Jpm Circle of Life

8/7/2019 Jpm Circle of Life

1/56


2/56


3/56


4/56

4

North America Equity Research19 August 2010

Thomas J Lee, CFA(1-212) [email protected]

#1: BIG PICTURE: In past decade, bonds beat stocks by largestmargin ever....not a good omen for bonds As shown in Figure 1, over the past 10 years, Treasuries outperformed equities by 96% through 01/10 and 88% (8,800bp) as of today. This is an even greater outperformance than during the Great Depression (when bonds beat by 7,400bp).

Below we have shown the corresponding forward 10-year returns of equities. And as shown below, stocks have seen positive10-year forward returns after every period of major underperformance (vs. bonds).

Figure 1: S&P 500 Relative Total Return (Trailing 10 Years) vs. S&P 500 Forward 10-Year ReturnMonthly Data since 1900

S&P 500 10 Year less 10 Yr Treasuries total return (rolling)

Current-88%12/78,

-48%8/39,-74%

6/32,-55% 1/10,

-96%-200%

-100%

0%

100%

200%

300%400%

500%

600%

%

S t o c

k s

O u

t p e r f o r

B o n

d s

O u

t p e r f o r m

S&P 500 Forward 10Yr Total Return

-50%

150%

350%

550%

1910 1917 1924 1931 1938 1945 1952 1959 1966 1973 1980 1987 1994 2001 2008 2015 S & P 5 0 0 1 0 Y r

F o r w a r

R e

t u r n

Source: J.P. Morgan and Shiller. S&P 500 total return includes dividend and the return for US Treasuries assumes bonds will be held until maturity. Note: Past performance is not indicative of future results.


5/56

5



Every 10-year period of Stock underperformance was followed bystrong 10-year Equity returns, with average CAGR of 13.6%We plotted on a scatter chart below the relative 10-year performance of Stocks (vs. bonds) and the subsequent total return of stocks over the following decade. Not surprisingly, this data suggests an inverse relationship: the worse stocks did over a 10-yearperiod (vs. bonds), the better the future performance of stocks.

Moreover, as shown below, whenever the return was NEGATIVE (below ZERO), the subsequent 10-year return of stocks waspositive with a range of 97%-450% (or CAGR of 7%-19%).

The average gain was 258%, or 13.6% per year, meaningfully above the 2.6% yield offered by Treasuries.

Figure 2: Trailin g 10-Year Relative Return vs. Forward S&P 500 10-Year ReturnMonthly Data since 1900

-100%

0%

100%

200%

300%

400%

500%

600%

-150% -50% 50% 150% 250% 350% 450% 550%

S&P 500 Total Return less Treasuries Total Return (Trailing 10 Year)

S & P 5 0 0 F o r w a r d

1 0 Y r

T o

t a l R e

t u r n

Source: J.P. Morgan and Shiller. S&P 500 total return includes dividend and the return for US Treasuries assumes monthly. Note: Past performance is not indicative of future results.

Following NEGATIVEequity vs. bond returns(10-yr), equities haveseen strong 10-yr forward total return:

Cumulative: 258%CAGR: 13.6%/year

ZERO line


6/56

6



Will this be 20 years of positive equity performance?In Figure 3 below, we looked at the rolling 10-year performance of stocks vs. bonds. This chart shows that we have gone fullcircle in terms of investor preference for bonds over equities, as the historical outperformance of stocks over bonds disappeared inthe past decade.

The average negative performance of stocks lasted 10-16 years, and the average up-cycle lasted 20-25 years. The one questionwe wonder about is whether the forces of excess leverage are sufficient to lead to worse forward performance for equities.

Figure 3: 10-Year Rolling Total Return S&P 500 vs. 10-Year US TreasuriesMonthly Data since 1900

3/09, -30%9/39, -29%-11%

7/59, 569%

9/29, 500%

1/75, 17%

9/00, 484%

76%

-100%

0%

100%

200%

300%

400%

500%

600%

700%

1910 1917 1924 1931 1938 1945 1952 1959 1966 1973 1980 1987 1994 2001 2008

C u m u

l a t i v e

1 0 Y r

R e

t u r n

S&P 500 (10 Yr Rolling Tot al Return) Treasuries Total Return (Held until Maturity)

10-yrs

16-yrs

10-yrs

20-yrs

25-yrs

20-yrs?

Source: J.P. Morgan and Shiller. S&P 500 total return includes dividend and the return for US Treasuries assumes bonds will be held until maturity. Note: Past performance is not indicative of future results.


7/56


8/56

8



First, the Fed drives return-seekers into duration or riskAs one client noted, a zero interest rate coupled with economic stability makes it painful to be in risk-free assets. In other words,eventually, the Fed will drive return-seeking investors into duration or risky assets. As shown below in Figure 5, we are seeing aprogressive move for investors out of risk-free assets into:

Longer-duration treasuries (pushing down 10-year);

Investment grade corporate bonds (pushing down bond yields);

And eventually equities (further on the spectrum of risky assets).

Figure 5: Zero Fed Funds Rate Is Driving Investors in to Duration or Risky Assets.

Low for long (1Q12)

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

1/07 1/08 1/09 1/10 1/11 1/12

Fed Funds Target Rate

pushed down 10-year to 1950 levels

1.75%

2.25%

2.75%

3.25%

3.75%

4.25%

4.75%

5.25%

1/07 7/07 1/08 7/08 1/09 7/09 1/10 7/10

10yr Treasury Yield

driving record-low corporate bond yields

4.00%4.50%5.00%5.50%6.00%6.50%7.00%7.50%

8.00%8.50%9.00%

10/08 2/09 6/09 10/09 2/10 6/10

HG Bond Yield

and eventually should make its way into equit ies

1,000

1,050

1,100

1,150

1,200

1/10 3/10 5/10 7/10 9/10

S&P 500

Source: J.P. Morgan and Bloomberg.

In other words, we think the 10-year yield in many ways reflects monetary policy as much as it reflects the economic outlook.


9/56

9



Second, corporate borrowing costs have dropped so much, equity is now the mostexpensive for issuersAs shown in Figure 6, high-grade bonds now yield a record-low 4.4%, which is implicitly a 22.7x P/E ratio (see right).

Even more startling is that for the first time in history, the yield of high-yield bonds is about to dip below the earnings yield onthe S&P 500think about that, it means that equity funding costs are perceived as higher than high yield.

Does that make sense?

Figure 6: Comparative Cost of Funding ; Equities, High Grade, and High YieldSince 12/99; Equities Is Earnings Yield (inverse is P/E)

Record-low yields in High-Grade and High-Yield

S&P 500, 8.1%HY, 8.3%

HG, 4.4%

0%

5%

10%

15%

20%

25%

12/99 4/01 8/02 12/03 4/05 8/06 12/07 4/09 8/10 12/11

Y i e l d

S&P 500 Earnings Yield HY Yield HG Yield

Implied P/E of High-Grade, High-Yield very high and now both trade above Par...

S&P 500, 12.3xHY, 12.0x

HG, 22.7x

4x

9x

14x

19x

24x

29x

12/99 4/01 8/02 12/03 4/05 8/06 12/07 4/09 8/10 12/11

P E

S&P 500 PE (NTM) HY PE (1/Yield) HG PE (1/Yield)

Source: J.P. Morgan, FactSet, and Dataquery.


10/56

10



and record-low corporate borrowing costs skew debt issuanceThe main pushback on our relative value argument has been, How is it resolved?

We argue it is resolved by companies shifting their funding mix. As shown below, this indeed has been the case. The top portionof Figure 7 shows the differential in funding costs of Equity (EY) vs. Debt (IG debt).

In the mid- to late 1990s, the cost of equity was much lower than debt and, as a result, the funding mix was over 50% equity

(as % of gross capital issuance). The exact opposite situation exists today, where the cost of equity funding is higher vs. debt and, as a result, the mix is now

15-20% equities, a level not seen in the past 20 years.

Figure 7: Equity Issuance as % of Total Issuance (Equity + Debt) Ex-FinancialsSince 1994, LTM

15%

20%

25%

30%

35%

40%

45%

50%

55%

12/93 12/94 12/95 12/96 12/97 12/98 12/99 12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/10

% o

f G r o s s

I s s u a n c e

Equity Is suance % of Total Avg % Equity Iss uance

2. Thus, dramatic shift in funding mix AWAY from equities.

4. Thus, heavier funding mix of equities.

-3.5%

-1.5%0.5%

2.5%

4.5%

E Y m

i n u s

B Y

1. Equity cost of funding, more expensive than debt..

3. Equity cost of funding much lower

Source: J.P. Morgan, Standard & Poor's, Shiller, and Dealogic.

Corporates resolve thedifferential in fundingcosts of equity vs. debt,by shifting fundingmix

Higher debt mixultimately should bePER SHARE ACCRETIVEto equities


11/56

11



looking like an Era of De-EquitizationUltimately, this implies lower equity dilution, particularly compared to the 1950s and 1970s when equity issuance diluted EPSreturns ( Figure 8) . During the 1950s and 1970s, corporates raised approximately 1% of their market cap per year in new equityissuance. However, the current era seems more like the 1980s, when the markets refrained from issuing new equity and themarkets actually rose 14.8% compounded annually from 1984 to 1989. We think the situation bodes well for EPS growth andpositive technicals with shrinking supply.

Figure 8: Net Equity Issued as % of Market Value of Equities Nonfarm, Nonfin ancial Corporate Bus inessSince 1952

Avg level -4.6%

Avg level 1.2% Avg level 0.9%

Avg level -3.0%

-9%

-7%

-5%

-3%

-1%

2%

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

N e

t E q u

i t y

i s s u e

d a s

% o

f M a r k e t

V a

l u e o

f E q u

i t i e s

Net Equity issued as % of Market Value of Equities Avg level

Source: J.P. Morgan, FactSet, Standard & Poor's, and Federal Reserve Flow of Funds.


12/56

12



de-equitization enables S&P 500 companies to generate EPS growth > GDP growthOne investor concern as we head towards 2011 is how the S&P 500 can be expected to grow earnings by 15% when nominal GDPis only projected to grow by 3-4%, particularly given that margins may have already peaked for many companies. Part of thisstrong EPS growth is likely to be driven by a contraction in the equity base as net equity issuance remains negative.

As shown in Figure 9, there has been a strong inverse correlation between the level of corporate equity issuance (as % of market cap) and the magnitude by which corporate profits growth outpaced GDP growth. As net equity issuance (as % of

market cap) contracted, similar to today, S&P 500 EPS growth tended to outpace nominal GDP growth by a larger margin. Given that the cost of equity funding is currently higher relative to bonds (due to the valuation gap between stocks and bonds),

the funding mix is likely to remain more skewed towards bonds than equities, preventing the equity base from expanding anddiluting EPS.

Figure 9: S&P 500 EPS Growth Stronger than GDP Growth as Equi ty Base ContractedSince 1952

y = -2.5643x - 0.0382R2 = 0.5933-12.0%

-7.0%

-2.0%

3.0%

8.0%

13.0%

18.0%

23.0%

28.0%

-8.5% -6.5% -4.5% -2.5% -0.5% 1.5%

Net Equi ty Issued as % of Market Value of Equi ties

S & P 5 0 0 E P S g r o w

t h m

i n u s

N o m

i n a

l G D P g r o w

t h

Source: J.P. Morgan, FactSet, and Federal Reserve Flow of Funds.

A contracting equitybase providessupport for strongEPS growth.

We are here


13/56

13



Third, room for home prices to inflate, which now stand at 158% of GDP, the lowest levelssince the 1970sAs shown below in Figure 10, homes aggregate value (calculated as total units per the U.S. Census Bureau multiplied by medianprice for an existing single-family home per National Association of Realtors) is 158% of GDP (on a 12-month moving average).This is well off the 217% level seen at the peak in 2006 and comfortably below the 175% long-term average. In fact, this level of home value is the lowest since the 1970s.

Figure 10: US Total Home Value (All Units * Median Price) as % of GDP 12-Month AverageSince 1965

Average, 175%

5/06, 217%

158%

135%

145%

155%

165%

175%185%

195%

205%

215%

225%

3/66 3/69 3/72 3/75 3/78 3/81 3/84 3/87 3/90 3/93 3/96 3/99 3/02 3/05 3/08 3/11

H o u s

i n g

V a

l u e a s

% o

f G D P

Average 12Month Moving Average

Source: J.P. Morgan and Bloomberg. Total unit data as per the Census Bureau and the median home price as per the National Association of Realtors.

Closing the gap versus the long-term average represents 17% of GDP, or $2 trillionIn other words, if the Fed, by maintaining low interest rates, is seeking to ultimately support higher home prices, this is notnecessarily creating a bubble in home prices. In fact, if home prices were to recover back to long-term average of 175% of GDP,this would add $2 trillion to homeowners net worth.

This is equivalent to a 10% rise in home prices from current levels.

lowest levels s ince the early 70s

Closing thegap (175% vs158%) wouldrepresent 17%of GDP, or $2T


14/56

14



#3: Can we double dip if most US economic metrics at troughlevels?Jobless claims have been stubbornly high and rising, which is no doubt a negative signal for the US recovery. What is unclear atthis time, however, is whether the layoffs of the 500k-plus temporary Census hires are affecting weekly claims. That is, 500k

layoffs over 12 weeks imply 42k increase in weekly claims during that time. But the more troubling concern is the potential thatthe US is seeing itself slip back into recessiona double dip. We still see the recent weakness as a growth scare, however.

According to our economists, a recession is triggered, historically, by one of three factors:

1. Inflation spikes, Fed responds. The recessions of the late 1960s, 1970s, 1980s, and early 1990s were mainly a story of highinflation leading to Fed tightening which pulled the economy down into recession. Often, inflation was associated with strongUS and global growth that pushed up oil prices. Fed tightening and higher interest rates were usually toughest on the credit-sensitive sectors, housing and autos, although weakness quickly spread to the rest of the economy.

2. Asset price bubble bursts. The recessions of 2001 and 2008-2009 were associated with sectoral booms getting exaggeratedand then crashing. In the late 1990s the tech boom and associated NASDAQ bubble pushed up spending, especially businessspending. When the NASDAQ bubble burst, business found itself over-extended and quickly cut spending and hiring whichled to recession. The more recent story was housing rather than tech, but when housing and house prices crashed, with majorshocks to the financial system, the whole economy went into recession.

3. Run on the currency. A common source of recessions in smaller, more open economies has come from imprudent political oreconomic policies that led to a run on the currency. The weaker currency led to much higher local interest rates and a cut-off of foreign investment inflows that led to recession.

And there are really 4 areas of the US economy that typically bear the brunt of a retrenchment and, hence, where the recession isevident:

1. Residential constructionHousing, basically;

2. Automobile sales;

3. Capital spending; and

4. Inventories.

We decided to look at the level of each of these four areas in the following section.


15/56

15



Housing, Autos, Capex, and Inventories are at Troughsthus, can we double dip?We compared the current levels of (i) Housing, (ii) Autos, (iii) Capex, and (iv) Inventories compared to previous recessiontroughs (since 1940) in Figure 11 below. And we also highlighted the average trough level with a dashed line.

What stands out to us is that the current level of economic activity for each of these areas of durables spending is alreadyBELOW troughs seen in past recessions. Thus, if these levels are already at the bottom, we wonder if they could in factdecline further. For instance, Housing is at 2.4% of GDP, well below the 4.2% trough seen in other recessions.

Figure 11: Recession Trough Levels vs. Current Level% of Nominal GDP

Residential Construction

5.3%

5.0%

4.5%

4.7%

4.2%

3.6%

4.0%

3.3%

3.2%

4.5%

2.4%

2.4%Avg, 4.2%

1.0% 2.0% 3.0% 4.0% 5.0% 6.0%

11/48 to 10/49

7/53 to 5/54

8/57 to 4/58

4/60 to 2/61

12/69 to 11/70

11/73 to 3/75

1/80 to 7/80

7/81 to 11/82

7/90 to 3/91

3/01 to 11/01

12/07 to 7/09

Current

% of GDP

Trough Level (% of GDP) Avg

Auto & Parts Sales

4.1%

3.3%

3.3%

3.1%

2.9%

3.0%

2.7%

3.2%

3.1%

4.1%

2.2%

2.3%Avg, 3.3%

1.0% 2.0% 3.0% 4.0% 5.0%

11/48 to 10/49

7/53 to 5/54

8/57 to 4/58

4/60 to 2/61

12/69 to 11/70

11/73 to 3/75

1/80 to 7/80

7/81 to 11/82

7/90 to 3/91

3/01 to 11/01

12/07 to 7/09

Current

% of GDP


Business Fixed Investment

9.0%

9.2%

9.6%

9.0%

10.2%

10.9%

12.9%

12.4%

10.3%

11.3%

9.7%

9.6%Avg, 10.5%

7.0% 9.0% 11.0% 13.0%

11/48 to 10/49

7/53 to 5/54

8/57 to 4/58

4/60 to 2/61

12/69 to 11/70

11/73 to 3/75

1/80 to 7/80

7/81 to 11/82

7/90 to 3/91

3/01 to 11/01

12/07 to 7/09

Current

% of GDP


Inventory

18.0%

18.3%

17.5%

18.2%

20.6%

19.6%

18.2%

15.0%

12.3%

11.1%

10.3%Avg, 17.5%

8.0% 13.0% 18.0% 23.0%

11/48 to 10/49

7/53 to 5/54

8/57 to 4/58

4/60 to 2/61

12/69 to 11/70

11/73 to 3/75

1/80 to 7/80

7/81 to 11/82

7/90 to 3/91

3/01 to 11/01

12/07 to 7/09

Current

% of GDP


Source: J.P. Morgan, BEA, and Bloomberg.


16/56

16



What is notable is how low Housing and Business investment are as % of GDP....We have plotted the ratio of Housing and Capital spending (as % of GDP) since the 1940s. The recessions are shaded.

ALL-TIME LOW IN HOUSING While known, it is still worth highlighting again. Housing at 2.4% of GDP is at theabsolute lowest ever, and well below the 4.6% long-term average. The fact that it has declined is ultimately not a surprisegiven the overbuilding that took place during the 2003-2006 timeframe. But today, the exact opposite has occurred. It is nowat extremely depressed levels.

BUSINESS CAPEX LOWEST SINCE 1960s... Similarly, the depressed level of capex is shown in Figure 13 below, whichshows that business fixed investment is currently only 9.6% of GDP, below the long-term average of 10.7%.

Figure 12: Residential Construction as % of GDPSince 1952

2.4%

LT Avg4.6%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

3/47 3/52 3/57 3/62 3/67 3/72 3/77 3/82 3/87 3/92 3/97 3/02 3/07

% o

f G D P

Recession Residential Construction % of GDP LT Avg

Source: J.P. Morgan and BEA.

Figure 13: Business Fixed Investment as % of GDPSince 1952

9.6%

LT Avg10.7%

8.0%

9.0%

10.0%

11.0%

12.0%

13.0%

14.0%

3/47 3/52 3/57 3/62 3/67 3/72 3/77 3/82 3/87 3/92 3/97 3/02 3/07

% o

f G D P

Recession Business Fixed Investment % of GDP LT Avg

Source: J.P. Morgan and BEA.

OFF THECHARTS! Lowest since 60s


17/56

17



From trough to long-term average implies $882b or 6% of GDPThe impact on US GDP would be significant if the four factors mentioned earlier were able to recover to their long-term averagepercentage of nominal GDP. As shown in Figure 14 below, these four factors would contribute $882 billion to nominal GDP if they returned to their long-term average (using the current level of nominal GDP of $14.6 trillion). For Inventory, we used the %of GDP from 3Q07 (prior to the start of the recent recession) rather than the long-term average since Inventory as a % of GDP hasbeen on a generally downward trend since the early 1980s.

Where there is incremental GDP, there are also incremental jobs One could actually argue that it is also these areas thatreflect where future jobs growth should come from. That is, when housing activity recovers, and capital spending revives, andcar purchasing normalizes, we should see significant recovery in labor markets associated with these areas.

Figure 14: What Would B e GDP Effect in $ Terms if Four Areas Normalize?$ impact if each factor returns to long-term avg. % of GDP

$154 $178$225

$325

$882

$0$100$200$300$400$500$600$700$800

$900$1,000

Business FixedInvestment

Auto & PartsSales

Inventory ResidentialConstruction

Total

$ i n b i l l i o n s

Source: J.P. Morgan, Bloomberg, and Federal Reserve Flow of Funds. Note: We used the % of GDP from 3Q07 rather than the long-term average for Inventory since Inventory as a % of GDP has been on a generally downward trend since the early 1980s.

Figure 15: and as % of GDP% impact if each factor returns to long-term avg. % of GDP

1.1% 1.2%1.5%

2.2%

6.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

Business FixedInvestment

Auto & PartsSales

Inventory ResidentialConstruction

Total

%

Source: J.P. Morgan, Bloomberg, and Federal Reserve Flow of Funds. Note: We used the % of GDP from 3Q07 rather than the long-term average for Inventory since Inventory as a % of GDP has been on a generally downward trend since the early 1980s.

In other words, rather than the potential downside of a double dip, we see potential upside associated with activity levels

normalizing.


18/56

18



MARKET STRATEGY: Leverage to economic activity increasesCyclicals still managing to outperform YTDBelieve it or not, Cyclicals are still managing to outperform the S&P 500 YTD by 230bp (see Figure 16) despite the drag fromTechnology (which is down 8.3%). That is not to say Defensives have not outperformed recentlyDefensives have moved fromunderperforming by 900bp in April to currently flat with the market overall.

The natural question looking into year-end is whether we still believe Cyclicals can outperform. The answer is yes with thearguments outlined in a recent report (please see US Equity Strategy FLASH: 8 Reasons why this is likely to be a longercycle for Cyclicals dated 8/5/2010).

Figure 16: Cyclicals Still Modestly Outperforming YTD....2009 and YTD

2009Cyclicals beat big

Energy, (12)Financials, (9)

Cyclicals, 17

Defensives, (14)

(30)

(25)

(20)

(15)

(10)

(5)

0

5

10

15

20

12/08 2/09 4/09 6/09 8/09 10/09 12/09 2/10

R e

l a t i v e

P e r f o r m a n c e s

i n c e

1 2 / 3 1 / 2 0 0 8

Energy Financials Cy clicals Defensives

2010Cyclicals s till modestly ahead of Defensives

Energy, (4.5)

Financials, 0.1

Cyclicals, 2.3

Defensives, 0.5

(12)

(9)

(6)

(3)

0

3

6

9

12

12/09 1/10 2/10 3/10 4/10 5/10 6/10 7/10 8/10 9/10

R e

l a t i v e

P e r f o r m

a n c e s

i n c e

1 2 / 3 1 / 2 0 0 9

Energy Financials

Cyclicals Defensives

Source: J.P. Morgan and FactSet.


19/56

19



Relative strength: Many groups showing positive relative strength.We decided to look at the recent equity performance of the 65 industry groups in the S&P 500 by comparing their relative strengthto that of the S&P 500 overall. We then grouped them into poor, recovering, or attractive, with attractive meaning thesegroups have had meaningful and sustained price appreciation against the broader market.

Defensives not the only outperformers. By our estimate, about 33% of Cyclical groups, 44% of Defensive groups, and even50% of Financials are showing attractive relative strength.

Figure 17: Recent Equity Price Trends of S&P 500 IndustriesRelative Strength of Industr ies (% of Groups)

Poor Recovering Attractive " Unattactive" on Relative Strength Groups "Attractive" on Relative Strength

Cyclicals 31% 36% 33%

Basic Materials 20% 20% 60% Construction Materials Chemicals Containers & Packaging Metals & Mining

Industrials 36% 18% 45% Aerospace & Defense Construction & Engineering Electrical Equipment Machinery

Industrial Conglomerates Commercial Svcs & Supplies Trading Cos & Distributors Air Freight & Logistics Road & Rail

Consumer Discretionary 25% 42% 33% Household Durables Diversified Consumer Svcs Hotels Restaurants & Leisure MediaSpecialty Retail Distributors Internet & Catalog Retail

Technology 38% 63% 0% Computers & Peripherals Electronic Equipment Semiconductors

Defensives 11% 44% 44%

Staples 33% 33% 33% Food & Staples Retailing Household Products Beverages Tobacco

Health Care 0% 67% 33% Health Care Technology Pharmaceuticals

Telecom Services 0% 0% 100% Diversified Telecom Svcs Wireless Telecom Svcs

Utilities 0% 50% 50% Electric Utilities Multi-Utilities

Other Financials 38% 13% 50% Commercial Banks Thrifts & Mortgage Finance Consumer Finance Capital Markets

Diversified Financial Services Real Estate Investment Trusts Real Estate Mgmnt & Dvlpmnt

Energy 0% 100% 0% Source: J.P. Morgan and FactSet.


20/56

20



Examples of Cyclicals with continued relative outperformanceBelow we illustrate two examples of Cyclicals with strong relative performance.

Containers and Packaging has been outperforming for most of 2010, supported by solid fundamentals of rising volumes andpricing.

Machinery continues to outperform the S&P 500 broadly, even with the group already close to its 2010 highs set in April.Machinery and engine sales remain strong, which again point to fundamentals supporting the equity performance in thisindustry group.

Figure 18: Relative Strength of Containers & Packaging and MachineryDaily price since 2005

Containers and Packaging recently renewed RSI

60

80

100

120

140160

S&P 500 / Containers & Packaging -IND (SPN77)18-Aug-2005 to 19-Aug-2010 (Daily) High: 159.09 Low: 59.31 Last: 122.63

25

5075Relative Strength Index (RSI)

'06 '07 '08 '09 '100.07

0.080.09

0.100.110.120.13

FactSet Research Systems

Relative Price to S&P 500

Machinery has been strong for some time and continued during correction

200

250

300350

400450500550

S&P 500 / Machinery -IND (SP177)18-Aug-2005 to 19-Aug-2010 (Daily) High: 537.71 Low : 187.13 Last: 427.86

25

5075Relative Strength Index (RSI)

'06 '07 '08 '09 '10

0.28

0.32

0.36

0.40

FactSet Research Systems

Relative Price to S&P 500

Source: FactSet.

Recently invigoratedContinuedstrength since


21/56

21



Valuations: 78% of S&P 500 companies Earnings Yield and FCF Yield > Bond YieldValuations are also attractive for equities at this time, in our view. Building on our theme of relative value, the relative valuechasm between equities and bonds is further shown in Figure 19 below. We calculated what % of companies have an earningsyield above their respective bond yield and a FCF yield above their bond yield.

77% of S&P 500 companies have a higher earnings yield than their respective bond yield ( Figure 19) . Most companies fallinto the 3.0-6.0% bucket, indicating that most S&P 500 companies earnings yield exceeds their respective bond yield by 300-

600bp. 78% of companies have a higher free cash flow yield than their respective bond yield. In fact, almost a quarter of companies

have a free cash flow yield that exceeds their respective bond yield by 900bp or more.

Figure 19: Distributio n of S&P 500 Companies Based on Earnings Yield minus Bond Yield% of S&P 500 companies

77% of companies have a Earning Yield > Bond Yield

11% 12%

20%

40%

12%

5%

0%

5%

10%

15%

20%

25%

30%

35%40%

45%

< -3.0% -3.0% to0.0%

0.0% to3.0%

3.0% to6.0%

6.0% to9.0%

> 9.0%

Ranges of EY minus BY

% o

f S & P 5 0 0 c o m p a n

i e s

78% of companies have a Earning Yield > Bond Yield

11% 11%

16%

27%

12%

23%

0%

5%

10%

15%

20%

25%

30%

< -3.0% -3.0% to0.0%

0.0% to3.0%

3.0% to6.0%

6.0% to9.0%

> 9.0

Ranges of FCF Yield minus BY

% o

f S & P 5 0 0 c o m p a n

i e s

Source: J.P. Morgan, FactSet, and Bloomberg.


22/56

22



TRADE IDEA: Stocks and industries leveraged to a recovery inResidential Construction or InventoryGiven that we remain confident that the US economy is unlikely to enter a double-dip scenario, we believe it is moreappropriate to focus on the areas that are likely to benefit as activity levels normalize. In Figure 20 below, we have highlighted the24 industries that have positive relative strength, and we have identified which of these groups have been correlated with arecovery in Residential Construction (as % of GDP) or Inventory (as % of GDP). We identified the industries with thesecorrelations by looking at the price of each of these industries (as a % of the S&P 500 price) since 1973 and compared that againstboth Residential Construction (as % of GDP) and Inventory (as % of GDP).

The industries that have been correlated with Residential Construction and also have positive relative strength are: Metals &Mining , Consumer Finance , Capital Markets , and Wireless Telecom Services .

The industries that are correlated with Inventory are: Chemicals , Metals & Mining , Machinery , Media , Distributors ,Diversified Telecom Services , Electric Utilities , and Multi-Utilities .


23/56

23



Figure 20: Industries with Positive Relative Strength and Strong Correlation with Residential Construction or InventoryIndustries correlated with Stocks on screen

Industries with Positive RelativeStrength Residential Construction Inventory

Stocks with EY 100bp > BY and FCFyield 100bp > BY

1 Chemicals Chemicals ASH, DD

2 Containers & Packaging

3 Metals & Mining Metals & Mining Metals & Mining FCX, NEM

4 Electrical Equipment5 Machinery Machinery CAT, DE, DHR, IR, ITW

6 Trading Cos & Distributors

7 Air Freight & Logistics

8 Road & Rail

9 Hotels Restaurants & Leisure

10 Media Media CBS, DISH, MHP, OMC, TWC

11 Distributors Distributors12 Internet & Catalog Retail

13 Beverages

14 Tobacco

15 Health Care Technology

16 Pharmaceuticals

17 Consumer Finance Consumer Finance

18 Capital Markets Capital Markets BK, GS, MS

19 Real Estate Investment Trusts

20 Real Estate Mgmnt & Dvlpmnt

21 Diversified Telecom Svcs Diversified Telecom Svcs

22 Wireless Telecom Svcs Wireless Telecom Svcs

23 Electric Utilities Electric Utilities ETR

24 Multi-Utilities Multi-Utilities CMS Source: J.P. Morgan, Datastream, and FactSet. Note: Past performance is not indicative of future results.


24/56

24



Within the industries highlighted above that have both positive relative strength and a correlation with Residential Construction orInventory, we screened for stocks that are attractive on both Earnings Yield and Free Cash Flow Yield (relative to Bond Yield).Specifically, we identified 19 stocks using the following criteria:

Industry has positive relative strength;

Industry has historically had a strong correlation with either Residential Construction (as % of GDP) or Inventory (as % of GDP);

Earnings Yield at least 100bp greater than Bond Yield; Free Cash Flow Yield at least 100bp greater than Bond Yield; and

Rated Overweight by J.P. Morgan.

The resulting 19 stocks are shown below in Figure 21.


25/56


26/56


27/56


28/56

28



Update on Clobbered Stocks with FCF Yield > Bond Yield TradeWe are keeping our Clobbered Stocks trade open, which we opened in June. As a reminder, for this trade we identified 25 stocksthat had been clobbered, using the following criteria: 1) FCF Yield > Bond Yield; 2) Overweight rated by J.P. Morgan; and3) Declined by >17% from 3-month high.


29/56


30/56


31/56


32/56


33/56

33



Update on Pro-Cyclical Stocks Trade IdeaWe are keeping our Pro-Cyclicals trade from November open, in which we compiled a list of 25 Pro-Cyclical stock ideas, sincewe continue to favor Cyclicals in the near term. The list identified stocks with a pro-Cyclical tilt, and where our analysts had aforecast above Street consensus. More specifically, we used the following criteria: 1) In the Energy , Materials , Industrials ,Discretionary , Technology , or Telecom sectors, since we saw the most upside in these sectors into year-end; 2) J.P. Morgan EPSestimate for 2010 at least 10% above Street consensus estimate for 2010; 3) Rated Neutral or Overweight by J.P. Morgan toensure there was a strong fundamental story; and 4) Market Cap > $4 billion.


34/56

North America Equity ResearchThomas J Lee CFA


35/56

35



Figure 30: Circle of Life Trades since Launch of PublicationPerformance of tradesPublication Dates Pair Trade Re-Cap Long/Short Performance Sector rating changes

Trade Open Trade Close Long Short Sector Perf + or - % chg L o n g

R E L P e r f

v s S & P 5 0 0

S h o r t

R E L

P e r f v s

S & P

5 0 0

Upgrade/Downgrade Sector

6/3/2010 - Open Long 25 Clobbered Stocks with FCF Yld > BY -7.9% x +100.0% -7.9% -5.4% Downgrade Energy OW ---> N

4/22/2010 - Open Long 25 Employment Demographics Stocks -21.5% x +100.0% -21.5% -10.5%

3/25/2010 - Open Long 23 Price Target Upgrade Stocks -4.9% x +100.0% -4.9% 2.8%

2/11/2010 - 3/25/2010 Long 24 Correction Stocks 11.4% x +100.0% 11.4% 3.3%

1/14/2010 - Open Long 19 Financials Stocks -1.7% x +100.0% -1.7% 4.7%

11/19/2009 - Open Long 25 Pro-Cyclical Stocks 6.2% x +100.0% 6.2% 8.0%

12/11/2009 Upgrade Health Care UW ---> N

10/22/2009 - 11/19/2009 Long 25 High Debt Stocks -2.0% x +100.0% -2.0% -2.2%

9/18/2009 - 10/22/2009 Long 26 Cyclical Stocks for the Next Leg of the Recovery -2.5% x +100.0% -2.5% -4.8%

8/5/2009 - 1/14/2010 Long Top 15 Energy Stks (Composite Score) 19.2% x +100.0% 19.2% 4.7% Upgrade Energy N ---> OW

Downgrade Health Care N ---> UW7/1/2009 - 8/5/2009 Long 15 Top Smoke Stackey Industries 14.7% x +100.0% 14.7% 6.1%

6/25/2009 Upgrade Industrials N ---> OWUpgrade Materials N ---> OW

Source: J.P. Morgan and FactSet. Note: The table above shows the performance of hypothetical trades assuming an investor bought and sold on the dates shown above, according to the trade parameters highlighted in each of our past Circle of Life reports.

North America Equity ResearchThomas J Lee CFA


36/56

36



Figure 31: Circle of Life Trades since Launch of Publication (continued)Performance of tradesPublication Dates Pair Trade Re-Cap Long/Short Performance Sector rating changes

Trade Open Trade Close Long Short Sector Perf + or - % chg L o n g

R E L P e r f

v s

S & P 5 0 0

S h o r t

R E L

P e r f v s

S & P

5 0 0

Upgrade/Downgrade Sector

6/4/2009 - 7/1/2009 Long 6 Sub-Industries -1.9% x +100.0% -1.9% 0.1%Short 5 Sub-Industries -6.6% x -100.0% 6.6% 4.6%

4/29/2009 - 6/4/2009 Long Consumer Ideas -0.3% x +100.0% -0.3% -8.2%Short Consumer Ideas -1.2% x -100.0% 1.2% 9.1%

4/29/2009 - 6/4/2009 Long Discretionary 4.5% x +100.0% 4.5% -3.4% Upgrade Energy UW ---> NShort Staples 8.0% x -100.0% -8.0% -0.1%

3/30/2009 - 4/29/2009 Long Materials 12.6% x +100.0% 12.6% 1.7% Upgrade Industrials UW ---> NLong Industrials 18.2% x +100.0% 18.2% 7.3% Downgrade Health Care OW ---> N

Short Utilities 2.4% x -100.0% -2.4% 8.6%

2/19/2009 - 3/30/2009 Long Materials 8.0% x +100.0% 8.0% 6.9% Upgrade Materials UW ---> NShort Telecom Svcs 8.4% x -100.0% -8.4% -7.3% Downgrade Telecom OW ---> N

1/16/2009 - 2/19/2009 Long Health Care 0.0% x +100.0% 0.0% 8.3% Upgrade Health Care N ---> OWShort Energy -7.3% x -100.0% 7.3% -1.1% Downgrade Energy N ---> UW

Source: J.P. Morgan and FactSet. Note: The table above shows the performance of hypothetical trades assuming an investor bought and sold on the dates shown above, according to the trade parameters highlighted in each of our past Circle of Life reports.

North America Equity ResearchThomas J Lee, CFA


37/56

37

q y19 August 2010

,(1-212) [email protected]

Sector ComparativeRelative Price PerformancePrice vs. 50-Day Moving AvgMonthly Relative Sales RevisionRelative Sales Growth (vs. S&P 500)Monthly Relative Earnings RevisionRelative Earnings MomentumJULI Spreads (Relative to All Industries Average)First Call Mean Rating (Relative to S&P 500)Short Interest (Relative to S&P 500)ETF Fund FlowsPrice/10-Yr EPS (Relative to S&P 500)

Circle of Life Metrics Monthly ChangesQuarterly Price Performance

Sector Comparative

North America Equity ResearchThomas J Lee, CFA


38/56

38

19 August 2010(1-212) [email protected]

North America Equity Research19 A 2010

Thomas J Lee, CFA(1 212) 622 6505


39/56

39


Trailing 1-Month Relative Price Performance SectorsFigure 32: Resources: Energy

-15%

-10%

-5%0%5%

10%

15%20%

12/03 12/04 12/05 12/06 12/07 12/08 12/09

Recession Trailing 1-mos Relative Perf. MAVG past 12mos

C

Figure 33: Resources: Materials

-10%

-5%

0%

5%

10%

12/03 12/04 12/05 12/06 12/07 12/08 12/09


Figure 34: Exports: Industrials

-10%

-5%

0%

5%

10%

12/03 12/04 12/05 12/06 12/07 12/08 12/09


Figure 35: Exports: Technology

-8%

-6%-4%-2%0%2%4%6%8%

12/03 12/04 12/05 12/06 12/07 12/08 12/09


Figure 36: Defensives: Staples

-8%-6%

-4%-2%0%2%4%6%8%

10%

12/03 12/04 12/05 12/06 12/07 12/08 12/09


Figure 37: Defensives: Health Care

-15%

-10%

-5%

0%

5%

10%

12/03 12/04 12/05 12/06 12/07 12/08 12/09


Figure 38: Defensives: Telecom

-10%

-5%

0%

5%

10%

15%

12/03 12/04 12/05 12/06 12/07 12/08 12/09


Figure 39: Defensives: Utilities

-10%

-5%

0%

5%

10%

15%

12/03 12/04 12/05 12/06 12/07 12/08 12/09


Figure 40: Discretionary

-10%

-5%

0%

5%

10%

12/03 12/04 12/05 12/06 12/07 12/08 12/09


Figure 41: Financials

-20%-15%-10%-5%0%5%

10%15%

12/03 12/04 12/05 12/06 12/07 12/08 12/09


Source: J.P. Morgan and Datastream.

Relative Price Performance:

Trailing 1-Mo Price Performance ofSector Minus Trailing 1-Mo PricePerformance of S&P 500

G: Has underperformedin latest month

N: Underperformancerecently

N from G: Global recoveryproviding support

G from U:Outperformance recently

G from N: Outperformingin past two months

G: Outperformedfor several months

N from U: Outperformed in

latest month

N from U: Defensivesoutperformed recently

N from U: Several monthsof underperformance

N from G: Mostlyoutperforming recently


Thomas J Lee, CFA(1 212) 622 6505


40/56

40


Price vs. 50-Day Moving Avg Sectors (best is low and rising)Figure 42: Resources: Energy

54%

0%

10%20%30%40%50%60%70%80%90%

100%

12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09

% o

f s

t o c

k s a

b o v e

5 0 d a y m a v g

%of stocks above mavgCaution

Zone

BuyZone


59%

0%10%20%30%40%50%60%70%80%90%

100%

12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09

% o

f s

t o c

k s a

b o v e

5 0 d a y m a v g

%of stocks above mavgCautionZone

BuyZone


45%

0%10%20%30%40%50%60%70%80%90%

100%

12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09

% o

f s

t o c

k s a

b o v e

5 0 d a y m a v g


Zone

BuyZone


25%

0%10%20%30%40%50%60%70%80%90%

100%

12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09

% o

f s

t o c

k s a

b o v e

5 0 d a y m a v g


Zone

BuyZone


49%

0%10%

20%30%40%50%60%70%80%90%

100%

12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09

% o f s

t o c

k s a

b o v e

5 0 d a y m a v g


Zone

BuyZone


51%

0%10%

20%30%40%50%60%70%80%90%

100%

12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09

% o f s

t o c

k s a

b o v e

5 0 d a y m a v g


Zone

BuyZone


67%

0%10%

20%30%40%50%60%70%80%90%

100%

12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09

% o f s

t o c

k s a

b o v e

5 0 d a y m a v g


Zone

BuyZone


85%

0%10%

20%30%40%50%60%70%80%90%

100%

12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09

% o f s

t o c

k s a

b o v e

5 0 d a y m a v g


Zone

BuyZone


37%

0%10%20%

30%40%50%60%70%80%90%

100%

12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09

% o

f s t o c

k s a

b o v e

5 0 d a y m a v g


Zone

BuyZone


41%

0%10%20%30%40%50%60%70%80%90%

100%

12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09

% o

f s t o c

k s a

b o v e

5 0 d a y m a v g


Zone

BuyZone


Price Momentum:

% of stocks in sector above 50-daymoving average.

G

U from G

N N from G G from N

G G N

G from N N from U


Thomas J Lee, CFA(1-212) 622-6505


41/56

41

19 August 2010(1 212) 622 [email protected]

Monthly Sales Revision SectorsFigure 52: Resources: Energy

-40.0%

-20.0%

0.0%

20.0%

40.0%

1/05 1/06 1/07 1/08 1/09 1/10

N T M S a l e s

R e v

i s i o n


-12.0%

-8.0%

-4.0%

0.0%

4.0%

8.0%

1/05 1/06 1/07 1/08 1/09 1/10

N T M S a l e s

R e v

i s i o n


-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

1/05 1/06 1/07 1/08 1/09 1/10

N T M S a l e s

R e v

i s i o n


-8.0%

-6.0%-4.0%-2.0%0.0%2.0%4.0%6.0%8.0%

1/05 1/06 1/07 1/08 1/09 1/10

N T M S a l e s

R e v

i s i o n


-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

1/05 1/06 1/07 1/08 1/09 1/10

N T M S a l e s

R e v

i s i o n


-1.0%0.0%

1.0%2.0%3.0%4.0%5.0%6.0%

1/05 1/06 1/07 1/08 1/09 1/10

N T M S a l e s

R e v

i s i o n


-2.0%

0.0%

2.0%

4.0%

6.0%

1/05 1/06 1/07 1/08 1/09 1/10

N T M S a l e s

R e v

i s i o n


-7.5%

-5.5%

-3.5%

-1.5%

0.5%

2.5%

4.5%

1/05 1/06 1/07 1/08 1/09 1/10

N T M S a l e s

R e v

i s i o n


-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

1/05 1/06 1/07 1/08 1/09 1/10

N T M S a l e s

R e v

i s i o n


-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

1/05 1/06 1/07 1/08 1/09 1/10

N T M S a l e s

R e v

i s i o n

Source: J.P. Morgan and Datastream. Change in Sales (NTM) as compared to one month ago divided by total sales of the sector.

Sales Revisions:

Change in Sales NTM (Current vs.1 month ago) divided by SectorSales (1 month ago).

Based on bottom-up consensusSales of current S&P 500constituents.

G: Revisions h ave beenconsistently positive

G: Positive for several months

G: Upward revisionscontinue

G: Positiverevisions recently

G: Small butconsistently positive

N: Minor revisions

G: Revisionsconsistently flat or up

G: Consistentl ositive

U: Revisions skewed tothe downside

G: Consistentlypositive


Thomas J Lee, CFA(1-212) 622-6505


42/56

42

g( )[email protected]

Relative Sales Growth (vs. S&P 500) Sectors (best if tail is rising)Figure 62: Resources: Energy

19.0%

-30%

-20%

-10%

0%

10%

20%

30%

40%

12/05 11/06 10/07 9/08 8/09 7/10 6/11

R e l

S a l e s

G r o w

t h M o m e n

t u m


3.7%

-16%

-12%

-8%

-4%

0%

4%

8%

12/05 11/06 10/07 9/08 8/09 7/10 6/11

R e l

S a l e s

G r o w

t h M o m e n

t u


0.0%

-8%

-4%

0%

4%

8%

12/05 11/06 10/07 9/08 8/09 7/10 6/11

R e l

S a l e s

G r o w

t h M o m e n

t u m


5.1%

-6%

-4%

-2%

0%

2%

4%

6%

8%

12/05 11/06 10/07 9/08 8/09 7/10 6/11

R e l

S a l e s

G r o w

t h M o m e n

t u


-1.4%

-8%

-4%

0%

4%

8%

12%

12/05 11/06 10/07 9/08 8/09 7/10 6/11

R e l

S a l e s

G r o w

t h M o m e n

t u


-1.2%

-4%

0%

4%

8%

12%

16%

12/05 11/06 10/07 9/08 8/09 7/10 6/11

R e l

S a l e s

G r o w

t h M o m e n

t u


-5.9%

-20%

-10%

0%

10%

20%

30%

12/05 11/06 10/07 9/08 8/09 7/10 6/11

R e l

S a l e s

G r o w

t h M o m e n

t u


0.0%

-12%

-8%

-4%

0%

4%

8%

12/05 11/06 10/07 9/08 8/09 7/10 6/11

R e l

S a l e s

G r o w

t h M o m e n

t u


-2.3%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

12/05 11/06 10/07 9/08 8/09 7/10 6/11

R e l

S a l e s

G r o w

t h M o m e n

t u m


-14.9%

-30%

-20%

-10%

0%

10%

20%

30%

12/05 11/06 10/07 9/08 8/09 7/10 6/11

R e l

S a l e s

G r o w

t h M o m e n

t u m


Relative Sales Growth NTM:

Sales growth NTM of Sector lessSales growth NTM of S&P 500.

Based on bottom-up results ofcurrent S&P 500 constituents.

Historical data reflects actualgrowth.

Dashed line reflects First Callbottom-up consensus.

Up or Down trend of line is mostimportant indicator for determiningsector momentum.

N: Momentum turningne at ive

G: Momentumimproving

G: V-shapedrecovery in sales

U: Waiting for trendto turn positive

G: Less momentumrecently

G: Improving growth

N: Momentum turningne at ive

N: Outlook for consumer unclear

N: Tougher compsin 2010

U: Weak momentum


Thomas J Lee, CFA(1-212) 622-6505


43/56

43

[email protected]

Monthly Earnings Revision SectorsFigure 72: Resources: Energy

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

1/05 1/06 1/07 1/08 1/09 1/10

N T M E a r n i n g s

R e v

i s i o n s


-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

1/05 1/06 1/07 1/08 1/09 1/10


R e v

i s i o n s


-2.0%

-1.6%-1.2%-0.8%-0.4%0.0%0.4%0.8%

1/05 1/06 1/07 1/08 1/09 1/10


R e v

i s i o n s


-1.2%

-0.8%

-0.4%

0.0%

0.4%

0.8%

1/05 1/06 1/07 1/08 1/09 1/10


R e v

i s i o n s


-0.4%-0.3%

-0.2%-0.1%0.0%0.1%0.2%0.3%

1/05 1/06 1/07 1/08 1/09 1/10


R e v

i s i o n s


-0.2%-0.1%

0.0%0.1%0.2%0.3%0.4%0.5%

1/05 1/06 1/07 1/08 1/09 1/10


R e v

i s i o n s


-2.0%-1.6%

-1.2%-0.8%-0.4%0.0%0.4%0.8%1.2%

1/05 1/06 1/07 1/08 1/09 1/10


R e v

i s i o n s


-0.8%-0.6%

-0.4%-0.2%0.0%0.2%0.4%0.6%0.8%

1/05 1/06 1/07 1/08 1/09 1/10


R e v

i s i o n s


-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1/05 1/06 1/07 1/08 1/09 1/10


R e v

i s i o n s


-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

1/05 1/06 1/07 1/08 1/09 1/10


R e v

i s i o n s

Source: J.P. Morgan and Datastream. Change in Net Income (NTM) as compared to one month ago divided by market cap.

Earnings Revisions:

Change in net income NTM(current vs. 1 month ago) dividedby sector market cap.

Based on bottom-up consensus net

income of current S&P 500constituents.

G: Positiverevisions recently

N: Flat revisionsrecently

G: Strong positiverevisions recentl

G: Strong positiverevisions

N: No clear upwardtrend just yet

G: Positiverevisions

N from G: Revisionspositive recently

N from G:Revisions positive

N: Mixedrevisions recently

N: Minor revisions


44/56


Thomas J Lee, CFA(1-212) 622-6505thomas lee@jpmorgan com


45/56

45

[email protected]

JULI Spreads (Relative to All Industries Averages) Sectors (best is high and narrowing)Figure 92: Resources: Energy

(325)

(200)

(75)

50

175

'01 '03 '05 '07 '09 J U L I S p r e a

d r e

l t o a l

l I n d u s

t r y a v g

( b p )

Energy Z Spread (Libor) Avg 1 STD

Widening

Narrowing


(325)

(200)

(75)

50

175

'01 '03 '05 '07 '09

J U L I S p r e a

d R e l

t o I n d A v g

( b p )

Materials Z Spread (Libor) Avg 1 STD

Widening

Narrowing


(325)

(200)

(75)

50

175

'01 '03 '05 '07 '09

J U L I S p r e a

d R e l

t o I n d A v g

( b p )

Industrials Z Spread (Libor) Avg 1 STD

Widening

Narrowing


(325)

(200)

(75)

50

175

'01 '03 '05 '07 '09

J U L I S p r e a

d R e l

t o I n d A v g

( b p )

Technology Z Spread (Libor) Avg 1 STD

Widening

Narrowing


(325)

(200)

(75)

50

175

'01 '03 '05 '07 '09

J U L I S p r e a

d R e l

t o I n d A v g

( b p )

Staples Z Spread (Libor) Avg 1 STD

Widening

Narrowing


(325)

(200)

(75)

50

175

'01 '03 '05 '07 '09

J U L I S p r e a

d R e l

t o I n d A v g

( b p )

Healthcare Z Spread (Libor) Avg 1 STD

Widening

Narrowing


(325)

(200)

(75)

50

175

'01 '03 '05 '07 '09

J U L I S p r e a

d R e l

t o I n d A v g

( b p )

Telecoms Z Spread (Libor) Avg 1 STD

Widening

Narrowing


(325)

(200)

(75)

50

175

'01 '03 '05 '07 '09

J U L I S p r e a

d R e l

t o I n d A v g

( b p )

Utilities Z Spread (Libor) Avg 1 STD

Widening

Narrowing


(325)

(200)(75)

50

175

'01 '03 '05 '07 '09

J U L I S p r e a

d R e l

t o I n d A v g

( b p )

Discreationary Z Spread (Libor) Avg 1 STD

Widening

Narrowing


(325)

(200)

(75)

50

175

'01 '03 '05 '07 '09

J U L I S p r e a

d R e l

t o I n d A v g

( b p )

Financials Z Spread (Libor) Avg 1 STD

Widening

Narrowing


Relative JULI Spreads:Calculated as Spread of Sectorless Avg Spread of 10 Sectors.

A figure above zero means sectorhas higher yields (relative).

When line is falling, it meansspreads are tightening on a relativebasis.

N from G: Tightening

G from N: Tighteningrecently

N: Widening recently

N: Spreads stabilizing

recently

N: Spreads stable athistorical avg

N from G: Spreads flatrecentl

G: Spreads tighteningN: Spreadsstabilizing

N from G: Somewidening recently

N: Stable recently


Thomas J Lee, CFA(1-212) 622-6505thomas lee@jpmorgan com


46/56

46

[email protected]

First Call Mean Rating (Relative to S&P 500) Sectors (best is low and rising)Figure 102: Resources: Energy

(0.55)

(0.35)

(0.15)

0.05

0.25

0.45

11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09

Recession Avg Relative FC Mean Rating Average

LessLiked

MoreLiked


(0.55)

(0.35)

(0.15)

0.05

0.25

0.45

11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09


LessLiked

MoreLiked


(0.55)

(0.35)

(0.15)

0.05

0.25

0.45

11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09


LessLiked

MoreLiked


(0.55)

(0.35)

(0.15)

0.05

0.25

0.45

11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09


LessLiked

MoreLiked


(0.55)

(0.35)

(0.15)

0.05

0.25

0.45

11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09


LessLiked

MoreLiked


(0.55)

(0.35)

(0.15)

0.05

0.25

0.45

11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09

Recession Avg Relative FCMean Rating Average

Less

Liked

MoreLiked


(0.55)

(0.35)

(0.15)

0.05

0.25

0.45

11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09


Less

Like

MoreLiked

Figure 109: Defensives: Util ities

(0.55)

(0.35)

(0.15)

0.05

0.25

0.45

11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09


LessLiked

MoreLiked


(0.55)

(0.35)

(0.15)

0.05

0.25

0.45

11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09


LessLiked

MoreLiked


(0.55)

(0.35)

(0.15)

0.05

0.25

0.45

11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09


LessLiked

MoreLiked


Relative FC Mean Rating:

Bottom-up FC Mean Rating ofStreet for Sector less S&P 500overall.

Negative "relative" value means

Street has more Buys on Sector vs.S&P 500.

When line is rising, it means Streetis upgrading.

G: Stable recently

N: Street rating nearing

parity with ov erall S&P 500

G: Upgradescontinuing

G: Upgrades continue

N: Downgrades slowing

U: Downgrades

continue

U: Sharp relativedowngrades

G: Upgrades recently N: Upgrades leveling off

U: Downgrades may bestarting




47/56

47

[email protected]

Short Interest (Relative to S&P 500) Sectors (best is high and falling)Figure 112: Resources: Energy

-1.5%

-0.5%

0.5%

9/99 9/01 9/03 9/05 9/07 9/09


-1.0%

0.0%

1.0%

9/99 9/01 9/03 9/05 9/07 9/09


-1.4%

-0.9%

-0.4%

9/99 9/01 9/03 9/05 9/07 9/09


-1.0%

-0.5%

0.0%

0.5%

1.0%

9/99 9/01 9/03 9/05 9/07 9/09


-1.9%

-1.4%

-0.9%

-0.4%

9/99 9/01 9/03 9/05 9/07 9/09


-1.5%

-1.0%

-0.5%

0.0%

9/99 9/01 9/03 9/05 9/07 9/09


-1.9%

-0.9%

0.1%

1.1%

9/99 9/01 9/03 9/05 9/07 9/09


-1.5%

-0.5%

0.5%

1.5%

9/99 9/01 9/03 9/05 9/07 9/09


0.0%

1.0%

2.0%

3.0%

9/99 9/01 9/03 9/05 9/07 9/09


-0.8%0.3%1.3%2.3%3.3%

9/99 9/01 9/03 9/05 9/07 9/09

Source: J.P. Morgan and FactSet. Note: Calculated as shares sold short as % of shares outstanding in each sector minus shares sold short as % of shares outstanding for S&P 500.

Relative Short Interest:

Calculated as sector short interest(as % shares outstanding) lessaverage for S&P 500.

Calculated bi-weekly.At extremes, we see short interestas a useful potential contrarianindicator, i.e., if relative shortinterest is high, we see the sectoras vulnerable to anydisappointments

G from N: Highand declining

N: Has declinedsignificantly

G: PeakingN: Stable recently

N: In line withS&P 500

N: Stable recently after

rising rapidly

N: Volatile recently

G: Still elevated

G: Decliningrecently

N: May be peaking


48/56




49/56

49

Price/10-Yr EPS (Relative to S&P 500) Sectors (best if low and rising)Figure 132: Resources: Energy

0.4x

0.8x

1.2x

1.6x

'84 '88 '92 '96 '00 '04 '08

R e l a t

i v e

P / E t o S & P 5 0 0

Recessions Rel to SP500 STD +1STD -1 Avg


0.4x

0.8x

1.2x

1.6x

'84 '88 '92 '96 '00 '04 '08

R e l a t

i v e

P / E t o S & P 5 0 0



0.8x

1.0x

1.2x

1.4x

'84 '88 '92 '96 '00 '04 '08

R e l a t

i v e

P / E t o S & P 5 0 0



0.6x

1.2x

1.8x

2.4x

3.0x

'84 '88 '92 '96 '00 '04 '08

R e l a t

i v e

P / E t o S & P 5 0 0



0.2x

0.4x

0.6x

0.8x

1.0x

'84 '88 '92 '96 '00 '04 '08

R e l a t

i v e

P / E t o S & P 5 0 0



0.6x0.9x

1.2x

1.5x

1.8x

'84 '88 '92 '96 '00 '04 '08

R e l a t

i v e

P / E t o S & P 5 0 0



0.4x

0.6x

0.8x

1.0x

1.2x

'84 '88 '92 '96 '00 '04 '08

R e l a t

i v e

P / E t o S & P 5 0 0



0.2x

0.5x

0.8x

1.1x

'84 '88 '92 '96 '00 '04 '08

R e l a t

i v e

P / E t o S & P 5 0 0



0.8x

1.0x1.2x

1.4x

1.6x

'84 '88 '92 '96 '00 '04 '08

R e l a t

i v e P

/ E t o S & P 5 0 0



0.4x

0.6x0.8x

1.0x

1.2x

'84 '88 '92 '96 '00 '04 '08

R e l a t

i v e P /

E t o S & P 5 0 0



Relative P/10-Yr EPS:

Calculated as Sector P/10-Yr EPSdivided by S&P 500 P/10-Yr EPS.

The lower the line, the greater therelative discount.

U: Elevated

G: Extreme low

U: Very rich U: Coming off extreme levels

G: Attractive level

G: Below long-term avg

G: Attractive level

G: Attractive levelG: Attractive level N: At long-term

avg




50/56

50

Circle of Life Metrics Monthly ChangesFigure 142: Circl e of Life Metrics Monthly Changes

Energy

2/10 3/10 4/10 6/10 8/10

Price Performance

Price/50d mavg

Sales Revision

Sales Momentum

Earnings Revision

Earnings Momentum

JULI Spreads

FC Mean Rating

Short Interest

ETF Fund Flows

P/10Yr EPS

Total Delta -1 -1 1 0 2

Composite Score 0.4 0.3 0.4 0.4 0.5

Materials

2/10 3/10 4/10 6/10 8/10

2 0 -1 -2 -1

0.8 0.7 0.6 0.5 0.4

Industrials

2/10 3/10 4/10 6/10 8/10

1 -1 -1 2 -1

0.5 0.5 0.5 0.7 0.6

Technology

2/10 3/10 4/10 6/10 8/10

1 -2 0 -2 -1

0.8 0.6 0.6 0.5 0.4

Staples

2/10 3/10 4/10 6/10 8/10

2 -1 1 2 1

(0.1) (0.2) (0.1) 0.1 0.2

Health Care

2/10 3/10 4/10 6/10 8/10

Price Performance

Price/50d mavg

Sales Revision

Sales Momentum

Earnings Revision

Earnings Momentum

JULI Spreads

FC Mean Rating

Short Interest

ETF Fund Flows

P/10Yr EPS

Total Delta 3 -2 0 2 1

Composite Score 0.3 0.2 0.2 0.5 0.5

Telecom

2/10 3/10 4/10 6/10 8/10

1 -1 0 1 2

(0.1) (0.2) (0.2) (0.1) 0.3

Utilities

2/10 3/10 4/10 6/10 8/10

0 0 1 1 1

(0.5) (0.5) (0.5) (0.4) (0.3)

Financials

2/10 3/10 4/10 6/10 8/10

0 0 -1 2 -3

0.5 0.5 0.4 0.5 0.3

Discretionary

2/10 3/10 4/10 6/10 8/10

0 -1 0 0 1

0.8 0.7 0.7 0.7 0.8

Source: J.P. Morgan.




51/56

51

Quarterly Price PerformanceFigure 143: Sector Quarterly Price PerformanceShaded box highlights performance of sector, Bold/Italics highlights S&P 500 performanceEnergy3Q09 4Q09 1Q10 2Q10 QTD

25% 10% 12% -5% 11%

21% 9% 11% -6% 10%

21% 9% 10% -9% 8%

19% 7% 5% -11% 7%17% 6% 5% -12% 7%

15% 6% 3% -12% 7%

11% 5% 2% -12% 5%

9% 5% 2% -13% 5%

9% 5% 0% -13% 3%

5% 4% -5% -14% 3%

4% -4% -6% -16% 2%

Materials3Q09 4Q09 1Q10 2Q10 QTD

25% 10% 12% -5% 11%

21% 9% 11% -6% 10%

21% 9% 10% -9% 8%

19% 7% 5% -11% 7%17% 6% 5% -12% 7%

15% 6% 3% -12% 7%

11% 5% 2% -12% 5%

9% 5% 2% -13% 5%

9% 5% 0% -13% 3%

5% 4% -5% -14% 3%

4% -4% -6% -16% 2%

Industrials3Q09 4Q09 1Q10 2Q10 QTD

25% 10% 12% -5% 11%

21% 9% 11% -6% 10%

21% 9% 10% -9% 8%

19% 7% 5% -11% 7%17% 6% 5% -12% 7%

15% 6% 3% -12% 7%

11% 5% 2% -12% 5%

9% 5% 2% -13% 5%

9% 5% 0% -13% 3%

5% 4% -5% -14% 3%

4% -4% -6% -16% 2%

Technology3Q09 4Q09 1Q10 2Q10 QTD

25% 10% 12% -5% 11%

21% 9% 11% -6% 10%

21% 9% 10% -9% 8%

19% 7% 5% -11% 7%17% 6% 5% -12% 7%

15% 6% 3% -12% 7%

11% 5% 2% -12% 5%

9% 5% 2% -13% 5%

9% 5% 0% -13% 3%

5% 4% -5% -14% 3%

4% -4% -6% -16% 2%

Staples3Q09 4Q09 1Q10 2Q10 QTD

25% 10% 12% -5% 11%

21% 9% 11% -6% 10%

21% 9% 10% -9% 8%

19% 7% 5% -11% 7%17% 6% 5% -12% 7%

15% 6% 3% -12% 7%

11% 5% 2% -12% 5%

9% 5% 2% -13% 5%

9% 5% 0% -13% 3%

5% 4% -5% -14% 3%

4% -4% -6% -16% 2%

HealthCare3Q09 4Q09 1Q10 2Q10 QTD

25% 10% 12% -5% 11%

21% 9% 11% -6% 10%

21% 9% 10% -9% 8%

19% 7% 5% -11% 7%

17% 6% 5% -12% 7%

15% 6% 3% -12% 7%

11% 5% 2% -12% 5%

9% 5% 2% -13% 5%

9% 5% 0% -13% 3%

5% 4% -5% -14% 3%

4% -4% -6% -16% 2%

Telecom3Q09 4Q09 1Q10 2Q10 QTD

25% 10% 12% -5% 11%

21% 9% 11% -6% 10%

21% 9% 10% -9% 8%

19% 7% 5% -11% 7%

17% 6% 5% -12% 7%

15% 6% 3% -12% 7%

11% 5% 2% -12% 5%

9% 5% 2% -13% 5%

9% 5% 0% -13% 3%

5% 4% -5% -14% 3%

4% -4% -6% -16% 2%

Utilities3Q09 4Q09 1Q10 2Q10 QTD

25% 10% 12% -5% 11%

21% 9% 11% -6% 10%

21% 9% 10% -9% 8%

19% 7% 5% -11% 7%

17% 6% 5% -12% 7%

15% 6% 3% -12% 7%

11% 5% 2% -12% 5%

9% 5% 2% -13% 5%

9% 5% 0% -13% 3%

5% 4% -5% -14% 3%

4% -4% -6% -16% 2%

Financials3Q09 4Q09 1Q10 2Q10 QTD

25% 10% 12% -5% 11%

21% 9% 11% -6% 10%

21% 9% 10% -9% 8%

19% 7% 5% -11% 7%

17% 6% 5% -12% 7%

15% 6% 3% -12% 7%

11% 5% 2% -12% 5%

9% 5% 2% -13% 5%

9% 5% 0% -13% 3%

5% 4% -5% -14% 3%

4% -4% -6% -16% 2%

Discretionary3Q09 4Q09 1Q10 2Q10 QTD

25% 10% 12% -5% 11%

21% 9% 11% -6% 10%

21% 9% 10% -9% 8%

19% 7% 5% -11% 7%

17% 6% 5% -12% 7%

15% 6% 3% -12% 7%

11% 5% 2% -12% 5%

9% 5% 2% -13% 5%

9% 5% 0% -13% 3%

5% 4% -5% -14% 3%

4% -4% -6% -16% 2%



52/56




53/56

53


54/56
http://www.morganmarkets.com/https://mm.jpmorgan.com/disclosures/company


55/56


56/56

Jpm Circle of Life

Documents

Transcript of Jpm Circle of Life