2017 - True Believers

Eye on the Market Outlook 2017
J.P. MORGAN ASSET MANAGEMENT
True Believers. Two groups of true believers are driving changes in the developed world. The first: single-minded central bankers
who spent trillions of dollars pushing government bond yields close to zero (and below). While this unprecedented monetary
experiment helped owners of stocks and real estate, its regressive nature did little to satisfy the second group: voters who are
disenfranchised by globalization and automation, and who are on the march. What next? The fiscal experiments now begin (again).
Prepare for another single digit portfolio return year in 2017.
Click on the video to watch Michael Cembalest, Chairman of Market and Investment Strategy,
as he discusses how the themes he covers in True Believers shape his outlook for 2017.
Cover art by Robin Mork.
FOR INSTITUTIONAL/WHOLESALE/PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY –

NOT FOR RETAIL USE OR DISTRIBUTION
MARY CALLAHAN ERDOES
Chief Executive Officer
J.P. Morgan Asset Management
Expect the unexpected—that was the world’s lesson from 2016. From the U.K.’s decision to
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ourit.ever thought-provoking 2017 Outlook. As
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exciting investment opportunities, as well as some areas where we see reason to
proceed with caution.
We thank you for your continued trust and confidence in all of us at JPMorgan Chase.
Sharing these perspectives and opportunities is part of our deep commitment to
Mostyou and what we focus on each and every day. We are grateful for your continued
sincerely,
trust and confidence, and look forward to working with you in 2011.
Most sincerely,
EYE ON THE MARKET • MICHAEL CEMBALEST • OUTLOOK 2017 JANUARY 1, 2017
E Y E O N T H E M A R K E T  M I C H A E L C E M B A LE ST  O U T L O O K 2 0 1 7 JANUARY 1, 2017
FOR INSTITUTIONAL/WHOLESALE/PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY – NOT FOR RETAIL USE OR DISTRIBUTION
Executive Summary: True Believers
INTRODUCTION
Political upheavals and unorthodox central bank actions persist, but it looks like more of
the same in 2017: single digit returns on diversified investment portfolios as the global
economic expansion bumps along for another year.
How we got here. By the end of 2014, central bank stimulus lost its levitating impact on markets, GDP
and corporate profits, all of which have been growing below trend. Proxies for diversified investment
portfolios1 generated returns of just 1%-3% in 2015 and 6%-7% in 2016.
The fading impact of central bank government bond A slow growth world
purchases on global equity returns Y/Y % change (both axes)
46% 220 9% 60%
Hundreds
MSCI Developed World Global
44% 200 8%
Equity Index level nominal 40%
42% 180
Global
7% GDP corporate
40% 160 profits 20%
6%
38% 140
5% 0%
36% 120
% of developed world 4%
34% 100
gov't bond market owned -20%
32% 80 3%
by all central banks
30% 60 2% -40%
2008 2009 2010 2011 2012 2013 2014 2015 2016 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16
Source: National stats offices, Haver, MSCI, Bloomberg, JPMAM. Dec. 2016. Source: J.P. Morgan Securities LLC. Q3 2016.
The biggest experiment in central bank history ($11 trillion and counting as of November 2016) helped
employment recover in the US and UK, and more recently in Europe and Japan. Across all regions,
however, too many of the benefits from this experiment accrued to holders of financial assets rather than
to the average citizen. As a result, the political center of a slow-growth world has begun to erode,
culminating with the election of a non-establishment US President with no prior political experience, and
the UK electorate’s decision to leave the European Union. The market response to Trump’s election has
been positive as investors factor in the benefits of tax cuts, deregulation and fiscal stimulus and ignore
for now potential consequences for the dollar, deficits, interest rates, trade and inflation (see US section
on the “American Enterprise Institute Presidency”).
Employment growth in the developed world Erosion of the political center

Index (Q1 2006 = 100) Vote share, average of developed world countries
110 38%
United Kingdom
108 36%
106
34% Center left
Eurozone
104
32%
102
30%
100
Japan 28%
98
Center right
96 26%
United States
94 24%
2006 2008 2010 2012 2014 2016 '71 '74 '77 '80 '83 '86 '89 '92 '95 '98 '01 '04 '07 '10 '13 '16
Source: National statistics offices, Haver Analytics. Q3 2016. Source: Barclays Research. October 2016.
1
Weights and indices used for diversified portfolio proxies: 60% equities (using the MSCI All-Country World Equity
Index, including emerging markets), and 40% fixed income (using the Barclays US Aggregate for US$ investors, and
the Barclays Global Aggregate hedged into Euros for Euro investors).
Investment products: Not FDIC insured • No bank guarantee • May lose value
1 1
“True Believer” central banks have created unprecedented distortions in government bond
markets. Bond purchases and negative policy rates by the ECB and Bank of Japan led to negative
INTRODUCTION
government bond yields. Whatever their benefits may be, they also resulted in profit weakness and stock
price underperformance of European and Japanese banks. The poor performance of European and
Japanese financials was a driver of lower relative equity returns in both regions in 2015/20162.
Government bonds trading below 0% yield Bank earnings in the developed world
% of total government bonds by market value Trailing 12-month earnings as a % of risk-weighted assets
60% 2.0%
Non-Eurozone Europe
50% 1.5%
40%
US
1.0%
Eurozone countries
Japan
30%
0.5%
Netherlands
20%
Germany
Denmark
0.0%
Portugal
Belgium
Sweden
Finland
Austria
France
Ireland
Japan
Spain
10% Eurozone
Italy
-0.5%
0% '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16
Source: J.P. Morgan Securities LLC, JPMAM. December 15, 2016. Source: Bloomberg, JPMAM. Q3 2016.
For the last few years, I have written about a preference for an equity portfolio that’s overweight the US
and Emerging Markets, and underweight Europe and Japan3. This has been one of the most consistently
beneficial investment strategies I’ve seen since joining J.P. Morgan in 1987 (see chart below, right). It
worked again in 2016, and despite the negative consequences of rising interest rates and a rising dollar
for US and EM assets, I think it makes sense to maintain this regional barbell for another year as Europe
and Japan once again snatch defeat from the jaws of victory.
Eurozone and Japanese banks have underperformed Benefits of overweighting US/EM, underweighting
Cumulative total return, US$ Europe/Japan, 3-year rolling out (under) performance
20% 10%
10% MSCI World 8%
6%
0%
4%
-10%
2%
-20% MSCI Japan banks 0%
-30% -2%
MSCI Eurozone banks
-4%
-40% 1991 1994 1997 2000 2003 2006 2009 2012 2015
Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16
Source: Bloomberg, J.P. Morgan Asset Management. Dec. 15, 2016.
Source: Bloomberg, MSCI. December 28, 2016. Portfolio is quarterly rebalanced and assumes no currency hedging.
2
Eurozone and Japanese bank stocks rallied sharply in Q3 2016, mostly a reflection of steepening yield curves
which portend improved bank profitability. As the ECB gradually slows bond purchases in 2017, Eurozone bank
stocks could rise further. However, the rest of the Eurozone markets might suffer with less stimulative conditions.
3
Computations are based on an all-equity portfolio that is overweight the US by 10%, underweight Europe by
10%, overweight EM by 5% and underweight Japan by 5%. All overweights and underweights are expressed
relative to prevailing MSCI index weights.
2 2
We had a single digit portfolio return view for 2015 and 2016 (which is how things turned out),
and we’re extending that view to 2017 as well. There are some positive leading indicators which I
INTRODUCTION
will get to in a minute, but first, the headwinds:
 While global consumer spending has held up, global business fixed investment remains weak, in part
a consequence of the end of the commodity super-cycle and slower Chinese growth
 We expect the emerging market recovery to be gradual, particularly if Trump policies lead to
substantially higher interest rates and a higher US dollar
 We expect a near-term US growth boost (amount to be determined based on the composition of tax
cuts, infrastructure spending and deregulation), but trend growth still looks to be just 1.0% in Japan
and 2.0% in Europe
Components of global real GDP Stable, slow global growth

Percentage point contribution to Y/Y real GDP growth Y/Y real GDP growth
1.6% 10%
Hundreds
Consumer spending Emerging markets

1.4% 8%
1.2% 6%
1.0% 4%
0.8%
2%
0.6% Fixed investment 0%
0.4%
-2%
0.2% Developed markets
-4%
0.0% 1997 2000 2003 2006 2009 2012 2015
2012 2013 2014 2015 2016
Source: J.P. Morgan Securities LLC. Q3 2016. Dotted lines show GDP
Source: J.P. Morgan Securities LLC. Q3 2016. growth estimates through Q4 2017.
 The global productivity conundrum continues, leaving many unanswered questions in its wake4
 Even though private sector debt service levels are low, high absolute amounts of debt may constrain
the strength of any business or consumer-led recovery
The global productivity slowdown Developed world private sector debt

Productivity proxy (change in output per unit of employment) Debt to GDP Debt service to income
5% 180% 18.0%
Hundreds
Hundreds
4% Debt service ratio 17.5%
170%
3%
2% 17.0%
DM 160%
1%
16.5%
0% 150%
-1% Debt to GDP 16.0%
-2% EM 140%
15.5%
-3%
-4% 130% 15.0%
'02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 1991 1995 1999 2003 2007 2011 2015
Source: J.P. Morgan Securities LLC. Q3 2016. EM excludes India and China. Source: J.P. Morgan Securities LLC, BIS, IMF. Q2 2016.
4
Is productivity mis-measured since economists can’t measure benefits of new technology? This is a
complicated question, but the short answer is “I don’t think so”. I read two papers on the subject in 2016, one
from the Fed/IMF and the second from the University of Chicago. In the first paper, the authors state that “we find
little evidence that the [productivity] slowdown arises from growing mismeasurement of the gains from innovation
in IT-related goods and services”. And in the second, the authors conclude as follows: “evidence suggests that the
case for the mismeasurement hypothesis faces real hurdles when confronted with the data”. One smoking gun:
the productivity slowdown is similar across countries regardless of the level of their ICT penetration (information
and communication technology).
3 3
 And finally, even before Trump takes office, we’re already seeing a rise in protectionism as global
trade stagnates. The degree to which Trump follows through on campaign proposals on trade is a
INTRODUCTION
major question mark for 2017
Global rise in trade protectionism Global trade stagnant for the last decade
# of discriminatory trade measures % of world GDP
800
60%
700 55%
50%
600
45%
500 40%
400 35%
30%
300
25%
200 20%
2009 2010 2011 2012 2013 2014 2015 '60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10 '15
Source: Center for Economic and Policy Research. July 2016. Source: World Bank. 2015.
So, with all of that, why do we see 2017 as another year of modest portfolio gains despite the
length of the current global expansion, one of the longest in history? As 2016 came to a close,
global business surveys improved to levels consistent with 3% global GDP growth, suggesting that
corporate profits will start growing at around 10% again after a weak 2016. More positive news: a rise
in industrial metals prices, which is helpful in spotting turns in the business cycle (see Special Topic #8).
Global business surveys (PMI) point to higher growth Industrial metals prices are stabilizing
Output PMI, 50+ = expansion Q/Q % change, annualized Index level
56 4.0% 500
55 450
3.5%
PMI survey 400
54
350
53 3.0%
300
52 2.5% 250
GDP growth
51 200
2.0% 150
50
100
49 1.5% 2000 2002 2004 2006 2008 2010 2012 2014 2016
2011 2012 2013 2014 2015 2016
Source: Bloomberg. December 15, 2016. Index tracks aluminum, copper,
Source: J.P. Morgan Securities LLC, Haver Analytics. November 2016. zinc, nickel and lead.
4 4
E Y E O N T H E M A R K E T  M I C H A E L C E M B A LE ST  O U T L O O K 2 0 1 7
JANUARY 1, 2017
Furthermore (and I understand that there’s plenty of disagreement on the benefits of this), many
developed countries are transitioning from “monetary stimulus only” to expansionary fiscal
INTRODUCTION
policy as well. Political establishments are aware of mortal threats to their existence, and are looking to
fiscal stimulus (or at least, less austerity) as a means of getting people back to work. The problem: given
low productivity growth and low growth in labor supply, many countries are closer to full capacity than
you might think. If so, too much fiscal stimulus could result in wage inflation and higher interest rates
faster than you might think as well. That is certainly one of the bigger risks for the US.
Fiscal policy projected to ease US, Europe and Japan equity valuations
Government impact on growth Combined price-to-sales ratio on MSCI US, Europe and Japan
equities, ex-financials and energy
0.50% 2010-16 average Forward estimate 1.6x
Forward 12 months Trailing 12 months
0.25% 1.4x
0.00% 1.2x
-0.25% 1.0x
-0.50% 0.8x
-0.75% 0.6x
Japan Eurozone US UK Canada Australia China '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17
Source: Bridgewater Associates. August 2016. Source: IBES, Datastream, Bloomberg, JPMAM. December 15, 2016.
So, to sum up, here’s what we think 2017 "Ease of starting a new business": in the US, getting
looks like: less easy, US percentile rank relative to world and OECD
100
• A modest growth bounce in the US from some Easier
90 US vs. World
personal and corporate tax cuts, deregulation
and infrastructure spending, with tighter labor 80
markets, rising interest rates and a stronger
70 US vs. OECD
dollar eventually taking some wind out of the
US economy’s sails. If I’m underestimating 60
something, it might be the potential increase in 50
confidence, spending and business activity Harder
resulting from a slowdown in the pace of 40
'05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17
government regulation (see chart, right, and
Source: World Bank Doing Business, JPMAM. October 2016. N = 189.
page 13)
• A little better in Europe and Japan in 2017, but no major breakout from recent growth trends
• China grows close to stated goals, supported by multiple government bazookas firing at once
• Emerging markets ex-China continue recovering after balance of payments adjustments; while
countries with high exposure to dollar financing will struggle, overall risks around a rising dollar have
fallen markedly since 2011
• The world grows a little faster in 2017 than in 2016, but as shown above, a lot of that is already in
the price of developed market equities. So, another single digit portfolio year ahead
Michael Cembalest
J.P. Morgan Asset Management
5 5
EYE ON THE MARKET  MICHAEL CEMBALEST  OUTLOOK 2017 JANUARY 1, 2017

2017 Eye on the Market Outlook: Table of Contents Chapter links
Executive Summary: True Believers Page 1

United States: what will Trumpism look like in practice? Page 7
A modest growth boost from corporate tax cuts and deregulation, as Trump is only
able to deliver on parts of his proposed agenda; tighter labor markets, a stronger
dollar and higher interest rates cool things off in the latter half of the year
Europe: modest recovery, underperforming corporate sector and a heavy political calendar Page 14
Ignore the politics for now, it’s the growth dynamics that constrain upside for
investors; Europe should muddle along at 2% growth for another year, but is
fundamentally changed compared to its pre-crisis self
Japan: delusions of inflationary grandeur Page 20
Much ado about nothing: Abenomics is not delivering the goods. Japanese equities
remain a one-trick pony linked to the fortunes of the Yen
China: stabilization, courtesy of coordinated stimulus Page 21
After a blizzard of stimulus from multiple sources in 2015, China stabilized last year
after consecutive years of weakening data. Markets are getting closer to pricing in
the realities and constraints China now faces
Emerging markets ex-China: recovering from balance of payment adjustments Page 24
Concerns about a rising dollar and protectionism are justified, but the sensitivity to a
rising dollar has declined sharply since 2010 through restructuring and capital
spending adjustments; buy on weakness in 2017
Special topics (video links for each topic appear in each section) Page 26
Leverage What amount of leverage can survive a world of volatile markets? Now that the
window for low-cost borrowing may be closing, we look at history and the future
Active management The end of “peak central bank intervention” may reduce distortions and help
active managers
LNG Rising US natural gas prices due to large-scale US LNG exports? Unlikely on both
counts. What Dep’t of Energy LNG export approvals mean, and what they don’t
Tax efficient investing How to simultaneously employ tax loss harvesting and generate market returns
Infrastructure The role for public-private partnerships: PPPs have their critics, but the Obama
administration is not among them. When should investors participate?
Clean coal/CCS The biggest problem with “clean coal”: scope. Infrastructure required to make
carbon capture and storage a meaningful contributor is vastly underestimated
Internet-based How helpful have user growth metrics been in assessing new internet-based
business models business models? Not very
Commodity prices Markets are looking past inventory gluts given huge declines in capex;
remembering the commodity surge of the 1970s and Richard Nixon
Sources and acronyms Page 40
Investment products: Not FDIC insured • No bank guarantee • May lose value
1
6
United States: what will Trumpism look like in practice?
While S&P 500 EPS growth was up 4% in Q3 2016 (8% ex-energy), some of that growth was driven by
debt-fueled stock buybacks as companies re-engineered balance sheets rather than upgrading fixed
assets. Q3 2016 revenue growth was lower: 2%, and 4% ex-energy.
Dividends and buybacks increasing... ...along with leverage... ...and age of company assets
% of net income Net debt to EBITDA multiple Median asset age, # of years
150% 1.80x 7.5
1.70x
UNITED
S TAT E S
125% 7.0
1.60x
1.50x
100% 6.5
1.40x
75% 1.30x 6.0

1.20x
50% 1.10x 5.5
'09 '10 '11 '12 '13 '14 '15 '16* '09 '10 '11 '12 '13 '14 '15 '16* '09 '10 '11 '12 '13 '14 '15 '16*
Source: Goldman Sachs Research. Q3 2016. Universe for all charts: Russell 1000 ex-financials. *Trailing 12-months through Q3 2016.
A healthier labor market is good news, but rising wage inflation may create pressure on the Fed to
normalize rates faster than markets expect. There’s rising pressure on profit margins, since pricing power
is still weak; higher wages need to translate into spending gains for equities to sustain end-of-year gains.
Measures of US inflation Signs of a healthy US labor market

Y/Y % change, 3-month average % of labor force, 3-month average
2.5% 1.9%
Hundreds
Hundreds
5% Median wages 1.8%
Voluntary quit rate
Average hourly earnings 2.3% 1.7%
Employment cost index
4% 1.6%
2.0%
1.5%
3% 1.4%
1.8%
1.3%
2%
1.5% 1.2%
Core CPI & Core PCE Firing rate 1.1%

1%
1997 2000 2003 2006 2009 2012 2015 1.3% 1.0%
2001 2003 2005 2007 2009 2011 2013 2015
Source: BLS, BEA, FRB Atlanta, JPMAM. Note: prior to 2010, average hourly
earnings are only for production and nonsupervisory workers. Nov 2016. Source: Bureau of Labor Statistics, Haver Analytics. October 2016.
Margin pressure building for US small businesses Market currently expecting a slower rate hike cycle
3-month average than the median FOMC member, Fed funds target rate
40% 6%
Net % raising wages
Hundreds
30% 5%
20%
4%
10%
3% Median FOMC member
0%
2%
-10%
-20% 1% Market
Net % raising prices
-30% 0%
1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 2005 2007 2009 2011 2013 2015 2017 2019
Source: NFIB, Cornerstone Macro, Haver Analytics. November 2016. Source: Bloomberg, Federal Reserve, JPMAM. December 16, 2016.
7 7
Here’s another way to look at it: employment, housing and consumer activity are doing OK, but
businesses remain cautious, even with all-time lows in real interest rates. That yields trend GDP
growth of around 2.5%. Fiscal multipliers from government spending are much higher than for tax cuts,
so we will have to see what policy mix emerges before making substantial changes to our US growth
expectations. The outcome of the infrastructure debate (direct government spending financed through
taxes on offshore profits vs. public-private partnerships; see Special Topic #5) will affect our answer.
Divergence between employment and investment US consumer activity

Y/Y % change (both axes) PCE contribution to real GDP growth, 2-quarter average
5% 20% 4%
UNITED
S TAT E S
Employment
Hundreds
4% 15% 3%
3%
10%
2% 2%
1% 5%
1%
0% 0%
-1% 0%
-5%
-2% -1%
Real business -10%
-3%
fixed investment -15% -2%
-4%
-5% -20% -3%
'60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10 '15 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16
Source: BLS, BEA, Haver Analytics. November 2016. Source: BEA, Haver Analytics, JPMAM. Q3 2016.
US private residential investment What helps GDP growth the most?

% of GDP Estimated fiscal multiplier range
8%
Corporate tax cut Tax cuts
7% Homebuyer credit Spending
1 yr tax cut higher income
6%
2 yr tax cut lower/middle income
5% One-time payments to retirees
Transfer payments to individuals
4%
Transfers to state/local (non-infra)
3% Direct infrastructure
Fed gov goods/service purchases
2%
'50 '55 '60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10 '15 0.0x 0.5x 1.0x 1.5x 2.0x 2.5x
Source: Bureau of Economic Analysis, Haver Analytics. Q3 2016. Source: Congressional Budget Office. February 2015.
Risks for housing from higher rates

Index (Jan. 2000 = 100) Mortgage rate
180 8%
Housing affordability index
Hundreds
170
160 7%
150
140 6%
130
120 5%
30-year mortgage rate
110
100 4%
90
80 3%
'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16
Source: Natl Assoc. of Realtors, Bloomberg. December 28, 2016.
8 8
The big question for 2017: how will Trump policies affect this backdrop? Financial markets appear to be
pricing in a benign “American Enterprise Institute Presidency”:
 Plenty of deregulation (healthcare, energy, finance, internet5, etc)
What markets are pricing in
 Corporate tax cuts and little disruption from some very transformational tax proposals
 A small amount of personal tax reform that creates a modestly larger budget deficit, but not
a massive one
 Limited (if any) action on trade, tariffs and deportations of undocumented workers
UNITED
S TAT E S
 Large military expansion combined with an isolationist foreign policy
 Infrastructure financed through taxes on offshore profits and public-private partnerships
 Gradual, non-disruptive dismantling of the Affordable Care Act
 Given all of the above, a modestly higher and steeper yield curve that’s great for banks, but
not high enough to derail the housing expansion or worsen corporate debtor solvency
Whether this benign view is accurate or not is the big question for 2017. The right mix could be
stimulative, adding 0.2% to 0.4% to GDP growth without much damage. But too much emphasis on
tax cuts, government spending or tariffs could result in large budget deficits, higher interest rates, a spike
in the dollar, rising Federal debt ratios (and a possible ratings downgrade) and higher inflation. There are
a lot of tea leaves to read, since the outcome depends on the President-elect’s intentions, the disposition
of House/Senate majority leaders and the degree to which Democrats filibuster Trump policies.
The charts below show estimates of the deficit and debt consequences of Trump tax and spending plans
assuming they’re enacted in full, but I don’t think that’s a good central scenario. I think we will end
up somewhere in between, with a mix of infrastructure spending (in sizes way below figures Trump has
cited), corporate tax cuts, small personal tax cuts (if any), some trade restrictions on Mexico, deregulation
of healthcare/financials/energy, a modestly higher budget deficit and 3%+ on the 10-year Treasury by
the end of 2017. Higher interest rates create risks for housing and P/E multiples more broadly, but the
impact on corporate income statements should be gradual given the weighted average maturity of S&P
debt at 10.4 years, only 14% of which is floating rate.
Estimated impact of Trump tax plan on budget deficit Federal debt held by the public and the impact of the
Ten-year cumulative revenue impact , USD trillions Trump tax plan, % of GDP
$0.0 120%
TPC estimate based
-$1.0
100% on Trump tax plan
-$2.0
80%
-$3.0 CBO baseline
-$4.0 60%
-$5.0 40%
Static
-$6.0
Dynamic 20%
-$7.0
Tax Policy Center Tax Foundation 0%
'40 '45 '50 '55 '60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10 '15 '20 '25
Source: Tax Policy Center (October 2016), Tax Foundation (September 2016).
Note: assumes income from pass-through entities is taxed at corporate rates. Source: CBO, Tax Policy Center, Haver, JPMAM. October 2016.
5
In November, we wrote about a potential shift at the Federal Communications Commission to end net neutrality,
and its impact on content providers and cable companies/internet service providers. This ecosystem represents 12%
of the stock market. Substantial changes could happen, and happen fast:
https://www.jpmorgan.com/directdoc/eotmfccease_am.pdf.
9 9
When combining our base case scenario with pre-existing conditions and current equity
valuations, 2017 looks to me like a year of single digit profits growth and equity market
returns (i.e., 6%-8%). However, there are substantial changes taking place underneath the hood. The
second chart shows some of the changing fortunes in the US equity market since the election.
US equity valuation: cyclically adjusted P/E ratio Shift in the US equity market since the election
Price to 10-year trailing real earnings Performance of top third vs. bottom third exposure to factor
45x 10%
8%
40x 6%
35x 4%
UNITED
S TAT E S
2%
30x 0%
-2%
25x -4%
20x -6%
-8% Jan 2016 to election
15x -10% Since election
10x -12%
High Value High High High Low
5x volatility (Low P/E) corporate operating domestic dividend
'50 '55 '60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10 '15 taxes leverage sales yield
Source: Shiller, S&P, Haver, Bloomberg, JPMAM. December 15, 2016. Source: RBC Capital Markets. December 9, 2016. Universe: S&P 500.
Some market factors have been improving since the US Presidential election:
 Value stocks (with low P/E ratios), such as banks and industrials (presumed beneficiaries of a steeper
yield curve, deregulation and greater infrastructure investment)
 Companies with high tax rates (given the prospects for corporate tax reform)
 Companies with high domestic sales (given the possibility of rising tariffs and trade disputes
negatively affecting multinational stocks; see next page)
 Higher operating leverage (given the prospects for modestly higher economic growth)
 Stocks with low dividends and higher volatility (since higher interest rates could reduce the frenzy for
bond proxy stocks)
Many of these factors have further to run given how distorted market preferences had become due to
zero interest rates and the scarcity of organic revenue growth. Once these market factors began to shift
in Q3 2016, excess returns in actively managed large-cap, mid-cap and small-cap equity mutual funds
improved6, a possible sign that Fed-induced distortions have been negatively impacting active manager
performance (for more on active management prospects, see Special Topic #2).
While the markets look to us to have already priced in corporate tax reform, the details are not
clear yet, and some proposals are quite transformational. While lower statutory rates are a
commonly stated goal (a corporate tax rate of 25% could lift S&P earnings by 8%-10%), there are a lot
of details to sort out. The House GOP proposal entails fairly radical changes in the corporate tax code.
We wrote about it at the end of December in a detailed note; here’s a summary.

7
The elimination of interest deductibility, and the ability to immediately expense capital expenditures
 Imports would no longer be deductible, and exports would be exempt from taxation (a step which
would raise revenue on a net basis and support a reduction in the statutory rate)
 One-time tax of 10% or less applied to accumulated, non-repatriated offshore profits
6
J.P. Morgan Securities Equity Strategy and Quantitative Research, November 21, 2016.
7
Most versions of these proposals grandfather deductibility of existing debt, and create carve-outs for financial
firms. But what does this mean for short-term obligations like commercial paper; would they no longer be
deductible when rolled? Unclear. Note that immediate expensing of capital expenditures for tax purposes is only a
timing benefit, and nothing more.
10 10
While in the long run these policies could eliminate distortions in the tax code, encourage capital
spending, reduce excessive leverage and reduce incentives to shelter income or move HQ offshore
through tax inversions, the adjustment period could be disruptive. There are likely to be winners and
losers from such changes, particularly if the dollar does not rally as expected by some economists8.
On trade, domestically-oriented stocks should get the benefit of the doubt. The President has varying
degrees of unilateral influence on trade policy. While campaign promises of across-the-board tariffs of
35% and 45% are unlikely, I believe Trump will take steps which raise tariffs on foreign goods.
The risk: more expensive imports and a profit squeeze at import-dependent companies. The Peterson
Institute modeled a “full trade war” by assuming that the US imposes 35% tariffs on Mexico and 45%
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S TAT E S
on China, and that these countries retaliate in kind with similar tariffs. The result: roughly stagnant real
US GDP for three years, from 2017-2020. The last time that happened: 1979-1982, a period of
economic malaise, high unemployment and fragile financial markets. Again, I think the full trade war
scenario is highly unlikely, even considering the unilateral power the President has to provoke one.
Rising interest rates should help banks, whose share prices have been negatively impacted by falling
rates and a flatter yield curve since 2010. The perception of a changing regulatory environment is also
contributing to rising bank valuations, which are still well below pre-crisis levels.
Since 2010, bank stocks hurt by lower rates US bank valuations

Correlation of relative returns with the total return of treasuries Price-to-book value ratio
80% 2.2x
60% 2.0x
40% 1.8x
20% 1.6x
0% 1.4x
-20% 1.2x
-40% 1.0x
-60% 0.8x
-80% 0.6x
'30 '35 '40 '45 '50 '55 '60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10 '15 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16
Source: Empirical Research Partners. November 2016. Source: MSCI, Datastream, JPMAM. December 15, 2016.
The technology sector outlook is mixed. While higher Foreign Effective Foreign Effective
global growth should help, a higher dollar and trade Sector Sales Tax Rate Sector Sales Tax Rate
barriers could hurt since the tech sector has the Tech 59% 21.2% Cons Disc 27% 28.5%
highest percentage of foreign sales. Tech also has the Materials 49% 25.3% Health Care 20% 24.6%
lowest effective tax rate, reducing relative benefits Energy 41% 25.9% Financials 18% 27.9%
from any corporate tax reform. The underperformance Industrials 36% 28.1% Utilities 6% 31.7%
of tech stocks vs. the market since the election may Staples 28% 29.5% Telecom 1% 28.0%
also reflect rotation out of heavily crowded positions Source: Compustat, Deutsche Bank. 2015.
into under-owned bank and industrial names.
8
The elimination of import deductibility is assumed by some economists to result in no disadvantages for
importers, or material changes to trade flows, since the dollar is assumed to rally in such a scenario by an amount
equal to the value of the foregone tax deductibility of imported goods. If the policy were adopted under a 20%
corporate tax rate regime, it would require a roughly 25% appreciation (!!) of the US dollar, pushing it to its
highest level since 1990. As I type this, I’m imagining all the ways that real life could intrude on this assumption.
For example: will this work in a world of fixed and managed exchange rates of US trading partners? If for whatever
reason, exchange rate adjustments do not work as planned, the following sectors have the highest degree of
import content, and stand to be hurt the most: apparel, computers, autos and electrical equipment.
Another remarkable thing about destination-basis taxation: some people like it explicitly because they believe
that it is protectionist, and other people like it because they resolutely believe that it’s not.
11 11
Policy changes are also afoot in healthcare. The internals of the Affordable Care Act are unstable
(sharply rising premiums and deductibles, falling number of insurers on state exchanges), and remind me
of the video of the undulation and ultimate collapse of the Tacoma Narrows Bridge in the 1940s. The
GOP controls many of the legislative levers needed to change/repeal it. What might the future look like?
As per Ryan’s plan, it could be composed of tax credits to purchase private health insurance, interstate
competition and Medicaid grants. The proposal eliminates employer and individual mandates, and
widens allowable premium variation based on age from 3:1 to 5:1 to encourage younger, healthier
people to participate. Most likely timeline: implementation after the 2018 midterm elections.
Should the GOP make changes to the Affordable Care Act, insurers, biotech and large-cap pharma could
UNITED
S TAT E S
benefit at the expense of hospitals and medical device companies. As shown below, on a broad sector
basis, healthcare valuations are close to the lowest levels relative to the overall market since 1990.
Healthcare versus the market

Price-to-forward earnings ratio relative to S&P 500, 3-month average
1.6x
1.5x
1.4x
1.3x
1.2x
1.1x
1.0x
0.9x
0.8x
0.7x
'90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16
Source: Bloomberg, J.P. Morgan Asset Management. December 15, 2016.
Biotech stocks plummeted in 2015 when Clinton indicated that she would act on multiple fronts after
Turing’s price increase on Daraprim. Her plan included (a) creation of a drug pricing oversight committee
with the ability to impose fines, (b) acceleration of FDA generic approvals9 and (c) approval of emergency
imports. Trump also commented on the need to rein in drug price increases, but if his solutions are
focused on (b) and (c) and not (a), the market impact may be smaller. If so, biotech may recover some of
what was lost in the prior couple of years when its valuations converged to large-cap pharma.
Nasdaq Biotech performance following Clinton and Biotechnology and pharmaceutical stocks priced at
Trump comments, 100 = index level on day before comment similar levels, Price-to-forward earnings ratio
100 65x
Trump (December 7, 2016)
95 US biotechnology
55x
90
45x
85
80 35x
Clinton (September 21, 2015)
75 25x
70
15x
65 US pharmaceuticals
0 10 20 30 40 50 60 70 80 90 100 5x
Days after comment on drug prices '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16
Source: Bloomberg, Twitter, Time, JPMAM. December 28, 2016. Source: Morgan Stanley Research. December 15, 2016.
9
In 2015 and 2016, pending FDA approvals were 6x-8x the rate of actual FDA approvals.
12 12
What about a Clinton Presidency?

There are multiple pathways by which Trump policies could result in adverse outcomes given deficit and
tariff issues, and his lack of experience. Still, it’s also worth thinking about the counter-factual: how
would a Clinton administration have delivered a positive jolt to an aging, highly indebted US economy
that has lost its productivity mojo, and whose entitlement payments are increasingly crowding out
10
discretionary spending that contributes to future growth ? Clinton’s agenda included high frequency
trading fees and risk fees on banks; a drug pricing oversight committee with the ability to impose fines
and penalties; regulations impeding corporate tax inversions11; regulations on a variety of niche for-profit
industries; Federal support for labeling guidelines and soda/sugar taxes; further Medicaid expansion; new
UNITED
S TAT E S
regulations on paid leave; revised energy efficiency standards; expansion of insurance coverage
requirements; and policies Clinton described as effectively eliminating hydraulic fracturing, even though
she also described natural gas as a bridge fuel to a renewable energy future in one of the debates.
While each proposal has its merits, they would have further expanded the regulatory footprint of the
Federal Government. Compared to B. Clinton and G. W. Bush, the pace of Obama regulation was
considerably faster, a trend which has been affecting small business sentiment. As the business cycle
ages, productivity becomes more important as a means of preventing inflation. It’s unclear how
Secretary Clinton’s regulatory agenda would have helped on this front.
Fewer active workers relative to retirees and rising debt Entitlement and non-defense discretionary spending
Ratio of active to retired workers Federal debt to GDP % of GDP, with ratio of entitlement to non-defense spending
6.5x 80% 14%
Current
Hundreds
6.0x Active to retired workers 70% 12%
5.5x 60% 10% Entitlement spending
5.0x 50% 8%
3.2x
4.5x 40% 6% 1.0x Budget Control Act
Debt to GDP
4.0x 30% 4%
Non-defense discretionary spending
3.5x 20% 2%
'67 '70 '73 '76 '79 '82 '85 '88 '91 '94 '97 '00 '03 '06 '09 '12 '15 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025
Source: BLS, Social Security Administration, OMB, JPMAM. Nov. 2016. Source: CBO, JPMAM. March 2016. Dotted lines are CBO projections.
Cumulative number of economically significant What's the largest problem facing small business?
regulations published during equivalent periods in office % of respondents, 6-month average
500 35%
Hundreds
450 Fall 2016 Unified Agenda

President Obama
30% Regulation
400 Taxes Poor sales
350 President Bush 25%
300 President Clinton
20%
250
200 15%
150 10%
100
5% Quality of labor
50
0 0%
2009 2010 2011 2012 2013 2014 2015 2016 1986 1990 1994 1998 2002 2006 2010 2014
Source: George Washington University Regulatory Studies Center. 2016. Source: NFIB, Haver Analytics, JPMAM. November 2016.
10
Examples of discretionary spending: job training/worker dislocation programs; Federal spending on education;
consumer and occupational health and safety; Federal law enforcement/judiciary; pollution control and abatement;
air, ground, water infrastructure; US Army Corps of Engineers; science research, NASA; energy R&D demonstration
projects; NIH/CDC spending on disease control and bioterrorism; international drug control and law enforcement.
11
See our December 20, 2016 Eye on the Market for more on corporate tax inversions, and the House GOP
proposal for a destination-based cash flow corporate tax as a means of reducing the incentive to engineer them.
13 13
Europe: a modest recovery, an underperforming corporate sector and a heavy political calendar
Europe’s economy is stable, but trend growth is still well below pre-crisis levels. While business surveys
have been in expansion territory since the beginning of 2015 and consumer confidence has risen, all of
this simply corresponds to GDP growth of around 2.0%. The growth news is better in Spain (3% in Q3
2016), but at just 10% of Eurozone profits, GDP and employment, let’s not get carried away with its
overall importance. While Italy has its problems (see box) and 50% of Italian bank retail bonds mature in
2017, I expect Italy and the European Commission to find ways of avoiding an unwanted banking crisis
by coming up with a variety of accommodations.
Eurozone business surveys: manufacturing/services Eurozone consumer confidence

Composite output PMI, Index (50+ = expansion), 3-month average Net balance of positive and negative response
65 0%
-5%
60
Spain
-10%
Germany
EUROPE
55 Italy -15% Average

since 1985
50 -20%
France -25%
45
-30%
40 -35%
2010 2011 2012 2013 2014 2015 2016 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16
Source: Markit, Haver Analytics. December 2016. Source: European Commission, Haver Analytics, JPMAM. December 2016.
Eurozone real GDP growth: cresting at 2%?

Y/Y % change, history extended from individual countries
6%
4%
2%
0%
-2%
-4%
-6%
1980 1985 1990 1995 2000 2005 2010 2015
Source: Eurostat, Bloomberg, J.P. Morgan Securities, Haver. Actual data
through Q3 2016; dots are consensus estimates for Q1 and Q3 2017.
La Forza del Destino. The Italian referendum “no” vote reduced the likelihood of Italy enacting structural
reforms to close its productivity gap with Germany. A short list of Italy’s problems include the weakest growth and
productivity trends in the region; slow uptake of information and communication technology (Italy ranks alongside
Romania and Bulgaria); a high share of small and medium-size enterprises which limits economies of scale,
particularly compared to the UK, Germany and France; labor market rigidities, low labor participation rates,
inefficiency of public administration, archaic legal treatment of non-performing loans, etc, etc.
In last year’s Outlook, we showed some broad measures of economic vibrancy and competitiveness by country.
The gap between Italy and Germany was around the same as the gap between Mexico and the US. Currency
unions make strange bedfellows.
14 14
Bank lending has picked up now that the ECB has provided banks with incentives to lend, but still, this is
another Eurozone trend that’s growing at just 2%. The charts below on bank lending are perhaps
the best way of understanding how the Eurozone is fundamentally changed compared to its
pre-crisis self: much less reliance on explosive growth in household and corporate borrowing in the
European periphery. When I look at Italy and Spain from 2005 to 2008, it brings to mind a sentiment
attributed to Marcel Proust: “Remembrance of things past is not necessarily a remembrance of things as
12
they were” . The mid-decade surge in Southern European growth was never as real as it seemed, and
was built on the faulty edifice of monetary union among countries with radically different growth and
productivity characteristics.
Eurozone bank lending to households Eurozone bank lending to non-financial corporations

Y/Y % change, adjusted for loan sales and securitizations Y/Y % change, adjusted for loan sales and securitizations
30%
20% Spain Spain
25%
Italy
15% 20%
France
EUROPE
15%
10%
France 10%
Italy
5% 5%
Germany
0%
0%
-5% Germany
-5% -10%
'05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16
Source: European Central Bank, Haver Analytics. October 2016. Source: European Central Bank, Haver Analytics. October 2016.
Fiscal stimulus in Germany might help, but I’m not sure how much we will see. Germany’s Council of
Economic Experts wrote in its annual report to Merkel that “the extent of monetary easing is no longer
appropriate”, and that “additional fiscal stimulus is currently not appropriate” either. While German
home prices are rising after a couple of decades of stability, German wage growth and other inflation
measures are stable. As a result, when it chooses to, the ECB should be able to slowly step back from its
stimulus campaign, rather than abruptly. Still, it’s striking to see the continued outperformance of
Germany vs. France, which is not a healthy dynamic between the Eurozone’s two largest countries.
German inflation showing up in housing, but not in Germany vs. France real per capita GDP, 1850-2016
wages or prices, Y/Y % change Germany divided by France, ratio
6% 1.25
5% 1.20
House prices
4% 1.15
Hourly
3% wages 1.10
2%
1.05
1% GDP deflator 1.00
0%
0.95
-1% Unit labor cost
0.90
-2% 1850 1865 1880 1895 1910 1925 1940 1955 1970 1985 2000 2015
2010 2011 2012 2013 2014 2015 2016
Source: "Statistics on World Population, GDP and Per Capita GDP",
Source: Bundesbank, Statistisches Bundesamt, Haver, JPMAM. Q3 2016. University of Groningen, Conference Board, JPMAM. May 2016.
12
Proust was a Neuroscientist, J. Lehrer, 2007.
15 15
European equities underperformed again in 2016, culminating in its worst decade of relative
performance vs. the US since we can track both series in 1970. This outcome has tempted many
strategists to recommend Europe as a non-consensus pick every year over the last few years. However,
Europe’s underperformance is almost entirely explained by inferior corporate results, rather than by
pessimistic pricing of European equities:
 Earnings. Over the last 10 years, Europe posted its worst EPS growth vs. the US since the 1970s. An
illustrative data point: through November, European EPS was still 46% below its pre-crisis peak, while
US EPS was 10% higher. Europe has lagged the US on every component of profitability since 2007,
particularly stock buybacks
 Return on equity. Europe’s relative return on equity is also close to the lowest levels since the 1970s.
Currently, the ROE of the median European industry group is 4.4% lower than its US counterpart. Of
24 industry groups, only 3 have ROEs which are higher in Europe than in the US (the largest positive
difference in favor of Europe is for a sector that only has a 0.5% index weight)
 Multiples. Despite all of this, European P/E multiples are actually not trading at much of a discount
EUROPE
vs. US equities (less than 1 P/E point lower during November and December 2016)
Europe vs. US: equity performance Europe vs. US: earnings per share growth
10-year rolling relative equity performance, local currency 10-year rolling relative EPS growth
100% 125%
Europe outperforms Europe outperforms
100%
75%
75%
50%
50%
25% 25%
0%
0%
-25%
-25%
-50%
Europe underperforms Europe underperforms
-50% -75%
1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016
Source: MSCI, Datastream, JPMAM. December 15, 2016. Source: MSCI, Datastream, JPMAM. November 2016.
Europe vs. US: return on equity Europe vs. US: profitability components
Difference in ROE by sector, Europe minus US Contribution to earnings per share growth since 2007
20%
Buybacks US
15%
Europe
Comm Serv
Effective Tax Rate

Insurance
10%
Pharma
Non-Operating Income Cumulative EPS

5% Amount Of Debt growth since 2007:
US: 78%
0% Cost Of Debt Europe: -27%
Food & Bev
Telecomms
Cons Dur
Retailing
Banks
Real Estate
Semis
Div Fin
Utilities
Healthcare
Househ. Prod
Energy
Cap Goods
Transport
Software
Media
Materials
Food Retail
Tech Hardware
-5% Depreciation
Autos
Cons Serv
-10% Operating Margins

Sales Growth
-15%
-30% -20% -10% 0% 10% 20% 30% 40%
-20% Source: MSCI, Bloomberg, Morgan Stanley Research. June 2016. Excluding
Source: MSCI, Bloomberg, JPMAM. November 2016. commodities and financials.
16 16
What about European politics?

For active readers of Eye on the Market, you’re probably aware of our research indicating that politics
(whether local or global) tend not to have a large impact on markets. That’s why we generally
pay more attention to the business cycle than to politics.
That said, half of the Eurozone’s population will vote in Presidential elections in 2017. If populist parties
take control, it could result in heightened market volatility, since in addition to risks around Eurozone
referendums, most European populist parties (unlike Trump) are generally not advocating deregulation,
lower corporate tax rates and other pro-business policies as the core part of their agenda. To be clear,
however, most of these parties are still in the minority and not on the cusp of being asked to be
part of a majority government. Also, popular support for the Euro remains at 70%.
Support for populist parties in Europe French, Italian, Spanish, and Greek real GDP per capita
% of support in polls (3-month average) 7-year annualized % change, population-weighted
50% 6%
Austria (Freedom Party)
45% Netherlands (Party for Freedom) 5%
EUROPE
40% Italy (5-Star Movement)
France (National Front) 4%
35% Spain (Podemos)
30% Greece (Syriza) 3%
25% Germany (AfD) 2%
UK (UKIP)
20% 1%
15%
0%
10%
5% -1%
0% -2%
2010 2011 2012 2013 2014 2015 2016 '55 '60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10 '15
Source: Various national polls. November 30, 2016. Source: The Conference Board, JPMAM. May 2016.
Why did anti-establishment parties emerge in Europe, despite recent economic improvements?
First, the improvement is pretty modest if you look over a longer period. The chart (above, right) shows
per capita GDP growth in France, Italy, Spain and Greece. The last few years have been terrible, similar
to results seen during WWII, WWI, the Spanish Civil War (1930s), the Franco-Prussian War (1870s) and
the Phylloxera epidemics in France (1880s) and Spain (1890s). Secondly, if we take Eurobarometer
surveys at face value, Europeans are very concerned about immigration and the surge of asylum-seekers.
What do you think are the two most important issues Asylum-seekers and illegal migration to Europe
facing the EU?, % of respondents Number of people, millions
70% 0.9 2.0
Economic 0.8 1.8
60% situation Immigration Illegal migration into
0.7 the EU 1.6
50% 1.4
State of the member 0.6
40% 1.2
state's public 0.5
EU ex-Germany 1.0
30% 0.4
asylum seekers 0.8
Unemployment 0.3
20% 0.6
Terrorism 0.2 0.4
10% 0.1 Asylum seekers in Germany
0.2
Crime
0% 0.0 0.0
2010 2011 2012 2013 2014 2015 2008 2009 2010 2011 2012 2013 2014 2015
Source: Eurobarometer. 2016. Source: Eurostat, Frontex, Pew. 2015.
17 17
At a client event we held in Paris last November, Henry Kissinger and I debated why Europe is doing little
in the Middle East to slow the pace of asylum-seekers. We concluded that two factors help explain why:
[1] gradual European disarmament (only 4 of 24 European countries are meeting NATO military spending
targets), and [2] increasing European reliance on Russian oil and gas, which now accounts for almost as
much energy as Europe produces for itself.
Combined forces: UK, Germany, Italy, France, Spain European reliance on Russian oil and natural gas
Manpower (mm) Combat aircraft Warships Battle tanks Thousand barrels a day of oil equivalents
1.4 2,000 140 6,000 14,000
European oil and gas production
Thousands
1,800 12,000
1.2 120 5,000
1,600
10,000
1.0 1,400 100
4,000
1,200 8,000
0.8 80
1,000 3,000 6,000
0.6 800 60
2,000 4,000
0.4 600 40
400 2,000
EUROPE
0.2 20 1,000 European oil and gas imports from Russia

200 0
0.0 0 0 0 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14
2000 2013 2000 2013 2000 2013 2000 2013 Source: BP Statistical Review of World Energy, Gazprom, Eurostat, Perovic
Source: Roland Berger Strategy Consultants, Statista. 2013. et al, JPMAM calculations. 2015.
Bottom line on the Eurozone. 2% GDP growth, stable bank lending, a modestly steeper yield curve
(which helps bank stocks), improved earnings at commodity companies and a weak Euro should deliver
single digit earnings growth, and single digit growth in equities as well. If so, Europe should muddle
through another year in 2017 without too much drama. The next big existential challenge for the
Eurozone will probably be the Italian General election in late 2017/early 2018, assuming that the
National Front13 does not win the French Presidential election in May 2017 (if it does, all bets are off).
But to be clear, even if the Eurozone survives these challenges, it is fundamentally changed when
compared to its pre-crisis self, a model which had relied on unsustainable leverage and consumption
in the European periphery to drive growth and profitability.
13
For some French citizens, as my friend Louis Gave says, “the National Front is an intellectual descendant of Vichy
France and not an acceptable option”. If Thatcherite candidate Francois Fillon is elected and is able to
liberalize France’s labor laws (ending the 35-hour work week), cut corporate tax rates, reduce pension
burdens on companies and abolish the wealth tax, there could be a positive market reaction.
18 18
Brexit: the hard part lay ahead, but so far, UK economy holding up better than expected
It’s too soon to tell, but as I wrote before the vote, some commentary on Brexit seems overwrought. In
much of the Brexit research I read, I can’t tell how much of the fears expressed by the authors are based
on dispassionate assessments of the risks, and how much is based on their anger and frustration at the
vote’s outcome.
After a prolonged period of de-industrialization, it will be hard for the UK to immediately reap the
benefits of a weaker pound (which has further to fall in 2017, and which is already feeding into higher
inflation). However, since Brexit, business surveys and commercial property enquiries bounced back from
their initial swoon, retail sales are holding up and job listings reflect logical responses to a weaker pound.
Measures of UK economic surprises rose sharply in November 2016, mostly since dire outcomes expected
by many economists didn’t happen. Perhaps the most important thing to watch is business investment
plans, which plummeted after the vote. More recently these plans have improved a little, as businesses
wait and see what the deal with the EU will look like once Article 50 is triggered.
EUROPE
The gradual de-industrialization of the UK UK business surveys
Manufacturing as a % of total gross value added PMI level, Index (50+ = expansion)
30% 65
Construction Brexit
25%
60
UK ranks 30th out
20% Services
of 34 countries in
the OECD 55
15%
50
10% Manufacturing
5% 45
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2011 2012 2013 2014 2015 2016
Source: Office for National Statistics, Haver Analytics, JPMAM. Q3 2016. Source: Markit, Haver Analytics. November 2016.
UK retail sales volume growth Post-Brexit rebalancing in UK job market reflects impact
Y/Y % change, 3-month average of a weaker Pound, Y/Y growth in # of jobs advertised
7% 30%
Brexit
6% 25%
Manufacturing
5% 20%
Automotive
4% 15%
3% 10%
Retail
Total
2% 5%
1% 0%
-5% Banking
0%
-1% -10%
-15%
-2%
'05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 -20%
Source: UK Office for National Statistics, Haver Analytics. Nov. 2016. Source: Reed Job Index. Q3 2016.
19 19
Japan: delusions of inflationary grandeur
Abenomics was designed to reflate Japan. Inflation picked up in 2014, but then rolled over. While the
Bank of Japan has been projecting higher inflation (brown dots, right chart), their forecasts have been
way too optimistic. I’m not going to spend too much time this year dissecting all the Japanese data,
since the core objective of Abenomics isn’t working.
Japanese core inflation Bank of Japan overestimated the inflationary benefits

Y/Y % change, both adjusted for 2014 VAT of quantitative easing, Y/Y % change, ex-fresh food
2.0% 2.0%
Prime Minister Prime Minister
1.5% Abe elected 1.5% Abe elected
Ex-food
1.0% and energy 1.0%
0.5% 0.5%
0.0% 0.0%
-0.5% -0.5% Adjusted for

Ex-fresh food
-1.0% -1.0% 2014 VAT Forecast realization
Year forecast made
-1.5% -1.5%
'10 '11 '12 '13 '14 '15 '16 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19
Source: Japan MIC, Haver Analytics, JPMAM. November 2016. Source: Japan MIC, Bank of Japan, Haver Analytics, JPMAM. Nov. 2016.
For investors, I leave you with this. Where I grew up, every few years, insects called cicadas emerged
JAPAN
after spending a decade or more underground, and then flew around for a few weeks before dying. In
Japan, the cicada is known as the higurashi, and it’s a good metaphor for the Japanese equity market.
The chart below (left) shows the benefits of overweighting Japanese equities and underweighting a mix
of US, Europe and Emerging Markets equities14 since 1988. For a few short periods over the last 28
years, Japanese equities had their place in the sun, flying around for a while before submerging again.
Otherwise, they weren’t really worth owning on a relative basis.
Renewed weakness in the Yen should help Japanese exporters in 2017, fiscal spending is rising, and
investors may benefit from Japanese companies increasing buybacks and M&A (cash holdings in Japan
are roughly 3x US levels as a % of market capitalization). I’d be comfortable with a neutral position in
Japan in 2017 but not an overweight, since I don’t think 2017 will be the year of the higurashi,
particularly if the Yen starts to rally again.
Higurashi Moments: the benefits of overweighting Japan Japan equities and the Yen: a one-trick pony
3-year rolling out (under) performance Exchange rate Index level
2% ¥125
Japan outperforms USD/Yen FX rate 1000
0% ¥120
¥115 900
-2%
¥110
-4% 800
¥105
-6% ¥100
700
-8% ¥95
-10% ¥90 600
-12% ¥85
MSCI Japan equities 500
Japan underperforms ¥80
-14%
1991 1994 1997 2000 2003 2006 2009 2012 2015 ¥75 400
2010 2011 2012 2013 2014 2015 2016
Source: Bloomberg, J.P. Morgan Asset Management. Dec. 15, 2016.
Portfolio is quarterly rebalanced and assumes no currency hedging. Source: Bloomberg. December 16, 2016.
14
Computations are based on an all-equity portfolio that is overweight Japan by 7.5%, underweight the US by
3.5%, underweight Europe by 2.5% and underweight emerging markets by 1.5%. All overweights and
underweights are expressed relative to prevailing MSCI index weights.
20 20
China: stabilization, courtesy of coordinated stimulus
2016 was a year of stabilization in China, and 2017 looks like it will be more of the same. As shown
below (left), a massive, coordinated stimulus effort involving bank lending, government spending and
fixed investment by state-owned enterprises took place towards the end of 2015. In response, the
Chinese economy stabilized in 2016 (see 2nd chart on employment, exports, business surveys, corporate
earnings, GDP, industrial production, retail sales, etc).
Pump Up the Volume China: stabilization in 2016

Y/Y % change
30% Legend: employment surveys, exports,
Government spending business conditions, GDP, corporate earnings,
Mortgage lending industrial production, retail sales, non-state
25% owned enterprise fixed asset investment
Total social financing
20%
15%
10%
Fixed asset investment: SOE

5%
2011 2012 2013 2014 2015 2016 2011 2012 2013 2014 2015 2016
Source: JPMS, PBOC, CNBS, Haver Analytics. March 2016. Source: CFLP, Markit, CC, PBOC, CNBS, MSCI, Haver, JPMAM. Nov 2016.
While stabilization is welcome, parts of China’s corporate sector are still highly indebted and suffering
from both chronic overcapacity and an overvalued exchange rate. China’s corporate debt surge is now
by some measures as large as the Japanese version of the 1980s. Some consequences: 25% of listed
Chinese companies have cash flow that is less than the interest they owe to banks and bondholders15;
and a meager 1.5% return on assets at state-owned enterprises. All things considered, and given the
difficulties involved with running massive stimulus indefinitely, Chinese GDP growth is probably headed
CHINA
to 5.5%-6.0% by 2018.
Corporate debt levels in China Long-term appreciation of the Chinese RMB

Non-financial corporate debt, % of GDP RMB real effective exchange rate index
180% 130
170% Stronger
160% 120
150%
110 REER: exchange rate index weighted by
140%
trading partner size, adjusted for inflation
130%
120% 100
110%
90
100%
90% 80
80% Weaker
70% 70
'94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16 1995 2000 2005 2010 2015
Source: Bank for Int'l Settlements, Haver, Gavekal, JPMAM. Q3 2016. Source: J.P. Morgan Securities LLC, Bloomberg. December 16, 2016.
15
“China – avoiding the Japanese sinkhole?”, Lombard Street Research, May 10, 2016.
21 21
The good news: markets have come closer to pricing in the realities of Chinese fundamentals.
The premium for A shares (onshore stocks trading in Shanghai and Shenzhen) relative to H shares (Hong
Kong-listed) has come down by half, indicating less of a frenzy in the local markets. Furthermore, margin
balances declined sharply after the boom-bust fiasco in 2015, and institutional protections were put in
place (higher reserve requirements, limits on structured finance vehicles). Finally, many of the circuit
breakers and trading suspensions have been lifted. As a result, equity-raising has resumed in China,
allowing many companies to recapitalize and pay down debt.
However, some remnants of China’s reaction to the 2015 equity market collapse remain:
corruption investigations into “market manipulators” continue, regulators still tightly control the IPO
market, and the government still appears to own a lot of the stock it bought as the equity market was
declining. Eventually, the depth of the Chinese equity market should improve as domestic institutional
investors such as pension funds increase their allocations. Currently, individuals still account for 80% of
the trading and 70% of free float ownership.
China: margin debt vs. onshore equity prices China price-to-earnings multiples
Price index level Outstanding margin debt, % of GDP Forward price-to-earnings ratio, equal weighted by sector
5,500 3.5% 26x
5,000 3.0%
Onshore
Index of 22x (A shares)
4,500 onshore equity
prices (CSI 300) 2.5%
4,000 18x
Offshore
2.0%
3,500 (H shares)
14x
1.5%
3,000
10x
2,500 Margin debt 1.0%
2,000 0.5% 6x
Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16
Source: National statistics offices, Bloomberg, JPMAM. December 16, 2016. Source: MSCI, Bloomberg, Datastream, JPMAM. December 16, 2016.
CHINA
Investors should also remember that the Chinese financial system is a work in progress, and that the
government continues to clean up the shadow banking system. The government is currently imposing
new capital charges and risk provisions on distributors of asset management products. Good news in the
long run, but potentially destabilizing in the short run.
22 22
The gradual rebalancing of the Chinese economy should continue in 2017, with consumption
growing relative to capital spending. Real incomes and real consumption are still growing at 6%-
7% per year, and for investors, it’s worth paying attention to the continued rapid growth in the number
of affluent Chinese households. One illustrative consequence: faster growth in SUV purchases than
sedan purchases, faster growth in overseas travel, preference for fresh coffee (vs. instant) and maturation
in the internet penetration rate at around 55%16.
Chinese household consumption expenditures Chinese households by wealth level

Share of GDP & GDP growth, % Million households
55% 400
350
50%
300 Affluent (RMB136,000)
45% Share of GDP 250 Established (RMB89,000)
40% 200 Emerging (RMB54,000)
150 Below all 3 thresholds
35%
100
30%
Share of GDP growth 50
25% 0
'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '95 '00 '05 '10 '15 '20 '25
Source: China National Bureau of Statistics. 2015. Source: Gavekal Dragonomics Chinese Consumer Outlook, Nov. 2016.
For investors interested in China/Asia consumption, I always caution against looking to Chinese
17
public equity markets as a way of expressing this view. In countries like China , Taiwan and Hong
Kong, the combined weight of consumer staple and consumer discretionary stocks is less than 10% of
stock market capitalization. What makes more sense to me: a targeted strategy, either in public or
private equity markets. As shown below, on an industry-wide basis, private equity and venture capital
managers have outperformed public equity markets in Asia. Part of the explanation lay in manager
decisions to overweight consumer-related companies and underweight state-owned enterprises, banks,
CHINA
heavy industry, airlines and utilities.
Private equity performance versus public equity in Asia China dominates emerging markets private investments
10-year annualized return through Q2 2016 Index weight
14% 70%
12% 60% South Korea

50% India
10%
South Korea
8% 40%
6% 30% India
China
4% 20%
China
2% 10%
0% 0%
MSCI MSCI Asia DM Asia EM Emerging Markets MSCI Emerging Markets
Pacific EM Asia PE & VC PE & VC PE/VC Index
Source: Cambridge Associates LLC, MSCI, Bloomberg, JPMAM. Source: Cambridge Associates, MSCI, Bloomberg. December 2015.
16
Gavekal Dragonomics Consumer Chartbook, November 2016.
17
This comment is based on the MSCI China Index, which includes H shares, B shares, Red chips and P chips.
23 23
Emerging markets ex-China: recovering from balance of payment adjustments
Emerging market equities and currencies declined after the US election due to fears of a rising dollar and
protectionism emanating from the US. These concerns are well-founded (particularly with respect to
Mexico18), and I expect more weakness in EM FX rates in the next few months as markets price in
implications of higher US interest rates as well. The reason a rising dollar worries investors is generally
nd
due to EM reliance on US dollar financing. However, as shown in the 2 chart, EM and global
reliance on foreign capital has declined over the last few years. So, a rising dollar may hurt EM
borrowers, but not as much as it would have 3-4 years ago when balance of payments and balance sheet
adjustments were just beginning. As a result, buying EM on any pronounced weakness seems like the
best strategy for 2017.
How did sensitivity to dollar financing decline? Mostly via sharp capital spending cuts by EM commodity
companies that are very large dollar borrowers, which in turn contributed to stabilization in commodity
prices (see Special Topic #8). In aggregate, their free cash flow is now positive after being sharply
negative in 2015. Signs of reduced stress are seen in the sharp declines in credit default swap rates for
Petrobras, Pemex, Vale, Rosneft and Gazprom.
Emerging markets foreign exchange and equities sell- Declining sensitivity to dollar financing
off after the US election, Index level (both axes) 90% 100
70 105 % of EM countries significantly
80% 90
69 EM FX reliant on foreign capital
70% 80
68 100
70
67 60%
60
66 95 50%
50
65 40%
EM equities 40
64 90
(in LC terms) 30%
30
63
20% 20
62 85
61 US Election 10% Global sensitivity 10
60 80 0%
to US$ liquidity 0
Jan-16 Apr-16 Jul-16 Oct-16 1975 1980 1985 1990 1995 2000 2005 2010 2015
Source: J.P. Morgan Securities, MSCI, Bloomberg. December 15, 2016. Source: Bridgewater Associates. October 2016.
The chart below (left) is a rough measure of sensitivity to dollar financing conditions for EM countries.
EM Asia is generally better positioned than Latin America to ride out another surge in the US dollar.
EMERGING
MARKETS
Sensitivity to dollar financing by country Sharp rise in the dollar parallels early 1980s rise
Index, 100 = highest sensitivity Real effective US dollar exchange rate index
100
125
90 Stronger
80 120
115
1980-1984
70
60 110
50
105
40 2012-2016
Saudi Arabia
South Africa
100
South Korea
30
Philippines
Indonesia
Argentina
Colombia
Malaysia
Thailand
20 95
Mexico
Turkey
Russia
Taiwan
Weaker
China
Brazil
Chile
Peru
India
10 90
0 2012 2013 2014 2015 2016
Source: Bridgewater Associates. October 2016. Source: J.P. Morgan Securities LLC, BIS, Bloomberg. December 15, 2016.
18
As of December 15, the MSCI EM equity index (in local currency terms) is roughly flat since the election. Mexico
is a possible target for some of Trump’s trade agenda, which explains the 5% decline in the MSCI Mexico equity
index and another 8.5% decline in the Peso. Russian equities, on the other hand, are up the most. Plenty of room
for some interesting conclusions, should you want to draw them.
24 24
In two prior cycles, after a sharp decline in EM currencies, EM equities outperformed the developed
markets (shaded area in the first chart). Then, as EM exchange rates rose over the next few years, EM
assets eventually underperformed again. In theory, structural reforms could reduce the magnitude of
these cycles, but I don’t think we’re anywhere near that point. As a result, EM is best thought of as a
value play that makes the most sense after a balance of payments crisis, when imports and
unit labor costs have declined, and when competitiveness has been (temporarily) restored.
Signals that indicate that this view is on track: the stabilization of portfolio inflows into EM countries, and
a modest improvement in earnings estimates for the EM corporate sector. We will have to watch both
closely now that the dollar has started rising again.
When EM exchange rates bottomed, EM equities EM portfolio inflows: stabilizing

improved, EM real exchange rate index vs. US$, 1991=100 % of GDP, 2-quarter average, ex-China
120 6%
Shaded area:
115 outperformance of 5%
EM vs. DM equities 4%
110
3%
105
2%
100
1%
95
0%
90 -1%
85 -2%
80 -3%
'84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16 1980 1985 1990 1995 2000 2005 2010 2015
Source: J.P. Morgan Securities LLC, JPMAM. November 30, 2016. Source: National statistics offices, IMF, Haver Analytics. Q2 2016.
EM corporate earnings estimates: improving Brazil credit spread on external sovereign debt
12-month forward consensus earnings, ex-China 5-year credit default swap, basis points
60% 550
40% 500
450
20%
400
0%
350
-20%
300
EMERGING
MARKETS
-40% 250
-60% 200
'05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16
Source: IBES, JPMAM. December 9, 2016. Indexed to January 2016. Source: Bloomberg. December 28, 2016.
A good example of post-crisis deep value investing: Brazil. In last year’s Eye on the Market
Outlook, we discussed how Brazil’s economy was as bad as anything I had seen since 1994 (growth,
current account deficit, trade balance). Nevertheless, I wrote that the risk of Brazilian sovereign default
on external debt was lower than in 2002, primarily due to a shift in sovereign financing from external to
domestic debt. In other words, while Brazil has a lot of problems, unlike Greece (2009) and Argentina
(2001), Brazilian sovereign external debt is NOT the core problem, and defaulting on it would probably
not be a part of a solution. The chart above shows the rally in Brazilian sovereign external debt that
began in January 2016.
25 25
2017 Eye on the Market Outlook Special Topics Chapter Links
1 Leverage What amount of leverage can survive a world of volatile Page 27

markets? Now that the window for low-cost borrowing may
be closing, we look at history and the future
2 Active The end of “peak central bank intervention” may reduce Page 29
management distortions and help active managers
3 LNG Rising US natural gas prices due to large-scale US LNG exports? Page 31
Unlikely on both counts. What Dep’t of Energy LNG export
approvals mean, and what they don’t
4 Tax efficient How to simultaneously employ tax loss harvesting and Page 33
investing generate market returns
5 Infrastructure The role for public-private partnerships: PPPs have their critics, Page 34
but the Obama administration is not among them. When
should investors participate?
6 Clean coal/CCS The biggest problem with “clean coal”: scope. Infrastructure Page 36
required to make carbon capture and storage a meaningful
contributor is vastly underestimated
7 Internet-based How helpful have user growth metrics been in assessing new Page 37
business models internet-based business models? Not very
8 Commodity prices Markets are looking past inventory gluts given huge declines in Page 38
capex; remembering the commodity surge of the 1970s and
Richard Nixon
In each section click on the video icon to watch Michael discuss each topic.
26 26
[1] What amount of portfolio leverage can survive a world of volatile markets?
In our study of state pension plans, we found that median expected long-term returns on plan assets
were around 7.5%. While corporate plans discount liabilities at lower rates than state plans, Milliman
cites a funding ratio of 76% for the 100 largest corporate plans, indicating that many may need higher
returns. As a result, some pensions, endowments, foundations and individuals have contemplated
leverage (in one form or another) to increase portfolio returns. Since the window of opportunity to
borrow at historically low levels may be closing, we wanted to take a closer look at leverage this year.
How much leverage can a portfolio sustain in a world of volatile markets, particularly since
correlations among asset classes can rise close to 1.0 during a crisis? For purposes of this analysis,
we define successful use of leverage as a scenario in which a portfolio does not experience “failure” over
a 10-year period. We also assume that leverage is implemented through long-term fixed rate borrowing,
and that leverage proceeds are used to gross up existing portfolio holdings on a pro-rata basis.
We looked at leverage from two perspectives: historical, and forward-looking. Our definitions of failure
differ in each approach. The goal: develop some rough estimates of how much leverage a portfolio
could carry without causing regret and recriminations at some point down the road.
The empirical, historical analysis

In the first approach, we start with a representative diversified portfolio of marketable securities that is
rebalanced quarterly. We then compute the following: over each ten-year period, using actual daily
returns on each asset class, what is the maximum amount of leverage that the portfolio could have
employed without experiencing failure? In this approach, failure is defined using a “margin call”
concept, one which is imposed by the provider of the financing, and which is triggered when/if the
portfolio declines to a 75% loan to value.
As shown in the chart, during the 1990s, our prototype portfolio could have employed 60%-70%
leverage and not hit the margin call trigger19. However, as you might imagine, the tech collapse and the
financial crisis then redefined the universe of bad market outcomes. In early 2008, based on this
analysis, the diversified portfolio could not have taken on more than 40% leverage. To be clear, while
the portfolio could have carried 40% leverage, that doesn’t mean that leverage would always have
delivered positive returns. We are simply measuring the portfolio’s ability to sustain a market decline and
keep going, without forced sales of assets along the way.
Maximum leverage possible to avoid margin call

Leverage, defined as a % of the gross portfolio value
Asset class Index Weight
75%
Large-cap US equities S&P 500 Total Return 30%
70% Small-cap US equities Russell 2000 Total Return 5%
65% International equities MSCI EAFE Total Return 10%
Emerging mkt equities MSCI EM Total Return 10%
SPECIAL
TOPICS
60%
Investment grade bonds US Aggregate Total Return 20%
55% US high yield US Corp HY Total Return 10%
Commodities S&P GSCI Total Return 5%
50%
Leveraged loans S&P/LSTA LL Total Return 5%
45% Emerging mkt debt JPM EMBI Global Total Return 0%
Ten-year period beginning in... REITs DJ Equity REIT Total Return 5%
40%
Jan-90 Jan-94 Jan-98 Jan-02 Jan-06 Cost of debt 3.5%
Source: JPMAM, Bloomberg. Assumes margin call at loan-to-value of 75%.
19
This is a theoretical exercise in portfolio leverage; rules around maximum allowable collateralized leverage differ
by jurisdiction.
27 27
Should the universe of bad market outcomes forever be impacted by the implosion in 2008,
given increases in bank capitalization, the reduction in the shadow banking system, the migration of
certain derivative contracts to centralized exchanges, the decline in non-conforming mortgages, etc?
That is something that every portfolio manager, risk manager, chief investment officer and investor has
to grapple with. If your answer is “yes”, then leverage of 40% would be as high as you would go based
on the historical analysis.
The forward-looking analysis

In this approach, future returns are based on J.P. Morgan’s Long-Term Capital Markets Assumptions, and
are subject to various “non-normal” and “fat left tail” shocks20. In this approach, financing is assumed
to be non-recourse. As a result, failure is effectively defined by the CIO, who would have to decide if it
was a good or bad idea in hindsight to have used leverage. This is obviously a subjective question, but
we can try to put some parameters around it. We define failure as follows: when the portfolio’s value
falls to the point where, given the time remaining and our expected returns, it would be very unlikely to
earn its way back21.
The chart below shows the rising probability of failure at different levels of leverage. The bar is higher
here since, unlike the prior analysis which simply has to avoid a margin call, this portfolio needs to
generate a return at least equal to the cost of its leverage over the entire horizon. That’s one reason why
the failure rate is never zero. Looking again at the 40% leverage case, is an incremental 15% failure rate
“too high”? That’s a subjective determination that has to be considered against the consequences of
unlevered portfolio returns that are below target levels, the ability to restructure pension obligations if
needed, and the ability of the plan and/or its workers to make emergency contributions. Our Multi-Asset
Solutions Quantitative Research and Strategies group looks closely at these questions on behalf of our
institutional clients, and can go into greater detail regarding the calculations and assumptions used in
this part of the analysis.
Failure rate as a function of leverage

Change in failure rate vs. 0% leverage baseline
35% Asset class Weight
30%
Global equities 40%
US investment grade bonds 30%
25%
US high yield bonds 5%
20%
Diversified hedge funds 5%
15% US private equity 5%
10% Commodities 5%
5% US real estate 10%
0% Cash 0%
10% 20% 30% 40% 50% 60% 70% Cost of debt 3.5%
Leverage, as a % of gross portfolio value
SPECIAL
Source: J.P. Morgan Asset Management. December 2016.

TOPICS
20
For more information on modeling such scenarios, see “Non-Normality of Market Returns: A Framework for Asset
Allocation Decision-Making”, Abdullah Sheikh, J.P. Morgan Asset Management.
21
In each scenario, we assume a target return of at least the cost of the debt on the entire portfolio over the 10-
year window. We then assume failure occurs when the investor has less than a 20% chance of achieving the
stated goal based on the portfolio’s value at that point and future expected returns.
28 28
[2] Prospects for improved active equity management performance
The last few years have been difficult for some large-cap US active equity managers. In my view, this
outcome is partially explained by distortions resulting from the most extreme monetary policy experiment
in history. Now that markets are beginning to price in gradual exits from these policies, prospects for
active equity management may improve.
While it’s hard to generalize, the typical large-cap US active equity manager employs many of the
following approaches:
 Prefers low P/E stocks to high P/E stocks
 Prefers to equal-weight portfolios rather than market-cap weight them
 Underweights high-dividend, low-volatility stocks such as consumer staples, REITs, telecom and
utilities (the “bond proxy” stocks)
 Does not prefer stocks simply based on their positive price momentum
 Holds some cash rather than being fully invested
 Often has an out-of-index position in European, Asian or US mid-cap stocks
 Prefers stocks with high degrees of idiosyncratic risk (i.e., stocks whose returns are not easily
explained as a function of other factors)
The first chart shows how many of these 10 factors that “worked” over time (blue bars). There have
been 3 swoons in factor performance since 2006. These swoons fit reasonably well with the percentage
of large-cap US equity managers that outperformed on a net of fee basis (red line). With the US Federal
Reserve moving slowly toward rate normalization, the ECB announcing its tapering plans and the BoJ
moving to a yield targeting regime, I believe we are now past “peak monetary intervention”, which may
explain improving factor performance since the middle of 2016. The second chart shows the return for
each of the ten factors since June 30, 2016.
US large-cap core equity manager outperformance Factor returns since June 30, 2016
closely related to factor performance %
# of factors % outperforming, 1-year basis 6%
10 % of managers 80%
# of factors w/ positive rolling 12M
4%
Equal vs. mkt-cap wgt
9 outperforming
Mid-cap vs. S&P 500
Low vs. High momentum
return 70%
O/W Idiosyncratic risk

Low vs. High div yield
High vs. Low volatility
Cash vs. S&P 500

8
Low vs. High P/E
U/W Mega-caps
60% 2%
7
EAFE vs. US
6 50%
0%
5 40%
4 30% -2%
3
20%
2 -4%
1 10%
SPECIAL
TOPICS
0 0% -6%
'96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16
Source: JPMAM, Morningstar. November 2016. Performance net of fees. Source: JPMAM, Morningstar, Factset. November 30, 2016.
29 29
As additional signs that market conditions are changing in ways that may help active managers, consider
the following charts on sector dispersion (rising), realized correlation amongst stocks (falling) and implied
correlations between stocks (falling). These patterns may be signaling a return to a more normal stock-
picking environment for active managers.
Sector dispersion is rising... ...as realized stock correlation is falling...

4-day difference in top vs. bottom sector performance Average 3-month correlation
25% 0.8
Hundreds
0.7
20%
0.6
15% 0.5
10% 0.4
0.3
5%
0.2
0% 0.1
'01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16
Source: Bloomberg. November 14, 2016. Source: Goldman Sachs Research. December 7, 2016.
...and implied stock correlation is also falling

CBOE implied correlation index
90
80
70
60
50
40
30
20
'07 '08 '09 '10 '11 '12 '13 '14 '15 '16
Source: Bloomberg. November 18, 2016.
SPECIAL
TOPICS
30 30
[3] Rising US natural gas prices due to large-scale US LNG exports? Unlikely on both counts
I was reading reports that mentioned how the US Department of Energy has approved applications for
US firms to export 50 billion cubic feet per day of liquid natural gas (LNG), an amount equal to 2/3 of
current US natural gas production. Some analysts see this as a catalyst for much higher US natural gas
prices. A closer look: first, it would be surprising if US LNG exports were to exceed 20% of production,
and second, much of the US LNG export arbitrage opportunity disappeared over the last three years as
Asian LNG import prices fell.
The chart shows Japanese and Korean LNG import prices on the left axis, and on the right axis, US
natural gas production (green line) and current export applications (blue dots), both in billions of cubic
feet (bcf) per day.
LNG: Asian import prices and US export applications

$ per MMBtu Billion cubic feet per day
$22 90
US natural gas
80
production
$18 70
US export
60
$14 applications
A 50 A: Applications approved by DoE to export LNG to FTA
B
40 B: Applications received by DoE to export LNG to non-FTA
$10 Japan-Korea LNG
import price 30
$6 20 C: Applications approved by DoE to export to non-FTA
C
10 (less contingent approvals)
D
D: LNG export facilities under construction
$2 0
2010 2011 2012 2013 2014 2015 2016 2017
Source: DoE, EIA, FERC, J.P. Morgan Securities, JPMAM. Dec. 12, 2016.
Here’s how we see it:

• Understanding what DOE approvals really mean. The DOE has “approved” 50 bcf per day of
US LNG exports to Free Trade Agreement countries (point A on the chart). However, approvals to
FTA countries are basically a rubber stamp and do not entail substantial documentation requirements.
Korea is the only FTA country of 20 with large LNG import demand22, and now Korean LNG import
prices have fallen, reducing the arbitrage potential which existed three years ago. A large price
differential vs. the US is needed to justify LNG exports given the high cost of constructing LNG
import/export facilities and shipping costs.
• We mostly focus on DOE approvals to NON-FTA countries. What matters more are DOE
approvals to non-FTA countries that are large LNG importers: China, Taiwan, Japan and India. While
the DOE has received export applications for 46 bcf per day (point B), they have only approved 14-15
bcf (point C). Around 2/3 of these approved projects are now under construction at 6 US LNG
SPECIAL
TOPICS
facilities (point D).
• Some non-FTA projects are unlikely to proceed given Asian LNG price declines, and rising
costs of project approval. What about the 31 bcf of non-FTA LNG export applications that have
been received but not approved? Given the decline in Asian LNG import prices, we’d be surprised to
see many of these projects proceed, particularly given new rules which require DOE applicants to first
obtain costly approvals from the Federal Energy Regulatory Commission. A shortage of investment-
grade counterparties is also a challenge for LNG project developers, given the need for long-term
bond/bank financing.
22
Most FTA countries import natural gas via pipeline from Russia, Norway and the Netherlands.
31 31
• How does the DOE make decisions on LNG export projects? The DOE takes a lot of things into
account when considering non-FTA approvals, including the adequacy of the domestic natural gas
supply, US energy security, impacts on the US economy (particularly the cost of electricity23 and gas-
related input costs for manufacturers), international considerations and environmental impacts. As
part of this process, the DOE issued a study in October 2015 that considered the macroeconomic
impact of US LNG exports reaching 20 bcf per day, which may represent an upper bound in their
thinking on the subject. Their primary conclusion: any increase in US LNG exports would mostly
result from increases in US domestic production, and not result in much higher US prices or
constrained demand.
The bottom line: given the decline in Asian LNG import prices, lower-cost gas import options for
Eastern and Western Europe (pipelines from Russia, Norway and the Netherlands, and LNG from Algeria),
the high costs of constructing LNG plants, the need for high-quality counterparties to secure long-term
financing, the cost and complexity of the US approval process and the likelihood that higher US natural
gas prices would unleash a domestic production response, we’d be surprised to see US LNG exports
exceed 20% of US production. We also do not expect US natural gas prices to change much when LNG
facilities under construction come online.
As for the increase in natural gas prices since February 2016 (their all-time low), this appears to be more
a reflection of falling US shale production than of the prospect of rising US LNG exports.
Natural gas price and US production

$ per MMBtu Billion cubic feet per day
$13 85
Production 80
$11
75
$9
70
$7 65
Price 60
$5
55
$3
50
$1 45
'06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16
Source: EIA, Bloomberg. December 28, 2016.
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23
Residential and commercial electricity prices in the US are roughly 30%-40% lower than in Europe and China.
32 32
[4] For taxable US investors: how to track a benchmark on a tax-aware basis
Tax-loss harvesting has been around for a long time. The general premise: securities sold at a loss can be
used to offset capital gains for tax purposes. This technique particularly benefits investors with large
short-term capital gains, which are taxed at almost twice the rate of long-term gains. This asymmetry
suggests that accelerating short-term losses can be valuable for investors.
However, mutual funds and exchange-traded funds are typically not ideal vehicles for individuals to use
for tax-loss harvesting. The reason: when units are sold, tax consequences are based on the changing
price of the unit itself, which reflects all of the gains and losses in the fund and not just the losses. In
many years (see 1st chart), S&P stocks with substantial declines are offset by stocks that rise sharply. To
isolate the tax losses inside a portfolio, it makes more sense to use a separately managed account.
Here’s the goal of this exercise: can a separately managed equity account isolate tax losses while
still tracking a specific equity index closely? We asked a manager we work with that specializes in
nd
this approach to illustrate how it can be done. As shown in the 2 chart, the performance of indicative
separately managed portfolios is almost identical to the S&P 500 (the performance series are practically
superimposed on each other).
Intra-index price dispersion in the S&P 500 Very little performance deviation between portfolio &
% of stocks benchmark, Pre-tax quarterly total return
100% 20%
stocks w/ return > 15%
80% 15%
60% 10%
40% 5%
20% 0%
0% -5%
-20% -10%
S&P 500
-40% -15%
Portfolio
-60% -20%
stocks w/ return < -15% -25%
-80%
'02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16
-100%
Source: Parametric Portfolio. Q3 2016. Shown for illustrative purposes only.
'94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16
Average annualized tracking error of 0.73% vs. 4.1% for active US large-cap
Source: Bloomberg, JPMAM. December 16, 2016. equity funds and 0.04% for passive S&P 500 tracker ETFs.
Low return dispersion vs. the benchmark is a Distribution of realized tax events
good sign, but what about the portfolio’s tax- % of all realized tax events by vintage year, cumulative through 2015
ST capital loss LT capital gain LT capital loss ST capital gain
loss harvesting capabilities? A manager of such a 100%
strategy tries to realize short-term capital losses, and
when gains must be taken to rebalance the portfolio, 80%
they are generally deferred until they qualify as long- 60%

term. As shown in the final chart, illustrative tax-
aware portfolios have done exactly that: the tax 40%
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realizations are dominated by short-term capital 20%
losses and long-term capital gains. Ultimately, this
0%
is all about maximizing tax efficiency while minimizing '02 '03 '04 '05 '06 '07 '08 '09 '10
return deviation from an index. The ample liquidity Source: Parametric Portfolio, JPMAM. Q4 2015. Shown for illustrative
and depth of the US equity market enables these purposes only. Past performance is not indicative of future results.
kinds of strategies to pursue both goals.
Even if some parts of Trump’s tax plan are enacted,
tax-aware investing will still make sense given the
spread between tax rates on short-term gains and
long-term gains.
33 33
[5] Infrastructure investing and the role for public-private partnerships
The GOP and Democrats seem to agree that infrastructure investment is a high priority. However, there’s
disagreement about how to do it. Clinton’s plan relied on direct government spending on infrastructure,
financed through taxes on accumulated and untaxed offshore corporate profits. Trump’s plan appears to
rely more on private sector investment by offering tax breaks to private enterprises to construct and
operate new revenue generating projects in concert with public agencies (i.e. public-private partnerships,
or PPPs). Some commentators have criticized Trump’s plan (Krugman called it “basically fraudulent”24
and Sanders described it as “corporate welfare”25). However, there are ways that PPPs can drive
infrastructure investing, particularly if the use of proceeds is to finance new greenfield projects. It all
depends on the details.
Let’s start with the recognition that the current system does not produce the necessary amount of US
infrastructure spending26. Since Federal debt ratios are close to the highest levels since WWII and since
most municipalities are constrained on spending (due to unfunded pension and retiree healthcare costs),
some analysts believe that PPPs can play an important role. In fact, Obama’s Treasury department
issued a report in 2015 on the subject which strongly endorses PPPs as a means of building
infrastructure for the future27. Here are some of its conclusions:
 “The need to reverse years of underinvestment in infrastructure, despite tighter budgets at
every level of government, calls for us to rethink how we pay for and manage infrastructure
Strong PPP endorsement from the Obama administration
investment”
 “When the private sector takes on risks that it can manage more cost-effectively, a PPP may
be able to save money for taxpayers and deliver higher quality or more reliable service over a
shorter timeframe compared to traditional procurement”
 “When sponsors contract with private partners that support strong labor standards, PPPs can
also provide local economic opportunity and create good, middle-class jobs that benefit
current and aspiring workers alike”
 “While PPPs cannot eliminate the need for government spending on infrastructure, we can
help meet our nation’s infrastructure needs by expanding the sources of investment and
using those dollars, whether public or private, as effectively as possible to advance the
public’s interest”
 “Other advanced economies, including Australia, Canada, and the United Kingdom, rely
more heavily than the United States on PPPs to secure equity financing for infrastructure”
 “Although the role of PPPs in the US market is limited, the US Department of the Treasury’s
research and engagement with stakeholders indicate that significant private capital could be
mobilized for infrastructure investment”
 “However, in order to attract this capital, US public infrastructure assets will have to support
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higher rates of return than are currently generated through 100 percent low-cost debt
financing in the municipal bond market”
24
“Build He Won’t”, Paul Krugman, New York Times, November 21, 2016.
25
“Let’s Rebuild our Infrastructure, Not Provide Tax Breaks to Big Corporations and Wall Street”, Bernie Sanders,
Medium.com, Nov. 21, 2016.
26
In 2013, the American Society of Civil Engineers graded the United States infrastructure in a 74-page report. The
grades: B- for solid waste, C+ for bridges & railways, C for ports, D+ for energy, D for aviation systems, dams,
drinking and waste water, schools, transit, and roads, and D- for inland waterways and levees.
27
“Expanding the market for infrastructure public-private partnerships: alternative risk and profit sharing approaches
to align sponsor and investor interests”, US Department of the Treasury, April 2015.
34 34
I asked our infrastructure group at J.P. Morgan Asset Management to weigh in on the subject. Here’s
what they had to say about PPPs:
 PPPs require some combination of federal grants, taxes and user fees to incent private capital to
participate. This framework has to exist before PPPs can be launched, and must often be preceded
by political outreach to gain support from taxpayers and other constituents. While user fees often
seem like a nuisance or private sector profiteering, they are essentially a replacement for public sector
spending and related taxes paid by citizens
 While the privatization of existing assets may not appear to generate much in the way of investment
or hiring on the asset privatized, the use of proceeds can accelerate greenfield (new) projects
that have higher multiplier effects
 In principle, a PPP that allocates responsibilities optimally would have governments deal with
legislation, jurisdictional considerations, procurement, permitting, siting, appeals, etc28. Then, private
sector operators would focus on project delivery and management
 There are examples of successful PPPs, some of which have taken place outside the US, as noted
in the Treasury report:
o Local privatization of 11 Canadian airports, with the Ministry of Infrastructure quid pro quo that
it be able to use proceeds for new greenfield projects
o Australian infrastructure program, in which existing infrastructure assets are sold to finance the
construction of new projects at the national and local level (similar in concept to Canada)
o In the UK, the £4.2 billion Thames Tideway wastewater project was financed through a PPP
which took advantage of low interest rates on project financing. The UK government took the
timing and construction cost overrun risk (immunizing private sector capital from a Boston-esque
“Big Dig” outcome), which then lowered the return requirement for private capital. The UK
intends to use the same approach for future electricity transmission and aquifer projects
o In Texas, with guidance and direction from government entities, private capital (a combination of
utilities, cooperatives and private investors) financed $7 bn of wind farm transmission lines from
2007 to 2013, supporting Texas’ 18.5 GW of installed wind capacity, the highest in the US
o In Los Angeles, major public transit projects are being financed in part by an increase in the sales
tax until 2062, based on a bill approved this fall. Projects include extending light rail to LAX,
extending the subway to Westwood, earthquake retrofits and highway improvements. Projected
tax proceeds of $120 bn will be used as the government’s contribution to projects that also entail
private sector capital and private sector project management and construction (thereby limiting
permanent employment increases for California’s public sector)
o Denver’s airport train system received a $1 bn Federal grant as part of a larger PPP in which
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private sector bidders identified design efficiencies that resulted in significant cost savings (one
TOPICS
example: double tracking wasn’t necessary for the entire route given train frequencies); the grant
would not have been available if it were a public-only project
28
A good example of the constructive role that government can play: the Path-15 electricity transmission
project in California. An impasse between the California Energy Commission and the California Public Utilities
Commission had prevented improvement of transmission bottlenecks that led to blackouts in 1996 and 2001. The
Western Area Power Administration (a Federal entity) was able to use the threat of jurisdiction and eminent domain
to get both parties to the table to complete the project.
35 35
[6] The biggest problem with “clean coal”: scope
“Clean coal” is a euphemism for coal powered electricity in which carbon capture and storage of CO2
takes place (CCS). By the end of 2016, CCS facilities in operation will be able to capture and store just
0.1% of the world’s CO2 emissions. Let’s put aside issues of large cost overruns on recent projects29, the
Department of Energy withdrawing support from several large projects (FutureGen in Illinois), project
cancellations in Europe, legal uncertainties about liability associated with CO2 leaks, evidence of leakage
and earthquake risk from CCS operations in the Middle East and the North Sea, and the ~30% energy
drag on coal facilities required to perform CCS in the first place.
Let’s assume that all of these problems can be solved via technological innovation and legislation (an
aggressive assumption, for sure). The bigger problem with CCS is the scope required to make a
difference. To see why, let’s assume the world aims to sequester just 15% of global CO2 emissions.
 In 2015, global CO2 emissions were 33.5 billion tonnes
 To sequester 15%, that would mean capturing, transporting and burying 5.0 billion tonnes of CO2
 That amount of CO2 by weight is equivalent to 6.3 billion cubic meters of CO2 by volume (assuming
0.8 tonnes per cubic meter of CO2 when compressed)
 How much volume is that? Global crude oil extraction in 2015 was 4.4 billion tonnes by weight,
which is equivalent to around 5.1 billion cubic meters of oil by volume
Compare the two bolded numbers above, and you can see the problem. Even capturing a small
portion of global CO2 emissions would require a CO2 compression/transportation/storage industry whose
throughput is even greater than the one used for the world’s oil transportation and refining, which has
taken 100 years to build (see map); and that’s without the benefit that oil provides as an energy input to
vehicle transportation and industry. There may be applications where CCS makes sense (enhanced oil
recovery, and meeting small amounts of commercial CO2 demand). But as a big picture solution to CO2
emissions, CCS infrastructure needs and costs are very daunting.
Global oil pipeline and refining networks

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Source: Rextag. November 2016.
29
According to the New York Times, the Kemper clean coal plant in Mississippi is more than two years behind
schedule, more than $4 billion over its initial budget of $2.4 billion, and still not operational.
36 36
[7] User-based digital business models and the monetization challenge
How helpful is information about user growth when digital internet companies go public? The answer:
not very, or at least not without a lot of other accompanying information. The 1st chart shows growth in
active users for a variety of different internet-based companies that went public over the last few years30.
For each one, user growth is indexed to 100 at month zero (the time of the IPO). The companies whose
stocks eventually fell well below their IPO price are shown in red; the winners are shown in green.
Among stocks that performed poorly after IPO, Zynga is actually the exception: a poorly performing stock
whose declining user base was a clear, coincident signal. For many of the other poorly performing
stocks, user growth was strong both before and also after the IPO, at least during the first year or
two. Some examples: Pandora, Zulily, Groupon, Etsy, Angie’s List and Twitter had rapid user growth out
of the gate post-IPO, sometimes faster than user growth at Yelp, Facebook and LinkedIn. Nevertheless,
the former group’s stocks substantially underperformed the latter.
User growth: an insufficient metric for investors Consensus projections versus actual performance
Index of user growth (final private observation = 100) Stock price change, %
350 200%
Last obs. ANGIE'S Consensus proj. 12-month
LIST
300 before IPO PANDORA
price change at IPO
150%
217%
335%
250 Stocks above LINKEDIN Actual performance to date
YELP
IPO price ZULILY
RetailMeNot
100%
Angie's List
200 GRUBHUB
Stocks below
Facebook
FACEBOOK
GrubHub
LinkedIn
Groupon
150 IPO price GROUPON
Zynga
Twitter
TWITTER
50%
Zulily
Etsy
Yelp
ETSY RETAILMENOT
100
50 ZYNGA
0%
Pandora
0
-50%
-36 -30 -24 -18 -12 -6 0 6 12 18 24 30 36 42 48 54 60 66
Months before/after last private observation
-100%
Source: Company filings, Bloomberg, JPMAM. October 2016. Source: Bloomberg. December 15, 2016.
It might seem with the benefit of hindsight that some of the red-lined stocks in the chart on the left were
challenged from the beginning. But at the time these stocks went public, that wasn’t the case, at least
not among the analyst community that covered them. The chart on the right shows consensus price
forecasts for each company. With the exception of Groupon and Pandora, the consensus was that these
stocks would either remain stable or rise sharply after IPO.
Here’s some additional information that we look for when evaluating pre-IPO and post-IPO investments
in companies like these: “lifetime customer value”, which incorporates churn rates, revenues and variable
costs; user engagement, measured either in time or in features accessed; daily active users (rather than
monthly active users); customer acquisition costs, which include total marketing expenses; and data on
both “bookings and “revenues”, with the latter recognized only when service is provided.
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However, this kind of information is often not available before or at the IPO, requiring investors
to make a lot more assumptions than usual about what the future holds for these businesses. That‘s one
reason (among many) why J.P. Morgan Asset Management has generally not included pre-IPO positions
in its equity mutual funds, despite a small allowable allocation to do so. The liquidity, disclosure and
overall risk of pre-IPO positions, particularly in digital/internet companies, are better suited to vehicles
specifically designed for them.
30
We collected the user metric that each company reports. Facebook, Pandora, Twitter, LinkedIn, and Yelp report
monthly active users. Other companies report daily active users (Zynga), trailing twelve month active users
(GrubHub, Zulily, Groupon, Etsy), quarterly visits (RetailMeNot) or paid memberships (Angie’s List).
All companies referenced are shown for illustrative purposes only, and are not intended as a recommendation or
endorsement by J.P. Morgan in this context.
37 37
[8] A large capex decline set the stage for rising industrial metals prices
In January 2016, some colleagues showed me a report on commodity super-cycles dating back to 1779,
and how on average, they took 15 to 30 years to bottom after the peak. The implication: there’s a long
way to go before the damage from the current super-cycle ends, since we’re only 4-5 years into its
unwinding. However, as I wrote in February 2016, commodity prices typically declined by 50%-70%
when these prior super-cycles unwound. In that regard, the damage had been done: commodity
prices had already declined by roughly half from their peak by the end of 2015. For investors, I
think “price” is more important than “time”, which is why we became more optimistic on industrial
metals prices in early 2016.
st
The 1 chart shows the stabilization in industrial metals prices. Why did prices stabilize if inventories are
still at or close to multi-year highs (2nd chart)? Note: while zinc is an outlier given its declining inventory
levels, it is much less important than the other three: the dollar value of zinc inventory is only 7% of the
total inventory value of the 4 metals shown.
Industrial metals prices are stabilizing Global copper, aluminum, nickel and zinc inventories
Index level Index, 1985 = 100
500 350
450
300 Nickel
400
350 250 Aluminum
300 200
250
150 Zinc
200
Copper
150 100
100
2000 2002 2004 2006 2008 2010 2012 2014 2016 50
'85 '88 '91 '94 '97 '00 '03 '06 '09 '12 '15
Source: Bloomberg. December 15, 2016. Index tracks aluminum, copper,
zinc, nickel and lead. Source: Wood Mackenzie, JPMAM. Dec 2015. Dot is an estimate for 2016.
In our view, markets are looking past the current inventory glut and paying more attention to
the sharp decline in capital spending on industrial metal extraction. This capex decline is very
similar to the one taking place in oil, which is also having a stabilizing effect on oil prices. Our view on
commodity prices is “stabilization” rather than a sharp upward spike like 2006 or 2009; that should be
sufficient to stabilize conditions in many EM commodity exporters as well.
Global copper, aluminum, nickel, zinc and oil capex On Oil. In our 2016 Outlook, we wrote that the
Index, 2000 = 100 supply-demand adjustment in oil would be well
1,600
underway by 2017, which pointed to higher prices.
1,400 In June 2016, we wrote again about the oil capex
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1,200 decline, large investor short positions, rising non-

1,000 OPEC field decline rates, stable oil demand growth
800
and the utter irrelevancy of renewable energy when
Zinc discussing prospects for oil markets. Where to
600
Copper from here? An oil supply deficit is now in plain sight
400 Nickel by the end of 2017, particularly if OPEC countries
200 Oil adhere to their historical 50% compliance rate with
Aluminum
0 announced cuts. Peaking shale oil productivity per
'00 '02 '04 '06 '08 '10 '12 '14 '16 rig is another factor which may contribute to further
Source: Wood Mackenzie, Barclays. Dec 2015. Dot is an estimate for 2016. tightening in supply-demand conditions.
38 38
Time capsule on the 1970s: what if True Believer central banks lost control of inflation?
I don’t think it will get nearly this bad, but as a reminder, this is what can happen if central banks lose
control of inflation and are forced to play catch-up from behind. During the 1970s, real returns on
commodities were substantial, particularly when compared to the zero real returns earned on stocks and
bonds over the course of the decade. Richard Nixon may have opened the door to China, but he also
opened the door to stagflation, through the imposition of wage/price controls, and through interference
in the inner workings of the Federal Reserve (see box).
Real total return on stocks, bonds and commodities in

the 1970s, January 1970 = 100
400
350
Commodities
300 (S&P GSCI)
250
200
Intermediate
150
US treasuries
100
S&P Composite
50
'70 '71 '72 '73 '74 '75 '76 '77 '78 '79 '80
Source: Shiller, Ibbotson, S&P, Bloomberg, JPMAM. December 1979.
Remembering Richard Nixon

Interference at the Federal Reserve. When Fed chairman Arthur Burns resisted pressure from Nixon to
guarantee full employment, the White House planted negative stories about Burns in the press. Nixon’s
people also floated stories about diluting the Fed Chairman’s power by doubling the Board’s members.
Nixon wrote to Burns: “There is no doubt in my mind that if the Fed continues to keep the lid on with
regard to increases in money supply and if the economy does not expand, the blame will be placed squarely
on the Fed.” In 1971, H.R. Haldeman spoke about the effectiveness of Nixon’s strategy: “We have Arthur
Burns by the [expletive deleted] on the money supply”.
Sources:
"Secrets of the Temple: How the Federal Reserve Runs the Country" by William Greider
"Before the Fall: An Inside View of the Pre-Watergate White House" by William Safire
"Monetary Policy and the Great Inflation in the United States: The Federal Reserve System and the Failure of
Macroeconomic Policy" by Thomas Mayer
Political shenanigans. It’s hard to talk about Nixon without also recalling how he and his operatives
conducted themselves during elections; Watergate was not an isolated event. Some examples: President
Nixon and an aide discussed planting McGovern campaign literature in the apartment of the man who shot
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George Wallace; Nixon operatives produced counterfeit mailings on Muskie letterhead that were critical of
Ted Kennedy, and that accused Hubert Humphrey and Henry Jackson of sexual misconduct; Nixon aides
hired phony Muskie volunteers to call people at home in the middle of the night, ringing back multiple
times with the same questions; Nixon aides hired a woman to strip outside Muskie’s hotel room yelling “I
Love Ed Muskie!”; and invitations to non-existent events with (alleged) free food and alcohol were
distributed by Nixon operatives on behalf of other candidates, angering people when there was none.
Sources:
New York Times, December 14, 1992
William Manchester and J. Anthony Lucas in “Nightmare: The Underside of the Nixon Years”
39 39
LinkedIn updates
Since August 2016, we have posted the following market and economic updates on LinkedIn:
12/12/2016 Life Away from Home, Part 2 (Holiday Eye on the Market)
11/30/2016: Japan equities: Higurashi moments are rare
11/11/2016: Orange is the New Tack: Implications of a Trump Presidency
11/2/2016: Why voter clustering matters and the battle for the House
10/26/2016: Electric cars: a 1% solution? (with commentary on renewable energy)
10/12/2016: The tell-tale heart of the Buffett Rule
10/5/2016: After the fall, own some emerging markets
9/28/2016: Presidential debate chart-watch
9/21/2016: The distant meteor of unfunded pensions
9/14/2016: War on savers retirement kit
9/7/2016: Worst moments from the Party conventions
8/30/2016: China’s environmental mess
8/25/2016: The high price of bond-like stocks
8/23/2016: The limited impact of geopolitics on markets
Sources and acronyms

“Challenges to mismeasurement explanations for the US productivity slowdown”, Chad Syverson,
University of Chicago, NBER Working Paper, February 2016.
“Does the United States have a productivity slowdown or a measurement problem?”, Byrne et al, Federal
Reserve and the IMF, Brookings Paper on Economic Activity, March 2016.
“Piles of Dirty Secrets Behind a Model Clean Coal Project”, New York Times. July 5, 2016.
“The Chinese Consumer: Outlook and Trends 2016”, Gavekal Research. November 2016.
“The truth behind 10 years of earnings underperformance”, Morgan Stanley Research, June 7, 2016.
“There’s actually a way for Trump to help coal and still help the climate”, Washington Post, Nov. 17, 2016.
AfD: Alternative for Deutschland; bcf: billion cubic feet; BEA: Bureau of Economic Analysis; BLS: Bureau
of Labor Statistics; BOJ: Bank of Japan; CBO: Congressional Budget Office; CBOE: Chicago Board
Options Exchange; CC: China Customs; CCS: carbon capture and storage; CFLP: China Federation of
Logistics & Purchasing; CNBS: China National Bureau of Statistics; DOE: Department of Energy; EBITDA:
earnings before interest, taxes, depreciation and amortization; ECB: European Central Bank; EIA: Energy
Information Administration; EM: emerging markets; EPS: earnings per share; ETF: exchange-traded fund;
FDA: Food and Drug Administration; FERC: Federal Energy Regulatory Commission; FOMC: Federal
Open Market Committee; FRB: Federal Reserve Board; FTA: free-trade agreement; ICT: Information and
Communication Technologies; IMF: International Monetary Fund; IPO: Initial Public Offering; LNG:
liquefied natural gas; LT: long-term; NATO: North Atlantic Treaty Organization; NFIB: National
Federation of Independent Business; OECD: Organization for Economic Cooperation and Development;
P/E: price-to-earnings ratio; PBOC: People’s Bank of China; PCE: personal consumption expenditures;
PMI: Purchasing Managers’ Index; PPP: public-private partnership; QE: quantitative easing; ROE: return
on equity; SOE: state-owned enterprise; ST: short-term; UKIP: UK Independence Party; VAT: value
added tax
40 40
E Y E O N T H E M A R K E T  M I C H A E L C E M B A L E ST  J . P . M O R G A N A S SE T M A N A G E M E N T JANUARY 1, 2017
EYE ON THE MARKET • MICHAEL CEMBALEST • OUTLOOK 2017
F O R I N S TI TU TI O N A L / W H O L ES A L E/ PRO F ES S I O N A L CL I EN T S A N D Q U A L I F I ED I N V ES TO RS O N L Y –
N O TINSTITUTIONAL/WHOLESALE/PROFESSIONAL
FOR F O R RETA I L U S E O R D I S TRI BU TICLIENTS
ON AND QUALIFIED INVESTORS ONLY – NOT FOR RETAIL USE OR DISTRIBUTION
JANUARY 1, 2017
NOT FOR RETAIL DISTRIBUTION: This communication has been prepared exclusively for
institutional/wholesale/professional clients and qualified investors only as defined by local laws and
regulations.
The views contained herein are not to be taken as an advice or a recommendation to buy or sell any investment in any
jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the
transactions mentioned herein. Any forecasts, figures, opinions or investment techniques and strategies set out are for
information purposes only, based on certain assumptions and current market conditions and are subject to change without prior
notice. All information presented herein is considered to be accurate at the time of writing, but no warranty of accuracy is given
and no liability in respect of any error or omission is accepted. This material does not contain sufficient information to support an
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addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and
determine, together with their own professional advisers, if any investment mentioned herein is believed to be suitable to their
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should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance
with market conditions and taxation agreements and investors may not get back the full amount invested. Both past
performance and yield may not be a reliable guide to future performance.
J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates
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Copyright 2017 JPMorgan Chase & Co. All rights reserved. 1016-0947-04
1
41
MICHAEL CEMBALEST is the Chairman of Market and Investment Strategy for
J.P. Morgan Asset Management, a global leader in investment management and
private banking with $1.8 trillion of client assets under management worldwide (as
of September 30, 2016). 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 more than 250,000 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.
42

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2017 - True Believers

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Eye on the Market Outlook 2017

J.P. MORGAN ASSET MANAGEMENT

Cover art by Robin Mork.

FOR INSTITUTIONAL/WHOLESALE/PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY –

Executive Summary: True Believers

Employment growth in the developed world Erosion of the political center

10% MSCI World 8%

Components of global real GDP Stable, slow global growth

Consumer spending Emerging markets

The global productivity slowdown Developed world private sector debt

major question mark for 2017

EYE ON THE MARKET • MICHAEL CEMBALEST • OUTLOOK 2017 JANUARY 1, 2017

2017 Eye on the Market Outlook: Table of Contents Chapter links

Executive Summary: True Believers Page 1

Sources and acronyms Page 40

United States: what will Trumpism look like in practice?

75% 1.30x 6.0

Measures of US inflation Signs of a healthy US labor market

Core CPI & Core PCE Firing rate 1.1%

Divergence between employment and investment US consumer activity

US private residential investment What helps GDP growth the most?

Risks for housing from higher rates

Since 2010, bank stocks hurt by lower rates US bank valuations

Healthcare versus the market

What about a Clinton Presidency?

6.0x Active to retired workers 70% 12%

5.5x 60% 10% Entitlement spending

450 Fall 2016 Unified Agenda

Eurozone business surveys: manufacturing/services Eurozone consumer confidence

55 Italy -15% Average

Eurozone real GDP growth: cresting at 2%?

Eurozone bank lending to households Eurozone bank lending to non-financial corporations

Effective Tax Rate

Non-Operating Income Cumulative EPS

-10% Operating Margins

What about European politics?

0.2 20 1,000 European oil and gas imports from Russia

Japan: delusions of inflationary grandeur

Japanese core inflation Bank of Japan overestimated the inflationary benefits

-0.5% -0.5% Adjusted for

China: stabilization, courtesy of coordinated stimulus

Pump Up the Volume China: stabilization in 2016

Fixed asset investment: SOE

Corporate debt levels in China Long-term appreciation of the Chinese RMB

Chinese household consumption expenditures Chinese households by wealth level

12% 60% South Korea

Emerging markets ex-China: recovering from balance of payment adjustments

When EM exchange rates bottomed, EM equities EM portfolio inflows: stabilizing

2017 Eye on the Market Outlook Special Topics Chapter Links

1 Leverage What amount of leverage can survive a world of volatile Page 27

The empirical, historical analysis

Maximum leverage possible to avoid margin call

The forward-looking analysis

Failure rate as a function of leverage

Source: J.P. Morgan Asset Management. December 2016.

[2] Prospects for improved active equity management performance

O/W Idiosyncratic risk

Cash vs. S&P 500

Sector dispersion is rising... ...as realized stock correlation is falling...

...and implied stock correlation is also falling

LNG: Asian import prices and US export applications

Here’s how we see it:

Natural gas price and US production

[4] For taxable US investors: how to track a benchmark on a tax-aware basis