Global Asset Allocation

J.P. Morgan Chase Bank NA, J.P. Morgan Securities Ltd. Mar 30, 2012

J.P. Morgan View

The big questions for Q2
Asset Allocation Strong Q1 returns and lack of positive triggers raise risk of profit taking in April. But without strong negatives, a correction should be shallow. We stay long equities and credit for Q2. Economics China is slowing, but non-China Asia is rebounding strongly and is more correlated with DM growth. Fixed Income Open Euro area peripheral spread wideners and stay short duration in the US into next weeks payrolls. Equities Slower rally will refocus attention on convertibles and highdividend stocks. Credit Stay long credit. Foreign exchange Take part profit on shorts of commodity currencies Commodities Implied oil volatility is at very low levels by historical standards and not consistent with the risks. Buy a Dec-14 straddle on Brent. Today marks the last trading day of Q1, and we must say it worked wonderfully, at least for markets, though less so for the world economy. The best that can be said for the latter is that we started the year with a weak Q1 growth forecast of 1.8%, and by now we have raised that to an only mildly sub-par 2.4%. This barely nudged up our full 2012 projection from 2.1% to 2.2% for the world economy. The message on growth is low and steady. Equities are all up about 10-12% YTD, with mid-risk assets (commodities, EM FI, HY) around the 5% mark and government debt barely beating cash. The Nikkei is at the top in local terms, but in line with others in USD given the yen fall. Asset class returns are nicely in line with their respective market betas/ volatilities, and cash is at the bottom of our YTD hit-parade (chart on right), which fits with a quarter driven by asset reflation and easy money. We address here the big issues investors are raising as we enter Q2. (1) Will risk markets correct after the headlong rush of Q1? (2) Is the rotation from bonds to equities finally starting? (3) How bad is China? (4) Will the Euro crisis return? (5) What are the best risk assets and hedges to own. Correction risk. Q1 returns are cleanly in line with our relative forecasts issued last year, but are running twice as fast in absolute terms, as over half of our 2012 projections have been realised already. This clearly raises the risk of a profit-taking correction. Last year, equities were broadly flat in Q2, after solid risk returns in Q1, in response to weakening in PMIs. This year, Q1 returns were twice as strong, and PMIs are again falling, though much less so. Tactical players are now long equities and credit, and short bond duration. But the run-up in long equity positions is much less extreme than last year, exactly because market participants fear a repeat of 2011. In addition, the move to tactical longs in equities came much later in the quarter, which means that profits are very recent and not as extensive. We feel that with many position takers having missed the rally, there is strong buy-on-dips support for equiThe certifying analyst is indicated by an AC. See page 7 for analyst certification and important legal and regulatory disclosures. Matthew Lehmann Leo Evans Jan LoeysAC John Normand Nikolaos Panigirtzoglou Seamus Mac Gorain

YTD returns through Mar 29

%, equities are in lighter colour.

Topix* S&P500 MSCI AC World* MSCI EM* MSCI Europe* EM $ Corp. US High Yield EM FX Gold GSCI TR EMBIG US High Grade EM Local Bonds** US Fixed Income Europe Fixed Income* Global Gov Bonds** US cash
0 5 10 15 20
Source: J.P. Morgan, Bloomberg. Returns in USD. *Local currency. **Hedged into USD. Euro Fixed Income is Iboxx Overall Index. US HG, HY, EMBIG and EM $ Corp are JPM indices. EM FX is ELMI+ in $.

Global Asset Allocation J.P. Morgan View

ties. Overall, we understand the risk of a profit taking correction, which would depress credit, but such a correction should be shallow, and not a major fundamental reason to sell risky assets. One needs to be nimble and fast to play this correction, something we feel is hard and risky by itself. We thus stay long credit and equities against bonds and cash. Bonds were stable this quarter, except for a 1-week surge in yields mid-March, following an FOMC statement that suggested no need for more QE. Many are now wondering whether we have seen the start of the eventual reallocation from bonds to equities. We are significantly long equities and credit versus govt debt, but are barely short duration, as we do not see a big bond-toequity allocation happening this year. The reason is in essence a form of financial repression: large institutional investors central banks, commercial banks, pension funds and insurance companies are each forced, through a varied set of regulations, to invest in bonds instead of equities, despite the large gap in IRRs between these two worlds. And the end investor remains more concerned about capital preservation than returns, as reflected by the larger flows into bond than equity products. The real bond bear market will come when central banks start normalizing, which is some time away. How bad is China? Recent activity data are mucked up by the early Chinese year end, but should clear up in coming weeks. Market sentiment has moved to the hard landing scenario, which is not our best guess. If H1 growth does fall to 5-6%, then it should mainly affect assets vulnerable to China (EM equities, commodities, resource sectors and commodity sectors), but barely the overall DM economies and markets. The market is currently not paying enough attention to the strong rebound in non-China EM Asia, which is much closer correlated with DM growth. Will EMU risk return? The Euro crisis has moved from front page to p.2. It could moved further to p.4, but unlikely to p.16. The LTROs have bought time and European banks recognize their survival depends on supporting their own governments. Focus is on data and austerity plans. A single country going against the Fiscal Pact is a sure negative, but a concerted effort to favor growth over austerity, backed up with joint funding, would be a positive. Best risk assets and hedges: Equities are tops given positions and value. Credit exposure is no. 2, as risk premia are back to cycle averages and positions are more extended, despite still strong inflows into the asset class. We are flat commodities overall, and trade bonds with a bearish bias. Hedges are focused on oil (Iran risk) and inflation break-evens, as easy money is the main driver of the rally.

2012 global GDP growth forecasts: JPMorgan and Consensus

% 4.0

3.5 3.0 2.5 2.0 JPM

Consensus

1.5 Jan-11 Apr-11 Jun-11 Sep-11 Dec-11 Feb-12

Source: J.P. Morgan, Consensus Economics. Consensus Economics forecasts are for regions and countries that we averaged using the same 5-year rolling USD GDP weights that we use for our own global growth forecast.

Fixed income DM bonds rallied this week, while Euro peripheral spreads widened a little and
EM local bonds were slightly down. Bunds have been in a relatively tight range this year and we expect this to continue in Q2, and wait for higher yields before entering long duration trades. We expect intra-EMU spreads to widen modestly from here and recommend peripheral spread wideners. In the US, we remain short duration going into payrolls next week. If payrolls come in stronger, then US 10s should sell off more than they would rally on a weak release. This risk skew keeps us short.

Mar 30, 2012

Global Asset Allocation J.P. Morgan View

We turn neutral duration in EM local bonds and now recommend being short
duration in Asia. Within EM, we continue to OW Brazil, Poland and South Africa and we now open UWs in Thailand, Malaysia and Turkey. We recommend reducing the Brazil OW as the rally is likely to slow but we expect low inflation to allow the central bank to keep interest rates low for longer than the market expects. In EMEA EM, we stay with our OW in South Africa despite the recent backup in yields, given the downside surprise in the latest CPI reading. In Turkey, risks are skewed towards a more hawkish central bank going forward which should put upward pressure on Turkish rates.

Equities Lack of drivers and broadly elevated positions have caused a pause in the
equity rally. At the same time, worries about China continue to weigh on Cyclical sectors and EM exposures. The disappointment in last weeks Chinese PMI induced us to cover our EM and Cyclical exposures. To re-enter these trades, we need to see either an higher Chinese PMI or a strong policy response. BRICs are particular vulnerable not only because of renewed Chinese worries but also due higher positions by EM equity managers in BRICs vs non-BRICs. For investors who see the recent selloff in EM as overdone, tech and industrials, and Korea among countries, are our preferred plays.

The pause in equity markets increases the attractiveness of high-dividend

yield stocks and bond-like equities such as convertible bonds. Convertible bonds in particular are facing a very favourable backdrop this year due to limited supply and strong demand. US Convertible bonds also appear cheap vs. the S&P500 given their relative performance over the past two years.

JPMorgan has constructed the J.P. Morgan European Sustainable Yield Basket
(JPDEUSYB <Index>) and the J.P. Morgan US Sustainable Yield Basket (JPDUSSYB <Index>) which contain stocks with sustainable dividends according to certain screens: 1. Reasonable payout ratios: between 35% and 85% over the last and next 2 forecast years; 2. Gearing under control: debt/ equity is less than 100%; 3. No dramatic change to dividend cover: last and next years forecast payout ratio are within +/- 20% of each other; and 4. Strong DPS track record: DPS hasnt been cut in the last 6 years.

Credit
A second week of widening sent spreads away from the YTD lows registered a few weeks back and Chinese concerns saw both EM $ sovereigns and corporates underperform. Yet our base case scenario envisages a rebound in Chinese activity in H2 and whilst valuation-based arguments are less compelling on the back of a straight-line rally, supply/demand conditions remain supportive. Particularly for EM sovereigns, where fund flows towards hard currency debt are near record highs, positions are still underweight, and the net issuance picture looks more balanced going forward: more than enough reasoning to stay long. As it comes to a close, Q1 has been a fairly stellar period for credit. The narrative has been one of abundant liquidity, total returns among the highest of any quarter in a decade, low rates, and recording breaking demand from retail investors. Q2 is highly unlikely to replicate this performance, but it doesnt need to for credit to be among the more attractive asset classes. US HY is in a sweet spot; US economic momentum remain in place, and default
Mar 30, 2012 3

Global Asset Allocation J.P. Morgan View

rates, already low, are being anchored by near-record issuance this quarter given the focus on refinancing. Stay long.

FX weekly change vs USD

2%

Foreign Exchange March is ending with very little trend in the broad dollar, whether measured
by the DXY (six currencies) or the J.P. Morgan index JPMQUSD (16 pairs). There are many more regional dynamics in play than this global stability suggests, including Chinas slowdown, Japans inflation targeting, the Fed policy debate and Spains financing stress. Since many of these are offsetting in terms of their implication for the dollar, it is unsurprising that the tradeweighted indeed is stable while currency correlations and FX volatility decline.

1%

-1%

-2%

But insofar as China has dominated recent weeks and will also drive the next
three, EUR/Asia and EUR/commodity cross rates continue to exhibit decent momentum as those most exposed to China underperform. One need not be a China watcher to recognize that April will turn on Asia: this is the first month when New Year distortions will begin to fade from the data. Is it also a month when the Bank of Japan could raise its inflation target (yen-bearish) or continue with business as usual (yen-bullish). There is still enough Asia uncertainty to justify commodity currency shorts and to take the yen on a week-by-week basis.

USD EUR GBP JPY CHF CAD AUD TWI

Source: J.P. Morgan

Changes to the view are minor. Expect an 80-82.5 range on JPMQUSD and
underperformance of commodity currencies vs USD, EUR and JPY, but take part profits in view of Marchs move. We have been short commodity currency calls since mid-March and long EUR and JPY vs CAD and NZD since last week. The China data calendar is so full for Q2 that it is unlikely that all measures stabilize simply as Lunar New Year effects fade. Indeed, retail sales and IP due April 13 probably entail the highest risk. Of the basket of six commodity currency trades, we take profits on half (short calls on AUD/USD and NOK/SEK, long EUR/NZD cash) given how much they have moved in March. Keep the other three (short NZD/SSD call, long EUR/NZD skew, short CAD/JPY cash): the China debate may advance but wont be resolve in April.

Commodities Commodities are down another 2.5% this week. Agriculture was the worst,
down almost 4%. Anecdotal evidence suggests that warm and dry weather in the US has led farmers to start planting corn earlier than usual. Our agriculture strategists argue that earlier planting typically leads to a larger corn crop. However, the dry weather that enables early planting could damage crops later on if it persists.

Oil markets have been range bound for the last few weeks with implied
volatility in crude oil options fallen significantly to multi-years lows. The gap between implied and realised volatility is now at its lowest for three months, creating an attractive opportunity to open a long position in oil volatility. The oil market remains tight, as evidenced by the steeply backwardated Brent forward curve. Negotiations with Iran are due to restart, but discussions will likely go on for months, creating the potential for upward pressure on implied volatility. A growth slowdown in China and a flair up in the Euro area crisis would also likely push implied volatility higher. We recommend holding a Dec-14 Brent straddle which would also be a positive carry trade.

Mar 30, 2012

Global Asset Allocation J.P. Morgan View

Interest rates
United States Euro area United Kingdom Japan GBI-EM hedged in $ Fed funds rate 10-year yields Refi rate 10-year yields Repo rate 10-year yields Overnight call rate 10-year yields Yield - Global Diversified

Current 0.125 2.22 1.00 1.79 0.50 2.20 0.05 0.99 6.43 Current 192 247 633 809 334 379

Jun-12 0.125 2.50 0.75 2.00 0.50 2.55 0.05 1.15

Sep-12 0.125 2.50 0.75 2.00 0.50 2.55 0.05 1.05

Dec-12 0.125 2.50 0.75 2.00 0.50 2.40 0.05 1.05 6.30

Mar-13 0.125 2.50 0.75 2.00 0.50 2.40 0.05 1.15

YTD Return* -1.0% 0.2% -1.9% 0.2% 1.6% YTD Return* 2.4% 3.8% 5.2% 12.1% 4.8% 6.0%

Credit Markets
US high grade (bp over UST) Euro high grade (bp over Euro gov) USD high yield (bp vs. UST) Euro high yield (bp over Euro gov) EMBIG (bp vs. UST) EM Corporates (bp vs. UST)

Index JPMorgan JULI Porfolio Spread to Treasury iBoxx Euro Corporate Index JPMorgan Global High Yield Index STW iBoxx Euro HY Index EMBI Global JPM EM Corporates (CEMBI) Quarterly Averages

Commodities
Brent ($/bbl) Gold ($/oz) Copper ($/metric ton) Corn ($/Bu)

Current 125 1666 8325 6.47

12Q2 112 1825 8500 6.60

12Q3 120 1900 8875 6.70

12Q4 125 1925 9000 6.40

13Q1 125 1850 8750

GSCI Index Energy Precious Metals Industrial Metals Agriculture

YTD Return* 7.2% 5.3% 5.4% -2.6%

Foreign Exchange
EUR/USD USD/JPY GBP/USD USD/BRL USD/CNY USD/KRW USD/TRY

Current 1.33 82.5 1.59 1.81 6.31 1135 1.80

Jun-12 1.34 86 1.59 1.77 6.20 1120 1.80

Sep-12 1.36 84 1.61 1.78 6.20 1070 1.77

Dec-12 1.36 83 1.61 1.80 6.10 1090 1.70

Mar-13 1.36 82 1.61 1.80 6.10 1090 1.70

3m cash YTD Return* index in USD EUR JPY GBP BRL CNY KRW TRY 2.8% -6.4% 2.8% 4.5% 0.4% 2.0% 7.9%

YTD Return

US

Europe YTD -0.2% 9.1% 10.0% 15.8% 4.4% 1.8% 13.8% 14.5% -3.0% 1.7% 8.8%

Japan
YTD 12.3% 18.1% 17.3% 29.9% 14.6% 10.1% 33.4% 20.0% 0.4% 10.0% 18.3%

EM
YTD ($) 12.0% 10.5% 17.5% 11.6% 11.6% 13.2% 13.6% 20.5% 7.3% 11.4% 14.0%

Equities
S&P Nasdaq Topix FTSE 100 MSCI Eurozone* MSCI Europe* MSCI EM $* Brazil Bovespa Hang Seng Shanghai SE

Current 1398 3066 853 5855 145 1108 1041 65782 20669 2350

(local ccy) 11.7% 17.3% 18.3% 6.2% 11.2% 8.8% 14.0% 15.9% 11.0% 2.4%

Sector Allocation *
Energy Materials Industrials Discretionary Staples Healthcare Financials Information Tech. Telecommunications Utilities Overall

YTD 3.1% 10.7% 10.8% 15.5% 4.9% 8.3% 21.4% 21.9% 2.0% -2.2% 11.7%

*Levels/returns as of Mar 29, 2012 Local currency except MSCI EM $

Source: Bloomberg, Datastream, IBES, Standard & Poor's Services, J.P. Morgan estimates

Mar 30, 2012

Global Asset Allocation J.P. Morgan View

Global Economic Outlook Summary

Real GDP
% over a year ago

Real GDP
% over previous period, saar

Consumer prices
% over a year ago

2011 The Americas United States Canada Latin America Argentina Brazil Chile Colombia Ecuador Mexico Peru Venezuela Asia/Pacific Japan Australia New Zealand Asia ex Japan China Hong Kong India Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand Africa/Middle East Israel South Africa Europe Euro area Germany France Italy Norway Sweden United Kingdom Emerging Europe Bulgaria Czech Republic Hungary Poland Romania Russia Turkey Global Developed markets Emerging markets
Source: J.P. Morgan

2012 2.2 2.3 3.6 4.5 3.1 5.0 5.0 4.0 3.3 5.5 4.0 1.7 3.0 2.9 6.5 8.4 2.8 7.1 5.2 3.3 3.9 4.3 2.6 2.8 5.1 2.9 2.7 -0.4 0.7 0.1 -1.8 1.4 -0.3 0.8 2.8 1.5 -0.2 0.5 3.2 0.8 3.7 2.5 2.2 1.2 5.0

2013 2.2 2.5 4.0 4.0 4.5 4.5 5.0 4.0 3.5 7.0 1.0 1.3 3.3 2.7 7.1 9.1 4.2 7.3 5.4 4.0 3.2 4.8 3.9 5.1 3.5 4.4 3.6 0.3 1.3 0.3 -0.7 1.8 1.7 1.9 3.5 2.5 1.7 1.5 3.0 2.7 3.7 4.5 2.6 1.5 5.6

3Q11 1.8 4.2 2.9 3.6 -0.2 1.4 6.2 7.1 5.1 5.3 6.7 7.1 3.2 2.8 6.4 8.4 0.4 7.5 5.9 3.4 6.1 3.4 2.0 -0.2 3.4 3.8 1.7 0.6 2.3 1.3 -0.7 3.1 3.5 2.3 3.5 -0.4 1.7 4.1 7.4 3.5 3.0 2.3 4.9

4Q11 3.0 1.8 2.4 3.2 1.3 8.2 5.4 1.0 1.7 2.8 3.5 -0.7 1.7 1.4 4.8 9.2 1.6 3.8 9.9 1.3 4.8 3.5 -2.5 -0.6 -36.4 3.2 3.2 -1.3 -0.7 0.9 -2.9 2.5 -4.4 -1.2 4.9 -0.5 1.2 4.5 -0.8 7.0 1.6 0.6 4.1

1Q12 1.5 2.1 2.9 0.0 2.6 5.1 4.5 2.0 2.5 5.2 6.0 2.2 3.1 5.1 8.2 7.2 3.0 13.0 5.0 3.0 5.0 4.3 6.1 3.3 45.0 0.8 2.3 0.0 1.0 0.0 -2.0 0.0 -0.5 2.0 2.4 -0.8 -0.3 2.8 -1.2 3.5 2.4 1.2 5.7

2Q12 2.5 2.6 5.5 5.5 5.7 4.9 4.9 3.5 5.5 5.8 6.0 1.6 1.9 2.1 6.7 7.8 4.0 5.5 4.5 4.0 2.0 4.9 5.3 4.8 20.0 3.2 2.6 -1.5 0.0 -1.0 -2.5 0.0 -0.5 -1.0 1.4 -1.0 0.3 2.0 -1.5 2.0 2.0 0.7 5.4

3Q12 3.0 2.3 3.9 6.5 5.5 4.6 4.1 4.0 0.6 6.2 4.0 1.2 3.7 3.7 7.2 9.5 5.5 6.3 5.0 4.5 2.0 5.7 3.2 5.8 2.0 6.1 2.8 -0.3 1.0 0.0 -1.5 1.0 0.5 2.5 2.5 1.1 1.0 2.5 0.8 3.0 2.6 1.6 5.5

4Q12 2.0 2.4 3.4 5.0 5.7 4.7 3.0 4.0 1.0 7.3 -3.0 1.0 4.1 3.0 7.5 10.0 6.0 6.5 5.0 5.0 2.5 4.9 2.0 6.5 0.5 7.4 3.2 0.3 1.0 0.0 -1.0 1.0 1.0 1.5 3.4 2.3 1.5 3.0 2.4 4.0 2.5 1.3 5.8

1Q13 1.5 2.7 4.4 3.0 4.5 4.5 5.7 4.0 5.0 8.0 0.0 1.2 4.5 0.9 7.0 9.1 3.0 6.7 5.5 4.0 4.0 4.5 4.5 4.5 5.0 4.5 3.8 0.5 1.5 0.5 -0.5 2.0 2.0 2.0 3.5 3.3 1.5 3.0 2.5 4.0 2.5 1.3 5.7

4Q11 3.3 2.7 7.2 9.6 6.7 4.0 3.9 5.5 3.5 4.5 28.5 -0.3 3.1 1.8 4.9 4.6 5.7 8.4 4.1 4.0 3.2 4.7 5.5 1.4 4.0 2.5 6.1 2.9 2.6 2.6 3.7 0.9 2.3 4.6 6.4 2.4 4.1 4.6 3.4 6.8 9.2 3.6 2.8 5.7

2Q12 2.1 1.7 6.4 10.0 5.1 4.2 3.6 5.3 4.2 3.3 23.9 -0.2 2.5 1.2 4.0 2.8 4.5 7.8 8.0 3.4 2.6 3.9 4.6 1.3 2.8 2.3 6.0 2.4 2.3 2.3 3.5 0.9 1.1 3.0 5.1 2.7 5.3 3.3 3.3 4.4 9.0

4Q12 1.7 1.7 6.3 11.0 5.1 3.9 3.3 4.7 4.0 2.4 23.4 -0.1 3.3 2.5 4.2 3.1 3.6 8.2 9.1 3.5 2.2 4.0 3.4 1.7 1.4 2.5 6.2 2.0 2.1 2.0 3.9 1.4 1.1 3.0 5.6 2.9 5.4 3.3 4.4 6.3 6.8

2Q13 1.5 2.0 6.9 11.0 5.3 3.4 3.0 4.7 3.8 3.0 31.7 -0.2 3.0 2.7 4.7 4.2 3.2 8.5 9.2 3.5 1.8 4.0 2.8 1.2 1.4 2.1 5.9 1.6 1.8 1.6 3.5 1.7 1.5 2.7 6.1 2.5 3.5 2.9 4.0 6.8 8.8 2.6 1.5 5.5

1.7 2.5 4.3 8.9 2.9 6.0 5.9 8.0 3.9 6.9 4.2 -0.7 2.0 1.4 7.0 9.2 5.0 7.0 6.5 3.6 5.1 3.7 4.9 4.0 0.1 4.8 3.1 1.5 3.1 1.7 0.4 2.7 4.0 0.7 4.7 1.7 1.7 1.7 4.3 2.5 4.3 8.2 2.6 1.3 5.8

2.7 1.9 4.8

2.6 1.7 5.0

Mar 30, 2012

Global Asset Allocation J.P. Morgan View

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Mar 30, 2012