2014 - The Great Race

EYE ON THE MARKET
OUTLOOK 2014
J.P. Morgan Asset Management
The Great Race. Markets have zoomed ahead since 2009, anticipating that eventually the world’s economies would
catch up. Thanks to extra fuel from the Fed, the U.S. is running at a steady pace and should accelerate modestly in
2014. China has hit some potholes but is still moving, just more slowly. Japan’s experimental model is designed to
overtake EM surplus countries; still a work in progress. The Eurozone is moving again, but its design is economically
and aerodynamically flawed. The EM debtors are temporarily off-road. See inside for more details.
The countries and regions depicted on the cover make up 75%-80% of the world on both a GDP and equity
market capitalization basis. The remainder is primarily made up of developed countries of two kinds: commodity
exporters like Canada and Australia, and countries in Europe that do not use the Euro (UK, Denmark, Sweden,
Norway, Switzerland, etc.). With the exception of Australia (which has been affected by the China slowdown), all
these countries are in growth mode as 2013 comes to a close. From an artistic license perspective, they would
have been depicted on the cover near the front of the pack. These countries are all different, but similar in one
important way: they set their own monetary policy and do not suffer from the albatross of a common currency.
Countries referred to as “Emerging Markets” do not rely on the same economic model. Some still rely on
substantial foreign capital for growth (India, Brazil, Indonesia and Turkey), while others run a trade surplus
(exporters of Southeast Asia), or run small trade deficits and no longer require large inflows (Mexico, Poland
and the Czech Republic). The eventual return to a higher interest rate world is a bigger risk for the first group
than the second or third.
Returns shown on the front cover represent the period from January 1, 2010 to November 30, 2013. Note: Past
performance is not indicative of future returns. See sources and definitions at the end of this publication.
Cover illustration by Matthieu Forichon
FOR INSTITUTIONAL AND PROFESSIONAL INVESTOR USE ONLY | NOT FOR RETAIL USE OR DISTRIBUTION
MARY CALLAHAN ERDOES
Chief Executive Officer
How do you summarize a year that was in many respects indefinable? On one
Happy New Year. As we enter 2014, we remind ourselves of how much has changed in the past
hand, the European sovereign debt crisis, contracting housing markets and high
two unemployment
years, from 2012’sweighed
uncertain landscape
heavy on alltoof2013’s increased
our minds. Butstability and markets
at the same moving
time, record
corporate profits and strong emerging markets growth left reason for optimism.
quickly as a result. But even as markets surged, corporate profits, employment and economic
growth have struggled
So rather than lookto back,
keep pace.
we’d like to look ahead. Because if there’s one thing that
we’ve learned from the past few years, it’s that while we can’t predict the future,
we can certainly help you prepare for it.
So where do we go from here? What needs to happen in the coming year to close these gaps?
That’s
Toexactly what you
help guide Michael Cembalest,
in the our Chairman
coming year, our ChiefofInvestment
Market and Officer
Investment Strategy,
Michael
sets Cembalest hasinspent
out to answer the past
his Outlook several
2014, “The months working
Great Race.” with
Michael andour investment
team take a closer look
leadership across Asset Management worldwide to build a comprehensive view
at the
of factors that will determine
the macroeconomic the markets’
landscape. continued
In doing progress,
so, we’ve and most
uncovered someimportantly
potentiallythe
excitingopportunities
investment investment weopportunities,
can expect asasa well as some areas where we see reason to
result.
proceed with caution.
The Sharing
2014 Outlook
thesereflects our viewand
perspectives of the global investment
opportunities is partlandscape andcommitment
of our deep focuses on theto
you and what
opportunities in thewe focus
year on Iteach
ahead. and
is our every leadership
thought day. We are
andgrateful for your continued
sound investment guidance
trust and confidence, and look forward to working with you in 2011.
that have enabled us to provide our clients with the most effective solutions for the last
Most sincerely,
175 years.
Thank you, as always, for your continued trust and confidence in J.P. Morgan.
Most sincerely,
EYE ON THE MARKET OUTLOOK 2014  J.P. MORGAN ASSET MANAGEMENT
FOR INSTITUTIONAL/WHOLESALE OR PROFESSIONAL CLIENT USE ONLY/
EYE ON
FOR IN THE
S TI TU TI O MARKET • AOUTLOOK
N A L / W H O L ES 2014
L E O R P RO F ES SIONAL CL I EN T U S E O N L Y /NOT
N OFOR
T FRETAIL
O R RE TA I L D I S T RI BU TI O N
DISTRIBUTION JJANUARY
A N U A R Y 11,, 2014
2014
The Great Race: Growth and profit improvements needed to propel financial assets further
Markets zoomed ahead of the facts on the ground over the last year and were taking a pit stop as
the year came to a close. After a recession, markets often rally first, profits follow and economic
growth brings up the rear; there’s nothing unique about that. But as shown in a note we sent last
year1, the current gap between markets and economic/profit conditions is larger than in the past. For
equity market gains to be sustained and built upon, profits and economic growth will have to catch
up to what markets are anticipating. The outcome of this Great Race is what we believe will drive
market returns in 2014.
Let’s take a closer look. In 2013, GDP growth and earnings growth were both in low single digits,
and the pace of positive economic surprises slowed. Equities rallied anyway, and price-to-earnings
multiples rose back to long-term historic averages. A variety of other indicators also moved back to
pre-crisis levels (see box).
2013 was a year of low profit and GDP growth, globally and in the U.S.
Y/Y percent change in 12-month forward earnings per share Y/Y percent change in real GDP
40% 6%
S&P 500 5% Global
30%
MSCI World 4%
20% 3%
10% 2%
1%
0% 0%
-10% -1%
U.S.
-2%
-20%
-3%
-30% -4%
1998 2001 2004 2007 2010 2013 1998 2001 2004 2007 2010 2013
Source: J.P. Morgan Securities LLC. November 2013. Source: International Monetary Fund. Q3 2013.
Global equities diverging from economic surprises Indicators back at pre-crisis levels
Index level
80 (see page 24 for details)
1600  Speculative long equity / short bond positions on the
MSCI World Equity Index 60
1500 40 Chicago Futures exchange
20
 The volatility of U.S. and European equities
1400
 California home and condo sales executed within 6
0
1300
months of purchase
-20
1200  Investment grade and high yield corporate bond yields
-40
1100
 Discount rates applied by purchasers of U.S. and
-60
Economic Surprise Index, Major Economies European commercial properties
1000 -80
Jan-10 Jul-10 Dec-10Jun-11 Dec-11Jun-12 Dec-12Jun-13 Dec-13
Source: Bloomberg. December 2013.
1
Eye on the Market, September 3, 2013
1
1
EYE ON THE MARKET OUTLOOK 2014  J . P . M O R G A N A S SE T M A N A G E M E N T
FEYE
OR INON THE
S TITU MARKET
TIO N • AOUTLOOK
A L /W H O L ES 2014
N OFOR
T F RETAIL
O R REDISTRIBUTION
TA I L D I S T RI BU TI O N JJANUARY
A N U A R Y 11,, 22014
014
A major factor contributing to the equity rally has been easy monetary policy almost
everywhere. One purpose of low Central Bank policy rates was to accelerate the post-recessionary
rise in financial asset prices; that part worked. Central Bank policy rates will probably not change
much in 2014, apart from a few places like China. But at this stage, it will probably take more than
another year of cheap money to drive markets higher. We will have to see concrete improvements in
economic and profit conditions.
Central Bank policy rates expected to remain low... ...while longer term rates rise modestly higher
Percent 10-year gov't bond yields less core inflation, percent
14% 5%
Aus
12% 4% Can
10% 3% Fra
Emerging markets
8% UK
2%
6% US
1% Swi
4%
Developed markets 0% Jpn
2%
Ger
-1%
0%
1998 2000 2002 2004 2006 2008 2010 2012 Curr.
2014
2000 2002 2004 2006 2008 2010 2012
Source: Various central banks, J.P.Morgan Asset Management. Sept 2013. Source: Various central banks and statistical offices. November 2013.
That’s why manufacturing surveys are the most important indicator we’re looking at. These
surveys are useful in forecasting economic and profits growth. In the U.S., the recent uptick drives
our expectation of a 2014 profits rebound of 8%-10%. In Europe, leading indicators have also risen
but the gains are smaller. We are not expecting a sharp European profits rebound; the profits spike
of 2003-2007 was a temporary by-product of the doomed Southern European consumption boom.
Nevertheless, the Eurozone is emerging from a recession, and its corporate sector is seeing sequential
profits growth again.
Rising U.S. business surveys point to rebound in earnings Similar but more muted outcome in the Eurozone
Purchasing Managers' manufacturing survey Y/Y % change Purchasing Managers' manufacturing survey Y/Y % change
65 50% 65 50%
PMI business PMI business activity
activity survey 40% 40%
60 60 survey
30% 30%
55 20% 55 20%
50 10% 50 10%
0% 0%
45 -10% 45 -10%
40 -20% 40 -20%
U.S. earnings growth
-30% -30%
35 (4 months lag) 35 Eurozone earnings growth
-40% (2 months lag) -40%
30 -50% 30 -50%
1989 1993 1997 2001 2005 2009 2013 1998 2000 2002 2004 2006 2008 2010 2012
Source: ISM, J.P. Morgan Securities LLC. November 2013. Source: Markit, J.P. Morgan Securities LLC. December 2013.
2 2
FEYE
OR INON THE
S TITU MARKET
TIO N • AOUTLOOK
N OFOR
T F RETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 22014
014
Global business surveys also show a world gradually getting back to normal. The two-fisted
combination of a global recession in 2008-2009 and the European debt crisis two years later took its
toll. As 2013 came to a close, leading indicators suggested a return to 3.5% global growth in 2014,
and a rising number of countries in expansion mode. A decline in fiscal austerity should help; in the
developed world, the 2014 fiscal drag should be around half of what it was in 2012 and 2013.
Rising number of countries in expansion mode

% of PMI leading indicator universe > 50, or 6-month change ≥ 4
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
2005 2006 2007 2008 2009 2010 2011 2012 2013
Source: Based on Markit's 35-country universe using data as of November
2013. PMI of 50 denotes expansion.
The potholes: the Eurozone (still) and Emerging Markets debtor nations. The latter are
undergoing a traditional balance of payments problem, defined by falling growth, the exodus of
foreign capital, rising interest rates and a period of retrenchment. Less liquidity from the U.S.
Federal Reserve is a challenge for capital importers like the EM debtor nations. As for the Eurozone,
recent improvements are notable, but the region is still suffering from deleveraging, sub-trend
growth, and sharply diverging fortunes between Germany and the Periphery (and France). Net
private sector credit creation is a clear indicator of whether a region is getting back to normal, and in
the Eurozone, it’s still zero. 2014 looks like a better year for Europe, but there are reasons to be
concerned about its long-term growth.
U.S. leads in the private sector credit recovery A growing gap between EM debtor nations and the rest
Net private sector credit creation as % of public plus private 6-month annualized % change in industrial production
100% 25%
UK 20% EM excluding
80%
debtor nations
15%
10%
60%
U.S. 5%
Eurozone
40% 0%
-5%
EM debtor
20% -10% nations
Japan
-15%
0% -20%
1999 2001 2003 2005 2007 2009 2011 2013 2007 2008 2009 2010 2011 2012 2013
Source: JPMAM, FRB, ECB, Bank of England, Bank of Japan. Q2 2013. Source: Haver Analytics, JPMAM. GDP-weighted aggregates. Sept 2013.
3 3
F OR IN S TITU TIO N A L /W H O L ES A L E O R P RO F ES S I O N A L CL I EN T U S E O N L Y / N O T F O R RE TA I L D I S T RI BU TI O N
JANUARY 1, 2014
FEYE
OR INON THE
S TITU MARKET
TIO N • AOUTLOOK
N OFOR
T F RETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 22014
014
On regional equity markets, last year was a break in the trend of U.S./Emerging Markets
On regional
portfolios equity markets,
outperforming last year wasThis
Europe/Japan. a break in theatrend
was mostly of U.S./Emerging
by-product Markets
of Emerging Markets
portfolios outperforming Europe/Japan. This was mostly a by-product
underperformance at a time when investors re-embraced Europe and an unorthodox policy of Emerging Markets
underperformance
experiment in Japan. at Keep
a timeinwhen
mind investors re-embraced
that Japan’s experiment Europe
is not and
just an unorthodox
monetary: policy on page
As outlined
experiment in Japan. Keep in mind that Japan’s experiment is not just monetary: As
16, Japan is attempting to steer hundreds of billions (in USD) of Japanese household and pension outlined on page
16, Japan is attempting to steer hundreds of billions (in USD) of Japanese household
assets into equities. With more Japanese stimulus coming and the problems of the EM debtor and pension
assets into
nations, equities.
2014 Withanother
looks like more Japanese stimulus coming
year of developed market andequitytheoutperformance
problems of thevs.
EMEMdebtor
equities.
nations, 2014 looks like another year of developed market equity outperformance vs. EM equities.
The era of Central Bank-driven equity rallies We expect 2014 to mark a return to more traditional
The era
Equity of Central
markets Bank-driven
total return equity rallies
index, 12/31/2008 = 100 We expect relationships
risk/return 2014 to mark a return to more traditional
Equity markets total return index, 12/31/2008 = 100
230 risk/return relationships
Annualized Annualized
230 Time period
205 U.S. Time period
Annualized
Return Annualized
Volatility
205 U.S.
EM
Return Volatility
Post Bretton Woods to pre-crisis
180 Operation EM 10.9% 16.0%
EUR Post Bretton Woods
to to pre-crisis
180 Operation
Twist
10/1972 05/2008 10.9% 16.0%
155 EUR 10/1972 to 05/2008
Twist Financial crisis
155 JPN -53.0% 48.0%
Financial
05/2008 crisis to 03/2009 -53.0% 48.0%
130 JPN
130 05/2008 to 03/2009
Volatile, high-return post-crisis recovery 22.9% 21.4%
105 Abenomics
105 Draghi's Speech Volatile,
03/2009high-return
to post-crisis
12/2011 recovery 22.9% 21.4%
Draghi's Speech Abenomics
80 03/2009 to 12/2011
Jan-09
80 Jan-10 Jan-11 Jan-12 Jan-13 Easy money spreads to ECB, BoJ 23.1% 12.1%
Jan-09Bloomberg.
Jan-10 Jan-11 Jan-12 Jan-13 Easy money spreads
12/2011 to to ECB, BoJ
11/2013 23.1% 12.1%
Source: Q3 2013.
Note: S&P
Source: 500 indexQ3
Bloomberg. used for U.S., MSCI indices for other regions.
2013. 12/2011
Source: to 11/2013
Bloomberg. November 2013.
Note: S&P 500 index used for U.S., MSCI indices for other regions. Source: Bloomberg. November 2013.
To summarize, we expect the markets car to slow down from its break-neck pace as the
To summarize,
economic vehicleswe catch
expectup, the
andmarkets carto
for 2014 tobeslow down
a year of from
more its break-neck
modest pace asinthe
appreciation
economic vehicles catch up, and for 2014 to be a year of more modest
equity, credit and real estate markets. After the surge since the spring of 2009, we anticipate appreciation in a
equity, credit and real estate markets. After the surge since the spring of 2009, we
gradual return to high single-digit equity market gains and double-digit market volatility. As for fixed anticipate a
gradual
income, return
we aretoemerging
high single-digit equitywhen
from a period market gains and
Central Banksdouble-digit market volatility.
drove government Asto
bond yields fororfixed
income, we are emerging from a period when Central Banks drove government bond
below the rate of inflation; long-term interest rates are now starting to rise modestly. Consequently, yields to or
below the rate of inflation; long-term interest rates are now starting to rise
2014 also looks like another year in which cash and lower-risk fixed income don’t add much tomodestly. Consequently,
2014 also2.looks
portfolios If so,like another would
investors year in which cash
benefit in and
2014lower-risk fixed income
from maintaining don’tofadd
many themuch to
portfolio
2
portfolios . If so, investors would benefit in 2014 from maintaining
allocations that have been working since the global recession ended in 2009. many of the portfolio
allocations that have been working since the global recession ended in 2009.
This year’s Eye on the Market Outlook walks through our views on markets by region, followed by an
This
in-depth Eye onofthe
year’sanalysis Market
a few Outlook
portfolio andwalks through
market topics our views
(public on markets
equity, privateby region,
equity, followedbonds,
municipal by an
in-depth analysis of a few
hedge funds and credit markets). portfolio and market topics (public equity, private equity, municipal bonds,
hedge funds and credit markets).
Michael Cembalest
Michael Cembalest
2
2
Let’s take the U.S. Barclays Aggregate Index of government, agency and corporate bonds as an example, and
Let’s take the
incorporate U.S. Barclays
its current Aggregate
yield of 2.4% andIndex of government,
sensitivity agencyrates
to rising interest and (including
corporate the
bonds as an function
reaction example,ofand
incorporate its current yield of 2.4% and sensitivity to rising interest rates (including the reaction
mortgage prepayments). Assuming a 0.50% parallel shift higher in the Treasury curve in 2014, we estimate function of
mortgage prepayments).
that the Index would returnAssuming a 0.50%
0.5%-1.0% parallel
for the year. shift higherrates
If interest in the Treasury
were curve in
unchanged, 2014,
that we estimate
estimate would rise
that
to the Index would
2.5%-3.0%. return
In 2013, 0.5%-1.0%
through for the
December 16,year. If interest
the Index rates -1.9%.
returned were unchanged, that estimate would rise
to 2.5%-3.0%. In 2013, through December 16, the Index returned -1.9%.
4
4
4
FEYE ON
OR IN THE
S TITU MARKET
TION • AOUTLOOK
N OFOR
T FRETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 2
2014
014
Table of Contents
United States: Post-austerity growth improvements to show up by mid-year 6

Europe: Enjoy the intermission 9
Emerging Markets: Debtor nation balance of payment crises not as severe as prior episodes 12
Japan: The experiment continues, but so far, only weakening the Yen seems to work 15
In-depth investment topics
Risk and opportunity in credit markets 19
A revised look at private equity performance, and some themes for 2014 20
On recent underperformance of hedge funds vs. equities, and outperformance vs. bonds 21
Tracking performance trends in active equity management 22
How different are the countries of the European Monetary Union? 23
Indicators cited in the preface that have returned to pre-crisis levels 24
U.S. fiscal outlook: Quieter in 2014, with long-term battles ahead 25
U.S. municipal bond outlook and the question of Detroit 26
5 5
FEYE ON
OR IN THE
S TITU MARKET
TION • AOUTLOOK
N OFOR
T FRETAIL
O R RE TA I L D I S T RI BU TI O N
A N U A R Y 11,, 2014
2014
United States: Post-austerity growth improvements to show up by mid-year
It would be great to be able to say that the U.S. economy is doing well enough for
monetary policy to get back to normal, but this is not the case. As shown by the motorcycle
on the cover, the Fed’s support for growth is still substantial. While the pace of Fed asset purchases
will slow in 2014, there are two important things to remember:
 The Fed will be around for a long time. The size of the Fed’s balance sheet will not
probably peak until late 2014, and we expect it to remain above 2011 levels until 2020.
Remember, the Fed has stated that it has some tolerance for a period of inflation in excess of
its long-term targets.
 Fed tapering was mitigated by a recommitment to low policy rates for a long period.
The output gap (a proxy for spare capacity in the economy) is substantially larger than in
comparable post-recession periods. In more concrete terms, zero percent real wage growth
and a large cohort of involuntarily unemployed people are still problems for the Fed.
Bottom line: We expect policy rates at or close to zero until 2016.
Fed's stock of securities holdings should remain high A proxy for excess capacity explains the Fed's go-slow
Fed securities holdings, USD trillions approach so far, output gap, percent of potential GDP
U.S. Treasuries (< 1yr) 4%
4.0 U.S. Treasuries (1-5 yrs)
U.S. Treasuries (5-10yrs) Projection 2% 1973
3.0 U.S. Treasuries ( > 10yr) 0%
Agency debt FOMC
Agency MBS participants' -2%
2.0 expectations 1990
for when the -4% 1981
target federal CBO
1.0
funds rate will -6% projection
be 1% 2007
-8%
0.0
-3 -2 -1 0 1 2 3 4 5 6 7
2007 2009 2011 2013 2015 2017
Source: Federal Reserve, J.P. Morgan Asset Management. November 2013. Number of years from business cycle peak
FOMC: Federal Open Market Committee. Source: NBER, CBO, J.P. Morgan Asset Management. September 2013.
6 6
FEYE ON
OR IN THE
S TITU MARKET
TION • AOUTLOOK
N OFOR
T FRETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 2
2014
014
Another reason we think the Fed will go slow: in addition to a large output gap, the
recovery has been driven so far by interest-rate-sensitive sectors. This is typical for a recovery,
but highlights the risk of interest rates rising prematurely. As things stand now, real hourly earnings
have experienced no material rise since 2008; weak wage growth is the largest single factor behind
the corporate profits boom. GDP growth is still in the 1.5%-2.0% range.
The importance of low interest rates to the recovery The pillars of U.S. economic growth
GDP contribution, index, Q2 2009 =100 Three-month annualized rate of change, percent
115 16% 30%
Production
14% 25%
Interest-rate-sensitive Housing
112 12%
sectors* 20%
10%
109 15%
8%
106 Everything else 6% 10%
4% 5%
103 2%
0%
0%
100 Employment -5%
-2% Consumption
97 -4% -10%
2009 2010 2011 2012 2013 Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13
Source: BEA, JPMAM. *Durable goods consumption plus structures. Q3 2013. Source: NAR, BLS, BEA, Census, JPMAM. October 2013.
With that backdrop, why is the U.S. car in the lead in the Great Race? Because we believe
2014 will show signs of improvement after last year’s austerity. When taking into account
increased taxes (payroll, income and Obamacare) and spending cuts, 2013 was the third-largest fiscal
drag in the past 50 years. Furthermore, there was the distraction of a government shutdown. Without
these roadblocks in 2014, we expect growth to improve. The long-term fiscal situation is still a
problem, but after the 2011 Budget Control Act and the 2013 tax act, the 10-year deficit outlook has
stabilized since the August 2011 rating agency downgrade (see page 25).
Other reasons for optimism: U.S. household and corporate balance sheets have undergone
substantial healing. There are two ways to look at this: on a debt/GDP basis (the Eurozone is shown
for comparison purposes), and based on debt service to household income. The latter has fallen to
early-1990’s levels, courtesy of low interest rates. To be clear, there are few signs of households or
small businesses adding much credit right now; credit growth is primarily confined to student loans
and borrowing by large businesses. But the deleveraging trend has slowed.
U.S. deleveraging appears to be slowing Debt service declining more sharply than debt levels
Debt of households and nonfinancial corporations, % of GDP Percent of household disposable income
150% 220% 130% 14.5%
145% 210% 120% 14.0%
140% 13.5%
200% 110% Household debt service
135% 13.0%
130% 190% 100% 12.5%
U.S.
125% 180% 90% 12.0%
120%
Household debt
Eurozone 11.5%
170% 80%
115% 11.0%
110% 160% 70% 10.5%
105% 150% 60% 10.0%
1999 2001 2003 2005 2007 2009 2011 2013 1980 1990 2000 2010
Source: FRB, BEA, Eurostat. Q2 2013. Source: Federal Reserve, BEA. Q2 2013.
7 7
EYE ON THE MARKET  OUTLOOK 2014  J . P . M O R G A N A S SE T M A N A G E M E N T
FEOR
Y EINOS TITU
N TH TION
E MA LA/W
RHKOELTESALO
E O
URT PLRO
OO F ES
K S2I O0N1A4L CLJI EN
. P .T M
U SO
E R
ONGLAY N/ NAOSTSE
F OTR M
REA
TANI LADGI SETM
RI BU
E NTITO N JANUARY 1, 2014
FEYE ON
OR IN THE
S TITU MARKET
TION • AOUTLOOK
L E O R P RO F ES S I O N A L CL I EN T U S E O N L Y /NOT
N OFOR
T FRETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 2
2014
014
More ammunition for a U.S. recovery:
More
3
A lot of cash heldfor
ammunition by ahouseholds and companies , and low corporate debt levels
U.S. recovery:
 ASigns of cash
lot of continual
held byeasing in bank and
households lending standards
companies 3
, and low corporate debt levels
 State and local payroll growth increasing
Signs of continual easing in bank lending standards for the first time since the financial crisis; state and local
 consumption
State and localand investment
payroll growthare now thefor
increasing strongest
the firstintime
foursince
yearsthe financial crisis; state and local
 Cheaper electricity costs in the U.S., a topic discussed
consumption and investment are now the strongest in four years in detail in last year’s annual energy piece4
and on page
 Cheaper 20 costs in the U.S., a topic discussed in detail in last year’s annual energy piece4
electricity
 and
Evenon after
pageaccounting
20 for shadow inventory, new and existing homes for sale as a percentage of
households is very low
 Even after accounting for (a by-product of several
shadow inventory, newyears
andofexisting
limitedhomes
new construction). The numberof
for sale as a percentage
of 25-34 year olds living with their parents is at a 35-year high
households is very low (a by-product of several years of limited new construction). The number
Someof believe
25-34 yearthat olds livingcash
elevated withbalances
their parents
and lowis atbusiness
a 35-year high spending are structurally
capital
permanent by-products of an aging population, zero interest rates
Some believe that elevated cash balances and low business capital spending and/or theare
long-term Federal debt
structurally
outlook. I see a mix of structural and cyclical forces at work, with structural issues
permanent by-products of an aging population, zero interest rates and/or the long-term Federal being more ofdebt
a
problem
outlook. for businesses
I see than households.
a mix of structural All forces
and cyclical thingsatconsidered, by mid-2014,
work, with structural issuesabeing
3% growth
more ofrate
a
in the U.S. is within reach.
problem for businesses than households. All things considered, by mid-2014, a 3% growth rate
in the U.S. is within reach.
Lots of cash, everywhere S&P 500 net debt to market cap
Household and corporate cash balances, % of tangible assets Percent
Lots of cash, everywhere
26% S&P 500 net debt to market cap
50%
Household and corporate cash balances, % of tangible assets Percent
26% 45%
50%
40%
45%
23% Ex-financials & tech
35%
40%
23% 30% Ex-financials & tech
35%
25%
20% 30%
20% Ex-financials
25%
20%
15% Ex-financials
20%
17% 10%
15%
1952 1962 1972 1982 1992 2002 2012 1990 1993 1996 1999 2002 2005 2008 2011
17% 10%
Source: UBS Securities LLC. Q3 2013.
Source: Federal Reserve. Q2 2013.
1952 1962 1972 1982 1992 2002 2012 1990 1993 1996 1999 2002 2005 2008 2011
Source: Federal Reserve. Q2 2013. Source: UBS Securities LLC. Q3 2013.
Falling vacancy rates will eventually lead to new The U.S. electricity advantage
construction, investment in commercial structures, % of GDP Electricity prices by region, USD per MWh
Falling vacancy rates will eventually lead to new
1.0% The U.S. electricity advantage
350
construction, investment in commercial structures, % of GDP ElectricityHouseholds
prices by region, USD per MWh
Tax boom
1.0% 300
350
0.8% Industrial users
Tax boom Households
Tech boom 250
300
0.8% Credit Industrial users
0.6%
Tech boom boom 200
250
Office buildings Credit
0.6% 150
0.4% boom 200
Office buildings Shopping
malls 100
0.4% Shopping 150
0.2%
malls 50
100
Hotels
0.2%
0.0% 0
50
Hotels
1947 1954 1961 1968 1975 1982 1989 1996 2003 2010 U.S. CHN FRA UK GER JPN
0.0%
Source: BEA. 2012. 0
Source: IEA, National Development and Reform Commission. Q2 2012.
1947 1954 1961 1968 1975 1982 1989 1996 2003 2010 U.S. CHN FRA UK GER JPN
Source: BEA. 2012. Source: IEA, National Development and Reform Commission. Q2 2012.
3
While global M&A activity has been weak, the stock buyback story has generally been positive. In September
2013, FactSet noted that the number of S&P companies engaging in both a dividend and a buyback over the
3
While global M&A activity has been weak, the stock buyback story has generally been positive. In September
trailing twelve-month period reached its highest level since 2005 (71% of the S&P 500 index). Q2 buybacks in
2013, FactSet noted that the number of S&P companies engaging in both a dividend and a buyback over the
dollars were up 24.2% from Q1, and up 12.3% vs. 2012. However, y/y growth when measured in dollars
trailing twelve-month period reached its highest level since 2005 (71% of the S&P 500 index). Q2 buybacks in
would have been roughly flat without Apple.
dollars
4
were up 24.2% from Q1, and up 12.3% vs. 2012. However, y/y growth when measured in dollars
Realityhave
would Check: Annual
been Energy
roughly Eye on the
flat without Market, October 28, 2013
Apple.
4
Reality Check: Annual Energy Eye on the Market, October 28, 2013 8
8 8
EYE ON THE MARKET  OUTLOOK 2014  J . P . M O R G A N A S SE T M A N A G E M E N T
FEYE
O R I NON THE
S TI TU MARKET
TI O N • AOUTLOOK
A L / W H O L ES 2014
N OFOR
T F RETAIL
O R REDISTRIBUTION
TA I L D I S T RI BU TI O N J JANUARY
A N U A R Y 11,, 22014
014
Europe: Enjoy the intermission
Signs of improvement appeared on a number of fronts in the Eurozone last summer.

Manufacturing surveys started rising again and we began to see foreign capital returning, even in
Spain and Greece. Examples include foreign capital seeking non-performing loan sales by European
banks, and distressed real estate and bank acquisitions in Spain. In the U.S., these kinds of
transactions have historically signaled that the worst is over.
Eurozone rebound: everywhere but France "Non-Eurozone Europe" doing better

Purchasing Managers' Composite Index, level Purchasing Managers' Manufacturing Index, level
65 65
Germany
60 France 60 Denmark, Poland, Norway,
UK Sweden, Switzerland, UK
55
Germany 55
50 50
45 Periphery 45
Rest of the
Eurozone
40 40
2010 2011 2012 2013 2010 2011 2012 2013
Source: Markit, J.P. Morgan Securities LLC. December 2013. Source: Markit, J.P. Morgan Securities LLC. November 2013.
Other positive news:

• European countries that don’t use the Euro (Denmark, Norway, Poland, Sweden, Switzerland, UK,
etc.) are doing better, in large part a result of having their own independent monetary policies
• Consumer confidence is rising, and leading indicators on hiring are picking up
• Current account deficits in Spain, Greece and Portugal are in balance after having registered
massive gaps of 10%-14% of GDP in 2008. These indicators suggest on paper that Southern
Europe has finally shed its reliance on foreign capital
• Unit labor cost gaps versus Germany, a primary feature of the Eurozone for over a
decade, have declined by half in Ireland, Portugal, Spain and Greece (not Italy or France)
• Fiscal austerity in Europe will be considerably smaller next year: In 2012, the fiscal drag on growth
was 1.7% of GDP; in 2013 0.9%; and in 2014, is estimated at 0.7%
• Low-cost ECB lending reduced near-term default risk: Spanish and Italian banks borrowed from
the ECB and bought the lion’s share (50%-60%) of government debt issuance since 2008
• Germany is setting a pro-growth agenda (higher minimum wage, more government spending,
tax incentives for housing and R&D). The German IFO business survey surged into year-end
Germany goes for growth; Eurozone job outlook improves Competitiveness improvements in Portugal, Spain and
Eurozone PMI on employment IFO Index Greece, unit labor costs relative to Germany, index, Q4 2000=100
58 120 135
115 less competitive

54 Eurozone 130
employment PMI labor market
110
125
50 Italy
105
120
46 100 France
115
95 Spain
42
90 110 Portugal
38 German IFO Business Greece
Climate Index 85 105
34 80 100
1997 1999 2001 2003 2005 2007 2009 2011 2013 2000 2002 2004 2006 2008 2010 2012
Source: Markit, IFO Institute. November 2013. Source: Eurostat, J.P. Morgan Asset Management. Q3 2013.
9 9
FEOR
Y EINOS TITU
N TH E NM
TIO A LA/W
RHKOELTESALO URT PLRO
E O OO K S2I O0N1A4L CLJI EN
F ES . P .T M
U SO
E R
ONGLAY N/ NAOSTSE
F OTR M
REA
TANI LADGI SETM E NTITO N
RI BU JANUARY 1, 2014
FEYE
OR INON THE
S TITU MARKET
TIO N • AOUTLOOK
N OFOR
T F RETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 22014
014
The problem: these improvements may only result in a growth rebound of ~1.5%, which
may not improve
The problem: these conditions
improvementsmuch. may
Even only
where surveys
result are
in a rising, actual
growth rebound consumption
of ~1.5%,and which
production have not picked up as much. If GDP growth peaks at 1.5%,
may not improve conditions much. Even where surveys are rising, actual consumption Eurozone employmentand may
5
remain weak with little improvement to unemployment rates, which are at
production have not picked up as much. If GDP growth peaks at 1.5%, Eurozone employment may all-time highs . On
improved
remain weak current
with accounts, a collapseto
little improvement inunemployment
consumption and imports
rates, whichhas
area at
lotall-time
to do with
highshow
5
. Onthese
6
deficits closed
improved current; this was notajust
accounts, an export-led
collapse result. Finally,
in consumption European
and imports has corporate
a lot to dodeleveraging
with how these has
further to fall (see
6
page 7), and the Euro’s rise vs. the Yen is not going to help European
deficits closed ; this was not just an export-led result. Finally, European corporate deleveraging has exports.
further to fall (see page 7), and the Euro’s rise vs. the Yen is not going to help European exports.
Employment: two ships passing in the night Death in Venice
Index of employment, Q1 2007 = 100 Industrial Production Index, 2000 = 100
Employment: two ships passing in the night Death in Venice
102 140
Index of employment, Q1 2007 = 100 Industrial Production Index, 2000 = 100
101
102 140
130 Euro exchange
European Union rate fixed Germany
100
101 130
120 Euro exchange
99 European Union rate fixed Germany
100 120
Eurozone 110
98
99
Eurozone 110
100
97
98
100
90
96
97
95 U.S. 90
80 Italy
96
94
95 U.S. 80
70 Italy
2007 2008 2009 2010 2011 2012 2013 1982 1986 1990 1994 1998 2002 2006 2010
94 70
Source:
2007 BLS, Eurostat.
2008 Q2 2013.
2009 2010 2011 2012 2013 Source:
1982 OECD,
1986 GaveKal
1990 Securities.
1994 September
1998 2013.
2002 2006 2010
Source: BLS, Eurostat. Q2 2013. Source: OECD, GaveKal Securities. September 2013.
Let’s put the cyclical issues aside for a moment. The fundamental challenge for the Eurozone
remains:
Let’s puthow
the to reconcile
cyclical macroeconomic
issues and microeconomic
aside for a moment. differences
The fundamental between
challenge for member
the Eurozone
countries. We have published dozens of charts about this, and the one
remains: how to reconcile macroeconomic and microeconomic differences between member that resonates most is the
one on industrial
countries. We have production
publishedindozens
Germany and Italy.
of charts aboutAfter
this,moving
and theinonetandem for decades,
that resonates they
most is the
were
one ondriven apart
industrial by the Euro.
production On page
in Germany and23, we After
Italy. includemoving
some work we havefor
in tandem done on regional
decades, they
divergence,
were driven including
apart by a chart showing
the Euro. how cross-country
On page 23, we includedifferences
some workinwe thehave
Eurozone
done are as high as
on regional
for a hypothetical monetary union comprised of all countries in the world beginning
divergence, including a chart showing how cross-country differences in the Eurozone are as with thehigh
letter
as
“M”. Where this issue becomes more tangible: if these differences prevent more aggressive,
for a hypothetical monetary union comprised of all countries in the world beginning with the letter
proactive
“M”. Where ECBthis
action
issueregarding
becomesSouthern European
more tangible: deflation
if these risks. ECB
differences monetary
prevent policy even as it
more aggressive,
now stands is causing concerns about inflation risk and stealth expropriation
proactive ECB action regarding Southern European deflation risks. ECB monetary policy of savers in even
Germany.
as it
These challenges explain why the Euro is depicted on the cover as an albatross following
now stands is causing concerns about inflation risk and stealth expropriation of savers in Germany. the region.
These challenges explain why the Euro is depicted on the cover as an albatross following the region.
5
Despite very high levels of unemployment, an explicitly anti-Euro party has not succeeded at the polls.
However,
5 as cited
Despite very highby Germany’s
levels Friedrich Ebert
of unemployment, Foundation,
an explicitly there has
anti-Euro been
party has anot
noticeable
succeededriseatinthe
“right-wing”
polls.
and “extremist” parties in parts of Europe. This is a different issue, but one that bears risks of its
However, as cited by Germany’s Friedrich Ebert Foundation, there has been a noticeable rise in “right-wing” own.
6
In real
and terms, import
“extremist” contraction
parties in parts ofexplains
Europe. 19%
This of
is athe currentissue,
different account
but improvement
one that bearsinrisks
Portugal, 23% in Spain,
of its own.
15%
6 in Italy and 30% in Greece, with rising exports accounting for the rest. However, in
In real terms, import contraction explains 19% of the current account improvement in Portugal, 23% in Asia (1990’s) and
Spain,
Latin America (1980’s), import contractions accounted for 0%-10% of current account improvements.
15% in Italy and 30% in Greece, with rising exports accounting for the rest. However, in Asia (1990’s) and In
other words, (1980’s),
Latin America it is rareimport
that an import collapse
contractions plays
accounted forsuch a big of
0%-10% role.
current account improvements. In
other words, it is rare that an import collapse plays such a big role. 10
10 10
FEOR
Y EINOS TITU
N TH E NM
TIO A LA/W
RHKOELTESALO URT PLRO
E O OO K S2I O0N1A4L
F ES J.P. M
CL I EN T
 U SO
E R
ONGLAY N/ NAOSTSE
F OTR M
REA
TANI LADGI SETM E NTITO N
RI BU JANUARY 1, 2014
EYE ON THE MARKET • OUTLOOK 2014
F OR IN S TITU TIO N A L /W H O L ES A L E O R P RO F ES S I O N A L CL I EN T U S E O N L Y NOT
/ NO T FRETAIL
FOR O R RE TA I L D I S T RI BU TI O N
A N U A R Y 1,
1 , 2014
2014
On investments in Europe. In 2011, when financial markets were pricing in a high certainty of
negative outcomes,
On investments in European
Europe. equities
In 2011,were
whenmuch cheaper
financial thanwere
markets U.S. pricing
counterparts.
in a highThe Draghi of
certainty
“whatever it takes” speech in July 2012 immediately lowered perceptions
negative outcomes, European equities were much cheaper than U.S. counterparts. The Draghi of disintegration risk and
the equity valuation gap versus the U.S. began to close. This revaluation process
“whatever it takes” speech in July 2012 immediately lowered perceptions of disintegration risk and is mostly complete
with perhaps
the equity a bit more
valuation gap to go inthe
versus 2014,
U.S.particularly if the This
began to close. ECB revaluation
engages in process
the kindisofmostly
large-scale
complete
7
securities
with perhaps purchases undertaken
a bit more to go inby the Federal
2014, Reserve
particularly if the. ECB
So far, the ECB
engages in is
thesaying
kind these measures will
of large-scale
only be taken
securities if there’s
purchases another shock.
undertaken As a reminder,
by the Federal Reserve7long-term growth
. So far, the ECB isrates in France,
saying Spain andwill
these measures
8
Italy are at their lowest levels since the 1820’s (ex-wartime).
only be taken if there’s another shock. As a reminder, long-term growth rates in France, Spain and
8
Italyconclude,
To are at theirourlowest
viewlevels sinceisthe
on 2014 1820’s
that (ex-wartime).
investors should enjoy the intermission during which
Eurozone
To conclude,economic
our viewgrowth andisfinancial
on 2014 asset prices
that investors shouldimprove.
enjoy theAsintermission
shown on page 2, rising
during which
business surveys do point to better earnings growth. However, if a 1.0%-1.5% GDP
Eurozone economic growth and financial asset prices improve. As shown on page 2, rising growth
rebound surveys
business proves insufficient,
do point to many
betterof the structural
earnings growth.issues will return
However, to the forefront.
if a 1.0%-1.5% As shown on
GDP growth
the cover, the Eurozone as currently configured is not built for speed.
rebound proves insufficient, many of the structural issues will return to the forefront. As shown on
the cover, the Eurozone as currently configured is not built for speed.
European equity discount to U.S. continues to fall European earnings growth crawling back to positive
European P/E ratio divided by U.S. P/E ratio territory, Y/Y percent change, 12-month forward earnings per share
European equity discount to U.S. continues to fall
40%
European earnings growth crawling back to positive
50%
European P/E ratio divided by U.S. P/E ratio
Premium MSCI Europe territory, Y/Y percent change, 12-month forward earnings per share
30% 40% MSCI Europe S&P 500
40% to U.S. 50%
20% Premium MSCI Europe 30%
40% MSCI Europe
30% S&P 500
to U.S. 20%
10%
20% 30%
10%
20%
0%
10%
0%
10%
-10%
0% -10%
0%
-20%
-10% -20%
-10% EuroStoxx 50
-30%
-20% -30%
Discount
-20% EuroStoxx 50
-40%
-30% -40%
to U.S. EuroStoxx 50 -30%
-50%
-40% Discount -50%
-40%
1969 to U.S.
1975 1981 1987EuroStoxx
1993 50
1999 2005 2011 1998 2001 2004 2007 2010 2013
-50%
Source: MSCI, Datastream, Factset. November 2013. -50%
Source: J.P. Morgan Securities LLC. November 2013.
1969 1975 1981 1987 1993 1999 2005 2011 1998 2001 2004 2007 2010 2013
Source: MSCI, Datastream, Factset. November 2013. Source: J.P. Morgan Securities LLC. November 2013.
Two indices are most often referred to as “European equities”: the EuroStoxx 50 and the MSCI
Europe Index.are
Two indices Theymost
are quite
oftendifferent:
referredThere
to asis“European
only a 26%equities”:
overlap in the
companies due50
EuroStoxx toand
the the
higher
MSCI
concentration
Europe and larger
Index. They market
are quite capitalization
different: There issizes
only in the EuroStoxx.
a 26% overlap in The other big
companies difference:
due The MSCI
to the higher
Europe Index has
concentration andlarge exposures
larger to the UK (34%)
market capitalization sizesand Switzerland
in the EuroStoxx.(14%), whilebig
The other thedifference:
EuroStoxxThehasMSCI
none.
Europe Index has large exposures to the UK (34%) and Switzerland (14%), while the EuroStoxx has none.
7
According to an analysis by J.P. Morgan Securities LLC, a European bond-buying program would need to be
around
7 550 to
According billion Euros, derived
an analysis in order Securities
by J.P. Morgan to maximize
LLC,employment
a European without jeopardizing
bond-buying program price stability.
would need to be
8
around
See Eye550 billion
on the Euros,April
Market, derived in order
1, 2013, for to maximize
a chart employment
on 7-year without
real growth sincejeopardizing priceSpain
1826 in France, stability.
and Italy.
8
See Eye on the Market, April 1, 2013, for a chart on 7-year real growth since 1826 in France, Spain and Italy. 11
11 11
FEYE ON
OR IN THE
S TITU MARKET
TION • AOUTLOOK
N OFOR
T FRETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 2
2014
014
Emerging Markets: Debtor nation balance of payments crises not as severe as prior
episodes, but still painful
For once, the main story in emerging markets is not about China. There’s an old-fashioned balance
of payments crisis going on in the “debtor nations” (Brazil, India, Indonesia and Turkey). A
combination of factors makes this episode less problematic than prior ones in Latin America in the
1980’s and Asia in the 1990’s, but we don’t think the adjustments are over yet.
What’s a balance of payments crisis? The next three charts tell the abbreviated story. First, capital
floods into a country, allowing interest rates to fall and consumption to rise. The country typically
experiences a large current account deficit due to rising imports and falling exports. Then, if capital
inflows do not result in sufficient growth and productivity improvements, eventually growth declines
and investors want their money back.
Rising vulnerability to capital outflows in the Big 4: Nominal GDP growth of EM debtors
Brazil, India, Indonesia and Turkey, percent of GDP Y/Y percent change
8% 30%
6% 25% India
Net capital inflows Indonesia
4% 20%
2% 15%
0% 10%
-2% 5%
Turkey Brazil
-4% 0%
Current account
-6% -5%
2002 2004 2006 2008 2010 2012 2006 2008 2010 2012
Source: National Central Banks, J.P. Morgan Asset Management. Q3 2013. Source: National statistical agencies. Q3 2013.
Capital outflows generally cause a decline in growth and asset prices, and a decline in the currency.
It would be tempting for a Central Bank to lower interest rates to reinvigorate growth, but if the
country is running close to full capacity, lower interest rates could cause inflation. Instead, affected
countries often have to raise interest rates to defend their currencies and prevent inflation
from rising too much. That is what has happened so far.
Debtor nation bond yields rising sharply

5-year government bond yields, percent
13%
12% Brazil
11%
10% Turkey
9%
8%
7%
India
6%
5% Indonesia
4%
Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13
Source: Bloomberg. December 2013.
12 12
FEYE
OR INON THE
S TITU MARKET
TIO N • AOUTLOOK
N OFOR
T F RETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 22014
014
Fortunately, there are two major differences compared to prior crises. First, countries involved
have a lot of foreign exchange reserves, allowing them to defend their currencies as capital flees. This
prevents a collapse in their exchange rates, and reduces risks of inflation and domestic bankruptcy.
The second difference is that these countries do not have fixed exchange rates, making the “rush for
the exit” problem less acute. 2014 should be another difficult year of adjustment, but we expect the
process to play out with less damage to their economies and to the rest of the world than in the past.
EM external account measures, past and present,
with key differences vs. prior episodes circled in red
1980's: 1996: Today*:
ARG, BRL, INDO, KOR, BRL, IND,
MEX, VEN MAL, THA INDO, TUR
External Debt (% of Exports) 401% 130% 156%
Interest on External Debt (% of Exports) 39.7% 6.6% 4.6%
Reserves (% of External Debt) 7.7% 28.8% 61.6%
Current Account (% of GDP) -5.1% -4.5% -3.7%
Exchange Rates vs. the USD -97.5% -61.1% -13.7%
Exchange Rate Type Managed Managed Floating
Source: IMF, Economist Intelligence Unit, JPMAM. *2013 YTD. December 2013.
As for China, recent data have been positive, with GDP growth at 8%-9%. Manufacturing
surveys show signs of modest improvement and key indicators like electricity production have picked
up. Production growth is at the strongest level since 2010 and fixed investment growth is stable.
The risk in China relates to the credit expansion that took place after the global recession.
China’s real growth is lower than reported after adjusting for credit expansion and loose
fiscal policy. While inflation is low, there are signs of rapid growth in real estate prices, rising wages
and tight labor markets. Short and medium-term interest rates have risen sharply and will probably
remain high, which will likely reduce growth to ~7%. Tighter monetary policy appears to be part of
the plan announced by China’s Central Bank, which has referred to “periods of deleveraging and
capacity reduction”. China’s plan re-emphasizes market mechanisms and a reduced presence for
inefficiently run state-owned enterprises. Sounds good on paper, but the immediate future entails
tighter monetary policy to address asset inflation and credit risks.
Chinese manufacturing surveys point to modest Electricity production confirms positive momentum
expansion, Purchasing Managers' Index, level Y/Y % change in electricity production
60 25%
20%
55
15%
10%
50
5%
Markit PMI
45 0%
China NBS PMI
-5%
40 -10%
2005 2007 2009 2011 2013 2005 2007 2009 2011 2013
Source: Markit, National Bureau of Statistics of China. November 2013. Source: International Strategy & Investment Group LLC. Q3 2013.
13 13
FEYE
OR INON THE
S TITU MARKET
TIO N • AOUTLOOK
N OFOR
T F RETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 22014
014
Are EM debtor countries worth buying? The debtor nations underperformed the rest of EM in
2013 by ~15%, but their P/E multiples are still higher. This is partially explained by sector differences,
since debtor markets are more heavily weighted to consumer and technology stocks that trade at
higher multiples. Nevertheless, markets might be too sanguine about 2014, particularly as the Fed
reduces its asset purchases, which in turn reduces global liquidity. We prefer countries that run a
current account surplus, or at most a small deficit (Mexico, Korea, the Czech Republic,
Taiwan, the Philippines) for the reasons discussed above. We also see 2014 as another year in
which emerging market equities trail developed markets. Even in some EM surplus nations, exports
have slowed down and the general commodity price decline is taking a toll. As discussed in the next
section, Japan’s stimulus plan is designed in part to recapture export market share from other
emerging Asian countries through a weak Yen.
EM debtor nations trade at higher multiples than Private equity has outperformed public equity in Asia and
surplus nations, P/E multiple,12-month forward Latin America, 5-year annualized return through Q2 2013, percent
13.0x 10%
12.5x 8%
Brazil, India,
12.0x Indonesia and Turkey 6%
11.5x
4%
11.0x
2%
10.5x
0%
10.0x
-2%
9.5x Rest of the Emerging Markets
9.0x -4%
MSCI MSCI EM Asia PE & Asia EM MSCI EM LatAm &
8.5x Pacif ic Asia Index VC Index PE & VC Latin Caribbean
Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Index America PE & VC
Source: MSCI. JPMS LLC. November 2013. Sector neutral P/Es used. Source: Cambridge Associates LLC. Index
One last observation on investing in emerging markets. Investors are often focused on rising
household wealth and consumption in emerging countries. In many countries, however, there aren’t
enough publicly tradable consumer discretionary and consumer cyclical companies, leaving equity
markets to be dominated by industrials, exporters, banks, utilities, etc. As a result, investors often
look to private equity markets as well. Private equity has outperformed public equity in both Asia
and Latin America over the past five years. In our experience, one of the primary reasons is a greater
focus on consumer-related investments by EM private equity managers.
14 14
E
EYYEE O
ON N TTHHEE M
MA AR RKKEETT O

OU UTT LL O
OOOKK 2 20 01144


JJ .. P
P .. M
MOOR
RGGA
ANN A
A SS SE
SE T
T M
MAAN
NAAG
GEEM
MEEN
NTT
FEYE ON
OR IN THE
S TITU MARKET
TION •
A L /W H O L ES AOUTLOOK 2014
L E O R P RO F ES SIONAL
F OR IN S TITU TION A L /W H O L ES A L E O R P RO F ES S I O N A L
FOR
CL I EN INSTITUTIONAL/WHOLESALE
T U S E O N L Y / N O T F O R OR
CL I EN T U S E O N L Y /NOT
N OFOR
REPROFESSIONAL
T FRETAIL
TA I L D I S T RICLIENT
O R REDISTRIBUTION
BU TI USE
O N ONLY/
TA I L D I S T RI BU TI O N
JJJANUARY
A
ANNU
UAAR
RYY 1
11,,, 2 0
01
2014
2 14
4
Japan:
Japan: The
The experiment
experiment continues,
continues, but
but so
so far,
far, only
only weakening
weakening the
the Yen
Yen seems
seems to
to work
work
9
At
At the
the end
end of
of 2012,
2012, Japan
Japan was
was still
still mired
mired in
in its
its 25-year
25-year malaise
malaise .. A
9
A radical
radical approach
approach was
was launched
launched
that involves monetary stimulus that dwarfs what the Fed and ECB have done. Goals: 3% nominal
that involves monetary stimulus that dwarfs what the Fed and ECB have done. Goals: 3% nominal
GDP
GDP growth
growth andand 2%
2% real
real GDP
GDP growth,
growth, levels
levels that
that haven’t
haven’t been
been seen
seen in
in Japan
Japan in
in 20
20 years.
years.
Japan’s
Japan’s leaders
leaders point
point to
to similar
similar efforts
efforts during
during thethe 1930’s
1930’s byby Finance
Finance Minister
Minister Takahashi
Takahashi that
that ended
ended
deflation.
deflation. Takahashi’s
Takahashi’s policies
policies included
included aa 40%
40% decline
decline in
in the
the Yen,
Yen, lower
lower tax
tax revenue
revenue and
and aa rise
rise in
in
public
public works
works spending
spending (note:
(note: the
the only
only spending
spending Takahashi
Takahashi cut
cut was
was military
military spending,
spending, which
which led
led to
to his
his
assassination by Japanese military officers in 1936).
assassination by Japanese military officers in 1936).
Japan's
Japan's massive
massive money
money experiment
experiment The
The end
end of
of Japanese
Japanese deflation
deflation in
in the
the 1930's
1930's
Central
Central Banks'
Banks' balance
balance sheets,
sheets, percent
percent of
of GDP
GDP Y/Y
Y/Y percent
percent change
change Inception
Inception of
of the
the Takahashi
Takahashi
120% financial
120%
30% financial policy
policy
30%
contingent
contingent Nominal
Nominal
90%
90% 20% GNP
20% GNP
Real
Real GNP
GNP
committed GNP
committed 10%
10% GNP deflator
deflator
60%
60%
Bank
Bank of
of 0%
Japan 0%
30% Japan
30%
ECB -10%
-10%
ECB
Federal Period
Period of
of severe
Federal Reserve
Reserve deflation
severe
0%
0% -20%
-20% deflation 1926-1931
1926-1931
2000 2004 2008 2012 2016 2020 1920
2000 2004 2008 2012 2016 2020 1920 1922
1922 1924
1924 1926
1926 1928
1928 1930
1930 1932
1932 1934
1934 1936
1936 1938
1938
Source:
Source: Federal
Federal Reserve,
Reserve, ECB,
ECB, Bank
Bank of
of Japan,
Japan, JPMS
JPMS LLC.
LLC. November
November 2013.
2013. Source:
Source: Nomura,
Nomura, Japan's
Japan's Economic
Economic Planning
Planning Agency.
Agency.
Is
Is itit working?
working? The The Japanese
Japanese stock
stock market
market liked
liked the
the idea
idea and
and took
took off.
off. It
It sure
sure looked
looked like
like the
the program
program
was working during the spring and summer of 2013 when exports, machinery
was working during the spring and summer of 2013 when exports, machinery orders, consumer orders, consumer
spending
spending and and consumer
consumer confidence jumped. Unfortunately,
confidence jumped. Unfortunately, this this bump
bump appears
appears to to simply
simply
coincide
coincide (as (as it
it has
has over
over thethe last
last 25
25 years)
years) with
with aa period
period of of Yen
Yen depreciation.
depreciation. As As soon
soon as
as the
the
Yen’s
Yen’s slide ended, most economic data rolled over as well, and (as in the U.S.) cheap money had a
slide ended, most economic data rolled over as well, and (as in the U.S.) cheap money had a
more
more durable
durable impact
impact onon the
the Nikkei
Nikkei than
than onon Japan’s
Japan’s economy:
economy:
 Its Its monetary
monetary base
base grew
grew byby 50%,
50%, butbut money
money supply
supply (reflecting
(reflecting private
private sector
sector activity)
activity) is
is up
up <
< 5%
5%
 Most signs of rising inflation are more related to energy costs
Most signs of rising inflation are more related to energy costs than wages than wages
 Rising
Rising corporate
corporate profits
profits have
have led
led to
to an
an increase
increase inin capital
capital spending
spending by by Japanese
Japanese companies,
companies, butbut
almost
almost all
all the
the increase
increase hashas been
been outside
outside Japan
Japan rather
rather than
than domestic
domestic
 Most
Most ofof the
the increase
increase in in hiring
hiring has
has been
been related
related to
to part-time
part-time rather
rather than
than full-time
full-time workers
workers
The
The temporary
temporary summer
summer 2013
2013 improvement
improvement in
in Japan...
Japan... ...coincided
...coincided with
with a
a weaker
weaker Yen
Yen
3-month
3-month %
% change Index
Index level JPY
change level JPY per
per USD
USD
30%
30% 105
105
Exports 45
45
25%
25% Exports
Consumer 100
100
Machinery Consumer
20%
20% Machinery orders
orders confidence 43
43
confidence
15%
15% 95
95
41
41
10%
10% 90
90
5% 39
39
5%
0% 37 85
0% 37 85
-5%
-5% Consumer
Consumer 35 80
-10% spending 35 80
-10% spending
-15%
-15% 33
33
75
75
Jan-11
Jan-11 Jul-11
Jul-11 Jan-12
Jan-12 Jul-12
Jul-12 Jan-13
Jan-13 Jul-13
Jul-13 Jan-11
Jan-11 Jul-11
Jul-11 Jan-12
Jan-12 Jul-12
Jul-12 Jan-13
Jan-13 Jul-13
Jul-13
Source: Source: Bloomberg. December 2013.
Source: BoJ, Cabinet Office of Japan, Chain Stores Assn. October 2013.
BoJ, Cabinet Office of Japan, Chain Stores Assn. October 2013. Source: Bloomberg. December 2013.
9
9On
On March
March 18,18, 2013,
2013, we
we reviewed
reviewed the
the dismal
dismal state
state of
of Japanese
Japanese nominal
nominal and
and real
real GDP
GDP growth,
growth, corporate
corporate
profits, earnings per employee and net exports. In level
profits, cash earnings per employee and net exports. In level terms, Japan is a rich nation but
cash terms, Japan is a rich nation the growth
but the growth in
in
these variables has been negligible, which is what deflation is all about.
these variables has been negligible, which is what deflation is all about.
15 15
15
JANUARY 1, 2014
FEYE
OR INON THE
S TITU MARKET
TIO N • AOUTLOOK
N OFOR
T F RETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 22014
014
Japan’s government is using more than monetary policy to try and boost its financial markets:
Japan’s government is using more than monetary policy to try and boost its financial markets:
The Nippon Investment Savings Account allows notoriously equity-averse Japanese
The NippontoInvestment
households buy ~US$10K Savings
per year Account
of riskyallows
assets notoriously
and exempts equity-averse Japanesefor five
them from taxation
households to buy ~US$10K per year of risky assets and exempts them
years as long as the account is invested in equities or mutual funds. This plan could prompt from taxation for five
years as long as the account is invested in equities or mutual funds. This
hundreds of billions of dollars to shift from bank deposits to equities over the next five years plan could prompt
hundreds
(Japanese of billions ofhave
households dollars
~US$8 to shift fromofbank
trillion deposits
deposits). to equities
Nomura over the
estimated last next
May five
thatyears
NISA
(Japanese households have ~US$8 trillion of deposits). Nomura estimated
accounts could reach ~US$260 billion by 2018. If Toshin investment funds are any guide, last May that NISA
accounts
Japanese could reach would
households ~US$260 investbillion
aroundby 2018.
half ofIf Toshin investment
their NISA balancesfunds are anysecurities.
in Japanese guide,
Japanese households would invest around half of their NISA balances in Japanese securities.
A November 2013 report from a government-appointed panel proposed new guidelines for
A November
Japan’s US$3 2013 report
trillion from a government-appointed
Government Pension Investment panel proposed
Fund that wouldnewraise
guidelines
weightsforin
Japan’s US$3 trillion Government Pension Investment Fund that
domestic and non-Japanese equities from 24% to 40%. The proposal is still under consideration, would raise weights in
domestic
and wouldand non-Japanese
represent anotherequities
source from 24% to
of demand for40%. The proposal
Japanese equities ifis adopted.
still under consideration,
and would represent another source of demand for Japanese equities if adopted.
To be clear, Japan’s demographic and debt outlook is still terrifying. In the next few years,
To be clear,
Japan’s Japan’s
net debt demographic
will reach 150% of GDP and10debt and outlook is still terrifying.
its demographics are awful. In thegovernment
The next few years,
assumes
10
Japan’s net debt will reach 150% of GDP and its demographics are awful.
it will be able to generate what I would describe as a productivity miracle: substantial benefits The government assumes
from
it will be able to generate what I would describe as a productivity miracle:
increased business capital spending and a free trade deal that involves major changes to Japan’s from substantial benefits
increased
service andbusiness capital spending
manufacturing and a free trade
sectors. Furthermore, the deal
plan that involves
assumes major
a large changes
increase to Japan’s
in female labor
service and manufacturing sectors. Furthermore, the plan assumes a large
force participation, presumably achieved by introducing more maternity leave, child care programs, increase in female labor
force participation,
etc. None of this willpresumably
be as easy achieved
in reality by as itintroducing
is on paper, more maternity
particularly in leave,
Japan.child care programs,
etc. None of this will be as easy in reality as it is on paper, particularly in Japan.
Japan's plan: a productivity and labor force miracle
Japan's plan: a productivity and labor force miracle
Productivity Real GDP
Productivity
(output per + Labor force = Real GDP
(output
(output
hour)per + Labor force
growth = (output
growth)
hour) growth growth)
2000-2010
2000-2010 0.80% -0.20% 0.60%
Actual 0.80% -0.20% 0.60%
Actual due to
aging
due to
2010-2020 aging
2010-2020 0.80% -0.60% 0.20%
Baseline 0.80%productive cap -0.60% 0.20%
increased
Baseline spending
productiveand
cap female labor
increased
spending and
Trans-Pacific femaleparticipation
force labor
2010-2020 Partnership
Trans-Pacific
2.00%Partnership force participation2.00%
0.00%
2010-2020
Abenomics 2.00% 0.00% 2.00%
Abenomics
Source: Japan Cabinet Office, Gavekal Research.
Source: Japan Cabinet Office, Gavekal Research.
10
The debt bubble is why Japan is seeking to increase inflation. If Japan had been able to run just 3% nominal
10
Thegrowth
GDP debt bubble is of
instead why Japan
0% sinceis1990,
seeking
its to increase
gross inflation.
debt to If Japan
GDP would had been ableinstead
be 100%-130% to runof
just 3% nominal
230%.
GDP growth instead of 0% since 1990, its gross debt to GDP would be 100%-130% instead of 230%.
16
16
16
FEYE
OR INON THE
S TITU MARKET
TIO N • AOUTLOOK
N OFOR
T F RETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 22014
014
Nevertheless, it seems risky to be underweight Japanese equities. Japanese equity valuations

are not low compared to other countries, and poor return on equity has been a problem (see table).
However, earnings growth estimates are rising for 2014, and the cyclical aspect of the government’s
plan has the potential to override Japan’s structural problems for another year. That’s what we think
will happen in 2014. If global exports are a zero-sum game, it’s also risky to be underweight Japan if
its short-term success comes at the expense of other industrialized export nations in Asia and Europe.
Global equity market valuations
Asia
Pacific EM EM EM
U.S. UK Europe EMU Japan ex-JPN Asia Latam EMEA
Price-to-Book 2.7x 1.9x 1.8x 1.5x 1.3x 1.6x 1.6x 1.7x 1.2x
Return on Equity (2013E) 14.6% 13.8% 10.9% 8.5% 8.0% 12.4% 13.4% 11.7% 13.5%
Price-to-Earnings (12m Fwd) 15.4x 12.4x 13.2x 12.9x 14.4x 13.5x 11.0x 12.6x 8.6x
Source: MSCI, J.P. Morgan Securities LLC. December 2013.
Japanese TOPIX forward price-to-earnings ratio

Multiple
80x
70x
60x
50x
40x
30x
20x
10x
1993 1997 2001 2005 2009 2013
Source: FactSet. December 2013.
17 17
FEYE ON
OR IN THE
S TITU MARKET
TION • AOUTLOOK
N OFOR
T FRETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 2
2014
014
Beyond the Great Race
The remainder of this year’s Outlook provides further analysis of some market and investment themes
that are part of our portfolio thinking for 2014.
I: Risk and opportunity in credit markets

II: A revised look at private equity performance, and some themes for 2014
III: On the recent underperformance of hedge funds relative to equities, and outperformance
vs. bonds
IV: Tracking performance trends in active equity management
V: How different are the countries of the European Monetary Union?
VI: Indicators cited in the preface that have returned to pre-crisis levels
VII: U.S. fiscal outlook: Quieter in 2014, with long-term battles ahead
VIII: U.S. municipal bond outlook and the question of Detroit
18 18
FEYE ON
OR IN THE
S TITU MARKET
TIO N • AOUTLOOK
N OFOR
T F RETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 22014
014
I: Risk and opportunity in credit markets

Five years into the Fed’s zero interest rate policy, the search for yield continues. In addition to the
decline in credit yields (see page 24), covenant-lite loan issuance has risen above 2007 levels, the
riskier CCC-rated component of the high yield market is rising, and the number of loans and bonds
trading below a price of 80 is shrinking. On the plus side, credit fundamentals are positive: cash flow
coverage of debt service is high, default rates are low and as shown on page 8, the S&P 500 debt-to-
market cap is low as well. The concern is not one of recession or debt service coverage, but
whether credit market enthusiasm has gone too far. 2014 might be a good year to make sure
portfolios do not own too much credit that is priced for perfection.
Tracking underwriting standards in high yield, leveraged loan and leveraged buyout markets
Percent of total annual issuance % Debt/cash flow
50% 40% LBO senior 6x
35% HY issues rated CCC and lower debt-to-cash

Covenant-lite leveraged loans as % of HY total issuance flow multiple
40%
30% 5x
HY bonds with PIK/Toggle features
30% 25%
20% 4x
20%
15%
10% 10% 3x
5%
0%
0% 2x
02 03 04 05 06 07 08 09 10 11 12 13
1998 2001 2004 2007 2010 2013
Source: J.P. Morgan Securities LLC. October 2013. Source: J.P. Morgan Securities LLC, Capital IQ. November 2013.
U.S. HY bonds and loans trading <= 80% of face value Debt issuance by mid-market firms (EBITDA <= $50mm)
Percent of all outstanding loans and bonds Number of deals, quarterly
50% Peak levels (Nov. '08) 140
45% Bonds: 77%
120
40% Bonds Loans: 81%
35% 100
30%
80
25%
20% 60
15% Loans
40
10%
5% 20
0%
0
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Source: J.P. Morgan Securities LLC, Standard and Poor's, S&P/LSTA 1997 1999 2001 2003 2005 2007 2009 2011 2013
Leveraged Loan Index. November 2013. Source: S&P Capital IQ. Q3 2013.
The flood of money into public credit markets has resulted in tighter spreads and modestly weaker
underwriting standards. The same dynamics are less prevalent in private credit markets. Many small
and mid-size companies (and real estate entities) that used to have access to public credit
markets find that access is harder now, and borrow from private credit and mezzanine debt
markets instead. Private credit portfolios generally entail less diversification and less liquidity in
exchange for higher lending rates and at times, call protection, debt service coverage, escrow
requirements and change of control provisions sometimes absent in public credit markets.
As outlined in a November Eye on the Market, bank loan sales in Europe are finally picking up
across countries. This process has accelerated as rising earnings allow banks to absorb more losses.
As an example, Lloyd’s, Unicredit, BBVA, Commerzbank and Société Générale took asset charges
equal to 90% of gross operating profit in 2012. PricewaterhouseCoopers cites bank loan sales at 10
to 40 cents on the Euro in Ireland, and UK/German real estate loan sales at 40 to 50 cents. Loan-to-
deposit ratios of European banks are still high, so we expect bank loan sales to continue for an
extended period.
19 19
E Y E O N T H E M A R K E T O U T L O O K 2 0 1 4  J . P . M O R G A N A S SE T M A N A G E M E N T
FEYE
FOR ON
OR IN
IN THE
SSTITU
TITU TION
TIO MARKET
N ALL/W
A /WHHO • AAOUTLOOK
OLLES
ES LLEE O
ORR PPRO 2014
ROFFES
ES SSIIO
ONNA
ALL CL
CLIIEN
ENTT U
USSEE O
ONNLLY
Y //NOT
NO
N OFOR
TT FFRETAIL
ORR RE
O RE TAIILL D
TA DIISSTTRI
DISTRIBUTION RIBU
BUTI
TIOON
N JJANUARY
A N U A R Y 11,, 2014
2014
II: A revised look at private equity performance, and some themes for 2014
Juneofof2013,
In July 2013,we
wewrote
wroteaadetailed
detailedpaper
paperon
onprivate equity1111, ,part
privateequity partof
ofwhich
whichfocused
focusedon
onrecent
recent
findings by an Oxford lecturer regarding problems with a commonly used private equity performance
database. Due to stale records, missing cash distributions and incomplete fund records, widely read
prior studies factored in a downward performance bias for private equity. After the exclusion of
incomplete fund records, the previously estimated private equity underperformance of 3%-6%
against the S&P 500 turns into outperformance of 4% per year.
A separate 2013 paper from academics in Virginia, Oxford and Chicago confirms these findings.
The authors found that buyout funds outperformed the S&P 500 in each of the last three
decades. Venture capital funds, on the other hand, had a great run in the 1990’s, after which
industry performance has been below equity markets. The authors also found that performance of
buyout funds did not differ substantially by fund size, and that there is no identifiable relationship
between manager fees or GP ownership levels and buyout fund performance.
Subsequent to our paper’s release, the most frequent questions we received were:
How do buyout funds perform relative to public equity when using benchmarks other than the S&P
500 (to reflect the small/mid-cap nature of companies often acquired by private equity firms)?
The authors of the paper cited above also computed buyout fund performance using the Russell
2000, the Russell 2000 Value Index and the NASDAQ. Buyout fund outperformance using an S&P
500 benchmark was 1.22x; using the Russell 2000, Russell 2000 Value Index and NASDAQ, the ratios
were 1.22x, 1.16x and 1.20x, respectively. In other words, basically the same.
How does buyout fund outperformance look when applying leverage to the S&P 500 benchmark (to
reflect the high level of leverage often used by buyout funds)?
The authors reran their analyses using a leveraged S&P 500 benchmark. Buyout outperformance fell
to 1.08x; still positive, but less than the original results. Interestingly, this measure was 1.28x for the
2000’s, 1.09x for the 1990’s and 0.76x for the 1980’s. Applying leverage to the S&P during a
decade with two 40%+ declines in the market created a lot of distress in the benchmark.
Private equity in 2014 The U.S. energy advantage
If our views on leading indicators are correct, global GDP $300
$300
Italy
growth will pick up in 2014 close to pre-crisis averages. Industrial electricity
$250
$250
If so, one theme that we expect to continue is the price, USD per MWh
Japan
increase in energy-related investments in private equity $200
$200
portfolios. The phrase “energy-related” is broad, and Germany
refers to projects designed to increase proven and $150
$150
UK
producing oil/gas reserves that are subsequently sold to China
India
$100 France
integrated and independent energy companies; $100 U.S.
12
infrastructure and logistics companies12; and
$50
$50
recapitalization of manufacturing and associated service Korea*
companies. The chart shows electricity costs for industrial $0
$0
users and domestic/import prices for natural gas across $2
$2 $6
$6 $10
$10 $14
$14 $18
$18
countries. Natural gas/LNG price, USD per mmbtu
Source: Bloomberg, FERC, China NDRC, World Bank, IEA, Reuters.
Source: Bloomberg, FERC, China NDRC, World Bank, IEA, Reuters.
Another trend to watch: there’s increasing pressure on ** Korean
Korean industrial
industrial electricity
electricity prices
prices are
are heavily
heavily subsidized.
subsidized.
companies with slowing earnings growth and elevated
cash balances to sell non-core businesses, often at the urging of shareholder activists. Private equity
firms aim to restructure these underperforming units as stand-alone entities with revitalized growth
prospects and greater management focus.
11
11
Eye on the Market “Private Investigations”, July 9, 2013
12
In 2012, the U.S. completed 45,000 oil and gas wells compared to 4,000 in the rest of the world, excluding
12
Canada. “The Shale Oil Boom: A U.S. Phenomenon”, Leonardo Magueri, Harvard Belfer Center, June 2013.
20 20
FEYE
OR INON THE
S TITU MARKET
TIO N • AOUTLOOK
N OFOR
T F RETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 22014
014
III: On the recent underperformance of hedge funds relative to equities, and

outperformance vs. bonds
For the first time since the late 1990’s, the hedge fund industry has lagged equities. This assessment
is based on two methods commonly used to evaluate performance. The first compares hedge funds
to a stock-bond portfolio, and the second compares hedge funds to equities on a risk-adjusted basis.
In the charts, when the lines are positive, hedge funds are outperforming and vice versa. For the bulk
of the 2000’s, hedge funds (measured by the HFRI Composite) held their own. Over the last two
years, relative performance moved into negative territory, indicating hedge fund underperformance.
Hedge Funds vs. Stock/Bond portfolio Hedge Funds vs. Equity Markets
Hedge fund return less stock/bond return, rolling 2 years Hedge fund return/risk less equity return/risk, rolling 2 years
20% HFRI Composite - 60% S&P / 40% Barc Agg 6
HFRI Composite vs. S&P
HFRI Composite - 60% MSCI AC World / 40% Barc Agg 5 HFRI Composite vs. MSCI AC World
15%
10% 4
3
5%
2
0%
1
-5%
0
-10% Hedge f unds Hedge f unds
-1
underperf orm underperf orm
-15% -2
1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Source: Bloomberg. HFRI. October 2013. Monthly portf olio rebalancing. Source: Bloomberg. HFRI. October 2013. Volatility based on monthly returns.
MSCI AC World is an all-country index of global equities including emerging markets. "S&P" refers to the S&P 500 Index. "Agg" refers to the
Barclays U.S. Aggregate, an index of U.S. government, agency and corporate bonds. "Hedge funds" denotes the HFRI Composite Index, a fund-
weighted index of over 2,200 hedge funds.
Individual hedge fund portfolios will of course differ from the HFRI Composite, which measures
performance across the entire industry. Even so, the charts demonstrate the extent to which many
hedge funds trailed investor performance objectives during the double-digit, low-volatility equity rally.
The unwinding of Central Bank liquidity should help level the playing field for hedge funds, which are
typically less “long” than equity managers. In any case, before monetary policy normalizes, it seems
premature to assume that there has been a permanent and structural shift in the performance of
hedge funds relative to equities.
Investors who bought diversified hedge funds of funds as replacements for overpriced
government bonds, on the other hand, have seen better results. When thinking about a
portfolio proxy for bonds, we need to switch from the HFRI Composite to the HFRI Fund of Funds
Diversified Index, since the latter has a lower volatility that is more consistent with bonds and credit.
Over the last two years, the HFRI Fund of Funds
Rising correlations and falling long-short HF returns
Index has outperformed the Barclays Aggregate Percent
Index both on a nominal and risk-adjusted basis. 50%
Large Cap pair-wise correlations
In the next section, we review how the pair-wise 40%
correlation of stocks is finally coming down after
30%
spiking to the highest levels in several decades. We
expect a decline in correlations to benefit long-only 20%
active equity managers, and long-short hedge fund 10%
managers as well. As shown in the chart, there is a
clear pattern in which rising correlations correspond 0%
to lower returns on the HFRI Equity Hedge Index -10% HFRI Equity Hedge annualized returns, 3-year rolling
since the early 1990’s. 1993 1997 2001 2005 2009 2013
Source: Bloomberg, Empirical Research Partners. November 2013.
21 21
F OR IN S TITU TIO N A L /W H O L ES A L E O R P RO F ES S I O N A L CL I EN T U
FOR S E O N L Y / N O T F O R OR
INSTITUTIONAL/WHOLESALE REPROFESSIONAL
TA I L D I S T RICLIENT
BU TI O N ONLY/
USE JANUARY 1, 2014
FEYE
OR INON THE
S TITU MARKET
TIO N • AOUTLOOK
N OFOR
T F RETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 22014
014

As part of our institutional Investment Insights series, we took a look at manager performance trends
As part of our institutional Investment Insights series, we took a look at manager performance trends
in active equity management13 . As shown below (and as we explain in great detail in the paper),
in active equity management13. As shown below (and as we explain in great detail in the paper),
manager outperformance trends have been positive in most investment styles with the exception of
manager outperformance trends have been positive in most investment styles with the exception of
U.S. Large Cap Growth and Mid Cap Growth.
U.S. Large Cap Growth and Mid Cap Growth.
Generally positive manager outperformance trends over the last 5 and 7 years, with the exception of U.S. LC Growth
Generally
Percent positive
of active manager
managers outperformance
outperforming trends
their respective over
investible the last 5 and 7 years, with the exception of U.S. LC Growth
benchmarks
Percent
100% of active managers outperforming their respective investible benchmarks
100%
90%
90% 5-year basis 7-year basis
80% 5-year basis 7-year basis
80%
70%
70%
60%
60%
50%
50%
40%
40%
30%
30%
20%
20%
10%
10%
0%
0% LC LC LC MC MC MC SC SC SC Multi Multi Multi Equity EAFE EM Global ACWI EUR JPN Asia
LC
Core LC
Value LC
Grow MC
Core MC
Value MC
Grow SC
Core SC
Value SC
Grow Multi
Core Multi
Value Multi Income
Grow Equity EAFE EM Global ex-U.S.
ACWI EUR JPN Asia
ex-JPN
Core Value Grow Core Value Grow Core Value
Source: eVestment, J.P. Morgan Asset Management. September 2013. Grow Core Value Grow Income ex-U.S. ex-JPN
Source: eVestment, J.P. Morgan Asset Management. September 2013.
These outperformance trends coincided with a difficult period for some active managers given the
These outperformance trends coincided with a difficult period for some active managers given the
sharp rise in pair-wise stock correlations. We are finally seeing a decline in correlations, in both U.S.
sharp rise in pair-wise stock correlations. We are finally seeing a decline in correlations, in both U.S.
and international markets. If history is any guide, this decline may be a positive signal for Large Cap
and international markets. If history is any guide, this decline may be a positive signal for Large Cap
Growth and other strategies. Before the global recession, outperformance for U.S. Large Cap and
Growth and other strategies. Before the global recession, outperformance for U.S. Large Cap and
Mid Cap growth categories was well above 50%.
Mid Cap growth categories was well above 50%.
Pair-wise stock correlations falling... ... which in the past coincided with higher outperformance
Pair-wise
%, stock correlations
1-year average falling...
cap-weighted return correlations ... of
% which in the
managers past coincided
outperforming with higher
ETF, 1-year outperformance
basis, 1996-2013
%, 1-year average cap-weighted return correlations % of managers outperforming ETF, 1-year basis, 1996-2013
50% 100%
50% 100%
45%
45%
40% 80%
40% U.S. Large Cap 80%
35% U.S. Large Cap
35% 60%
30%
30% 60%
25%
25% 40%
20% 40%
20%
15%
15% 20%
10% 20%
10% International
5% U.S. Small Cap
5% International 0%
0% U.S. Small Cap 0% 5%
0%1964 15% 25% 35% 45% 55%
1972 1980 1988 1996 2004 2012 5% U.S. 15% 25% return
stocks pair-wise 35% 45%%
correlation, 55%
1964 1972 1980 1988 1996 2004 2012
Source: Empirical Research Partners. September 2013. Source: J.P. U.S. stocks
Morgan, pair-wise
eVestment, return
Empirical correlation,
Research % June 2013.
Partners.
Source: Empirical Research Partners. September 2013. Source: J.P. Morgan, eVestment, Empirical Research Partners. June 2013.
Other findings:
Other findings:
 Outperformance trends in U.S. markets were markedly higher before the global recession
 Outperformance trends in U.S. markets were markedly higher before the global recession
 Risk-adjusted outperformance measures were similar to nominal ones
 Risk-adjusted outperformance measures were similar to nominal ones
 Managers that outperform over 5 years usually underperform in 2 or 3 individual years
 Managers that outperform over 5 years usually underperform in 2 or 3 individual years
 We did not find a consistent relationship between outperformance and manager size
 We did not find a consistent relationship between outperformance and manager size
 We computed outperformance based on stated benchmarks and based on investible benchmarks
 We computed outperformance based on stated benchmarks and based on investible benchmarks
(exchange-traded funds). In U.S. markets, differences were minor. Outside U.S. markets, ETF fees
(exchange-traded funds). In U.S. markets, differences were minor. Outside U.S. markets, ETF fees
and tracking error are higher. As a result, outperformance trends were higher using ETFs. We
and tracking error are higher. As a result, outperformance trends were higher using ETFs. We
believe ETF comparisons come closer to the “real investible experience”, since using stated
believe ETF comparisons come closer to the “real investible experience”, since using stated
benchmarks effectively assumes index replication with no fees and no tracking error.
benchmarks effectively assumes index replication with no fees and no tracking error.
13
A search for intelligent life in the active equity management universe, November 2013
13
A search for intelligent life in the active equity management universe, November 2013
22 22
22
EYE ON THE MARKET  OUTLOOK 2014  J . P . M O R G A N A S SE T M A N A G E M E N T
FEYE ON
OR IN THE
S TI TU MARKET
TI O N • AOUTLOOK
A L / W H O L ES 2014
N OFOR
T FRETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 2
2014
014
V: How different are the countries of the European Monetary Union?

The Death in Venice chart on page 10 is an example of what can happen when two countries with
different levels of productivity are joined in the same monetary union. How pervasive is this
problem in Northern and Southern Europe? While some of the important gaps are closing (e.g.,
unit labor costs versus Germany), there are material differences that remain. The table below shows
country rankings for select categories from the World Economic Forum, with a rank of 1 = best and
144 = worst. Southern Europe has some stark differences with Northern Europe in terms of the day-
to-day life of a citizen, a consumer or a business owner.
World Economic Forum Report, 2012-2013: 1=Best, 144=Worst
Legal
Diversion Public Irregular Judicial Gov't Burden of framework to Bus. costs
Property of public trust in pmnts / Independ officials gov't settle Gov't policy of crime / Organized
rights funds politicians bribes ence favoritism regulations disputes transparency violence crime
Northern Europe
Germany 14 16 33 18 7 15 71 20 27 21 32
France 18 29 44 32 37 39 126 37 47 47 39
Netherlands 9 8 10 12 3 4 34 8 14 32 21
Belgium 31 21 40 27 28 27 133 45 62 22 27
Finland 1 3 12 2 2 7 6 2 2 3 4
Southern Europe
Spain 48 53 79 40 60 54 120 69 77 34 46
Italy 69 85 131 68 68 116 142 139 139 91 131
Greece 73 119 141 104 98 114 141 135 122 81 68
Portugal 49 45 67 34 67 67 129 121 71 15 26
Using all the factors analyzed by the World Economic Forum, we took this one step further: How
does the European Monetary Union compare to other monetary unions, either real or
imagined? As shown below, the European Monetary Union has around the same cross-country
factor dispersion as a hypothetical monetary union composed of all countries beginning with the
letter “M”. The rest, including monetary unions composed of countries that were members of the
Ottoman Empire or the Soviet Union, exhibit more cross-country similarities than Europe. The
European Monetary Union, for all its successes and pitfalls, is a road less traveled.
60% The European Economic and Monetary Union (EMU): A Road Less Traveled
Measuring the dispersion of hypothetical and actual monetary unions
More different
Dispersion measures the standard deviation of country-specific factors in each union. Factors reflect over
100 economic, social and political characteristics. 52.6 52.9
50%
Source: World Economic Forum Global Competitiveness Report, J.P. Morgan Asset Management. May 2012.
40%
30%
20%
Less different
10%
0%
Market United Central Gulf state Reconstit. of Northern Reconstit. of Eastern and East Asian All countries Countries Major
economies Kingdom America GCC Union of Europe Ottoman Southern Tigers on Earth at beginning countries of
of Latin and its countries Soviet including Empire, Africa the 5th with the European
America English Socialist Scandinavia circa 1800 parallel letter "M" Monetary
speaking Republics north Union, EMU
offshoots latitude
Hypothetical monetary unions
23 23
FEYE
OR INON THE
S TITU MARKET
TIO N • AOUTLOOK
N OFOR
T F RETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 22014
014
VI: Indicators cited in the preface that have returned to pre-crisis levels
In the charts below, we show the items cited in the preface whose valuations or levels have returned
to where they were in 2007. On corporate bonds, usually we look at credit spreads over Treasuries.
Given the intervention by Central Banks (directly and indirectly) in government bonds, credit yields
are probably a better measure of value right now.
Global and U.S. trailing price-to-earnings ratios Speculative stock-bond position

Multiple Net CFTC stock-bond futures position, percent
35x 15%
30x MSCI World 10%

S&P 500
25x 5%
20x 0%
-5%
15x
-10%
10x
-15%
5x 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
1970 1978 1986 1994 2002 2011
Source: Bloomberg, Empirical Research. JPM Securities. November 2013. Source: CFTC, J.P. Morgan Securities LLC. November 2013.
U.S. and European volatility indices Homes resold within 6 months of purchase in California
Index Number of units
50 2,000
EuroStoxx 50
45
1,600
40
35 1,200
30
25 800
S&P 500
20
400
15
10 0
1990 1994 1998 2002 2006 2010 2001 2003 2005 2007 2009 2011 2013
Source: Chicago Board Options Exchange, Bloomberg. November 2013. Source: Empirical Research Partners, PropertyRadar.com. October 2013.
U.S. corporate investment grade and high yield bonds Discount rates for newly underwritten core real estate
Yield to worst (both axes) transactions, percent
10% 23% 10%
9% 21%
19%
U.S. unlevered real
8% U.S. corporate 9% estate discount
investment grade 17%
7% rates
15%
6% 8%
13%
5%
11%
4% 9% 7%
3% 7%
U.S. corporate high yield
2% 5% 6%
2002 2004 2006 2008 2010 2012 2007 2009 2011 2013
Source: Bloomberg. November 2013. Source: J.P. Morgan Asset Management. November 2013.
24 24
FEYE
OR INON THE
S TITU MARKET
TIO N • AOUTLOOK
N OFOR
T F RETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 22014
014
VII: U.S. fiscal outlook: quieter in 2014, with long-term battles ahead
After a tumultuous couple of years in Washington, it looks like 2014 will be quieter on the fiscal
policy front. In 2011, the budget outlook was pretty dire: the Alternative Fiscal Scenario from the
Congressional Budget Office projected the federal debt at 109% of GDP by 2023. Since then, the
2011 Budget Control Act and 2013 tax act significantly contributed to deficit reduction and the 2023
debt outlook has fallen to 70%-80% of GDP. The trajectory of the federal debt has stabilized for
now, and the budget deficit should improve for cyclical reasons to 3.3% of GDP in 2014.
In 2014, we do not foresee any major tax policy legislation, any material changes to the Sequester’s
net impact over a 10-year period, or any significant change in entitlements. We expect a budget deal
to push debates about the debt ceiling and other fiscal issues into 2015.
Federal debt held by the public
Percent of GDP
110% 2011 Alternative
100% Fiscal Scenario
90%
2013 Alternative
80% Fiscal Scenario
70%
60%
Baseline
(current law)
50%
40%
30%
20%
1940 1950 1960 1970 1980 1990 2000 2010 2020
Source: CBO. September 2013.
The long-term battle in Washington is now about the mix of government spending as well
as the level. The Budget Control Act cuts non-defense discretionary spending as a % of GDP to the
lowest level in 40 years. This category of spending includes the items in the table below, which in
aggregate impact the productivity and future of the U.S. economy (infrastructure, worker retraining,
renewable energy R&D, general science research). The prioritization of entitlements over non-
defense discretionary spending has taken over. As shown, the ratio of entitlement to discretionary
spending began at 1:1 in the 1970’s; has risen to 2.5:1 today; and is headed to 4:1 by the end of the
decade. The concept of “generational theft” has entered the American policy lexicon, and the
battles should heat up as the line in the chart below keeps rising.
Ratio of entitlement spending to non-defense Components of non-defense discretionary spending
discretionary spending at the federal level:
4.0x -Job training and worker dislocation programs
-All elementary, secondary and higher education
3.5x -Health research and training
-Consumer and occupational health and safety
3.0x -Federal law enforcement and federal judicial system
-Pollution control and abatement
2.5x -Air, ground and water transportation
-U.S. Army Corps of Engineers
2.0x CBO -General science research, NASA
projection -Energy R&D and demonstration projects
1.5x
-NIH/CDC spending on disease control and bioterrorism
-International drug control and law enforcement
1.0x
1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 2013 2017 2021
Source: CBO. September 2013.
25 25
JANUARY 1, 2014
FEYE
OR INON THE
S TITU MARKET
TIO N • AOUTLOOK
N OFOR
T F RETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 22014
014

Over the past few years, there has been a proliferation of dire warnings on Average number of
Over themunicipal
the U.S. past few years, there hasWhile
bond market. been there
a proliferation
have been of dire warnings
a few high- on Average 9number of year
Chapter filings per
the U.S.defaults,
profile municipalproperly
bond market. While there
diversified haveportfolios
municipal been a few high-not
should Chapter 9 filings per year
profile defaults, properly diversified municipal portfolios should not 1980-1989 7.1
be experiencing too much stress. Over the long haul, municipal default 1980-1989
1990-1999 7.1
10.4
be experiencing too much stress. Over the long haul, municipal
rates have been low. Looking at all investment grade municipal bonds rated default 1990-1999 10.4
2000-2009 6.8
rates have been
by Moody’s that low.
wereLooking at all1970-2012,
issued from investment grade
5-yearmunicipal
and 10-year bonds rated
cumulative 2000-2009 6.8
2010-2012 10.3
by Moody’s
default ratesthat
were were
0.03%issued
andfrom 1970-2012,
0.07%, 5-year
respectively. and levels
These 10-year cumulative
compare to 2010-2012 10.3
Source: Chapman and Cutler LLP
default
1.07% and 2.78% for investment grade corporate bonds over the same to
rates were 0.03% and 0.07%, respectively. These levels compare Source:onChapman
based available and Cutler
court and LLP
1.07%
period. and 2.78%Chapter
Municipal for investment
9 filingsgrade corporate
have risen in thebonds overyears
last three the same
from based on available
governmental court2013.
records. and
period. Municipal Chapter 9 filings have risen in the last three years from governmental records. 2013.
7 cities per year to a little over 10, but these levels are still very low for a
7 cities per year to a little over 10,
market with tens of thousands of issuers. but these levels are still very low for a
market with tens of thousands of issuers.
Income taxes driving state tax revenues higher Slower rebound in property tax collection on local level
Income
Y/Y taxes
percent driving state tax revenues higher
change Slower
Y/Y rebound
percent changein property tax collection on local level
Y/Y percent change
20% Y/Y percent change
14%
20% 14%
15% 12%
15% 12%
10% 10%
10% 10%
8%
5%
8%
5% 6%
0% 6%
0% 4%
-5% 4%
2%
-5%
-10% 2%
0%
-10% 0%
-15% -2%
-15% -2%
-20% -4%
-20%1995 1998 2001 2004 2007 2010 2013 -4%1995 1998 2001 2004 2007 2010 2013
1995U.S. Census
Source: 1998 Bureau.
2001Q2 2013.
2004 2007 2010 2013 1995 U.S. Census
Source: 1998 Bureau.
2001Q2 2013.
2004 2007 2010 2013
Source: U.S. Census Bureau. Q2 2013. Source: U.S. Census Bureau. Q2 2013.
State and local taxes have begun to rebound at a national level. Some of the increase may be
State and localoftaxes
a consequence have begun
accelerated incometo rebound at
recognition by ainvestors
national level. Some
anticipating of the
higher increase
capital gainsmay
taxesbe
aonconsequence of accelerated income recognition by investors anticipating
the top two brackets last year. However, withheld taxes on ordinary income have been increasing higher capital gains taxes
on
at athe top two
7%-8% brackets
rate, indicating last year.
that the However,
trends arewithheld
real. We taxeslookonatordinary
both stateincome
and have
local been
propertyincreasing
taxes
when thinking about municipal risk. When evaluating city issuers, the property tax base is moretaxes
at a 7%-8% rate, indicating that the trends are real. We look at both state and local property
when
useful.thinking
Accordingabout municipal
to the risk. When
U.S. Census Surveyevaluating
of State and cityLocal
issuers, the propertyproperty
Governments, tax basetaxes
is more
make
useful.
up ~75% of total city tax receipts. At the state level, property taxes are less important: 83% make
According to the U.S. Census Survey of State and Local Governments, property taxes of state
up
tax ~75%
revenues of total
comecity fromtaxsales
receipts.
and income state level,
At the taxes. What property
about bond taxes insurance?
are less important:
A decade 83%ago,of state
tax revenues come from sales and income taxes. What about bond
municipal bond insurers such as AMBAC and MBIA wrapped around 50% of the entire market. insurance? A decade ago,
municipal bond no
Today, virtually insurers
new issuessuch as areAMBAC
insured,andandMBIA wrapped
the insured around 50%
component of the
of the entire market.
outstanding stock has
Today, virtually no new issues are insured, and the insured component
fallen to 30%. This argues for more rigorous credit analysis applied to municipal portfolios. of the outstanding stock has
fallen to 30%. This argues for more rigorous credit analysis applied to municipal portfolios.
The difficult questions for some municipalities lie in the long-term rather than the short-
The
term. difficult questionsrelate
Some challenges for some municipalities
to underfunding lie in the
of certain long-term
pension plans. rather than the
While financial short-
assets have
term. Some challenges relate to underfunding of certain pension plans.
rallied since their 2009 lows, public plan liabilities grew uninterrupted throughout the prior decade. While financial assets have
rallied since their 2009 lows, public plan liabilities grew uninterrupted
There’s around a $1 trillion negative gap between plan assets and liabilities, assuming a 7.5% throughout the prior decade.
There’s around
discount rate ona liabilities.
$1 trillionTo negative
close thisgapgap
between planstarting
over time assets andtoday,liabilities,
annual assuming
pension plana 7.5%returns of
discount rate on liabilities.
14 To close this gap over time starting today,
9% would be needed14. Bridgewater estimates that if the contribution-outlay relationship of annual pension plan returns
publicof
9% would be needed . Bridgewater estimates that if the contribution-outlay
plans remains unchanged, in 10 years, this annual required return would rise to 13%. If so, and relationship of public
if
plans remains unchanged, in 10 years, this annual required return
such returns were not achieved, there may be a need for (a) higher taxes, (b) revised pensionwould rise to 13%. If so, and if
such returns were not achieved, there may
formulas and/or (c) reductions in non-pension spending. be a need for (a) higher taxes, (b) revised pension
formulas and/or (c) reductions in non-pension spending.
14
14
Bridgewater Daily Reports, November 21, 2013.
Bridgewater Daily Reports, November 21, 2013.
26
26
26
FEYE
OR INON THE
S TITU MARKET
TIO N • AOUTLOOK
N OFOR
T F RETAIL
O R REDISTRIBUTION
A N U A R Y 11,, 22014
014
Investor focus is now understandably on Detroit where an emergency manager has been appointed
by the state to sort things out. The emergency manager proposed write-downs of 80%-90% on
holders of Detroit unsecured general obligation bonds, as well as reductions in unfunded pension
fund and healthcare obligations to retirees. The latter are 2-3 times larger than the former.
The more relevant issue for municipal investors: how similar is Detroit to the rest of the
city-level municipal market? That is an issue we addressed in depth last year in “How Different is
Detroit?”, Eye on the Market, August 6, 2013. We examined where Detroit stands relative to other
cities in terms of growth (gross metropolitan product), income per capita, labor force growth,
population growth, property tax base per capita, etc. As shown by the black lines in each chart,
Detroit is considerably worse. In the view of our municipal bond managers, portfolios with much
better economic fundamentals can be constructed. The blue lines depict a mapping of our largest
general obligation holdings based on balances held as of August 2013.
Growth in Gross Metropolitan Product Growth in personal income per capita

Index, 2001=100, with percentiles Index, 1990=100, with percentiles
210 250
95%ile
95%ile
190 225 80%ile
170 80%ile 200
20%ile
150 175 5%ile
20%ile Detroit
130 150
5%ile
110 125
Detroit
90 100
2001 2003 2005 2007 2009 2011 1990 1993 1996 1999 2002 2005 2008
Source: Bureau of Economic Analysis. JPMAM. 2011. Source: Bureau of Economic Analysis. JPMAM. 2009.
Labor force growth (employed + unemployed) MSA-level population growth

Index, Jan. 2000 = 100, with percentiles Index, 1970 = 100, with percentiles
140 400
130 95%ile 350 95%ile

300
120 80%ile
250
110 80%ile
200
100 20%ile
150
5%ile 20%ile
90 100
Detroit Detroit 5%ile
80 50
2000 2002 2004 2006 2008 2010 2012 1970 1975 1980 1985 1990 1995 2000 2005 2010
Source: Bureau of Labor Statistics, JPMAM. May 2013. Source: U.S. Census Bureau, JPMAM. 2012.
Our August Eye on the Market goes into more detail, but to summarize, our view is that Detroit is
more an outlier than a paradigm. While Cleveland, Youngstown, Dayton and Toledo share some
of Detroit’s problems, Detroit in aggregate stands alone. There may be more city bankruptcies in the
years ahead, but the visibility around Detroit’s problems and those of similarly positioned cities should
allow defensive-minded municipal portfolio managers to avoid large exposures to the country’s
biggest problems.
27 27
FEYE
OR I NON THE
S TITU MARKET
TIO N • AOUTLOOK
L E O R P RO F ES SIONAL CL I EN T U S E ON L Y / NOT
N OT FO
FOR R REDISTRIBUTION
RETAIL TA I L D I S T RI BU TI ON JANUARY
JA N U A R Y 11,
, 22014
014
Cover art data sources

Leveraged Loans – S&P Leveraged Loan; High Yield – Barclays U.S. Corporate High Yield; U.S. Commercial
Property – NCREIF Property Index; Hedge Funds – HFRI Composite; Emerging Markets – MSCI EM; USD EM
Debt – J.P. Morgan EMBI Global. Note: NCREIF Property Index cumulative returns are for the period from
January 1, 2010 to September 30, 2013.
Acronyms
ACWI – All Country World Index; AMBAC – American Municipal Bond Assurance Corporation; BEA – Bureau
of Economic Analysis; BLS – Bureau of Labor Statistics; CBO – Congressional Budget Office; CFTC – Commodity
Futures Trading Commission; EAFE – Europe, Australasia and Far East; ECB – European Central Bank;
EM – Emerging Market; ETF – Exchange-Traded Fund; FRB – Federal Reserve Bank; GDP – Gross Domestic
Product; HFRI – Hedge Fund Research, Inc; IEA – International Energy Agency; IMF – International Monetary
Fund; ISM – Institute for Supply Management; MBIA – Municipal Bond Insurance Association;
MBS – Mortgage Backed Security; MSCI – Morgan Stanley Capital International; MWh – Megawatt hour;
NAR – National Association of Realtors; NBER – National Bureau of Economic Research; OECD – Organisation
for Economic Co-operation and Development; P/E – Price-to-earnings; PIK – Payment in Kind;
PMI – Purchasing Managers’ Index; VC – Venture Capital; Y/Y – Year-over-Year
FOR INSTITUTIONAL/WHOLESALE OR PROFESSIONAL CLIENT USE ONLY - NOT FOR RETAIL DISTRIBUTION
NOT FOR RETAIL DISTRIBUTION: This communication has been prepared exclusively for Institutional/Wholesale Investors as
well as Professional Clients as defined by local laws and regulation.
The opinions, estimates, forecasts, and statements of financial markets expressed are those held by J.P. Morgan Asset
Management at the time of going to print and are subject to change. Reliance upon information in this material is at the
sole discretion of the recipient. Any research in this document has been obtained and may have been acted upon by
J.P. Morgan Asset Management for its own purpose. References to specific securities, asset classes and financial markets are
for illustrative purposes only and are not intended to be, and should not be interpreted as advice or a recommendation
relating to the buying or selling of investments. Furthermore, this material does not contain sufficient information to
support an investment decision and the recipient should ensure that all relevant information is obtained before making any
investment. Forecasts contained herein are for illustrative purposes, may be based upon proprietary research and are
developed through analysis of historical public data.
J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates
worldwide. This communication may be issued by the following entities: in the United Kingdom by JPMorgan Asset
Management (UK) Limited which is authorised and regulated by the Financial Conduct Authority.; in other EU jurisdictions
by JPMorgan Asset Management (Europe) S.à r.l.; in Switzerland by J.P. Morgan (Suisse) SA; in Hong Kong by JF Asset
Management Limited, or JPMorgan Funds (Asia) Limited, or JPMorgan Asset Management Real Assets (Asia) Limited; in
India by JPMorgan Asset Management India Private Limited; in Singapore by JPMorgan Asset Management (Singapore)
Limited or JPMorgan Asset Management Real Assets (Singapore) Pte Ltd; in Australia by JPMorgan Asset Management
(Australia) Limited; in Brazil by Banco J.P. Morgan S.A.; in Canada by JPMorgan Asset Management (Canada) Inc., and in
the United States by J.P. Morgan Investment Management Inc., JPMorgan Distribution Services Inc., and J.P. Morgan
Institutional Investments, Inc. member FINRA/ SIPC.
© 2014 JPMorgan Chase & Co. All rights reserved. 1113-1158-01
28 28
EYE ON THE MARKET • OUTLOOK 2014 NOT FOR RETAIL DISTRIBUTION
JANUARY 1, 2014
MICHAEL CEMBALEST is Chairman of Market and Investment Strategy for J.P. Morgan
Asset Management, a global leader in investment management and private banking
with $1.5 trillion of client assets under management worldwide (as of September 30,
2013). He is responsible for leading the strategic market and investment insights across
the firm’s Institutional, Funds and Private Banking businesses.
Mr. Cembalest is also a member of the J.P. Morgan Asset Management Investment
Committee and a member of the Investment Committee for the J.P. Morgan Retirement
Plan for the firm’s 260,000 employees.
Mr. Cembalest was most recently Chief Investment Officer for the firm’s Global Private
Bank, a role he held for eight years. He was previously head of a fixed income division
of Investment Management, with responsibility for high grade, high yield, emerging
markets and municipal bonds.
Before joining Asset Management, Mr. Cembalest served as head strategist for Emerging
Markets Fixed Income at J.P. Morgan Securities. Mr. Cembalest joined J.P. Morgan in
1987 as a member of the firm’s Corporate Finance division.
Mr. Cembalest earned an M.A. from the Columbia School of International and Public
Affairs in 1986 and a B.A. from Tufts University in 1984.
29

2014 - The Great Race

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

2014 - The Great Race

Uploaded by

Copyright:

Available Formats

EYE ON THE MARKET

Rising number of countries in expansion mode

United States: Post-austerity growth improvements to show up by mid-year 6

United States: Post-austerity growth improvements to show up by mid-year

Europe: Enjoy the intermission

Signs of improvement appeared on a number of fronts in the Eurozone last summer.

Eurozone rebound: everywhere but France "Non-Eurozone Europe" doing better

Other positive news:

115 less competitive

Debtor nation bond yields rising sharply

External Debt (% of Exports) 401% 130% 156%

Interest on External Debt (% of Exports) 39.7% 6.6% 4.6%

Reserves (% of External Debt) 7.7% 28.8% 61.6%

Current Account (% of GDP) -5.1% -4.5% -3.7%

Exchange Rates vs. the USD -97.5% -61.1% -13.7%

Exchange Rate Type Managed Managed Floating

Nevertheless, it seems risky to be underweight Japanese equities. Japanese equity valuations

Japanese TOPIX forward price-to-earnings ratio

Beyond the Great Race

I: Risk and opportunity in credit markets

I: Risk and opportunity in credit markets

35% HY issues rated CCC and lower debt-to-cash

III: On the recent underperformance of hedge funds relative to equities, and

IV: Tracking performance trends in active equity management

V: How different are the countries of the European Monetary Union?

Hypothetical monetary unions

Global and U.S. trailing price-to-earnings ratios Speculative stock-bond position

30x MSCI World 10%

VIII: U.S. municipal bond outlook and the question of Detroit

Growth in Gross Metropolitan Product Growth in personal income per capita

Labor force growth (employed + unemployed) MSA-level population growth

130 95%ile 350 95%ile

Cover art data sources

© 2014 JPMorgan Chase & Co. All rights reserved. 1113-1158-01

You might also like