key trade and risk june 21 2010
TRANSCRIPT
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Emerging MarketsEquity Research21 June 2010
Key Trades and RisksEmerging Markets Equity Strategy
Emerging Markets Equity Strateg
Adrian MowatAC
(852) 2800-8599
J.P. Morgan Securities (Asia Pacific) Limite
Ben Laidler(1-212) 622-5252
J.P. Morgan Securities Inc.
Deanne Gordon(27-21) 712-0875
J.P. Morgan Equities Ltd.
Rajiv Batra
(91-22) 6157-3568
J.P. Morgan India Private Limited
Sanaya Tavaria
(91-22) 6157-3312
J.P. Morgan India Private Limited
Ankita Kochar
(91-22) 6157-3263
J.P. Morgan India Private Limited
See page 90 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 that the firm mhave a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making thinvestment decision.
Figure 1: MSCI EM relative performan
20
40
60
80
100
120
140
96 98 00 02 04 06 08 10
vs USA
vs World
Source: Bloomberg, 14 June 2010.
Equities are fundamentally attractive. Global growth in our view issustainable. This growth is combined with low inflation and interestrates.
This is likely to be a volatile summer. Markets will focus on PMI datafor evidence of financial market weakness feeding through to the realeconomy. We believe investors are over estimating their influence on thereal economy. Regulatory reform and fiscal policy are additional sourcesof volatility.
The rebalancing of the Chinese economy from investment toconsumption is healthy. But mind the gap, the near term impact would
be lower commodity prices and potentially lower profit margins. Weexpect that commodity prices will correct this summer which couldpotentially lead to weaker EM equities.
Our key trades ranked by conviction are:
CEMBI Surfers; OverweightIndia and Turkey
Growth surprise from developed, not emerging,economies. Overweight Mexico, Taiwan and Turkeyplus technology and transportation.
Macro policy and rising inflation - QR not QE in EM:
Underweight Brazil, China, energy and commodities
The main risk to our view is that financial market stress results inweaker European growth than a bearish consensus. For more on riskssee page 8.
Key asset allocation calls:OW: Taiwan, Korea, India, Mexico, South Africa, Turkey and thePhilippines
OW: Technology and industrial cyclicals (i.e. transportation)
UW: China and Brazil
UW: Commodities, energy, telecoms and Utilities
For our Key Trade stock ideas,click hereto download the Bloombergsheet.
http://pull.jpmorgan-research.com/p/2-178F/582529/JPM_Key_Trades_bloomberg_updatable_EM.xlshttp://pull.jpmorgan-research.com/p/2-178F/582529/JPM_Key_Trades_bloomberg_updatable_EM.xlshttp://pull.jpmorgan-research.com/p/2-178F/582529/JPM_Key_Trades_bloomberg_updatable_EM.xls -
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Table of ContentsSummer Swings........................................................................3
Risks to our strategy................................................................8
Global emerging markets model portfolio by country ........14Global emerging markets model portfolio by sector...........15
Key Trades ..............................................................................16
China: Mind the gap ...............................................................26
Brazil: Better Outlook for Domestics ....................................28
South Korea: Buying opportunity.........................................30
Taiwan: Potentially Oversold ................................................32
Russia: Strong balance sheet and earnings ........................34
India: Global concerns drag Indian equities ........................36
South Africa: A low beta equity market ................................38
Mexico: Cyclical Macro Momentum......................................40
Malaysia: Reform agenda keeping the buzz ........................42
Thailand: Resilient despite turmoil .......................................44
Indonesia: An eye on politics................................................46
Turkey: Cyclical view secular trend ..................................48
Philippines: Market re-rating likely .......................................50
Extended markers ..................................................................53
Consensus Asset Allocation.................................................55
Hindsight trades: What has worked......................................56
Composite valuation indicators ............................................58
EMBIG100................................................................................62
Emerging Markets Strategy Dashboards .............................70
In this report, we highlight:
Our top trade ideas
Risks
Our model portfolio
Valuation stress test
Key ratios for EMBIG 100
Consensus country weights
We have two pages on each
significant emerging market. The
first page has a qualitative
review of events driving the past
12 months, the outlook and a
comment on valuations; the
second page displays the
scorecard, which presents key
economic and equity marketdata
The extended markers: This
report contains 36 pages of data
designed to help track emerging
economies and markets
The emerging market
dashboards efficiently display
key economic, equity and debt
data, demonstrating change and
perspective.
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Summer Swings
There is a conflict in our strategy. This is a serious
conflict that could damage performance. Investors in our
view are too, and increasingly pessimistic, on thesustainability of the recovery. Our base case remains that
the global recovery is led by the private sector and is
sustainable. Economic growth combined with falling
core inflation is a strong fundamental backdrop for
equities. Note that J.P. Morgan's economists just pushed
out the first increase in Fed Funds rate to 4Q11 (SeeA
change to our Fed call, Michael Feroli et al, 17 June
2010). But EM investors need to consider the risk of the
correlation between EM equities and commodities. In our
view commodity investors are not pricing in China's
changing growth model.
Recognizing the conflict and risk, we are setting anartificial time limit on the fear of a correction in
commodities. The time limit is September 2010. By then
we believe that the decline in bulk commodity prices will
"scare" the new investors in commodities to redeem,
generating a broader correction.
Market confidence in a sustainable economic recovery is
waning. It is the risk of too rapid a fiscal consolidation
that is hitting confidence. We agree this risk has
increased but we also believe that financial investors are
over estimating their influence on the real economy. Post
the sub-prime crisis, business and consumer respect for
financial institutions and markets has declined. In
responding to the conflicting signals of weaker capital
markets and stronger than expected demand (see Figure
2) manufacturers should be more influenced by their
customer orders than stock market levels. This is
particularly true when investors appear shell-shocked in
their over-reaction to poor fundamental data.
Our expectation is that manufacturing PMIs will decline
from their post recovery highs but remain in an
expansionary range. Growth should hopefully broaden to
the service sectors. If this occurs then investor
confidence in a sustainable recovery would increase.
China's economic and policy dynamics are changing.
Consumption as a percentage of GDP declined in the last
decade. This is partly a function of the decline in the
share of household income as a percentage of GDP. The
tacit support for recent wage disputes may indicate a
more proactive policy to boost household income and
thus consumption (see Figure 4). Reducing China's
export competitiveness through higher wages, rather than
a stronger Renminbi, has a number of political and
economic advantages. It helps address Chinas strained
social contract by increasing household income as a share
of GDP at the expense of corporate profits (see risksection on page 8). There is a leveraged impact on
discretionary income. Economists may argue that a
stronger currency would indirectly boost real income due
to lower inflation but there are higher tangible benefits to
workers of higher wages rather than a lower cost of
imported goods.
Figure 2: Monitor European PMIs
25
30
35
40
45
50
55
60
65
Jun-07 May -08 Apr-09 Mar-10
Euro area
Germany
GreeceSpain
Source: J.P. Morgan Economics, May 2010
Figure 3: Domestic Savings as a percent of GDP in China
13
13
21
18
1
9
22
0
5
10
15
20
25
Enterprises
Financial
Institutions
Government
Households
1997-99 2005-07
Source: IMF
Figure 4: China consumption as a % of GDP
35
40
45
50
55
78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08
Source: J.P. Morgan economics, 2008.
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With such a clear policy to boost consumption investors
will desire exposure. But only 11% of MSCI China is
consumer companies. High growth and low free floatsresult in high relative valuations. There is a similar trend
in US where the EPS CAGR, since 1973, for consumer
discretionary at 10.5% is a premium to the market's
7.5%. Its long term average PE at 20 is also a premium to
the market average of 15.
A recentXinhau news article was critical of state owned
enterprises. It noted that SoEs scale and influence on the
Chinese economy may hinder economic growth. The
government controls these companies and can accelerate
the shift of GDP from corporate to household. Note that
80% of MSCI China is SoEs.
There is a Mexican stand-off in the property market.
Successive anti-asset-price-inflation measures have
discouraged buyers who now expect prices to fall. But
cash rich property companies and home owners mean a
lack of forced sellers. The result is a sharp decline in
property transactions. This in turn would lead to a fall in
construction activity. Infrastructure spending is
decelerating. Bank loans funded the bulk of last years
stimulus program. Greater regulatory scrutiny of lending
to local government funding vehicles is likely to lead to
less capital for infrastructure. These measures are
consistent with a policy to rebalance growth from
investment to consumption.
The demand for bulk commodities and energy is
declining as the growth driver shifts from fixed asset
investment to consumption in China. There is renewed
focus on energy efficiency. The five year plan target to
reduce energy use per unit of GDP by 20% has not been
met. Beijing is putting pressure on energy intensive and
polluting industries to close capacity. The market is also
applying pressure with steel prices declining while
contract iron ore and coking coal prices increase. Chinese
steel mills could make a loss in 3Q10.
Weak steel and aluminum prices may already be
indicating a slowdown in FAI. If our rebalancing thesis is
correct then steel prices should continue to fall. It is this
signal that we believe could lead to a broader correction
in commodity markets. The numerous presentations on
Chinas significant demand for commodities at our China
conference this month reflects Chinas key role in the
commodity super-cycle debate. Evidence of slowing
Chinese demand when combined with increased supply
could lead to disproportionate corrections in commodity
prices.
Commodity markets are technically weak. Investor
confidence in the asset class is falling due to poor returns
and a diminished diversification benefit. A broadcorrection in commodity prices would require these
investors to reverse a long standing trend to increase
asset allocation to commodities (See Figure 15 and
Figure 16).
Figure 5: China iron ore spot and contract prices
0
50
100
150
200
Apr 02 Apr 04 Apr 06 Apr 08 Apr 10
China iron ore spot price
Landed cost of contract iron ore in China
Source: Bloomberg. Note: The landed cost of contract iron ore are Vale's SSF cost +
freight costs from Brazil to China. For 3Q10 forecasts, Vale's SSF costs are calculated as
the average of the spot prices from Mar 10 to May 10. The freight costs in 3Q10 are
assumed to remain unchanged at today's levels.
Figure 6: MSCI EM Energy relative to MSCI EM
80
90
100
110
120
130
Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10
Source: Bloomberg. Note: Index rebased to 100 from January 2007.
Figure 7: MSCI EM Materials relative to MSCI EM
80
90
100
110
120
130
140
Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10
Source: Bloomberg. Note: Index rebased to 100 from January 2007.
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If the commodity market corrects then EM equities are
likely to decline led by Brazil and Russia. This
potentially would lead to redemptions in EM fundsleading to a broader correction (See Figure 11and Figure
12). We would view this event as an exceptional buying
opportunity.
Upgrading Korea to overweight
We upgraded Korea to overweight from neutral on 2
June in both Asian and Emerging Market portfolios. The
market has underperformed EM by 3% since 3
September 2009. Prior to that, from 26 February 2008 to
9 March 2009, MSCI Korea outperformed MSCI EM by
26%.
Our upgrade was opportunistic. On 20 May, the South
Korean government released a multinational combined
intelligence report that concluded that the South Korean
navy ship Cheonan was torpedoed by a DPRK
submarine. The report accelerated the correction in the
market and currency.
The Won declined by 9% in May. The result is that
MSCI Korea is the cheapest market in APxJ (PE 9.3) and
one of the most undervalued currencies in EM (REER).
We are more positive on global growth than the
pessimistic consensus. This, plus a competitive currencyis positive for exporters (note Yen and NT dollar cross
rates). Banks are inexpensive, in our view. The end of
price controls should boost domestic margins.
Our preferred sectors are exporters, banks and domestics.
Our top picks include Hyundai Mobis, HMC, Kia
Motors, Hyundai Department Store, Shinsegae, Lotte
Shopping, KB Financial, Hynix and SEC.
The risks to our view are: (1) a further deterioration in
the North Korean situation, (2) weaker global demand,
(3) price controls remaining, and (4) excessive tech
capex.
Figure 8: MSCI Korea Forward PE relative to MSCI EM
0.7
0.8
0.9
1.0
1.1
1.2
1.3
May -05 Jan-06 Sep-06 May -07 Jan-08 Sep-08 May -09 Jan-10
Avg
+1SD
-1SD
Source: IBES, MSCI, Datastream, 31 May 2010.
Figure 9: REER deviation from long term mean since 1975 -An
undervalued Won
-60
-40
-20
0
20
40
60
80
100
BRL
RUB
CLP
CZK
AUD
CNY
CHF
ZAR
TRY
PHP
PLN
HUF
IDR
MXN
THB
EUR
USD
TWD
KRW
Source: J.P. Morgan.
Figure 10: Performance of KRW/USD
800
1000
1200
1400
1600
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
05-07 Average FX rate: 969
Source: Bloomberg, 21 June 2010.
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Conclusion
Equities are fundamentally attractive with a backdrop of
sustainable growth and low core inflation. We wish toadd EM equity risk but fear a correction in commodity
prices. A change in Chinas perceived demand for
commodities as its economy rebalances is the catalyst for
the correction in commodity prices. We hope this will
provide an outstanding buying opportunity. Evidence of
China's slowing commodity demand should appear over
the next few months. If no correction occurs before
September we will review our thesis and are likely to add
risk then.
Few investors share J.P. Morgan's optimism on
sustainable growth. European PMIs are forecast to
decline from recovery highs but remain above 50.
Key asset allocation calls
OW: Taiwan, Korea, India, Mexico, South Africa,
Turkey and the Philippines
OW: Technology and industrial cyclicals (i.e.transportation)
UW: China and Brazil
UW: Commodities, energy, telecoms and Utilities
Our key trades ranked by conviction are:
1. CEMBI Surfers; OW India and Turkey
2. Growth surprise from developed, not emerging,economies. OW Mexico, Taiwan and Turkey plus
technology and transportation
3. Macro policy and rising inflation QR not QE in
EM: UW Brazil, China, energy and commodities
For more details on these key trades, please see page 16
Please see pages 13,14,15 for our Global Emerging
Markets model portfolio and descriptions of changes
made this month.
Risks are many:
1. Strained social contract
2. Underestimating euro sovereign stress contagion risk
3. Rising economic risks
4. EM inflation and speed of policy normalization
5. Lack of G3 policy flexibility
6. Central banks target asset prices
7. Commodity EM equities feedback loop
8. Trade friction
9. Tension between the two Koreas
10.Thai political unrest
11.Bond market volatility
12.Election-induced volatility
For more details on these risks, please see page 8.
Please see pages 26 to 50 for our detailed country views.
Figure 11: S&P GSCI Industrial Metals Index
500
1000
1500
2000
2500
Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10
Source: Bloomberg
Figure 12: Cumulative inflows into commodity fund by year (US4billion)
50.4
8.911.8
18.4
16.016.3
5.7-10
0
10
20
30
40
50
60
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
2004 2005 20062007 2008 20092010
Source: J.P. Morgan, May 2010
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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 25%, Materials is 15% and
Energy is 14% of EM. All recommendations are relative to EM. The Industrials sector consists of an eclectic group ofstocks. We are overweight technology and transportation.
Table 1: Key country and sector recommendations
Country/Sector Weight Reco US$ Return (%) PE 09 PE10E
PE11E
EPSGrowth
09
EPSGrowth
10E
EPSGrowth
(%)
DY10E
ROE10E
ROE
1 yr 3 yr 5 yr X X X (%) (%) CAGR05-10E
% % 03-08Avg
EM 100 -- 18 (3) 86 14.3 11.2 9.6 2 28 8.8 2.9 15.3 16.2China 18.7 UW 5 10 157 15.8 12.6 10.7 17 25 13.3 2.9 16.2 16.1China Financials 7.1 N 7 23 265 14.5 11.5 9.4 25 25 28.5 3.2 17.8 13.3China Energy 3.2 UW 10 14 161 13.4 10.6 9.6 (5) 26 8.3 3.8 17.8 21.4China Telecom 2.5 UW (6) 11 174 12.3 12.1 11.5 (4) 1 14.8 3.6 15.0 18.2China Industrials 1.4 n/a (10) (25) 55 20.3 13.3 11.8 58 53 5.4 2.1 11.0 12.8Brazil 16.1 UW 20 28 243 13.5 11.2 9.0 7 20 6.1 3.4 16.1 18.8Brazil Materials 4.3 UW 31 29 308 19.2 9.3 6.6 (40) 106 10.1 3.2 19.2 27.9Brazil Energy 3.7 N (0) 62 310 10.3 10.8 9.5 (5) (5) 2.8 2.5 15.5 25.3Brazil Financials 3.8 OW 27 21 243 11.9 11.5 9.5 45 4 5.9 3.6 16.1 22.4Korea 13.1 OW 23 (22) 47 13.8 9.5 9.1 56 45 8.4 1.2 15.4 14.3Korea IT 4.0 OW 40 3 38 18.1 10.0 11.1 (2,217) 81 13.7 0.2 18.1 17.0Korea Financials 2.2 OW 16 (43) 32 15.6 8.8 7.6 (31) 77 3.0 2.2 11.7 13.3Korea Industrials 1.8 n/a (3) (49) 71 14.9 11.4 10.4 26 30 10.6 1.3 11.4 12.0Korea Materials 1.7 N 27 0 173 10.7 8.9 8.2 (2) 20 7.7 1.2 32.1 17.6Korea CD 1.8 OW 50 23 72 9.3 8.1 7.8 125 15 16.9 0.8 20.2 13.4Korea CS 0.6 N 12 (25) 46 15.0 13.7 11.8 7 9 11.3 1.7 14.4 14.9Taiwan 10.7 OW 12 (12) 15 24.6 12.8 11.3 36 92 5.1 3.8 13.5 13.3Taiwan IT 6.5 OW 16 (17) 12 29.1 12.0 10.9 9 143 11.5 3.6 16.9 14.3Taiwan Financials 1.5 N (4) (21) (19) 19.6 13.2 10.6 859 48 9.3 3.3 8.7 6.6Taiwan Materials 1.3 UW 16 7 78 17.1 14.5 12.0 NM 18 (7.8) 4.8 10.5 20.7India 8.0 OW 15 9 143 21.4 17.2 13.6 3 25 13.4 1.3 16.3 21.0India Financials 2.0 OW 14 3 148 23.5 19.3 15.3 0 22 13.7 1.2 12.3 14.9
India Energy 1.2 N (7) 12 285 20.5 14.4 12.0 (0) 42 14.7 1.2 16.3 21.1India IT 1.3 OW 54 3 104 24.2 21.1 17.4 5 15 16.1 1.2 24.4 31.3South Africa 7.4 OW 21 4 93 16.6 12.3 9.8 (18) 35 10.7 3.2 16.3 19.1SA Materials 2.1 OW 15 (13) 97 47.0 16.8 11.9 (54) 179 22.2 2.1 13.5 9.9SA Financials 1.9 OW 36 8 82 13.1 10.7 8.8 (15) 23 5.9 4.5 15.0 19.6SA Telecom 0.9 UW (2) (1) 95 12.3 10.2 8.7 (10) 20 10.2 3.0 20.0 28.9SA Cons Discr 0.9 N 50 25 119 16.2 13.2 10.5 10 23 10.9 2.4 17.0 23.1SA Energy 0.7 UW (5) 18 59 11.9 9.9 7.7 (22) 20 6.3 3.6 17.2 23.8Russia 6.5 N 11 (31) 56 8.2 6.4 5.1 (21) 29 9.1 2.2 13.8 16.6Russia Energy 3.8 N (2) (33) 34 5.7 5.0 4.6 (12) 14 6.0 2.3 13.7 16.6Mexico 4.8 OW 38 (14) 102 18.0 14.4 12.1 2 25 7.7 2.7 16.7 19.1Mexico Telecom 1.9 UW 33 (13) 154 14.3 12.4 10.9 (2) 15 16.4 4.1 36.5 31.2Mexico CS 1.1 N 52 21 133 18.9 19.0 15.8 54 (0) 14.1 1.7 15.1 16.0Mexico Materials 0.8 OW 45 (41) 32 30.8 14.6 10.9 (16) 111 (8.8) 1.6 8.0 15.8Malaysia 2.9 N 28 7 96 18.2 14.8 12.7 (1) 23 7.5 3.5 12.5 13.2Indonesia 2.3 N 44 53 206 16.3 13.8 11.9 21 18 16.4 3.0 23.8 25.4Turkey 1.6 OW 56 7 88 11.0 9.5 8.3 3 16 12.8 3.1 17.4 17.2
Turkey Financials 1.0 OW 74 29 129 9.7 8.8 7.8 30 11 18.4 2.4 18.1 16.6Chile 1.5 n/a 26 25 127 18.7 16.2 13.5 NM 15 19.1 2.3 11.2 10.1Thailand 1.5 N 25 23 79 12.8 11.2 9.6 33 14 (0.9) 4.0 15.1 19.4Poland 1.4 N 22 (39) 28 15.2 13.2 11.0 (26) 15 (1.4) 3.7 11.7 17.0Hungary 0.4 N 11 (40) (8) 12.1 10.9 8.5 (37) 11 (2.7) 3.6 11.9 23.8Philippines 0.5 OW 25 (6) 114 17.3 15.4 13.4 25 13 5.5 3.9 15.6 14.4
Source: J.P. Morgan Asian strategy team, MSCI, Datastream. Table sorted by descending weight in index, countries first followed by country-sectors, 10 June 2010.
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Risks to our strategy
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 the profits as a shareof GDP are near cycle highs but unemployment is 10%.
Policy makers constrained by high fiscal deficits are
likely to redress this imbalance through higher taxes and
increased regulation.
As is the case in the US, Chinese corporates share of
GDP increased while the household share decreased.
Labour 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.
But near term the result is lower profit margins.
Underestimating Euro sovereign stress contagion risk
After Greece, there is speculation that Spain might reach
out to the EU or IMF for financial support. The Spanish
banking system is under significant pressure to address
its solvency issues, especially among its saving banks.
These concerns have impaired the ability of Spanish
banks to raise market funding, and increased the
possibility of seeking external liquidity support. If this
were to be true, Spanish bond yields which have already
increased by 50 bps in the last one week would likely rise
further and issuance become more difficult.
Euro sovereign stress generates both economic andmarket risk. The economic risk is that business in core
Europe slows investment decisions. As we witnessed in
2008, rational individual risk reduction results in a
destructive downward spiral in risk assets.
In Emerging Markets Outlook and Strategy, June 8,
2010, Joyce Chang, our Global head of Emerging
Markets and Credit Research , notes two scenarios.
Scenario 1: Deeper economic and financial crisis, but
contained to peripheral Europe. Scenario2: Crisis spreads
to core Europe due to contagion from the periphery,
pushing the Euro area into a double dip recession. If the
crisis were to spread to core Europe, it could have asignificant impact on emerging markets. In such a
scenario, emerging markets would reverse incipient
tightening. Emerging markets may also have to resort to
greater fiscal stimulus to offset the weakness in the
private sector. (Please see Page 23 for more details)
The feedback loop between banks struggling to fund and
a subsequent reduction in the availability of credit is
another key risk.Nikolaos Panigirtzoglou in his weekly,
Flows and Liquidity, 4 June 2010 notes that: European
banks continue to face a difficult funding environment.
The primary market for unsecured bank debt remains in
hibernation. The contraction in the CP/CD issued by
European banks in the US is accelerating. Note thatEuropean banks need to refinance nearly $130bn per
month for the remainder of the year.
Rising economic risks
Private payrolls at 41K for the month of May were
disappointing. Note that firms are using their existing
workers more intensively as they lengthen the work
week, and companies cannot increase work hours
indefinitely. Private sector job creation should improve
over the rest of the year. However, if the job data
continues to be below expectations, it could adversely
impact consumer spending and a sustained economic
recovery.
Figure 13: Strained social contract: US profit share andunemployment
8
10
12
14
16
18
20
22
70 75 80 85 90 95 00 05 10
0
3
6
9
12
% sa
Unemploym ent rate (inv erted)
Profit share
Source: J.P. Morgan. Note: Chart shows % share of gross value added, JPMorgan
forecast for 2010.
Figure 14: Spread between Spanish and German 10 year bondyield
0
50
100
150
200
250
Jan 08 Jul 08 Jan 09 Jul 09 Jan 10
Source: Bloomberg
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EM inflation and speed of policy normalization
Our base case is that inflation plateaus mid-year as the
base effect becomes more favorable. If we are wrong and
inflation continues to rise then this is bearish for equities.
The EM dashboard has a sheet designed to help monitor
inflation across EM countries. Remember modelinginflation in emerging economies is difficult due to the
short history of floating exchange rates and large
weighting of food and other primary products.
Lack of G3 policy flexibility
High fiscal deficits and record-low interest rates limit
policymakers ability to respond to a relapse in growth. A
growth relapse is not our base case. If it occurred, it
would be a serious blow to risk assets. Credit spreads
could widen and equities would fall.
Central banks target asset prices
Central banks are targeting asset prices in EM, notably inChina. These policies introduce economic and sector
specific risk. Note how poorly real estate stocks have
performed in EM despite low interest rates.
Commodity EM equities feedback loop
Commodity markets are in our view vulnerable. Investors
are frustrated by low to negative returns due to the high
roll cost in forward markets in contango. In 2009, net
retail inflows into commodity funds were $50billion; this
year, subscriptions have slowed sharply. A combination
of negative momentum and Chinese economic
rebalancing could be a catalyst for significant
redemptions. The liquidation of contango arbitrageinventory (i.e. leasing supertankers to buy spot and sell
forward) adds to the downside risk for commodities.
Weak commodity prices will drive Brazilian, Russian
and Indonesian markets lower, in our view. It is
reasonable to expect redemptions in BRIC funds.
Trade friction
It is no fun being a politician today. High fiscal deficits
in the developed economies and rising inflation in
emerging economies will mean uncomfortable policy
choices. In this environment it is appealing to look for
others to blame. A building risk is trade sanctions against
China. The rhetoric on the Renminbi is heating up.
China's priority is to manage a rebalancing economy. We
doubt Beijing wishes to add currency volatility to the
mix. Hopefully this war will be fought in the media
rather than with sanctions. Our overweight exporters is
very exposed to a trade war.
Tension between the two Koreas
On 20 May, the South Korean government released a
multinational combined intelligence task force report that
concluded that the South Korean navy warship was
torpedoed by a DPRK submarine on 26 March. The
Korean Won has weakened by 5% in the last one month
to KRW/USD1213.
Thai political unrest
The Thai market and baht are remarkably resilient
considering the violence in Bangkok.
Figure 15: Oil forward curve ($/bbl)
70
75
80
85
90
95
Jul-10 Jul-12 Jul-14 Jul-16 Jul-18
Crude Oil, WTI : 6/9/2010
Source: Bloomberg. 9 June 2010.
Figure 16: Underperformance of TR Crude Oil Index and Energyvs WTI
70
100
130
160
190
220
Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10
WTI JPM Crude Oil TR JPM Energy TR
Source: Bloomberg.
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Bond market volatility
The end of QE plus banks unwillingness to add to
duration risk is a dangerous technical situation for
government bonds. Risk assets typically struggle as bond
yields rapidly increase to normal levels. EM equities
typically correct when bond market volatility rises. Ourwork on quantifying the relationship between the
direction of US Treasury yields and EM equity returns
suggests that the probability of such a correction in 2010
is high if UST yields rise rapidly and increases the risk of
a rapid adjustment. We advise investors to monitor the
pace of change in 10-year UST yields in 2010.
Election-induced volatility
Brazilian elections in October 2010 are likely to be a
source of volatility rather than a change in macro-
economic policy.
Figure 17: Global bond supply ($tr)
$0
$1
$2
$3
$4
$5
$6
$7
2009 2010
Gov ernment Agencies, Supra, Muni, etc
Corporates incl Govt Guranteed Securitized
Source: J.P. Morgan. Global bond supply and demand 2009 and 2010 in $tr, demand and
supply figures are annualized, supply is calculated by the change in bond out standings at
face value, demand is calculated by the change in bond out standings at market value.
Figure 18: Global bond demand ($tr)
$0
$1
$2
$3
$4
$5
$6
$7
2009 2010
QE BanksFX Reserv es Retail Bond FundsInsurance + Pension Other
Source: J.P. Morgan. Global bond supply and demand 2009 and 2010 in $tr, demand andsupply figures are annualized, supply is calculated by the change in bond out standings at
face value, demand is calculated by the change in bond out standings at market value.
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Figure 19: Public Debt and Fiscal Balance as a % of GDP for EM and DM in 2010
Turkey
S Africa
Russia
Poland
HungaryCzech
Thai
Phil
Malaysia
Korea
Indonesia
India
ChinaPeru
Mexico
Chile
BrazilEM
Australia
UK
Portugal
Ireland
Greece
Spain
Italy
France
Germany
Euro area
Japan
US
DM
-14
-12
-10
-8
-6
-4
-2
0
0 50 100 150 200 250Public Debt
FiscalBalance
Source: J.P. Morgan estimates
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Model portfolio changes
This months model portfolio reflects the changes made
in the Regional model portfolio in Off Balance to
Rebalance', Perspectives and Portfolios, Mowat et al, 3
June 2010
In Russia, we replaced VTB with Sberbank. Sberbanks
1Q10 earnings beat consensus estimates owing to
resilient net interest margin as well as other revenue
items. We believe that the stabilization of asset yield and
asset mix is in the offing creating conditions for
stabilization of NIM.
In South Africa, we booked profits in Firstrand, Foschini
and JD Group. We are rebalancing our portfolio in South
Africa in favor of high conviction, defensive names.
In China, we added Belle International Holdings Ltd.
We like consumer discretionary in China as the Chinese
economy prepares itself for rebalancing towards
consumption. Belles valuations are relatively high, but
still below big cap peers.
In Malaysia, we replaced Digi.Com with Genting BHD.
Genting had strong first quarter results, with 14% yoy
increase in revenue. We expect gaming revenue to
benefit from the improving economy and cyclical
recovery through increased consumer spending. Its
Singapore resort (RWS), which begun operations in mid
February 2010, is already experiencing slot wins that are
3-5x that of Macau. VIP revenue also surprised on theupside, coming in at 50% of overall gaming revenue.
In Off Balance to Rebalance, Perspectives and
Portfolios, Mowat et al, 6 May 2010, we added Hyundai
Department Stores, Hyundai Mobis, and KB
Financial in Korea and dropped Korean Air as we
upgraded the market to overweight.
In India, we added DLF as the stock looked attractive
post the recent correction. We expect the stock to benefit
from an improvement in the commercial business and
volume growth returning back in the affordable homes
segment. We dropped BHEL.
Table 2: Country asset allocation relative to MSCI EM
Country Deviation
Taiwan 4.1India 4.0Mexico 3.8Turkey 3.5South Africa 3.3Korea 3.1Philippines 2.3Russia 0.7Thailand -0.3Malaysia -1.1Indonesia -1.3CE3 -1.3Brazil -8.4China -8.7
Source: J.P. Morgan.
Table 3: Sector asset allocation relative to MSCI EM
Sector DeviationFinancials 10.6Information Technology 9.1Consumer Discretionary 5.3Industrials 4.7Utilities 0.0Health Care -2.4Consumer Staples -3.3Materials -5.5Telecommunication Services -8.5Energy -10.2
Source: J.P. Morgan.
Figure 20: Performance of GEM Model Portfolio vs. MSCI EM
-5
5
15
25
35
1M 3M 12M
GEMs Model Portfolio MSCI EM
Source: J.P. Morgan Strategy, Bloomberg, 15 June 2010. Note: This is capital only return
i.e. no reinvestment of divs.
Please see pages 14 and 15 for our Global EmergingMarkets Model Portfolio.
Please note: Source for Data in Global emerging
market portfolio is: Bloomberg, MSCI, J.P. Morgan
estimates. Prices and valuations are as of 15 June 2010.
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Global emerging markets model portfolio by countryTicker Price JPM Change Change Portfolio MSCI Deviation P/E P/E DY ROE
LC Rating 4 Wk (%) YTD (%) Weight(%) Weight(%) (%) 10E (x) 11E (x) 10E (%) 10E (%)China 59.5 3.0 -6.7 10.1 18.7 -8.7 13.6 11.5 2.7 16.2Bank of Communications 3328 HK 8.4 OW 7.3 -7.3 2.1 0.2 1.9 10.7 8.9 3.1 21.1Belle International Holdings 1880 HK 10.7 OW 7.8 18.3 2.0 0.2 1.8 28.5 27.2 1.2 19.4
China High Speed Transmission 658 HK 16.9 OW -9.9 -11.1 1.4 0.1 1.3 15.6 12.5 2.1 27.6China Shipping Container Lines 2866 HK 2.7 OW -10.7 -5.0 2.1 0.0 2.1 NM 24.0 0.0 0.4Lenovo 992 HK 4.4 N -23.9 -10.3 1.3 0.1 1.3 37.1 15.0 0.1 9.8Xinao Gas 2688 HK 16.5 N -31.5 -17.3 1.1 0.1 1.0 16.4 12.5 1.5 15.0Brazil 219,725.3 0.1 -11.0 7.6 15.9 -8.4 11.3 9.0 3.4 18.0BM&F Bovespa BVMF3 BZ 11.9 OW 3.5 -2.8 3.3 0.4 2.9 14.3 12.3 na naPDG Realty PDGR3 BZ 16.0 OW 10.4 -7.8 1.7 0.2 1.6 12.8 8.4 1.4 14.2Petrobras PBR/A US 32.0 N -4.0 -24.6 2.6 3.1 -0.5 8.5 6.7 2.8 15.2Korea 481.8 -3.1 -3.3 16.6 13.5 3.1 10.4 9.4 1.2 13.4Cheil Worldwide 030000 KS 13,050 NR 1.6 3.6 1.1 0.0 1.1 15.1 14.1 2.8 16.8Hynix Semiconductor 000660 KS 27,100 N 1.9 17.1 2.0 0.4 1.6 6.7 10.0 0.0 33.8Hyundai Department Stores 069960 KS 115,000 OW 11.1 2.2 1.6 0.0 1.5 10.6 9.6 0.5 13.8Hyundai Mobis 012330 KS 200,500 OW 3.4 17.3 1.5 0.4 1.1 10.2 9.2 0.5 19.3KB Financial 105560 KS 51,200 OW 1.2 -14.2 2.0 0.5 1.6 8.1 6.8 2.0 11.7LG Chem 051910 KS 295,000 OW -0.2 29.1 2.0 0.4 1 .6 11.0 10.8 1.2 27.5Samsung Electronics 005930 KS 798,000 N -1.5 -0.1 4.4 2.4 1.9 10.0 11.4 0.0 18.0SEMCO 009150 KS 146,500 OW -3.0 36.3 2.1 0.2 1.8 19.8 16.9 0.4 18.3Taiwan 262.6 -4.1 -12.0 14.9 10.8 4.1 13.6 11.7 3.7 14.1China Airlines 2610 TT 15.8 OW 18.4 39.2 2.1 0.0 2.1 NM 17.6 0.0 1.3Fubon Financial Holdings 2881 TT 37.1 OW -3.4 -5.6 1.9 0.2 1.7 11.9 9.9 5.2 11.7Hon Hai 2317 TT 121.0 OW -15.7 -20.1 1.8 1.0 0.9 12.3 10.9 1.7 17.6Mediatek 2454 TT 516.0 N -1.7 -7.5 1.9 0.5 1.5 12.7 11.1 5.0 36.2Nanya Technology Corporation 2408 TT 25.4 OW -6.6 -22.3 1.4 0.0 1.4 16.3 7.0 0.0 13.3TSMC 2330 TT 61.4 OW 0.3 -4.8 2.1 1.5 0.5 10.8 10.7 4.9 27.6UMC 2303 TT 14.7 OW -3.3 -14.5 1.9 0.2 1.8 10.6 11.0 3.5 8.0Yuanta FHC 2885 TT 17.4 OW -7.2 -26.0 1.7 0.1 1.6 10.5 8.9 5.3 11.4India 702.9 0.5 0.1 12.0 8.1 4.0 17.2 13.7 1.1 17.7DLF DLFU IN 272.5 OW -8.7 -24.6 1.8 0.1 1.7 25.5 18.2 0.0 7.2HDFC Bank HDFCB IN 1,963.9 OW 0.6 15.4 1.5 0.4 1.1 30.5 22.5 0.7 16.1IDFC IDFC IN 165.3 OW 0.0 7.1 1.6 0.1 1.5 20.2 17.6 1.0 16.1Infosys INFO IN 2,734.7 OW 3.1 5.1 1.9 0.9 1.0 25.2 22.5 0.9 28.8Kotak Mahindra Bank KMB IN 770.7 OW 1.7 -4.5 2.0 0.1 1.9 21.8 17.9 0.2 16.7Larsen & Toubro LT IN 1,724.5 OW 12.8 2.8 1.6 0.2 1.4 29.7 24.1 0.0 19.4TCS TCS IN 766.1 OW 0.3 2.1 1.7 0.3 1.5 21.8 20.2 3.1 36.8South Africa 708.1 -2.0 -2.3 10.6 7.3 3.3 12.1 9.7 3.3 17.5
ABSA Group Ltd ASA SJ 125.8 OW -6.8 -2.1 1.9 0.2 1.7 8.8 7.3 4.5 19. African Rainbow Minerals ARI SJ 172.1 OW -5.3 -1.0 2.2 0.1 2.1 4.8 4.5 2.5 25.7 Anglo Platinum AMS SJ 778.0 OW 4.0 1.0 2.0 0.2 1.8 21.6 16.2 1.4 25Shoprite SHP SJ 85.0 OW 8.0 30.3 2.5 0.1 2.4 18.8 15.6 2.6 40.1Standard Bank SBK SJ 105.6 N -3.8 3.5 2.0 0.5 1.5 10.9 8.7 3.6 16.4Russia 722.9 -4.9 -7.7 7.0 6.4 0.7 6.5 5.2 2.2 14.8Globaltrans Investments GLTR LI 13.2 OW 8.0 33.3 2.7 0.0 2.7 13.0 8.5 0.0 24.7MRSK Holding MRKH RU 0.1 OW -16.0 8.8 1.3 0.0 1.3 NA NA NA NARosneft ROSN LI 6.9 OW -5.6 -20.3 1.5 0.4 1.1 6.2 6.8 1.5 19.4Sberbank SBER RU 2.4 OW -7.3 -15.8 1.5 0.0 1.5 9.8 5.1 8.5 18.8Mexico 29,852.0 3.1 4.0 8.4 4.6 3.8 14.8 12.4 2.6 18.5Cemex CX US 10.9 OW 2.2 -8.0 1.8 0.0 1.8 35.1 15.8 NA NAFirst Cash Financial FCFS US 21.6 OW 0.6 -2.6 1.8 0.0 1.8 13.5 11.7 NA 18.0ICA ICA* MM 30.1 OW -3.1 -1.2 1.5 0.0 1.5 28.1 20.4 0.0 3.6Ternium TX US 35.6 OW 3.1 0.4 1.8 0.0 1.8 9.3 8.5 1.4 13.6Urbi URBI* MM 24.0 OW -12.7 -18.5 1.4 0.0 1.4 11.0 9.0 0.0 12.9Malaysia 472.7 -3.5 7.2 1.8 2.9 -1.1 13.7 11.8 3.5 14.8Genting BHD GENT MK 7.2 OW 2.1 -2.3 1 .8 0.2 1.6 22.3 13.7 1.0 8.3
Indonesia 3,810.4 -0.1 8.7 1.0 2.3 -1.3 15.0 12.9 3.0 25.9Bank Danamon BDMN IJ 5,150.0 OW -1.9 13.2 1.0 0.1 0.9 15.1 11.3 2.2 16.7Thailand 316.9 2.5 10.5 1.2 1.5 -0.3 11.6 10.0 3.6 16.0Siam Commercial Bank SCB TB 82.0 N -2.4 -5.5 1.2 0.1 1.1 12.5 10.9 3.0 15.2Turkey 811,914.4 -1.1 2.2 5.2 1.7 3.5 9.6 8.4 3.1 18.4Sabanci SAHOL TI 6.5 NR 4.8 13.0 2.2 0.1 2.1 8.3 6.9 1.2 13.6Vakifbank VAKBN TI 3.5 OW -1.1 -17.4 1.1 0.1 1.0 6.4 5.0 4.7 17.5Yapi Kredi YKBNK TI 4.3 OW 4.9 31.1 1.9 0.1 1.8 9.5 6.4 0.0 20.7CE3 NA NA NA 0.9 2.2 -1.3 11.9 10.0 4.4 13.6Erste Bank EBS AV 28.5 OW -8.7 9.3 0.9 0.0 0.9 9.8 6.5 1.4 9.3Philippines 615.6 -3.3 4.6 2.8 0.5 2.3 15.5 13.4 4.2 16.0
Ayala Corp AC PM 320.0 OW -0.8 5.8 1.6 0.0 1.6 18.8 15.3 1.3 8PNOC-EDC EDC PM 4.6 OW -13.2 -2.1 1.2 0.0 1.1 12.2 12.4 8.2 24.2Emerging Markets 41,339.3 -0.7 -4.9 100.0 100.0 0.0 11.4 9.7 2.8 16.1
Source: J.P. Morgan, MSCI, Datastream, IBES estimates for NR stocks
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Global emerging markets model portfolio by sectorTicker Price JPM Change Change Portfolio MSCI Deviation P/E P/E DY ROE
LC Rating 4 Wk (%) YTD (%) Weight(%) Weight(%) (%) 10E (x) 11E (x) 10E (%) 10E (%)
Consumer Discretionary 525.6 3.3 4.4 11.0 5.7 5.3 12.4 10.7 1.8 16.8Belle International Holdings Ltd. 1880 HK 10.7 OW 7.8 18.3 2.0 0.2 1.8 28.5 27.2 1.2 19.4
PDG Realty PDGR3 BZ 16.0 OW 10.4 -7.8 1 .7 0.2 1.6 12.8 8.4 1.4 14.2Cheil Worldwide 030000 KS 13,050.0 NR 1.6 3.6 1.1 0.0 1.1 15.1 14.1 2.8 16.8Hyundai Department Stores 069960 KS 115,000.0 OW 11.1 2.2 1.6 0.0 1.5 10.6 9.6 0.5 13.8Hyundai Mobis 012330 KS 200,500.0 OW 3.4 17.3 1.5 0.4 1.1 10.2 9.2 0.5 19.3Urbi URBI* MM 24.0 OW -12.7 -18.5 1.4 0.0 1.4 11.0 9.0 0.0 12.9Genting BHD GENT MK 7.2 OW 2.1 -2.3 1.8 0.2 1.6 22.3 13.7 1.0 8.3Consumer Staples 442.3 4.0 6.9 2.5 5.8 -3.3 18.0 15.4 2.3 16.5Shoprite SHP SJ 85.0 OW 8.0 30.3 2.5 0.1 2.4 18.8 15.6 2.6 40.1Energy 891.4 3.4 2.9 4.0 14.2 -10.2 9.1 8.1 2.5 14.6Petrobras PBR/A US 32.0 N -4.0 -24.6 2.6 3.1 -0.5 8.5 6.7 2.8 15.2Rosneft ROSN LI 6.9 OW -5.6 -20.3 1.5 0.4 1.1 6.2 6.8 1.5 19.4Financials 407.0 5.4 6.1 34.9 24.3 10.6 12.8 10.5 2.7 14.4Bank of Communications 3328 HK 8.4 OW 7.3 -7.3 2.1 0.2 1.9 10.7 8.9 3.1 21.1BM&F Bovespa BVMF3 BZ 11.9 OW 3.5 -2.8 3.3 0.4 2.9 14.3 12.3 NA NAKB Financial 105560 KS 51,200.0 OW 1.2 -14.2 2.0 0.5 1.6 8.1 6.8 2.0 11.7Fubon Financial Holdings 2881 TT 37.1 OW -3.4 -5.6 1.9 0.2 1.7 11.9 9.9 5.2 11.7Yuanta FHC 2885 TT 17.4 OW -7.2 -26.0 1.7 0.1 1.6 10.5 8.9 5.3 11.4DLF DLFU IN 272.5 OW -8.7 -24.6 1.8 0.1 1.7 25.5 18.2 0.0 7.2HDFC Bank HDFCB IN 1,963.9 OW 0.6 15.4 1.5 0.4 1.1 30.5 22.5 0.7 16.1IDFC IDFC IN 165.3 OW 0.0 7.1 1.6 0.1 1.5 20.2 17.6 1.0 16.1Kotak Mahindra Bank KMB IN 770.7 OW 1.7 -4.5 2.0 0.1 1.9 21.8 17.9 0.2 16.7
ABSA Group Ltd ASA SJ 125.8 OW -6.8 -2.1 1.9 0.2 1.7 8.8 7.3 4.5 19.Standard Bank SBK SJ 105.6 N -3.8 3.5 2.0 0.5 1.5 10.9 8.7 3.6 16.4Sberbank SBER RU 2.4 OW -7.3 -15.8 1.5 0.0 1.5 9.8 5.1 8.5 18.8First Cash Financial FCFS US 21.6 OW 0.6 -2.6 1.8 0.0 1.8 13.5 11.7 NA 18.0Bank Danamon BDMN IJ 5,150.0 OW -1.9 13.2 1.0 0.1 0.9 15.1 11.3 2.2 16.7Siam Commercial Bank SCB TB 82.0 N -2.4 -5.5 1.2 0.1 1.1 12.5 10.9 3.0 15.2Sabanci SAHOL TI 6.5 NR 4.8 13.0 2.2 0.1 2.1 8.3 6.9 1.2 13.6Vakifbank VAKBN TI 3.5 OW -1.1 -17.4 1.1 0.1 1.0 6.4 5.0 4.7 17.5Yapi Kredi YKBNK TI 4.3 OW 4.9 31.1 1.9 0.1 1.8 9.5 6.4 0.0 20.7
Ayala Corp AC PM 320.0 OW -0.8 5.8 1.6 0.0 1.6 18.8 15.3 1.3 8Erste Bank EBS AV 28.5 OW -8.7 9.3 0.9 0.0 0.9 9.8 6.5 1.4 9.3Health Care 542.3 2.0 11.0 0.0 2.4 -2.4 19.9 16.6 1.2 16.8Industrials 218.7 4.0 7.7 11.5 6.8 4.7 13.2 11.2 2.0 12.6China High Speed Transmission 658 HK 16.9 OW -9.9 -11.1 1.4 0.1 1.3 15.6 12.5 2.1 27.6
China Shipping Container Lines 2866 HK 2.7 OW -10.7 -5.0 2.1 0.0 2.1 NM 24.0 0.0 0.4China Airlines 2610 TT 15.8 OW 18.4 39.2 2.1 0.0 2.1 NM 17.6 0.0 1.3Larsen & Toubro LT IN 1,724.5 OW 12.8 2.8 1.6 0.2 1.4 29.7 24.1 0.0 19.4Globaltrans Investments GLTR LI 13.2 OW 8.0 33.3 2.7 0.0 2.7 13.0 8.5 0.0 24.7ICA ICA* MM 30.1 OW -3.1 -1.2 1.5 0.0 1.5 28.1 20.4 0.0 3.6Information Technology 225.3 5.6 5.0 22.6 13.5 9.1 12.3 11.5 2.5 19.4Lenovo 992 HK 4.4 N -23.9 -10.3 1.3 0.1 1.3 37.1 15.0 0.1 9.8Hynix Semiconductor 000660 KS 27,100.0 N 1.9 17.1 2.0 0.4 1.6 6.7 10.0 0.0 33.8Samsung Electronics 005930 KS 798,000.0 N -1.5 -0.1 4.4 2.4 1.9 10.0 11.4 0.0 18.0SEMCO 009150 KS 146,500.0 OW -3.0 36.3 2.1 0.2 1.8 19.8 16.9 0.4 18.3Hon Hai 2317 TT 121.0 OW -15.7 -20.1 1.8 1.0 0.9 12.3 10.9 1.7 17.6Mediatek 2454 TT 516.0 N -1.7 -7.5 1.9 0.5 1.5 12.7 11.1 5.0 36.2Nanya Technology Corporation 2408 TT 25.4 OW -6.6 -22.3 1.4 0.0 1.4 16.3 7.0 0.0 13.3TSMC 2330 TT 61.4 OW 0.3 -4.8 2.1 1.5 0.5 10.8 10.7 4.9 27.6UMC 2303 TT 14.7 OW -3.3 -14.5 1.9 0.2 1.8 10.6 11.0 3.5 8.0Infosys INFO IN 2,734.7 OW 3.1 5.1 1.9 0.9 1.0 25.2 22.5 0.9 28.8TCS TCS IN 766.1 OW 0.3 2.1 1.7 0.3 1.5 21.8 20.2 3.1 36.8Materials 595.3 7.2 11.0 9.8 15.4 -5.5 12.6 9.9 2.4 15.3
LG Chem 051910 KS 295,000.0 OW -0.2 29.1 2.0 0.4 1.6 11.0 10.8 1.2 27.5 African Rainbow Minerals ARI SJ 172.1 OW -5.3 -1.0 2.2 0.1 2.1 4.8 4.5 2.5 25.7 Anglo Platinum AMS SJ 778.0 OW 4.0 1.0 2.0 0.2 1.8 21.6 16.2 1.4 25Cemex CX US 10.9 OW 2.2 -8.0 1.8 0.0 1.8 35.1 15.8 NA NATernium TX US 35.6 OW 3.1 0.4 1.8 0.0 1.8 9.3 8.5 1.4 13.6Telecommunication Services 278.5 3.1 6.2 0.0 8.5 -8.5 12.3 11.1 4.3 18.6Utilities 351.0 2.7 4.3 3.6 3.5 0.0 12.9 11.0 3.3 9.5Xinao Gas 2688 HK 16.5 N -31.5 -17.3 1.1 0.1 1.0 16.4 12.5 1.5 15.0MRSK Holding MRKH RU 0.1 OW -16.0 8.8 1.3 0.0 1.3 NA NA NA NAPNOC-EDC EDC PM 4.6 OW -13.2 -2.1 1.2 0.0 1.1 12.2 12.4 8.2 24.2Emerging Markets 41,339.3 -0.7 -4.9 100.0 100.0 0.0 11.4 9.7 2.8 16.1Source: J.P. Morgan, MSCI, Datastream, IBES estimates for NR stocks
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Key TradesGrowth Surprise from DM not EM
Confidence in a sustainable economic growth has declined. Investors fear that theEuro sovereign stress will lead to excessive fiscal consolidation in developed
economies. We believe the market is exaggerating this risk. The key economic datapoints still support a sustainable recovery driven by private sector demand.Werecommend investors buy exporters, technology, transportation, Korea andMexico. The drivers are:
1. Sustainable US and a better core Europe. Private sector is driving US andcore European growth. Acceleration in business spending and recovering job growthare generating strong lift in global demand. J.P. Morgans proxy of global final salesgrew at 9.7% saar in 1Q10, its fastest gain in over a decade. G-3 capital goods ordersand shipments are booming. Global capital spending is expected to rise at its fastestpace in 25 years. Despite financial market stress, economic data from core Europe isimpressive. Core Europe has a good fiscal position and is benefiting from a weakeuro. Germanys manufacturing PMI has risen to 58.4 from 52.7 at end-2009. Euroarea industrial output was up 16% QoQ saar in the first quarter, after 8.8% in 4Q09.
2. Delayed monetary stimulus.
3. A turn toward inventory restocking. The inventory cycle is turning from adrag on GDP to a contributor to growth. The global economy was poorly preparedfor the 2008 demand shock. IP growth exceeded final demand from 2006, as risinginflation hit real purchasing power. The result was high inventories ahead of thesynchronized global recession. It was a painful adjustment with global IP decliningby 21% peak to trough and many quarters of inventory de-stocking. With demandand production each rising at a rapid pace during 1Q10, inventories remain lean andthe restocking cycle has only just begun. We think the consensus is underestimatingthe impact of this tailwind.
4. Strong recovery in exports (see table of 3M SAAR exports by country).
5. This is not a jobless recovery. The non-farm-payroll and working hours are
now expanding; the result is a growth.
Table 5: Growth surprise from developed & emerging economiesStock Ticker JPM Mkt cap Price P/E DY ROE
Rating (US$B) (LC) 10E 11E 10E 10E
OW ITSamsung Electronics 005930 KS N 94.0 793000 9.8 11.2 0.0 16.7TSMC 2330 TT OW 48.3 60.3 10.6 10.5 5.0 25.9Hon Hai 2317 TT OW 31.4 118.5 11.0 9.2 2.1 17.7Mediatek 2454 TT OW 17.6 521.0 12.0 9.8 5.0 33.9Hynix Semiconductor 000660 KS N 12.3 26000 6.4 9.5 0.0 28.9Lg Display 034220 KS OW 11.8 41000 5.3 5.6 1.8 21.5Lg Electronics 066570 KS N 11.0 94400 5.7 5.2 0.9 21.7SEMCO 009150 KS OW 8.6 143000 19.1 16.4 0.4 17.0Chimei Innolux 3481 TT OW 8.5 34.1 9.3 7.9 0.0 8.8
Au Optronics 2409 TT N 8.3 30.3 11.3 23.2 0.0 7
UMC 2303 TT OW 5.7 14.3 10.4 10.7 3.6 8.0 Advanced Semicondctr 2311 TT OW 4.4 26.0 8.7 7.8 2.1 18Inotera Memories 3474 TT N 2.7 19.2 22.4 7.6 0.0 6.0Nanya Technology 2408 TT OW 2.6 25.1 16.1 6.9 0.0 12.5OW Transportation
Air China Ltd-H 753 HK OW 16.9 8.1 14.0 12.6 0.0 17Lan Airlines LFL US OW 6.5 19.1 20.5 15.9 1.6 NAChina Shipping Container 2866 HK OW 5.5 2.5 230.1 19.9 0.0 0.4Korean Air Lines 003490 KS N 4.4 76800 93.4 23.5 0.0 2.0Embraer ERJ US UW 4.0 21.4 15.4 11.9 2.7 10.0China Airlines Ltd 2610 TT OW 2.1 14.8 118.8 16.5 0.0 1.3Copa Holdings CPA US N 2.1 47.5 8.8 7.7 1.4 22.7Eva Airways Corp 2618 TT OW 1.6 17.6 NM 14.8 0.0 -1.6
Source: Bloomberg, IBES, J.P. Morgan estimates. Share prices as of 11 June 2010.
Figure 21: European PMIs
20
30
40
50
60
70
J un-07 Jun-08 Jun-09
Greece
Spain
Euro Area
Source: J.P. Morgan economics, May 2010.
Table 4: Recovering exports
Country 3M/3MSAAR
Current%oya
Brazil 111.9 47.7India 94.0 54.5Taiwan 84.7 57.9Korea 65.7 41.9Mexico 46.4 43.2SA 27.5 24.7Philippines 23.8 43.8Thailand 21.9 34.6Malaysia 20.4 41.3Turkey 14.0 25.1Indonesia 3.1 42.6Chile (12.3) 27.4Russia (12.6) 61.3Poland (14.0) 27.0China (30.9) 30.4Hungary (33.0) 20.5
Source: Bloomberg.
Figure 22: Non farm vs. Temporaryemployment
-800-600
-400
-200
0
200
400
600
00 02 04 06 08 10
-150
-100
-50
0
50
100Temp. employment
(RHS)
Non-farm
pay roll (LHS)
Source: Bloomberg, 31 May 2010. Note: Chart
shows mom net change in non farm payrolls and
temporary employment.
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OW Mexico Leveraged to the US
Our bullish equity strategy case for Mexico remains unchanged, and we still see
robust upside to our year-end Mexbol target of 38,500. The three key drivers are:
Broadening Macro Recovery
Mexicos beta to US economic growth is two times. J.P. Morgan's 2010 US GDPgrowth forecast is 3.5%; this would suggest upside risk to the current forecast of
4.5% growth for Mexico. Based on the forecast the swing in GDP 09/10E is the third
largest. The macro recovery is manufacturing and auto led. March IP was up an
above-consensus 7.6% oya. Construction is now showing positive growth, after
seven months. We have changed our monetary policy call to a low-for-long view; no
change in expecting no rate hike before 2H 2011, as inflation expectations remain
well anchored, the output gap remains wide, and we expect Banxico to wait for
developed market rates to rise first.
Undervalued Mexican Peso
The Mexican peso is still 15% below its pre-credit crunch level.
Mexico is under-owned by global and local investors
Non-dedicated global investors are few, especially relative to larger EMs, such as
Brazil. This is partly understandable given the markets relatively small size (4.7% of
EM, 7 stocks make up 75% of index), but also odd, given the clear leverage to a
rebounding US. Local investors pension funds and mutual funds also remain UW
their own market. We do not see them as upside drivers, but as a defensive floor as
inflows remain robust, weightings low, and regulatory change pushing for greater
equity involvement. This is notwithstanding the upcoming end of the voluntary afore
agreement to not invest inflows outside Mexico.
Table 6: OW MexicoStock Ticker JPM Mkt cap Price P/E DY ROE
Rating (US$B) (LC) 10E 11E 10E 10E
Cemex CX US OW 10.7 10.2 32.9 14.8 0.0 0.7Ternium TX US OW 7.0 34.8 9.1 8.3 1.3 12.0Urbi URBI* MM OW 1.8 23.9 11.0 9.0 0.0 12.9ICA ICA* MM OW 1.5 29.9 27.9 20.2 0.0 3.6First Cash Finl Svcs FCFS US OW 0.6 21.4 13.4 11.5 na 18.0
Source: Bloomberg, IBES, J.P. Morgan estimates. Share prices as of 10 June 2010.
Figure 23: Correlation of Bolsa withS&P 500 Index
15%
30%
45%
60%
75%
90%
95 97 99 01 03 05 07 09
1 Year Rolling
Correaltion of
Weekly Returns
Source: Bloomberg, 9 June 2010.
Figure 24: GDP Swing 09/10e
(1.0) 4.0 9.0 14.0
Russia
Taiwan
Mexico
TurkeyJapan
Argentina
Brazil
Chile
UK
DW
USA
EM
Peru
Korea
Euro
S. Africa
Colombia
ChinaIndonesia
Ecuador
India
Source: J.P. Morgan
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Macro policy and rising inflation - QR not QE in EM
Underweight: Brazil, China, commodities and energy
China and Brazil are booming. GDP in China expanded at 13.1%q/q saar in 1Q10;
with strong contribution from domestic private-sector demand and a significant
upturn in exports. Brazil is leading LatAm growth. J.P. Morgan has increased the
2010 GDP growth forecast to 7.5%; the highest growth in 25 years. Consistent with
higher growth they have brought forward the timing of higher interest rates; the Selic
overnight rate is forecast to touch 12.5% by end 2010. Latin America is now
expected to grow 4.9% in 2010, nearly 2% above its estimated potential growth rate.
The exit from aggressive pro-growth policies and rising headline inflation are macro
headwinds for the consensus overweight EM consumption trade. Higher inflation
slows the growth in discretionary income this is the opposite trend to 2009.
QR not QE in EM
QR= quantitative restrictions; this is the use of administrative policies to manage theallocation of capital. The asset inflation trade (a consensus position in 2009) is
battling policymakers who are fighting asset inflation with quantitative restrictions in
EM. We have been underweight simple asset inflation trades for some time e.g.
property. Capital controls/taxes could slow EM F/X appreciation. After significant
underperformance we would not short these stocks.
Figure 25: Domestic consumerdiscretionary relative to MSCI EM
90
100
110
120
130
Dec-08 May-09 Oct-09 Mar-10
Source: Datastream, 9 June 2010. Note: Chart
shows the performance of J.P. Morgan index of
domestic consumer discretionary relative to EM.
Figure 26: Valuation of Domesticconsumer discretionary relative toMSCI EM
9
13
17
21
25
29
00 01 02 03 04 05 06 07 08 09
Source: Datastream. Note: Chart shows the PE
of J.P. Morgan index of domestic consumer
discretionary relative to EM, 31 May 2010.
Figure 27: Performance of Chinaproperty and EM real estate rel EM
50556065707580859095
100105
Jul-09 Oct-09 Jan-10 Apr-10
China Property
rel EM
EM Real Estate rel
EM
Source: Bloomberg, 7 June 2010.
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Underweight Brazil and China
So we are bullish on growth assets yet underweight the booming economies of
Brazil and China. The track record of these countries economic management is
good. These economies do not need low interest rates or fiscal stimulus. In our viewthe market is too complacent on the pace of normalization and eventualtightening. In China it seems reasonable that Beijing will continue to concentrate
efforts to slow growth in investment, rather than exports or consumption, as they
attempt to rebalance growth. The 1H10 record commodity demand from China is
consistent with peak implementation of FAI. We are not willing to extrapolate this
growth. Chinas share of world steel and iron demand is six times its share of global
GDP demand. Per capita consumption when adjusted for purchasing power is also
excessive. Evidence of economic rebalancing in China is already building. Property
transactions are slowing. Steel prices are falling. Recent wage increases suggest a
growing share of labor income to GDP (stronger consumption but less currency
appreciation). This is good for long-term sustainable growth but bad for bulk
commodities and manufacturers margins. Economic rebalancing in China has
implications for Brazilian commodity exports.
Brazils link with China
China is Brazil's largest customer. As noted earlier we believe that China will
continue to slow fixed asset investment; both infrastructure and real estate. This
makes us nervous on iron ore demand from China.
The Presidential election
The October presidential race is yet another source of volatility regardless of the two
candidates, with greater market awareness as campaigning really starts, political
platforms are debated, and coalitions formed.
An overvalued Real
We remain somewhat concerned by the risk/reward for the BRL. Our base-casescenario is the real trading in a range. Aggressive FX intervention, deteriorating
current account deficit and fundamental BRL over valuation should set a ceiling to
BRL appreciation. Balancing these forces, however, the case for appreciation is that
terms of trade are at historical highs, growth-related capital inflows remains resilient,
and increasing interest rates all set a cap to depreciation.
Figure 30: J.P. Morgan REER: Deviation (%) from long term meansince 1975
-40
-20
0
20
40
60
80
100
BRL
RUB
CLP
CZK
AUD
CNY
CHF
ZAR
TRY
PHP
PLN
HUF
IDR
MXN
THB
EUR
USD
TWD
KRW
Source: J.P. Morgan estimates.
Figure 31: Brazil CPI (%oya) and SELIC overnight rate
0
4
8
12
16
20
24
28
00 02 04 06 08 10
Selic ov ernight target rate
CPI
Source: J.P. Morgan.
With the downgrade of Brazil to
underweight (19 April 2010), we
are now predicting that the two
largest markets will
underperform MSCI EM.
Figure 28: China: Squeezing thesteel margin
250
350
450
550
650
750
850
950
07 08 09 10
Iron Ore + Coking coalHRC Price
Source: Bloomberg. Note: Iron ore + coking coal
is the spot price of iron X 1.6 and spot coking
coal price X 0.6
Figure 29: China FAI & Retail Sales
510
15
20
25
30
35
40
04 05 06 07 08 09
Retail Sales
FAI
Source: Bloomberg, April 2010. Chart shows
%yoy growth in FAI and retail sales.
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CEMBI surfers OW India, Turkey, South Africa
CEMBI is J.P. Morgans emerging market corporate bond index. CEMBI yield
(JCBYBLYD Index) is 6.5% (year low 6.1% end April). Since 3 May, CEMBI
spreads (JCBSBLSD Index) have increased by 93bp to 367bp reflecting the current
uncertainty in global financial markets. Supply is on hold. New issues from EM
corporates slowed to USD3.3 bn in May vs. an average of 16bn per month over Jan-April. J.P. Morgans full year supply target is 127.5 bn out of which 68bn has been
issued YTD. This forecast is at risk as we believe EM corporates will prefer to stay
out of the market rather than pay generous concessions to get investors in from the
sidelines.
J.P. Morgan forecasts CEMBI spreads to range between 350 to 400bp through mid
year. However, we remain confident in EM growth fundamentals and believe
that as the market stabilizes, spreads will recover to 300 bps by year-end. This is
also a function of the treasury yield which is forecast to increase from 3.26%
currently to 4% by Dec 10.
CEMBI is particularly important to India as the Indian private sector funds the
current account deficit. India's nominal GDP growth could be 17% this year. Longterm borrowing costs are half the level of nominal GDP (Indian 10Y bonds 7.6% and
CEMBI yields 6.5%). Many Indian companies will view today's monetary conditions
as supportive of growth.
In the past ECB data has been fairly volatile and does not seem to be affected from
the change in CEMBI spreads. The exception is the blowout after Oct-08 when ECBs
fell in line with the spike in spreads. In the current CEMBI spread rise so far, there
has not been much impact on ECB approvals/ utilization of pre-approved ECBs.
There might be a larger impact in the 2H. We are monitoring our OW on India
closely. In the recent past, corporate India has been borrowing substantial amounts
overseas and the relative importance of ECBs has also been increasing. Annual net
ECB borrowing rose from USD2 bn in 2005 to 23bn in 2008. It was 8bn in 2009 and
is forecast to be 11bn in 2010. Typically the spreads and markets are concurrentlynegatively correlated.
Turkey is also a beneficiary of lower borrowing costs due to its reliance on external
financing. Its current account deficit is forecast to widen from 3.4% to 4.2% of GDP
in 2010. Nominal GDP growth is forecast to be 15% in 2010 versus 10 year bond
yields of 10% and 6.5% CEMBI. Turkish corporates should benefit from the delayed
monetary stimulus.
Table 7: Yields for government and corporate bonds plus earnings yield for US & EM equitymarkets
High Low Avg 05-07 Spot DiffUS EARNINGS YIELD 11.4 6.1 6.6 7.9 1.3US High Yield 21.0 7.5 8.4 9.5 1.1EM EARNINGS YIELD 17.3 6.8 8.7 9.6 0.9CEMBI 14.3 5.7 6.4 6.5 0.1EMBI 12.0 6.2 7.0 6.5 (0.4)JULI 8.7 4.8 5.7 5.1 (0.6)US 10 Yr 5.2 2.1 4.6 3.2 (1.3)1 Month T-Bill 5.2 (0.1) 4.0 0.0 (4.0)
Source: Bloomberg, 11 June 2010.
Figure 32: CEMBI Yield and India10Y Govt Yield
4
8
12
16
Apr 06 Oct 07 Apr 09
Indian 10
Year yields
CEMBI
Yields
Source: Bloomberg, 7 June 2010.
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OW South Africa
The drivers of our overweight on South Africa are:
1. Positive SA growth surprises:The South African economy is finally starting todeliver positive growth surprises. Leading economic indicators are positive. SA realGDP growth surprised on the upside at 4.6%q/q saar in 1Q10. This was the fastest
growth pace in seven quarters as low interest rates worked through to boost domesticdemand. The MPC adopted a decidedly more upbeat tone on growth in the JuneMPC meeting than at the last meeting and disclosed a growth forecast of 3.6% for2011, but kept its growth projection for 2010 broadly unchanged at 2.6%y/y. J.P.Morgans SA economics team forecast SA real GDP growth to surprise on the upsideat c3% in 2010.
2. Countercyclical accommodative monetary policy: The SARB kept the repo rate
unchanged at 6.5% in the Monetary Policy meeting in May. J.P. Morgan economists
now expect the first hike in the second quarter of 2011, given risks to the global
recovery and the likely delay in the start of the hiking cycle in many developed
markets. In the Q&A session, the Governor indicated that the outlook for rates is to
remain steady at 6.5% as inflation is expected to be contained below 6% throughout
the forecast period. J.P. Morgan economists agree with the SARBs benign view oninflation in 2010, but highlight that relatively high wage settlements and base effects
from low food prices pose some risks that inflation could exceed the upper end of the
target band in the second half of 2011.
3. Earnings recovery off a decimated base in 2009: The fall in SA earnings growth
in 2009 was the biggest on record (-29% vs. an average of -9.3% during previous
cyclical lows). We forecast EPS growth of c30-35% in both 2010 and 2011, one of
the highest in EM. This relative earnings growth outperformance of SA vs EM into
2011 should drive the SA catch-up trade.
4. Relatively attractive valuations: SA offers a combination of low relative
valuations with high earnings growth.
5. The Rand - risk and reward: The Rand remains the wildcard, having appreciated
3% 2010-to-date. Our valuation tools suggest that the Rand is some 10% overvalued.
However, given the demand for carry as a function of global liquidity (J.P. Morgan
expectations of a first Fed hike in 2Q11), we expect the Rand to stay stronger-for-
longer underpinned by an environment of high growth, strong commodity prices
and healthy risk appetite.
Our preferred domestic cyclical sectors are banks, food, retailers and General
Industrials. We are overweight banks for six reasons: (1) Sustained low SA interest
rates through 2010 vs. tightening elsewhere in EM; (2) Recovery in loan growth; (3)
Unwinding of bad debts; (4) Strongest forecast earnings growth rebound in EM in
2010/11; (5) Attractive relative valuations; and (6) SA Banks are under-owned. Ourtop stock picks include ABSA, Standard Bank, Shoprite, ARM and AngloPlat.
Table 8: OW South Africa
Stock Ticker JPM Mkt cap Price P/E DY ROE
Rating (US$B) (LC) 10E 11E 10E 10E
African Rainbow ARI SJ OW 4.6 16866 4.7 4.4 3.0 2 Anglo Platinum AMS SJ OW 25.7 75700 21.0 15.7 1.4 25Standard Bank Gr SBK SJ N 20.5 10218 10.6 8.4 3.9 16.4
Absa Group Ltd ASA SJ OW 11.4 12365 8.7 7.2 4.6 19Shoprite Hldgs SHP SJ OW 5.6 8008 18.1 15.0 2.8 40.1
Source: Bloomberg, IBES, J.P. Morgan estimates. Share prices as of 10 June 2010.
Figure 33: SA Real GDP growth%yoy
-2
-1
0
1
2
3
4
5
6
00 02 04 06 08 10
Source: J.P. Morgan economics. Grey are
denotes forecasts till 2011.
Figure 34: Record low SA policy
rates for now
4
6
8
10
12
14
16
00 02 04 06 08 10
SA
EM
Source: J.P. Morgan.
Figure 35: SA rates on hold vstightening for rest of EM
-100 0 100 200
HungaryRussiaCzech
IndonesiaMexico
SAPhilippines
MalaysiaTaiwan
ThailandKoreaChinaIndia
TurkeyBrazil
Source: J.P. Morgan estimates. Note: Chart
shows forecasted change in policy rates from
now till 4Q10.
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Country asset allocation changes
Table 9: Summary of country asset allocation changes from 2007Country From To Recommendation Relative return from the date of
RecommendationYTD relative return
Taiwan 20-Feb-07 27-Aug-07 N (6.2)Thailand 21-Mar-07 20-Jul-09 OW 2.8
Turkey 21-Mar-07 24-Sep-07 N 14.3Poland 18-Apr-07 17-Jan-08 N (26.0)Russia 18-May-07 27-Jul-08 N 3.3Brazil 18-May-07 31-Jan-08 OW 22.4Malaysia 14-Jun-07 24-Aug-07 N (7.3)South Africa 14-Jun-07 24-Aug-07 N (8.0)Malaysia 24-Aug-07 14-Mar-08 OW (0.8)South Africa 24-Aug-07 5-Feb-08 OW (11.3)Taiwan 24-Aug-07 28-Feb-08 UW 9.6Turkey 27-Sep-07 27-Jul-08 UW 16.6India 2-Nov-07 17-Jan-08 N 15.7India 18-Jan-08 7-Jan-09 UW 15.3Poland 18-Jan-08 18-Aug-09 UW 15.7Mexico 1-Feb-08 26-Feb-09 OW (2.4)Brazil 1-Feb-08 16-Jun-08 N 16.9South Africa 6-Feb-08 16-Jun-08 N 2.1Taiwan 29-Feb-08 2-Apr-08 OW 6.0Malaysia 17-Mar-08 14-May-09 N 8.8Taiwan 3-Apr-08 17-Apr-08 N 3.3Taiwan 18-Apr-08 19-Nov-08 OW 0.2China 16-May-08 16-Jun-08 N (4.7)Brazil 17-Jun-08 22-Sep-08 UW 7.9China 17-Jun-08 14-May-09 OW 14.1South Africa 17-Jun-08 27-Jul-08 UW (7.7)Russia 28-Jul-08 14-May-09 UW 21.0Turkey 28-Jul-08 5-Oct-08 OW 7.0South Africa 28-Jul-08 14-May-09 N 8.2Brazil 23-Sep-08 16-Apr-10 N 4.6Turkey 6-Oct-08 1-Dec-09 N (16.2)Indonesia 3-Nov-08 30-Mar-09 UW (5.3)Taiwan 19-Nov-08 30-Mar-09 N 3.9India 8-Jan-09 5-Aug-09 N 27.0South Korea 26-Feb-09 3-Sep-09 OW 25.6
Mexico 27-Feb-09 23-Mar-09 N 2.0Philippines 16-Mar-09 3-Sep-09 N (2.0)Mexico 23-Mar-09 18-Aug-09 OW 6.5Taiwan 30-Mar-09 - OW (24.2) (24.2)Indonesia 30-Mar-09 14-May-09 N 11.1Russia 15-May-09 18-Oct-09 N 4.1South Africa 15-May-09 17-Sep-09 UW (6.1)China 15-May-09 17-Sep-09 N (3.3)Indonesia 15-May-09 3-Sep-09 OW 21.2Malaysia 15-May-09 2-Feb-10 UW 4.8Thailand 20-Jul-09 17-Sep-09 N 0.3India 6-Aug-09 - OW 7.8 7.8Poland 19-Aug-09 25-Oct-09 OW 8.2Mexico 19-Aug-09 1-Dec-09 N (3.1)Indonesia 3-Sep-09 - N 18.2 18.2Philippines 3-Sep-09 - OW 4.2 4.2South Korea 3-Sep-09 6/1/2010 N (3.8)
South Africa 17-Sep-09 16-Apr-10 N (6.1)China 17-Sep-09 - UW 7.3 7.3Thailand 17-Sep-09 14-Dec-09 OW (8.2)Russia 19-Oct-09 7-Dec-09 OW (8.2)Poland 26-Oct-09 - N (12.9) (12.9)Turkey 2-Dec-09 - OW 15.6 15.6Mexico 2-Dec-09 - OW 7.2 7.2Russia 8-Dec-09 - N 2.8 2.8Thailand 15-Dec-09 - N 17.0 17.0Malaysia 2-Feb-10 - N 6.8 6.8South Africa 19-Apr-10 - OW 3.1 3.1Brazil 19-Apr-10 - UW 2.6 2.6South Korea 2-Jun-10 - OW 1.6 1.6
Source: J.P. Morgan, 16 June 2010.
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Stress testing our current baseline forecasts for EM : Resiliancy to hold
Joyce ChangAC
, Global Head of Emerging Markets & Credit Research
Thus far, positive cyclical growth trends in the US and
EM have not been disrupted by financial market
volatility or concerns about growth in Europe. Beyond a
modest downward revision to the Euro area growthforecast, J.P. Morgans economists have not materially
altered their global outlook in the face of the latest wave
of financial market stress. For the past year, forecasting
global growth has been relatively easy given the
consistency in activity indicators in the US and Emerging
Asia. Our G-3 economists do acknowledge that the
financial shock emanating from Europe still has the
capacity to temper growth, and may prompt downward
forecast revisions at some point. There is a growing risk
that the positive feedback loop between markets and the
economy could shift into reverse. To be sure, there are
important offsets to the fall in price of risk assets
notably lower energy prices and risk-free interest rates.While growth momentum across EM countries remains
largely positive, there are also signs the Emerging Asia is
downshifting in responses to a policy induced cooling in
China.
We stress-test our growth, FX and policy rate forecasts
by considering two alternative scenarios for Europe. In
considering alternative scenarios we note that the direct
effects of lower growth in Europe on the US are fairly
minimal since US exports of goods and services to all of
Europe account for only about 2% of US GDP. The
major effect would occur through financial market
contagion, i.e. sharply lower stock prices or a muchstronger dollar or both. Indeed, the usual rule-of-thumb
about effects of US exchange rates say that a 10%
decrease in EUR/USD would push up the trade-weighted
dollar 1.8% and would take about 0.4% off of US real
GDP, spread over two years, or 0.2% per year. Taking
these considerations into account, we contemplate two
alternative scenarios for Europe to assess the impact on
EM.
The potential negative spillovers to growth are obviously
greatest in the Euro area, which is the epicenter of the
financial shock. For now, our European economists viewthe financial shock as sufficient to limit the regional
upturn to around 2% growth in the coming quarters; J.P.
Morgan pencils in full-year growth forecasts for the Euro
area at 1.3%oya in 2010 and 1.9% in 2011. Looking to
the second half of the year, growth prospects will
certainly be diminished by the latest developments even
if near term cyclical forces are still positive. In judging
the magnitude of the drag, it is important to recognize
two points about the current position of the regional
economy. First, following three quarters in which GDP
growth averaged less than 1% annualized, a powerful
cyclical tailwind is pushing up economic activity into
midyear. Second, fiscal policy is actually neutral for
2010. Indeed, despite the additional actions taken on theperiphery, the fiscal easing in Germany, the Netherlands,
Austria, and Finland leaves the regions fiscal thrust
roughly neutral this year. However, fiscal tightening
becomes a large drag next year, with our forecast
pointing to a tightening of a little more than 1% of GDP.
Scenario 1: Deeper economic and financial crisis, but
contained to peripheral Europe. We assume a slowdown
in Euro area growth to less than 0.5% this year and less
than 1% in 2011 (i.e., one full %-pt below our current
forecasts of 1.4% and 1.9%, respectively), and a
sustained fall in oil prices to an average of $65-75/bbl in
2010-2011. EUR/USD drops to 1.10-1.15 in thisscenario. The impact on US growth is of around 1/2% to
3/4%-pts of lower US growth relative to J.P. Morgans
current forecasts of 3.5%oya this year and 3.1% in 2011,
taking into account the impact of both the lower Euro
area growth and the appreciation of the USD.
Scenario 2: Crisis spreads to core Europe due to
contagion from the periphery, pushing the Euro area into
a double-dip recession. In this case, the Euro area growth
goes down to -0.5% this year (implying a 5.5% pace of
contraction in 2H10) and -1% in 2011 (despite being still
negative in %oya terms, this implies a relevant recovery
in sequential terms next year). EUR/USD reaches parityin this scenario, and the impact on US growth is of
around 1% to 1.5%-pts of lower growth relative to our
current 2010 and 2011 forecasts (given the stronger
growth momentum in the US, maybe it avoids a double-
dip recession itself, but the economy at least displays flat
growth for a couple of quarters). This produces a
sustained fall in oil prices to an average of $50-60/bbl in
2010-2011.
Our current projections call for EM growth to reach an
above-potential pace of 6.9%oya in 2010 (Latin America
5.1%, CEEMEA 4.1%, Emerging Asia 8.9%) and tomoderate to 5.8% in 2011 (Latin America 3.8%,
CEEMEA 4.8%, Emerging Asia 7.2%). Under Scenario
1, EM growth performance remains above potential, with
no material impact on Latin America and Emerging Asia
in particular. Under Scenario 2, the impact is material
and the Euro sovereign and bank crisis is no longer a
regional issue. Incipient tightening would be reversed
and EM currencies would need to weaken considerably.
EM countries would likely resort to greater fiscal
stimulus to offset weakness in the private sector.
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Adrian Mowat(852) [email protected]
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Emerging
Markets:Outlook&
Scorecard
s
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JPM Mkt cap P/E EPS Div Yld. ROE
Price Code Rating (US$B) 10E 11E 10E 11E 10E 10E(CNY) (x) (x) (CNY) (CNY) (%) (%)
Top picksChina Resources Power Holdings 16.0 836 HK OW 9.6 12.6 9.9 1.3 1.6 2.5 15.1Huaneng Power 4.2 902 HK N 9.6 11.0 10.8 0.4 0.4 2.1 9.8China Mengniu Dairy 23.5 2319 HK OW 5.2 30.1 22.5 0.8 1.0 0.7 14.9Zhejiang Expressway 7.1 576 HK OW 4.0 15.1 13.5 0.5 0.5 4.4 14.1Huabao International 9.3 336 HK N 3.7 21.6 17.7 0.4 0.5 0.0 39.7Stocks to avoidGuangzhou R&F 10.0 2777 HK OW 4.1 7.9 6.3 1.3 1.6 5.1 22.6
Aluminum Corp of China 6.1 2600 HK N 17.6 19.0 NA 0.3 NA 1.1 6.4
Source: Datastream, J.P. Morgan estimates. Note: The share price and valuations are as of 10 June 2010.
ChinaMarket Strategy China: Mind the gap
Frank LiAC
(852) [email protected]
Recommendation
OW: (1) new economy stocks; (2)
expressways; (3) consumer staples;
(4) menswear; (5) IPPs
UW: (1) property; (2)
commodities; (3) home appliances;
(4) energy
Key drivers
Undemanding valuations for
MSCI-China, more pro-
consumption measures for the
remainder of the year, and solid
balance sheet conditions
Key risks
Downside earnings risk to MSCI
China and policy risks
Market Statistics (%)
MSCI China Index 58.2Weightings in Region (%) 18.9CNY/US$ 6.83
Avg. Daily Turnover (US$MM) 3652MSCI Total Mkt. Cap (US$B) 551
Source: Datastream. Prices as of 10 June 2010.
Issues over the last 12 months
China led both equity and the economic recovery in EM and the world in 2009. Late 2008s
aggressive monetary and fiscal stimuli brought about a strong economic recovery, which in
turn, translated into strong stock market performance (+52%) in FY09. Entering 2010,
Chinas stock market underperformed major stock markets this year because of (1) the
expected sharp fall in Chinas excess liquidity growth (M2growh minus nominal GDP
growth) from 21% in FY09 to 5% in FY10 due to the combined effect of the drop in M2
growth and the rise in nominal GDP growth; (2) a series of policy tightening risks as
reflected in the three 50bp RRR hikes, the window guidance for banks to strictly follow the
quarterly lending quota, and the recent crackdown on the housing sector. YTD 2010, the
MSCI China index declined -8.9%, underperforming MSCI EM by 3.5%.
Outlook
We stay cautious on MSCI China in the coming months, despite possible technical rebound
because: (1) We see downside earnings risk to MSCI China due to the economic
deceleration on the back of the combined ripple effect of the crack-down on property sector
and slowdown in banks lending to local government-funded investment projects. (2)
Policy risks, such as the resource tax, which may hurt the earnings of and de-rate the
multiples of the energy and upstream resources companies. (3) Tight liquidity situation in
China, as reflected in the recent rise in short-term interest rate in the repo market as well as
inter-bank market. (4) Possible additional tightening measures in the property and FAI
areas, such as raising share capital funds requirement for investment projects, and property
tax on tier one cities on a pilot basis, etc. We recommend investors to wait for a better entry
point until the above-listed concerns are addressed before buying Chinas secular growth
sectors. We firmly believe in Chinas bright medium-term growth prospects: (1) Strong
balance sheet at the country, household, and consumer level. (2) Favorable demographics.
(3) Sectors with low penetration rates and solid secular growth. (4) Powerful central
government with strong execution capability to carry on the necessary economic reforms.
Recommendations
We are bullish on: (1) consumer staples; (2) expressways with good dividend yields; (3)
new economy plays such as high-tech manufacturing and strategic new industries, such as
new materials, and new energy etc; (4) menswear with strong secular growth; (5) IPPs. We
stay cautious on commodities, property, home appliances, and energy.
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China scorecardKey Financial Data Summary Local Interest Rates and Inflation Trend
EPS Growth P/E ROE Yield Spot -3M +3M 2008 -10.9 18.3 14.4 2.2 3 Month 3.3 1.1 -0.8
2009E 13.6 16.1 15.0 2.4 Long Bond 3.3 -0.2 0.72010E 21.3 13.3 16.2 2.8 Inflation 2.7 0.3 0.92011E 18.3 11.2 17.1 3.3 Real 3 Month 0.6 0.8 -1.7
Economic Forecasts Risk AppetiteGDP (YoY) Forecast -3M - EMF - Cons US$ Spread Spot -3M +3M 2008 9.6 0.7 4.7 0.0 BAA 2.9 0.4 na2009E 10.8 0.8 3.9 0.7 EMBI 3.3 0.7 0.72010E 9.4 0.0 3.6 0.2 Country 0.7 0.0 na
Country Relative -2.6 -0.7 naEconomic Momentum Foreign Fund Flows (US$ mils)
GDP Q1 10E Q2 10E Q3 10E Q4 10E Month 09 YTD Avg 12-Mo AvgGDP SAAR 13.1 9.4 9.3 9.0 EM Funds* -4,759 2,095 3,840
Asia ex Japan* -2,251 438 880China -576 -513 394
MSCI China Absolute and Relative (vs EMF) Index MSCI Fair value Range
0
100
200
300
400
500
600
700
800
Jan-03 Dec-03 Nov-04 Oct-05 Sep-06 Aug-07 Jul-08 Jun-09 May-10
Absolute Relativ e to MSCI EMF
(28)
(46)
(29)
(46)
(59)
(56)
(57)
(70)
(81)
(80)
10 30 50 70 90 110 130 150
FWD PER
PER
PBR
DY
BY/EY
BY/DY
Currency Outlook (CNY/USD) EPS Integer over Time
6.0
6.5
7.0
7.5
8.0
8.5
Dec 04 Jul 06 Feb 08 Sep 09 Mar 11
Spot Forecast Consensus
J.P. Morgan
J.P. M organ forecast:
end Jun 10: 6.65
end Sep 10: 6.58
end Dec 10: 6.50
Consensus
90
100
110
120
130
140
Feb 09 May 09 Aug 09 Nov 09 Feb 10 May 10
2010 2011
Source: MSCI, Bloomberg, IBES, Datastream, CEIC, J.P. Morgan, Consensus Economics. Unless stated all forecasts are J.P. Morgans. The scorecards are designed to assis t in tracking trends
and expectations. -3M refers to the change in this factor over the past three months and +3M refers to the forecast change in this factor over the next three months. The Economic Forecast
table contains J.P. Morgans real GDP forecasts, the change in these forecasts over the past three months, the difference between these forecasts and the average for emerging markets and the
final column is the difference between J.P. Morgans forecast and consensus expectations. The MSCI Fair Value chart is designed to show current valuations relative 10 year valuation history. The
vertical dotted line is the current index level. The five horizontal bars show a +/- one standard deviation range for these valuation measures. A dotted line to the left indicates a market that is cheap
relative to history. *US Mutual fund subscriptions.
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JPM Mkt cap P/E EPS Div Yld. ROE
Price Code Rating (US$B) 10E 11E 10E 11E 10E 10E
(BRL) (x) (x) (BRL) (BRL) (%) (%)
Top picksBM&F Bovespa 12.0 BVMF3 BZ OW 13.6 14.4 12.4 0.8 1.0 na naBradesco 29.9 BBDC4 BZ OW 51.4 11.3 9.7 2.7 3.1 2.9 20.3Gafisa 10.8 GFSA3 BZ OW 2.6 12.9 9.7 0.8 1.1 1.5 13.1Stocks to AvoidCSN 15.0 SID US UW 22.7 8.5 6.4 1.8 2.3 10.3 43.9Sabesp 35.1 SBSP3 BZ UW 4.4 6.5 7.1 5.4 5.0 5.4 10.2
Source: Datastream, J.P. Morgan estimates. Note: The share price and valuations are as of 10 June 2010.
BrazilMarket Strategy Brazil: Better Outlook for Domestics
Emy ShayoAC
(5511) 3048-6684
Recommendation
OW: Financials, Homebuilders
Key drivers
Strong portfolio and FDI inflows
7%+ growth driven by domestic
demand
Commodity prices
Key risks
Large Petrobras Capitalization
China slowdown/ hard landing
October 2010 presidential elections
Market Statistics (%)MSCI Brazil Index 219577Weightings in Region (%) 15.8BRL/US$ 1.80
Avg. Daily Turnover (US$MM) 2899MSCI Total Mkt. Cap (US$B) 461
Source: Datastream. Prices as of 10 June 2010.
Issues over th