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Review of the macroeconomic environment

Review of the macroeconomic environment. Healthier global economy. 2012. 2011. 2013. Aug. Jul. Sep. Oct. Dec. Jan. Feb. Mar. Apr. May. Jun. Nov. Aug. Nov. Jul. Oct. Sep. Dec. Jan. Feb. Mar. Apr. May. Jun. Nov. Expansion. Global Economy. Eurozone. France. Germany.

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Review of the macroeconomic environment

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  1. Review of the macroeconomic environment

  2. Healthier global economy 2012 2011 2013 Aug Jul Sep Oct Dec Jan Feb Mar Apr May Jun Nov Aug Nov Jul Oct Sep Dec Jan Feb Mar Apr May Jun Nov Expansion Global Economy Eurozone France Germany Europe Italy Spain Ireland UK US Developed Japan Brazil Russia India Emerging China Korea Taiwan Lowest relative to 50 PMI Highest relative to 50 PMI 50 Source: Markit, J.P. Morgan Asset Management. Heatmap colours are based on PMI relative to 50, which indicates expansion or contraction of the sector, for the time period shown. Expansion is percentage of 35 country universe covered by Markit with a PMI greater than 50 or a six month increase in the index that is greater or equal to four. “Guide to the Markets - Europe”. Data as at 31 December 2013.

  3. US economy cruising around its potential... Real GDP Change quarter on quarter, SAAR Components of GDP 2Q13 nominal GDP, $ billions 3,2% Housing % $ Global Economy 13,0% Investment ex-housing 18,6% Government spending 68,2% Consumption $1.482bn of output recovered $639bn of output lost -3,0% Net exports Source: (Both charts) BEA, FactSet, J.P. Morgan Asset Management “Guide to the Markets - Europe”.SAAR is seasonally adjusted annual rate. Percentages may not sum to 100% due to rounding. Data as at 31 December 2013.

  4. …as consumers are enjoying a positive wealth effect Household Debt Service Ratio Civilian Unemployment Rate Seasonally adjusted Debt payments as % of disposable personal income, seasonally adjusted 3Q07: 14.0% Global Economy Oct. 2009: 10.0% 1Q80: 11.1% 4Q13*: 10% Economy Household Net Worth 4Q13*: $79,765 Billions USD, saar 3Q07: $69,028 Dec. 2013: 7% 50-yr. avg.: 6.1% Source: (Left) BLS, FactSet, J.P. Morgan Asset Management (Right) BEA, FRB, J.P. Morgan Asset Management. *3Q13 household debt service ratio and 4Q13 household net worth are J.P. Morgan Asset Management estimates. Values may not sum to 100% due to rounding. 3

  5. Pent-up demand should support this dynamic going forward… Light vehicle sales Millions, SAAR Manufacturing and trade inventories Days of sales, seasonally adjusted Global Economy Nov2013: 16,3 Average: 15,2 Oct 2013: 39,2 Housing starts Thousands, SAAR Real capital goods orders Non-defensive capital goods orders ex. aircraft, $ billions, seasonally adjusted $ Nov 2013: 1.091 Nov2013: 60,5 Average: 57,1 Average: 1.363 Source: (Top left) BEA, FactSet, J.P. Morgan Asset Management “Guide to the Markets - Europe”. (Top right, bottom right & bottom left) Census Bureau, FactSet, J.P. Morgan Asset Management “Guide to the Markets - Europe”. Capital goods orders deflated using the producer price index for capital goods. SAAR is seasonally adjusted annual rate. Data as at 31 December 2013.

  6. ...while Fed tapering shouldn’t derail the economic recovery Housing Affordability Index US Federal Reserve: Balance sheet & tapering scenario $ trillions Avg. mortgage payment as a % of household income Forecast $ Global Economy Nov. 2013: 13.2% Average: 20.5% Home Inventories Millions, annual rate, seasonally adjusted Other US Treasuries Nov. 2013: 2.3 Agency MBS Source: (Left) US Federal Reserve, FactSet, J.P. Morgan Asset Management “Guide to the Markets - Europe”.(Top right) Census Bureau, J.P. Morgan Asset Management. Monthly mortgage payment assumes the prevailing 30-year fixed-rate mortgage rates and average new home prices excluding a 20% downpayment. (Bottom right) Census Bureau, National Association of Realtors, J.P. Morgan Asset Management. Guide to the Markets – U.S

  7. Europe finally out of recession but risks of deflation persist… Real GDP EU27, change year on year Inflation EU27, change year on year Europe Economy % % Average: 1,4% Source: (Both charts) Eurostat, FactSet, J.P. Morgan Asset Management “Guide to the Markets - Europe”. Data as at 31 December 2013.

  8. …as unemployment and fragmentation remains important Unit labour costs Rebased to 100 at December 1998 Europe Economy Latest Unemployment Rates for European Countries October/November 2013, seasonally adjusted Germany 5.2% Italy UK 7.7% Spain EU 10.9% Ireland France 10.9% Greece Italy 12.5% Germany Portugal 15.7% Spain 26.7% Greece 27.9% 0% 5% 10% 15% 20% 25% 30% Equity markets Total return, rebased to 100 at January 2005 Core Periphery Source: J.P. Morgan Asset Management “Guide to the Markets - Data as at 31 December 2013.

  9. The ECB will have to battle on all fronts... ECB balance sheet: assets € trillions Europe Economy Adjustable-rate mortgage issuance % of new residential mortgage lending, 1Q07-1Q13 average € Jan 2005 – Jun 2012: 248% ECB balance sheet and the euro € trillions, real broad effective exchange rate (REER*) European lending rates Non-financial corporations, new business lending up to €1 million % ECB Balance Sheet (RHS, inverted) Euro REER* (LHS) Spain Germany ECB policy rate Italy France Source: (Top left) ECB, J.P. Morgan Asset Management “Guide to the Markets - Europe”. (Topright) European Mortgage Federaltion, Bank of England, Mortgage Bankers Association, J.P. Morgan Asset Management. (Bottom left) ECB, J.P. Morgan Economics, J.P. Morgan Asset Management “Guide to the Markets - Europe”. (Bottom right) ECB, J.P. Morgan Asset Management “Guide to the Markets - Europe”. *Real effective exchange rate is defined as the weighted average of a country's currency relative to a basket of other major currencies adjusted for the effects of inflation. The weights are determined by comparing the relative trade balances, in terms of one country's currency with each other country within the index. Latest lending rate data is July 2013. Data as at 30 September 2013.

  10. In Japan, Abenomics has so far delivered on promises, but… Global Economy Bank of Japan Balance sheet Government Fiscal Balance Yen trillions, JGB Holdings & Monetary base % of GDP IMF forecast Source: Japanese Cabinet Office, Ministry of Internal Affairs and Communications, Japan Department Stores Association, The Bank of Japan, Real Estate Economic Institute, FactSet, J.P. Morgan Asset Management “Guide to the Markets – Asia.”(Top Right, Bottom Left) Department store sales, new condominium sales and price per square meter are 3-month moving average figures. (Bottom Right) Forecast for September 2013 from Bank of Japan Tankan Short-Term Economic Survey of Enterprises in Japan. Data reflect most recently available as of 1/10/13. 9

  11. China : slower but more sustainable economic growth Global Economy International

  12. Emerging Markets: the ‘Fragile Five’ have replaced the BRIC in the headlines International reserves % of GDP Current account, inflation and currency depreciation % Global Economy Current account surplus/deficit (% GDP) Emerging markets ‘Fragile five’ % Currency depreciation (May ‘13 - Aug ‘13) % Source: (Left) IMF World Economic Outlook April 2013, FactSet, J.P. Morgan Asset Management “Guide to the Markets - Europe”. (Right) IMF World Economic Outlook April 2013, J.P. Morgan Asset Management “Guide to the Markets - Europe”. *All data is as at 2012 except India which uses 2008 data. Data as at 30 September 2013. 11

  13. Investment Themes for 2014

  14. Economic environment and Fed tapering should lead to a gradual normalization of real interest rates… Real 10-year Government Bond Yields Germany U.S. Japan Fixed Income • Average 12/31/13 • U.S. 3.00% 1.3% Germany 3.54% 0.7% Japan 2.67% -0.4% Source: TullettPrebon, BLS, Bundesbank, FactSet, Ministry of Internal Affairs & Communication, J.P. Morgan Asset Management. Real 10-year government bond yields are calculated as the monthly yield less year-over-year core inflation for that month. Core inflation for Japan is ex-fresh food. Data are as of 11/27/13.

  15. ...which will have negative mark to market effects on bond portfolios Source: (Top chart) US Treasury, TullettPrebon, FactSetJ.P. Morgan Asset Management “Guide to the Markets - Europe”. (Bottom chart) Barclays, FactSetJ.P. Morgan Asset Management “Guide to the Markets - Europe”.*Interest rate volatility is the three month moving average of the absolute value of the daily change in the 10 year US Treasury yield and the 10 year German Bund yield.Fixed income sectors shown are provided by Barclays Capital and are represented by – Treasury Europe: Barclays Pan-Euro Aggregate Government - Treasury Index; IG credit: Barclays Global Aggregate – Corporates Index; High yield: Barclays Global High Yield Index; EMD sovereign ($): Barclays Emerging Markets – Sovereigns index; EMD corporate ($): Barclays Emerging Markets – Corporates Index; EMD sovereign (LC): Barclays Emerging Market Local Currency Government Index. Change in bond price is calculated using both duration and convexity. Data as at 30 September 2013. Interest rate volatility* Three month moving average of daily absolute change % 10y US Treasury 10y German Bund Fixed Income Estimated price impact of a 1% rise in local interest rates on selected indices % Price return Total return Treasury: Europe Investment grade credit EMD USD sovereign EMD USD corporate EMD LC sovereign 1-3 years 5-7 years 10+ years High yield 14

  16. Re-positioning portfolios for rising rates Fixed Income Source: Barclays Capital, FactSet, J.P. Morgan, J.P. Morgan Asset Management. *Market value is shown in the local currency of the index. Fixed income sectors shown are represented by the following indices: Europe Treasuries – Barclays Pan-Euro Aggregate Government-Treasury indices, US Treasuries – Barclays US Bellwether indices, MBS – Barclays US Aggregate Securitized-MBS, IG Credit – Barclays Global Aggregate-Corporates, High yield – Barclays Global High Yield, Floating rate – Barclays Euro Floating Rate Notes, Convertibles – Barclays Global Convertibles Composite, EMD USD sovereign – Barclays Emerging Markets USD Aggregate – Sovereign, EMD USD corporate – Barclays Emerging Markets USD Aggregate – Corporate, EMD LC sovereign – Barclays Emerging Market Local Currency Government. “Guide to the Markets - Europe”. Data as at 31 December 2013. 15

  17. At this stage equities are a the best hedge against rising rates... Correlations between weekly equity returns and interest rate movements Rolling two-year correlation of weekly returns of the S&P 500, MSCI Europe Index and the ten-year US Treasury yield, 1980 – 2013 S&P 500 MSCI Europe Positive relationship between yield movements and equity returns Equities Correlation coefficient Negative relationship between yield movements and equity returns % Ten-year US Treasury yield Source: Standard & Poor’s, US Treasury, MSCI, FactSet, J.P. Morgan Asset Management. Returns are based on price index only and do not include dividends. “Guide to the Markets - Europe”.Data as at 31 December 2013. 16

  18. Some equity markets might be close to fair value... Equities

  19. ...but the bull market may have more room to run... Equities Source: Institute of Supply Management, MSCI, Standard & Poor’s, J.P. Morgan Asset Management “Guide to the Markets – Asia.” *Valuations are based on real earnings yield for the S&P 500 which is defined as (trailing four quarters of reported earnings/price) - year over year core CPI inflation. Period after average valuation defined by 15-day moving average passing below average real earnings yield.** Subsequent 3-month performance from January 1988 – present. Data reflect most recently available as of 30/9/13.

  20. ...even though return expectations need to be tempered... Equities Source: Standard & Poor’s, IBES, FactSet, J.P. Morgan Asset Management. Earnings estimates are for the next 12 months and taken at quarter end dates throughout the year. Forward Price to Earnings is price divided by consensus analyst estimates of earnings per share for the next 12 months. Data reflect most recently available as of 30/9/13.

  21. ...while a correction cannot be excluded MSCI Europe Index intra-year declines vs calendar year returns Despite average intra-year drops of 15,7% (median 12,0%), annual returns are positive in 26 of 34 years Intra-year decline Calendar year return % Equities Source: MSCI, FactSet, J.P. Morgan Asset Management. Returns are based on price only and do not include dividends. Intra-year decline refers to the largest market fall from peak to trough during the calendar year. Returns shown are calendar years from 1980 to 2013. “Guide to the Markets - Europe”.Data as at 31 December 2013.

  22. Five Investment Themes for the Year of the HORSE • Healthier global economy • Optimism in equities • Re-position portfolio for rising rates • Selective in fixed income • Emerging Markets differentiation

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