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www.jpmorganmarkets.com
North America Equity Research
12 December 2012
U.S. Year Ahead 2013
Be Selective
Portfolio Strategy
Thomas J Lee, CFAAC
(1-212) 622-6505
Director of Americas Equity
Research
Noelle V. Grainger
(1-212) 622-6504
J.P. Morgan Securities LLC
Bloomberg JPUS2013
Bloomberg subscribers can use the ticker
JPUS2013 to access tracking information on a
basket created by the J.P. Morgan Delta One
desk to leverage the theme discussed in this
report. Over time, the performance of
JPUS2013 could diverge from returns quoted
in this report, because of differences in
methodology. J.P. Morgan Research does not
provide research coverage of this basket and
investors should not expect continuous
analysis or additional reports relating to it. For
information on JPUS2013, please contact
your J.P. Morgan salesperson or the Delta
One Desk.
See page 140 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 may
have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their
investment decision. In the United States, this information is available only to persons who have received the proper option risk disclosure documents.
Please contact your J.P. Morgan representative or visit http://www.optionsclearing.com/publications/risks/riskstoc.pdf.
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US Year Ahead 2013
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North America Equity Research
December 2012
US Year Ahead 2013
-
J.P. Morgan Securities LLC Equity Research 383 Madison Avenue, New York, NY 10179 3
December 12, 2012
Dear Investor,
While 2012 comes to a close amid continued uncertainty, the U.S. equity market looks
to end the year more than 12% higher than at its start. Some of the gains posted early
in the year were pared in the second quarter as economic momentum slowed and
macro overhangs loomed. However, the S&P 500 advanced steadily from June
through October leading up to the presidential election, after which investor focus
shifted to the likelihood of a compromise in Washington.
Optimistic expectations at the beginning of the year have given way to the realization
that the U.S. recovery is more likely to be a marathon than a sprint, and fiscal
challenges present a major hurdle along the way. We anticipate that some, but far from
all, of the austerity implied by the fiscal cliff will be realized next year and expect the
expansion to soldier on, in spite of the fiscal policy headwinds, with housing carrying
the baton. Our economists expect inflation could move even lower and look for
supportive monetary policy to offset some of the drag from fiscal actions.
Following solid performance this year, we remain constructive on U.S. equities. Tom
Lee, J.P. Morgans Chief U.S. Equity Strategist, expects the secular bull market to
continue for a fifth year and has established a year-end 2013 target for the S&P 500 of
1580, which would represent a new all-time high. He anticipates stronger performance
in the second half after a tricky first half, as policy clarity and acceleration in durable
goods spending should lead to multiple expansion.
We designed this report as a sector-by-sector guide to equity investing in the United
States for the upcoming year. We asked our analyst teams to identify key drivers of
sector stock prices and to present their best investment ideas, framed by commentary
from our economists, strategists, as well as derivatives and accounting experts. One of
the most common themes was the need for investors to be selective, given
uncertainties related to fiscal policy and notable risks to both upside and downside.
Against this backdrop, we highlight 73 best ideas.
As always, we aim to provide analysis that proves helpful in your investment decision-
making process and hope you find this report useful.
Noelle Grainger
Director of Americas Equity Research
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US Year Ahead 2013
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North America Equity Research
December 2012
US Year Ahead 2013
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5US Year Ahead 2013North America Equity Research
December 2012
Table of Contents
Macro
Portfolio Strategy ............................................................................. 7
Accounting & Tax Policy................................................................. 42
Economics..................................................................................... 45
Equity Derivatives .......................................................................... 49
Equity Derivatives & Quantitative Strategy ...................................... 58
Equity Quantitative Strategy ........................................................... 63
Capital Goods/Industrials
Aerospace & Defense .................................................................... 65
Boeing Company (BA)
Airfreight & Surface Transportation................................................. 66
Canadian Pacific Railway (CP)
Electrical Equipment & Multi-Industry.............................................. 67
Danaher (DHR)
Engineering & Construction............................................................ 68
Quanta Services, Inc. (PWR)
Environmental Services.................................................................. 69
Waste Connections (WCN)
Machinery...................................................................................... 70
Eaton Corp. (ETN)
Marine Transportation .................................................................... 71
Teekay Offshore Partners (TOO)
Consumer
Airlines .......................................................................................... 73
Delta Air Lines, Inc. (DAL)
Autos & Auto Parts......................................................................... 74
Harman International (HAR)
Beverages ..................................................................................... 75
PepsiCo (PEP)
Food Manufacturing ....................................................................... 76
Hershey (HSY)
Food Retail .................................................................................... 77
Whole Foods Market (WFM)
Gaming.......................................................................................... 78
Las Vegas Sands Corp. (LVS)
Homebuilding & Building Products.................................................. 79
PulteGroup, Inc. (PHM), KB Home (KBH)
Household & Personal Care Products............................................. 80
Newell Rubbermaid Inc. (NWL)
Leisure .......................................................................................... 81
Harley-Davidson (HOG)
Consumer (cond)
Lodging.......................................................................................... 82
Wyndham Worldwide (WYN)
Restaurants Casual Dining .......................................................... 83
Brinker International (EAT), DineEquity Inc. (DIN),
Texas Roadhouse (TXRH)
Restaurants QSR ........................................................................ 84
Starbucks (SBUX), McDonalds (MCD)
Retailing Broadlines, Apparel & Footwear .................................... 85
Macys (M)
Retailing Hardlines/Discounters ................................................... 86
Target (TGT)
Retailing Specialty....................................................................... 87
Urban Outfitters (URBN)
Tobacco......................................................................................... 88
Reynolds American (RAI)
Energy
Electric Utilities............................................................................... 89
Duke Energy Corp. (DUK)
Energy MLPs ................................................................................. 90
Oneok Inc (OKE), EQT Midstream Partners (EQM)
Independing Refiners ..................................................................... 91
Phillips 66 (PSX)
Integrated Oils and Major Producers............................................... 92
Suncor Energy (SU.TO)
Oil & Gas Exploration & Production................................................. 93
Denbury Resources (DNR)
Oilfield Services & Equipment......................................................... 94
Schlumberger (SLB)
Financials
Asset Managers, Brokers and Exchanges....................................... 95
Invesco Ltd. (IVZ)
Banks Large Cap......................................................................... 96
Bank of America (BAC)
Banks Mid- and Small Cap .......................................................... 97
First Republic (FRC)
Insurance Life ............................................................................. 98
Prudential Financial (PRU)
Insurance Non-Life ...................................................................... 99
Allstate Corp. (ALL)
REITs/Real Estate Services.......................................................... 100
ProLogis (PLD)
Specialty & Consumer Finance..................................................... 101
Capital One (COF)
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US Year Ahead 2013
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North America Equity Research
December 2012
US Year Ahead 2013
Health Care
Biotechnology ...............................................................................103
Gilead (GILD)
SMid Biotechnology ......................................................................104
Onyx Pharmaceuticals (ONXX)
Healthcare Technology & Distribution ............................................105
McKesson Corporation (MCK)
Life Sciences Tools & Diagnostics .................................................106
Agilent Technologies (A)
Managed Care ..............................................................................107
Cigna (CI)
Medical Supplies & Devices ..........................................................108
Heartware International (HTWR)
Medical Technology SMid Cap ..................................................109
Intuitive Surgical (ISRG)
Pharmaceuticals Major...............................................................110
Pfizer Inc. (PFE)
Pharmaceuticals Specialty..........................................................111
Mylan (MYL)
Materials
Chemicals Specialty, Commodity & Agricultural...........................113
LyondellBasell Industries (LYB)
Coal..............................................................................................114
CONSOL Energy (CNX)
Gold .............................................................................................115
Goldcorp Inc (GG)
Metals & Mining ............................................................................116
Carpenter Technology (CRS)
Paper & Packaging .......................................................................117
MeadWestvaco (MWV)
Silver............................................................................................118
Silver Wheaton (SLW)
Media & Telecom
Internet ........................................................................................ 119
eBay (EBAY)
Media .......................................................................................... 120
CBS Corporation (CBS)
Telecom, Cable & Satellite............................................................ 121
Comcast (CMCSA)
Technology
Alternative Energy LED ............................................................. 123
Cree Inc. (CREE)
Alternative Energy Solar PV....................................................... 124
First Solar (FSLR) Avoid
Applied & Emerging Technologies ................................................ 125
Verint Systems (VRNT)
Business Services........................................................................ 126
Robert Half International (RHI)
Communications Equipment & Data Networking............................ 127
Ciena Corp. (CIEN)
Computer Services & IT Consulting .............................................. 128
Visa Inc. (V)
Education Services....................................................................... 129
American Public Education (APEI)
Information Services..................................................................... 130
Nielsen Holdings N.V. (NLSN)
IT Hardware................................................................................. 131
Apple Inc. (AAPL)
Semiconductor Capital Equipment ................................................ 132
Nanometrics Incorporated (NANO)
Semiconductors ........................................................................... 133
Texas Instruments (TXN)
SMid Semiconductors................................................................... 134
Broadcom Corporation (BRCM)
Software ...................................................................................... 135
Oracle Corp. (ORCL)
Software Technology.................................................................... 136
Guidewire Software (GWRE)
Disclosures .................................................................................. 140
US Equity Research Staff List.................................................... 144
Note: Unless otherwise noted, all stock prices and coverage lists in
this report are as of the close on December 6, 2012, and target prices
for December 2013.
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US Year Ahead 2013
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North America Equity Research
December 2012
Portfolio Strategy
Year-End 2013 S&P 500 Target Is 1580: Tricky 1H, Clearer 2H
Tricky 1H, Clearer 2H
We remain constructive on equities overall with an expectation of upside risks for
2013. Our base case (and framework) remains that we are in a secular bull market,
which started in March 2009 and will continue beyond 2013. We are establishing a
year-end 2013 target for the S&P 500 of 1580, based on a P/E multiple of 13.5x our
2014 EPS estimate of $117, and see the drivers of this 12% upside as (1) clearing of
policy uncertainty (Washington and Europe) aiding the multiple, (2) acceleration of
durable goods spending lifting P/E, (3) resultant pickup in earnings growth (hence
estimated EPS of $117) and (4) fifth years in bull markets historically being
unusually strong.
Tricky 1H, Clearer 2H. We see risks building in 1H and, thus, expect the
S&P 500 to be range-bound in 1H13 with a mid-year target of less than 1400
(discussed below) related to the following: (1) uncertainty from fiscal cliff
overhang is likely to suppress P/E multiple; (2) economic growth in 1H13 is
forecast to slow to 1.25%, reflecting partial impact of cliff (slowing consumption
and government spending); (3) strategists, in our view, are broadly optimistic
about 2013 prospectsthus, we expect a rocky 1H to reduce bullishness; and
(4) historically fifth years of bull markets have tended to be flattish in 1H and
stronger in 2H (1982-1987 best analogy, see Figure 17 and Figure 21).
We believe the housing recovery that started in 2011 stands at the front-end
of a larger recovery in durable goods. Currently, durable goods spending
stands at 21% of GDP and, as shown in Figure 22, is at the lowest level since
World War II. This should bode well for P/E expansion as historically a rise in
durable goods spending has tended to lift P/E by 1.8 turns (see Figure 23). We
define durable goods spending as capex plus construction (both residential and
non-residential) plus consumer purchases of durable goods, among which
spending is significantly below trend in Housing, Autos, capex and commercial
construction. In other words, the underinvestment is broad-based. Capex (as % of
sales) for corporates at 6.2% is barely above the 2009 lows of 5% and well off the
8% seen at cycle highs (see Figure 31).
Another incremental positive in 2013 is the anticipated easing of bank
lending standards. There is a misconception that an ease in mortgage lending
standards precedes or coincides with an upturn in US housing. As we highlight in
Figure 30, bank lending in the prior three housing cycles eased 16-37 months
after the start of the housing up-cycle. We anticipate mortgage lending standards
to ease in 2013, further accelerating the recovery in durable goods spending. This
is supported by household debt-service ratios at the best level since the early 90s
(Figure 34).
History has shown that returns in the fifth year of bull markets have been 19%,
with P/Es expanding by an average of 0.75x, implying more than two-thirds of
the gains have been due to EPS growth (we forecast 5% y/y). As shown in
Figure 17 and Figure 18, there have been eight bull markets lasting four years in
duration and five extended beyond the fifth year. Of the three that expired, two
Thomas J Lee, CFAAC
(1-212) 622-6505
Katherine C Khor
(1-212) 622-0934
J.P. Morgan Securities LLC
Bloomberg JPMA TLEE
Ma
cro
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US Year Ahead 2013
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North America Equity Research
December 2012
were due to recession (42 bull and 57 bull) and the third saw GDP growth
decelerate from 10% (real) to 2% (probably felt like a recession, 62 bull).
We favor remaining Cyclical and our top picks are Materials, Technology and
Energy. Cyclicals have outperformed in 2012 by 200bp and we still see them as
attractive with above-average expected EPS growth (2013E EPS growth of 6%)
and P/E multiples that still stand at a substantial discount to those for Defensives
(98% vs. 122% on 2014E P/E). History also has shown that Cyclicals typically
have led in the fifth year of a bull market. Moreover, we believe investors should
focus on capital gainsthat is, stocks with potential to re-rate. We found that
companies with high FCF yields and low dividend yields have tended to
outperform in the fifth year of a bull market.
Bottom line, we remain constructive. Our year-end target represents an all-time
high for the S&P 500 (previous peak was 1565 in October 2007) and would validate,
in our view, the ability of equities to generate real returns (above inflation). Our
target represents upside of about 11% with a total return of 13% (with dividends).
We list the 2013 best ideas of J.P. Morgans fundamental equity analysts. There are
72 LONG ideas and 1 AVOID idea. The Long ideas are: A, AAPL, ALL, APEI,
BA, BAC, BRCM, CBS, CI, CIEN, CMCSA, CNX, COF, CP, CREE, CRS,
DAL, DHR, DIN, DNR, DUK, EAT, EBAY, EQM, ETN, FRC, GG, GILD,
GWRE, HAR, HOG, HSY, HTWR, ISRG, IVZ, KBH, LVS, LYB, M, MCD,
MCK, MWV, MYL, NANO, NLSN, NWL, OKE, ONXX, ORCL, PEP, PFE,
PHM, PLD, PRU, PSX, PWR, RAI, RHI, SBUX, SLB, SLW, SU.TO, TGT,
TOO, TXN, TXRH, URBN, V, VRNT, WCN, WFM and WYN. The Avoid idea is
FSLR.
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US Year Ahead 2013
9
North America Equity Research
December 2012
TARGET: Year-End 2013 Target of 1580
1H13 Tricky, Then 2H Rally to 1580
We are establishing a year-end 2013 target of 1580 for the S&P 500, based on a
target P/E multiple of 13.5x our 2014 EPS estimate of $117 (see Figure 1).
This target represents price appreciation of about 11.5% (from current levels),
slightly lower than the 2012 return for the S&P 500 (13% plus 2% dividends, or
15% total return).
We forecast the forward P/E to rise from 12.9x currently to 13.5x, consistent with
trends in maturing bull marketstypically P/E has expanded in the fifth year of
bull markets.
Moreover, we see 2013 as likely to be back-end loaded, and believe markets will
be flattish in 1H13.
Figure 1: Year-End 2013 Target Sensitivity
S&P 500 Target
EPS
2014E EPS $117.00P/E
1580 $109 $113 $117 $121 $125
Target YE P/E (2014E) 13.5X12.5X 1,365 1,415 1,465 1,515 1,565
2013E Target 1,58013.0X 1,415 1,470 1,520 1,575 1,625
13.5X 1,470 1,525 1,580 1,635 1,690
14.0X 1,525 1,580 1,640 1,695 1,750
14.5X 1,580 1,640 1,695 1,755 1,815
Source: J.P. Morgan.
Contrarian on Timing: Consensus Sees New Highs in 2013
(Therefore Positive to Start), Suggesting 1H Could Be Weak
In contrast to last year, investors and strategists seem optimistic about 2013. We
expect equity markets to rise in 2013 but believe this optimism needs to be
challenged. Hence, our belief equity markets will perform poorly in 1H13.
Seven of 10 strategy forecasts (NI WGT ) look for all-time highs for the
S&P 500 in 2013. (Recall, as noted above, more than half did not think 2011
highs would be exceeded in 2012.)
Moreover, our sense from clients is that they missed the 2012 rally (and
underperformed) and intend to compensate for this by moving to risk-on in 2013.
This does suggest the potential for a big January effect for small-cap stocks.
Thus, the consensus seems constructive to start the year. This creates a tricky
dilemma for us. On the one hand, we see reasons to be constructive for the year.
However, in past years the 1H has seemed to run counter to consensus. Thus,
given the constructiveness noted above, and the past pattern of markets foiling
consensus, we see downside risks in 1H.
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US Year Ahead 2013
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North America Equity Research
December 2012
Why Flattish 1H13? Cliff, Economy, Sentiment and History
The main reasons we expect a flat 1H are listed below in Figure 2. But, simply, US
economic momentum should be better in 2H than 1H, sentiment is too bullish (in our
view) and history has shown that there is more likely to be a rally in 2H.
Figure 2: Why 1H13 Is Likely to Be Flattish
Fiscal cliff overhang into 1H13 is likely to create uncertainty, suppressing P/E multiple.
Economic growth in 1H13 is forecast to slow to 1.25%, reflecting partial impact of the sequestration and tax cut
expiration (slowing consumption and government spending).
Strategists, in our view, are broadly optimistic about 2013 prospectsthus we expect a rocky 1H will reduce
bullishness.
We see 1982-1987 as the best analogy and markets were sluggish during 1H during that time frame (see
Figure 17 to Figure 21).
Source: J.P. Morgan.
Investors Need to Be Contrarian to Consensus
One of the frustrations for investors over the past few years has been that consensus
base case rarely has been realized. Rather, the outcomes, particularly market
direction, have been either meaningfully better or worse than consensus. Figure 3,
below, lists year-ahead S&P 500 targets since 2009 (Bloomberg: NI WGT
).
As highlighted, in three of the last four years, the market meaningfully
outperformed consensus (and we were ahead of consensus as well). The
exception was 2011 but, as we highlight, the Street was very optimistic on
2011hence, the outcome was worse than expected.
On 2013 expectations, we believe the Street is probably not bullish enough on the
full-year outcome (we believe 1526 is too low). That said, we believe the Street
may be too optimistic on 1H13hence, our view that 1H is likely to be tricky. In
other words, the need to be contrarian on timing.
Figure 3: Year-Ahead S&P 500 Targets, 2009-2013
Consensus Average from Bloomberg (NI WGT )
Source: J.P. Morgan and Bloomberg.
Delta
Year
Date target
published JPM Target
Consensus
Target
Actual YE
closing price
JPM vs
consensus
Actual vs
consensus
2009 12/17/08 1100 1061 1115 +39 +54
2010 12/10/09 1300 1225 1258 +75 +33
2011 12/10/10 1425 1384 1258 +41 -126
2012 12/9/11 1430 1344 1430 +86 +86
2013 12/12/12 1580 1526 +54
Consensus
OPTIMISTIC
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US Year Ahead 2013
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North America Equity Research
December 2012
Drivers in Place to Support Rally in Spread Product in 2013
J.P. Morgans fixed income strategists also see positive returns in their respective
markets in 2013 (see 2013 Outlook dated 9/21/12); this should support higher
equity returns (due to comparative return). As shown in Figure 4 below, basically,
every major fixed income market is expected to rally in 2013.
High grade is expected to tighten from 170bp STW to 125bp STW, or 45bp.
High yield, which is most correlated to equities, is expected to rally from 613bp
to 585bp STW.
Emerging market bond spreads are expected to fall from 307bp to 238bp.
Overall, a positive year for credit should mean positive returns for equities.
Figure 4: J.P. Morgan 2013 Return Forecasts and Analytics
From 2013 US Fixed Income Outlook by Terry Belton and Srini Ramaswamy
Interest Rate Forecast Financial Markets Forecast
Source: 2013 US Fixed Income Outlook by Terry Belton and Srini Ramaswamy. Note: For chart on the left-hand side, * Fed funds assumed to be 0.125% for Fed funds/3m Libor calculation. For the
chart on the right-hand side, * spread to Treasuries, while ** spread to swaps.
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US Year Ahead 2013
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North America Equity Research
December 2012
EPS Forecast: 2013E/2014E of $110/$117
We are maintaining our 2013 EPS forecast of $110 and establishing a 2014 EPS
estimate of $117, representing 6% growth, $9 below consensus.
In our view, $7 of incremental EPS in 2014 appears reasonable and reflects
meaningful contributions from Energy ($1.52), Technology ($1.13), Financials
($0.88), Discretionary ($0.82) and Industrials ($0.85).
As for point contribution to our target of 1580, the largest contributors are
Technology (39 pts), Energy (28) and Financials (27). However, on a
percentage basis, Basic Materials (up 22%) is the largest.
Figure 5: 2013E/2014E EPS Summary
$ per share
B/U consensus JPM Strategy EPS EPS % (JPM)2014 P/E Relative 2014E P/E Point Contribution
JPM
Strategy
Rating 2012E 2013E 2014E 2012E 2013E 2014E
'13E
vs.
'12E
'14E
vs.
'13E Current Target
Long-
Term
Avg Current Target
Long-
Term
Avg Current Target
Point
Upside
%
Upside
Cyclicals
Materials OW $3.29 $4.21 $4.59 $3.95 $4.20 $5.04 6% 20% 9.4x 11.5x 16.5x 78% 85% 94% 47 58 10 22%
Industrials OW $10.38 $11.43 $12.55 $10.40 $11.30 $12.15 9% 8% 11.7x 12.8x 16.5x 97% 95% 96% 142 156 14 10%
Discretionary OW $9.67 $11.13 $12.93 $9.70 $10.30 $11.12 6% 8% 14.3x 15.8x 17.9x 119% 117% 101% 159 176 17 10%
Technology OW $21.54 $24.32 $26.96 $21.50 $22.50 $23.63 5% 5% 11.7x 13.4x 23.6x 98% 99% 131% 277 316 39 14%
Near Cyclicals
Energy OW $12.86 $13.10 $15.25 $14.75 $15.15 $16.67 3% 10% 8.7x 10.4x 14.8x 73% 77% 82% 145 173 28 19%
Financials OW $17.71 $19.87 $21.94 $16.65 $17.65 $18.53 6% 5% 11.3x 12.7x 13.2x 94% 94% 75% 209 236 27 13%
Defensives
Staples UW $10.19 $11.08 $12.04 $10.30 $10.70 $11.14 4% 4% 15.1x 16.2x 17.5x 126% 120% 103% 168 180 12 7%
HealthCare OW $12.28 $13.04 $13.91 $12.30 $12.55 $12.87 2% 3% 13.1x 14.7x 19.6x 109% 109% 115% 169 189 21 12%
Telecom N $1.99 $2.33 $2.91 $2.20 $2.40 $2.70 9% 12% 16.0x 16.9x 16.6x 133% 125% 96% 43 46 2 6%
Utilities UW $3.14 $3.14 $3.36 $3.25 $3.25 $3.25 0% 0% 14.7x 15.5x 12.3x 122% 115% 72% 48 50 3 6%
S&P 500 $103.04 $113.68 $126.44 $105.00 $110.00 $117.09 5% 6% 12.0x 13.5x 19.8x 1,407 1,580 173 12%
S&P ex-Fin $85.33 $93.81 $104.50 $88.35 $92.35 $98.56 5% 7% 12.2x 13.6x 17.3x 101% 101% 99% 1,198 1,344 146 12%
Cyclicals $44.88 $51.10 $57.03 $45.55 $48.30 $51.94 6% 8% 12.0x 13.6x 18.6x 100% 101% 105% 625 705 80 13%
Near-Cyclicals $30.57 $32.98 $37.19 $31.40 $32.80 $35.20 4% 7% 10.1x 11.6x 14.0x 84% 86% 79% 354 409 55 15%
Defensives $27.59 $29.60 $32.22 $28.05 $28.90 $29.96 3% 4% 14.3x 15.5x 16.5x 119% 115% 97% 428 466 38 9%
Cyclicals vs. Defensives $17.28 $21.50 $24.80 $17.50 $19.40 $21.98 3% 4% -2.2x -2.0x 2.1x -19% -15% 9% 197 239 42 395 bp
Source: J.P. Morgan.
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US Year Ahead 2013
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North America Equity Research
December 2012
How Close to Peak? We See Peak EPS of $145-$160 by 2017
In our view, an S&P 500 EPS earnings peak will coincide with the next recession.
Given the potential for a durable goods boom in the US (fueling another leg of
S&P 500 EPS growth), we remain constructive on the potential for meaningful gains
in S&P 500 EPS. In Figure 6 below, we have noted peaks and troughs for S&P 500
EPS since 1952, and also noted the change in every decade:
S&P 500 EPS has gained 50%-100% every 10 years. In other words, whatever
the prior peak in EPS has been from the last cycle (i.e., 2007 of $92.15), EPS has
increased 50% beyond that ($147-165) over the following decade.
The exception was probably in the early to mid-80s as inflation fell. With EPS
distorted by inventory profit gains (LIFO plus inflation, adding as much as 40%
of reported EPS in the 1970s and 1980s), reported EPS stagnated as inflation fell.
Still, historical trends argue for further strong advances in S&P 500 EPS.
Figure 6: S&P 500 EPS
Since 1952
3/51
$2.83
12/55
$3.62
12/66
$5.55
9/69
$5.89
9/74
$9.11
3/80
$15.29
12/84
$16.64
6/89
$25.22
9/00
$57.37
6/07
$92.15
6/52
$2.34
12/58
$2.89
9/67
$5.30
12/70
$5.13
9/75
$7.76
3/83
$12.42
6/87
$14.42
12/91
$18.48
3/02
$44.19
6/09
$51.97
$2.00
$20.00
$200.00
12/50 12/55 12/60 12/65 12/70 12/75 12/80 12/85 12/90 12/95 12/00 12/05 12/10 12/15
S&P 500 EPS
(LTM)
Peak two cycles
back
$147 to
$165
+53%
+160%
+65%
+127%
+61%
+60%-80%
Source: J.P. Morgan.
Historically EPS Has Peaked BEFORE Profit Margins
Profit margins have been flattish for the past eight quarters, and this has raised
concerns about whether S&P 500 EPS may have peaked. Since 1980, EPS peaks
have preceded profit margins peaks. In other words, the fact that margins have been
flattish recently does not necessarily argue that profits have peaked, in our view. The
logic being profit margins generally have rolled over after EPS peaked.
We believe the current period, with EPS moving higher since October 2011, may
be more analogous to the mid-90s (Figure 7). At that time, profit margins dipped
for a few years before recovering. And this was below the peak in margins.
Moreover, we think the drivers are in place for S&P 500 profit margins to
expand. Labor slack remains substantial and pricing power of companies over
their suppliers is high.
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Sales as % of GDP at 61% not near peaks of 65% in 2000 and 64% in 2008
Ultimately, top line is the primary driver of further margin expansion. The S&P 500
top line is approximately $10T (LTM) but around 61% as a percentage of US GDP.
As shown below in Figure 8, this is lower than the peaks of 65% in 2000 and 64% in
2008. Thus, we see room for further margin expansion as top line expands further.
In terms of incremental sales, an increase to peak levels (61% vs. peaks of 64-
65%) would represent about $300 billion on top of incremental sales generated by
global GDP expansion. Thus, we see a case for top line to expand and arguably at
a faster rate as capital spending recovers (see discussion of Capex in the Durable
Goods section).
Figure 7: Net Profit Margins (All Stocks)
Since 1980
2
3
4
5
6
7
8
9
10
12/80 12/84 12/88 12/92 12/96 12/00 12/04 12/08
Ne
t p
rofi
t m
arg
in (a
ll s
toc
ks
)
Recessions Net profit margin (all stocks)
S&P EPS Troughs S&P EPS Peaks
Source: J.P. Morgan, BEA and DataStream.
Figure 8: Sales vs. Nominal GDP
Since 1993
2000
65.3% 2008
64.4%
2009
57.2%
2012 LTM
60.8%
52.0%
54.0%
56.0%
58.0%
60.0%
62.0%
64.0%
66.0%
1993 1996 1999 2002 2005 2008 2011
Sales as % of Nominal GDP
Source: J.P. Morgan, FactSet and BEA. Annual data for S&P 500 Index. Latest data as of
12/2011.
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SECTORS: Cyclicals Should Outperform
Again in 2013; Focus on Materials,
Technology and Energy
We are sticking with the Cyclical play given better economic visibility (particularly
in 2H13) coupled with valuations that are more attractive than those for Defensives.
Take a look at Figure 9 below.
Cyclicals EPS are projected to grow 300-400bp faster than those for Defensives
in 2013/2014 and Cyclicals still have lower P/E multiples (average discount of
10-15%).
We understand the appeal of Defensives; however, they underperformed the
S&P 500 by 300bp in 2012 and we expect 300bp of 2013 underperformance.
Figure 9: Summary Sector Views on 2013
$ per share
JPM Strategy EPS EPS % (JPM) 2014 P/E
JPM
Strategy
Rating 2012E 2013E 2014E
'12E
vs.
'11
'13E
vs.
'12E
'14E
vs.
'13E Current Target
Long-
Term
Avg
%
Upside Comments
Cyclicals
Materials OW $3.95 $4.20 $5.04 -1% 6% 20% 9.4x 11.5x 16.5x 22% Works best in 5th yr. Better '14 EPS gth plus low valuation
Industrials OW $10.40 $11.30 $12.15 7% 9% 8% 11.7x 12.8x 16.5x 10% Play on global recovery plus US durable goods boom
Discretionary OW $9.70 $10.30 $11.12 7% 6% 8% 14.3x 15.8x 17.9x 10% Leader in a bull market and consumer supported by better housing
Technology OW $21.50 $22.50 $23.63 8% 5% 5% 11.7x 13.4x 23.6x 14% Still defensive growth. Low multiples and benefit from global recov ery
Near Cyclicals
Energy OW $14.75 $15.15 $16.67 -8% 3% 10% 8.7x 10.4x 14.8x 19% Should improv e as EPS growth recov ers in '13e/'14e
Financials OW $16.65 $17.65 $18.53 25% 6% 5% 11.3x 12.7x 13.2x 13% Play on US housing and durable goods boom
Defensives
HealthCare OW $12.30 $12.55 $12.87 0% 2% 3% 13.1x 14.7x 19.6x 12% Still like lower P/E and GARP'y names in this group
Telecom N $2.20 $2.40 $2.70 0% 9% 12% 16.0x 16.9x 16.6x 6% Improv ing EPS growth positive
Staples UW $10.30 $10.70 $11.14 2% 4% 4% 15.1x 16.2x 17.5x 7% Fairly expensive group
Utilities UW $3.25 $3.25 $3.25 -4% 0% 0% 14.7x 15.5x 12.3x 6% Trades at a meaningful premium to the S&P 500
S&P 500 $105.00 $110.00 $117.09 5% 5% 6% 12.0x 13.5x 19.8x 12%
Cyclicals $45.55 $48.30 $51.94 7% 6% 8% 12.0x 13.6x 18.6x 13%
Near-Cyclicals $31.40 $32.80 $35.20 8% 4% 7% 10.1x 11.6x 14.0x 15%
Defensives $28.05 $28.90 $29.96 0% 3% 4% 14.3x 15.5x 16.5x 9%
Source: J.P. Morgan.
Cyclicals Still Valued More Attractively
Last year, Cyclicals outperformed the S&P 500 while Defensives lagged (see
Figure 10), and Cyclicals have outperformed Defensives in three of the last four
years (2011 was the exception). We continue to see Cyclicals as attractive:
Foremost, Cyclicals are projected to deliver EPS growth 700bp above the 10%
EPS growth forecasted for the S&P 500 (using bottom-up consensus). This is a
meaningful acceleration from Cyclicals EPS growth of 5% growth in 2012.
Leading this forecast growth are Basic Materials (up 28%), Discretionary (up
15%) and Technology (up 13%). Energy EPS growth is also expected to reverse
from a decline of 8% in 2012 to an increase of 2% (1,000bp swing).
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As for valuations, note that Cyclicals still trade at a sizable discount to
Defensives, although both trade at a premium to the S&P 500. Historically,
Defensives have traded at a 15-20% discount to Cyclicals, but the opposite is
the case currently, with Cyclicals trading at a discount of approximately 17% to
Defensives.
Lastly, as noted in Figure 14, Cyclicals typically have outperformed by 700bp in
the fifth year of a bull market, with a win ratio of 75%. In fact, the two best-
performing sectors in the fifth year of a bull market have been Basic Materials
and Energy (1,600bp and 1,500bp outperformance, respectively).
Figure 10: Sector Performance Since 2009
Since Start of 2009 Bull Market; P/E Multiples as of the Start of the Year for 2009, 2010, 2011 and 2012
Annual Return YoY EPS Growth Premium/Discount: P/E relative to SPX (NTM)
Forecast Forecast
2009 2010 2011 2009 2010 2011 2012 2013E 2014E 2009 2010 2011 2012 2013E 2014E
S&P500 23% 13% 0% 12% 0% 38% 14% 5% 10% 11% 13.2x 20.3x 20.3x 16.5x 16.5x 14.4x
Cyclicals 40% 20% -2% 12% -4% 55% 21% 5% 17% 11% 108% 103% 110% 94% 102% 101%
Near Cyclicals 13% 14% -8% 11% -115% 111% 22% 8% 7% 13% 128% 91% 100% 78% 86% 88%
Defensives 9% 6% 9% 9% -3% 1% 2% 0% 8% 12% 100% 105% 111% 115% 119% 120%
Materials 45% 20% -12% 7% -49% 92% 32% -1% 28% 9% 132% 110% 113% 86% 97% 95%
Industrials 17% 24% -3% 9% -32% 24% 22% 7% 10% 10% 109% 105% 112% 98% 101% 101%
Discretionary 39% 26% 4% 21% 63% 62% 11% 7% 15% 16% 99% 98% 118% 106% 116% 116%
Technology 60% 9% 1% 13% 2% 44% 17% 8% 13% 11% 90% 98% 98% 86% 93% 92%
Energy 11% 18% 3% 1% -58% 50% 36% -8% 2% 16% 126% 92% 85% 82% 89% 91%
Financials 15% 11% -18% 20% -172% 171% 7% 24% 12% 10% 130% 90% 115% 73% 83% 85%
Staples 11% 11% 11% 10% 3% 2% 6% 2% 9% 9% 102% 106% 114% 118% 121% 125%
HealthCare 17% 1% 10% 15% 1% 3% 7% 0% 6% 7% 85% 90% 89% 93% 103% 107%
Telecom 3% 12% 1% 14% -23% -8% -4% 0% 17% 25% 122% 130% 145% 133% 137% 129%
Utilities 7% 1% 15% -3% 6% 6% -2% -4% 0% 7% 89% 93% 97% 115% 113% 119%
2012
(YTD)
Source: J.P. Morgan and Datastream.
Focus on Basic Materials
Basic Materials has been a notable laggard. Over the past two years, this group has
lagged the S&P 500 by 2,300bp, the worst relative performance, followed closely by
Energy (underperformed by 700bp). The fundamentals have lagged (look at EPS
discussion above) given the downshift of global growth over the last two years, but
price performance, we believe, has been worse than the fundamentals.
Figure 11, below, shows two-year trailing returns; note that the current level of
underperformance has been seen four times since 1975.
In three of the four instances, Basic Materials outperformed by about 2,000bp
over the following yearthat is, a forecast return of 10% for the S&P 500 would
imply a gain of 30% for Basic Materials. The only exception was the in the late
90s when underperformance continued for multiple years.
We believe the prospect for outperformance in 2013 (mean reversion) has
fundamental support, in light of our views for US durable goods (rising), China
stabilization (good) and Europe exiting recession (good). In other words, given
Cycli
cals
Near-
Cycli
cals
Defe
nsiv
es
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the reduced expectations, and P/E of 9.4x 2013E (Energy only sector that is
cheaper), we see the potential for outperformance.
Figure 11: Basic Materials Two-Year Trailing Return vs. S&P 500
Since 1975; Two-Year Rolling Relative Return
Source: J.P. Morgan and Datastream.
Aluminum, Coal, Mining and Steel Have Lagged Most (If
One Is Thinking of Low Expectations)
As shown in Figure 12, several groups have suffered historic underperformance.
We sorted these industries based on worst overall one- and two-year relative returns
(percentiles vs. their history).
For instance, Aluminum stocks have seen the worst two-year performance since
1973. We also note Steels underperformance of 4,500bp is nearly as bad. While
deceleration in China and Europe has pressured pricing, an improvement in
pricing could follow upside surprises to growth.
Mining and Gold stocks are not far behind (9th/25th percentile, respectively).
Clearly fundamentals are challenged and exports weak. But, again, with 3,000-
4,000bp of underperformance over two years, expectations are likely to be
extremely low, in our view.
-80%
-60%
-40%
-20%
0%
20%
40%
60%
80%
1/75 7/77 1/80 7/82 1/85 7/87 1/90 7/92 1/95 7/97 1/00 7/02 1/05 7/07 1/10 7/12
1-yr forward return (relative) Basic Materials Current
Outperforms OutperformsOutperformsSecular
issues
We are here
today
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Figure 12: Basic Materials Industry-Level Performance
S&P 500; Rank Since 1973
Source: J.P. Morgan and Datastream.
J.P. Morgan Analyst Coverage of Basic Materials: CRS, GG,
MWV, SLW and LYB Are Top Ideas
We have compiled J.P.Morgan analyst coverage of the Basic Materials sector in
Figure 13. The largest sub-group (GICS level 4) is Specialty Chemicals ($122B).
And the names in most of the sub-industries tend to be mid-cap.
J.P. Morgan Analyst 2013 top picks are shown as well. The tickers are CRS, GG,
MWV, SLW and LYB.
Figure 13: J.P. Morgan Analyst Coverage of Basic Materials
S&P 1500; $ millions
Source: J.P. Morgan and Bloomberg.
2-year returns 1-year returns Avg (1 & 2-yr)
Relative
%
%-tile rank
(100=highes
t)
Relative
%
%-tile rank
(100=highes
t) %-tile
Aluminum -56% 1 -30% 8 5
General Mining -40% 5 -37% 10 8
Steels -45% 12 -34% 8 10
Gold Mining -30% 25 -40% 8 17
Non-ferrous Metals -38% 5 -7% 39 22
Commodity Chemicals -11% 29 -5% 40 35
Forestry 42% 46 19% 62 54
Specialty Chemicals 6% 48 7% 65 57
Paper & Forest Products 12% 79 11% 82 81
GICS 4 Industry
# Stocks
(S&P
1500)
Market
Cap (S&P
1500)
JPM Analyst
Coverage
Top
Pick Other Stocks Covered
1 Specialty Chemicals 23 $122,038 Jeffrey J. Zekauskas LYB ALB, ASH, CE, ECL, FOE, FUL, IFF, MTX,
ROC, RPM, SHW, VAL
Tycho W. Peterson SIAL
2 Diversified Chemicals 7 $114,432 Jeffrey J. Zekauskas DOW, DD, EMN, HUN, PPG
3 Fertilizers & Agri Chem 6 $82,835 Jeffrey J. Zekauskas AGU, CF, MON, POT, SMG, MOS
4 Industrial Gases 3 $56,670 Jeffrey J. Zekauskas APD, PX
5 Diversified Metals &
Mining
8 $39,819 Michael F. Gambardella FCX, GSM, IMN.TO, MCP, RTI, TCKb.TO, TC,
TIE
Jeffrey J. Zekauskas CMP
6 Steel 13 $37,609 Michael F. Gambardella CRS AKS, ATI, CLF, CMC, HAYN, MUSA, NUE,
RS, STLD, X, WOR
7 Paper Products 10 $29,531 Phil Gresh, CFA MWV UFS, IP
8 Gold 2 $27,001 John Bridges, CFA, ACS GG AEM, ABX, BVN, GRZ, JAG, KGC, NEM, NG
9 Metal & Glass Containers 6 $17,826 Phil Gresh, CFA ATR, BLL, CCK, GEF, OI, SLGN
10 Paper Packaging 5 $17,816 Phil Gresh, CFA BMS, BZ, GPK, PKG, RKT, SEE, SON
11 Construction Materials 5 $15,274 Scott Levine EXP, MLM, VMC
Michael Rehaut, CFA CSTE
12 Aluminum 3 $10,970 Michael F. Gambardella AA, CENX
13 Commodity Chemicals 5 $4,947 Jeffrey J. Zekauskas CBT, GGC, WLK
14 Precious Metals &Minerals John Bridges, CFA, ACS SLW CDE, HL, PAAS, SWC
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Cyclicals Outperformed in Year 5 of Each Bull Since 1974
History strongly argues for investors to stay Cyclical. Figure 14, below, shows the
returns by Sector in the fifth year of bull markets (we have data since 1974).
The best-performing groups have bee Basic Materials and Energy, with
outperformance of 1,500-1,600bp. Overall, Cyclicals (Industrials, Materials,
Technology and Discretionary) outperformed in each bull market, with average
outperformance of 700bp. Near-Cyclicals (Energy and Financials) also
outperformed in each bull market, with an average outperformance of 500bp.
In the 2013 context, outperformance of Cyclicals is logical, in our view. After all,
given the improving global economic picture (China and Europe) and the upturn
in US economic growth in 2H, we can see early cycle names outperforming.
These would be Materials and Energy. However, these names are not likely to be
without risk.
Figure 14: Relative Sector Performance in Year 5 of Bull Market
Year 5 of the 1974, 1982, 1987 and 2002 Bull Markets
1978 1986 1991 2006 Avg
Win
Ratio
S&P500 (Abs) 6% 38% 13% 16% 18% 100%
Cyclicals -3% 11% 9% 11% 7% 75%
Near Cyclicals 12% -1% 0% 8% 5% 75%
Defensives -13% -20% -2% 3% -8% 25%
Materials 4% 22% 7% 31% 16% 100%
Energy 21% 24% -14% 28% 15% 75%
Technology -3% 10% 10% 10% 7% 75%
Industrials -3% 5% 3% 8% 3% 75%
Discretionary -11% 7% 16% -5% 2% 50%
Staples -12% -9% 4% 3% -3% 50%
Financials 2% -27% 15% -12% -5% 50%
HealthCare -8% -6% -4% -6% -6% 0%
Telecom -17% -22% 2% 9% -7% 50%
Utilities -14% -43% -11% 6% -15% 25%
Source: J.P. Morgan and Datastream.
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15 Best and Worst Industries in Year 5 of Bull Markets
We decided to drill down another layer and highlight the best and worst industries in
the fifth year of bull markets. These groups (of roughly 115) are shown in Figure 15
and Figure 16 below. There are no major surprises here (compared to Sectors).
But, notice how many groups have outperformed in the fifth year of each bull
market. These include Metals, Semis, Telco Equipment and Marine
Transportation. Not far behind (from a win-ratio perspective) have been the
Steel stocks (these have been laggards for three years running). And the
magnitude of outperformance is notable, ranging from 2,200bp to 5,900bp.
As for the laggards, it is interesting to note that only a handful have
underperformed in the fifth year of each bull market (0% win ratio), with the only
two being Airlines and Food Products.
Figure 15: Top 15 Industries Relative
Performance in Year 5 of Bull Market
Year 5 of the 1974, 1982, 1987 and 2002 Bull
1978 1986 1991 2006 Avg
Win
Ratio
Software 155% 23% -2% 59% 75%
Nonferrous Met 16% 58% 7% 128% 52% 100%
Consumer Eltro 43% 66% 55% 100%
Tires -19% 96% 32% 94% 51% 75%
Travl & Toursm 40% 37% 57% 45% 100%
Home Con 125% 8% 69% -55% 37% 75%
Iron & Steel 70% -5% 37% 44% 36% 75%
Heavy Con 41% -19% 7% 105% 34% 75%
Semiconductors 23% 48% 56% 3% 32% 100%
Marine Transpt 2% 42% 39% 36% 30% 100%
Footwear 21% 20% 26% 23% 100%
Telecom Eq 6% 19% 73% 6% 26% 100%
Gold Mining 26% 106% -28% -5% 25% 50%
Oil Eq & Svs 23% 48% -17% 44% 24% 75%
Fd Rtl & W 10% -10% 12% 77% 22% 75%
Average 37% 85%
Source: J.P. Morgan and Datastream.
Figure 16: Bottom 15 Industries Relative
Performance in Year 5 of Bull Market
Year 5 of the 1974, 1982, 1987 and 2002 Bull
1978 1986 1991 2006 Avg
Lose
Ratio
Apparel Rtl -42% 21% -22% -21% -16% 75%
Biotechnology -19% -2% -12% -11% 100%
Airlines -20% -5% -1% -15% -10% 100%
Speciality Fin 3% -20% 8% -29% -9% 50%
Pipelines -5% -24% -9% 1% -9% 75%
Mobile T/Cm -7% -29% 3% -3% -9% 75%
Asset Managers-15% -15% -11% 6% -9% 75%
Mortgage Fin -6% -23% 16% -21% -9% 75%
Eqt Ivst Ins -8% -8% 100%
Investment Cos. -8% -8% 100%
Pharm 2% -6% -17% -11% -8% 75%
Water 5% -41% -7% 11% -8% 50%
Investment Svs -8% -26% 9% -5% -7% 75%
Food Products -7% -12% -1% -8% -7% 100%
Brewers -16% -5% -7% 0% -7% 75%
Source: J.P. Morgan and Datastream.
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Year 5 in Bull Markets Has Been Strong
This is the twelfth bull market since 1935 (see Figure 18 below) and eight have
lasted for at least four years (that carries us into today). We have modeled the
composite returns in the fifth year of bull markets in Figure 17 below.
Of the eight that lasted at least four years, five continued into the fifth year (green
line) with an average gain of 19%.
The other three turned into bear markets (red dashed line) with a significant
correction taking place.
Notice also that performance in 1H of the fifth year has tended to be flat. We
believe this also is likely to be the case in 2013 (see prior section).
Bottom line, we are constructive on 2013, but see 2H13 as the upside story. In other
words, we recommend investors buy the dips in 1H.
Figure 17: Bull Markets that Have Reached Year 4 Have Tended to Do Well in Year 5
100=Start of Bull
1942, 1949, 1957, 1962, 1974, 1982, 1987, 2002 and 2009 Bull Markets
Current
196.8
Remained Bull in Yr 5
217.6
Turned Bear in Yr 5
166.8
140.0
150.0
160.0
170.0
180.0
190.0
200.0
210.0
220.0
230.0
Yr 3 Yr 4 Yr 5 Yr 6
Current Remained Bull in Yr 5 Turned Bear in Yr 5
Source: J.P. Morgan and Bloomberg.
Avg. return in
5th year of bull
was up 19%
Notice that the market
has tended to be
flattish in 1H of the
5th year of bull
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Recession or Big Downshift in GDP for Three Bull
Markets Ending in Fifth Year
The natural question is what has caused bull markets to end by the fifth year.
Figure 18, below, shows returns in each year of the 11 bull markets since 1932.
There have been three that ended during the fifth year:
1942-1946, with a recession starting in February 1945;
1957-1961, with a recession starting in April 1960); and
1962-1966, after GDP growth of 10% annually for several years downshifted to
2% beginning in 1966in addition, the Vietnam War was starting.
In the five that lasted through the fifth year, the average gain in year 5 was 19%,
even stronger that in year 4. As we do not expect a recession in 2013, we do not
expect the current bull market to end.
Figure 18: Bull Markets Annual Equity Market Returns
% Change; Since 1932 (Based on S&P 500 Returns)
SPX
Bull Markets Annual % change
Start Date End Date
Length
(months) Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10 Yr 11 Yr 12
3/14/1935 3/10/1937 24 77 29
4/28/1942 5/29/1946 49 54 3 24 26
6/13/1949 8/2/1956 86 42 12 13 (2) 20 37 16 5
10/22/1957 12/12/1961 50 31 10 (5) 28
6/26/1962 2/9/1966 44 33 17 2 4
10/7/1966 11/29/1968 26 33 7
5/26/1970 1/11/1973 32 44 11
10/3/1974 11/28/1980 74 38 21 (7) 7 6 16
8/12/1982 8/25/1987 60 58 2 14 28 38
12/4/1987 3/24/2000 148 21 29 (8) 18 13 8 (2) 34 25 29 21 19
10/9/2002 10/9/2007 60 34 8 7 13 15
Average return ALL years 59 42 13 5 15 19 20 7 19 25 29 21 19
3/9/2009 12/3/2012 45 69 16 3 4
Source: J.P. Morgan and Bloomberg.
recession 2/45
recession 4/60
US GDP downshifts from 10% saar to 2% plus Vietnam war
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P/E Ratios in Those Three Markets Also Considerably
Higher than Current Level
In Figure 19, below, we illustrate the NTM P/E multiples at the beginning of each
year in the 11 bull markets since 1932, and highlight the higher P/E multiples for
those bull markets that ended by the fifth year.
The P/Es ranged from 16x to 22x, well above the current 14x.
In contrast, the P/Es for the bull markets that extended into the fifth year have
been lower at 9-16x although 1992 was an exception (P/E of around 20x).
Figure 19: Bull Markets P/E Ratio
NTM P/E; Since 1932
Bull Markets P/E ratio
Start Date End Date
Length
(months) Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10 Yr 11 Yr 12
3/14/1935 3/10/1937 24 19.1x 17.8x
4/28/1942 5/29/1946 49 10.7x 12.8x 14.9x 20.7x
6/13/1949 8/2/1956 86 8.4x 7.7x 9.9x 9.9x 11.3x 12.7x 12.6x 13.8x
10/22/1957 12/12/1961 50 17.7x 16.6x 16.4x 22.3x
6/26/1962 2/9/1966 44 18.9x 19.2x 18.2x 16.1x
10/7/1966 11/29/1968 26 18.0x 18.3x
5/26/1970 1/11/1973 32 19.5x 18.5x
10/3/1974 11/28/1980 74 11.4x 10.7x 8.8x 8.7x 7.1x 8.9x
8/12/1982 8/25/1987 60 13.3x 10.2x 12.3x 16.3x 19.4x
12/4/1987 3/24/2000 148 11.9x 14.4x 14.5x 20.7x 20.4x 18.0x 15.2x 16.4x 18.4x 21.3x 25.6x 28.6x
10/9/2002 10/9/2007 60 19.8x 17.4x 16.2x 15.9x 17.1x
Average return ALL years 59 15.3x 14.9x 13.9x 16.3x 15.1x 13.2x 13.9x 15.1x 18.4x 21.3x 25.6x 28.6x
3/9/2009 12/3/2012 45 18.4x 15.4x 14.0x 13.6x
Source: J.P. Morgan and Bloomberg.
1982 Bull Market Still Good Analog: 2H13 Story?
We have written in the past that we see the 1982-1987 period as the most analogous
for the current bull market. Please see US Equity Strategy FLASH dated 9/19 for a
full discussion. In both cases, investors have been still skeptical several years into a
bull market.
This is very much the case today with the public still skeptical of this bull market.
In 1985-1986, the turning point arguably occurred when inflation finally broke
(breaking stagflation fears).
In 2012-2013, we believe this is likely to be more about proving the US recovery
has escape velocity beyond support provided by QE (previously this recovery has
been supported by stimulus) and is therefore highly dependent on a sustained
recovery in US housing and auto sales.
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This market is tracking 1982-1987 closely both on price and P/E
We have plotted price and P/E for both markets (1982-1987 and 2009-2014) below
in Figure 20 and Figure 21. Thus far, this market is tracking 1982-1987 closely.
On price, if this market follows the prior markets trend, we see 1H13 as flattish.
On P/E, note how the P/E multiple really began to re-rate as the prior market
(1985-1986 period) moved forward.
Figure 20: Comparative Price 2009 Bull Market vs. 1982 Bull Market
S&P 500 in 2009-2014 vs. 1982-1987
Source: J.P. Morgan and Bloomberg.
Figure 21: Comparative P/E 2009 Bull Market vs. 1982 Bull Market
S&P 500 P/E in 2009-2014 vs. 1982-1987
Source: J.P. Morgan and Bloomberg.
Flattish
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P/E to Re-Rate on Durable Goods Boom
Beyond Housing, Durable Goods Lowest Since 1951
This year has been a story about recovery in demand for US housing. We see this
extending into a broader story about durable goods. Figure 22, below, shows durable
goods spending (as % of GDP) since World War II. As this series shows, US durable
goods spending (as % of GDP) of 21% is the lowest since 1951. We define durable
goods spending as capex plus construction (both residential and non-residential) plus
consumer purchases of durable goods.
The line in Figure 22 represents the five-year average (to reduce noise); as shown
below, the latest level of 21% is the lowest reading since World War II.
We do not believe this stems from the US shifting manufacturing overseas. The
long-term average has been around 24%, a level seen as recently as 2008.
Rather, we attribute this collapse to the credit crisis, which has resulted in a
multiyear contraction in durable goods spending.
Figure 22: U.S. Fixed Investment & Consumption of Durable Goods as % of GDP (Five-Year
Trailing Avg.)
Since 1951
9/12
21%
LT Avg (Since 1951),
24%
18%
20%
22%
24%
26%
28%
3/51 3/56 3/61 3/66 3/71 3/76 3/81 3/86 3/91 3/96 3/01 3/06 3/11
U.S
. P
riv
ate
Fix
ed
In
ve
stm
en
t &
Pe
rso
nal
Co
ns
um
pti
on
of D
ura
ble
Go
od
s a
s %
of
GD
P
Recession 5-yr trailing avg
Source: J.P. Morgan and BEA. Note: Data from 1951 to the present reflects quarterly data.
Rising Durable Goods Spending Has Driven P/E Expansion
In Figure 23, below, we highlight the behavior of the S&P 500 P/E multiple during
the eight precedent periods of rising durable goods spending since 1950.
On average, the S&P 500 P/E ratio has expanded by 1.8 turns from 15.3x to
17.1x. This implies potential for upside to the current P/E ratio and the main
reason we expect upside to equity performance in a period of rising durable
goods spending.
GDP growth typically has been higher as well during periods of rising durable
goods spending. As shown, real GDP growth has been around 5%, above the 3%
considered trend, during periods of rising durable goods spending.
The next closest period was
the early 90swhich was
followed by a period of above-
trend growth
-
US Year Ahead 2013
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North America Equity Research
December 2012
This is logical to us, since credit generally is required to fund durable goods
purchases, and the related cycle leads to above-trend growth.
Figure 23: P/E Ratios Have Expanded During Periods of Rising Durable Goods Spending
GDP CAGR
Start date End date Start End Change Start End Change
9/30/1958 9/30/1959 21.90% 24.00% 2.10% 13.7 16.4 2.6 6.9%
6/30/1961 3/31/1966 21.80% 24.70% 2.90% 17.9 17.8 (0.1) 6.2%
3/31/1967 3/31/1969 22.60% 24.40% 1.80% 16.2 17.6 1.4 4.1%
12/31/1970 3/30/1973 22.80% 26.50% 3.70% 15.9 18.6 2.7 6.2%
6/30/1975 3/30/1979 22.90% 27.60% 4.70% 10.7 8.8 (1.8) 5.1%
9/30/1982 9/30/1986 23.70% 26.40% 2.70% 8.3 13.2 4.9 5.0%
12/31/1991 3/31/2000 21.00% 26.70% 5.70% 17.4 27.0 9.6 3.9%
3/31/2003 3/31/2006 24.10% 26.00% 1.90% 22.2 17.6 (4.6) 3.5%
Average 22.60% 25.79% 3.20% 15.3 17.1 1.8 5.1%
S&P PE, trailing 8Q averageDurable goods and fixed investment spending
Periods of rising durable goods spending
Source: J.P. Morgan and BEA. Note: Data from 1929 to 1946 reflects annual data. Data from 1947 to the present reflects quarterly
data.
P/E re-rates
-
US Year Ahead 2013
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North America Equity Research
December 2012
Positive Effect on S&P 500 EPS
Figure 24 below plots durable goods spending (as % of US GDP) with the peaks and
troughs of S&P 500 EPS marked.
What stands out, in our view, is that S&P 500 EPS has never peaked when
durable goods spending has been this low. In fact, the current level of US durable
goods spending typically has been seen at S&P 500 EPS troughs.
The data in Figure 25 essentially bears this out: S&P 500 EPS typically has
peaked when durable goods spending has reached around 25% of GDP. As
highlighted below, given durable goods spending nearly 500bp below that level,
we estimate there is another $1.5T in top line or nearly $50 in EPS before peak.
Figure 24: S&P 500 EPS Peak and Troughs Notated
vs. Durable Goods Spending
Since 1951
9/12
20%
LT Avg (Since
1951), 24%
18%
20%
22%
24%
26%
28%
3/51 3/56 3/61 3/66 3/71 3/76 3/81 3/86 3/91 3/96 3/01 3/06 3/11
U.S
. P
riv
ate
Fix
ed
In
ve
stm
en
t &
Pe
rso
nal C
on
su
mp
tio
n o
f D
ura
ble
Go
od
s a
s %
of G
DP
Recession
Durable goods spending as % of GDP
SPX Trough
SPX Peak
Source: J.P. Morgan, Bloomberg and BEA. Note: Data from 1947 to
the present reflects quarterly data.
Figure 25: S&P 500 EPS Has Peaked When Durable Goods Spending Peaked
% of GDP and $ per share
Source: J.P. Morgan and BEA. Note: Data from 1929 to 1946 reflects annual data. Data from 1947 to the present
reflects quarterly data.
S&P 500 Peak EPS % GDP
Dates EPS
Durable Goods
Capex + Construction
+ Consumer durables)
Construction
(Private Fixed
Investment in
Auto Sales
(Nominal consumption of
motor vehicles and parts)
1 3/51 $2.83 26.5% 4.3%
2 12/55 $3.62 25.4% 4.2%
3 12/66 $5.55 23.4% 3.5% 3.7%
4 9/69 $5.89 24.2% 4.2% 3.8%
5 9/74 $9.11 24.9% 4.3% 3.4%
6 3/80 $15.29 26.7% 4.8% 3.4%
7 12/84 $16.64 26.0% 4.4% 3.8%
8 6/89 $25.22 24.5% 4.3% 3.8%
9 9/00 $57.37 26.4% 4.4% 3.6%
10 6/07 $92.15 24.8% 4.6% 2.9%
Avg 25.3% 4.3% 3.7%
Current $101.64 20.5% 2.3% 2.5%
Current vs Avg (Delta) -4.8% -2.0% -1.1%
Current vs Avg (%)
below
prior
peaks...
$748b in
incremental
GDP, or $1.5T
in top-line
(using
multiplier)
-
US Year Ahead 2013
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North America Equity Research
December 2012
Global Perspective: Shift Back to US?
To put some global context around this, we have compared US durable goods
spending (using data from the CIA World Factbook) to that in other major countries.
This is summarized in Figure 26, in which we compare GDP per capita and a
countrys fixed investment (as a percentage of GDP).
The US is an outlier: its GDP per capita is one of the highest yet its durable goods
spending as a percentage of GDP is one of the lowest (#144 globally). And note
that countries with similar GDP per capita spend substantially more for durable
goods.
Similarly, China is also an outlier: its durable goods spending at 46% of GDP is
more than twice the typical level globally and well above the 27% for Emerging
Markets countries like Korea, India and Brazil.
Figure 26: GDP per Capita vs. Gross Fixed Investment as a % of GDP
Underinvestment in the US
Estimates for 2011; Rank of Gross Fixed Investment as % of GDP in
parentheses
India (# 19)
Korea* (# 28)
Canada (# 59)Hong Kong (# 68)
Turkey (# 71)
Spain (# 80)Russia (# 76)Mexico (# 82) Switzerland (# 91)
Japan (# 87)
Italy (# 97)
France (# 94)
Brazil (# 100) EU (# 112) Sweden (# 115)Germany (# 116)
Greece (# 141) UK (# 139)
US (# 144)
Singapore (# 53)
Norway (# 92)
United Arab Emirates
(# 30)
Netherlands (# 119)
Kuwait (# 134)
Austria (# 77)
Ireland (# 149)
Australia (# 33)
Iceland (# 140)
Zimbabwe (# 70)Burundi (# 61)
Indonesia (# 13)
Belgium (# 86)
Egypt (# 136)
Saudi Arabia (# 81)
China (# 3) ($8,500;
46.2%)
Qatar (#21; $98,900;
28.6%)
Luxembourg (# 104;
$80,600; 19.0%)
10%
15%
20%
25%
30%
35%
0 10,000 20,000 30,000 40,000 50,000 60,000
Gro
ss
Fix
ed
Inve
stm
en
t a
s %
of G
DP
(2
011
es
t.)
GDP Per Capita ($) (PPP) (2011 est.)
Source: J.P. Morgan and CIA World Factbook. Note: The gross fixed investment entry (shown
above) "records total business spending on fixed assets, such as factories, machinery,
equipment, dwellings, and inventories of raw materials, which provide the basis for future
production. It is measured gross of the depreciation of the assets, i.e., it includes investment
that merely replaces worn-out or scrapped capital." Data reflects 2011 estimates for 228
countries. Korea* reflects South Korea. The top 10 countries listed are, in order of rank:
Equatorial Guinea, Sao Tome and Principe, China, Cape Verde, Republic of the Congo,
Belarus, Armenia, Kosovo. Lesotho and Seychelles. GDP per capita (PPP) is defined as GDP
on a purchasing power parity (PPP) basis divided by population as of 1 July for the same year.
The top 10 countries listed for GDP per capita, in order of rank: Qatar, Liechtenstein,
Luxembourg, Bermuda, Singapore, Jersey, Falkland Islands (Islas Malvinas), Norway, Brunei,
Hong Kong and United States.
Figure 27: Gross Fixed Capital Formation as a % of GDP US vs. China
% of GDP
2011E
12.1%
2011E
46.2%
10%
15%
20%
25%
30%
35%
40%
45%
50%
19
65
19
67
19
69
19
71
19
73
19
75
19
77
19
79
19
81
19
83
19
85
19
87
19
89
19
91
19
93
19
95
19
97
19
99
20
01
20
03
20
05
20
07
20
09
201
1E
Gro
ss
fix
ed
ca
pital f
orm
atio
n a
s %
of G
DP
US Gross fixed capital formation as % of GDP
China Gross fixed capital formation as % of GDP
Source: J.P. Morgan, CIA World Factbook and World Bank. Note: 2011E US reflect estimates from the CIA
World Factbook. Data from 1965 through 2011 reflects World Bank estimates. Gross fixed capital formation
(formerly called gross domestic fixed investment) is defined by the World Bank as "includes land improvements
(fences, ditches, drains, and so on); plant, machinery, and equipment purchases; and the construction of roads,
railways, and the like, including schools, offices, hospitals, private residential dwellings, and commercial and
industrial buildings. According to the 1993 SNA, net acquisitions of valuables are also considered capital
formation."
We provide a time series of this metric for the United States and China since 1965 in
Figure 27 above. Notice that from 1975 to 2000 spending levels in both the US and
China generally were range-bound. It was not until 2005 that the trajectories of
spending for each country diverged meaningfully.
Chinas spending surged to 46% of GDP from a prior range of 25-35%. Over the
next decade, in our view, this is likely to revert to the prior range of 25-35%.
Conversely, US spending has collapsed since 2007 from its long-time range
during 1975 to 2003. We similarly expect this spending to recover as the US
cannot defer spending indefinitely.
Range-bound
Lift-off
Lift-off
Range-bound
Revert
to prior
range
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US Year Ahead 2013
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North America Equity Research
December 2012
Where Has There Been Underinvestment in US?
The US underinvestment in durable goods is summarized in Figure 28 below. We
include for each category the number of standard deviations the current level is from
long-term trend and shaded those more than 1.0 standard deviations from trend.
To the downside, these include Motor Vehicles (-1.9), Furniture (-1.6), Non-
Residential Structures (-1.1) and Housing (-2.3).
Within structures (see right side), these include Office Space (-1.6), Malls (-1.8),
Restaurants (-1.9) and Electric (-0.6).
Figure 28: GDP Components Components as a % of GDP
As of 3Q2012
GDP Components Components as a % of GDP (excl. chg private inventories, net exports
and govt expenditures)
Line Item (from BEA)
% of GDP
(3Q12) LT Avg
Delta vs.
LT Avg
# of std dev
from LT avg
Personal consumption expenditures 70.6% 65.0% 5.6% 1.8
Goods 24.0% 29.2% -5.2% (1.1)
Durable goods 7.7% 8.8% -1.1% (1.7)
Motor vehicles and parts 2.6% 3.5% -0.9% (1.9)
Furnishing and durable household equipment1.7% 2.3% -0.6% (1.6)
Recreational goods and vehicles 2.2% 1.9% 0.4% 1.0
Other durable goods 1.2% 1.0% 0.2% 1.7
Nondurable goods 16.3% 20.4% -4.1% (0.9)
Services 46.6% 35.8% 10.8% 1.5
Gross private domestic investment 13.2% 15.9% -2.7% (1.6)
Fixed Investment 12.6% 15.3% -2.7% (1.9)
Nonresidential 10.2% 10.7% -0.5% (0.4)
Structures 2.9% 3.6% -0.7% (1.1)
Equipment and software 7.3% 7.1% 0.2% 0.2
Residential 2.5% 4.6% -2.2% (2.3)
Structures 2.4% 4.5% -2.1% (2.3)
Equipment 0.1% 0.1% 0.0% (2.0)
GDP Components, Private Fixed Investment: Nonresidential Structures as a % of GDP
Line Item (from BEA)
% of GDP
(3Q12) LT Avg
Delta vs.
LT Avg
# of std dev
from LT avg
Structures 2.9% 3.6% -0.7% (1.1)
Commercial and health care 0.6% 1.2% -0.6% (1.9)
Office 0.2% 0.4% -0.3% (1.6)
Health care 0.2% 0.3% 0.0% (0.8)
Hospitals and special care 0.2% 0.2% 0.0% (0.8)
Hospitals 0.1% 0.2% 0.0% (0.5)
Special care 0.0% 0.0% 0.0% (1.3)
Medical buildings 0.0% 0.1% 0.0% (0.5)
Multimerchandise shopping 0.1% 0.2% -0.1% (1.8)
Food and beverage establishments0.0% 0.1% -0.1% (1.9)
Warehouses 0.0% 0.1% -0.1% (1.9)
Other commercial 0.1% 0.1% -0.1% (2.4)
Manufacturing 0.3% 0.5% -0.2% (1.1)
Power and communication 0.6% 0.7% -0.1% (0.5)
Power 0.5% 0.5% 0.0% (0.1)
Electric 0.3% 0.3% -0.1% (0.6)
Other power 0.2% 0.1% 0.1% 1.1
Communication 0.1% 0.2% -0.1% (1.8)
Mining exploration, shafts, and wells1.0% 0.5% 0.5% 1.6
Petroleum and natural gas 0.9% 0.5% 0.5% 1.6
Mining 0.0% 0.0% 0.0% 0.5
Other structures 0.4% 0.7% -0.3% (1.9)
GDP Components, Private Fixed Investment: Residential Structures as a % of GDP
Line Item (from BEA)
% of GDP
(3Q12) LT Avg
Delta vs.
LT Avg
# of std dev
from LT avg
Structures 2.4% 4.5% -2.1% (2.3)
Permanent site 1.0% 2.8% -1.8% (2.3)
Single-family structures 0.8% 2.2% -1.4% (2.3)
Multifamily structures 0.1% 0.5% -0.4% (1.3)
Other structures 1.4% 1.6% -0.2% (0.8)
Manufactured homes 0.0% 0.1% -0.1% (1.6)
Dormitories 0.0% 0.0% 0.0% (0.1)
Improvements 1.0% 1.1% -0.1% (0.6)
Brokers' commissions on sale of structures0.4% 0.4% 0.0% (0.1)
Net purchases of used structures 0.0% 0.0% 0.0% 0.7
Source: J.P. Morgan and BEA. Note: BEA tables 1.1.5; 2.4.5U; 5.3.5; 5.5.5U and 5.4.5U.
-
US Year Ahead 2013
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North America Equity Research
December 2012
Housing Is a Big Factor
It remains our view that US housing is in a three- to five-year upcycle that ultimately
will lead to starts reaching 2.0M sometime by 2015 or so (see Positive on Housing
Food Chain IV dated 8/29). The key is a favorable supply/demand mix in US
housing markets over the next five years: we estimate housing starts are set to rise to
1.3-1.8M annually (see Figure 29), after languishing at 450-550k for three years
(2009-2011).
It simply comes down to short supply (low supply plus scrappage).
And demand driven by the Echo boom and basement dwellers (pent-up
formation). The adult population is projected to increase by 12.2M over the next
five years and pent-up household formation is estimated to total another 2.4M.
And each 250,000 increase in US housing starts adds about 1M jobs.
Figure 29: Implied Annual Housing Starts, 2012-2017E
Housing in Actual Units
Supply
(a) Excess homes/rentals/other 678,000
(b) Scrappage '12-'17 (250k x 5 years) -1,250,000
(c ) = (a) + (b) Total starting supply -572,000
Demand
(d) Adult population change '12-'17 12,244,000
(e) Ratio pop/ shelter 2.04
(f) = (d) / (e) Incremental housing units demand 6,008,000
(g)=(f) - (c ) Net required housing units to be built 6,580,000
/ 5 years 5
Base case: 12-'17 annual housing starts BASE case 1,316,000
(h) Plus: pent-up household formation 2,356,000
(i)=(g) + (h) - (c ) Net required housing units to be built 8,936,000
/ 5 years 5
Upside case: 12-'17 annual housing starts HIGH case 1,787,200
Source: J.P. Morgan and U.S. Census Bureau. Note: Census data as of 2Q12.
Figure 30: Rising Births and Adults Behind This Rise...
Newborns: Births 5-Yr Avg.; Adults: Becoming 20-Yr Old 5-Yr Avg.
2,000
2,500
3,000
3,500
4,000
4,500
2025202020152010200520001995199019851980197519701965
00
0s
5-yr avg : entering age 20 5-yr avg births
1950s-1960s 1970s-1980s 1990s-2000s 2010s...
Rising births Rising adults Rising births
Rising birthsRising adults
Fewer adults Fewer births Fewer adults
Source: J.P. Morgan, Census Bureau and CDC.
Capex to Sales Highlights Underinvestment as Well
Another area of accelerating spending should be capex. Figure 31 shows the capex-
to-sales ratio for S&P 500 companies. The current figure is 6.2% of sales, in the
lower end of the 16-year range of 5.1% to 8.1%.
There are multiple reasons for this but we ultimately attribute this to corporate
caution stemming from policy overhangs (globally) and generally poor
confidence in the global recovery.
This level of spending is low for both Cyclicals and Defensives, as seen below.
This is indicative of overall caution by businesses, both those selling staples (less
cyclical) and those with leverage to the economy.
Over the cycle, this figure should rise to 8% of GDP. This implies capex could
rise from the current level of $550 billion annually towards $800 billion. Again,
this would represent a substantial increase of around $250 billion in the run rate.
-
US Year Ahead 2013
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North America Equity Research
December 2012
Figure 31: Capex to Sales of S&P 500 Companies
% of Sales
Source: J.P. Morgan and FactSet. Note: LTM reflects estimates. Near-Cyclicals reflects an average of energy and financials.
Automobile Demand Recovering: 15.2M SAAR in Nov 12
Automobile demand is recovering and recently reached a SAAR of 15.2M in
November. We believe there is room for automobile demand to recover further.
J.P. Morgans Auto & Auto Parts analyst has written extensively on this but we
present some simple charts below in Figure 32 to Figure 34. Basically, even with the
recent recovery in auto sales, sales per adult is still quite low.
As Figure 33 shows, the average vehicle life has extended significantly since
1996, rising from 8.7 years to 10.8 years.
The current level of auto sales works out to about 49.7 cars per 1,000 adults, as
shown in Figure 34 below, a level that is still quite low. Historically such a level
of sales has been associated with troughs in auto demandthis is analogous to
the situation in housing as well. Basically, we believe the SAAR of auto sales can
recover towards 16M, aided by an easing of credit standards.
CAPEX / Sales (%)
Current Low High Decile
LTM % Date % Date Low High
S&P 500 6.2% 5.1% 2009 8.1% 1998
Cyclicals 5.0% 4.1% 2009 7.7% 1996
Materials 6.8% 4.4% 2004 9.7% 1996
Industrials 5.1% 4.1% 2010 10.4% 1996
Discretionary 4.5% 3.9% 2009 8.1% 1997
Technology 5.0% 3.7% 2009 8.0% 1995
Near-Cyclicals 7.7% 4.2% 2000 8.1% 1997
Energy 12.4% 5.8% 2000 14.0% 1997
Financials 2.9% 2.2% 2004 3.8% 2009
Defensives 5.5% 5.5% 2006 15.2% 2001
Staples 2.7% 2.7% 2010 4.4% 1997
HealthCare 1.9% 1.7% 2010 6.1% 1995
Telecom 14.0% 13.6% 2009 27.6% 2001
Utilities 24.1% 15.2% 2006 41.2% 2002
-
US Year Ahead 2013
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North America Equity Research
December 2012
Figure 32: Scrappage Rate
From 1996
Source: J.P. Morgan, NADA and Wards Auto.
Figure 33: Average Vehicle Life
From 1996
Source: J.P. Morgan and Polk.
Figure 34: Auto Sales per 1,000 People
From 1950
Source: J.P. Morgan and Bureau of Economic Analysis.
6.3%
5.8%5.7%
6.8%
6.6%
6.1%
5.5%
4.9%
4.3%
5.0%
5.2%
5.6%
4.2%
5.1%
5.1%
5.3%
2008
4.2%
2011
5.3%
4.0%
4.5%
5.0%
5.5%
6.0%
6.5%
7.0%
1996 1998 2000 2002 2004 2006 2008 2010
Scrappage % of Vehicles
8.68.6
8.88.88.98.9
9.09.1
9.49.5
9.79.8
10.0
10.3
10.6
10.8
8.50
9.00
9.50
10.00
10.50
11.00
1996 1998 2000 2002 2004 2006 2008 2010
Recessions Average Vehicle Life
12/09
33.9
11/12
49.7
25.0
30.0
35.0
40.0
45.0
50.0
55.0
60.0
65.0
70.0
12/50 3/62 6/73 9/84 12/95 3/07
Recessions Auto Sales per 1,000 People
-
US Year Ahead 2013
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North America Equity Research
December 2012
Credit Easing Should Be Visible in 2014
In Last Three Housing Cycles, Bank Lending Eased 16-37
Months AFTER Trough in Housing
There appears to be a misconception that bank lending has eased to start a housing
upcycle. In fact, it seems the opposite has occurred. As shown in Figure 35, an ease
in bank lending has never preceded or coincided with an upturn in US housing.
The earliest that bank lending has eased was 16 months after the start of an
upcycle (1992) and in 2000 it took 37 months (more than three years).
This makes sense from a banks perspective. Loan losses need to contract and an
improvement in housing activity and prices is needed prior to a banks gaining
confidence to increase lending. Thus, we would not expect these conditions to
precede an upturn in starts.
As we have argued in our past pieces, US housing recoveries are a result of an
improvement in pent-up demand vs. supply balance. And, thus, that is the driver
of an upturn in housing.
Figure 35: Bank Mortgage Loan Standards
% of Respondents Tightening Standards; Federal Reserve Senior Loan Officer Opinion Survey
Source: J.P. Morgan and Bloomberg. Note: Latest survey released for October 2012.
While US Private Sector Has High Liquidity
Corporate cash (as % of assets) near all-time highs
One way to measure corporate cash balances is to look at these balances as a
percentage of assets. As shown in Figure 36 below, the current level is 11%, well
above the long-term average of 8% and basically the highest since the 1950s.
Consider the favorable position of the private sector at the moment. At a time
when durable goods spending is the lowest in 50 years corporate liquidity is
nearly the highest in 50 years.
This contrasts with the early 90s (the last time durable goods spending rose)
when corporate liquidity was not nearly as strong.
-20.0%
0.0%
20.0%
40.0%
60.0%
80.0%
9/90 9/92 9/94 9/96 9/98 9/00 9/02 9/04 9/06 9/08 9/10 9/12 9/14
Net
% o
f R
esp
on
den
ts T
igh
ten
ing
Sta
nd
ard
s
Mortgage Loan Standards Prime Mortgage Loans Non-Traditional Mortgage Loans
3/91 6/95 12/00 9/11
Start of Housing Upcycle
7/92 4/97
Start of easing (% < 0%)
1/04
16 mos 22 mos 37 mos
-
US Year Ahead 2013
34
North America Equity Research
December 2012
Figure 36: Corporate Cash as % of Assets
Since 1952
Source: J.P. Morgan and Federal Reserve Flow of Funds.
US debt service ratios back to best levels in 30 years
Leading up to the recession, the household debt service ratio climbed to 20-year
highs as households increased mortgage borrowings. Since the 2007 peak, the
household debt service ratio has declined significantly, falling below the long-term
average, to 1993 levels.
About one-third of that decline has been due to lower borrowings and the balance
to lower interest costs.
As shown in Figure 37 below, the debt service ratio has only been as low as the
most recent 10.7% (per the Federal Reserve) in the early 80s and early 90s.
Figure 37: Debt Service Ratio for Households
Since 1980; Ratio of Household Service to Disposable Personal Income; Seasonally Adjusted (SA, %)
LT Avg, 11.96%
1 st dev
1 st dev2Q2012, 10.7%4Q1993
3Q2007, 14.1%
10.0%
10.5%
11.0%
11.5%
12.0%
12.5%
13.0%
13.5%
14.0%
14.5%
1Q
19
80
1Q
19
81
1Q
19
82
1Q
19
83
1Q
19
84
1Q
19
85
1Q
19
86
1Q
19
87
1Q
19
88
1Q
19
89
1Q
19
90
1Q
19
91
1Q
19
92
1Q
19
93
1Q
19
94
1Q
19
95
1Q
19
96
1Q
19
97
1Q
19
98
1Q
19
99
1Q
20
00
1Q
20
01
1Q
20
02
1Q
20
03
1Q
20
04
1Q
20
05
1Q
20
06
1Q
20
07
1Q
20
08
1Q
20
09
1Q
20
10
1Q
20
11
1Q
20
12
1Q
20
13
1Q
20
14
Ho
use
ho
ld d
eb
t s
erv
ice
ra
tio
(S
A)
(%)
Household Debt Service Ratio (SA, %) LT Avg 1 st dev
Source: J.P. Morgan and Federal Reserve Flow of Funds. Note: Household debt service ratio defined by the Federal Reserve Board
as an estimate of the ratio of debt service payments (consistent of the estimated required payments on outstanding mortgage and
consumer debt) to disposable personal income.
12/55
11%
12/59
9%12/63
9%
12/76
6%
12/86
7%
9/12
11%
4%
5%
6%
7%
8%
9%
10%
11%
12%
3/52 3/56 3/60 3/64 3/68 3/72 3/76 3/80 3/84 3/88 3/92 3/96 3/00 3/04 3/08 3/12
Cas
h a
s %
of
To
tal
Ass
ets
Recession Cash as % of Total Assets (ex-Financials)
-
US Year Ahead 2013
35
North America Equity Research
December 2012
STYLES: Favor High FCF, Low Div Yield
High FCF and Low Dividend Yield Are Two Best Styles
We also looked at the historical performance of styles in the fifth year of bull
markets since 1973. This was based on the attributes of the roughly 118 industry
groups with trading history, rather than the individual S&P 500 constituents, as the
fundamental data from our sources at the company level only went back to 1980. As
a result, we examined industry groups based on quintiles of attributes:
We list the best- and worst-performing attributes in Figure 38 and Figure 39.
Note the substantial outperformance of high FCF yield. The highest-quintile
groups typically outperformed by 2,100bp with a win ratio of 79%.
After high FCF yield, low dividend yield performed the best, with average
outperformance of 1,800bp and a win ratio of 67%. Interestingly, this would
mark a reversal for dividend strategies, as high dividend yield stocks have
performed so well.
In the 2013 context, we can see this as logical. After all, if we are looking for a
P/E re-rating as durable goods spending ramps up, this would favor companies
with potential to re-rate higher.
These would encompass companies with higher FCF, rather than dividend payers.
Recall that not every company with a high FCF yield pays a high dividend.
Figure 38: Average Relative Annual Return in Year 5 of a Bull Market
Since 1973; Sorted from Best to Worst
21%
14%
11%
10%
9%
4%
18%
14%
12%
10%
8%
4%
FCF Yield - Highest Quartile
Div Yield - Lowest Quartile
ROE - Lowest Quartile
P/E - Highest Quartile
Interest Charge Coverage - Lowest Quartile
P/E (Percentile) - Highest Quartile
P/E (Percentile) - Lowest Quartile
ROE - Highest Quartile
Interest Charge Coverage - Highest Quartile
P/E - Lowest Quartile
Div Yield - Highest Quartile
FCF Yield - Lowest Quartile
Source: J.P. Morgan and Datastream. Note: ROE, Interest Charge Coverage and FCF Yield
calculations exclude the 1974 Bull Market due to unavailable data.