Bank of Ireland Spain Bankinter BBVA Popular Sabadell Santander Pastor Italy Intesa Sanpaolo UBI Mediobanca Montepaschi UniCredito Banco Popolare Banca Popolare di Milano Switzerland Credit Suisse UBS 3.0 3.7 0.1 2.8 3.6 0.5 0.4 10.0 8.2 1.5 3.8 Source: Datastream.1 7.3 0.7 12.7 0.8 0.1 0.3 2.0 10.5 0.7 0.6 3. Morgan.7 10.7 14.2 3.8 3.1 3.5 12.2 7.2 7.2 7.7 4.5 1.9 3.6 0.1 3.8 0.6 10.4 3.6 0.3 4.7 3.1 8.8 1.7 0.5 5.9 1. J.1 14.5 7.7 9.9 8.7 4.7 0.1 1.3 5.1 0.6 0.0 0.1 14.5 7.0 7.6 3.2 2.2 3.7 P/Book 1.9 3.0 3.4 1.8 1.3 3.1 5.9 11.5 0.0 7.1 11.7 5.1 0.9 10.8 1.8 3.0 7.6 3.2 7.5 5.1 1.7 0.9 1.2 5.7 3.1 2.0 14.0 0.3 18.6 5.3 2.0 1. 2010 66 .1 1.8 13.1 2.4 3.7 0.8 0.6 12.7 4.9 1.8 5.8 3.6 3.5 9.7 4.7 2.5 12.P.5 P/Book 0.0 1.0 8.0 9. prices as at cob 29th July.4 3.0 6.3 0.3 4.4 6.6 4.0 3.7 2.1 14.1 9.8 3.5 1.9 12.8 2.0 0.9 4.4 4.4 3.3 3.9 3.6 10.8 0.1 0.5 1.3 0.7 0.1 0.4 1.9 10.3 0.3 3.0 9.2 1.2 3.9 3.6 3.4 0.5 1.0 10.1 9.4 5.8 4.8 4.3 3.6 9.0 13.1 10.8 8.9 1.5 3.9 3.7 4.2 6.1 8.3 1.7 5.8 2.4 2.0 3.2 16.

Datastream 67 .7 0. 5% 3. 5% 48 51 54 57 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 U S Dom es tic financ ial c orporate profits as a % of G DP F inanc ials s hare of U S m ark et c ap (rhs ) av erage av erage (rhs ) 25% 23% 21% 19% 17% 15% 13% 11% 9% 7% 5% European Financials ROE 18% 16% 14% 12% 10% 8% 6% 4% 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 European Financials RoE Source: Datastream RoE average to '98 Source: BEA. 0% 1.7 0.1 1.4 80 82 84 86 88 90 92 94 96 98 00 +1 s d 02 04 -1 s d 06 08 10 Bank s trailing P/E relativ e to m ark et Av erage Bank s P/B relativ e to m ark et Av erage Source: Datastream Source: Datastream US financial corp.5 0.9 0.6 0.9 0. profits % GDP vs Financials % market cap 4.8 0. 0% 2. 5% 2. 5% 1.0 0.3 73 75 77 79 81 83 85 87 89 91 93 95 97 99 +1 s d 01 03 05 -1 s d 07 09 European banks P/Book relative to the market 1.1 0.5 1.BANKS: longer-term context difficult Near-term picture more favourable than longer-term one.7 1. 0% 0.5 0.3 1. long term ROE to be muted European banks P/E relative to the market 1. 0% 3.

w. AFS or HTM portfolios for NBG.w. other non domestic Other Government risk Other public finance risk Government securities o. Held to maturity Gvt bonds as a % of assets NAV sensitivity to 1% decline in value SEB Government securities o.476 EFG 12.628 3 7% 1% SAN 38.367 13.832 2.178 99.896 9% 2% NBG 21.127 n.374 55.w.233 2.499 8. 16% and 12%) Our analysts calculate that for each 100bp decline in government bond values.783 0 0 0 0 0% 2% 4.056 39.500 260 3.467 1. 3.432 1.738 6% 2% 4% 1% BKIR 11.723 42.294 1.200 immaterial n.147 8% 4% SAB 5.042 63.256 1.531 36.w. Greece o.400 17.632 8.000 1.542 13.127 0 0 7% 8% POP 6.613 21.127 63.650 1.a.a.w. NBG and BNP (20%.216 8.000 BTO 6.562 69.800 100 100 2.000 200 14.334 59.000 500 5% 1% 2.900 9.P. Company reports and J.346 ISP 55.800 2. Greece o.a.000 9.207 8% 2% Erste 16. trading o.500 63.525.a.516 2. 7% of assets Banks with larger holdings of bonds are KBC.715 9632 69.950 1.995 43.535 610.546.941 0 7.349 Source: J.195 1.900 3. n.500 41 5.332 50 15.178 CASA 123.383 4.w.200 24.P.30% BKT 2.595 Nordea 8.200 27.000 0 0 immaterial 1.534 BCP 4.126 MPS 15. other non domestic Other Government risk Other public finance risk Government securities o. n.349 20 BP 5.a.346 20.365 17.a. Morgan Banks research team.439 10.000 0 567 79 488 0 1% 0% 168 5.542 4. domestic o.677 nd 1.000 6. 20.935 BPM 567 MB 5. securities across trading.632 29. AFS o.516 5.989 48.930 UCG 50.w.660 n.300 2. n.660 0 1.000 5.000 6.383 Dexia 48.815 3. n.699 794 255 4% 1% 0 4.200 29.935 4.000 17. Held to maturity Gvt bonds as a % of assets NAV sensitivity to 1% decline in value 3% 1% 8% 2% 7.588 8% 4.531 28. trading o.500 5. AFS o.995 SG Danske 59.000 0 18.820 22.467 CBK 63.035 15.w.600 2. 2% 0% BES 2.352 1.881 30.676 0 3% 1% Alpha 3. domestic o.w.500 0 3.347 675.126 450 3.736 12% 4% 123.a.896 5560 16.391 8% 2% 3% 1% 5% 1% 5% 1% 6% 1% 5% 1% 4% 1% 10% 1% 38. as at 30th April 2010 68 .715 10. * Split of govt.000 6.a.400 1.333 298.865 DNB Nor 4.026 46.605 3% 0% 701 7.w. Morgan estimates. Alpha and EFG only includes GGB holdings.723 15.748 4. the sector would potentially see 1% of NAV erosion European banks’ holdings (€m) of government bonds and NAV sensitivity Total Government securities o.Banks: Sovereign risk exposure and sensitivity Direct exposure to government bonds/loans for European banks is c.748 UBI 4.700 0 533 AIB 2.800 676 6.783 749 700 1.662 0 854 256.216 7.125 1 9% 1% BBVA 27.873 850 BNP 256.900 3.233 1.100 0 16% 3% 2. 5% 1% 2% 0% 15.w.800 n.713 50.662 20% 10% 17.w.055 1.304 11.000 8.475 3.075 143.548 0 3.600 4% 1% 6.625 Swed 9.234 5% 1% KBC 69.896 7.900 1.

P. Credibility needs to be regained first. Eurozone sovereign bonds as an asset class actually appreciated and the ultimate potential loss likely to be far smaller than from the sub-prime crisis Ytd Investment gains/losses. *based on GBI indices.Banks: Potential capital loss in the context of ’08 sub-prime crisis Ytd Investment gains/losses on Govt Bonds Immediate debt restructuring unlikely to achieve anything. Restructuring of debt further down the line is probable. but the losses might not need to be booked directly by the retail banks=> the “bad” exposures will be offloaded in the meantime to the ECB and the SPV Ytd. Billion US$ 69 . up to 27th July Source: Bloomberg. Morgan Fixed income research. on Government Bonds (€bn) Germany France Netherlands Austria Belgium Finland Italy Gains Ireland Spain Portugal Greece Losses 31 29 8 7 6 2 1 84 -1 -3 -5 -41 -50 34 Banks writedowns and capital raised for subprime Writedowns & Credit losses Worldwide Americas Europe Asia 1771 1192 538 41 Capital Raised 1483 811 537 135 New Capital / Losses 84% 68% 100% 328% Net Gains Source: J.

288 30.000 146. Insurance is not leveraged to equity upside anymore 70% 60% 50% 40% 30% 20% 10% 0% European Insurance investments breakdown 95 96 97 98 99 00 01 02 03 04 05 06 07 08 F ix e d in c o m e / T o ta l in v e s tm e n ts E q u itie s / T o ta l in v e s tm e n ts Source: Worldscope.100 11.240 4. unless otherwise stated.P. 0% 2% 2% 2% 7% 0% 4% 2% 1% 0% 6% BBB % market cap 263% 35% 89% 42% 59% 21% 35% 36% 14% 237% 88% Sub-inv % Market cap 62% 5% 21% 4% 7% 2% 1% 4% 3% 86% 12% Period 1Q 10 4Q 09 4Q 09 1Q 10 1Q 10 1Q 10 1Q 10 4Q 09 4Q 09 4Q 09 4Q 09 Source: J.INSURANCE: NEUTRAL Bonds / Equity exposure The sector suffers from the environment of low yields and will be under pressure if/when yields start rising.900 51.821 96.681 38.304 32.338 34.808 40. bottom-up aggregated Corporate bond gearing 4Q 09 / 1Q 10 Aegon ING Axa Swiss Re (SFm) Allianz ZFS ($m) Munich Re Generali Baloise (SFm) Swiss Life (SFm) Aviva £m Market cap 8. Mkt cap as on 29th July 2010 70 .000 17.537 98.265 Corporate bonds on balance sheet 56.234 % A-rated or better 53% 81% 73% 51% 66% 85% 69% 88% 94% 70% 60% %BBB 38% 15% 20% 43% 24% 14% 26% 9% 5% 22% 30% % sub-inv grade 9% 2% 5% 4% 3% 1% 1% 1% 1% 8% 4% % N. Morgan Equity Research Insurance team.R.080 20.215 69.170 3.132 29.555 10. Figures are in € million.915 24.598 17.240 27.

197 500 na 800 291 222 32 154 31 140 26 32 na Italy1 4.100 1. Morgan Insurance research team.380 11.055 1.P.300 1.356 7.208 23.713 19.049 259 560 273 876 34 As % SH equity 102% 53% 52% 45% 40% 29% 28% 28% 28% 24% 16% 15% 9% 7% 5% 4% 4% 1% Fortis Unipol Generali Mapfre Delta Lloyd ING Allianz SNS Reaal Axa Zurich -$m Munich Re Aegon CNP Hannover Re Aviva .166 3.675 5.057 144 20.240 1.800 1.843 6.053 11.768 1.801 6.386 6.846 4.570 9.800 na 3.201 3.200 4.894 Portugal1 1.011 3.747 7.456 667 999 241 79 350 44 22 na 1.855 15 749 541 232 1.226 na na na na na na na na na na na 1.692 29.048 55.200 2.824 1.747 1.915 2.300 895 9.117 22.334 na 2.712 10.478 15.765 3.600 819 5.049 8.713 467 1. millions) Spain5 UK Germany France US Benelux 911 252 762 782 124 3.877 na 8.120 606 6.835 1. as at 6th May 2010 71 .112 90 828 1.440 36.011 na 1.300 na na 5.334 352 na 501 1.513 na 1.915 11.500 1.013 16.977 7.166 5.503 na 114 na na na 50 Others 1.449 na na 2.193 1+2+3 +4+5 8.398 0 600 na na 1.766 1.875 6.042 38.548 3.115 3.742 2.687 7.450 6.Insurance: Sovereign credit exposure Sovereign credit net exposure Shareholder Equity 8.863 40.334 7.898 5.707 6.800 7.448 79.415 10.892 11.337 4.282 6.350 3.890 1.741 7.352 4.700 7.076 4.694 4.797 40.600 3.600 745 45.556 1.323 4.888 33.899 8.829 29. companies report.120 22.304 763 Total 15.491 1.114 3.585 16.473 2.827 900 149 500 168 667 52 113 20 70 38 582 Sovereign credit net exposure (local currency.652 6.564 na na na 6.333 1.800 447 3.225 15.557 na 559 1.843 na na na 281 8.334 80 438 24 na 102 105 34 Ireland3 272 33 304 na na 1 500 na 400 437 667 77 103 105 na 64 134 Greece4 1.468 49 na na na na na 576 na 2.£m Swiss Life Swiss Re SCOR Source: J.213 3.659 1.483 595 na na na 563 4.

2 1.8 0. MSCI. MSCI 72 Source: J. moved to N for 2010 and upgraded back to OW on 28th May Mining is the only Cyclical sector underperforming the market ytd Chinese inflation to peak in Q3 and to allow policymakers to slow down the tightening process Sectors ytd perf vs EPS revisions 15% 10% 5% IT 0% -5% -10% Utilities -15% -10% -5% 0% 5% 10% 15% 20% 25% 30% 35% Energy -60% 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 EM relative performance and Mining relative 80% 60% 40% 20% 0% Ytd perf Discretionary Industrials Staples Ytd revision in 2010e EPS Financials Europe Telecom s Healthcare M aterials -20% -40% M S C I E M v s DM % y oy M et& M in rel to E urope % y oy Source: Datastream.0 0.000 120.000 140.MATERIALS: OVERWEIGHT Metals & Mining top pick for ‘09.000 100.P.000 70. Morgan economic research .000 80.4 1.000 110.000 130. IBES Source: Datastream Metals & Mining 12m Fwd P/E rel 1.000 06 07 08 09 China Merchandise ex ports (US$ million.6 1.4 95 96 97 98 99 00 01 02 03 04 av erage 05 06 07 +1stdev 08 09 10 -1stdev China merchandise exports 150.000 90.6 0. sa) 10 M etals & M ining 12m th Fw d P/E rel Source: Datastream. IBES.

rh s ) Source: Datastream Source: Datastream. rs ) U S Hotels R ev PAR (%y oy ) 3 m onth m ov ing av erage Source: Datastream.e m p lo y m e n t E u ro -a re a a d v e rtis in g s p e n d in g (% y o y ) E M U R e a l G DP (% y o y . Morgan estimates EMU Retail sales vs unemployment rate 4% 3% 2% 1% 0% -1% -2% -3% -4% -5% 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 forec as ts -15% -10% -5% 0% 5% 10% 15% 20% 25% 30% 35% US hotels revenues per room 20 15 10 5 0 -5 -10 -15 -20 -25 -30 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 EM U R etail s ales v olum e ex autos (%y oy ) EM U unem ploy m ent rate (%y oy . Morgan 73 .P.DISCRETIONARY: OVERWEIGHT Labour market is the key The stabilisation in labour market and corporate profitability to drive the sector ISM manufacturing employment 70 65 60 55 50 45 40 35 30 25 20 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 Eurozone Advertising spend vs GDP 10% 6% 5% 4% 2% 0% 0% -5 % -2 % -1 0 % -4 % -6 % 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10e -1 5 % IS M m a n u fa c tu rin g s u rv e y . rhs .P. Morgan estimates Source: J. J.P. J.

Restaurants&Leisure Food & Drug Retailing Food Beverage & Tobacco Household Products Healthcare Banks Insurance Real Estate Software and Services Technology Hardware Semicon & Semicon Equip Telecoms Utilities Source: Datastream 1975 2% 3% 2% -12% 6% -4% 6% 7% -1% -8% 4% -3% 0% 2% 0% 0% -9% -22% 46% 22% -2% 0% 1980 5% -13% 4% -3% -10% -5% -24% -9% -9% 6% 11% 10% -4% -3% -1% 4% 14% 3% 19% -24% 3% -16% 1983 15% 12% -10% -6% -7% 10% 20% 6% 15% -5% -1% -15% -9% -15% -7% -5% -2% -13% 82% 0% -6% -16% 1991 -4% 1% -12% -14% -5% 4% -11% 20% 12% 13% 5% 3% 9% -1% 14% -3% -5% -8% -3% -14% -6% 3% 8% 2003 -4% 1% -12% -14% -5% 4% -11% 20% 12% 13% 5% 3% 9% -1% 14% -3% -5% -8% -3% -14% -6% 3% 8% Average 3% 1% -6% -10% -4% 2% -4% 8% 6% 4% 5% 0% 1% -3% 4% -1% -1% -10% 28% -6% -6% 0% -3% Median hit ratio 2% 1% -10% -12% -5% 4% -11% 7% 12% 6% 5% 3% 0% -1% 0% -3% -5% -8% 19% -14% -6% 3% 0% 60% 80% 40% 0% 20% 60% 40% 80% 60% 60% 80% 60% 60% 20% 40% 40% 20% 20% 60% 20% 60% 60% 60% 74 .DISCRETIONARY: OVERWEIGHT European sectors relative performance in the 6 months following the first positive payrolls +6m Europe Energy Chemicals Construction Materials Metals & Mining Capital Goods Transport Automobile Consumer Durables Media Retailing Hotels.

4 1. IBES Avg ex bubble +1 SD Source: J.8 1.0 2.7 1.5 2.IT: OVERWEIGHT Preference for semiconductors/Software US Financials profits vs Tech capex Within the sector.5 1.5 1. Datastream IT 12m fwd P/E relative 3.3 1.8 01 02 03 04 05 06 07 08 09 M e d ia n 10 40% 30% 100% 80% 60% 20% 10% 40% 20% 0% 0% -1 0 % -2 0 % -4 0 % -6 0 % -2 0 % 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 U S te c h c a p e x (% y o y ) -8 0 % U S F in a n c ia ls c o rp o ra te p ro fits (% y o y .P.5 3.0 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 -1 SD T a iw a in a n d K o re a H ig h -te c h in v e n to ry to s h ip m e n t ra tio European IT 12m fwd P/E rel to mkt Source: Datastream.0 1. Morgan 75 .2 1. we are most positive on semiconductors.1 1.6 1. b ro u g h t fo rw a rd 3 q u a rte rs ) Source: BEA.9 0. They should benefit from significant operational leverage and USD strength The sector will benefit from a recovery in IT spend The inventories in the supply chain are not flashing warning signs yet Taiwan and Korea High-tech Inventory/Shipment ratio 1.0 0.

3 2.1 -1.9 2.8 -3.1 -1.2 -1. MSCI 76 .8 LT average -0.6 2.1 3. Energy trades at a 25% P/E discount.6 3.7 5.3 1.2 -1.0 0.5 -1.1 -2.7 3.0 3.3 -0.6 3.2 -2.9 -1.9 0.5 3.1 1.6 3.1 -0.7 2.3 0.8 3. +ve EPS momentum The relative performance of Energy has displayed a tight correlation to relative EPS momentum Valuations are also attractive.3 1.9 6. and third most attractive equity yield vs credit yield Energy P/E relative 1.5 -1.2 0. IBES.8 Telecom Energy Chemicals Staples Real Estate Technology -28% Building Materials Capital Goods Transport Autos Source: Datastream Energy %y oy perf rel Energy %y oy EPS rel Source: Datastream.4 -2.5 4.6 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 E nergy 12m th F w d P /E rel to E urope +1S D av erage -1S D Source: IBES Energy annual perf vs EPS relative 50% 40% 30% 20% 10% 0% -1% -10% -20% -30% -40% 95 96 97 -16% -26% -32% 98 99 00 01 02 03 04 05 06 07 08 09 10e -8% -7% -11% -17% -14% -5% -7% 18% 10% 10% 2% 12% 10% 5% 14% 13% 10% 9% 2% 6% 8% 1% 44% European sectors’ dividend yield vs high grade yield % Dividend yield Utilities 24% 15% High grade yield 3.3 -1.7 0.8 0.8 -1.3 2.0 4.3 2.2 1.ENERGY: OVERWEIGHT Cheap.5 2.5 -2. near record DY relative at a 50% premium.9 2.6 Difference 2.1 2. high yield.2 -1.

IBES 2011e 10.5 2.8% 6.7% 9. since 1995) Telecoms 12m Fwd P/E relative to Europe 2.7 95 96 97 98 99 00 01 02 03 04 av erage 05 06 07 +1s tdev 08 09 -1s tdev 10 European sectors FCF yield 2010e Telecommunications Services Healthcare Consumer Staples Information Technology Europe Consumer Discretionary Industrials Materials Utilities Energy Source: Datastream.5 1.0% 4.1% 7.0% 3.1% 6.7% 6.9% 3.0% 1. IBES 77 .5% 4.1% Telecoms rel to Europe (%qoq av g. MSCI.7% 5.0% -3.3 1.5% T elec om 12 m th fw d P/E relativ e to m ark et Source: Datastream.3% Q2 Q3 Q4 -1. Morgan Telecoms rel to Europe (%qoq median.2% 4.6% 6.P.0% 0% -2% -4% Q1 -0. since 1995) Source: Datastream.7 1.3 2.6% -1.9 0.9 1.3% 8.5% 1.1 1.1% 0.9% 5.4% 4.2% 10.TELECOMS: NEUTRAL Downgraded on 8th December Telecom displays the highest free cash flow yield among European sectors Seasonality usually supports the sector in Q4 8% 6% 4% 2% Telecoms seasonality 5.8% -0.2% 7.1 0.9% 6. J. MSCI.

power usage stabilizing Gas oversupply to remain a concern in the medium-term Power CPI vs Oil Price* 20% 15% 10% 5% 0% -5% -10% 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 200% 150% 100% 50% 0% -50% -100% CPI . risk of rising taxation Valuations attractive.0 1.0 -1.0 Utilities dividend-corporate bond yield spread 99 00 01 02 03 04 05 06 07 08 09 10 Utilities 12 mth fw d P/E relativ e to market Av erage Utilities Div idend .1 1.4 1.8 0.5 1.UTILITIES: UNDERWEIGHT Regulatory risks. Gas and other fuels(%y oy . rhs) Utilities 12mth Fwd P/E relative 1. weak pricing Low FCF yield. lags by 7m) Source: Datastream.0 0.3 1.P. J.0 2.0 -4.7 95 96 97 98 99 00 01 02 03 04 05 06 07 +1 sd 08 09 10 -1 sd -2.0 98 4.Europe Electricity .0 3. * assuming 70$/bbl WTI until year end) Crude oil (%y oy .2 1.9 0.0 0. high capex requirements.High grade Yield Source: IBES Source: Datastream.0 -3. Morgan 78 .

4 1.Republicans 1993 Clinton health care plan 1988 .1 1.Democrats 2004 .Democrats 1984 .Republicans 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 Healthcare 12 mth fw d P/E relativ e to market Source: IBES Av erage Pharma rel Europe Pharma rel US Source: Datastream. Morgan 79 2008 .Republicans 1976 .5 1. J.P.7 76 1.5 1.3 1. a Democrat victory was negative for the sector On the positive side.9 0. pricing weakness and downgrades to long-term earnings outlook Historically.7 Healthcare performance vs US presidential elections 2000 .Democrats 1996 .6 1.2 1.7 1.9 0. faces political pressures We downgraded Pharma in December 2008 Pharma faces a number of headwinds such as political pressures.Democrarts 10 .1 1.3 2.3 1992 .1 2.HEALTHCARE: UNDERWEIGHT Consensus long.9 1.Republicans 1.0 0.Republicans 1980 . sector’s valuations are attractive Healthcare valuations 1.8 95 96 97 98 99 00 01 02 03 04 05 06 07 +1 sd 08 09 10 -1 sd 0.

8 0.8 1.STAPLES: UNDERWEIGHT No-win situation. brought forw ard 12m. MSCI Eurozone Food CPI . IBES Staples earnings vs Food inflation 80% 60% 40% 20% 0% -20% -40% 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 5% 4% 3% 2% 1% 0% -1% -2% -3% Food CPI-PPI and Staples EPS relative 8% 6% 4% 2% 0% -2% -4% -6% 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 80% 60% 40% 20% 0% -20% -40% -60% Food & Bev trailing EPS relativ e (%y oy ) Food & Bev CPI relativ e (%y oy . margin pressure is building Low food inflation is a negative for Staples’ earnings Staples P/E relative 1. rhs) Source: Datastream.PPI (%yoy) Source: Datastream.6 1. Eurostat Food & Bev trailing EPS relative (%yoy. rhs) 80 .4 1.0 0.2 1. rich valuations a problem The valuation overhang for Staples is still significant on a number of measures In addition.6 95 96 97 98 99 00 01 02 03 av erage 04 05 06 +1stdev 07 08 09 -1stdev 10 Staples 12mth Fw d P/E rel Source: Datastream.

Mar 33) US Recession (May 37-Jun 38) US Recession (Nov 48-Oct 49) US Recession (Aug 57-Apr-58) US Recession (Apr 60-Feb-61) European bear markets since 1970* Peak Bottom % fall Length of fall (m) Macro Dec-61 Feb-66 Nov-68 Jan-73 Nov-80 Aug-87 Jul-90 Mar-00 Median Mean US Recession (Dec 69-Nov 70) US Recession (Nov 73-Mar-75) and 1st oil shock US Recession (Jul 81-Nov 82) and 2nd oil shock Black Monday US Recession (Jul 90-Mar-91). Data Shiller. NBER *assuming Mar 9th was the low 81 . the median fall of European equities was 35%. Bloomberg. MSCI. In the latest bear market they fell 57% over 20 months Peak Trough % fall Length of fall (m) Backdrop Sep-02 Sep-06 Dec-09 Nov-16 Jul-19 Sep-29 Sep-32 Feb-34 Feb-37 May-46 Jul-57 Oct-03 Nov-07 Dec-14 Dec-17 Aug-21 Jun-32 Feb-33 Mar-35 Apr-42 Jun-49 Oct-57 Jun-62 Oct-66 May-70 Oct-74 Aug-82 Dec-87 Oct-90 Oct-02 -29% -38% -29% -33% -32% -85% -41% -32% -57% -25% -21% -22% -22% -36% -48% -27% -34% -20% -49% -32% -36% 13 14 61 13 25 33 5 13 63 38 3 6 8 18 21 21 3 3 31 14 21 US Recession (Sep 02-Aug-04) US Recession (May 07-Jun-08) US Recession (Jan 10-Jan 12 and Jan 13Jan-14) World War I US Recession (Jan 20-Jul 21) US Depression (Aug 29-Mar 33) US Depression (Aug 29. compared to the recent 57% fall in 16 months Historically. S&L LTCM US (Mar 01-Nov 01) and German Recession Jun-07 Mar-09 -57% 20 Financial crisis and 3rd oil shock Oct-07 Mar-09 -57% 16 Financial crisis and 3rd oil shock Source: Datastream. *market down 20% for more rom peak. monthly before *assuming March 9th was the low Source: Datastream. daily data since ’80. S&L crisis US Recession (Mar 01-Nov 01) Feb-72 Oct-87 Jul-90 Jul-98 Sep-00 Median Average Jan-75 Nov-87 Jan-91 Oct-98 Mar-03 -41% -35% -24% -31% -58% -35% -38% 36 1 6 3 31 6 15 US (Nov 73-Mar-75) and European Recession Black Monday US (Jul 90-Mar-91) and European Recession. lasting “only” 6 months. the S&P500 posted median falls of 32% with a median duration of 14 months.The latest bear market in a historical context Past US bear markets since 1900 In past bear markets.

5% 2.3% 8.7% -3.8 #N/A 15.0% 6.2% 2.1% Sep 91 to Oct 91 -6.3% Aug 89 to Jun 91 -4. J.4% 8.5 30.2 9.3 Real GDP (peak to bottom) Period -12.1% -5.9% 5.2% 5.6% -6.6% 13. Morgan.1% 19.1% Use of public funds as % of GDP 7% 3% 4% 14% Source: Datastream.9 10.7% 13.6 71% 23.6% 1.1%* 10 yr yields peak to bottom 10 yr yields peak 10 yr yields bottom -6.3% 6.5% 3.0% 1.5% 5. *latest 82 .9 12. Japan house prices relate to Tokyo residential land prices.0% -7.0% 9.8% 7.8 -9% Valuations at bottom 4.0% 5.The Dark Side: Scandinavian and Japanese experience Finland 5 year performance to peak Market peak to bottom Period -75% Apr 89 to Sep 92 Norway 276% -54% Aug 90 to Aug 92 Sweden 203% -57% Aug 89 to Oct 92 Japan 216% -62% Dec 89 to Oct 98 US 104% -57%* Oct 07 to Mar 09 Valuations at peak Premium to last 5 yr average 12.4% -8.2008 Q2 to 2008 Q4 IP (peak to bottom) Period -40.3% -4.9% 0.P.7% Dec 90 to Feb 93 -14.0% 13.8% 2.7%* 4.7 19% 17.2% 7.6% 3.9 36% 60.4% May 91 to Jan 94 -11%* Jan 08 to current 5 year change in house prices to peak House price fall Period 107% -41% 1989 Q2 to 1993 Q1 96% 88% -30% -20% 1987 to 1992 1991 Q1 to 1993 Q3 134% -59% 1991 to 2006 75% -27%* Jul 06 to current Unemployment rate change Trough unemployment rate Peak unemployment rate 17.8% 1989 Q2 to 1993 Q2 1987 Q2 to 1991 Q4 1990 Q2 to 1992 Q4 -1.7%* . Bloomberg.

50 0.2 0.0 2.8 3.5 2.45 2.50 0.10 Forecast for end of 10 Yr Govt Bond Yields United States Eurozone United Kingdom Japan July 28.00 1.6 2.25 1.5 1.P.1 -4.03 93 Mar 11E 1.35 1.1 2.5 3Q10E 2.1 4Q10E 0.3 1.47 1.85 3.35 4.8 1.Economic.2 3.125 1.6 2.50 0.3 2.9 1.8 3.50 3.4 5.0 6.8 2.00 0.8 3Q11E 3.8 1.25 1.5 2.2 2.3 2.9 Real GDP % oqa.06 87.38 1.5 2.1 -1.4 -4.00 0.2 Consumer prices % oya 2Q10E 1.10 Dec 10 0.3 1.30 1.6 5.9 -1.50 0.5 2.0 2.2 5.40 Mar 11E 4.1 -1.3 1.8 2.7 2.90 1.5 2.3 1.9 1. 2010 2.7 3.7 5.5 3.00 93 Sep 11E 1.10 1.08 Sep 10E 3.15 3.15 3.0 1Q10E 2.50 0.125 1.1 2.125 1.125 1.6 0.4 2011E 2. saar 4Q10E 3.56 1.00 0.10 Sep 11 0.20 1.5 2.75 0.6 2Q10E 2.75 1.5 2.57 1.9 -0.2 5.0 2. Morgan estimates.0 1Q10E 2.10 Sep 10 0.00 0.1 4.5 1.90 3.10 Forecast for Mar 11 0.25 0.25 0.5 2010E 2.25 1.5 5.10 Jun 11 0.04 95 Dec 11E 1.5 3.4 1.5 0.15 1.8 1. 2010 1.7 0.8 1.44 1.30 Dec 10E 3.00 0.9 Forecast Official interest rate Federal funds rate Refi rate Repo rate 3-month Swiss Libor Overnight call rate next change 4Q 11 (+25bp) On Hold May 11 (+25bp) 16 Dec 10 (+25bp) 2Q 12 (+15bp) Current 0.25 0.3 3.42 1.9 1Q11E 2.2 5.4 Sep 10E 1.0 1.25 1.2 1.25 1.09 98 Source: J.9 1.0 2.42 1.0 7.25 4.75 3.4 2.50 Jun 11E 4.0 4.125 1.5 5.125 1.55 1.0 2.06 90 Dec 10E 1.9 2Q11E 1.9 1.1 3.7 0.0 1.8 2Q11E 2.8 5. Datastream 83 .0 2.5 3.6 6.5 2.5 -5.55 Exchange rates vs US$ EUR GBP CHF JPY July 28.02 93 June 11E 1.1 -2.5 1.00 0.6 3.5 4. Interest Rate and Exchange Rate Outlook Real GDP % oya 2009E United States Eurozone United Kingdom Switzerland Japan Emerging markets Global -2.0 2.00 1.98 2.5 2.

1 1.9 2.75 2. Morgan 84 .Bear -1% 0% 3% 4% 3% 5% 5% 5% 29% -10% 0% 10% 20% 30% 40% Europe 6m fwd average return VIX index 90 80 70 60 50 40 30 20 10 0 -10 04 05 VIX Source: Datastream 06 6m av g 07 +1 sd 08 -1 sd 09 +2 sd 10 -2 sd Source: Bloomberg.00 1.5 2. Morgan Source: Datastream.0% 4.0% 2.7 2. J.0% 8.7 00 01 02 03 04 05 06 07 08 09 4% 7% 6% 3% -2% 1% -4% -9% -11% -15% -10% -5% 0% 5% 10% Europe 6mfwd average return Europe 6m fw d av erage return EStoxx 1 year Skew Source: Datastream.5 3.0% 6.50 1. Morgan Put Call ratio 2.9 1.75 1.3 3.00 0.25 1.P.3 2.0% 3.P.1 2.P.50 04 05 06 07 08 S&P Put Call ratio 09 10 Skew 7% 4% 4% 4% 1% 4% 2% 3% 5% 0.75 0. J. J.50 2.25 2.Technical indicators AAII Bulls vs Bears index 75% 60% 45% 30% 15% 0% -15% -30% -45% -60% 04 05 06 07 08 09 10 AAII Bull .

1 % 12% -1 .8 % 1 .6 % 100% 7% 3% 100% 0 . J.4 % 1 .0 % 9% 24% -1 .9 % O v e rw e ig h t + + + + + 1 3 .3 % 1 0 .2 % -2 .1 % 9% 0 .1 % U n d e rw e ig h t = - 1 0 .0 % 4% 1 .4 % 10% -0 .R e s ta u ra n ts & L e is u re C o n s u m e r S ta p le s F o o d & D ru g R e ta ilin g F o o d B e v e ra g e & T o b a c c o H o u s e h o ld P ro d u c ts H e a lth c a r e F in a n c ia ls B a n ks D iv e rs ifie d F in a n c ia ls In s u ra n c e R e a l E s ta te In fo r m a tio n T e c h n o lo g y S o ftw a re a n d S e rv ic e s T e c h n o lo g y H a rd w a re S e m ic o n & S e m ic o n E q u ip T e le c o m s U tilitie s Source: MSCI.2 % 9 .7 % R e c o m m e n d a tio n O v e rw e ig h t N e u tra l = = + 1 0 .8 % 5 .P. Morgan A llo c a tio n 11% 11% D e v ia tio n 0 .0 % U n d e rw e ig h t O v e rw e ig h t + = = = 3 .6 % 0% N e u tra l U n d e rw e ig h t B a la n c e d 85 .European Sector Allocation Sector Allocation Sector Allocation M S C I E u r o p e W e ig h ts E n e rg y M a te r ia ls C h e m ic a ls C o n s tru c tio n M a te ria ls M e ta ls & M in in g In d u s tr ia ls C a p ita l G o o d s T ra n s p o rt C o n s u m e r D is c r e tio n a r y A u to m o b ile C o n s u m e r D u ra b le s M e d ia R e ta ilin g H o te ls .4 % N e u tra l = = 8 .4 % 2 3 .0 % O v e rw e ig h t + = + 6 .

P. YE 2010 1.300 185 6. Morgan. J./ underperform the index over the next six to 12 months.150 M SCI Europe M SCI Eurozone FTSE 100 86 . Datastream *Others include Denmark. Sweden and Switzerland Note: We use the MSCI Europe index as the benchmark against which to determine our regional allocations.European Asset Allocation Asset Allocation B enchm ark w eighting Equities Bonds Cash 60% 30% 10% 100% A llocation 70% 25% 5% 100% Deviation 10% -5% -5% 0% Recom m endation O verw eight U nderw eight U nderw eight B alanced Regional Asset Allocation M SC I Europe W eights Eurozone United K ingdom O thers* 50% 33% 17% 100% A llocation 53% 30% 17% 100% Deviation 3% -3% 0% 0% Recom m endation O verw eight U nderw eight N eutral B alanced Index Targets Index Europe Eurozone United K ingdom Source: MSCI. Our Overweight/Underweight recommendations reflect our belief that the relevant region will out. Norway.

3 1.8 1.7 13.8 3.European Market Performance & Valuations 29-Jul-10 3M Performance US Europe UK Euro Switzerland 12M Performance US Europe UK Euro Switzerland P/Book (-1M) US Europe UK Euro Switzerland 12M Frw Cons P/E pre GW US Europe UK Euro Switzerland Cons 12M EPS% pre GW US Europe UK Euro Switzerland Dividend Yield US Europe UK Euro Switzerland 12.6 24.4 25.8 11.9 24.7 18.8 3.6% 47.9 4.1 3.3% 2.1% 24.8 3.5 4.0 9.2 -0.2% Healthcare -7.1% 31.2% -5.5 23.7% 6.0 1.3% 9.5 1.5 13.8 12.0 13.4 15.0 3.3% 0.6 6.0 1.6 11.3 2.2 -0.4 14.4% 38.2 1.5 10.7 1.3% 18.5 39.8% 12. MSCI.6 9.7 27.9 6.1 82.7% 5.6 1.6% -8.2% 25.2 8.1 0.6 10.1% 8.7 1.6% Euro Switzerland 20.6 2.5 12.6 3.1 10.1 46.8% -0.9% -6.2 9.6 1.3% -0.2% -5.9 1.0 1.1 9.3 27.4 11.5 3.4 12.6 7.0 7.4 7.2 25.0% 0.3 10.4 1.9% 10.7 1.1% -20.8 1.0 3.8 76.3 2.9 9.3 0.7% 20.7 10.3% 12.3 3.6 4.0 43.0 10.3 9.3 2.4 32.5 1.6 8.1 3.3% -14.3% 27.0 13.9% 28.7% -0.5 7.1 22.2 13.7% 5.3% 19.8 45.3 8.4 5.3 2.1% -9.1 3.1% 14.6% 14.3% -2.3 21.2 17.5% -0.1 4.3 9.8% 4.8% 13.2 11.5% 2.2% Telecom 3.2 6.8 0.0 - Sector neutral P/E 11.8% -14.3% 0.9% 13.5% 23.8 12.9% 2.3 14.5% -2.8% -5.9% US Europe UK 17.4% Utilities 2.3% -5.9 1.7 2.6% 17.2 4.4 2.4 1.8% 4.7% 11.1% 4.2% 6.5% 5.5 6.4% -4.9% -4.8% 0.1% 8.8 2.5% 12.5 3.0 2.5 4.2 11.7 2.5 9.4% -12.1 1.8 1.5 10.4 3.5 1.7 14.1 3.7% -0.1% 3.0% Energy -11.1 9.0 3.1% -8.2% Staples -1.3% IT -7.4% 1.0 11.3 12.4 21.4 2.8% - 2.6 10.3% 28.0% Discretionary -9.8 2.1 6.3 15.2 8.5% 7.3 12.4 3.1% 10.8 10.9 3.0 54.9 41.5 1.6 - 2.1 0.0 3.8% -0.2 12.6 12. Datastream 87 .5 - 2.1 2.3% -2.3 2.9% -7.3 1.9 9.3 1.7 14.8 Discount -14.2% Note: Swiss calculations exclude Energy and Utilities sectors Source: IBES.4% 4.8 2.9% 0.2% 65.3 20.5 2.7% 16.8% 1.2 1.5 1.5 24.0 10.9 1.0 12.8 8.0% 2.8 6.5% 6.8% 2.7% -4.4 3.4% -19.0 2.8% Materials -7.4 12M fwd P/E 12.3% Industrials -7.7 9.0 9.8 2.1% 10.4 5.6 3.7% -11.4 7.4 13.6% Market -7.4% 3.8% 27.5 -0.1 2.0 10.1% 26.9 - 2.1 4.1 2.1 36.3 64.0 10.2 3.5 45.4 2.3% 19.3 16.3 2.0% 23.2 8.9% -10.5 10.2 12.6% -8.0 1.3% 0.7 3.6 3.4% -5.9 7.5 41.4% 12.3 12.2 - 12.8 19.0 11.4 2.4 2.3 2.3 7.6 1.2 15.3 - 12.1% -5.5 2.2% Financials -9.0% -4.8 2.7 2.6 15.4% -6.0 7.8 13.1 Forward ROE 2.9% 17.5% 2.3 2.1 4.4 21.1% 20.0 Sector neutral discount -6.2% 19.6% 11.7 27.3 7.3 9.5% 1.7% -0.3 13.9% 9.2% 0.5 1.2% 27.0% 0.

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