Global Investment Strategy
Jan G. Loeys
jan.loeys@jpmorgan.com
(1-212) 834-5874
Jan G. Loeys is Managing Director and Head of Global Asset Allocation and Alternative Investments. He
functions as chief market strategist for JPMorgan. He works from New York and writes and edits
JPMorgan’s Global Markets Outlook and Strategy, The JPMorgan View, Investment Strategies, and Global
Issues.
Mr. Loeys joined JPMorgan in New York in 1986 where he worked in International Economics and in Markets
Research. Between 1992 and 2010, he worked from London as Chief Bond Strategist and then as Head of
Markets Research. Prior to his arrival at JPMorgan, Mr. Loeys was Senior Economist at the Federal Reserve
Bank of Philadelphia. He has taught finance and economics at UCLA, the Wharton School, NYU, and
Fordham University.
Mr. Loeys received a Lic. in Economics and Bac. in Philosophy from the Katholieke Universiteit te Leuven
(Belgium) in 1975 and a Ph.D. in Economics from UCLA in 1982.
O C T O B E R 2011
1
The US equity risk premium remains very high
Slope of the risk-return trade-off line
Risk-return tradeoff line
0.6
16
IRR %
Mar 09
14
12
0.5
0.4
Jun-09
10
S&P500
Oct-11
8
HY
0.3
Jun-11
0.2
6
4
0.1
HG
2
USTs
0 Cash
0.00
To 13th October 2011
0
53
5.00
10.00
15.00
Historic vol %
59
65
71
77
83
89
95
01
07
-0.1
Source: J.P. Morgan. IRRs are calculated as current yield, minus expected default or
downgrade losses in the case of credit. The IRR for equities is earnings yield, based on trend
earnings for either operating earnings, plus the expected long-term rate of inflation. The x-axis
is historical vol. The slope is calculated by applying a linear regression of the IRR of various
assets against their historical vol.
2
Flow momentum in global portfolios
Outstandings
Estim. 30 Sep
Average
Gap
Cash
$58
40.7%
37.3%
3.5%
Global portfolio weighting of FI, Equities and Cash
Equity
$41
28.6%
32.4%
-3.9%
% of total portfolio of FI, Equities and Cash
Bonds
$44
30.7%
30.3%
0.4%
Total
50%
$142tr
45%
40%
Cash
35%
Equities
30%
FI
25%
20%
Jan-89
Jan-91
Jan-93
Jan-95
Jan-97
Jan-99
Jan-01
Jan-03
Jan-05
Jan-07
Jan-09
Jan-11
Source: J.P. Morgan
3
Flows and positions: HFs and M&A
21-day rolling betas of daily HFRX return indices
Global M&A and share buyback activity
monthly volumes in $bn. Last observation is September 2011.
0.7
$bn
600
0.5
Equity L/S
HF: beta to
S&P500
$bn
160
140
500
120
0.3
400
100
Global M&A
300
80
0.1
60
200
40
-0.1
Global Macro HF:
beta to S&P500
100
20
Global share
buybacks
0
-0.3
Jan-09 Jun-09 Nov-09 Apr-10 Sep-10 Feb-11 Jul-11
Source: J.P. Morgan, Bloomberg
Jan-07
0
Jan-08
Jan-09
Jan-10
Jan-11
Source: J.P.Morgan, Reuters, Datastream, Federal Reserve
4
High risk premia met by high risks
Where?
What?
Solution?
US
Recession
Stimulus
EMU
Sov. Debt crisis
Solidarity
EM
Inflation
Slower growth
Policy
Data
NC
5
Consumer spending growth collapses and production stalls in 1H
Real consumer spending, dev mkts
%2q, saar
Global industrial production
%q/q, saar (both scales)
4.0
20
100
3.0
Total production
2.0
10
50
1.0
0.0
0
0
-1.0
-2.0
Motor vehicles
-10
-50
-3.0
-4.0
00 01 02 03 04 05 06 07 08 09 10 11 12
-20
-100
00
02
04
06
08
10
12
6
Main US risk: US economy at stall speed?
• Stall speed is 2 quarters < 1% ar, or 1 year < 2%
• Over 50% of time, a recession followed
• Recession misses were largely due to policy easing
• 95Q1-Q2:
Fed eased 75bp, USTs fell 2.5%
• 02Q4-03Q1:
Fed ease and Bush tax cuts
• 06Q2-Q3:
No stimulus
but only 2.3% growth for 5Qs
US real GDP growth
Rolling 2qtr annualised growth rate. Grey bars show US recessions
10
and then the 2008 recession
• Today: almost out of bullets
5
• Conflicting signals
• -- Philly, confidence, PMIs
0
• + claims, car sales
-5
-10
80
85
90
95
00
05
10
7
US household deleveraging progressing rapidly
US household debt, net flow
US HH debt and servicing burden
%oya
% of income, both scales
20
140
19
Debt
Mortgages
15
120
18
10
100
17
5
80
60
Debt servicing
and other
obligations
40
60 65 70 75 80 85 90 95 00 05 10
16
0
Consumer
credit
15
-5
52 57 62 67 72 77 82 87 92 97 02 07
8
US faces largest fiscal headwind in over four decades
US fiscal tightening
%-pt of GDP; Change in deficit
US fiscal policy changes for 2012
Billion USD
Current Obama
Net
law
plan change
6
4
2
0
Payroll tax
-110
+175
+65
Other taxes
-25
+70
+45
Infrastructure,
S&L support
-125
+140
+15
Unemp relief
-50
+62
+12
Other spending
-40
-
-40
Total
-350
+447
+97
-2.3
+3.0
+0.6
-1.8
2.4
0.5
% of GDP
-2
GDP impact (%pt)
-4
60 65 70 75 80 85 90 95 00 05 10
Note: Obama plan incorporates changes that will not be fully
implemented in 2012
9
2011 GDP expectations
US
Global
4.1
JPM
3.5
3.0
3.2
2.1
1.9
Consensus
Consensus
1.5
1.2
Jan-10
Jul-10
2.5
Jan-11
Jul-11
Jan-10
Japan
6.2
JPM
6.1
2.0
Jul-10
Jan-11
Jul-11
EM
0.5
0.0
5.7
-0.5
5.6
-1.0
5.5
Jan-10
Jul-10
Jan-11
Jul-11
Jan-10
Jan-10
Jul-10
Jan-11
Jul-11
DM
2.8
2.4
JPM
JPM
5.9
5.8
Consensus
1.3
6.0
Consensus
JPM
1.7
1.8
2.3
1.0
2.3
JPM
2.4
2.6
1.5
2.5
3.6
3.8
2.9
Euro area
2.0
Consensus
Consensus
1.6
1.2
Jul-10
Jan-11
Jul-11
Jan-10
Jul-10
Jan-11
Jul-11
Source: J.P. Morgan, Consensus Economics, Blue Chip
10
2012 GDP expectations
3.8
3.5
JPM
Consensus
3.1
3.4
3.0
Euro area
US
Global
1.4
JPM
2.3
2.6
0.7
1.9
2.2
1.5
0.0
1.8
1.1
-0.7
Jan-11
Mar-11
May-11
Jul-11
Sep-11
Japan
4.1
Jan-11 Mar-11 May-11
6.2
JPM
Jul-11
Sep-11
EM
5.8
JPM
5.6
3.1
Consensus
Consensus
2.1
Jan-11 Mar-11 May-11 Jul-11
JPM
1.1
5.0
0.6
4.8
1.6
Sep-11
Jan-11 Mar-11 May-11
Consensus
1.6
5.2
2.1
DM
2.6
5.4
2.6
Consensus
Jan-11 Mar-11 May-11 Jul-11 Sep-11
3.1
6.0
3.6
JPM
2.1
2.7
Consensus
2.8
Jul-11
Sep-11
Jan-11 Mar-11 May-11 Jul-11 Sep-11
Source: J.P. Morgan, Consensus Economics, Blue Chip
11
The mother of all whipsaws: Philly Fed Surprises
Actual release less Bloomberg median forecast
20
10
0
-10
-20
-30
-40
98
99
00
01
02
03
04
05
06
07
08
09
10
Source: Bloomberg, J.P.Morgan
Record negative surprise in Aug, followed by record positive surprise this week
12
US EASI vs. S&P500
1500
40
1400
S&P500
30
1300
20
1200
10
1100
0
1000
-10
900
-20
800
US EASI
-30
700
-40
600
-50
500
Jan-08
Jul-08
Source: J.P.Morgan
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
13
Momentum on growth and profit expectations
US GDP and corporate profit consensus forecast revisions
15
30
10
20
5
10
Real GDP
0
0
-5
-10
-10
-20
Corp profits
-15
Dec-86
-30
Feb-91
Apr-95
Jun-99
Aug-03
Oct-07
t
Growth
Up Down
Up
0.70 0.34
Down
0.30 0.66
t+1
Source: J.P. Morgan
14
EMU crisis
THE PROBLEM
• Unfinished integration
• Monetary, without fiscal union is
unstable as it makes countries
subject to a run
SOLUTION
• Fiscal federalism =
• Fiscal solidarity + discipline
BINARY OUTCOMES
WATCH FOR
• Dialling the clock back to just before
EMU (1999) is not feasible
• Actions to put in fiscal rules and
discipline
• EMU either moves to fiscal federalism,
with powerful ESM, eurobonds, and
stronger Stability Pact ...
• Ignore extra liquidity measures from ECB
• ... Or moves to disintegration with
reintroduction of national currencies
• Focus on sovereign funding by IT, SP, FR.
• The problems are not Greece or the
banks.
15
EM inflation and the overheating risk
Headline CPI
EM vs DM trade
%3m, saar
+ Higher EM growth
8
+ Higher EM carry
+ Better growth, fiscal, monetary
6
EM
- EM is higher beta
- EM inflation not yet undercontrol
4
- Negative momentum
Global
2
DM
0
- underperforms in crises and recessions
• We are short EMFX vs DM
• OW EMBIG vs CEMBI
-2
• Long duration in EM Local markets
2010
2011
• Neutral in EM equities
16
What stops the rot?
VALUE
POSITIONS
• Risk premia are already very high
• HFs have covered, and are biased to
recession
• But little timing value
• Worst needs to be priced
• US recession is 50-50% priced
• Lower vol needed
• Huge delevering has taken place, but
speed of sell off was too fast to clean
up most positions
• Global investors are UW equities, but
still OW credit
BETTER DATA
POLICY
• Forecast momentum remains negative
• US has few bullets left. Left is Operation
Switch, minor tax cuts, and USD
depreciation
• US recession is forecast by few
• Surprise index needs to return to flat
• Euro area has more bullets, but is
reluctant to use them
• EM has most bullets left
17
Price momentum is negative for risky assets
YTD Returns – as of Oct 13
6-month Returns
Gold
Gold
US Fixed Income
US Fixed Income
US High Grade
Global Gov Bonds**
EMBIG
US High Grade
EM Local Bonds**
EM Local Bonds**
Global Gov Bonds**
EMBIG
EM $ Corp.
Europe Fixed Income*
US High Yield
Relative
momentum
Europe Fixed Income*
US cash
US cash
EM $ Corp.
US High Yield
EM FX
Absolute
momentum
S&P500
EM FX
S&P500
GSCI TR
Topix*
MSCI AC World*
MSCI AC World*
MSCI Europe*
MSCI Europe*
MSCI EM*
MSCI EM*
Topix*
GSCI TR
-20
-10
0
10
20
%
-20
-10
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 $.
0
10
20
%
18
How much of a US recession is priced in? Equities
1800
1600
1400
1200
1000
800
600
Jan-99
Jan-02
Jan-05
Jan-08
Jan-11
S&P500
S&P500
peak
trough
Jun-48
Jun-49
Jan-53
Sep-53
Jul-56
Dec-57
Jan-60
Oct-60
Dec-68
Jul-70
Jan-73
Dec-74
Feb-80
Apr-80
Nov-80
Aug-82
Dec-89
Oct-90
Mar-00
Sep-01
Oct-07
Mar-09
Average
Median
Average in Deep
Average in Mild
S&P500 price decline S&P500 EPS decline
peak-to-trough
peak-to-trough
-17%
-3%
-11%
-12%
-17%
-22%
-13%
-12%
-34%
-13%
-46%
-15%
-15%
-5%
-27%
-19%
-16%
-26%
-37%
-23%
-56%
-45%
-26%
-18%
-17%
-15%
-33%
-25%
-18%
-9%
Earnings
decline
Mild
Mild
Deep
Mild
Mild
Deep
Mild
Deep
Deep
Deep
Deep
Source: J.P. Morgan
19
US credit spreads are 2/3rds on the way to recession
US High Grade Credit
600
US High Yield Credit and default rates
bp
2000
550
18%
bp
500
1800
16%
450
1600
14%
1400
12%
1200
10%
1000
8%
800
6%
600
4%
400
2%
200
0%
400
350
300
250
200
150
100
50
0
73
77
81
Source: J.P. Morgan
85
89
93
97
01
05
09
87
91
95
99
03
07
11
2011 forecast
1.5%
20
How much of a US recession is priced in?
100%
Commodities in recessions
80%
Recession
Peak to trough
60%
1980
-44%
40%
1981
-43%
1990
-29%
2001
-31%
2007
-66%
Average
-43%
20%
0%
S&P500
US HG
Credit
US HY
Credit
USTs
Base
Metals
Source: J.P. Morgan
21
US equities during recessions
S&P500 performance before and after the start of a recession
Cumulative return
20%
15%
40%
1969
1973
1980
1981
30%
1990
2001
2007
2011
20%
10%
10%
0%
5%
-10%
0%
-20%
Average
-5%
-30%
-40%
Current cycle
-10%
-50%
-15%
-60%
-24
-12
0
12
24
36
48
60
72
No. weeks
-24 -16 -8
0
8
16 24 32 40 48 56 64 72
No. Weeks
Current cycle assumes a recession started on the 2nd of Sep 2011. The average is the average over past recessions in the second chart.
USTs during recessions
Change in UST 10yR yield before and after the start of a recession
Change in yield
2.0
4.0
3.0
1.5
2.0
Current cycle
1.0
1.0
0.0
0.5
-1.0
0.0
-2.0
-3.0
Average
-0.5
-4.0
-1.0
-5.0
-24
-12
0
12
24
36
48
60
72
No. weeks
1969
1990
-24 -16 -8
1973
2001
0
8
1980
2007
1981
2011
16 24 32 40 48 56 64 72
No. Weeks
Current cycle assumes a recession started on the 2nd of Sep 2011. The average is the average over past recessions in the second chart.
Credit during recessions
Change in BAA – 10YR UST spread before and after the start of a recession
Cumulative spread change
1.5
4.0
3.0
1.0
Average
0.5
2.0
1.0
0.0
0.0
-0.5
Current cycle
-1.0
-2.0
-1.0
-24
-12
0
12
24
36
48
60
72
No. weeks
1969
1990
-24 -16 -8
1973
2001
0
8
1980
2007
1981
2011
16 24 32 40 48 56 64 72
No. Weeks
Current cycle assumes a recession started on the 2nd of Sep 2011. The average is the average over past recessions in the second chart.
Commodities during recessions
GSCI performance before and after the start of a recession
Cumulative return
20%
80%
15%
60%
1973
1980
1981
2001
2007
2011
1990
40%
10%
Average
20%
5%
0%
0%
-20%
-5%
-40%
Current cycle
-10%
-60%
-15%
-80%
-24
-12
0
12
24
36
48
60
72
No. weeks
-24 -16 -8
0
8
16 24 32 40 48 56 64 72
No. Weeks
Current cycle assumes a recession started on the 2nd of Sep 2011. The average is the average over past recessions in the second chart.
Base metals during recessions
GSCI industrial metals performance before and after the start of a recession
Cumulative return
20%
40%
15%
30%
10%
1980
2007
1981
2011
1990
2001
20%
5%
10%
0%
Average
-5%
0%
-10%
-10%
-20%
-15%
-30%
-20%
Current cycle
-25%
-40%
-30%
-50%
-35%
-60%
-24
-12
0
12
24
36
48
60
72
No. weeks
-24 -16 -8
0
8
16 24 32 40 48 56 64 72
No. Weeks
Current cycle assumes a recession started on the 2nd of Sep 2011. The average is the average over past recessions in the second chart.
Gold during recessions
Gold spot performance before and after the start of a recession
Cumulative return
20%
100%
15%
80%
10%
Average
5%
60%
40%
0%
20%
-5%
0%
-10%
-20%
-15%
-20%
-40%
Current cycle
-25%
-60%
-30%
-80%
-24
-12
0
12
24
36
48
60
72
No. weeks
1969
1990
-24 -16 -8
1973
2001
0
8
1980
2007
1981
2011
16 24 32 40 48 56 64 72
No. Weeks
Current cycle assumes a recession started on the 2nd of Sep 2011. The average is the average over past recessions in the second chart.
EM Asia FX during recessions
EM Asian FX performance against the USD before and after the start of a recession
Cumulative return
3%
10%
1981
2001
2011
8%
2%
Average
1990
2007
6%
1%
4%
0%
2%
-1%
0%
-2%
-2%
Current cycle
-4%
-3%
-6%
-4%
-8%
-5%
-10%
-6%
-12%
-24
-12
0
12
24
36
48
60
72
No. weeks
-24 -16 -8
0
8
16 24 32 40 48 56 64 72
No. Weeks
Current cycle assumes a recession started on the 2nd of Sep 2011. The average is the average over past recessions in the second chart.
EM Asian FX is an equally weighted average of: CNY, HKD, SGD, INR, MYR and THB vs. the USD.
EM FX during recessions
EM FX performance before and after the start of a recession
Cumulative return
6%
10%
4%
Current cycle
1990
2001
2007
2011
5%
2%
0%
0%
-2%
-4%
-5%
-6%
-10%
-8%
Average
-10%
-15%
-12%
-20%
-14%
-24
-12
0
12
24
36
48
60
72
No. weeks
-24 -16 -8
0
8
16 24 32 40 48 56 64 72
No. Weeks
Current cycle assumes a recession started on the 2nd of Sep 2011. The average is the average over past recessions in the second chart.
EM FX is an equally weighted average of: CNY, HKD, SGD, INR, MYR, THB, CLP, ILS, MXN, ZAR and TRY vs. the USD.
Real Broad Effective Exchange Rate
120
USD
110
140
130
Euro
120
100
110
90
100
80
90
70
80
70 74 78 82 86 90 94 98 02 06 10
180
EM Asia ex China
70 74 78 82 86 90 94 98 02 06 10
130
125
160
G6
120
140
115
120
110
105
100
100
95
80
70 74 78 82 86 90 94 98 02 06 10
70 74 78 82 86 90 94 98 02 06 10
30
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"Other Disclosures" last revised September 30, 2011.
Copyright 2011 JPMorgan Chase & Co. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of J.P. Morgan.
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