jp morgan latam 2011
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Latin America Equity Research12 November 2010
LatAm Year Ahead 2011Stay Invested
Head of Latin America Research
Ben LaidlerAC
(1-212) 622-5252
ben.m.laidler@jpmorgan.com
J.P. Morgan Securities LLC
Contents
Strategy .......................................................
Sectors.........................................................4Economics and Commodities ....................1
LatAm Data................................................1For a complete list of contributors tothis report, please see table ofcontents on page 3.
See page 158 for analyst certification and important disclosures, including non-US analyst disclosures.J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware thathe firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a singfactor in making their investment decision.
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Latin America Equity ResearchNovember 2010
Ben Laidler(1-212) 622-5252ben.m.laidler@jpmorgan.com
LatAm Year Ahead 2011 Stay InvestedWhat to own
Brazil
Colombia
Argentina
Off-Index
Discretionary
Financials
Telecoms
Focus on sectors within countries rather than country
recommendations.
What to avoid
Chile
Peru
Materials
Utilities
Staples
A detailed view of our country and sector recommendations
within LatAm is available on page 14. For more detail
lease see country and sector pages.
10 Top Analyst Picks(See page 16)
Top Picks Country To PT (%)
Vale Brazil 49.4
PDG Realty Brazil 41.6
Cemex Mexico 35.7
Bradesco Brazil 34.9
Santander Brasil Brazil 34.7
Corporacion Geo Mexico 32.3
ICA Mexico 32.1
Grupo Mexico Mexico 31.1
Copasa Brazil 29.0
Brasil Foods SA Brazil 26.9
10 Stocks to Avoid(See page 17)
Stock to avoid Country To PT (%)
Ecopetrol Colombia (36)
SQM Chile (28)
Grupo Financiero Inbursa Mexico (24)
Telmex SA Mexico (21)Fibria Brazil (13)
CPFL Energia Brazil (6)
IAM Chile (4)
Bancolombia Colombia (2)
Buenaventura Peru (1)
Eletropaulo Brazil 0
Source: J.P. Morgan. Note: To PT = Returns to analyst price target from 28 Oct 2010.
The year-ahead process
The goal of this document is to present our key strategy themes for 2011 using most- and least-favored stocks from J.P.
Morgans LatAm equity research team.
This 150+ page handbook includes strategy sections from our country strategists as well as overviews on the outlook foreach major company sector and the analysts top picks and stocks to avoid for the year ahead. Analysts were asked to pick1-2 large cap stocks that should lead performance in 2011 as well as a large cap stock they expected to underperform.
We are positive LatAm into 2011. Macro fundamentals are robust, credit conditions very supportive, EM fund inflows
expected to remain strong. Valuations are not stretched, and the earnings backdrop robust. Risks range from the fiscal and
interest rates outlook in Brazil, to the security situation in Mexico, and the presidential elections in 2011 in Argentina and
Peru. Capital control risks also remain real, especially in Brazil.
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Latin America Equity ResearchNovember 2010
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Latin America Equity ResearchNovember 2010
LatAm Strategy
We are positive LatAm into 2011. Macro fundamentals
are robust, credit conditions very supportive, EM fund
inflows expected to remain strong. Valuations are not
stretched, and the earnings backdrop robust. Risks range
from the fiscal and interest rates outlook in Brazil, to the
security situation in Mexico, and the presidential
elections in 2011 in Argentina and Peru. Capital control
risks also remain real, especially in Brazil. We are
overweight Brazil relative to MSCI LatAm index, as
valuations are reasonable, flows returning, and market
overhangs such as the Petrobras offering and the
presidential election are lifting. We also see
outperformance from Colombia and Argentina. We areneutral Mexico, and underweight Chile. We focus on
domestic stocks for which we see good growth and
reasonable valuations, such as financials and
homebuilders.
Fundamentals to remain robust: 2010 and 2011 GDP
growth expectations have been rising, and are above
long-term potential GDP growth. This has been
supporting the earnings revision cycle. Inflation
expectations have also been rising, and Central Banks
are expected to gradually tighten policy in 2011, within
the constraint of appreciating currencies but partly offset
by output gaps remaining in some countries. Long-termREERs point to the undervaluation of the Mexican Peso,
and overvaluation of the Brazilian Real. For more on
economics teams view, please see Latin America
Outlook Presentation.
LatAm GDP outlook
2010e 2011e Long-termForecast Current Forecast Current potentialJan-10 forecast Jan-10 forecast GDP growth
LatAm 4.4 5.7 3.4 4.1 3.4 Argentina 4.0 8.5 3.0 5.5 3.5Brazil 6.2 7.5 4.0 4.5 4.0Chile 5.0 5.5 5.0 6.0 4.2
Colombia 3.0 4.5 4.0 4.1 4.5Ecuador 2.0 2.5 3.0 3.0 3.0Mexico 3.5 4.5 2.5 3.5 2.5Peru 5.5 8.2 6.0 6.0 6.0Venezuela 1.0 -2.2 2.5 1.0 3.0
Source: J.P. Morgan Economics.
Ben LaidlerAC
(1-212) 622-5252
ben.m.laidler@jpmorgan.com
J.P. Morgan Securities LLC
Bloomberg JPMA LAIDLER
LatAm inflation outlook2010e 2011e
Forecast in Current Forecast in CurrentJan-10 forecast Jan-10 forecast
Latin America 7.2 7.3 6.8 7.3 Argentina 9.0 10.5 10.0 Brazil 4.7 5.4 4.6 5.1Chile 2.5 3.8 3.0 3.4Colombia 3.8 2.7 4.0 4.0Ecuador 4.0 3.4 3.8 3.8Mexico 5.1 4.8 4.0 4.0
Peru 2.0 2.4 2.5 2.5Venezuela 40.0 33.0 40.0 35.0
Source: J.P. Morgan Economics.
Credit conditions remain supportive: This could
support a meaningful multiple rerating and increased
equity fund flows and is already altering corporate
behavior. The strong outperformance of EM corporates
has significantly improved relative valuations. The lower
LatAm cost of equity has pushed up fair value for
stocks. Regional corporates are responding by
releveraging and stepping up M&A activity, and
financials are boosting capital. EM corporates are seeing
strong fund inflows. This is a mirror of what equities areseeing. We believe the drivers here are sustainable into
2011, with risk-free rates likely to stay very low, EMBI
spreads tight, and the EM growth premium high. See our
recent note for details: LatAm Strategy Credit rally
supports equities.
LatAm fair value vs 12m fwd P/E
5.0
7.0
9.0
11.0
13.0
15.0
03 03 04 05 06 07 08 09 10
12 mth Fw d PE Gordon Grow th
Source: MSCI, IBES, Datastream.
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7
Latin America Equity ResearchNovember 2010
Implied P/E LatAm corps & equities
0.0
3.0
6.0
9.0
12.0
15.0
18.0
21.0
2001 2003 2004 2005 2006 2007 2008 2009 2010
Cembi Latin HY Cembi Latin IG MSCI LatAm CEMBI LatAm Broad
P/E:
CEMBI Latin IG - 19.5x
CEMBI Latin - 17.4x
CEMBI Latin HY- 12.6x
MSCI LatAm - 11.9x
Source: J.P. Morgan, MSCI, Datastream. * 12m fwd MSCI LatAm P/E and inverse of J.P. Morgan CEMBI Corporate Bond Yields.
EM fund flows continue strong: Year-to-date equity
fund flows into EM have exceeded US$70 billion, above
the previous record of US$64bn in 2009. These flows
have been focused on ETF products and on EM and Asia
funds. Flows into LatAm, as proxied by LatAm funds,
have been poor. Fund flows should continue strong, as
both global equity allocations increase, EM allocations
within global equities are built, and LatAm flows withinEM recover as Brazil overhangs lift. This is a
phenomenon across the asset class and has arguably been
more powerful in corporate and FX markets so far. We
generally see this as another source of upside risk to
multiples. Risk here is from issuance, which has been
high. Please see our weekly fund flows product for
details: Herd Instinct.
GEM fund cumulative US$bn flows
22.4
40.8
(39.4)
64.469.7
(60)
(30)
0
30
60
90
120
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2006 2007 2008 2009 2010
Source: EPFR Global.
2010 LatAm fund flows, US$mn
(2,500)
(1,500)
(500)
500
1,500
2,500
Jan 10 Feb 10 Apr 10 May 10 Jul 10 Aug 10 Oct 10
ETF Flows
Total Flows
Source: EPFR Global, J.P. Morgan.
Capital control risks: Virtually every EM CB has
intervened, and a number already have controls. Pressure
will likely continue, as we expect more FX appreciation,
with US$ weakness to persist and EM inflows to build.
We see real capital controls, such as unremunerated
reserve requirements and minimum holding periods, as
unlikely. An increase in transaction costs such as
Brazils 2% equity IOF is a last resort, but arguably
near inevitable in this flows environment. It is not
enough to change our positive view on Brazil, wherethe
potential upside beats a moderate potential transaction
cost increase. For details see our report: The threat from
capital controls.
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8
Latin America Equity ResearchNovember 2010
Other risks:Brazil fiscal and rates outlook.In the short
term we await to see the composition of Dilma
Rousseffs first cabinet and the outlines of fiscal policy
going forward. This is important as an early indication of
the policy direction of the new administration at a timewhen inflation expectations are drifting higher and the
economy is growing above potential.Mexico security
concerns.Investor angst here is high. We see this as an
unfortunate issue that detracts from growth (1-1.5%pa)
at a bad time, with the economy weak. We believe
greater concerns here are likely overdone, with violence
localized and largely between cartels. The risk is that this
spreads to Mexico City or cartels decide to openly target
the State and civilians.The electoral calendar in 2011 is
significant.Peru presidential elections are in April, with
three centrist candidates leading in the polls and leftist
Ollanta Humala currently 4th. He is likely to rise
somewhat (and this could unnerve markets) though
unlikely to ultimately prevail. Argentina also goes to the
polls in October. The political environment has been
thrown open by the unexpected death of ex-President
Kirchner. This potentially opens the way for a more
market-friendly candidate, possibly from within the
Peronist party.
Valuations are not stretched: We do not see LatAm
valuations as demanding, with most metrics within
historical ranges or at discounts to peers. LatAm is
currently trading on 11.9x 12m forward P/E, compared
to 11.6x for emerging markets and 11.5x for globalequities. This 12m forward P/E is at the top end of the
regions 15-year average. As highlighted before, the
current regional cost of equity would argue for
significant multiple expansion from these levels. When
comparing EM countries we are also careful to adjust for
index composition. This makes commodity-heavy
indices such as Brazil more expensive and staples-heavy
indices such as Mexico and Chile somewhat cheaper.
15-year MSCI LatAm 12m fwd P/E
5.00
7.00
9.00
11.00
13.00
15.00
95 97 98 99 00 01 02 03 04 05 06 07 08 10
EM Latam Av erage +1SD -1SD
Source: IBES, MSCI, J.P. Morgan.
Sector-neutral P/E
Sector-Neutral P/E 12 Mth Fwd P/E Diff
Chile 16.0 17.8 (1.8)Mexico 14.5 15.3 (0.9)Indonesia 14.8 15.3 (0.5)Korea 9.9 10.0 (0.0)South Africa 11.8 11.7 0.2EM 11.9 11.6 0.3Turkey 11.4 10.9 0.5India 17.7 17.0 0.6Brazil 12.3 11.1 1.2China 14.3 12.0 2.3Taiwan 15.6 12.9 2.8Russia 11.8 6.6 5.2
Source: MSCI, IBES, J.P. Morgan. Sector-neutral P/E multiplies the country sector P/E by
the MSCI Emerging Markets Index sector weight.
LatAm enjoyed a strong earnings recovery cycle in
2010. We expect this to stabilize in 2011. LatAm
earnings growth (local currency) is forecast at 21% for
next year versus 15% for developed markets. This is a
high number, and we see risks as balanced. Commodity
earnings have been easing especially in steels and
Petrobras. Domestic earnings have been moving higher
as GDP expectations are raised, and earnings remain
below all-time highs despite higher nominal GDP
growth. Forecasts for Mexico and Brazil are very similar
(~20-21%).
LatAm EPS growth expectations
EPS Growth Expectations %
2010e 2011e 2012eColombia 29.4 52.5 5.0Peru 27.3 31.6 13.1S.Africa 26.5 27.1 17.8India 23.4 22.7 17.6Brazil 16.3 21.6 11.5EM Latam 15.8 21.4 16.1Indonesia 20.3 20.9 13.5Mexico 9.0 20.4 16.3EM 30.6 17.2 14.0Malaysia 29.4 15.7 11.2Russia 29.8 15.4 17.1Global 36.2 15.3 13.2DW 37.2 15.0 13.0China 26.7 14.9 16.4EMEA 25.0 14.7 15.6EM Asia 40.7 14.6 13.9
Korea 51.4 13.1 11.1Chile 23.0 11.2 7.1Taiwan 89.1 9.4 11.2Turkey 18.5 8.2 13.6
Argentina 5.4 6.4 18.1Czech -4.8 3.3 5.7
Source: MSCI, IBES, J.P. Morgan.
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Latin America Equity ResearchNovember 2010
MSCI LatAm EPS revision cycle
80.0
90.0
100.0
110.0
120.0
130.0
140.0
150.0
Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10
2011 EPS 2010 EPS
Source: IBES, MSCI, J.P. Morgan.
MSCI Brazil domestic vs commodity 12m fwd earnings integer
60.0
90.0
120.0
150.0
180.0
Jan 07 Aug 07 Mar 08 Oct 08 May 09 Dec 09 Jul 10
Brazil Commodities Brazil Domestics
Source: IBES, MSCI, J.P. Morgan.
Attractive risk/reward for 2011 justifies continued
bullish positioning. We run three valuation scenarios for
2011. The MSCI LatAm potentialupside is 53% and thepotential downside 14%. For details see our report:Measuring the risk/reward.
1. The positive view is that lower risk-free rates aresustainable for 2011, as we forecast, and this justifiesfurther multiple rerating. This could be significant. OurGordon-growth fair value target is near 15.0x earnings,
over 30% above current multiples. This indicator hastracked well historically. Upside here is concentrated inBrazil. This targets 53% upside for the region and 70%for Brazil. Mexico is penalized by a potentially tooaggressive 2.5% potential GDP growth.
2. The mid-case assumes current multiples are fair, atthe top end of long-term historical ranges, and consensusearnings growth correct, at a reasonable premium tonominal GDP growth. This targets respectable 18%upside, with all countries closely clustered. This wouldbe our Mexico base case.
3. The cautious view assumes both a derating and thatearnings fall. A derating scenario back to long-termhistorical multiples (down 14%, from 12.0x to 10.5xearnings) and a 20% fall in index earnings versus currentexpectations, as we assume earnings growth only in linewith nominal GDP growth. This shows 14% downsidefor the region, led by Colombia, with Chile defensive.
Our baseline view is somewhere between the more
bullish two scenarios, looking for even lower Treasuryyields and tight EM spreads, whilst the relativeEmerging growth and earnings premium remain high,continuing to attract flows and support multiples. QE2and recent developed market data have reduced
downside tail-risks.
Summary year-end 2011 target and index levels
Positive Target % Upside Mid-Case Target % Upside Cautious Target % Upside
LatAm 122,500 53 94,500 18 69,000 (14)Brazil 122,000 70 84,500 18 61,500 (14)Mexico 39,500 8 42,500 17 31,600 (13)Chile 5,450 8 5,700 13 4,700 (6)Colombia 16,000 1 18,000 14 10,600 (33)
Argentina 2,300(31) 3,950 19 3,275 (1)Peru 41,300 101 24,500 19 16,500 (20)
Source: J.P. Morgan estimates.
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Latin America Equity ResearchNovember 2010
We remain overweight Brazil, with valuations
significantly derated, strongly returning flows, and
multiple overhangs (election, rate cycle, Petrobras, China
slowdown) reduced. Fiscal policy and equity IOF risks
remain but are manageable. The focus remains ondomestic stocks, especially those with growth at
reasonable multiples, such as financials and
homebuilders. We have good growth visibility, the
earnings revision cycle remains positive, and valuations
ex-staples are all cheap/fair. Top-performing staples and
retailers are expensive and will likely keep performing in
this environment if they can continue delivering on
earnings. However, this does not mean the risk/reward is
attractive. We are selective and own CBD. We see cheap,
underowned, but low-growth sectors such as utilities
and telecom as value traps but have continued to
selectively add where we see pockets of growth (such as
NII Holdings and TSU). In our model portfolio, we are
neutral energy (positive oil and E+P but cautious
Petrobras), and underweight materials we are positive
Vale but own no Steels. The sector is cheap (though
earnings are falling), underowned, and benefiting in the
short term from perceived QE upside, though global
growth remains subpar and the sector chronically
oversupplied.
Brazil macro outlook
Source: J.P. Morgan Economics.
Brazil interest rate futures
9.5
10.0
10.5
11.0
11.512.0
12.5
13.0
Feb 10 Apr 10 Jun 10 Aug 10 Oct 10
Jan-11 Jan-12
Source: Bloomberg.
We are neutral Mexico. The market has performed well
in the last month on signs of a bottoming in US growth
expectations (we took our global growth numbers up for
the first time since April) and moderate Mexican
consumer acceleration. We do not see Mexico asunderweight, with the market well supported by a
gradual US growth reacceleration, high equity market
correlation, undervalued currency, easy monetary policy,
and valuations less expensive than they seem. However,
the traditional drivers of Mexican outperformance are
lacking major market sell-off, strong US data surprise,
or strong local consumer recovery. We focus on
domestic recovery plays Televisa, First Cash, AMX
and special situations Cemex and ICA.
US Economic Activity Surprise Index
(40.0)
(30.0)
(20.0)
(10.0)
0.0
10.0
20.0
30.040.0
Jan 09 May 09 Sep 09 Jan 10 May 10 Sep 10
Source: Bloomberg, J.P. Morgan.
Mexico consumer confidence and formal employment
Source: J.P. Morgan Economics, INEGI, IMSS.
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Latin America Equity ResearchNovember 2010
In the smaller markets, we struggle to see a sustainable
second leg to the well-known (and very positive)
Chilean story. Valuations are high, and the stocks we
want to own (banks/discretionary) are even pricier. We
do see further fundamental upside in Colombia on theongoing reform agenda, investment grade outlook, and
capital markets development, but would play this off
index (through Copa and Pacific Rubiales) given high
on-index valuations. We remain exposed to Argentina.
Valuations have become expensive at first glance, but
the outlook for real political change however moderate
means the market still likely has upside. Penetration
rates are low and nontraditional valuation metrics
(franchise value, replacement cost) attractive. We stick
with GF Galicia.
12 mth fwd P/E relative to MSCI LatAm: Smaller markets at
premium to LatAm
0.2
0.7
1.2
1.7
2.2
2.7
3.2
3.7
J an-03 Feb-04 Mar-05 Apr-06 M ay -07 J un-08 J ul-09 Aug-10
Chile Argentina Peru Colombia
Source: IBES, Datastream, MSCI.
Colombia pension fund equity exposure to rise onmultifunds/demographics
Estimated End-2010
AUM Equity % Limit % Cushion %
1 0.0 0.0 NM 0.0 20.0% 0.0 NM
2 90.6 39.4 43.5% 40.8 45.0% (1.4) -1.5%
3 0.0 0.0 NM 0.0 70.0% 0.0 NM
Total 90.6 39.4 43.5% 40.8 45.0% (1.4) -1.5%
Pro Forma 2011
AUM Equity % Limit % Cushion %
1 4.5 0.9 20.0% 0.9 20.0% 0.0 0.0%
2 53.4 24.0 45.0% 24.0 45.0% 0.0 0.0%
3 32.6 22.8 70.0% 22.8 70.0% 0.0 0.0%
Total 90.6 47.8 52.8% 47.8 52.8% 0.0 0.0%
Source: Superfinanciera and J.P. Morgan estimates.
Can Cristina maintain her currently positive image?
0.0%
20.0%
40.0%
60.0%
J-08 M-08 S-08 J-09 M-09 S-09 J-10 M-10 S-10
Source: Management y Fit and J.P. Morgan.
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Latin America Equity ResearchNovember 2010
Latin America Model Portfolio by Sector
Change Port. MSCI Dev. P/E P/E EPS ROE AnalystTicker Price* 1M YTD Weight (%) 10E 11E Growth 10E
(%) (%) (%) (%) (x) (x) 10E (%)Discretionary 667.8 2.1 9.2 13.0 5.3 7.7 17.6 13.8 27.9 16.1Gafisa GFSA3 BZ 14.3 2.8 0.9 5.0 0.4 4.6 17.0 12.7 31.3 9.3 Adrian E HuertaPDG Realty PDGR3 BZ 22.2 5.7 28.0 5.0 0.8 4.2 15.2 9.8 67.8 13.3 Adrian E HuertaTelevisa TV US 22.9 21.1 10.3 3.0 1.2 1.8 22.4 17.5 16.1 20.0 Rajneesh JhawarStaples 628.8 3.4 21.9 9.7 11.6 -1.9 24.0 19.8 21.5 12.9CBD PCAR5 BZ 66.1 11.1 1.7 6.0 0.4 5.6 30.5 24.9 -7.7 6.9 Andrea TeixeiraCencosud CENCOSUD CI 3717.2 14.0 116.1 3.7 0.8 2.9 38.9 30.3 78.6 8.0 Andrea TeixeiraEnergy 1161.3 2.6 -15.5 17.0 16.6 0.4 10.9 10.2 7.1 9.7OGX OGXP3 BZ 22.9 0.7 33.6 4.0 1.9 2.1 nm nm -96.4 2.1 Sergio TorresPacific Rubiales PRE CN 33.4 18.0 116.4 3.0 0.0 3.0 37.2 13.8 -266.7 18.2 Sergio TorresPetrobras PN PETR4 BZ 27.0 -1.4 -26.4 10.0 13.0 -3.0 8.3 10.4 -1.8 10.3 Sergio TorresFinancials 1064.7 3.3 22.0 27.0 22.3 4.7 14.7 12.3 19.6 16.2GF Galicia GGAL US 15.1 51.9 162.8 2.0 0.0 2.0 24.8 17.6 24.5 14.5 Saul MartinezCetip CTIP3 BZ 19.1 17.6 33.7 5.0 0.0 5.0 31.2 23.5 22.0 38.2 Frederic de MarizBradesco BBDC4 BZ 36.5 6.9 21.4 10.0 4.5 5.5 14.1 12.7 26.3 21.8 Saul Martinez
First Cash FCFS US 29.5 10.4 32.9 3.0 0.0 3.0 17.2 14.7 23.7 18.7 Ben LaidlerSantander Brasil SANB11 BZ 25.0 5.9 4.6 7.0 0.5 6.5 15.4 11.7 23.7 11.6 Saul MartinezIndustrials 277.0 3.8 28.5 6.0 4.6 1.4 27.4 22.0 24.6 10.2Copa CPA US 50.6 -3.8 -7.1 3.0 0.0 3.0 10.6 7.7 3.2 na Jamie BakerICA ICA* MM 33.3 8.2 9.2 3.0 0.0 3.0 31.1 22.5 -8.5 3.7 Adrian E HuertaMaterials 1219.1 3.0 12.3 14.3 24.4 -10.1 13.3 9.5 40.1 15.6Cemex CX US 9.2 10.7 -19.1 3.0 1.0 2.0 nm nm -233.3 -0.8 Adrian E HuertaVale PN VALE/P US 28.9 3.7 16.4 11.3 11.0 0.3 9.6 7.0 202.0 23.3 Rodolfo R. De AngeleTelecoms 588.6 3.6 8.1 13.0 8.7 4.3 12.4 10.7 15.4 27.1
AMX AMX US 58.0 6.6 23.4 6.0 6.4 -0.4 15.8 13.5 -24.9 25.0 Andre BaggioNII Holdings NIHD US 42.6 0.3 26.9 5.0 0.0 5.0 25.5 13.0 -26.4 8.9 Andre BaggioTIM Participacoes TSU US 34.1 4.5 14.8 2.0 0.2 1.8 31.0 15.0 -41.9 5.2 Andre BaggioUtilities 383.9 2.3 9.2 0.0 5.5 -5.5 11.7 10.7 8.8 8.7EMF LATAM 79524.0 3.1 11.3 100.0 100.0 0.0 14.2 11.6 15.8 13.9
Source: Bloomberg, MSCI, J.P. Morgan estimates. All estimates are for the calendar year. Updated as of 3 November 2010.
LatAm Model Portfolio sector allocation relative to MSCI Emerging Latin America Markets Index
-12 -10 -8 -6 -4 -2 0 2 4 6 8 10
MaterialsUtilities
Staples
Energy
Industrials
Telecoms
Financials
Discretionary
Source: MSCI, J.P. Morgan estimates. Updated as of 3 November 2010.
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LatAm Model Portfolio country allocation relative to MSCI Emerging Latin America Markets Index
-4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0
Chile
Peru
Mexico
Argentina
Colombia
Brazil
Source: MSCI, J.P. Morgan estimates. Updated as of 3 November 2010.
Historical changes to model portfolio
Bought Sold
Nov 10 TIM Participacoes BM&F BovespaSep 10 Cetip, OGX, Cemex Banrisul, Banorte, Urbi
Aug 10 GF Galicia, Banrisul, Cencosud Lan Airlines, OGX, Banco MacroJul 10 Televisa, Banorte Cemex, TerniumJun 10 Gafisa, Copa Holdings Metalurgica Gerdau, TenarisMay 10 NIHD, Cemex, First Cash Financial Vivo, Grupo Mexico, Banorte
Mar 10 BM&F Bovespa, Metalurgica Gerdau, Vivo, Pacific Rubiales Cielo, Gerdau, Silver WheatonFeb 10 None NoneJan 10 ICA, CBD Cemex, Lojas Renner, GafisaNov 09 Santander Brazil, Cielo, Lan Airlines BM&F Bovespa, Banco do Brasil, Santander ChileOct 09 OGX, Silver Wheaton ALL, TelevisaSep 09 Itauunibanco, Geo, ALL Banco Bradesco, Urbi, TAM
Aug 09 Gerdau, Gafisa Bradespar, GVTJun 09 BM&F Bovespa, Banco Macro Porto Seguro, CredicorpMay 09 Ternium, Grupo Mexico Copa Holdings, Femsa. Apr 09 Lojas Renner, Banorte, Santander Embraer, Walmex, EntelMar 09 Banco do Brasil, ALL, Tenaris, Geo Bradesco, SLC, Ternium, AsurFeb 09 Banco Itau, Entel, Slc Agricola, Cemex Unibanco, Urbi, Gafisa, Santander ChileDec 08 Porto Seguro, Bradesco, Credicorp Telecom Arg., CCR, Banco do BrasilOct 08 Asur, Walmex, Bradespar, Urbi Banorte, Lojas Renner, HomexSep 08 GVT,PDG Realty CTC, Coeur d'Alene, Rodobens
Aug 08 Homex Megacable, UrbJul 08 Embraer VCPJun 08 Petrobras PN ADR, CCR, CTC, Coeur d'Alene Petrobras ON, NETC, Silver Wheaton Apr 08 Banco do Brasil, Megacable B2WFeb 08 Urbi, Rodobens, Gafisa, Telecom Argentina Cesp, Company SA, Cyrela
Source: J.P. Morgan Strategy.
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Analysts Top Stocks to Avoid
Top stocks to avoid
Name Share Price % Change Bloomberg JPM Analyst Mkt Cap, P/E (X) P/E (X) Price Target to target Ticker Rating US$ MM 2010E 2011E
BrazilCyrela Brazil Realty 22.8 29.0 30.3 CYRE3 BZ UW Adrian E Huerta 5,536 12.1 9.9 Eletropaulo 29.9 30.0 0.0 ELPL6 BZ UW Anderson Frey 3,229 4.8 8.4 Fibria 30.0 26.0 -16.7 FIBR3 BZ UW Debbie Bobovnikova 8,587 17.1 96.9 Minerva SA 6.1 8.1 34.1 BEEF3 BZ N Alan Alanis 376 10.6 5.8 Panamericano 7.7 10.0 37.7 BPNM4 BZ UW Frederic de Mariz 1,043 12.1 7.2 Tele Norte Leste 48.5 57.0 14.9 TMAR5 BZ N Andre Baggio 7,699 5.6 6.7 Usiminas 21.0 26.0 13.3 USIM5 BZ UW Rodolfo R. De Angele 14,775 20.5 11.1 MexicoConsorcio Ara 7.6 9.0 15.5 ARA* MM UW Adrian E Huerta 829 11.5 9.9 Grupo Inbursa 53.9 41.0 -21.6 GFINBURO MM UW Saul Martinez 14,247 25.3 21.0 Organizacion Soriana 37.2 31.0 -17.6 SORIANAB MM UW Andrea Teixeira 5,536 21.6 18.9 Telmex SA 15.2 12.0 -24.3 TMX US UW Andre Baggio 14,410 12.7 13.2 ChileIAM 747.0 720.0 -4.0 IAM CI N Anderson Frey 1,561 16.1 16.1 SQM 51.5 37.0 -29.4 SQM US N Brian P Chase 13,799 43.6 30.4 ColombiaBancolombia 66.0 65.0 -3.9 CIB US UW Saul Martinez 13,322 20.0 17.9 Ecopetrol 4360.0 2795.0 -39.9 ECOPETL CB UW Sergio Torres 102,728 22.1 14.9 PeruBuenaventura 51.7 46.0 -16.9 BVN US N John Bridges 15,262 19.8 14.6 ArgentinaEdenor 10.3 na na EDN US UW Anderson Frey 485 13.3 12.2
Source: Bloomberg, J.P. Morgan estimates. J.P. Morgan ratings: OW = Overweight; N = Neutral; UW = Underweight.
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Emerging Market Equity Strategy
The Drivers
1. The declining EM risk premium continues
2. Strong demand from EM credit continues
3. High nominal growth and nominal FX appreciation
4. DM neither a driver nor a drag
Potential Returns
MSCI EM end-2011 target 1500 (+25%) Forward PE at 1500 is 13 (based on consensus 2012
EPS)
Current credit conditions, FX appreciation, earningsgrowth, and earnings estimate revisions provide upside
Other targets
KOSPI 2300, NIFTY 7000
Investment themes
1. China drifts away from the Asian growth model
2. Structural OW on domestic demand
3. FDI in non-China EM increases
4. Growth premiums continue to expand
5. CEMBI Surfers still riding in 2011
6. Warning flags: Real credit growth and core CPI
7. Beware co-investing with governments
8. Liquidity without a valuation anchor
9. Higher REER bad for exporters margins
Risks
Market Risks Lack of valuation cushion Bond market volatility High correlationPolicy and Political risks
Capital controls
Anti-asset inflation policies Trade wars Leadership change in China, Thai and Philippines
elections
Strained social contractEconomic risks
Uncertain outlook for commodities Unintended consequences of QE2 Public sector debt stress in developed economies
Key issues for 2011 Briefing notes
1. Scale of emerging markets
2. Capital controls and FX intervention
3. Western-China-driven growth
4. Strength of consumption in China
5. Chinas infrastructure investment
6. Will China have a housing inventory problem?
Market Performance
MSCI EM and MSCI World performance
50
250
450
650
850
1050
1250
88 90 92 94 96 98 00 02 04 06 08 10
MSCI EM
MSCI World
Source: Bloomberg, 8 November 2010.
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Emerging Market EquityStrategyWe are bullish on EM equities. Our end 2011 target for
MSCI EM is 1500 (+25%). Based on consensus 2012
EPS the forward PE at 1500 is 13. Current credit
conditions could support a larger re-rating (please see
page 27 for potential returns). MSCI EM life high is
1338 (29 October 2007).
What about the biggest bull market of your career?
Between 11 March 2003 and 29 October 2007 MSCI
EM increased from 270 to 1338; +395%, or an
annualized return of 38%. On 2 March 2009 EM was
475. The index is 140% higher today. To match the
2003/7 bull market MSCI EM would need to be 2351 by20 October 2013. This requires an annualized return
of 21%.
In last years Emerging Markets Year Ahead our end-
2010 MSCI EM target was 1200. The index is within 5%
of this target. But the ride was not smooth; between 15
April and 25 May the index declined by 19% to 855.
Zero interest rates, QE2, currency wars, and high
correlation across asset classes are likely to lead to
volatility in 2011. Even with this years volatility, EM
volatility-adjusted returns are the highest for growth
assets.
Our asset allocation starts with long-term trends (EM
consumer, Chinas changing economic policy, sector
RoEs and investment cycles, currencies, etc.) combined
with short-term tactical allocation driven by market
factors (relative valuations and performance, retail
activity, consensus positioning). Benchmark composition
often represents historical rather than future growth
trends. We are bullish on the Brazilian and Chinese
domestic economies yet have been underweight these
markets in 2010. We have been overweight Brazilian and
Chinese domestic demand but underweight the larger
sectors, i.e., energy, materials and Chinese SoEs. As was
the case in 2010, focus on sectors within countries
rather than simple country asset allocation (see page
26).
Investors are seeking carry, growth and momentum.
Both emerging fixed income and equity markets offer
this. For now it is foolish to fight the trend. But
remember the risks (see page 31). QE2 is an experiment.
Chinas ability to rebalance the driver of growth from
investment to consumption is also an experiment.
Monitor the data; core inflation, property sales, actual
commodity demand rather than financial demand, etc.
MSCI EM performance
200
400
600
800
1000
1200
1400
Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
Source: Bloomberg.
Valuations in EM trend rather than mean revert
7
12
17
22
27
32
37
42
88 89 90 91 92 93 95 96 97 98 99 00 02 03 04 05 06 07 09 10
Forw ard PE based on Trend EPS
Forw ard PE based on
Consensus EPS
Source: Datastream, MSCI, IBES. Note: MSCI EM fwd PE based on trend and consensusEPS. The trend EPS is calculated by plotting a trend line through the log chart of MSCI
EM realized EPS.
Higher risk-adjusted returns in EM
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10
EM
World
US
Source: Bloomberg
Note: EM, US and World: Three-month rolling returns adjusted for 90-day volatility.
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There is limited statistical evidence of valuations mean
reverting in EM (see figure on previous page). Investors
should focus on factors that are currently driving a re- or
derating. The rerating factors are:
1. Expanding growth premium in a low-growth world
2. Equities are cheap relative to sovereign andcorporate bonds
3. Accelerating investment and consumption growth inkey EMs
4. Lower relative risk profile of EM versus DM
Base Case
In the risk section on page 31 we highlight the risks to
our base case.
The declining EM risk premium continues
Emerging economies survived the big ugly experiment
of an extreme external demand shock and a credit crisis.
This hit EM economies when they were a year into a
tightening cycle. In passing this test and with the
economies recovering ahead of developed economies,
the risk premium demanded for EM should decline. Note
that stock-specific risk (corporate governance,
transparency, policy risk, etc.) is still higher.
Strong demand for EM credit and carry continues
Investor appetite for risk has slowly increased since 9
March 2009. The bias is corporate credit for yield andemerging markets for growth. EM US dollar and local
currency credit offers both and is thus attracting large
flows relative to its market cap. J.P. Morgan forecast for
this to continue in 2011. We maintain ourCEMBI
surfer theme of favoring current account deficit
markets.
High nominal growth and nominal FX appreciation
Data support positive nominal GDP revisions. These
data include strong retail sales, car sales and loan
growth. EM Central Banks are slowing FX appreciation
but not reversing the trend.
DM neither a driver nor a dragFocus on the local EM dynamics rather than swings innet exports. Economic expansion in the US and EuroArea resumed in 3Q09. J.P. Morgan forecast 2011 GDPgrowth of 2.5% and 1.5% for the US and Euro Arearespectively. This growth may be politicallyunacceptable as it is too slow to reduce unemployment,but for EM, slow DM growth is a benign to positivebackdrop. It is benign for external demand and positiveas interest rates remain low.
EMBI and earnings yield spread between EM and DM
0
200
400
600
800
1000
1200
1400
1600
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
-1
0
1
2
34
5
6Earnings Yield Spread betw een
EM and DM (RHS)
EMBI Spread (LHS)
Source:Bloomberg, MSCI.
EM net debt inflow (Cum. USD bn)
34
-14
31
59
-20
0
20
40
60
80
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2007
2008
2009
2010
Source: J.P. Morgan estimates and EPFR Global.
EM net equity inflows (Cum. USD bn)
41
-40
6469
-60
-40
-20
0
20
40
60
80
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2007
2008
2009
2010
Source: EPFR Global.
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Investment Themes
China drifts away from the Asian growth model
China is a souped-up version of the Asian growth model.
Investment rather than consumption drives growth. Thisrequires a transfer of wealth from the household sector to
the corporate sector through low wages, low return on
savings and undervalued currency. 2010 policy and the
12th Five-Year Plan all point to a move toward
consumption. This is a long-term positive. But it may
mean that the growth in Chinese commodity demand is
overestimated. Beneficiaries of the change are a small
part of the benchmark, which may result in ongoing
underperformance of MSCI China.
Structural OW on domestic demand
This is where the growth is (globally). We acknowledge
that these stocks do trade at a premium and the call isconsensus.
Beware co-investing with governments
A third of MSCI market cap is companies in which
governments are the controlling shareholder. It can be
profitable being a minority shareholder in these
companies when the major shareholder offers favorable
policies and is focused on returns. With todays flood of
capital into EMs, investor-friendly policies may not be a
top priority and thus these companies could be at risk
from politically expedient policies.
SoEs are 79% of MSCI China market cap. Policiesdesigned to boost consumption by increasing the
household income-to-GDP ratio will reduce the ratio of
profits to GDP. SoEs in our view are particularly
vulnerable to policy risk. Our structural bias is to be
underweight SoEs. Russian oils stocks
underperformance is notable, with Rosneft, Lukoil and
Gazprom unchanged year to date. In contrast, Russian
financials are up 25% ytd. Gazprom, with one-sixth of
the worlds oil reserves, has a 2011e PE of 4. Russian
energy stocks are unlikely to rerate while the market
fears higher taxes.
Household income growth lagging tax and profits
343%
512%
748%
258%
0%
100%
200%
300%
400%
500%
600%
700%
800%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
GDP
GovernmentProfits
Income
Source: J.P. Morgan economics. Note: Income proxy is the change in urban per capita
household income; Profits are the growth in aggregate industrial profits.
EM and US as a share of global consumption%
20
25
30
35
40
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
US
EM
Source: J.P. Morgan economics.
Ownership structure in MSCI EM
Family
19%Cross
Institutional
27%
MNC
5%
Government
30%
Source: MSCI, Datastream, J.P. Morgan Strategy.
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FDI in non-China EM increases
Higher labor cost, strengthening Renminbi and tensions
between Japan and China improves the attractiveness of
other emerging markets for FDI. The main beneficiaries
are ASEAN, Turkey and Mexico. Note in table belowthat a small change in Chinas share of FDI could lead to
a large increase in FDI in ASEAN.
FDI into China and ASEAN
US$ billions
China Indonesia Malaysia Philippines Thailand
2007 138.4 6.9 8.6 2.9 11.32008 147.8 9.3 7.2 1.5 8.62009 78.2 4.9 1.4 1.9 6.0
Source: CEIC.
Warning flags: Real credit growth and core CPI
Central banks responding to inflation have always endedthe bull market in EM. As of now EM central banks have
maintained a pro-growth bias even when headline
inflation is higher than the target level. Each week we
publish a detailed table on inflation in our dashboards.
The warning flags are a combination of higher real credit
growth and rising core CPI. These conditions increase
the probability of the central bank moving to a policy
designed to slow growth in order to fight inflation. EM
equities are growth assets. Lower growth and higher
discount rates result in a derating.
Real credit growth and Core CPIReal Credit Growth %oya Core CPI %oya
China 15 0.7Brazil 14 5Korea 3 2Taiwan 4 0.7India 9 9South Africa 2 3Russia 0.1 5Mexico 3 4Malaysia 11 1.1Indonesia 14 5Turkey 16 4Thailand 4 1.1
Source: CEIC, J.P. Morgan economics, Bloomberg and central bank websites, September
2010. Note: Credit growth as of June 2010 for China, Korea, Taiwan, India, Malaysia,
Indonesia, Thailand and August 2010 for Brazil.
Growth premiums continue to expandLack of developed world growth combined with lowdiscount rates supports high growth premium. Maintain astructural bias to high growth themes; EM consumer.Compare valuations with other growth stocks rather thanmarkets.
CEMBI surfers still riding in 2011
Demand for EM credit remains strong (see Error!
Reference source not found.). The yield on the
emerging market corporate bond indices (CEMBI) is
5.3%; this is lower than the average investment gradebond yield in past decade (JULI). Our bias is to own
current account deficit markets when credit conditions
are favorable; OW India and Turkey.
EM equities cheap relative to bonds
5
8
11
14
17
20
01 02 03 04 05 06 07 08 09
CEMBI (1/y ld) Fw d PE
Source: MSCI, Bloomberg, J.P. Morgan Indices.
Note: The inverse of the CEMBI yield is used to compare PEs with EM corporate bond
yields.
Liquidity without a valuation anchor
The range of valuations since late 2007 is extremely
wide. Correlation of risk asset is high, indicating that
asset-specific fundamentals are secondary to general
market trend. Higher commodity prices are partlyjustified by monetary conditions rather than supply or
demand. Equities are inexpensive relative to bonds but if
economic activity improves then bonds are expensive.
Risk assets march in step: Correlation with MSCI US
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
JPM TR Energy
JPM Precious Metals TR
JPM Industrial Metals Index
Source: Bloomberg, J.P. Morgan indices.
Note: Three year correlation of monthly returns of MSCI US vs. JPMCI Energy, Precious
metals and Industrial metals.
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The lack of valuation anchors in equities, bonds,
commodities and currencies means a wide range of
possible returns and high volatility. It is critical to keep
monitoring the fundamentals while acknowledging that
the near term drivers of markets are dominated bymomentum and casual relationships between asset
classes. When implied volatility is low, consider buying
protection. Remember that the 2003/7 EM bull market
had five 15-20% corrections.
YTD Returns and Correlation with MSCI USYear to date
return3 year correlation of monthly
returns with MSCI USTopix -6 0.8Energy -4 0.6US cash 0.2 -0.4GSCI TR 4 0.6Global Gov Bonds 6 -0.3MSCI Europe 7 0.9EM FX 8 0.8US Fixed Income 9 0.2MSCI AC World 9 1.0EM Local Bonds 10 0.5US High Grade 11 0.4S&P500 12 1.0MSCI EM 15 0.9EM $ Corp. 16 0.6EMBIG 17 0.7Gold 27 0.1
Source: Bloomberg.
Higher REER bad for exporters margins
Capital-flows support EM FX appreciation. Nominal
appreciation combined with inflation differentials results
in a real effective exchange rate appreciation. In China
there have been a number of large wage increases in
foreign owned export factories. This is bad for margins.
Avoid export industries in Brazil and China with a large
labor cost.
Movement in major currencies
-20 -10 0 10 20 30 40 50 60 70
HKD
CN Y
PHP
TWD
INR
RU B
MYR
JPY
SGD
TR Y
THB
HUF
MXN
CZ K
PLN
IDR
KRW
BRL
ZAR
AUD
Av g 05-07 Mar low
Source: Bloomberg.
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Focus on sectors within countries rather than country recommendations
The table below provides a level summary of our views on sectors within countries. Financials is 26%, Materials is 15%and Energy is 14% of EM. All recommendations are relative to EM. The Industrials sector consists of an eclectic group of
stocks. We do not rate the sector.Key country and sector recommendations, performance and fundamentals
Country/Sector Wt Rec Demand Performance(USD Returns)
PE EPS Growth(%)
EPSCAGR
EPSCAGR
PEG DY(%)
RO(%
Classific-ation
Jan 06to date
EM lowto date
12M YTD 10E 11E 10E 11E (06-11) by SD Ratio 10E 10
EM 100 -- 64 154 24 17 13.5 11.6 28.4 16.3 8.4 0.5 1.7 2.4 14.China 18.5 N 149 167 15 12 14.3 12.2 26.8 17.6 14.1 0.9 1.1 2.5 16.China Financials 7.2 N DD 215 173 9 10 12.9 10.6 25.7 21.7 26.2 1.1 0.5 2.9 17.China Energy 3.2 UW GPT 144 236 27 21 12.6 11.4 26.2 10.4 10.4 0.7 1.3 3.2 17.China Telecom 2.1 UW DD 111 53 12 14 12.9 12.1 3.0 6.9 9.3 0.8 1.4 3.3 15.China Industrials 1.5 n/a 50% DD 92 176 17 15 14.9 13.6 64.7 10.1 10.5 0.2 1.7 1.8 11.China CS 1.1 OW DD 303 225 36 14 22.7 18.8 13.7 20.9 17 1.5 1.2 1.6 17.China Materials 1.0 UW GPT 132 335 9 8 17.0 12.5 54.2 36.2 2.5 0.1 7.6 1.4 11.China CD 1.0 OW DD 133 272 28 11 18.4 15.6 38.3 18.1 13.4 0.8 1.5 1.8 21.Brazil 16.2 N 146 190 9 7 13.5 11.2 15.5 20.1 9.2 0.6 1.5 2.6 14.Brazil Financials 4.3 OW DD 159 260 25 21 14.6 12.3 17.2 18.8 10.7 0.6 1.4 2.7 16.Brazil Materials 4.0 N GPT 201 219 13 11 11.5 8.1 87.8 41.5 14.6 0.2 1.1 2.4 17.Brazil Energy 3.7 UW GPT 130 126 -18 -17 11.6 12.0 -15.0 -3.1 0.7 0.0 13.4 1.9 10.Brazil CS 1.4 N DD 185 227 29 25 23.5 19.0 21.3 23.6 16.2 0.3 1.7 2.5 12.Korea 13.4 UW 28 163 32 19 10.6 10.0 46.7 5.3 10.3 0.3 1.0 1.0 14.Korea IT 3.4 UW GC/C 11 155 23 7 9.5 10.6 82.8 -10.4 11.0 0.0 0.8 0.1 17.Korea Financials 2.1 UW DD -17 92 5 3 10.6 8.8 61.7 19.5 1.6 0.0 8.0 2.2 10.Korea Industrials 2.3 n/a 60% DD 72 226 51 39 13.9 12.1 42.3 14.3 9.9 0.3 1.4 1.0 12.Korea Materials 1.9 N GPT 192 270 43 17 10.1 9.7 22.9 3.2 13.7 1.7 0.7 1.1 15.Korea CD 2.1 OW GC 55 283 70 49 10.6 8.9 9.2 18.9 27.4 0.5 0.4 0.7 17.Taiwan 10.5 N 19 102 21 8 14.1 12.7 86.7 11.5 4.3 0.1 3.5 3.4 13.Taiwan IT 6.0 N GC/C 4 97 16 1 12.6 11.4 125.1 10.5 3.4 0.0 4.1 3.4 16.Taiwan Financials 1.6 OW DD 6 117 11 6 19.6 15.0 29.0 30.6 20.1 0.0 1.1 2.6 6.9Taiwan Materials 1.4 N GPT 87 114 37 24 16.8 15.4 28.9 9.3 -0.8 0.0 NM 3.9 11.India 8.1 OW 123 186 39 25 20.8 17.0 19.8 22.2 12.7 0.8 1.9 1.2 16.India Financials 2.3 OW DD 153 209 48 42 24.9 19.8 17.5 25.3 15.7 1.6 1.7 1.0 11.
India IT 1.3 OW GCap 84 171 50 27 24.8 20.4 15.8 21.2 13.3 1.3 2.0 1.3 24.India Energy 1.1 OW GPT 202 140 23 10 16.5 13.2 40.1 24.7 12.7 0.9 1.7 1.1 15.South Africa 7.4 N 53 182 36 24 14.6 11.6 28.0 25.8 8.9 0.4 2.1 2.9 15.SA Materials 1.9 UW GPT 33 210 31 16 19.5 12.5 236.8 55.8 20.3 0.2 4.4 1.9 12.SA Financials 1.9 N DD 39 162 35 23 12.3 10.4 14.9 18.7 3.9 0.2 3.4 4.1 12.SA Cons Discr 1.0 OW DD 106 320 58 40 17.0 14.1 19.3 20.8 11.9 1.2 1.8 1.9 17.SA Telecom 1.0 OW DD 60 147 25 19 12.9 10.8 18.5 19.0 9.1 0.7 1.6 3.2 20.Russia 6.0 N 5 154 10 8 7.8 6.2 44.0 25.0 6.8 0.3 1.2 1.9 13.Russia Energy 3.3 UW GPT -20 115 -3 -2 5.6 4.8 25.9 16.2 6.2 0.4 0.9 2.2 14.Mexico 4.3 UW 58 136 31 21 17.8 14.8 7.4 20.4 5.5 0.3 4.3 2.4 16.Mexico Telecom 1.6 N DD 86 116 27 24 13.5 11.7 13.7 15.5 16.4 1.5 1.1 3.9 41.Mexico CS 1.1 UW DD 100 144 40 19 23.2 19.3 -5.0 20.4 18.7 0.6 1.3 1.4 14.Malaysia 2.8 OW 108 108 33 32 17.7 14.8 25.7 19.7 7.6 0.3 2.4 3.1 12.Indonesia 2.3 N 227 259 48 36 17.4 14.7 19.9 17.7 18 1.1 1.1 2.3 24.Turkey 1.8 OW 55 225 57 43 11.6 10.8 18.4 8.0 12.8 0.8 0.9 2.4 17.Turkey Financials 1.1 OW DD 78 316 69 50 10.7 10.2 14.4 5.1 20 0.8 0.5 1.8 18.Thailand 1.7 OW 101 224 72 58 15.2 13.2 17.2 15.0 5.9 0.2 2.6 3.0 15.
Chile 1.7 N 145 174 56 41 19.7 17.2 22.3 15.0 18.2 1.5 1.2 1.7 11.Poland 1.6 N 19 94 23 19 13.7 11.7 25.0 16.7 1.1 0.1 12.8 3.2 11.Philippines 0.5 OW 123 159 48 40 18.8 16.4 18.1 14.2 4.3 0.3 4.8 3.4 16.Hungary 0.4 N 1 134 6 4 12.9 10.0 -3.4 29.6 -4.9 -0.2 NM 3.0 10.Czech Republic 0.4 N 25 54 -10 -3 10.8 10.2 -2.4 5.5 8.7 0.6 1.2 6.4 17.
Source: MSCI, IBES, Bloomberg, J.P. Morgan, 5 November 2010. Note: Outperformance of more than 2% vs. MSCI EM.Underperformance of more than 2% vs MSCI EM. DD=Domestic
Demand, GPT=Global Price Takers, GC/C=Global Capex/Consumer, GC=Global Consumer, GCap=Global Capex.
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Potential Returns andEarnings Estimates
End-2011 strategy team index forecasts MSCI EM 1500 (+25%)
Base case
Current MSCI EM forward PE 11.6
2012 MSCI EM EPS 112 (before currencyappreciation)
EM FX appreciation 5%
10% re-rating to forward PE 13
Statistical warning
EM equity markets valuations trend rather than mean-
revert. Indices also evolve with sector compositionchanging. The growth characteristics of stocks also
change and thus their valuations. Prior to the mid-90s
current account crisis, fixed exchange rates and high
nominal growth supported high valuations. Investors
should be suspicious of statistical justification for index
targets.
Pick your methodology
To illustrate the impact of different methodologies on
potential returns we calculate index targets using six
assumptions:
1. Current earnings to bond yield ratio usingSeptember 2011 yield forecast and end-2011e PE.
5. Five-year average earnings to bond yield ratio usingSeptember 2011 yield forecast and end-2011e PE.
6. Current forward PE multiplied by 2012e EPS basedon the lower of 2012e EPS growth or potential
nominal GDP.
7. Current forward PE multiplied by 2012 EPS forecast.
8. Three-year average PE multiplied by 2012 EPSforecast.
9. Gordon Growth model theoretical PE multiplied by2012e EPS. This generates PE in excess of 30 for six
markets as local bond yields in these countries are
very low relative to nominal GDP growth and RoE.
Current forward PE with standard deviation ranges
Index CurrentFwd PE
Avg10Y
+1 SD -1 SD TopDecile
BottomDecile
EM 11.7 10.7 12.2 9.2 12.6 8.8EM Asia 12.7 11.5 13.3 9.7 14.0 9.3Latam 11.8 10.0 11.7 8.4 12.3 8.0EMEA 9.3 9.8 11.4 8.2 11.7 8.0China 13.0 13.1 16.3 9.8 17.3 9.9India 17.2 14.1 17.3 10.8 18.0 9.9Indonesia 14.9 9.6 12.9 6.2 13.7 5.0Korea 9.9 9.1 10.9 7.2 11.6 6.5Malaysia 15.0 14.1 15.5 12.7 15.9 12.3Philippines 16.6 13.9 16.1 11.7 17.1 11.5Taiwan 12.8 14.3 18.0 10.6 20.4 11.4Thailand 12.3 10.4 11.8 9.0 12.1 8.9Brazil 10.5 8.0 10.4 5.6 11.7 5.3Mexico 15.1 12.1 13.8 10.4 14.1 9.8Chile 17.4 15.6 17.6 13.5 18.2 12.8S Africa 11.7 10.0 11.4 8.7 11.7 8.1Russia 6.4 7.9 10.3 5.6 11.1 4.6Turkey 11.2 9.1 11.2 7.1 11.7 6.5
Source: MSCI, IBES, Datastream, 5 November 2010.Note: Current PE > +1SD in red.
Consensus Earnings Growth Forecast (%)
Index Consensus Earning Growth (%) EPS grow10E 11E 12E CAGR 11
EM 30.6 17.2 14.0 8.2Brazil 18.4 21.0 11.0 9.0Chile 23.1 12.0 11.0 18.3China 26.7 14.9 16.4 14.3Czech Republic (4.8) 3.3 5.7 9.1Hungary (2.9) 29.8 21.9 (4.9)India 23.4 22.7 17.6 10.6Indonesia 20.3 20.9 13.5 18.3Korea 51.4 13.1 11.1 8.6
Malaysia 29.4 15.7 11.2 7.8Mexico 2.9 28.9 13.1 5.7Peru 27.3 31.6 13.1 8.4Philippines 22.2 12.2 14.8 4.4Poland 23.9 16.9 9.3 1.1Russia 29.8 15.4 17.1 6.8South Africa 26.5 27.1 17.8 9.0Taiwan 89.1 9.4 11.2 5.4Thailand 19.1 18.7 15.9 7.2Turkey 18.5 8.2 13.6 12.9
Source: MSCI, Datastream, IBES, J. P. Morgan, 5 November 2010.
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Pick your methodology and thus your return: Percentage return to end-2011 targets based on multiple methodologies
IndexLevel
(1)CurrentEY/BY
(2)5yr avgEY/BY
(3)FWD PE
2010 EPS= GDP
(4)CurrentFWD PE
(5)3year
averageFWD PE
Median Max Min Range ofreturns
(6)GordonGrowth
PE
Brazil 249321 14 0 7 14 11 11 14 0 14 (38)Chile 5942 13 31 6 13 (1) 13 31 (1) 33 (21)China 73 15 5 11 18 15 15 18 5 12 169India 839 25 2 12 29 8 12 29 2 27 110Indonesia 4672 10 27 8 14 (7) 10 27 (7) 34 127Korea 543 4 20 5 11 7 7 20 4 16 153Malaysia 558 14 8 8 14 3 8 14 3 11 123Mexico 33913 18 10 6 18 (6) 10 18 (6) 24 (2)Philippines 774 29 41 7 20 (5) 20 41 (5) 47 115Poland 1904 12 6 6 12 2 6 12 2 10 39Russia 815 20 85 7 20 42 20 85 7 79 486South Africa 808 16 9 7 22 (1) 9 22 (1) 23 17Taiwan 301 6 63 6 14 42 14 63 6 57 172Thailand 425 8 15 7 24 (12) 8 24 (12) 36 165Turkey 1038342 15 59 7 15 (15) 15 59 (15) 74 51
Source: MSCI, IBES, Datastream, Bloomberg, J.P. Morgan. 5 November 2010
Note: All returns are local currency; please email EM_Equity_Strategy@jpmorgan.com for the assumptions.
Consensus EPS estimates and revisions since the beginning of 2010
Index Actual Current Consensus EPS Consensus EPS beginning of this Year Revision in Consensus EPS (%)08 09 10E 11E 12E 10E 11E 12E 10E 11E 12E
EM 58 65 84 98 112 77 93 104 9.3 6.0 7.5Brazil 15593 16618 19678 23812 26435 17942 21381 25574 9.7 11.4 3.4Chile 236 247 303 339 376 276 317 381 9.5 6.9 (1.2)China 3.31 3.76 4.79 5.51 6.41 4.64 5.39 6.03 3.3 2.1 6.2Czech 34.7 34.7 33.0 34.1 36.0 33.8 36.0 37.2 (2.4) (5.2) (3.1)Hungary 170 106 103 134 163 116 150 171 (11.1) (11.1) (4.4)India 29 34 42 51 60 42 50 61 (0.5) 2.3 (1.1)Indonesia 213 224 269 325 369 261 309 369 3.1 5.4 (0.0)Israel 18 21 27 31 37 28 33 34 (4.7) (4.5) 8.5
Korea 22 35 49 55 61 47 52 55 5.0 6.5 11.6Malaysia 31 25 32 37 41 30 35 39 5.3 6.6 5.4Mexico 1446 1713 1763 2272 2588 2063 2440 2834 (14.6) (6.9) (8.7)Peru 63 71 90 119 135 89 102 111 1.5 16.6 20.8Phi 30 34 42 47 54 41 46 70 2.5 1.1 (22.6)Poland 148 109 136 159 173 116 144 158 16.5 9.9 10.1Russia 111 91 118 136 159 98 144 151 19.8 (5.8) 5.4S Africa 57 42 52 66 78 56 71 85 (6.6) (6.9) (8.0)Taiwan 7.0 11 21 23 26 17 22 24 23.2 8.1 10.6Thailand 19 24 28 33 39 27 31 35 5.3 6.2 11.2Turkey 70564 72915 86436 93550 106291 78669 93247 108651 9.9 0.3 (2.2)
Source: MSCI, Datastream, IBES, J. P. Morgan, 5 November 2010.
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Dissection of EM EPSgrowth
The objectiveDisaggregate the EM EPS growth into countries, sectors
and key sectors in countries.
Main observations on 2011e EPS growth
MSCI EM weighted and median EPS growth is17%. This is 5% higher than our economists 2011
nominal GDP growth forecast of 12%.
Financials and materials are the highest contributorsto 2011e earnings growth.
The contribution of IT and healthcare is the lowest(see top table, next page).
Two sectors contribute c20% of MSCI EM 2011eEPS growth; Brazilian steel and Russian oil & gas
sectors (2011e EPS growth for Vale, Sider and
Gazprom is estimated by IBES to be 41%, 44% and
23% respectively).
Note that the weighted EPS growth for Taiwanelectronic components is high at 62% (primarily due
to losses or low profits at AU Optronics, ChimeiInnolux, Chunghwa picture tubes, E-Ink). Themedian EPS growth is 24% (see second table onnext page).
Dataset
IBES EPS forecasts for MSCI EM constituents
CalculationThe indexs calendar year EPS is calculated using the
profit-weight of the constituents.
Index EPS = I x ( (C-EPS x FFS) / (FFS x P))
where C-EPS = Index constiuents EPS, FFS = free float
shares for the constituents, I = index level and P =
current market price.
The check
Median EPS growth of the index constituents:
Reviewing the median helps identify sectors in which a
single stocks impact on weighted EPS growth is large.
This could be due its large weight in the index or moving
from loss to profit.
Emerging markets earning growth and contribution
Country Mkt Cap Earnings weights (%) Index EPS Growth Median EPS Growth Contribution to Earning growth (%)Weight 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E
Brazil 16.2 16.4 16.9 16.6 18.4 21.0 11.0 18.4 24.1 19.0 9 20 15Russia 6.0 11.2 12.4 12.4 29.8 15.4 17.1 33.4 34.5 15.4 13 20 13China 18.7 17.0 16.7 17.1 26.7 14.9 16.4 25.0 21.1 18.8 15 15 20South Africa 7.4 6.9 7.4 7.6 26.5 27.1 17.8 14.4 19.4 18.3 6 10 9Korea 13.2 17.6 16.2 15.7 51.4 13.1 11.1 31.8 14.3 12.9 24 8 13India 8.1 5.3 5.5 5.8 23.4 22.7 17.6 12.9 19.3 20.2 4 7 8Taiwan 10.5 10.3 9.6 9.5 89.1 9.4 11.2 25.3 13.3 10.0 20 6 8Mexico 4.4 3.1 3.4 3.4 2.9 28.9 13.1 15.6 17.2 12.4 0 5 4Indonesia 2.3 1.8 1.9 1.8 20.3 20.9 13.5 18.7 20.4 12.0 1 2 2Malaysia 2.8 2.2 2.2 2.1 29.4 15.7 11.2 19.7 12.5 10.0 2 2 2Thailand 1.8 1.6 1.6 1.6 19.1 18.7 15.9 15.5 19.9 15.7 1 2 2Poland 1.6 1.5 1.5 1.5 23.9 16.9 9.3 15.0 20.5 13.8 1 2 1Chile 1.7 1.2 1.2 1.1 23.1 12.0 11.0 33.8 16.5 8.9 1 1 0Peru 0.8 0.5 0.6 0.5 27.3 31.6 13.1 23.4 34.8 18.1 0 1 1Colombia 0.9 0.4 0.5 0.5 29.4 52.5 5.0 30.4 33.3 25.0 0 1 0Turkey 1.9 2.2 2.0 2.0 18.5 8.2 13.6 13.5 8.7 14.2 1 1 2Hungary 0.4 0.4 0.5 0.5 (2.9) 29.8 21.9 (0.9) 20.3 10.0 0 1 1Egypt 0.4 0.5 0.5 0.6 32.7 19.6 42.9 34.9 17.5 19.4 1 1 1Philippines 0.5 0.4 0.3 0.3 22.2 12.2 14.8 20.7 14.3 12.5 0 0 0Czech Republic 0.4 0.5 0.4 0.4 (4.8) 3.3 5.7 (7.8) 5.0 7.7 0 0 0Morocco 0.2 0.1 0.1 0.1 4.1 10.7 9.2 (0.4) 12.7 13.0 0 0 0Source: IBES, Datastream, J.P. Morgan calculations. Note: Sorted by 2011e earning growth contribution.
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EM Sectors earning growth and contribution
EM Sectors Mkt Cap Earnings weights (%) Index EPS Growth Median EPS Growth Contribution to Earning growth (%)Weight 2010 2011 2012 2010 2011 2012 2010 2011 2012 2010 2011 2012
Financials 26.3 24.1 25.2 25.9 25.1 22.2 16.8 20.7 19.4 16.1 19 31 31Materials 14.6 13.8 15.3 15.2 63.7 31.0 16.4 31.0 23.7 15.5 21 24 14Energy 14.3 19.9 19.3 18.8 11.8 10.2 9.0 21.5 15.5 14.0 13 15 16Utilities 3.4 2.8 3.5 3.3 7.4 26.5 14.2 1.9 13.2 9.0 -1 7 2Consumer Discretionary 6.8 6.4 6.4 6.5 28.6 15.5 13.7 19.5 17.2 16.1 6 6 7Telecommunication Services 7.8 8.3 7.9 7.7 7.4 10.7 10.7 7.0 6.7 9.1 3 5 6Industrials 7.3 6.6 6.4 6.4 47.5 13.9 15.4 20.7 15.2 16.8 9 5 6Consumer Staples 6.7 4.4 4.2 4.2 18.1 11.4 16.1 18.1 17.2 14.3 3 3 4Information Technology 11.9 13.6 11.9 11.9 118.5 7.6 13.2 33.3 15.4 12.4 27 3 11Health Care 0.8 0.5 0.5 0.5 32.7 15.6 13.8 14.3 17.6 19.9 0 0 1EM 100 100.0 100.0 100.0 30.6 17.2 14.0 19.9 17.5 14.8 100 100 100
Source: IBES, Datastream, J.P. Morgan calculation. Note: Sorted by 2011e earnings growth contribution.
Countries sub-industry contributing 70% of EM earning growth
Country Sub-Industry Mkt Cap Earnings weights (%) Index EPS Growth Median EPS Growth Contribution to Earning growth(%)
Weight 2010 2011 2012 2010 2011 2012 2010 2011 2012 2010 2011 2012
Brazil Steel 3.8 4.6 5.6 5.5 107 42.0 11.7 47.7 41.1 13.9 10 11 5Russia Integrated Oil & Gas 2.9 7.4 7.3 7.2 24.6 15.6 13.2 17.4 4.1 11.5 6 7 7China Diversified Banks 4.5 5.1 5.1 5.4 22.1 17.5 20.2 25.0 17.4 17.8 4 5 7Russia Diversified Banks 1.0 0.8 1.3 1.3 456 95.0 15.4 456 95.0 15.4 3 4 1Brazil Diversified Banks 3.7 3.6 3.6 3.7 17.8 19.1 15.0 23.8 17.1 14.9 2 4 4Korea Diversified Banks 1.2 1.5 1.9 1.9 77.8 43.6 16.8 65.2 15.0 11.8 3 4 2South Africa Gold 0.9 0.5 0.7 0.7 (377) 82.8 6.1 (3.7) 79.1 17.8 3 2 0Taiwan Electronic Components 0.9 0.6 0.8 0.9 (202) 61.0 36.7 46.4 24.2 13.7 4 2 2Korea Electric Utilities 0.2 (0.1) 0.2 0.3 623 (437) 40.7 NM NM 40.7 (0) 2 1Russia Div. Metals & Mining 0.4 0.4 0.6 1.0 NA 84.6 84.7 NM 84.6 84.7 0 2 4Brazil Homebuilding 0.5 0.7 0.8 0.9 52.1 37.8 22.6 64.6 35.2 23.8 1 1 1Mexico Wireless Telecom 1.5 1.5 1.5 1.4 18.0 14.3 12.5 18.0 14.3 12.5 1 1 1Mexico Construction Materials 0.2 (0.2) 0.0 0.0 (194) (120) 100.0 NM NM 100.0 (1) 1 0S Africa Wireless Telecom 0.9 1.0 1.0 1.0 23.2 20.0 13.0 23.3 15.8 9.0 1 1 1Russia Oil & Gas E&P 0.4 0.9 0.9 0.9 8.7 21.1 7.6 8.7 21.1 7.6 0 1 0
China Life & Health Insurance 1.6 0.8 0.8 0.9 9.8 24.2 24.1 13.6 25.4 24.7 0 1 1Taiwan Electronic Mftg Services 0.9 0.8 0.9 0.9 27.5 21.8 18.8 4.2 18.5 18.8 1 1 1South Africa Diversified Banks 0.7 0.8 0.9 0.9 14.4 21.9 23.0 11.0 20.2 24.2 0 1 1Taiwan Diversified Banks 0.8 0.7 0.8 0.7 63.4 25.0 2.2 34.0 25.0 0.0 1 1 0S Africa Precious Metals 0.6 0.4 0.5 0.5 43.1 48.3 22.1 16.7 41.2 26.3 0 1 1India Diversified Banks 1.3 0.7 0.7 0.8 18.4 23.0 23.6 19.7 22.9 23.7 0 1 1India Steel 0.5 0.5 0.5 0.6 56.3 33.3 19.9 11.7 20.0 21.9 1 1 1China Real Estate Development 0.9 0.9 0.9 0.9 18.9 17.2 25.6 22.8 19.4 24.3 1 1 2Russia Steel 0.3 0.2 0.3 0.4 (571) 61.7 29.2 504 55.5 29.3 1 1 1South Africa Int Oil & Gas 0.7 0.9 0.9 0.9 15.4 17.2 20.5 15.4 17.2 20.5 0 1 1China Oil & Gas E&P 1.2 1.1 1.1 1.0 71.9 12.8 6.4 74.1 22.5 15.1 2 1 0Korea Construction & Eng. 0.6 0.5 0.5 0.6 67.9 28.8 16.1 29.9 13.8 18.1 1 1 1Poland Diversified Banks 0.7 0.5 0.5 0.6 24.0 29.0 19.4 25.8 28.2 18.5 0 1 1India It Consulting & Other svs 1.3 0.7 0.7 0.8 12.3 19.1 19.8 11.2 18.5 20.7 0 1 1Mexico Div Metals & Mining 0.3 0.3 0.4 0.4 52.8 45.5 18.8 52.8 45.5 18.8 0 1 0Indonesia Coal & Consumable 0.3 0.2 0.3 0.3 20.0 58.0 1.9 (10.3) 52.3 1.2 0 1 0India Oil & Gas R&M 0.9 0.7 0.7 0.7 16.9 19.0 14.0 22.2 17.4 10.5 0 1 1
Korea Steel 0.9 1.4 1.3 1.2 24.3 9.1 9.2 34.3 7.0 8.3 1 1 1Thailand Diversified Banks 0.6 0.6 0.6 0.6 19.9 21.0 14.5 19.9 25.9 14.7 0 1 1Korea Auto Manufacturers 1.0 1.4 1.3 1.2 55.1 8.7 7.3 50.5 9.7 7.0 2 1 1Colombia Diversified Banks 0.2 0.2 0.2 0.2 36.9 66.3 (8.2) 36.9 66.3 (8.2) 0 1 (0)China Coal & Consumable Fuels 0.9 0.8 0.7 0.7 35.0 14.5 13.7 45.1 13.7 11.8 1 1 1Russia Wireless Telecom 0.4 0.4 0.4 0.5 132.6 27.5 20.0 25.0 35.6 29.3 1 1 1Taiwan Communications Equip 0.5 0.4 0.4 0.4 66.7 29.0 11.9 19.2 47.7 (13.8) 1 1 0Brazil Packaged Foods & Meats 0.3 0.2 0.2 0.3 81.9 61.5 35.9 223.1 46.2 41.4 0 1 1
Source: IBES, Datastream, J.P. Morgan calculation. Note: Sorted by 2011 earning growth contribution.
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Risks to our strategyMarket risks
Lack of valuation cushionOur strategy is biased toward growth with good
momentum but at a valuation premium. A growth
premium is justified in a world where growth is in short
supply. High valuations are vulnerable to a reversal in
EM portfolio flows and stock-specific risk.
Bond market volatility
The Feds objective with QE2 is to lower bond yields.
The result is that bonds are expensive relative to J.P.
Morgans growth forecasts. Higher US growth could
lead to a spike in bond yields.
High correlationHigh correlation between risk assets may propagate
volatility. A counter-trend rally in the US dollar may
drive that volatility.
Policy and Political risks
Capital controls
Strong foreign inflows and continued FX appreciation
have prompted EM central banks to implement capital
control measures. These include: 1) Increase in IOF tax
on foreign purchase of fixed income instruments from
2% to 6% in Brazil; 2) One-month minimum holding
period restriction on SBI bonds in Indonesia; 3) 15%withholding tax on foreign bond holders in Thailand; 4)
Restrictions on forward currency positions of foreign
bank branches and local banks in South Korea. For
equity investors, controls designed to reduce the
effective carry in fixed income markets are ok. Broader
capital controls which reduce the ability of equity
investors to buy and sell would be negative as they
reduce liquidity and increase volatility.
Anti-asset inflation policies
Central banks are targeting asset prices in EM to counter
asset inflation. These policies introduce economic and
sector-specific risks. Note how poorly real estate stockshave performed in EM despite low interest rates.
Trade wars
High US unemployment, Chinas large current account
surplus and polarized politics in the US increase the risk
of a trade war.
Politics: Elections and change of leadership in Brazil
and China
Leadership change in China will occur in 2012. The
transition may result in confusion on policy. Brazils
new president needs to maintain reform momentum anddevelop infrastructure.
2011 election calendar
Jan Feb Mar AprPeruPresidential &Legislative
May JunVietnamPresidential
TurkeyParliamentary
Jul AugPhilippines Subnational -Legislative
Sep Oct
ArgentinaPresidential
PolandParliamentary
Nov Dec
RussiaParliamentary
ThailandParliamentary(Tentative)
Source: IFES.
EM CPI and earnings yield
3
4
5
67
8
9
10
11
12
Jan-02 Jun-03 Nov -04 Apr-06 Sep-07 Feb-09 Jul-10
3
6
9
12
15
EM central banks'
av erage target range ceiling
EM CPI %oya
(LHS)
MSCI EM 12m Fwd PE
(RHS inv erted)
Source: J.P. Morgan economics, IBES, MSCI, November 2010. Note: CPI data is to
August 2010.
Strained social contract
Political and regulatory risk is high. The corporate sector
has emerged from the global recession and credit crunch
stronger than the households. Note that profits as a share
of GDP are near cyclical highs but unemployment is10%. Policy makers constrained by high fiscal deficits
are likely to redress this imbalance through higher taxes
and increased regulation. This would add to business
costs and delay normal investment decisions, threatening
the recovery.
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Ben Laidler
(1-212) 622-5252
ben.m.laidler@jpmorgan.com
29
Latin America Equity ResearchNovember 2010
As is the case in the US, Chinese corporate share of GDP
increased while the household share decreased. Labor
disputes and subsequent large pay increases may start to
reverse this trend. This rebalancing is healthy and should
move China to a more sustainable growth model. Butnear term the result is likely lower profit margins.
Economic risks
Uncertain outlook for commodities
Our commodities and energy underweight is driven by a
combination of long-term economic cycles and a
potential inflection point in the growth of Chinese
material demand. The timing is complicated by the large
influence of financial investors on commodity markets.
The timing risk in a bearish view on commodity
companies is high. Industrial metal prices rallied since
May while global leading indicators fell. Correlation ofcommodities to risk assets (equities) is high today.
Momentum in a world of zero interest rates is an
attractive attribute. An UW commodity call is unlikely to
work at this point. When it does eventually, the
correction may prove to be violent as financial investors
exit.
Unintended consequences of QE2
If QE2 results in a sharp increase in commodity prices it
may choke off growth and ultimately be
counterproductive.
Peripheral Europe sovereign stressGreek, Irish and Portuguese bond spreads to German
bunds are at record highs. Sovereign stress could disrupt
risk appetite as it did in 2Q10.
US state and municipal stress
US states and municipalities are required to balance their
budgets. The result may be rising unemployment as US
local government downsizes. This would place a larger
burden on the private sector to create jobs.
Strained social contract: US profit share and unemployment
8
10
12
14
1618
20
22
70 75 80 85 90 95 00 05 10
0
3
6
9
12
% sa
Unemployment rate (inverted)
Profit share
Source: J.P. Morgan. Note: Chart shows % share of gross value added, J.P. Morgan
forecast for 2010.
Shares outstanding in commodity ETF
30000
60000
90000
120000
150000
180000
210000
Dec -07 M ay -08 Oc t-08 M ar-09 Aug-09 Jan-10 Jun-10 N ov -10
Source: Bloomberg, DBCSO Index.
Peripheral stress in Europe
0
1
2
3
4
5
6
7
Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10
0
2
4
6
8
10
Greece (RHS)
Ireland (LHS)
Source: Bloomberg
Note: Spread of Greek and Irish 10-year bond yields to German bunds.
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Ben Laidler
(1-212) 622-5252
ben.m.laidler@jpmorgan.com
30
Latin America Equity ResearchNovember 2010
Brazil Strategy
Key country dynamics
Domestic growth and Chinas demand for commoditiesare the main drivers for Brazil in 2011, together with a
clearer definition of policies to be adopted by the newly
elected government. The exchange rate is an important
focus, with capital control risks on the rise.
Growth characteristics and how they are changing
Credit growth at around 20% combined with the best
labor market in a generation provides for a sturdy
outlook for consumption in 2011. We forecast GDP of
4.5% in 2011, on top of 7.5% in 2010e. Strong growth is
adding to inflation risks, and we expect a rise in interest
rates in 2011. Although GDP is little influenced by
commodities (exports = 11%), Brazils two largestcompanies are commodity driven. Over the next few
years, investment (under 18% of GDP) will need to rise
to meet the countrys need for more capacity and
infrastructure. This would also allow for faster
sustainable growth in the years to come.
Drivers of returns Multiples and growth
Valuation is not an impediment to Brazils performance.
The country is trading in line with the five-year average,
with commodities cheaper than domestics but with the
latter likely delivering more growth in the short/medium
run. Flows are key for performance and are catching up
in 4Q 2010 after being lackluster most of the year. With
major hurdles behind (large capitalizations, elections)
and DM prospects of a muddle-through, inflows into
Brazilian equities are likely to be boosted in 2011.
Recommendations
We recommend exposure to domestic names and are
focused on financials and homebuilders. Although we
like discretionary, we feel that there are better entry
points considering the strong performance of late. In
financials, Bradesco is our top pick, a blue chip, large
cap bank that can better withstand the rise in interest
rates as about 30% of its business is insurance. Inhomebuilders, we like PDG: the stock is cheaper than
peers, benefits from the Agre acquisition are not fully
priced, the company is fully exposed to the high-growth
lower-income segment. On the commodity side, we
likeVale: it is cheap, with risks mostly priced in already,
while China appears to be rebounding. In the oil and gas
sector, we recommend OGX as the better vehicle to get
exposure to offshore as more of the companys findings
are turning into reserves.
Emy Shayo ChermanAC
(5511) 3048-6684
emy.shayo@jpmorgan.com
Banco J.P. Morgan S.A.
Bloomberg JPMA SHAYO
Household consumption rising above GDP (4Q/4Q rolling average)
-1.0%0.0%1.0%
2.0%3.0%4.0%5.0%6.0%7.0%8.0%
1Q-03 1Q-04 1Q-05 1Q-06 1Q-07 1Q-08 1Q-09 1Q-10
GDP Househo ld Consumption
Source: IBGE.
Unemployment rate (%)
6
7
8
9
10
11
Jan-0
6
Jul-06
Jan-0
7
Jul-07
Jan-0
8
Jul-08
Jan-0
9
Jul-09
Jan-1
0
Jul-10
Source: IBGE.
BRL (rh, inverted scale) versus BZ Commodity Export Index (lh)
150
200
250
300
350
400
450
500
2/4/05 9/2/05 3/31/06 10/27/06 5/25/07 12/21/07 7/18/08 2/13/09 9/11/09 4/9/10
1.5
1.6
1.7
1.8
1.92.0
2.1
2.2
2.3
2.4
2.5
BZ Commodity Index
BRL
Source: Bloomberg; J.P. Morgan.
Foreign Net Inflows into Brazilian Equities (secondary) R$bi
-1.09
2.211.65
4.04
1.14 0.930.51
-2.10
-1.25
3.15
-1.08-1.51
-0.15
3.51
-0.60
3.14
1.60
-3
-2
-1
0
1
2
3
4
5
Jun-0
9
Jul-09
Aug-0
9
Sep-0
9
Oct-09
Nov-0
9
Dec-0
9
Jan-1
0
Feb-1
0
Mar-10
Apr-10
May-1
0
Jun-1
0
Jul-10
Aug-1
0
Sep-1
0
Oct-10
YTD 2010 = R$4.7 bi
YTD 2009 = R$19.2 bi
Source: BM&FBovespa; Bloomberg.
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Ben Laidler
(1-212) 622-5252
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31
Latin America Equity ResearchNovember 2010
Top picks and stocks to avoid
Mkt cap P/E (x) EPS Div. yield ROEPrice Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%)
Top picksBradesco 34.8 BBDC4 OW 73,018 13.5 12.1 2.59 2.88 2.9% 21.2%PDG Realty 10.6 PDGR3 OW 7,144 14.5 9.4 0.73 1.13 1.7% 19.2%
VALE 31.8 VALE OW 173,421 10.9 7.7 2.92 4.13 2.9% 23.3%OGX 21.7 OGXP3 OW 42,952 nm nm 0.06 0.02 0.0% 0.6%Stocks to avoidUsiminas 21.0 USIM5 UW 14,775 20.5 11.1 1.02 1.88 3.1% 8.8%Eletropaulo 29.9 ELPL6 UW 3,229 4.8 8.4 6.29 3.54 13.8% 18.0%Tele Norte Leste 48.5 TMAR5 N 7,699 nm nm 8.60 7.21 8.9% 14.9%
Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.
MSCI Brazil absolute and Relative to EMF Index
0
200
400
600
800
1000
1200
1400
Dec-02 Mar-04 May -05 Aug-06 Oct-07 Jan-09 Mar-10
Absolute Relative to MSCI EMF Index
Source: MSCI, Datastream.
MSCI fair value range
(135082)
(119256)
(124074)
(212792)
(196127) (326196)
(89127)(277670)
(273109)(445307)
(339385)
(211296)
50000 150000 250000 350000 450000
FWD PE
PE
PB
DY
BY/EY
BY/DY
Source: MSCI, IBES, Datastream, J.P. Morgan.
Currency outlook (BRL/USD)
1.4
1.6
1.8
2.0
2.2
2.4
2.6
2.8
3.0
Dec 04 Apr 06 Jul 07 Nov 08 Feb 10 Jun 11
Consensus
J.P. Morgan
J.P. Morgan forecast:
end Dec 10: 1.70
end Mar 11 : 1.80
end Jun 11: 1.82
Source: Bloomberg, J.P. Morgan.
MSCI EPS integer over time
80
90
100
110
120
130
140
150
Feb-09 Jul-09 Dec-09 May -10 Oct-10
2010
2011
Source: MSCI, Datastream.
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Ben Laidler
(1-212) 622-5252
ben.m.laidler@jpmorgan.com
32
Latin America Equity ResearchNovember 2010
Mexico Strategy
Key country dynamics
The key constraints on Mexican equities are structurallylower US GDP growth and a lackluster Mexican
consumer rebound. This is offset by a cheap currency,
easy monetary policy, a gradual reacceleration of US
economic growth at least into mid-2011 and a high
market correlation with US equities. Additionally, we
view some concerns as currently overdone such as the
fiscal situation (oil production has stabilized) and
security environment (violence localized) whilst others
are not such as Mexicos declining equity market
relevance on lack of issuance.
Growth characteristics and how they are changing
Mexican GDP growth is set to slow next year (to 3.5%from an estimated 4.5% in 2010), along with the US
(2.7% GDP growth to 2.5% in 2011e). Manufacturing
and IP, which led the sharp growth recovery from the
-6.5% seen in 2009, should slow and domestic demand
increasingly come to the fore. Consensus MSCI Mexico
earnings growth could be at risk, with expectations for
18% growth versus only 12% this year. Growth is
expected to be led by staples and materials.
Drivers of returns Multiples and growth
Mexico is trading at the high end of traditional valuation
ranges, and we do not see room for significant multiple
expansion. The valuation premiums to other markets are
lower than they seem, often just reflecting Mexicos high
staples and telecom index composition. Whilst the
traditional drivers of Mexican outperformance 1)
significant market weakness, 2) strong US macro
surprise, 3) strong Mexico consumer recovery look
absent to us in 2011, we do expect respectable absolute
performance. Local investors remain underweight the
market and are seeing robust inflows. Foreign investors
remain moderately overweight.
Recommendations
Our strategy focus is on stocks exposed to thestrengthening domestic demand environment at
reasonable valuations. We also like a number of special
situations exposed to recovering infrastructure segments.
We would avoid very defensive staples with high
valuations and low gearing to the strengthening
consumer.
Ben LaidlerAC
(1-212) 622-5252
ben.m.laidler@jpmorgan.com
J.P. Morgan Securities LLC
Bloomberg JPMA LAIDLER
Contributions to GDP growth, 2008-2011e
Source: J.P. Morgan Economics.
Mexico 12 mth fwd PE
7.00
9.00
11.00
13.00
15.00
17.00
95 97 98 99 00 01 02 03 04 05 06 07 08 10
Mex ico Average +1SD -1SD
Source: MSCI, IBES, Datatsream.
Mexico consumer confidence and formal employment
Source: J.P. Morgan Economics, INEGI, IMSS.
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Ben Laidler
(1-212) 622-5252
ben.m.laidler@jpmorgan.com
33
Latin America Equity ResearchNovember 2010
Top picks and stocks to avoid
Mkt cap P/E (x) EPS Div. yield ROEPrice Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%)
Top picks America Movil 57.1 AMX OW 119,244 15.8 13.4 44.98 52.72 0.7% 26Cemex 8.8 CX OW 9,800 nm nm -0.16 0.02 0.0% 0.1%Grupo Televisa 22.2 TV OW 13,699 22.0 17.2 12.54 16.02 1.4% 23.0%ICA 32.5 ICA* OW 1,781 30.4 22.0 1.07 1.48 0.0% 4.9%First Cash Financial 29.4 FCFS OW 913 17.1 14.6 1.72 2.01 0.0% 17.9%Stocks to avoidTelmex 15.2 TMX UW 14,410 12.7 13.2 18.51 17.30 5.0% 37.0%Grupo Inbursa 53.9 GFINBURO UW 14,247 25.3 21.0 2.13 2.57 1.4% 12.2%Consorcio Ara 7.6 ARA* UW 829 11.5 9.9 0.66 0.77 1.3% 10.1%
Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.
MSCI Mexico absolute and relative to EMF Index
0
50
100
150
200
250
300
350400
450
500
Dec-02 Mar-04 May -05 Aug-06 Oct-07 Jan-09 Mar-10
Absolute Relative to MSCI EMF Index
Source: MSCI, Datastream.
MSCI fair value range
(196457)
(20184)
(14776)
(24866)
(25349)
(17980) (22590)
(29973)
(25937)
(125613)
(41784)
(33101)
0 50000 100000 150000 200000 250000
FWD PER
PER
PBR
DY
BY/EY
BY/DY
Source: MSCI, IBES, Datastream, J.P. Morgan.
Currency outlook (MXN/USD)
9.0
10.0
11.0
12.0
13.0
14.0
15.0
16.0
Dec 04 Apr 06 Jul 07 Nov 08 Feb 10 Jun 11
J.P. Morgan
Consensus
J.P. Morgan forecast:
end Dec 10: 12.50
end Mar 11: 12.50
end Jun 11: 12.25
Source: Bloomberg, J.P. Morgan.
MSCI EPS integer over time
70
75
80
85
90
95
100
105
Feb-09 Jul-09 Dec-09 May -10 Oct-10
2010
2011
Source: MSCI, Datastream.
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Ben Laidler
(1-212) 622-5252
ben.m.laidler@jpmorgan.com
34
Latin America Equity ResearchNovember 2010
Chile Strategy
Key country dynamics
Chile will look to build on the momentum of an historic2010, which saw the inauguration of center-right Piera
(after 20 years of the center-left Concertacion), an 8.8-
magnitude earthquake (5th largest in history), World
Cup success (advancing to the round of 16), the
countrys 200-year anniversary and the unprecedented
extraction of 33 miners trapped underground for 68 days.
Confidence is running high, and the country appears to
be entering a period of renewal, which could accelerate
the path to developed country status (possibly by the end
of the decade). However, with expectations mounting,
there is room for disappointment, especially if
social/political differences get in the way of progress.
Growth characteristics and how they are changing
For the first time in recent years, Chile is expected to
lead regional growth in the coming year on the back of
an aggressive Piera pro-growth agenda, accelerated by
ongoing earthquake reconstruction efforts. This should
be further helped by supportive demand dynamics out of
China and expansionary fiscal policies (benchmark rate
not likely to surpass 4.25% lowest YE11e level in the
region), not to mention micro-level incentives for
investment by both locals and foreigners.
Drivers of returns Multiples and growth
The top-down scenario remains attractive, but valuations
are lofty at nearly 18x forward P/E, representing a 50%
premium to LatAm, which is just ahead of historical
levels (despite recent factors that are working to close
the spread such as the move to IFRS and regional
expansion). As the Chile premium suggests, performance
is largely tied to supportive domestic flows (and limited
foreign ownership). This support was strong in 2010
given weakness elsewhere. In the event that key markets,
such as Brazil, China and the US, perform well in 2011
(especially relative to domestic fixed income), this will
likely limit domestic flows, specifically from pension
funds, which may be forced to trim domestic equity
positions to remain within their limits.Recommendations
Although we like the Chile growth profile, we focus on
names that are expanding abroad (Falabella, CCU). We
also find copper play Antofagasta at an attractive
valuation with significant growth potential. We avoid
utility IAM, given strong relative outperformance in the
utilities sector and potential Aguas Andinas share sale
overhang. We also see limited upside after the
speculative rise in SQMs share price.
Brian P. ChaseAC
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