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North America Equity and Quantitative Strategy Research12 December 2014

Corrected Note (first published 11 December 2014) (See page 140 for details)

US Equity Markets2015 Outlook

US Equity Strategy, Global Quantitative and Derivatives Research

Dubravko Lakos-Bujas AC

(1-212) 622-3601

[email protected]

J.P. Morgan Securities LLC

Marko Kolanovic

(1-212) 272-1438

[email protected]


Bhupinder Singh

(1-212) 622-9812

[email protected]


Scott A Linstone

(1-212) 622-9970

[email protected]


Narendra Singh

(1-212) 622-0087

[email protected]


Arjun Mehra (AJ)

(1-212) 622-8030

[email protected]


Eduardo Lecubarri *

(44-20) 7134-5916

[email protected]

J.P. Morgan Securities plc

* Registered/qualified as a research analyst under NYSE/FINRA rules.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.

Bloomberg subscribers can use the tickers JPAMAIRL, JPAMENRG, JPAMFINL, JPAMSYLD, JPAMDREV, JPUSTP15, JPUSGP15, JPUSVP15, JPUSIP15 <Index> 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 JPAMAIRL, JPAMENRG, JPAMFINL, JPAMSYLD, JPAMDREV, JPUSTP15, JPUSGP15, JPUSVP15, JPUSIP15 <Index> could diverge from returns quoted in our research, 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 more information, please contact your J.P. Morgan salesperson or the Delta One Desk.

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Dubravko Lakos-Bujas(1-212) [email protected]

Please note this report was originally published on 11 December 2014. See page 141 for more detail.

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Equity Market Outlook - Key Takeaways

S&P 500 Forecasts

Price Target (2015 YE): 2,250EPS (2015): $127.00EPS (2014): $117.50VIX (Average): 16

Key Drivers

Solid economic growth with tame inflationReal GDP growth of 3% y/y; Core CPI of 1.1% y/y

Expected pick-up in consumer spendingJob and wage growth; “wealth effect” materializing

Stimulus from lower oil pricesTax cut for consumer; benefits corporate margins

Increasing G4 liquidityBOJ, ECB, PBOC accommodative monetary policy

Strong market technicalsBuoyant M&A and buyback activity

Rising corporate and consumer confidence

Sector Outlook

Discretionary (OW) — a direct play on rising disposable income and tame inflation

Technology (OW) — organic growth, healthy margins, high shareholder yield supportive

Financials (OW) — rising rates boost NIM, cheaperrelative valuation, higher domestic exposure

Healthcare (OW) — secular trends and new product launches driving earnings growth; strong M&A

Staples (N) — lower beta to consumer spending than discretionary; high negative correlation to rates

Industrials (N) — exposure to investment spending (+); E&P exposure (-); rising USD/rates (-)

Energy (N) — poor earnings visibility due to oil volatility but valuation increasingly more attractive

Materials (UW) — poor global demand, rising USD/rates negative for this capital intensive sector

Telecom (UW) —saturated end market, price competition, rising rates a negative

Utilities (UW) —compressed dividend yield, rising rates provide more alternatives for income investors

Volatility and Correlation Outlook

Volatility in ‘15 will look more like Q4 than H1 of ’14(~15% higher levels compared to ‘14 averages), with the VIX averaging ~16.

Despite perception that low volatility and declining correlations is good for stock picking, current record low stock dispersion makes a very difficult environment for equity long/short managers.

Style OutlookOur top-down macro framework suggests the US economy is still in “expansion” stage. Tilt toward Momentum and Value.

Themes1. Airlines (JPAMAIRL Index) — attractive

valuation, lift from corporate/consumer spending and cheap fuel to drive margin expansion

2. Contrarian Energy Picks (JPAMENRG Index) —Energy stocks that are best positioned for the current low oil environment

3. US Consumer Spending — industries levered to the expected rise in consumer spending

4. Financials (JPAMFINL Index) — most levered financial stocks to rising interest rates

5. Sustainable Shareholder Yield (JPAMSYLDIndex) — search for stocks with high and sustainable total yields (buybacks and dividends)continues

6. Domestic Firms over Multinationals (JPAMDREVIndex) — stronger US dollar and solid economic growth favors domestic companies

Small-cap Outlook

We prefer Small over Large-caps as a short-term reversion trade. Longer-term, rising rates are a concernfor Small-caps with their higher dependence on shorter maturity debt.

Risks

Rising rates US growth disappoints and housing disappoints again Global growth goes from low growth to recessionary Stronger USD pressures profit margins Oil – too low for too long could spike HY defaults Geopolitical risk in Europe and the Middle East

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Table of Contents2015 Outlook: Executive Summary.........................................5

Price Target: S&P 500 Rises to 2250 in ‘15 ..........................13

Macro: The Rise of the Consumer ........................................14

Fundamentals: 8% EPS Growth in 2015 ...............................30

Valuation: Multiple Largely Unchanged ...............................41

Volatility and Correlation Outlook.........................................48

Sector Outlook........................................................................53

Style Outlook ..........................................................................76

Small-cap Outlook..................................................................94

Investment Themes..............................................................108

AppendicesAppendix I: Equity Returns around Initial Rate Hikes.......131

Appendix II: Expenditures by GDP Category.....................132

Appendix III: J.P. Morgan Top Stock Picks ........................134

Appendix IV: Recoveries and Market Peaks ......................137

Appendix V: History of Shiller’s CAPE ...............................139

Prices in this report reflect the close on December 5, 2014 unless otherwise indicated.

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2015 Outlook: Executive Summary

S&P 500 continues to climb the wall of worry. The global economy stands on fragile footing and yet the S&P 500 has tested new record levels in each of the last seven consecutive quarters. It is not surprising that investors feel uneasy and are constantly second-guessing when the next correction might start. Call this behavioral finance—however, this continued skepticism is quite possibly what has kept S&P 500 momentum in check. If US fundamentals were weak, we believe we would not be sitting far from 2011 levels, a year that many have labeled a mini-recession. Yet, we stand 60% higher since then and are on path to soon break 2100. So what to expect in 2015?

We believe 2015 will turn out to be another positive year for US equities. Our positive outlook is primarily driven by: (1) solid momentum in US economic growth coupled with low inflation; (2) a materializing “wealth effect” and expected pickup in consumer spending; (3) better than expected 4Q14 and 1Q15 earnings coupled with strong guidance providing greater upside in the earlier parts of next year; (4) stimulus from lower commodity prices and continued lower financing costs; (5) increasing G4 liquidity and positive spillover effects from foreign central bank actions; and (6) strong US market technicals and corporate sentiment.

There are a number of solid fundamental drivers supporting our view. However, we remain optimistically cautious given concerns about global growth, deflation risk and transitions in global monetary policies. In that vein, we recognize that there is a larger than usual risk to our baseline forecast.

Remain constructive—price and earnings targets for 2015. We forecast the S&P 500 to reach 2,250 by year-end 2015. This implies 9% upside from current levels. EPS is expected to grow by 8% to $127. Positive earnings surprises and strong guidance are expected early next year on the back of already depressed expectations and likely pickup in consumer spending. However, full year should see slight negative revision to current bottom-up 2015 EPS consensus of $128.35. The benefit from lower oil prices is more immediate to the bottom line while the negative impact from rising dollar is more gradual (see pg. 13).

Our earnings growth forecast is driven by: (1) pick-up in revenue growth on the back of stronger expected US economic growth; (2) slight margin expansion benefitting from operating leverage and lower commodity prices; and (3) continued share buybacks given healthy corporate balance sheets with record high cash, low debt and strong cash flow generation.

Economic growth and labor market normalization—so far US economic recovery has been sub-par, featuring irregular, unbalanced and below trend growth that has been mainly investment driven. However, the middle two quarters of 2014 saw positive growth with domestic demand firing on all cylinders: consumption, capital spending, housing and government.

A continuation of this favorable trend is expected in 2015—solid growth with tame inflation. J.P. Morgan Economists forecast real GDP growth of 3.0% in 2015—with Q-o-Q expansion in 1H15 of 3.0%. Core CPI for 2014 is expected to be 1.8%—and is likely to remain tame and stable throughout 2015, with lower commodity prices and stronger dollar keeping a lid on inflation especially in the early part of next year. Further, the US labor market has seen strong improvement over recent quarters.

J.P. Morgan Forecasts — 2015YE

— S&P 500 Price Target: 2,250

— S&P 500 EPS: $127.00

— S&P 500 EPS (2014): $117.50

— VIX (2015 Average): 16

— US Real GDP: 3.00% y/y

— US Core CPI: 1.1% y/y

— Unemployment Rate: 5.4%

— First Rate Hike: 06/15 to 0.5%

— Fed Funds Target: 1.00%

— 10-yr Treasury: 2.80%

— Oil Price (Brent): $82/bbl

— EUR/USD: 1.18; USD/JPY: 128

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Unemployment rate is currently below 6% and we expect it to further tighten in 2015. This should put upward pressure on wage inflation and ultimately support consumer spending as well as the broader US equity market.

Expect the “wealth effect” to start materializing—a stronger US consumer should provide a lift to the equity market. While “wealth” creation has been strong thus far in this recovery, the absence of wage growth and a stubbornly high savings rate has limited the wealth “effect” from materializing. An already strong labor market that is expected to further tighten should drive wage growth. In turn, this should help the "wealth effect" materialize and further support consumer spending.

Additionally, global market dynamics should benefit the US consumer. Weaker China and strong supply is driving oil prices lower, thus providing savings through lower inflation. Weaker Eurozone and a lower Bund yield is exerting downward pressure on US treasury yields, thus providing prolonged cheaper financing. Bottom line, these trends should result in higher cash flow to the US consumer (e.g., higher disposable personal income, lower energy and food costs, lower financing costs) and encourage spending. With US being a consumer-driven economy, any pick-up in consumer spending should bode well for equity markets and especially consumer-based industries (See pg. 14).

A year of transition—J.P. Morgan is more hawkish than the Street, looking for first Fed rate hike mid 2015—although we do not expect that to derail US equities in the near term. With an improving labor market picture and expected above trend-line US growth, J.P. Morgan’s forecast looks for a first Fed rate hike to 0.5% in June 2015. We believe the transition in monetary policy will present a very different environment for policymakers and investor positioning going forward and may lead to increased market volatility.

While rising rates are typically a negative for equity markets, some evidence suggests that initial rate hikes do not necessarily derail equity returns. Market yielded a median return of 12.3% in the 12 months surrounding (i.e., +/-6 months around) the last 11 initial rate hikes. Intuitively, this makes sense especially for the initial hike—the Fed is unlikely to raise rates if the economy was fragile, in our view. Furthermore, equities have fared worst during tightening monetary policy periodsthat were accompanied by higher inflation, rising oil prices and higher long-term interest rates. None of these conditions are currently present in the US. Inflation is expected to remain tame and the cost of debt for corporations is likely to remain attractive until rates move a great deal higher. However, equity markets start slowing down later in the rate-cycle, typically 6 to12 months after the first rate hike. This could eventually take us into 2016 territory (see pg. 131).

Contrary to popular opinion, higher rates don’t necessarily mean higher interest expense today. In fact, our analysis suggests that weighted average maturity of S&P 500 debt is almost 10 years. Additionally, we expect the current record low effective interest rate of 2.4% that S&P 500 companies are paying to remain low. Companies are still rolling-off older debt that was issued at higher rates. All of this makes us believe that in the near-to-medium term financing costs of S&P 500 companies will remain less sensitive to rising rates. However, if Fed Fund rates do continually move higher as suggested by the FOMC dots, we estimate there will be a gradual headwind of around $10-15 to S&P 500 EPS over a period of 3-5 years (see pg. 37).

Rising US Consumer Cash Flow

Initial Fed Rate Hikes (since 1958)

Source: J.P. Morgan

DISPOSABLE PERSONAL INCOME(i.e. expected rise in wage growth)

+ENERGY & FOOD COSTS

(i.e. weaker China, lower oil prices…)

+FINANCING COSTS

(i.e. weaker Eurozone and lower Bund

Yield, thus low Treasury Yields…)

CASH FLOW TO US CONSUMER(i.e. increasing consumer spending)

S&P Performance

Around Initial Hikes

#

Hikes

6m

Before

6m

After

12m

Around

12m

After

Declining Oil 7 8.4% 7.7% 16.7% 8.8%

Increasing Oil 4 6.0% 2.6% 8.8% 2.2%

Low Inflation 4 9.1% 13.1% 23.2% 12.1%

High Inflation 7 6.6% 1.7% 8.4% 3.1%

Low Rates 2 10.0% 9.6% 20.8% 14.2%

High Rates 9 6.9% 5.0% 12.3% 4.6%

Median (all) 11 +6.0% +5.9% +12.3% +5.2%

S&P P/E Delta

Around Initial Hikes

#

Hikes

6m

Before

6m

After

12m

Around

12m

After

Declining Oil 7 +0.5x +1.0x +1.5x -0.3x

Increasing Oil 4 -0.2x -0.7x -0.9x -2.0x

Low Inflation 4 +1.1x +1.9x +3.0x +0.4x

High Inflation 7 -0.3x -0.5x -0.8x -1.7x

Low Rates 2 +1.0x +1.6x +2.6x +0.8x

High Rates 9 +0.0x +0.1x +0.2x -1.3x

Median (all) 11 -0.2x +0.1x +0.9x -1.4x

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For small cap stocks, negative implications are more immediate, as they depend on short-term bank financing with average maturity below 5 years that typically has variable rates—a direct negative in a rising rate environment.

Equity valuation is not cheap, but not very expensive either. Current P/E is at 18.4x and P/E (NTM) is at 17.3x. Depending on the valuation measure and the historical time frame used for comparison, current valuations are anywhere from in-line with historical average to slightly expensive. On a P/E (LTM & NTM), P/B, EV/Sales and EV/EBITDA basis S&P 500 is trading in-line or slightly above historical average, while based on Cash Flow Yield, the market still looks cheap. However, when normalizing current valuation for growth (i.e., PEG) or inflation (i.e.,Shiller’s CAPE or cyclically-adjusted P/E), the market looks stretched. In our view, CAPE may be overestimating equity valuation slightly given that current input costs—labor costs, financing costs, effective tax rate—are, and most likely will remain, structurally lower than on average during the last 10 years (see pg. 41).

Also, US equities look attractive relative to other US financial and non-financial asset classes. S&P 500 total yield (4.2%), including dividends and net buybacks, is above that of US 10-year treasury yield (2.3%), US municipal bond yield (2.2%) and US high grade corporate bond yield (3.8%). Housing is the only non-financial asset class that is cheaper than equities. From a global perspective, while US equities are rich relative to other G4 countries, we do not see that as a headwind as long as solid growth and economic momentum continue to persist in the US.

S&P 500 P/E multiple will stay largely unchanged in 2015. Equity valuation is not cheap and rising interest rates are typically a negative for the equity multiple.However, we believe that lower commodity prices, overall tame inflation and the fact that yields are rising from very low levels may provide some buffer. Additionally, positive supply/ demand technicals (i.e., strong expected M&A and buyback activity) should also provide some support to the multiple (see pg. 41).

Even though the current environment is unique, history provides some evidence that in the 12-month period surrounding the last 11 initial rate hikes the median P/E saw slight expansion, suggesting favorable economic and business conditions. Of those 11, only 2 initial rate hikes saw P/E contract. Those 2 periods were also associated with higher inflation, which we are not expecting to be the case in 2015. However, as expected a maturing rate cycle eventually did start to weigh in on the equity multiple. Assuming Fed hikes rates in mid-2015 and rates continue to tighten thereafter, this would become a bigger risk to US equities starting in 2016.

Given the sizable foreign revenue exposure (33.2%) of S&P 500, we believe a strengthening dollar could cause a meaningful valuation and earnings growth differential between domestic and US multi-national stocks. Historically, multi-nationals traded at a premium to domestic firms due to their exposure to faster growing markets. Recently this valuation trend reverted. Domestic companies are seeing stronger relative earnings growth and a 15% relative re-rating to multi-nationals, whose multiple has already contracted this year. We expect this divergence trend to persist, as the US dollar continues to strengthen.

Valuation Multiples

Source: J.P. Morgan

S&P 500 Revenue Exposure

Source: J.P. Morgan

S&P 500 Current

EV/Sales 2.2x

EV/EBITDA 11.2x

P/E (LTM) 18.4x

P/E (NTM) 17.3x

P/B 2.8x

P/E to Growth 1.45x

CAPE 26.5x

FCF Yield 5.0%

MV to NIPA Profits 15.7x

Nom GDP to MV of Equities 1.356x

P/E LTM 11/30/14 11/30/13 99 - '14 NTM

100% Domestic 19.8x 18.1x 16.0x 17.7x

2nd Quartile 21.4x 20.6x 18.4x 18.9x

3rd Quartile 20.0x 19.0x 19.0x 16.7x

>50% Foreign 19.0x 19.7x 19.2x 16.7x

S&P 500 20.0x 19.4x 18.1x 17.8x

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Where in the business cycle does the US stand and are we approaching recession territory? The latest reading from our top-down framework—which relies on various macro inputs—suggests that the US market is still in “expansion” stage. While 2013 was consistently characterized by the “expansion” stage, 2014 has been a constantly oscillating between “expansion” and “slowdown” as the market shifted gears and showed signs of fatigue. Since this summer, however, there has been a meaningful pick-up in macro activity with our top-down indicator more consistently pointing toward "expansion". Most supportive of this view are the growth indicators tied to the US except for the yield curve. Consumer sentiment is high and improving while earnings sentiment is soft. Inflation related indicators also show softening; however, we see that as a positive for US consumption and equity market. Credit conditions are good although they have reached the highest point in this cycle so far(see pg. 80).

This recovery has some further room to go, in our view. Examining 100+ years of history and all of the macro data available to us, 19 of the largest bull market peaks were preceded by a macro environment different from the one we are in today. Various indicators were examined, including short-term and long-term rates, yield curve behavior, inflation, oil price, profit margins and growth indicators. On average, a significant majority of these indicators were raising a red flag at previous market peaks. Today, however, of those indicators only the yield curve spread (narrow in historical terms and has been flattening) is worrisome for US equities. While that typically is seen as a negative for equity markets, technicals may be causing this dynamic currently—global yield scarcity (e.g., very low Bund yield exertingdownward pressure on the US 10Yr yield) (see pg.137).

Putting some numbers into perspective—since the Financial Crisis trough the S&P 500 is up 207% over almost 6 years, and since the European Debt Crisis trough the market is up 89% over little more than 3 years. In comparison, all recoveries since 1900 have yielded a mean return of 99% with a mean duration of 39 months. However, recoveries characterized by lower inflation and solid growth, similar to that of today, have on average been higher in magnitude at 140% return and longer in duration at almost 6 years. While it is premature to draw any substantial conclusion from such simplistic observations, we understand the concern of investors whowonder how close the equity market is to its cyclical peak.

Volatility Outlook—in our 2014 volatility forecast, we predicted that volatility would increase in H2 2014 due to the end of the Fed’s QE program and a turn in the rate cycle. October’s shock is an example of the market volatility we are likely to see in 2015 as the Fed increases rates, and the market adjusts to lower levels of liquidity. Our view is that volatility across assets in 2015 will look more like Q4 than H1 of 2014. This would translate into ~15% higher levels of volatility compared to 2014 averages, with the VIX averaging ~16 (median ~15.5).

In addition to asset volatility, levels of correlations are another important driver of equity portfolio risk. For long-short managers, high correlation also impacts portfolio returns by limiting managers’ ability to generate alpha. While correlations have declined from 2011 peak levels, average levels are substantially higher than what was observed in other periods of low volatility over the past 20 years. We believe that recent changes in correlation levels also point to low market liquidity, and elevated risk of a correlation spike similar to the ones we saw in 2010 and 2011.

Previous Market Peaks vs Today

Source: J.P. Morgan

Low Inflation Recoveries Have

Lasted Longer

Source: J.P. Morgan

Today

Historical

Indicator

Hit Rate

Fed Funds Rate high or rising 75%

10 Yr Bond Yield above trend 68%

Flat or Flattening Yield Curve ✓ 93%

High or Negative Inflation (CPI) 68%

Spike in Oil Price (inflation-adj) 74%

Declining EPS / GDP, Y/Y 68%

ISM declining or at extremes 67%

Since Mar 2009

Since Oct 2011

R² = 0.55

0

20

40

60

80

100

120

0% 5% 10% 15%

Mo

nth

s

Inflation Rate (CPI)

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Despite the perception that low levels of volatility and declining correlations are the environment most suitable for stock picking, we believe this is far from the truth. For instance, the average stock tracking error—a measure of alpha available to a long short manager—is currently at all time lows. It should not come as a surprise therefore that 2014 is on track to be one of the worst years for hedge fund closures since 2009 (461 HFs closed in the first half of 2014, compared to 1023 closed in 2009). Levels of dispersion are not equal across the market, and some sectors provide better opportunities to stock pickers than others. For instance, Energy and Discretionary sectors have relatively favorable levels of dispersion. Technology and Materials have below average correlations (see pg. 48).

Sector positioning—for sector recommendations we combine our top-down macro view with bottom-up fundamentals. Broadly, we look for sectors and industries with strong earnings and price momentum within a macro environment where the dollar is strengthening, oil remains near the current level, and interest rates are rising. With this in mind, our highest conviction sector pair is overweight Discretionary (a lift in consumer spending) and underweight Utilities (expensive valuation). Technology and Healthcare have secular earnings growth and support from M&A (see pg. 53).

More specifically, we would: overweight Consumer Discretionary on rising disposable income and expected wage growth, overall tame inflation with lower oil prices providing added stimulus, and relative underperformance in 2014 providing abetter entry point currently; overweight Technology on organic growth, strong margins, cheaper PEG than market, and supportive high shareholder yield at 4.5%; overweight Financials on increasing NIM from expected rising rates, higher domestic exposure, and third cheapest sector; overweight Healthcare on a longer-term strategic basis given secular growth with rising share of consumer wallet and strong M&A activity—however, we have a neutral view on a shorter-term tactical basis waiting for a better entry point and avoiding the expected early year momentum sell-off and value rally.

Our neutral sector views include: neutral Consumer Staples on rich valuation,lower beta to consumer spending than discretionary; neutral Industrials on expected benefits from investment spending but high exposure to E&P, negative correlation to rising dollar and rising interest rates; neutral Energy on overall poor visibility, high commodity volatility, and negative correlation to rising dollar.

Our underweight sector views include: underweight Materials on negative correlation to rising dollar, early cycle sector, and given that higher interest rates a negative for this capital intensive sector; underweight Telecom on constant price deflation, saturated market, and rising rates a negative; underweight Utilities as higher interest rates may be a catalyst for income investors to exit, especially with rich valuation and low organic growth.

Style investing—expect 2015 to be an active year in terms of style rotation. With the ever changing global macro environment and shifting monetary policies, we expect 2015 to be an active year in terms of style rotation. Our top-down framework marries phases of the economic cycle with optimal investment style returns. Currently our J.P. Morgan Composite Macro Indicator points toward a US economy that is in "expansion" stage. Using empirical analysis and historical tests from 1970s, the desired positioning in this phase of the cycle advocates for a balanced portfolio approach, such as growth-at-a-reasonable-price (GARP) or quality-at-a-reasonable-price (QARP).

2015 S&P 500 Sector Views

YTD S&P 500 Style Performance

Source: J.P. Morgan

Sector Rating

Discretionary OW

Technology OW

Financials OW

Healthcare OW

Staples N

Industrials N

Energy N

Materials UW

Telecom UW

Utilities UW

JPM Value 2%

JPM Grow th 4%

JPM Quality 1%

JPM Momentum 3%

JPM Low Vol 4%

JPM High Vol 0%

S&P 500 9%

Relativ e Return YTD 2014

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At the individual style level we recommend investors tilt toward Value and Momentum (i.e., stocks exhibiting strong earnings momentum and price momentum). Further, seasonal style effects can be quite pronounced especially in the first and last quarter of a year. Momentum effects tend to be the strongest starting in September and typically recede by November as investors take profit and start positioning for next year. Value has a tendency of achieving strong relative gains starting in December, accelerating in January, and lasting through April. This coincides with investors rebalancing their portfolios and bottom-fishing for new opportunities. With that in mind, we prefer Value over Momentum in early months of the year, and Momentum over Value in the later parts of the year (see pg. 76).

Deciphering market mood using style alignment—Glamour, Complacency and E-Motion. The alignment of stocks by style factors can tell us a lot about the “mood” of the market. Currently they suggest that the market has been: 1) Buying Glamour—in an environment where Growth is scarce, investors are prepared to forego Value premium just to get exposure to Growth; 2) Acting on E-Motion—investors are chasing Growth, and the interaction between Growth and Momentum is above average. This does raise risk to the Growth investment style, but the risk is not extreme as yet; 3) Rising Complacency—investors are increasingly taking on risk for a lower expected premium. We are still far from 2007 peak, but the trend is suggesting imbalance and may be a cause for some concern.

US Size positioning (Small-cap vs Large-cap)—there is potential for convergence, but be mindful of the Fed. Small-caps have been a painful trade in a rising 2014 market with the Russell 2000 significantly underperforming its larger S&P 500 peers by ~11%. This magnitude of such underperformance has occurred before, even though it is more commonly seen during multi-year period of Small-capunderperformance.

We have a positive shorter-term tactical view for US Small-caps going into early next year as we believe some convergence is likely to materialize. Expected M&A activity, rising CEO confidence and minimal foreign revenue exposure should help support our near-term view. Specifically, we recommend tilting toward Low Volatility and Momentum, and avoiding High P/E multiples. Our analysis suggests that such a portfolio composition should yield superior risk-adjusted returns.

However, the ultimate fate of this space will be closely tied to interest rates, market volatility and liquidity, and High Yield spreads. Interest rates remain the key risk for US Small-caps. As mentioned previously, small-cap companies typically depend on short-term bank financing with average maturity below 5 years that typically has variable rates—this is a direct headwind for their earnings in a rising rate environment. Given that J.P. Morgan forecasts rising rates coupled with higher volatility in 2015, our full year view is negative on US Small-caps relative to Large-caps (see pg. 94).

Global Small-cap positioning—from a global Small-cap perspective, our house view is to: 1) overweight developed markets (DM) over emerging markets (EM). EM valuations are not attractive and do not factor in the added risk versus DM counterparts, and EPS growth in EM is likely to remain relatively weak; 2) within DM to overweight Continental Europe over US. There is a large valuation gapwith Europe trading at a discount to US. Also, diverging central bank monetary policies should support this view, as US is expected to raise rates (a direct negative for Small-caps), while Europe is contemplating to adopt additional easing measures and inject further liquidity into the market (see pg. 98).

2015 S&P 500 Style Views

— Overweight Value

— Overweight Momentum

— Neutral Growth

— Neutral Quality

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Risks to our thesis—while we remain constructive on US equities for 2015, we are entering unchartered territory with the Fed expected to initiate a rate hike from the current zero interest rate level. Historically equities have weathered through initial rate hikes, but given the peculiarity of the current one, historical analysis and relationships may just not hold. One of the biggest risks of all for S&P 500 is an earlier than expected initial rate hike and/or a more aggressive hike schedule subsequently. J.P. Morgan is more hawkish than the Street and expects the initial hike in June 2015 with rates finishing at 1% by year-end. The market is not pricing in the first hike until late next year and is expecting substantially lower rates than the FOMC dots over the next two years.

There are plenty of other risks that could resurface and derail equities as the global economy remains on fragile footing: foreign economic slowdown and increasing global deflationary pressures; US growth disappoints and lack of consumer and corporate spending continues; accelerating rise in US dollar and deterioration of already record high profit margins; excessive decline in oil prices and implications that may have for energy sector, high yield market and oil exporting countries leading to contagion risk; very high federal government debt and risks of another debt ceiling showdown; geopolitical headwinds.

Further, lower market liquidity and higher market leverage in the US system makes equities very delicate and sensitive to potentially even small negative developmentsthat could possibly result in sharp corrections throughout the next year (see section on Volatility Outlook).

Recommended Investment Strategies and Themes for 2015

1) Get on Board the Airlines Industry (JPAMAIRL Index) —although the domestic Airlines sector has been a strong performer over the last 3 months (top US Airlines +13%, Transports +14%, Industrials +6%, SPX +4.5%), there are a number of reasons, both fundamental and technical, for the sector to continue its upward march in 2015 (see page 108).

2) Contrarian Energy Picks in a Low Oil Environment (JPAMENRG Index) — heading into a year in which oil is expected to remain low, we suggest going long a basket of Energy stocks that we believe are best positioned for a depressed oil environment. Contrarians who believe the overall sector is due for a rebound can consider call spreads on the Energy Sector ETF.

3) Consumer Spending Beneficiaries — favorable US and global market dynamics (i.e., higher disposable personal income driven by expected pickup in wage growth, lower energy and food costs driven by lower oil prices and tame inflation, lower financing costs given low interest rates) should result in higher cash flow to the US consumer and propel consumer spending. With US being a consumer-driven economy, any pick-up in consumer spending should bode well for equity markets and especially consumer-based industries.

4) Most Levered Financial Plays to Rising Interest Rates (JPAMFINL Index) — the Financials sector is (ex bond-proxy REITs) is one of our highest overweight conviction ideas on the expectation that rising interest rates will be a significant catalyst for performance due to two main reasons: 1) the space should benefit as rates rise from current depressed levels, and 2) valuation should

Fed Funds Rate Estimates

Source: J.P. Morgan

1.0

1.5

2.0

2.5

3.0

Sep-2013 Jan-2014 May-2014 Sep-2014

FOMC median

OIS

12



normalize as interest rates normalize and investors grow less concerned about banking system assets and financial system risk.

5) Sustainable Shareholder Yield (JPAMSYLD Index) — with rates expected to remain low, search for yield to continue, and a cautious investor base, shareholder-friendly companies with attractive total yields and strong cash flow generation should benefit from the current market environment.

6) Domestic Firms over US Multi-nationals (JPAMDREV Index) — S&P 500 has 33.2% of its revenue derived from abroad. Given that J.P. Morgan forecastsa strengthening US dollar, we prefer domestic firms over US multi-nationals(especially those with domestic production and high foreign exports). Additionally, there is more room for domestic stocks to re-rate higher given stronger expected earnings growth. On the contrary, US multi-nationals are already seeing multiple contraction and weaker earnings growth.

13



Price Target: S&P 500 Rises to 2250 in ‘15

We are establishing our 2015 price target of 2,250 based on $127 EPS and 17.7x P/E multiple. This price target assumes EPS growth of 8%.

S&P 500 price target of 2,250 implies 9% upside from current level of 2,060.

2015 EPS grows by 8% to $127 driven by stronger revenue growth on the backof economic momentum (see Figure 1). Slight margin expansion and continued share buybacks provide the remainder of EPS growth (see section on “Fundamentals’ starting on page 30).

P/E multiple remains unchanged versus current levels. J.P. Morgan’s forecast looks for the first rate hike mid-2015. Tame inflation, lower oil prices and positive supply/demand technicals (i.e., expecting strong M&A and buyback activity) are supportive of a stronger multiple.

History suggests initial rate hikes do not necessarily derail equities. While rising rates are typically a negative for equity markets, some evidence suggests that initial rate hikes do not necessarily derail equity returns. Market yielded a median return of 12.3% in the 12 months surrounding (i.e., +/-6 months around) the last 11intial rate hikes. Intuitively, this makes sense especially for the initial hike—the Fed is unlikely to raise rates if the economy was fragile (see page 25).

A decline in energy prices is a net positive for S&P 500 EPS through consumer spending. We believe benefits from oil decline and from tame inflation should offset negative impact from a strengthening US dollar and weakening Energy sector (oil is symptomatic of weaker global demand) in the near term (see pg. 27).

With sluggish foreign growth and yield scarcity likely to continue in 2015, flow dynamics may continue to favor US equities given that opportunities abroad and in other asset classes remain limited. We suggest investors remain constructive on US equities and where we see opportunities especially across specific themes, sectors (see pg. 53) and styles (see pg. 76).

Figure 1: S&P 500 Index Performance vs. EPS Growth

Actual EPS prior to 3Q 2014, estimates thereafter

Source: J.P. Morgan US Equity Strategy

6/07$92.15

9/09$50.81

12/14, $117.50

12/15, $127.00

1/91 1/93 1/95 1/97 1/99 1/01 1/03 1/05 1/07 1/09 1/11 1/13 1/15 1/17

0

500

1,000

1,500

2,000

2,500

$10.00

$30.00

$50.00

$70.00

$90.00

$110.00

$130.00

1/91 1/93 1/95 1/97 1/99 1/01 1/03 1/05 1/07 1/09 1/11 1/13 1/15 1/17

S&

P 5

00 In

dex

S&

P 5

00 L

TM

EP

S

LTM EPS S&P500 Index

J.P. Morgan Forecast

— 2015 S&P 500 price target of 2,250

— Implying 9.2% return upside

— EPS grows 8% to $127

14



S&P 500 Target Price Sensitivity to EPS Growth and P/E

In Figure 2, we show annual S&P 500 EPS growth, price performance, and the P/E (LTM) since 2004. If our thesis of 8% EPS growth with a slight multiple expansion were to materialize, this would slowly get us back to the same 18x P/E seen 10 years ago at the beginning of the previous bull market. Figure 3 shows target price sensitivity to EPS Growth and P/E (our base-case is highlighted in blue).

Figure 2: EPS Growth and PE MultiplesSince 2005

Source: J.P. Morgan and Factset

Figure 3: 2015 Price Target Sensitivity2015 EPS Growth and P/E Multiple

Source: J.P. Morgan Equity Strategy

Macro: The Rise of the Consumer

In this section we examine the basic GDP components1, including J.P. Morgan Economic forecasts2 and their implications for stock market, and discuss the growth drivers for each. On the income side we see rising disposable income for consumers, increasing profitability for Corporates, and stronger budgets across all levels of the Government, which are benefiting from higher revenues from payroll taxes and rising asset values.

The expenditure side of the picture also looks constructive: Consumers should come out of the trenches and act on pent-up demand; healthy cash flows and rising capacity utilization rates should support capital Investments; and Government spending is expected to go from a slight drag to positive growth. The view is tempered a bit with a stronger dollar and weaker growth abroad transmitted via weaker exports.

GDP = Consumers Lift all Boats + I + G + X. For 2015, consumers are expected to expand spending by 2.9% and this should be achievable due to: (1) expanding employment and rising wages; (2) lower inflation imported from abroad; (3) stronger effect from recent wealth accumulation; and (4) rising confidence that may result in expanding household leverage.

1 GDP = Consumption (C) + Investment (I) + Government Spending (G) + Net Exports (X)2 For more details on J.P. Morgan Economic forecasts see 2015 US Economic Outlook

S&P 500 Earnings S&P 500 Index P/E — Contraction/Expasnion

Date EPS

YoY

Growth Level

YoY

Change P/E Δ

Contraction/

Expansion

2004 $67.10 38% 1,212 9% 18.1x — —

2005 $76.28 14% 1,248 3% 16.4x -1.7x Contraction

2006 $88.18 16% 1,418 14% 16.1x -0.3x Contraction

2007 $85.12 -3% 1,468 4% 17.3x 1.2x Expansion

2008 $65.47 -23% 903 -38% 13.8x -3.5x Contraction

2009 $60.80 -7% 1,115 23% 18.3x 4.5x Expansion

2010 $85.28 40% 1,258 13% 14.7x -3.6x Contraction

2011 $97.82 15% 1,258 0% 12.9x -1.9x Contraction

2012 $103.80 6% 1,426 13% 13.7x 0.9x Expansion

2013 $109.68 6% 1,848 30% 16.9x 3.1x Expansion

2014E $117.50 7% 2,060 11% 17.5x 0.7x Expansion

2015E $127.00 8% 2,250 9% 17.7x 0.2x Expansion

2004-15 Δ $59.90 89% 1,038 86% -0.3x <-- Flat since 2004!!!

###### 15.7x 16.7x 17.7x 18.7x 19.7x

6% 1,955 2,080 2,205 2,329 2,454

7% 1,974 2,100 2,225 2,351 2,477

8% 1,994 2,121 2,248 2,375 2,502

9% 2,011 2,139 2,267 2,395 2,523

10% 2,029 2,158 2,288 2,417 2,546

P/E Multiple

EP

S G

row

th (2

015)

J.P. Morgan Economic Forecasts:

— Consumer spending expected to

expand at real growth of 2.9%

— Investments growth to remain

supported by 8.7% increase in

residential investment and 6.0% growth in business investment

— Fiscal policy becomes less of a

drag on Government spending

— In sum, stronger expected

economic growth should translate to

stronger revenue and earnings growth, supporting equity returns

https://jpmm-internal.jpmchase.net/research/ArticleServlet?doc=GPS-1569848-0&referrerPortlet=landing_economics_editors_choice

15



GDP = C + Solid Investment Growth + G + X. J.P. Morgan Economics is expecting solid investment growth driven by 8.7% increase in residential investment and 6.0% increase in business investments.

GDP = C + I + Government Fiscal Drag Fading + X. After a 2.0% contraction in 2013 followed by a flat -0.1% in 2014, Government spending is expected to expand by 1.2% driven by State and Local governments in 2015. Furthermore, J.P. Morgan Economists expect drags associated with the fiscal cliff to fade with spending expected to increase slightly in the future.

GDP = C + I + G + Net Exports a Headwind. Exports to be a drag on GDP with imports growing at a faster rate of 5.4% than exports at 4.4% in 2015. This combined with the stronger dollar is expected to shave 0.4% from US GDP.

Figure 4: 2014 Real GDP Growth Drivers% contribution to Real GDP

Source: J.P. Morgan

Figure 5: 2015 Drivers for Real GDP Growth% contribution to Real GDP

Source: J.P. Morgan

GDP = Consumers Lift all Boats + I + G + X

We view J.P. Morgan forecast of 3.0% real GDP growth coupled with sub-2% core CPI as setting up for a favorable environment for equities. Our Economics team expects 2.9% real growth in consumer spending in 2015 vs. 2.3% in 2014.

We believe consumers are up to the higher task with the following drivers in place: (1) expanding employment and rising wages; (2) lower inflation imported from abroad (i.e., weaker China, weaker commodities); (3) stronger effect from recent wealth accumulation; and (4) rising confidence may result in expanding household leverage. All of the above, coupled with lower financing costs, should increase US consumer cash flow—a positive for equities and especially consumer driven industries.

(1) Expanding employment and rising wages

Since the start of this recovery, the jobless claims steadily declined from a peak of 665k to around 300k. The recovery in jobless claims has been coincident with a decline in the unemployment rate from 10% to 5.8% along with a gain of about 10 million jobs (see Figure 7).

J.P. Morgan Economists expect 185K average monthly payroll gains to push unemployment rate down to 5.4% by YE 2015. If the economy were to create 2.2 million jobs in ‘15, this should provide a disposable income boost of ~$100b.

2.2%

1.6%

0.8% 0.0%

-0.36% -0.14%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

Con

sum

ptio

n(C

)

Inve

stm

ent (

I)

Gov

ern

men

t (G

)

Ne

t Exp

orts

(X)

Inve

ntor

y (I

nv)

Rea

l GD

P

2014

3.0%

2.0%

1.1%0.2%

-0.43% -0.01%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

Co

nsum

ptio

n(C

)

Inve

stm

ent (

I)

Go

vern

men

t (G

)

Net

Exp

orts

(X)

Inve

ntor

y (I

nv)

Rea

l GD

P

2015

US consumer cash flow is

expected to increase, driving spending—benefit for equities

16



Tighter labor markets provide a lift to wages. Until now the slack in the labor market has largely kept a lid on wage growth. As the unemployment rate declines to around 5.4% by mid-2015, according to J.P. Morgan Economics, there is a tendency toward larger increases in hourly labor compensation (Phillips curve).

So far during this recovery, the BLS ECI index averaged around 1.8% compared to 3.4% seen during the prior recovery. Given that total wage compensation is roughly $7 trillion in the U.S., every 100bp increase in wages means $75b ofcompensation (before taxes).

Figure 6: Jobless Claims still decliningClaims continue to decline…

Source: J.P. Morgan and Bloomberg

Figure 7: Cumulative Growth in PayrollRecovered all jobs lost + 1.7 million


Figure 8: BLS Employment Cost IndexQoQ, sa%


(2) Declining inflation is equivalent to tax cut for US consumers

Since the beginning of September, the consensus 2015 inflation expectation (US CPI YoY%) has fallen by 50bps to 1.7%—sub-2% inflation level should quell inflation fears and keep the Fed from turning too hawkish, which supports a case for higher equity multiples. This lowered inflation expectation is coincident with a rise in real GDP to the strongest level seen during this recovery (consensus at 3% for 2015).

If the net effect of lower inflation is lower prices for all goods and services, this 50bp decline could mean $60 billion in savings for the US consumers in 2015.

Figure 9: Consensus pushing CPI expectation lower for 2015

Bloomberg consensus

Source: J.P. Morgan and Bloomberg Consensus

400

600

800

1000

1200

1400

1600

1800

2000

2200

200

250

300

350

400

450

500

550

600

650

700

1/95 1/99 1/03 1/07 1/11 1/15

S&

P 5

00

Jobl

ess

Cla

ims

Jobless Claims (4Wk Avg)

S&P 500

2/10, (8,710)

1,680

(11,000)

(9,000)

(7,000)

(5,000)

(3,000)

(1,000)

1,000

3,000

1/08 10/08 7/09 4/10 1/11 10/11 7/12 4/13 1/14 10/14

Cum

ulat

ive

Gro

wth

in P

ayro

ll (in

000

's)

2.8%

1.8%

3.4%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

12/96 4/00 8/03 12/06 4/10 8/13

Em

plo

ymen

t Co

st In

dex

(SA

, Qo

Q%

)

BLS ECI QoQ, SA Current Recovery Avg

Post 2002 Avg

9/14, 2.20

1.70

1.5

1.6

1.7

1.8

1.9

2.0

2.1

2.2

2.3

10/13 12/13 2/14 4/14 6/14 8/14 10/14

2015

Co

nse

nsu

s C

PI

Exp

ecta

tio

n

17



The two forces driving inflation expectations lower are stronger dollar and declining energy prices. On the dollar front, the combination of divergent monetary policies and stronger relative US economic growth is providing a lift to the dollar—a lift that typically translates to higher consumer spending, stronger economy, and rising equity multiples. Given that US is a consumption-driven economy, a stronger dollar means higher purchasing power and potentially higher growth in the near term.

The US economy is surprising to the upside while Eurozone and Emerging Markets continue to disappoint (as shown in Figure 10 below). In a world with anemic growth, US economy could be seen as a relatively safe haven for global investors and US equities could benefit from incremental flows (recently equity flows have reversed in favor of domestic over international stocks; see Domestic Firms over US Multinationals Theme.

Secondly, the diverging monetary policy is also expected to benefit the dollar. As shown in Figure 11, the Fed is expected to raise interest rates the most followed by UK, while rates in Eurozone and Japan are expected to remain unchanged at near 0%. China is expected to cut rates by 25bp by end of 2015.

Figure 10: Diverging Economic Growth: Economic Surprise IndexUS, Eurozone, and Emerging Markets


Figure 11: Diverging Monetary PolicyIncreasing rates in the US vs. EM and DM

Source: J.P. Morgan Economics

The other factor driving inflation lower is sharply lower input prices driven by lower energy prices. In recent months, crude prices have declined largely due to excess supply and lower global demand. While the J.P. Morgan view does expect a major improvement for these commodities, a sharp reversal would be a risk to our thesis.

Overall, the US economy expanding at the strongest rate in this cycle, with inflation below 2%, should be a boon to consumer spending. And typically, what is good for US consumers is usually great for the equity market.

(3) Positive job outlook and rising confidence could unleash the Wealth Effect

This recovery has generated $25 trillion in additional Wealth; however, the Effect remains elusive. In other words, the incremental paper wealth has had less than expected impact on consumer outlays. The rising consumer confidence and a more positive job outlook (e.g., job quitters are gaining in number) could help to improve the conversion of wealth to spending in 2015.

The general rule of thumb for wealth effect based on J.P. Morgan Economics research is that for every $1 increase in wealth there is a corresponding 3.8 cent increase in consumer spending.

18

-32.4

-17.3

-100

-80

-60

-40

-20

0

20

40

60

80

100

2010 2011 2012 2013 2014

Cit

igro

up

Eco

no

mic

Su

rpri

se In

dex

US Eurozone Emerging Markets J.P. Morgan Economics Forecast

Current Dec '14 Mar '15 Jun '15 Sep '15 Dec '15 Delta

US 0.125% 0.125% 0.125% 0.500% 0.750% 1.000% 0.875%

UK 0.50% 0.50% 0.50% 0.75% 1.00% 1.25% 0.750%

Euro Area 0.05% 0.05% 0.05% 0.05% 0.05% 0.05% 0.000%

Japan 0.05% 0.05% 0.05% 0.05% 0.05% 0.05% 0.000%

China 5.60% 5.60% 5.35% 5.35% 5.35% 5.35% -0.250%

Stronger dollar, lower oil, and overall tame inflation is

providing an effective tax cut for

the US consumer—benefit for equities

Rising consumer confidence and

a positive job outlook should

help improve conversion of wealth to spending in 2015—

benefit for equities

18



Using this calculation, a 5% increase in wealth on the current base of around $80 trillion would imply $150 billion in additional consumer spending.

Figure 12: Total Wealth from Financial Assets and Housing

YTD as of 2Q14

Source: J.P. Morgan and Federal Reserve Funds Flow Data as of 2Q14

Historically, consumers tend to save less and spend more with rising wealth. As shown in Figure 13, savings rate and wealth/income ratio are correlated. More recently, however, this relationship has not held with savings rate pegged at a higher level even with the steadily improving wealth/income ratio. The current level of wealth-income ratio would suggest a savings rate less than 4%.

Similarly, wealth is increasing at a faster rate than consumption (in Figure 14). While this effect might be explained by a more frugal and less levered consumer, perhaps with more consumer confidence and job outlook there might be a tipping point. If this were to happen in 2015, this would benefit equities and be a significant driver of outperformance for consumer linked industries.

Figure 13: US Household Wealth and Saving Rate

Current wealth/income ratio would imply savings rate below 4%....


Figure 14: Wealth vs ConsumptionConsumption has been lagging wealth growth...

Source: J.P. Morgan Economics report titled "US: the incredible shrinking wealth effect" dated April 11, 2014.

$495 $143

($668)

$5,187

$6,691 $5,677

$4,291

$209

($10,401)

$1,720

$4,203

$1,057

$5,693

$9,229

$2,545

(14,000)

(12,000)

(10,000)

(8,000)

(6,000)

(4,000)

(2,000)

0

2,000

4,000

6,000

8,000

10,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 YTD

Agg

rega

te W

ealth

Effe

ct (

$bn)

Wealth Effect from Financial Assets Wealth Effect from Housing Total Δ in Wealth

2%

4%

6%

8%

10%4.2

4.8

5.4

6.0

6.6

1985 1990 1995 2000 2005 2010

Wealth-income ratio(inverted)

Saving rate

82

84

86

88

90

92

94

450

500

550

600

650

700

1952 1960 1968 1976 1984 1992 2000 2008

Wealth to Income (LHS)

Consumption to Income (RHS)

Improving wealth-to-income

ratio typically encourages lower savings rate and drives

consumption—benefit for

equities

https://markets.jpmorgan.com/research/email/-f6i9tij/GPS-1365964-0

19



Similar to consumption, the more frugal consumer has not increased leverage

As shown in the figures below, the household debt (as % of GDP and personal income) has steadily declined after the last recession with these metrics at levels last seen in 2002.

As for debt service ratio, which takes into account the current low interest rate environment, this metric is at its best historical levels with debt payment to income at 9.9% (in 2007 this was at the worst level in history at 13.2%).

We wonder if the improvement in the job outlook could drive a pent-up consumption demand in part driven by rising household leverage.

Figure 15: Household Debt to GDP & Personal IncomeSince 1980


Figure 16: Debt Service Ratio (Debt Payment to Income)Since 1980


The net effect is a supportive consumer spending environment with markedly higher disposable income, increasing wealth effect, and rising household leverage. We believe the immediate industries likely to benefit are goods and services that have smaller ticket prices, such as Retail and Restaurants, and mid-ticket prices, like Airlines and Hotels, especially with oil prices down. Then household items that require access to revolving credit and greater use of equity lines (Autos and Home Furnishings) should improve most with increasing household leverage, in our view. Also, categories with higher ticket items like Autos and Furnishings seem to be the most depressed compared with historical average. As shown in Figure 17, Auto SAAR has bounced back from the abyss but remains one standard deviation below historical average. As for retail sales as % of disposable income, this metric is alsobelow its pre-recession average around 29.5%. Given the sustained low rate of consumption for several years, an argument can be made for pent up demand as these metrics should bounce above average levels to replenish aging durable goods.

77.0

3/09, 114.0

91.0

30

50

70

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130

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5/84

7/88

9/92

11/9

6

1/01

3/05

5/09

7/13

9/17

Household Debt as % of GDP

Household Debt as % of Personal Income

Record low debt service ratio

coupled with strong consumer

confidence should lift consumer leverage and thus spending—

benefit for equities

20



Figure 17: Auto SAAR (in millions)Since 1976


Figure 18: Retail Sales ex Autos/Parts as % of Disposable IncomeSince 1992


Figure 19: Consumption Trend by Category

Since 1950

Source: J.P. Morgan and Bureau of Economic Analysis

17.1

18.3

8.0

10.0

12.0

14.0

16.0

18.0

20.0

22.0

1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016

Au

to S

aar

(in

mill

ion

s)

+/- 1 std dev of trendline since '76

Above Avg # of Cars Purchased...

Below Avg # of Cars Purchased...

28.0%

28.9%

26%

27%

28%

29%

30%

31%

32%

1992 1995 1998 2001 2004 2007 2010 2013

Mo

nth

ly R

etai

l Sal

es a

s %

of D

isp

osab

le In

com

e

Retail Sales ex Autos/Parts % of Disposable Income Avg since (1992)

Retail Sales as % of disposable income Below Avg...

Retail Sales as % of disposable income ABOVE Avg...

% of Total Consumption Avg monthly since 1950

PERSONAL CONSUMPTION CATEGORIES: 195

0-1

959

196

0-1

969

197

0-1

979

198

0-1

989

199

0-1

999

200

0-2

009

201

0

201

1

201

2

201

3

201

4

Lat

est

Me

dian

STD

ev

+/-

STD

ev

from

Avg

Durable goods 15% 14.5% 14.6% 13.6% 12.8% 12.4% 10.5% 10.5% 10.8% 10.9% 10.9% 10.9% 13.7% 1.4% -2.0

Motor vehicles and parts 6% 6.1% 5.9% 5.7% 5.2% 4.5% 3.4% 3.4% 3.6% 3.6% 3.7% 3.8% 5.4% 0.9% -1.8

Furnishings and durable equipment 5% 4.6% 4.2% 3.5% 3.0% 2.9% 2.5% 2.4% 2.4% 2.4% 2.4% 2.4% 3.8% 1.0% -1.4

Recreational goods and vehicles 2% 2.4% 2.9% 2.8% 3.0% 3.4% 3.1% 3.0% 3.0% 3.0% 3.0% 3.0% 2.8% 0.5% 0.5

Other durable goods 1% 1.4% 1.6% 1.6% 1.6% 1.6% 1.6% 1.7% 1.7% 1.8% 1.7% 1.7% 1.6% 0.1% 1.3

Nondurable goods 42% 37.1% 33.1% 28.2% 23.9% 22.3% 22.5% 23.1% 23.0% 22.7% 22.4% 22.5% 31.8% 7.9% -1.2

Food and beverages (off-premises) 21% 16.9% 14.6% 11.4% 9.0% 7.7% 7.7% 7.8% 7.7% 7.6% 7.5% 7.5% 13.5% 5.1% -1.2

Clothing and footwear 9% 7.5% 6.5% 5.5% 4.7% 3.5% 3.1% 3.2% 3.2% 3.1% 3.1% 3.1% 5.9% 2.1% -1.3

Gasoline and other energy goods 5% 4.3% 4.5% 4.0% 2.7% 3.0% 3.3% 3.8% 3.7% 3.6% 3.5% 3.5% 4.1% 0.9% -0.7

Other nondurable goods 8% 8.4% 7.5% 7.3% 7.5% 8.0% 8.3% 8.4% 8.4% 8.4% 8.4% 8.5% 7.9% 0.4% 1.6

Household Expenditures (for services) 44% 46.8% 50.7% 56.4% 61.2% 62.8% 64.3% 63.8% 63.6% 63.8% 64.0% 63.9% 57.1% 6.5% 1.0

Housing and utilities 17% 17.2% 17.1% 18.4% 18.2% 18.1% 18.7% 18.3% 18.1% 18.2% 18.3% 18.2% 18.0% 0.6% 0.2

Health care 5% 5.9% 8.6% 11.4% 14.1% 15.0% 16.6% 16.5% 16.7% 16.7% 16.7% 16.7% 11.4% 3.8% 1.4

Transportation services 3% 2.8% 3.2% 3.2% 3.6% 3.3% 2.9% 2.9% 2.9% 2.9% 2.9% 2.9% 3.2% 0.3% -0.8

Recreation services 2% 2.1% 2.3% 2.7% 3.6% 3.8% 3.8% 3.7% 3.8% 3.8% 3.8% 3.7% 2.8% 0.7% 1.3

Food services and accommodations 6% 6.1% 6.7% 6.7% 6.4% 6.0% 6.1% 6.1% 6.2% 6.2% 6.3% 6.3% 6.2% 0.3% 0.2

Financial services and insurance 4% 4.4% 5.2% 6.4% 7.4% 7.7% 7.5% 7.4% 7.1% 7.2% 7.4% 7.4% 6.6% 1.3% 0.6

Other services 8% 8.3% 7.8% 7.6% 8.0% 8.7% 8.9% 8.8% 8.8% 8.8% 8.8% 8.7% 8.2% 0.5% 1.1

Nonprofit Institutions 2% 1.6% 1.6% 1.8% 2.1% 2.6% 2.7% 2.6% 2.6% 2.7% 2.7% 2.7% 1.8% 0.4% 2.2

Note: Green if greater than last period, Red if less than last period.

21



GDP = C + Solid Investment Growth of 6% + G + X

During the last recession, private investment spending suffered the largest and most drawn out contraction of the four GDP components as consumer thirst for new homes dried up with the tightening of credit. However, since the start of the recovery, investment spending has seen the strongest, yet the most uneven recovery—some quarters growing at a double-digit saar along with some seeing outright contraction in spending.

Stronger investment growth (specifically residential) should directly benefit HomeBuilders, Building Products, Construction Materials, Paper & Forest Products and broadly a pickup in Capex will benefit IT Equipment and Software

While this volatility in investment spending is not new, the depressed levels for certain categories make a case for continued expansion in spending. As shown in Figure 20 below, the current Fixed Investment as % of GDP remains below average at 16.5% and could see growth with the expected increase in structures.

J.P. Morgan Economists expect total investment growth of 6.0% in 2015 driven by a 8.7% increase in residential investment ("homes”) after disappointing 1.7% growth in 2014. Residential investment is still more than 40% below peak levels seen prior to the recession.

As for equipment spending, all sub-categories are at peak levels with transportation seeing the most robust recovery in investment during this cycle. Interestingly, the growth in technology equipment spending has trailed the growth in industrial equipment.

Drilling activities fall into non-residential structures ("mining exploration"), which could be at a risk with sharply lower energy prices. According to J.P. Morgan Economist Michael Feroli, this sector makes up 8% of total capex and its share of GDP is only 0.9%—a sharp decline is estimated to impact GDP by a few tenths.

Figure 20: Private Fixed Investment still below average but rising…

Since 1947

Source: J.P. Morgan Economics Database

Declining vacancy may be a sign of rising housing starts

The homeowner vacancy rate has seen a steady improvement and the current 1.8% rate is back to 2005 level. As shown in Figure 21, this metric tends to lead the

16.5%

Average, 17.2%

10%

12%

14%

16%

18%

20%

22%

1947 1955 1963 1971 1979 1987 1995 2003 2011

Private Fixed Inveestment as % of GDP

Average

Stronger investment growth should directly benefit Home Builders, Building Products, Construction Materials, Paper & Forest Products, IT Equipment and Software

22



recovery in housing starts. This is intuitive and a low vacancy rate is a sign of a healthy market for new homes.

As shown in Figure 22, housing starts remain at a depressed level of 4.3 starts per 1000 population. This low level of housing starts together with functional obsolescence of the existing housing stock and the continued growth in household formation implies further reduction in housing inventory. The drop in inventory will eventually stimulate higher level of housing construction. Furthermore, on the demand side, an improving job market, low interest rates, improving credit environment and marriage- driven household formation all make a case for growth in housing.

Figure 21: Housing Starts vs. Vacancy RatesSince 1947


Figure 22: Housing Starts per 1000 Pop (age > 19)Since 1947


Corporate Capital Expenditure has been less than robust so far…

Corporate data gives us a similar picture with capital expenditures at lower levels than in recent decades. S&P 500 (ex-financials) companies are spending fewer dollars on capital investments compared to the previous two decades. This may be driven by the declining investment in structures combined with lower dollars spent on “old technology” products and services that are constantly suffering price declines.

Figure 23: Non-Financial Total Capex as % of Total AssetsQuarterly 1952-2013

Source: J.P. Morgan and Federal Reserve

Figure 24: S&P (ex-Financial) Total Capex as % of Total AssetsSince 1996


1,009

1.8

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) -IN

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Avg: 12.3

Avg: 10.2

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1/47 1/55 1/63 1/71 1/79 1/87 1/95 1/03 1/11 1/19

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>19)

Housing Starts per 1000 Pop (age >19)

Avg since '90

Avg '47-'90

Avg since (1947)

Housing Starts ABOVE Avg. Babyboom homeownership...

Housing Starts rise due to an increase in 2nd home purchases...

3.0%

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1952 1960 1968 1976 1984 1992 2000 2008

Capex as % of Total Assets

Current Level

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23



GDP = C + I + Government no Longer a Drag + X

The second largest and most stable component of the GDP is finally expected to make a positive contribution. After a 2.0% contraction in 2013 followed by flat 2014, J.P. Morgan Economists expect Government spending to expand by 1.2% driven by State and Local governments in 2015. Furthermore, drags associated with the fiscal cliff are expected to fade and spending is expected to increase slightly.These incremental dollars could go into Aerospace & Defense, Construction & Engineering and government linked Real Estate.

GDP = C + I + G + Net Exports a Headwind

J.P. Morgan Economists expect net exports to be a slight drag on GDP growth with imports growing at a faster rate (5.4%) than exports (4.4%) in 2015. The declining net exports is expected to shave 0.4% from US GDP.

The Net Exports drag is likely to negatively impact low margin Industrial, Technology and Energy Equipment, Automobiles, and Auto Components

Advancements in hydraulic fracturing and horizontal drilling methods resulted in a renaissance in energy exploration and production in the US. With a severe decline in oil prices, it remains to be seen if the path to energy independence will take a step backward as wildcatters deploying the latest technology may find it difficult to continue drilling profitably at WTI below $65. As shown in the figure below, the falling dollar combined with lower oil imports were significant drivers for the improvement in net exports. The actual impact of these factors becoming potentially less constructive remains to be seen.

Figure 25: Net Exports as % of GDP versus US Trade-weighted Dollar

Since 1973


40

80

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Net Exports as % of Total GDP

US Trade-weighted Dollar

Increase in Government spending

could benefit Aerospace &

Defense, Construction & Engineering and government

linked Real Estate

Net Exports drag to continue

and negatively impact low margin Industrial, Technology

and Energy Equipment,

Automobiles, Auto Components

24



Figure 26: J.P. Morgan Economics Projections Through 2015

2Q14 and 3Q14 Actual; 4Q14 and 2015 Projections


2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 2013 2014 2015 2013 2014 2015

Gross domestic productReal GDP 4.6 3.9 2.5 3.0 3.0 2.5 2.5 3.1 2.2 2.7 2.2 2.3 3.0 Final sales 3.2 4.1 2.8 3.0 3.0 2.6 2.5 2.6 2.2 2.8 2.1 2.2 3.0 Domestic 3.4 3.2 3.0 3.4 3.4 2.9 2.8 2.2 2.6 3.1 1.9 2.3 3.2 Consumer spending 2.5 2.2 3.1 3.3 3.3 2.8 2.5 2.8 2.3 2.9 2.4 2.3 2.9 Business inv estment 9.7 7.1 6.3 5.7 5.5 5.0 5.0 4.7 6.1 5.3 3.0 6.2 6.0 Equipment 11.2 10.8 6.0 8.0 8.0 7.0 7.0 6.2 6.6 7.5 4.6 6.8 8.0

Structures 12.6 1.1 8.0 3.0 2.0 2.0 2.0 4.5 6.0 2.2 -0.5 7.8 3.9

Intellectual property products 5.5 6.4 5.5 4.0 4.0 4.0 4.0 2.7 5.5 4.0 3.4 4.2 4.7

Residential inv estment 8.8 2.7 6.0 11.0 11.0 10.0 10.0 6.9 2.9 10.5 11.9 1.7 8.7 Gov ernment 1.7 4.2 0.0 0.9 0.9 0.9 0.9 -1.9 1.2 0.9 -2.0 -0.1 1.2

Net ex ports ($bn, chained $2009) -460 -431 -444 -464 -482 -501 -516 - - - - - -Ex ports (goods and serv ices) 11.0 4.9 4.0 3.5 3.8 3.8 4.5 5.1 2.4 3.9 3.0 3.2 4.4Imports (goods and serv ices) 11.3 -0.7 5.5 6.0 6.0 6.0 6.0 2.5 4.5 6.0 1.1 3.7 5.4Inv entories (ch $bn, chained $2009) 84.8 79.1 68.6 69.9 70.8 68.6 69.2 - - - - - -Contribution to real GDP grow th (% pts):Domestic final sales 3.5 3.3 3.0 3.4 3.4 2.9 2.8 2.3 2.6 3.1 1.9 2.4 3.2Net ex ports -0.3 0.8 -0.3 -0.4 -0.4 -0.4 -0.3 0.3 -0.3 -0.4 0.3 -0.1 -0.2Inv entories 1.4 -0.2 -0.3 0.0 0.0 -0.1 0.0 0.5 -0.1 0.0 0.0 0.0 0.0Income and profits (NIPA basis)Adjusted corp profits 38.3 8.6 8.0 8.0 6.0 5.0 5.0 4.7 2.2 6.0 4.2 -0.4 8.7Real disposable personal income 3.1 2.3 4.0 3.8 3.0 2.5 2.5 -1.9 3.2 2.9 -0.2 2.5 3.2

Sav ing rate1 5.1 5.0 5.2 5.4 5.3 5.2 5.2 - - - 4.9 5.1 5.3

Prices and labor costConsumer price index 3.0 1.1 -0.4 0.5 1.9 2.0 2.0 1.2 1.4 1.6 1.5 1.7 1.1

Core 2.5 1.3 1.7 1.8 1.9 2.0 2.0 1.7 1.8 1.9 1.8 1.8 1.8Producer price final demand index 2.4 1.3 1.0 1.2 1.9 2.0 2.0 1.2 1.7 1.8 1.3 1.7 1.5

Core 1.1 1.3 1.5 1.6 1.6 1.7 1.7 1.1 1.8 1.6 1.1 1.6 1.5PCE deflator 2.3 1.3 -0.1 0.5 1.6 1.7 1.7 1.0 1.2 1.4 1.2 1.4 1.0

Core 2.0 1.4 1.4 1.6 1.6 1.7 1.7 1.3 1.5 1.6 1.3 1.4 1.6GDP chain-ty pe price index 2.1 1.4 1.2 1.3 1.6 1.7 1.7 1.4 1.5 1.6 1.5 1.5 1.5S&P/C-S house price index (%oy a) 7.1 6.0 5.0 4.6 4.2 3.9 3.6 10.8 5.0 3.6 9.6 6.9 4.1

Productiv ity 2.9 2.3 1.5 1.5 1.5 1.5 1.3 2.0 0.5 1.4 0.9 0.9 1.7

Other indicators

Housing starts (mn units, saar)1 0.985 1.033 1.100 1.170 1.250 1.290 1.310 - - - 0.930 1.011 1.255

Industrial production, mfg. 7.0 3.9 2.5 3.0 3.0 3.0 2.5 2.9 3.7 2.9 2.6 3.4 3.2

Capacity utilization, mfg. (%)1 77.1 77.4 77.6 77.7 77.8 77.9 77.9 - - - 76.1 77.1 77.8

Light v ehicle sales (mn units, saar)1 16.5 16.7 16.7 16.7 16.8 16.8 16.8 - - - 15.5 16.4 16.8

Unemploy ment rate1 6.2 6.1 5.7 5.5 5.4 5.3 5.2 - - - 7.3 6.2 5.4

Pay roll employ ment (ch, '000s, samr)1 267 239 210 210 190 180 160 - - - 194 226 185

Nominal GDP 6.8 5.3 3.7 4.3 4.6 4.2 4.2 4.6 3.7 4.4 3.7 3.8 4.5

Current account balance ($bn)1 -102.3 -111.0 -100.1 -93.6 -102.3 -111.1 -117.8 - - - -400.3 -415.5 -424.8

% of GDP -2.4 -2.5 -2.3 -2.1 -2.3 -2.4 -2.5 - - - -2.4 -2.4 -2.3

Federal budget balance ($bn)1 - - - - - - - - - - -680.0 -483.0 -470.0

% of GDP - - - - - - - - - - -4.1 -2.8 -2.6

%q/q, saar %q4/q4 %y /y

25



What does Monetary Tightening mean for Equities?

The six-year zero interest rate policy experiment appears to be in its final stretch as we enter 2015. J.P. Morgan Economics forecast calls for an initial Fed rate hike in June 2015.

While rising rates are typically a negative for equity markets rising rates are typically a negative for equity markets, we do not expect the initial hikes to derail equity returns. However, as we approach the mid-to-late part of the cycle we expect equities to come under pressure.

Observing over 60 years of history we identified 11 monetary tightening periods—each one representing a Fed rate hike cycle from start to finish—to then examine the implications for equity performance and multiple behavior.

Around initial rate hikes, market performance has been significantly stronger than the long-term average. The market achieved a median return of 12.3% in the 12 months surrounding (i.e. +/-6 months around) the first hike (well above the 7.7% average market return since 1950) – see Figure 27.

Similarly, multiples have expanded in the months surrounding initial hikes.Median trailing P/E 6 months prior to the first hike date was 17.4x, and expanded to 18.3x over subsequent 6 months—resulting in almost 1x multiple expansion. This suggests the Fed typically starts to tighten only when economic conditions are expected to be resilient – see Figure 28.

Figure 27: S&P 500 Historical Median Returns around Initial Hike

Source: J.P. Morgan

Figure 28: S&P 500 Historical Median P/E Multiple around Initial Hike

Source: J.P. Morgan

However, rate hike implications start to change as the middle part of the rate cycle is approached, ultimately derailing equities. Around mid-cycle rate hikes, market significantly underperforms its long-term average. The market achieved a median return of 0% in the 12 months surrounding (i.e. +/-6 months around) mid-cycle rate hike (well below 7.7% average market return since ‘50) - see Figure 29.

Not surprisingly, equity multiples also contracted in the middle phase of the rate cycle. Median trailing P/E contracted by a median -1x in the 6 months prior to the first hike date, and a median -1.2x in the 6 months subsequent. In all, this resulted in a ~-2x contraction during the 12 months surrounding the mid-cycle phase of the rate hike – see Figure 30.

Key Take-Aways:

— S&P 500 median return in the

12-months surrounding prior initial

rate hikes was 12.3% (well above long-term average return of 7.7%)

— Similarly equity multiples tend to

expand by 1x in the 12-months surrounding the initial hike

— However, the equity-to-interest

rate relationship starts to change as the middle part of the rate cycle

is reached.

— In fact, the median return for S&P 500 is 0% during the 12-

months surrounding the mid-cycle

rate hike

— Likewise, the median equity P/E

multiple has historically contracted

by -2x in the 12-months surrounding the mid-cycle hike

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26



Figure 29: S&P 500 Hist Median Returns around Mid-Cycle Hikes

Source: J.P. Morgan

Figure 30: S&P 500 Hist Median P/E around Mid-Cycle Hikes

Source: J.P. Morgan

The US macro backdrop is getting favorable for policy tightening, including trend-line growth, a rapidly tightening labor market, and overall strong consumer and corporate confidence. While it is certainly useful to draw similarities to the past, differences in economic conditions, market valuation and other idiosyncratic factors must be recognized and understood.

As we compare to previous rate hikes we emphasize the importance of three key relationships that we believe give the equity market additional support as we approach the much anticipated rate hike cycle—the current mix of solid growth coupled with tame inflation, depressed oil prices and lower financing costs provide adds buffers to the equity market as the Fed starts tightening.

27



What does Low Oil mean for Equities?

Crude Brent price has declined over 40% since it peaked in June. Every few years crude oil price makes an unusually large move and invariably investors wonder what caused the shift and what does it mean for the future. A decline in oil price can be driven by higher supply or lower demand or most often by a combination of both. A research study by JPM Economics team suggests that the “... 55% of this year’s oil price decline owes to a supply shock; 40% reflects weaker EM growth. Assuming supply shock response is still coming, global growth to get 0.7%-pt (ar) boost over two quarters.” Based on their analysis, most of the demand shock in this episode is coming from the economic slowdown in Emerging Markets.

Equity markets should benefit from a plunge in oil price predominantly driven by supply forces – it keeps manufacturing cost down, makes transporting people and goods cheaper, tamps down inflation and by extension, keeps likelihood of monetary tightening in check.

On the other hand, a decline in oil price primarily driven by weak demand is typically a negative; the market still appreciates the cheaper oil (except for the energy sector) but not its cause. To analyze how this mix of supply-demand balance impacts equities, we divided the last 15 years of history (2000-2014) into four parts: periods of rising and falling oil price, and their intersection with periods of weak and robust growth. Historically, falling oil prices hurt equities on a contemporaneous basis indicating that demand for oil was driving equities. Looking at long history, (1970-2014) that relationship was much weaker indicating importance of positive impact of lower oil price on consumer.

Table 1: Relationship of Oil and S&P 500 since 2000

Impact on S&P 500, Same Q Impact on S&P 500, 1Q ahead Impact on S&P 500, 2Q aheadWeak Growth Robust Growth Weak Growth Robust Growth Weak Growth Robust Growth

Average ReturnRising Oil Price 3.2% 1.8% -7.0% 1.1% -13.9% 2.8%

Falling Oil Price -0.1% -3.1% 4.4% 2.5% 8.2% 4.7%

Standard DeviationRising Oil Price 8.5% 6.9% 13.9% 6.9% 31.8% 8.9%

Falling Oil Price 5.0% 6.1% 16.1% 9.8% 19.2% 9.5%

Sharpe RatioRising Oil Price 0.76 0.51 -1.00 0.33 -0.62 0.44

Falling Oil Price -0.02 -1.03 0.54 0.52 0.61 0.70

Weak Growth = less than 1.5% year-on-year GDP growth for OECD countries; Robust Growth refers to higher than Weak Growth.

Falling Oil Prices = less than 0% change in Brent Crude. Period analyzed 2000-2014.

Source: JP Morgan, Datastream

However, 1-2 quarters after decline in oil S&P 500 tends to respond positively. This relationship has held from 1970 and in various sub-intervals (such as 2000-2014).

In the 2001 and 2008-2009 recessions the correlation between oil price and the stock market was actually rising prior to the recession, probably because demand side shock had become more important (falling oil price, falling stock market). Also note how high the positive correlation between oil price and the market was until recently (high oil price, rising stock market). This likely reflects financial asset-like behavior of commodities due to excess liquidity induced by the Fed following the financial crisis. The declining correlation could reflect the return to more normalized behavior.

For the equity market, in general, the relative importance of

demand and supply shock in

driving the oil prices matters

https://jpmm.com/research/content/GPS-1572297-0

28



At the sector level, however, the implications of a drop in oil price are more clearly defined. For instance, energy tends to be positively correlated while consumer discretionary is typically negatively correlated and benefits from oil price declines—see Figure 32. For more details see our report: Impact of Rising USD and Falling Oil on Equities.

Figure 31: Oil Price and S&P 500—Time Varying RelationshipCorrelation analysis

Correlation is of trailing one year change in oil price and S&P 500, calculated over six months

and then averaged over one year.

Source: J.P. Morgan, Bloomberg.

Figure 32: Sector Performance During and After Oil Price DeclinesEvent Study since 1989

Source: J.P. Morgan Equity Derivatives Strategy, Bloomberg.

Cheap Oil and the Consumer: $80 Oil likely to net $53 Billion Stimulus to Consumer Spending

Currently, we view cheap oil more as a stimulus for domestic consumer spending than an indicator of a slowdown abroad. Oil will likely retrace some of this move if OPEC can move past their general lack of cohesion by their meeting in early 2015. Our commodity strategist forecast oil at $82 by YE 2015. In the base case of crude averaging ~$80 in 2015, our model shows a boost of $53 billion to discretionary consumer spending (or ~$500 per household) through a combination of lower energy expenditure and the wealth effect:

Gasoline makes up ~3% of consumption spending so naturally a reduction in oil prices will free up cash that can be reallocated elsewhere. If oil averages $80 we calculate that this reduction in energy spending will be $45 billion after accounting for price elasticity of demand (i.e. as gas gets cheaper people consume more gas) —see Figure 33.

But how much of that newly liberated cash will go under the mattress? None, according to historical averages. Perceived wealth has an interesting (and somewhat unintuitive) effect on consumption habits. Using historical data, declines in oil prices have actually lead to lower savings rates 73% of the time as the spare cash makes people feel more wealthy and thus able to spend a larger share of what they earn. We model this wealth effect to amount to $8 billion if crude averages $80 over the course of next year—see Figure 34.

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Recession Correlation, Oil Price and S&P 500

Unusually high correlation

https://jpmm-internal.jpmchase.net/#research.strategy.equity_derivatives

https://jpmm-internal.jpmchase.net/#research.strategy.equity_derivatives

29



Figure 33: Price Elasticity of Demand - Oil

Source: J.P. Morgan estimates, Bloomberg

Figure 34: Effect of Oil Price on Savings Rate

Source: J.P. Morgan estimates, Bloomberg

R² = 0.56

R² = 0.36

-50%

+0%

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30



Fundamentals: 8% EPS Growth in 2015

This recovery has been mired by one growth scare after another, from slowing growth in EM and a sovereign debt crisis in Europe to heightened unrest in the Middle East. In this sluggish revenue growth environment, US corporates have had to pull at all levers to expand earnings. Thus, it should be of little surprise that margin expansion and stock buybacks have contributed roughly half of total EPS growth since 2010.

Another year of low revenue growth of around 4%. Our 4% sales growth estimate for 2015 is based on J.P. Morgan Economics forecast of 4.5% nominal GDP growth. S&P 500 revenue growth is less than GDP growth due to its 33.2%foreign revenue exposure, which is expected to be impacted by both a stronger dollar and sluggish growth abroad.

35bp margin expansion on improving operating leverage and falling commodity prices. We believe operating margins have room to expand another 35bp with an increase in operational leverage through higher capacity utilization and lower raw commodity prices. As shown in Figure 44, we expect margin expansion to drive $3.09 in EPS contribution in 2015.

Share repurchases to drive 2.5% EPS growth in 2015. With US companies sitting on record cash levels at $4.1 trillion (of which $2.7 trillion is held by financials) and close to all-time low debt at 23% of S&P 500 total assets, we expect buyback activity to remain buoyant (see Figure 57).

In summary, we expect EPS to grow 8% in 2015 (see Figure 36), up from 7% EPS growth in 2014 (see Figure 35).

Figure 35: 2014 EPS Drivers for 7% Growth RateS&P 500 EPS

Source: J.P. Morgan US Equity Strategy Estimates

Figure 36: 2015 EPS Drivers for 8% Growth Rate S&P 500 EPS

Source: J.P. Morgan US Equity Strategy Estimates

The consensus estimate for 2015 EPS growth of 9.3% (to $128.78) assumes an improving YoY growth rate into YE15. We expect 1H15 earnings to surprise to the upside, while negative revisions are likely for 2H15, as stronger dollar starts to weigh in and lower oil price stimulus starts to fade (assuming oil prices stay around current levels).

7%

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S&P 500 Growth Forecasts:

— Revenue growth of 4%

— Margin expansion of 35bps drive

2.6% EPS growth

— Strong stock buybacks

contribute another 2.5% to EPS

growth

— 2015 S&P 500 EPS expands to

$127 from $117.50 in 2014E (8%

YoY growth)

— See Figure 40 for JPM S&P 500

Earnings Model

— Consensus bottom-up at $128.78 for 2015 and $117.74 for

2014

— Top-down consensus at $126.00 for 2015

31



Figure 37: S&P 500 Earnings Growth

IBES Consensus after 3Q14


Since October, the Street has been lowering estimates for all four quarters in 2015. Bottom-up consensus EPS for next year is now $128.78, but still remains above our estimate of $127.00. We expect further downward revisions to 3Q15 and 4Q15 EPS.

21%

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3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Qu

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Ear

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(Y

oY

)

Estimates S&P 500 S&P 500 (ex-financial)

Figure 38: Quarterly Consensus Bottom-up EPS Revisions1Q15E – 4Q15E for last 90 days


Figure 39: Annual Consensus Bottom-up EPS Revisions 2014E & 2015E for last 90 days


1Q15, $30.07

2Q15, $31.94

3Q15, $32.83

4Q15, $34.41

$29.50

$30.50

$31.50

$32.50

$33.50

$34.50

$35.50

$36.50

9/14 9/14 10/14 10/14 11/14 11/14

Qu

arte

rly

EP

S

2014, $117.74

2015, $128.78

JPM Strategy Est, $127.00

$115.00

$117.00

$119.00

$121.00

$123.00

$125.00

$127.00

$129.00

$131.00

$133.00

$135.00

9/14 9/14 10/14 10/14 11/14 11/14

An

nu

al E

PS

32



Figure 40: S&P 500 Earnings Model

Actual 2006 through 2Q14, Consensus & J.P. Morgan Strategy for 2014E & 2015E

Source: J.P. Morgan US Equity Strategy and Factset

Actual Annual/LTM — Per Share Data Bottom-up Consensus JPM US Equity Strategy

Income Statement Dec '06 Dec '07 Dec '08 Dec '09 Dec '10 Dec '11 Dec '12 Dec '13 Jun '14 2014 2015 2014 2015

Net Sales $953 $1,025 $1,042 $908 $963 $1,053 $1,092 $1,117 $1,141 $1,153 $1,188 $1,153 $1,200

• % chg Y-o-Y 8.9% 7.6% 1.7% -12.9% 6.0% 9.4% 3.8% 2.2% 3.3% 3.2% 3.1% 3.2% 4.1%

Less: Cost of Goods Sold 635 701 765 642 661 732 755 772 791 798 828

• % chg Y-o-Y 3.7% 10.3% 9.2% -16.0% 3.0% 10.7% 3.2% 2.3% 3.9% 3.4% 3.7%

• COGS as % of Sales 66.7% 68.3% 73.4% 70.7% 68.7% 69.5% 69.1% 69.1% 69.3% 69.25% 69.00%

Gross Income 317 325 277 266 301 321 338 345 350 355 372

• % chg Y-o-Y 21.2% 2.3% -14.5% -4.1% 13.3% 6.5% 5.1% 2.1% 2.0% 2.9% 4.9%

• Gross Margin 33.3% 31.7% 26.6% 29.3% 31.3% 30.5% 30.9% 30.9% 30.7% 30.8% 31.0%

Less: SG&A Expenses (ex D&A) 129 136 134 127 135 142 148 150 150 150 155

• % chg Y-o-Y 9.7% 5.3% -1.4% -5.0% 6.0% 5.3% 4.1% 1.2% -0.8% 0.2% 3.2%

• SG&A as % of Sales 13.5% 13.2% 12.8% 14.0% 14.0% 13.5% 13.5% 13.4% 13.1% 13.00% 12.90%

EBITDA 188 189 143 139 167 179 190 195 200 204 214 205 217

• % chg Y-o-Y 30.6% 0.2% -24.0% -3.2% 20.0% 7.5% 5.9% 2.8% 4.1% 4.5% 5.0% 4.9% 6.1%

• EBITDA Margin 19.8% 18.4% 13.8% 15.3% 17.3% 17.0% 17.4% 17.5% 17.5% 17.7% 18.0% 17.8% 18.1%

Less: D&A 41 45 50 46 46 49 53 56 58 63 63 63 63

• % chg Y-o-Y 4.0% 11.1% 9.5% -6.8% -0.5% 5.8% 8.7% 5.8% 5.3% 11.4% 0.3% 11.4% 0.3%

• D&A as % of Sales 4.3% 4.4% 4.8% 5.1% 4.8% 4.6% 4.9% 5.0% 5.1% 5.4% 5.3% 5.4% 5.2%

EBIT: Operating Income 147 143 94 93 121 130 137 139 142 141 151 142 154

• % chg Y-o-Y 40.5% -2.8% -34.6% -1.2% 30.2% 8.1% 4.9% 1.7% 3.7% 1.6% 7.2% 2.2% 8.7%

• as % of Sales 15.5% 14.0% 9.0% 10.2% 12.5% 12.4% 12.5% 12.4% 12.5% 12.3% 12.7% 12.3% 12.9%

Interest Expense 42 55 42 21 20 19 19 19 18 19 19

• % chg Y-o-Y 38.9% 30.9% -24.3% -49.7% -7.0% -0.4% -0.6% -3.7% -2.7% 1.7% 0.0%

• Implied Interest Rate (Int Exp as % Avg Debt) 4.9% 5.2% 4.1% 2.7% 2.6% 2.6% 2.6% 2.5% 2.4% 2.4% 2.4%

Other: GAAP to Operating EPS Adjustments (24) (39) (36) (12) (19) (26) (27) (31) (32) (33) (33)

• % chg Y-o-Y -32.8% 62.3% -6.2% -66.2% 51.3% 38.9% 4.4% 14.8% 20.6% 5.7% 0.0%

• Other as % of Revenues -2.5% -3.8% -3.5% -1.4% -1.9% -2.5% -2.5% -2.8% -2.8% -2.8% -2.8%

Pre-Tax Income 129 127 88 84 120 137 144 151 156 156 168

Income Taxes 39 39 23 23 33 36 39 40 41 41 44

• Effective Tax Rate (%) 30.2% 30.8% 26.5% 27.4% 27.8% 26.5% 26.7% 26.2% 26.4% 26.4% 26.4%

Stock Buyback Contribution to EPS $1.99 $2.72 ($0.53) $0.05 $1.13 $2.66 $1.94 $2.11 $0.52 $2.66 $3.10

• % Contribution to EPS 2.3% 3.2% -0.9% 0.1% 1.3% 2.7% 1.9% 1.9% 1.7% 2.3% 2.5%

Operating EPS (Thomson First Call) $88.18 $85.12 $65.47 $60.80 $85.28 $97.82 $103.80 $109.68 $114.50 $117.74 $128.78 $117.50 $127.00

• % chg Y-o-Y 15.9% -3.5% -23.1% -7.1% 40.3% 14.7% 6.1% 5.7% 7.6% 7% 9% 7% 8%

• as % of Sales 9.3% 8.3% 6.3% 6.7% 8.9% 9.3% 9.5% 9.8% 10.0% 10% 11% 10% 11%

33



Another year of low revenue growth of 4%For 2015 we are projecting another year of subpar revenue growth for the S&P 500. Even with relatively healthy domestic GDP growth, the revenue growth multiplier remains depressed due to economic growth pressures from abroad. We are modeling an above consensus revenue growth of 4.1% for next year, which is an incremental improvement from 3.2% in 2014.

During periods of expansion, the revenue/GDP growth multiplier has averaged ~1.3x. However, the recent slowdown in global GDP growth is being transmitted in this multiplier (US GDP is growing faster than S&P 500 revenue of which 33.2% is derived abroad).

The year-over-year top-line growth improvement from 3.2% to 4.1% is predicated on a stronger nominal US GDP growth expectation from 3.8% in 2014 to 4.5% in 2015 based on J.P. Morgan Economics. We are assuming a slightly lower revenue growth multiplier of 0.9x for 2015 than in the previous year.

Figure 41: J.P. Morgan US Equity Strategy Revenue Growth vs. Consensus

Estimates for full year 2014 & 2015

Source: J.P. Morgan

Our 4.0% revenue growth is above bottom-up consensus growth of 3.1%, which is consistent with the view that US GDP growth should be stronger in 2015 driven by stronger consumer and rising corporate confidence. The chart below shows consensus revenue growth rates (YoY) on a quarterly basis.

Figure 42: S&P 500 Bottom-up Consensus Revenue Growth

Quarterly growth (YoY)


Actual Annual/LTM — Per Share Data Estimate,

Income Statement Dec '06 Dec '07 Dec '08 Dec '09 Dec '10 Dec '11 Dec '12 Dec '13 Dec '14 Dec '15 Source

US Nominal GDP 14,066 14,685 14,550 14,567 15,230 15,785 16,333 17,078A = • US Nominal GDP Growth, YoY 5.1% 4.4% -0.9% 0.1% 4.6% 3.6% 3.5% 4.6% 3.8% 4.5% JPM Economics

B = Nominal GDP Growth, Consensus 3.9% 4.8% Bloomberg

C = Revenue Growth Multiplier Estimate 1.7x 1.7x -1.8x -112.7x 1.3x 2.6x 1.1x 0.5x 0.85x 0.90x JPM Eq Strategy

S&P 500 Net Sales, per share $953 $1,025 $1,042 $908 $963 $1,053 $1,092 $1,117 $1,153 $1,200= A*C • % chg Y-o-Y 8.9% 7.6% 1.7% -12.9% 6.0% 9.4% 3.8% 2.2% 3.2% 4.1% JPM Eq Strategy

D = Revenue Growth, Bottom-up 3.2% 3.1% IBES

12.7

%

15.5

%

14.2

%

2.5%

5.9%

0.3%

-0.4

%

3.9%

-0.4

%

2.0% 2.

9%

0.6%

2.9%

4.5%

3.9%

1.2% 1.

8%

1.7% 3.

1%

4.8%

-5%

0%

5%

10%

15%

20%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Qu

arte

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Rev

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e G

row

th (

Yo

Y)

Estimates S&P 500 S&P 500 (ex-financial)

34



Margins should expand by another 35bps

We acknowledge that US profit margins, one of the most debated topics currently amongst investors, have been expanding for the last two decades and are currently close to record highs. However, we do not see signs of that trend reverting just yet. While lower interest rates and more recently lower commodity prices have partially benefitted margins, the biggest drivers of this expansion trend continue to be: 1) globalization—manufacturing is where operating leverage has been continually realized, with more room to go; 2) automation—more is being produced with fewer people, and companies have continually been substituting higher but decreasing labor costs with lower capital costs.

In addition, this stop-and-go recovery combined with the lingering memories of the last recession has forced management teams to remain focused on expenses. Also, the current low revenue growth environment puts pressure on management to exploreadditional avenues for expense reduction to drive earnings growth. In summary, increasing operating leverage + declining commodity prices = higher margins in 2015.

For all the talk about peak margins, the chart below shows there were several periods where EBITDA margin was higher than current levels. During 2006, EBITDA margins peaked at 19.8% and reached 18.3% in 1999. Also, while some like to reference NIPA profits as a % of GDP as a proxy for corporate margins, we believe this is not the most precise measure for S&P 500. Instead we prefer examining the actual underlying operating margins.

There is a strong correlation between rising top-line growth and margins, which is intuitive as expenses are applied over a larger revenue base. Our 4% revenue growth assumption should drive another 35bp of operating margin,driven by rising capacity utilization and declining input prices.

Figure 43: S&P 500 EBITDA Margin should expand another 35bp

Actual 1994-2013, Estimated 2014-2015


In Figure 45, the 35bp improvement in margins is expected to drive $3.09 ofincremental EPS for the S&P 500. In an alternative scenario where raw material prices continue to fall and operating leverage is greater than we anticipate, a case can

16.0

%

15.8

%

16.4

% 17.7

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16.7

%

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17.6

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16.5

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12%

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16%

18%

20%

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1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

Rev

enu

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EB

ITD

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arg

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EBITDA Margins (LHS) Net Sales (RHS)

35



be made for a stronger growth in EPS. The model implies that every ±25bp change in margin impacts EPS by about ± $2.21.

Figure 44: 35bp of margin expansion drives $3.09 of incremental EPS

Top-line growth

Source: J.P. Morgan Equity Strategy Estimates

Figure 45: Margin Sensitivity to Operating Leverage...

25bp decline in each...


Consensus is expecting broad sector margin improvement with Financials expected to see the most significant improvement, while Staples and Technology are expected to see the least. At the index level, S&P 500 is expected to see 70bp improvement in margins.

Figure 46: Net Income Margins

S&P 500 Sectors


In the following section we do a line-by-line analysis of the income statement to break down where the improvement is likely to come from for S&P 500 companies. We focus on the following expense items: (1) COGS, (2) SG&A (ex D&A), (3) Interest Expense, and (4) Effective Tax Rate.

EPS Growth Drivers

Pre-tax Tax EPS

2014 2015 Delta EPS Rate Benefit

Sales Growth:

Sales/Share $1,153 $1,200 4.1%

COGS (as % of sales) 69.3% 69.0% -25bp $3.00 26% $2.21

SG&A (as % of sales) 13.0% 12.9% -10bp $1.20 26% $0.88

Total $4.20 26% $3.09

$3.09 50bp 25bp 0bp -10bp -35bp

50bp -$8.83 -$6.62 -$4.42 -$3.53 -$1.32

25bp -$6.62 -$4.42 -$2.21 -$1.32 $0.88

0bp -$4.42 -$2.21 $0.00 $0.88 $3.09

-25bp -$2.21 $0.00 $2.21 $3.09 $5.30

-50bp $0.00 $2.21 $4.42 $5.30 $7.51

SG

&A

as

% o

f Sal

es

COGS as % of Sales

Actual Net Income Margin Consensus Bottom-up

2013/1C 2013/2C 2013/3C 2013/4C 2014/1C 2014/2C 2014/3C 2014/4C 2015/1C 2015/2C 2015/3C 2015/4C Delta

Energy 8.2% 7.2% 7.2% 7.6% 8.0% 7.9% 7.9% 7.4% 7.5% 7.7% 7.8% 8.3% 92bp

Materials 9.2% 8.3% 7.1% 7.8% 8.8% 8.7% 8.2% 7.5% 9.7% 9.8% 8.7% 8.4% 91bp

Industrials 8.4% 9.0% 9.1% 9.0% 8.5% 9.7% 9.7% 9.4% 8.9% 9.8% 10.0% 9.9% 51bp

Discretionary 6.4% 7.2% 7.9% 6.8% 6.5% 7.2% 7.2% 6.8% 6.9% 7.9% 8.0% 7.7% 84bp

Staples 5.8% 6.2% 6.3% 6.2% 5.8% 6.3% 6.2% 6.1% 6.0% 6.4% 6.4% 6.3% 18bp

HealthCare 10.1% 10.2% 10.1% 9.3% 10.2% 10.6% 10.4% 10.0% 10.6% 10.9% 11.0% 10.9% 82bp

Financials 16.3% 17.3% 14.2% 16.3% 15.7% 15.4% 15.8% 17.0% 17.3% 17.5% 17.4% 18.1% 111bp

Technology 19.0% 18.1% 18.9% 20.1% 19.4% 18.9% 19.3% 20.6% 19.9% 20.1% 20.0% 21.0% 46bp

Telecom 8.9% 8.9% 8.9% 7.1% 10.1% 10.5% 10.4% 9.4% 11.0% 10.8% 10.6% 10.1% 69bp

Utilities 8.9% 8.7% 11.9% 7.8% 9.6% 8.7% 11.8% 9.0% 9.2% 8.8% 11.8% 10.0% 92bp

S&P 500 10.0% 10.0% 9.9% 10.0% 10.0% 10.2% 10.4% 10.4% 10.5% 10.8% 10.9% 11.1% 70bp

Cyclicals 10.6% 10.6% 11.0% 11.1% 10.8% 11.1% 11.2% 11.4% 11.3% 11.9% 11.9% 12.1% 67bp

Defensives 7.9% 8.1% 8.4% 7.5% 8.1% 8.5% 8.7% 8.1% 8.5% 8.6% 9.0% 8.6% 51bp

36



Cost-of-Goods-Sold (COGs) drives 25bp improvement in margins

The recent decline in raw material prices and improving capacity utilization bode well for the margin expansion thesis. During this expansion, the S&P 500 has seen COGs as % of sales decline from 73.4% to 69.3% (as of 2Q14), a trend that is likely to continue in 2015 with at least another 25bp improvement.

CRB BLS All commodities index is now down more than 10% since May 2014 and appears to be declining still. This broad index of 22 basic commodities from Metals and Raw Industrials to Textiles and Foodstuffs implies significant COGs reduction from lower raw material prices (see Figure 47).

The other driver for margin expansion is improvement in capacity utilization—since this recovery began, capacity utilization has steadily improved from a trough of 63.9% (2Q09) to 77.2% as of October 2014. J.P. Morgan Economists expect this metric to improve further to 77.8% by the end of ‘15 (see Figure 48).

Figure 47: Lower commodities prices across the board (down 11%)

CRB All Commodities Index

Figure 48: COGS as % of Sales Declines by another 25bp in 2015

Actual until 2Q14, estimates for 3Q14-4Q15

Source: J.P. Morgan and Factset Source: J.P. Morgan and Factset

Selling, General & Administrative (SG&A) drives the other 10bp of margin expansion

A close eye on expenses with higher capacity utilization should translate into another 10bp improvement in SG&A leverage (see Figure 49). With this improvement, SG&A as % of sales should decline to the best level of this economic recovery.

Figure 49: 25bp Improvement in SG&A (as % of sales) on improving productivity

S&P 500 Companies


5/6/2014, 505

452

430

440

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1/14 2/14 3/14 4/14 5/14 6/14 7/14 8/14 9/14 10/14 11/14 12/14 1/15

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12/08, 12.85%

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12/15, 77.9%

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37



Higher Fed Funds ≠ Higher Interest Expense in 2015

With the Fed Funds rate at virtually 0% since late 2008, the effective interest rate paid by S&P 500 companies declined to a record low of 2.4% from ~ 5% in 2007 (see Figure 50).

Contrary to popular opinion, higher rates don’t necessarily mean higher interest expense today. In our base-case expectation of a modest increase in Fed Funds rate in 2015, we are not modeling an increase to this record low effective rate.

Instead, we believe the headwind will be gradual (sometime after 2015) given that the weighted average maturity for the S&P 500 companies is ~10 years.

Assuming the Fed Fund rate moves higher, we estimate there will be a cumulative headwind of ~$10-15 EPS for the S&P 500 over next 5 years.

Small-caps should feel the headwinds sooner given their greater reliance on shorter-term bank debt, which is typically variable, compared to large-caps that have access to longer maturities via the bond market.

Figure 50: Interest Expense as % Total Debt at 2.4%

S&P 500 companies vs High Grade Bond Yield

Source: J.P. Morgan and Factset. Note: Implied interest rate = interest expense (LTM) / average total

debt.

Figure 51: Interest Expense is down from $55.09 in ‘07 to $18.48

S&P 500


The debt schedule curve for S&P 500 is skewed to the right

S&P 500 companies have reduced their rollover risk substantially by extending maturities well into the future. About 50% of total debt is scheduled to mature by 2020 with the rest coming due over the next several decades.

During this cycle, we have seen blue chip companies (such as Caterpillar, Apple, Wal-Mart) lock-in current low rates out multiple decades. This partially explains the debt schedule taking on a barbell shape.

During 2015, $463 billion of debt (or 10% of total) held by S&P 500 companies is maturing. Ex-financials the dollar amount is lower at $259 billion.

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38



Figure 52: Debt Schedule: about 10% coming due in 2015S&P 500 Companies


At the sector level, the average maturities range anywhere from 7.8 years for spread dependent Financials to about 13 years for capital intensive sectors like Utilities and Telecom.

Figure 53: Debt Schedule by Year

$'s in billions

Source: J.P. Morgan and Bloomberg. Note this only includes scheduled debt that is reported and collected by Bloomberg.

0%

25%

50%

75%

100%

$0

$125

$250

$375

$500

2015 2025 2035 2045 2055

Debt Maturing - S&P 500 (ex Financials, Left) Debt Maturing - Financials (Left)

Percentage of Total Debt Remaining (Right)

Total (2015-Beyond)

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

2025 &

Beyond

Total

Debt

% of

Total

Debt

Avg

Maturity

(Yrs)

Defensives: $123 $91 $99 $105 $108 $72 $84 $72 $72 $49 $415 $1,290 28% 11.1

Healthcare 57.5 30.8 36.3 33.9 42.0 19.7 32.0 22.8 20.2 17.2 86 399 9% 9.0

Staples 31.9 24.6 27.3 28.3 27.3 21.8 19.7 21.8 16.6 11.7 89 320 7% 9.8

Utilities 22.9 19.5 21.0 27.8 27.1 16.7 19.1 16.5 19.3 13.5 152 355 8% 13.3

Telecom 11.0 16.3 14.2 14.9 11.6 13.5 13.2 11.3 15.6 6.1 88 216 5% 13.1

Cyclicals: $120 $140 $150 $128 $149 $89 $114 $87 $73 $50 $340 $1,442 31% 9.4

Technology 16.5 29.0 34.8 33.1 38.6 19.2 28.7 14.0 17.6 13.9 54 299 7% 8.3

Industrials 62.5 60.7 61.5 45.2 58.8 26.8 34.2 30.5 19.1 12.2 125 537 12% 9.3

Discretionary 34.3 41.3 43.0 36.8 32.5 32.2 37.3 31.0 25.2 17.4 123 454 10% 10.1

Materials 7.1 9.4 10.5 13.2 19.0 11.2 13.9 12.0 11.5 6.6 37 152 3% 10.2

Other: $219 $222 $249 $187 $162 $89 $105 $89 $97 $79 $358 $1,857 40% 8.2

Financials 204 203 222 166 133 72 81 62 78 65 279 1564 34% 7.8

Energy 16 19 27 21 29 17 24 27 19 15 79 292 6% 10.1

S&P 500 $463 $454 $498 $420 $419 $250 $303 $249 $242 $178 $1,113 $4,588 100% 9.4

% of Total 10% 10% 11% 9% 9% 5% 7% 5% 5% 4% 24% — — —

ex Financials $259 $251 $276 $254 $286 $178 $222 $187 $164 $113 $834 $3,858 84% 10.2

% of Total ex Fin 7% 6% 7% 7% 7% 5% 6% 5% 4% 3% 22% — — —

39



Assuming rates continually rise, interest expense to become a gradual headwindby 2016/2017. The low interest rate policy has had a material impact on S&P 500 EPS with interest expense declining from $55.09/share in 2007 to around $18.50 in recent years (see Figure 51).

Deleveraging partially explains the decline in interest expense. Since 2007, there has been a 35% reduction in leverage for the S&P 500 (mostly financials).

Assuming the Fed Fund rate moves higher, we estimate the S&P 500 EPS could see a gradual headwind of $10-15 over a period of several years.

Effective tax remains well below statutory tax rate

As shown in the chart below, the effective tax rate for companies in the S&P 500 (calculated as income tax as a % of pre-tax income) has been relatively stable post-recession at around 28%. We are not anticipating a major change in the tax regime for the coming year and modeling the rate to remain at the current run rate.

The more domestic small-cap companies tend to have a tax rate that is closer to the US statutory tax rate of 35% than their larger peers. This is also true at the sector level; Energy/Retail/Utilities (much more Domestic) have significantly higher tax rate than Technology and Materials (greater International exposure).

Figure 54: More Domestic Exposure = Higher Corp TaxS&P 500 Sub-Sectors

Source: J.P. Morgan and Factset.

Effective Tax Rate by GICS Level 2

Median

(since 1993) Current Delta

Real Estate 2.6% 3.5% 87bp

Transportation 37.2% 6.4% -3082bp

Consumer Durables & Apparel 33.5% 10.0% -2349bp

Automobiles & Components 26.8% 15.6% -1114bp

Pharmaceuticals, Biotechnology & Life Sciences26.9% 17.9% -903bp

Semiconductors & Semiconductor Equipment26.1% 20.5% -559bp

Technology Hardware & Equipment 26.5% 23.2% -324bp

Insurance 27.4% 23.3% -416bp

Capital Goods 27.4% 24.1% -331bp

Software & Services 32.8% 24.5% -826bp

Household & Personal Products 29.9% 25.7% -422bp

Materials 30.6% 26.5% -418bp

Consumer Services 28.4% 27.5% -89bp

Food, Beverage & Tobacco 32.9% 27.6% -534bp

Commercial & Professional Serv ices 37.1% 29.6% -745bp

Telecommunication Services 29.5% 29.9% 39bp

Diversified Financials 31.7% 30.0% -178bp

Health Care Equipment & Serv ices 34.5% 31.3% -319bp

Utilities 33.4% 31.9% -152bp

Media 40.9% 32.3% -858bp

Retailing 37.0% 35.2% -179bp

Food & Staples Retailing 39.0% 35.3% -368bp

Energy 38.3% 38.2% -13bp

S&P 500 34.9% 27.7% -724bp

40



Companies sitting on healthy balance sheets

Balance sheet deleveraging continues for S&P 500 companies. As shown below, Cash as % of Total Assets of 13.7% is near record high (excluding Financials this metric is closer to 11%). S&P 500 companies are hoarding $4.1 trillion in cash of which $2.7 trillion is held by financials—to put this into perspective, there is enough cash held by non-financials to buy out 75% of the Russell 2000.

Figure 55: Cash levels near record high at 13.7% of total assets...S&P 500 Companies


Figure 56: ...while Debt as % of Total Assets is at 23%

S&P 500 companies


US corporates have not binged on cheap debt. As shown above, S&P 500 debt as % of total assets is at a trough level of 23%. This decline is mainly driven by Financials deleveraging after the last recession. Excluding financials, however, this metric declined slightly to 28% of total assets and is starting to see an uptick.

Overall, scarce growth coupled with high level of cash flow and low debt supports our view for continued strong stock buybacks and dividend payouts.

Figure 57: The buyback story continues

S&P 500 Companies


11.8%

14.1%

13.7%

11.2%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

3/96

6/97

9/98

12/9

9

3/01

6/02

9/03

12/0

4

3/06

6/07

9/08

12/0

9

3/11

6/12

9/13

12/1

4

3/16

S&P 500 S&P 500 (ex-Financials)

37%36%

23%

28%

20%

22%

24%

26%

28%

30%

32%

34%

36%

38%

40%

3/96

6/97

9/98

12/9

9

3/01

6/02

9/03

12/0

4

3/06

6/07

9/08

12/0

9

3/11

6/12

9/13

12/1

4

3/16

S&P 500 S&P 500 (ex-Financials)

4.2%

2.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

$0

$50

$100

$150

$200

$250

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Dividends ($Bn, Left)

Net Buybacks ($Bn, Left)

Total Yield (LTM, Right)

Gross Buybacks as % of Volume (Right)

S&P 500 companies returned

record shareholder capital in the

last 4 trailing quarters:

— $428 billion of net buybacks

— $364 billion in dividend payouts

— $792 billion total cash returned

41



Valuation: Multiple Largely Unchanged

Our price target of 2250 is based on 2015 EPS of $127 for S&P 500. Our pricetarget assumes a P/E multiple of 17.7x, which is largely in line with the current multiple of 17.5x. While we see a number of drivers supporting a higher multiple, several risks are emerging that can counterbalance that.

Drivers:

#1: Lower commodity prices and overall lower inflation tend to be supportive of a stronger multiple.

# 2: Positive supply and demand dynamic for equities (e.g., higher M&A activity) support a case for multiple expansion.

#3: A more liberal use of Buybacks puts upward pressure on multiples, especially in the current environment of low volumes and liquidity.

#4: With ZIRP (zero interest-rate policy) in place for several years, there are limited investment alternatives. With the exception of housing, almost all other asset classes have equally rich valuation with limited growth prospect.

Risks:

#1: Other than free cash flow yield, valuation is no longer cheap, with multiples trading in line or slightly higher than historical average. On a growth (PEG) or inflation (CAPE) normalized basis equity multiples appear expensive.

#2: Tightening monetary policy can be a negative for multiple expansion, even though that’s typically the case in the later part of the Fed Funds rate cycle.

S&P 500 Valuation: multiple

remains largely unchanged at current levels

— Current P/E (LTM) at 17.5x

— We expect multiple to remain roughly unchanged at 17.7x by

YE— Currently elevated levels of

equity P/E are inline with “P/Es” for other asset classes such as

Treasuries, Munis, High Grade and

High Yield bonds.

— Non-financial alternatives: Gold

and Oil trade inline with long-term average, US residential sector

much cheaper

42



Expect multiple to remain largely unchanged…

US equities are trading in line or slightly above historical average. The table below shows absolute and relative multiples for the equity markets. While valuation won’t likely be a major driver for investing in equities in 2015, we believe that current levels of valuation should not deter investors.

On an absolute basis, equity markets are trading slightly above historical averages.

Assessment of richness or cheapness largely depends on the time horizon used as a reference. For instance, comparing current equity P/E to 20 years of history (periods that includes tech bubble) the market looks fairly priced. On the contrary, compared to past 5 years (during which market recovered from financial crisis) it looks very expensive. Lastly, comparison to last 10 years (a period includes both bull market ’04-’07, market crash and recovery) the market looks only slightly expensive (see Figure below).

On a relative basis, valuation of equity markets is inline with other asset classes.

Figure 58: Valuation Metrics: Absolute & Relative

Current vs. Historical

Source: J.P. Morgan, Bloomberg, Factset. Balance and Earnings growth metrics as of 1995, JULI HG index as of 1999, and J.P. HY

index as of 1995.

Absolute & Relative Valuation, Median

Current

5Yr

Median

10Yr

Median

20Yr

Median

25Yr

Median

Δ

(Now vs

25Yr)

S&P 500 Multiples:

EV/Sales 2.2x 1.8x 1.9x 2.4x 2.0x 0.2x

EV/EBITDA 11.2x 9.3x 10.3x 11.0x 10.4x 0.8x

P/E (Trailing Last Twelve Months) 18.4x 15.4x 16.5x 18.1x 18.2x 0.2x

P/E (Next Twelve Months) 17.3x 13.8x 15.1x 16.1x 15.9x 1.4x

Price to Book 2.8x 2.2x 2.4x 2.8x 2.7x 0.1x

P/E to Growth 1.45x 1.33x 1.33x 1.29x 1.22x 0.2x

P/E, Cyclically Adjusted PE 26.5x 22.4x 23.4x 25.6x 23.8x 2.7x

FCF Yield 5.0% 7.5% 6.6% 4.1% 4.4% 0.6%

Market Value to NIPA Profits 15.7x 10.7x 12.4x 12.6x 12.2x 3.5x

Nominal GDP to Total MV of Equities 1.356x 1.030x 1.035x 1.022x 0.946x 0.4x

Fixed Income Multiples:

US Bonds (10yr) 43.4x 39.3x 30.0x 22.8x 20.1x 23.3x

Munis (10Yr AAA) 47.8x 42.9x 33.4x 26.5x 24.4x 23.4x

JPMorgan US Liquid Index (JULI HG) 26.0x 23.9x 19.4x 18.3x 18.3x 7.7x

Alternatives Relative to S&P 500:

Homes: Median Home Price to S&P 500 252x 300x 330x 326x 356x -104x

Gold: S&P 500 to Price of Gold (oz) 1.6x 0.9x 1.3x 2.2x 1.5x 0.1x

Oil:S&P 500 to Barrels of Oil 25.1x 14.7x 16.4x 24.7x 22.3x 2.7x

Economic Environment

Real GDP Growth, yoy 2.4% 1.9% 2.2% 2.6% 2.7% -30bp

Core Inflation (PCE Index), yoy 1.6% 1.5% 1.7% 1.7% 1.9% -33bp

Earnings Growth, S&P 500 8.2% 8.6% 9.3% 9.7% 9.7% -157bp

Cash as % of Assets, S&P 500 ex-Fin 11.2% 10.9% 10.0% 8.3% 8.3% 293bp

Debt as % of Assets, S&P 500 ex-Fin 28.4% 27.7% 28.3% 29.8% 29.8% -140bp

43



The S&P 500 valuation is slightly above long-term averages. As shown below, we look at several income statement/balance sheet/dividend multiples, all with the exception of FCF yield is trading near 25yr average.

Figure 59: Enterprise Value to Sales at 2.16x25Yr Median: 2.0x


Figure 60: EV/EBITDA at 11.2x25Yr Median: 10.4x


Figure 61: P/E (NTM) at 17.3x25Yr Median:15.9x


Figure 62: FCF Yield at 5.9%25Yr Median:4.4%


Figure 63: P/B at 2.8x25Yr Median:2.69x


Figure 64: Dividend yield at 1.9%25Yr Median:1.9%


2.16x

0.7x

1.2x

1.7x

2.2x

2.7x

3.2x

'90 '94 '98 '02 '06 '10 '14

EV

/Sal

es

EV/Sales Avg +1 STD -1 STD

11.2x

5.0x

7.0x

9.0x

11.0x

13.0x

15.0x

'90 '94 '98 '02 '06 '10 '14

EV

/EB

ITD

A (L

TM

)

EV/EBITDA Avg +1 STD -1 STD

17.3x

8x

10x

12x

14x

16x

18x

20x

22x

24x

26x

28x

'90 '94 '98 '02 '06 '10 '14

P/E

(N

TM

)

P/E (NTM) Avg

5.9%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

'90 '94 '98 '02 '06 '10 '14

FC

F Y

ield

FCF Yield Avg +1 STD -1 STD

2.81x

1.3x

1.8x

2.3x

2.8x

3.3x

3.8x

4.3x

4.8x

5.3x

'90 '94 '98 '02 '06 '10 '14

P/B

P/B Avg +1 STD -1 STD

1.9%

0.8%

1.3%

1.8%

2.3%

2.8%

3.3%

3.8%

4.3%

'90 '94 '98 '02 '06 '10 '14

Div

iden

d Y

ield

Dividend Yield Avg +1 STD -1 STD

44



Is Shiller CAPE indicating expensive valuation?

Many investors mention Shiller CAPE as evidence that the market is currently expensive. The current CAPE multiple is 26.5x, which is about 2x higher than the average level seen since the beginning of Greenspan era (24.3x).

Figure 65: S&P 500 CAPE

Source: J.P. Morgan and Robert Shiller Data

The possible reason to why CAPE appears expensive vs. history could be due to structural reasons—currently lower interest rates, labor costs and effective taxes than before (the Pro-forma CAPE that is adjusted for the currently lower input costs is shown in Figure 66: J.P. Morgan CAPE (adjusted for structurally low interest rates and corporate taxes).

Figure 66: J.P. Morgan CAPE (adjusted for structurally low interest rates and corporate taxes)

Shiller vs. J.P. Morgan CAPE


26.1x

0x

5x

10x

15x

20x

25x

30x

35x

40x

190

2

190

5

190

8

191

1

191

4

191

7

192

0

192

3

192

6

192

9

193

2

193

4

193

7

194

0

194

3

194

6

194

9

195

2

195

5

195

8

196

1

196

4

196

7

196

9

197

2

197

5

197

8

198

1

198

4

198

7

199

0

199

3

199

6

199

9

200

2

200

4

200

7

201

0

201

3

CA

PE

(Cyc

lical

ly A

dju

ste

d P

/E) V

alu

atio

n

Fed Reserve Regimes CAPE P/E Multiple Median PE

Ecc

les:

12.

8x

McC

abe:

10.

7x

Mar

tin

: 18.

4x

Bu

rns:

13.

3x

Mil

ler:

9.1x

Vo

lcke

r: 9

.4x

Gre

ensp

an: 2

4.3x

Ber

nan

ke: 2

2.1x

Bla

cks:

12.

3xM

eyer

:9.6

x

Har

din

g: 6

.5x Y

ou

ng

: 23.

0x

Cri

ssin

ger:

9.9x

Ham

lin

: 10.

5x

Pre

-Fed

:16.

5x

26x

22x

8x

13x

18x

23x

28x

33x

38x

43x

12/93 12/95 12/97 12/99 12/01 12/03 12/05 12/07 12/09 12/11 12/13

Cyclically Adjusted PE (Actual)

Cyclically Adjusted PE (Pro-forma)

45



More liberal use of Buybacks over Dividends puts upward pressure on multiplesSince the adoption of Rule 10b-18 in 1982 (Safe Harbor for Issuer Repurchases), there has been a precipitous decline in the dividend paid in favor of stock buybacks. The current dividend yield is 1.9%, which is less than half compared to pre-1982 levels—the average dividend from 1871 until 1982 was 5.0%.

The dividend payout ratio is also near its multi-century low of 36.2%—pre-1982 the average dividend payout ratio was closer to 65%. Bottom-line: the shareholder yield (dividend yield + stock buyback yield) is slightly below pre-1982 levels with share buybacks making up a larger contribution of the total payout.

Figure 67: S&P 500 Dividend YieldSince 1871

Source: J.P. Morgan and Shiller Data

Figure 68: S&P 500 Payout RatioSince 1871

Source: J.P. Morgan and Shiller Data

Limited opportunities for investors outside of equities

In the low yield environment triggered by ZIRP, investors have bid up income yielding asset classes. Figure below shows the valuation spread of S&P 500 P/E to implied P/Es of other asset classes. While P/E of equities re-rated higher over the past 4 years, so did P/E ratios of other asset classes too. In other words, the relative valuation of S&P 500 to other classes remained largely unchanged.

1.9%

Avg (1881-1981): 5.0%

Avg (since 1982): 2.6%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

1871 1896 1921 1946 1971 1996

Dividend Yield Average

36.2%

Avg (1881-1981): 64.7%

Avg (since 1982): 51.4%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

1871 1896 1921 1946 1971 1996

Payout Ratio (Dividends/EPS) Average

46



Figure 69: S&P 500 vs Credit Markets

Equities cheaper than all asset classes except HY

Source: J.P. Morgan and Dataquery

Similar is true for other non-financial asset class. As shown in the three charts below, the prices for Oil and Gold are also in-line with historical averages relative to S&P 500, while US Residential Homes look cheaper relative to equities.

Figure 70: Oil vs S&P 500In-line with historical relationship


Figure 71: Gold vs S&P 500Gold also in-line with historical relationship


Figure 72: US Homes vs. S&P 500Residential housing cheapest asset-class


Impact of US dollar and rates on equity valuation

Impact of rising dollar on equity P/E is different for different sectors. In particular, firms that derive a greater share of their revenue domestically will be the largest beneficiaries of a rising dollar, at the expense of their more global counterparts. The relative valuations of the more domestic subset of the S&P 500 (versus the more global) have historically tracked changes in the dollar index fairly closely.

US Bonds (10Yr), -27.4x

Munis (10Yr AAA), -31.9x

HY (YTW), 3.8x

JULI HG Index, -9.6x

-55x

-45x

-35x

-25x

-15x

-5x

5x

12/11 3/12 6/12 9/12 12/12 3/13 6/13 9/13 12/13 3/14 6/14 9/14 12/14 3/15 6/15 9/15

Rel

ativ

e Va

luat

ion

(S&

P 5

00 P

/E le

ss Im

plie

d P

/Es

Cro

ss A

sset

s

25.1LT Average, 25.7

0

10

20

30

40

50

60

70

80

90

100

12/

50

4/54

8/57

12/

60

4/64

8/67

12/

70

4/74

8/77

12/

80

4/84

8/87

12/

90

4/94

8/97

12/

00

4/04

8/07

12/

10

4/14

S&

P 5

00 In

dex

Bu

ys x

x B

arre

ls o

f Oil

Recession S&P 500 to Barrels of Oil LT Average

Equities CheapOil Expensive

Oil CheapEquities Expensive

1.63LT Average, 1.57

0

1

2

3

4

5

6

12/6

7

4/71

8/74

12/7

7

4/81

8/84

12/8

7

4/91

8/94

12/9

7

4/01

8/04

12/0

7

4/11

8/14

S&

P 5

00

Ind

ex

Bu

ys x

x O

un

ces

of G

old

...

Recession S&P 500 to Price of Gold (oz) LT Average

Equities CheapGold Expensive

Gold CheapEquities Expensive

252

LT Average, 571

0

200

400

600

800

1000

1200

1400

1/66

5/69

9/72

1/76

5/79

9/82

1/86

5/89

9/92

1/96

5/99

9/02

1/06

5/09

9/12

1/16

It ta

kes

xx u

nit

s o

f S&

P 5

00 In

dex

to

Bu

y an

Avg

Ho

me

Recession Median Home Price to S&P 500 Index LT Average

Equities CheapHomes Expensive

Homes CheapEquities Expensive

47



Figure 73: Post Globalization: US Dollar vs S&P 500

1995 to Present


Rising rate environment may not hurt equity multiple at current low levels of rates.

In the chart below we show the relationship between US 10yr bond yields and S&P 500 P/E. Since 1871 there has been a weak but positive relationship between 10yr yields and P/E.

Figure 74: US 10Yr Bond Yield vs S&P 500 EPS

A rise from very low rates a support for multiple expansion thesis


-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Δin

Rela

tive

P/E

(D

om

esti

cs/G

lob

al)

Δ in

Do

llar

Ind

ex

Change in the Dollar Index (trade-weighted, y/y, Left)

Change in Relative P/E (Domestic Basket vs Global Basket, y/y, Right))

y = -1715x2 + 216.85x + 9.2248R² = 0.1017

4.5x

9.5x

14.5x

19.5x

24.5x

29.5x

1.5% 3.5% 5.5% 7.5% 9.5% 11.5% 13.5% 15.5%

P/E

LT

M

US BondYield (10Yr)

2000 to Present

1980 to 1999

1960 to 1979

1940 to 1959

1900 to 1939

1871 to 1899

Poly. (All)

14.716.0x 15.8x

14.3x

11.5x

7.2x

12.9x

Companies with greater domestic exposure tend to re-

rate more than Global

Multinationals

48



Volatility and Correlation Outlook

2014 vs. 2015 VolatilityIn order to forecast volatility in 2015, one first needs to look at historical levels, as volatility tends to persist in a recent range and mean revert to long-term averages. Figure 75 shows levels of short-term implied volatility for Equities, Rates, Commodities and FX, as well as credit spreads during 2014. In the first half of the year volatilities declined, reaching ~15 year lows during the summer of 2014. The increase in volatility during October’s growth scare was particularly sharp and pushed volatility well above historical averages. In fact, Equity Volatility in October experienced one of the fastest increases (and fastest subsequent declines) on record, pointing to thin market liquidity (Table 2).

In our 2014 volatility forecast, we predicted that volatility would increase in H2 2014 due to the end of the Fed’s QE program and a turn in the rate cycle. October’s shock is an example of the market volatility we are likely to see in 2015 as the Fed increases rates (the first rate hike is expected in June), and the market adjusts to lower levels of liquidity. Our view is that volatility across assets in 2015 will look more like Q4 than H1 of 2014. This would translate into ~15% higher levels of volatility compared to 2014 averages.

Figure 75: 1M Implied Volatility Across Assets in 2014 (Levels on 1/1/2014 Normalized to 100)

Source: J.P. Morgan Equity Derivatives Strategy.

Table 2: Asset Volatility in 2014 - 15 Year Context


The median level of the VIX in 2014 was 13.4 (20th percentile since 1989) and S&P 500 realized volatility was 11% (28th percentile since 1989). Volatility itself was highly volatile (high ‘vol of vol’), with S&P 500 1M realized volatility reaching 20 year lows in September (5.6%), only to exhibit the sharpest absolute increase since 2011 (13 points or 127%) in October. Low liquidity and market positioning contributed to this unusual pattern. Record levels of call to put imbalance caused dealers to be long gamma in August and early September. Long gamma exposure and low levels of market activity caused the S&P 500 to get pinned at 2,000 for several weeks (Figure 77), pushing realized volatility to 20 year lows. The fast pace of the market selloff and volatility increase in October, with little change in fundamentals, points to high levels of liquidity risk. Equally impressive was the subsequent market rally and decline in volatility helped by investors selling volatility via listed options, inverse VIX ETNs, and ‘smart beta’ over the counter products.

60

80

100

120

140

160

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

Commodity

AverageEquityCreditFXRates

15 Year Lows

Volatility 2014 Low 15Y %tile Max 1M Incr. 15Y %tile

S&P 500 10.3 1% 14.1 99%

SX5E 12.7 2% 16.5 98%

NKY 14.0 2% 13.1 97%

Hang Seng 11.5 0% 8.6 96%

G7 FX 5.1 0% 2.0 97%

EM FX 5.8 0% 1.8 94%

US Rates 1Y 80.8 7% 9.8 93%

US Rates 1M 52.3 1% 38.5 98%

Gold 10.8 2% 6.8 96%

Oil 11.5 0% 12.5 94%

IG Credit 55.0 24% 20.1 92%

HY Credit 291.2 9% 89.9 90%

49



Figure 76: S&P 500 1M Realized Volatility and the VIX


Figure 77: S&P 500 Pattern around October Selloff


Volatility FundamentalsWe believe the turn in the interest rate and liquidity cycle will put upward pressure on volatility and would support mean reversion toward higher long-term average levels. These technical factors need to be compared to macro fundamentals that are another important driver of volatility. In our previous Outlook publications, we have demonstrated a relationship between GDP, unemployment, equity earnings and corporate default rates to levels of equity volatility. J.P. Morgan forecasts for these variables suggest that volatility is likely to be contained during 2015. In particular, US GDP is expected to rise and unemployment to fall, while our equity strategists forecast continued growth in corporate earnings and stable equity multiples (Figure 78). The trend in improving macro fundamentals will counter upward pressure on volatility coming from the rate cycle.

Figure 78: JPM Economics/Strategy Forecasts


Figure 79: Annual US equity returns vs. GDP


More difficult to estimate is the extent to which low current levels of volatility are already anticipating an improvement in macro data. Figure 79 shows YoY changes in real GDP over the past 65 years and equity market returns. One can notice that in 5 out of last 6 years, equity market returns were above the historical trendline, raising the possibility that strong fundamentals may already be priced into low levels of volatility. A historical regression analysis of the VIX vs. levels of nearly 100 macro

10

15

20

25

5%

8%

10%

13%

15%

18%

20%

Jan Mar May Jul Sep Nov

1M Realized VIX

OctoberSpike

S&P Pinned at 2000

Selloff in Poor Liquidity

Scramble for Yield

Latest

Observation 2015 Forecast Change

Global GDP (FY) 3.00% 3.40% 0.40%

US GDP (FY) 2.20% 3.00% 0.80%

Euro Area GDP (FY) 0.90% 1.60% 0.70%

US Unemployment 5.80% 5.40% -0.40%

US 2065 2300 11.4%

Europe 1411 1550 9.9%

Asia ex-Japan 469 525 11.9%

Japan 1428 1700 19.1%

IG Credit (bps) 61 60 -1

HY Credit (bps) 333 320 -13

Fed Funds Rate 0.13% 1.00% 0.88%

DM CB Rates 0.26% 0.69% 0.43%

EM CB Rates 6.01% 5.94% -0.07%

3M USD LIBOR 0.23% 1.05% 0.82%

US 3Y Treasury Yield 0.85% 2.00% 1.15%

US 10Y Treasury Yield 2.16% 2.80% 0.64%

Rates

Macroeconomic Data

Equity

Credit

2009

2010

2011

2012

2013

2014

-45%

-30%

-15%

0%

15%

30%

45%

-4 -2 0 2 4 6 8 10

US GDP YoY

S&P 500

50



time series covering labor, consumer, housing, manufacturing and sentiment data, also supports this conclusion. The analysis suggests that the VIX may be 0.8 standard deviations or ~5 points too low relative to current macro data.

To further investigate possibility of current low levels of volatility being already suppressed below fundamental levels, next we analyze various measures of volatility premia, leverage and flows.

Volatility Premia and Positioning Equity volatility premia have been steadily declining over the past 3 years.3 In our view, this is in part driven by central bank policies that reset the level of available yields lower, and pushed investors into higher risk strategies both by depriving them of yield and potentially lulling them into complacency by providing an implicit market backstop. Figure 80 shows the compression of VIX options (1M straddle) and term structure (2M-1M rolldown) risk premia.4 Figure 81 shows S&P 500 options term structure premia (6M-3M rolldown) and average implied-realized volatility premia for S&P 500 stocks. All of these risk premia contracted and are currently close to zero. This suggests excessive supply of volatility risk premia through yield generating strategies, combined with lower demand for equity protection.

Figure 80: VIX Risk Premia


Figure 81: Stock and Index Risk Premia


Several other datasets point to increased levels of leverage and financial risk taking. For instance hedge fund equity exposure (beta of HFRX to S&P 500) recently rose to near record levels and inflows into equity mutual funds and ETFs accelerated (Figure

3 Equity Volatility risk premia is the compensation an investor receives for being short equity risk via a derivative product. 4 For more details see our report VIX Risk Premia and Volatility Trading Signals.

-3

-1

1

3

5

Oct, 11 Jun, 12 Feb, 13 Oct, 13 Jun, 14

VIX Option Premia (1M)

-2

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VIX Term Premia (1M-2M)

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S&P 500 Term Premia (6M)

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-2%

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12%


Stock Volatility Premia (3M)


51



82).5 Figure 83 shows the percentage of US household assets allocated to equities (expressed as % of global equity capitalization) and NYSE margin debt (expressed as % of S&P 500 capitalization). While none of these measures can predict a market correction and spike in volatility, they clearly demonstrate increased levels of risk taking and perhaps risk complacency.

Figure 82: Hedge Fund Leverage and Mutual Fund / ETF Flows


Figure 83: NYSE Margin Debt and US Household Equity Holdings


As the rates and liquidity cycle turn in 2015, we believe levels of risk premia are likely to widen from current record lows.

Correlation RiskIn addition to asset volatility, levels of correlations are another important driver of a portfolio risk. For long-short managers, high correlation also impacts portfolio returns by limiting managers’ ability to generate alpha. While correlations have declined from 2011 peak levels, average levels are substantially higher than what was observed in other periods of low volatility over the past 20 years. Figure 84shows the average level of correlation of S&P 500 stocks and sectors. One can notice that sector correlations are particularly high, indicating the importance of macro factors that drive correlation.6 In addition to macro factors, in our previous research (Why we have correlation bubble) we have argued that structural developments caused a structural increase in market correlations.

We believe that recent changes in correlation levels also point to low market liquidity, and elevated risk of a correlation spike similar to the ones we saw in 2010 and 2011. Figure 12 shows a 20 year history of correlation levels of S&P 500 stocks. One can notice that this October, 1M correlation reached ~60%—similar to levels seen during the 1997/98 Asia Crisis/Russia Default and 2002 market bottom. Given that there was no major financial or economic crisis this October that would warrant such a sharp increase, we believe this reflects the market's vulnerability to liquidity driven correlation shocks.

5 It is often argued how the current level of HF leverage is much lower now as compared to pre-crisis year and hence the level of risk in the system is lower. According to data from our prime services, HF leverage is indeed lower now, but much of the leverage reduction came from market neutral quantitative strategies (whose unwind was not likely to affect the overall market in the first place).

6 For instance, Central bank meetings and rate policy decisions, Commodity prices, geopolitical developments, etc.

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HF Beta to the S&P 500

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2004 2006 2008 2010 2012 2014

NYSE Margin Debt (% S&P 500 Mkt Cap)

US HH Equity Allocation (% of Global Mkt Cap)


52



Figure 84: S&P 500 Sector and Stock Correlation over the past 20 Years


Figure 85: Correlation levels during October’s spike were similar to those seen during the 1997/98 Asia Crisis/Russia Default and 2002 market bottom


Despite the perception that low levels of volatility and declining correlations are the environment most suitable for stock picking, we believe this is far from the truth. Figure 86 shows average level of stock volatility and correlation for S&P 500 stocks over the past 20 years. One can notice the gap between the elevated levels of correlation (~65th historical percentile) and low levels of volatility (~15th historical percentile) is near record levels, resulting in a very unfavorable environment for stock pickers. For instance, the average stock tracking error – a measure of alpha available to a long short manager – is currently at all time lows. It should not come as a surprise therefore that 2014 is on track to be one of the worst years for hedge fund closures since 2009 (461 HFs closed in the first half of 2014, compared to 1023 closed in 2009).

Figure 86: Average S&P 500 Stock Volatility and Correlation


Figure 87: Average Stock Volatility and Correlation for each of 10 S&P 500 Sectors


Levels of dispersion are not equal across the market, and some sectors provide better opportunities to stock pickers than others. Figure 87 shows the average levels of stock volatility and stock correlation in each of 10 S&P 500 sectors. One can notice that Energy and Discretionary sectors have relatively favorable levels of dispersion.

20%

30%

40%

50%

60%

70%

80%

90%

10%

20%

30%

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60%

1994 1997 1999 2002 2004 2007 2009 2011 2014

S&P 500 Sector Correlation

S&P 500 Stock Correlation

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1994 1997 1999 2002 2004 2007 2009 2011 2014

Asia CrisisRussia Default

Oct '142002 Market Bottom

17%

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1994 1997 1999 2002 2004 2007 2009 2011 2014

Average Stock Correlation

Average Stock Volatility

S&P 500 Sector

%-tile Level %-tile Level

C. Discretionary 11 22.9% 47 31.5%

C. Staples 3 16.5% 53 32.1%

Energy 17 21.4% 39 48.9%

Financials 0 17.4% 68 52.0%

Health Care 24 22.6% 77 37.1%

Industrials 2 18.2% 79 52.1%

Technology 1 23.4% 16 30.5%

Materials 2 21.0% 35 38.7%

Telecomms 0 17.6% 60 50.0%

Util ities 17 16.4% 76 62.7%

Average 2 20.4% 62 43.6%

Stock Volatility Correlation

53



Sector Outlook

For the sector recommendations we combine our top-down macro view with bottom-up fundamentals for the ten GICS sectors. Broadly, we look for sectors and industries with strong earnings and price momentum within a macro environment where the dollar is strengthening, oil remains near the current level, and interest rates are rising.

With this in mind, our highest conviction sector pair is overweight Discretionary (a lift in consumer spending) and underweight Utilities (interest rate sensitive with bloated valuation). Technology and Healthcare have secular earnings growth and support from M&A.

Overweight (OW): price and earnings momentum, macro support, and M&A

Consumer Discretionary: rising disposable income, tame inflation, lower gas prices are a tax relief, pent-up demand after years of under consumption

Technology: organic growth, strong margins, cheaper PEG than market, and supportive high shareholder yield at 4.5%

Financials: rising rates, higher domestic exposure, and second cheapest sector

Healthcare: secular growth with rising share of consumer wallet and M&A

Neutral (N): on the bench until macro picture becomes more favorable

Consumer Staples: lower beta to consumer spending than discretionary

Industrials: benefits from investment spending but high exposure to E&P, negative correlation to dollar and rising interest rates

Energy: poor visibility, high commodity volatility, negative correlation to USD

Underweight (UW): not consistent with the macro picture and/or rich multiples

Utilities: higher interest rates may be a catalyst for income investors to exit the sector, especially with rich valuation and low organic growth

Telecom: constant price deflation, saturated market, and rising rates a negative

Materials: strong negative correlation to the dollar, early cycle sector, and higher interest rates a negative for this capital intensive sector

Industries/Themes: a more direct way to play macro trends and themes

Lenders over Capital Intensive: a transfer payment from capital intensive industries to money center and regional banks (NIM improves)

Multiline/Specialty Retail (OW) over Global Apparel: levered to US consumers while the production is abroad

Transportation/Leisure (OW): low energy prices drive bottom-line growth, especially Airlines (OW) with price and earnings momentum and declining oil

Sector Recommendations:

Overweight:

—Discretionary: direct play on

rising consumer

— Technology: secular growth at

market multiple

—Financials: rates rise from zero level

— Healthcare: positive

demographics and M&A

Neutral:

— Staples: a more expensiveconsumer play

— Industrials: investment growth,

but risks related to E&P, dollar, and rising rates

— Energy: low earnings visibility

keeps us sidelined

Underweight:

— Utilities: interest rate sensitive and near peak valuation

— Telecom: saturated market with

price deflation, capital intensive

— Materials: poor global growth

54



Banks, Autos, and Internet significant contributors to growth in 2015

The figures below show expected earnings growth and contribution to total S&P 500 earnings growth in 2015. Banks, Autos, and Internet Retail are all expected to show strong earnings growth, while Oil and Gas is expected to weigh on earnings.

Figure 88: Sector Contribution to S&P 500 EarningsBanks are expected drive ~25% of 2015 growth...

Source: J.P. Morgan and FactSet

Figure 89: Most industries are expected to grow earnings between 4-10%…S&P 500 Industries…


At the S&P 500 level, consensus net income margins are expected to expand by 70bp, which is more aggressive than our assumption of 35bp. Margin expansion is expected across all sectors with Financials expected to see the most improvement.

Figure 90: Actual Net-Income Incremental Margin

Consensus Bottom-up

Source: J.P. Morgan and Factset.

Energy Equipment &

Services

Oil, Gas & Consumable

Fuels

ChemicalsMetals & Mining

Aerospace & Defense

Electrical Equipment

Industrial ConglomeratesMachinery

Commercial Services & Supplies

Air Freight & Logistics AirlinesRoad & Rail

Auto Components

Automobiles

Household Durables

Textiles, Apparel & Luxury Goods

Hotels, Restaurants &

LeisureMediaInternet & Catalog

RetailMultiline Retail

Specialty RetailFood & Staples

RetailingBeveragesFood ProductsTobaccoHousehold Products

Health Care Equipment &

Supplies

Health Care Providers &

Services

BiotechnologyPharmaceuticals

Life Sciences Tools & Services

Banks

Diversified Financial Services

Consumer FinanceCapital MarketsInsurance

Real Estate Investment Trusts

(REITs)

Internet Software & Services

IT ServicesSoftwareCommunications Equipment

Electronic Equipment,

Instruments & Components

Semiconductors & Semiconductor

Equipment

Diversified Telecommunicatio

n ServicesElectric UtilitiesMulti-Utilities

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Energy Equipment & Services

Chemicals

Aerospace & Defense

Electrical Equipment

Industrial Conglomerates

Machinery

Commercial Services & Supplies

Air Freight & Logistics

Road & Rail

Auto Components

Household Durables

Textiles, Apparel & Luxury Goods

Hotels, Restaurants & Leisure

Media

Multiline Retail

Specialty Retail

Food & Staples Retailing

Beverages

Food Products

Tobacco

Household Products

Health Care Equipment & Supplies

Health Care Providers & Services

Life Sciences Tools & Services

Diversified Financial Services

Consumer Finance

Capital Markets

Insurance

Real Estate Investment Trusts (REITs)

IT Services

Software

Communications Equipment

Electronic Equipment, Instruments & Components

Semiconductors & Semiconductor Equipment

Diversified Telecommunication Services

Electric Utilities

Multi-Utilities

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2015 Earnings Growth

Actual Net Income Margin Consensus Bottom-up

2013/1C 2013/2C 2013/3C 2013/4C 2014/1C 2014/2C 2014/3C 2014/4C 2015/4C Delta

Energy 8.2% 7.2% 7.2% 7.6% 8.0% 7.9% 7.9% 7.4% 8.3% 92bp

Materials 9.2% 8.3% 7.1% 7.8% 8.8% 8.7% 8.2% 7.5% 8.4% 91bp

Industrials 8.4% 9.0% 9.1% 9.0% 8.5% 9.7% 9.7% 9.4% 9.9% 51bp

Discretionary 6.4% 7.2% 7.9% 6.8% 6.5% 7.2% 7.2% 6.8% 7.7% 84bp

Staples 5.8% 6.2% 6.3% 6.2% 5.8% 6.3% 6.2% 6.1% 6.3% 18bp

HealthCare 10.1% 10.2% 10.1% 9.3% 10.2% 10.6% 10.4% 10.0% 10.9% 82bp

Financials 16.3% 17.3% 14.2% 16.3% 15.7% 15.4% 15.8% 17.0% 18.1% 111bp

Technology 19.0% 18.1% 18.9% 20.1% 19.4% 18.9% 19.3% 20.6% 21.0% 46bp

Telecom 8.9% 8.9% 8.9% 7.1% 10.1% 10.5% 10.4% 9.4% 10.1% 69bp

Utilities 8.9% 8.7% 11.9% 7.8% 9.6% 8.7% 11.8% 9.0% 10.0% 92bp

S&P 500 10.0% 10.0% 9.9% 10.0% 10.0% 10.2% 10.4% 10.4% 11.1% 70bp

Cyclicals 10.6% 10.6% 11.0% 11.1% 10.8% 11.1% 11.2% 11.4% 12.1% 67bp

Defensives 7.9% 8.1% 8.4% 7.5% 8.1% 8.5% 8.7% 8.1% 8.6% 51bp

55



Figure 91: Stats: Performance, Consensus Growth, Correlations vs. Oil, Dollar, and Interest Rates

S&P 500 Sectors and Industries

Source: J.P. Morgan, Factset, and Bloomberg. Updated as of 12/5/2014

S&P 500

GICS 1,3 Sector,Industry

Return

from

3/09

Return

from

1/12

Return

(12M)

5Yr CAGR

EPS

Growth

P/E

(LTM)

P/E

(NTM)

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EBTIDA

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Growth

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Yield

Buyback

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Short

Interest

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Foreign

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Exp

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'90 10Yr 1Yr

Since

'90 10Yr 1Yr

Since

'90 10Yr 1Yr

10 Energy 74% 14% -7% 11% 15.1 13.4 7.2 11% 2.2% 2.4% 4.6% 2.5% 48% 45% 60% 74% -20% -35% -25% -1% 3% 15%

101010 Energy Equipment & Services 33% 7% -15% 12% 13.5 11.7 6.9 18% 1.6% 3.1% 4.7% 3.0% 63% 46% 63% 68% -20% -42% -23% 3% 6% 21%

101020 Oil, Gas & Consumable Fuels 47% 15% -5% 11% 15.5 13.7 7.2 10% 2.4% 2.2% 4.6% 2.4% 45% 41% 55% 72% -18% -30% -24% -2% 1% 12%

15 Materials 133% 47% 12% 14% 21.4 18.4 11.3 7% 2.1% 3.8% 5.9% 2.5% 48% 12% 36% 42% -18% -38% -20% 4% 1% -6%

151010 Chemicals 103% 71% 14% 16% 20.7 18.3 11.4 7% 2.0% 5.2% 7.2% 2.2% 51% 0% 13% 46% -7% -18% -10% 3% -2% -4%

151020 Construction Materials 15% 58% 10% 23% 66.3 48.8 14.8 32% 0.8% -0.5% 0.3% 6.2% 6% 4% 8% 28% 1% -11% -8% -1% 5% -5%

151030 Containers & Packaging 71% 74% 16% 9% 20.1 18.0 9.8 9% 1.7% 3.7% 5.3% 3.8% 49% -6% -5% -4% 1% 3% -6% 0% -3% -16%

151040 Metals & Mining -19% -23% -5% -2% 17.7 17.9 10.8 -3% 2.6% -1.8% 0.7% 2.7% 46% 27% 47% 18% -31% -47% -35% 3% 3% -2%

151050 Paper & Forest Products 150% 82% 20% 31% 16.5 16.6 13.1 10% 2.9% -0.3% 2.6% 3.8% 25% 7% 23% -11% -10% -17% 3% 3% 2% -8%

20 Industrials 203% 68% 13% 16% 19.0 17.9 10.7 12% 2.0% 3.1% 5.0% 2.0% 38% -7% -4% 6% 3% -4% 17% 9% 13% 16%

201010 Aerospace & Defense 127% 85% 13% 14% 17.6 16.8 10.7 8% 2.0% 3.3% 5.3% 1.4% 35% -7% -12% -8% 3% 9% 19% 3% 6% 1%

201020 Building Products 103% 150% 17% 42% 25.7 24.4 13.7 1% 0.8% 0.6% 1.4% 2.4% 20% -1% 8% -10% -13% -21% 15% 4% 7% -11%

201030 Construction & Engineering 20% 25% -16% 9% 15.2 14.5 7.5 4% 0.3% 2.9% 3.2% 1.8% 49% 11% 26% 46% -7% -23% 17% 6% 9% 40%

201040 Electrical Equipment 89% 52% -2% 17% 17.4 16.5 11.5 7% 2.2% 1.5% 3.7% 1.5% 53% 4% 11% 25% -3% -6% 20% 10% 9% 36%

201050 Industrial Conglomerates 75% 60% 5% 11% 18.8 17.7 11.9 15% 2.3% 1.2% 3.5% 1.1% 55% -5% -7% 3% 2% -3% 3% 5% 9% 17%

201060 Machinery 122% 50% 12% 22% 17.5 17.3 9.3 9% 2.1% 5.4% 7.5% 3.5% 53% 8% 23% 32% -8% -29% 0% 11% 13% 17%

201070 Trading Companies & Distributors 164% 21% -1% 14% 23.0 21.6 10.3 9% 1.3% 2.0% 3.3% 7.1% 17% -4% -1% 2% 3% 3% 24% 7% 10% 24%

202010 Commercial Services & Supplies 55% 48% 11% 4% 21.9 19.9 11.8 -1% 2.2% 5.3% 7.5% 4.7% 18% -8% -17% -3% 8% 13% -8% -2% -11% -16%

202020 Professional Services 101% 82% 14% 15% 20.4 19.5 14.0 5% 1.5% 1.5% 3.0% 2.2% 35% 1% 1% -14% 0% 0% 4% 15% 15% 6%

203010 Air Freight & Logistics 97% 60% 16% 14% 24.1 21.8 11.7 6% 1.6% 5.6% 7.2% 2.2% 28% -17% -25% -26% 9% 20% 15% -1% -6% -10%

203020 Airlines 245% 286% 83% 24% 18.3 16.7 8.7 38% 0.9% 2.1% 2.9% 2.4% 17% -22% -31% -48% 9% 15% 16% 1% -3% -4%

203040 Road & Rail 231% 88% 35% 23% 20.7 19.9 10.3 28% 1.9% 1.9% 3.8% 1.3% 4% 3% 10% 18% -3% -8% 10% 5% 10% 2%

25 Consumer Discretionary 266% 83% 9% 15% 20.7 20.6 11.3 10% 1.4% 3.3% 4.7% 3.4% 29% -14% -12% -50% 7% 7% -7% 7% 7% -12%

251010 Auto Components 99% 75% 8% 17% 15.0 13.8 10.2 3% 1.4% 2.6% 4.0% 1.6% 65% 2% 8% 3% -8% -19% 17% 8% 8% 13%

251020 Automobiles 123% 47% -9% 8% 13.9 13.9 4.8 24% 1.3% 2.1% 3.4% 2.4% 41% 3% 10% -15% -5% -16% -5% 5% 4% 8%

252010 Household Durables 198% 151% 22% 19% 18.7 17.2 12.7 9% 1.6% 1.6% 3.2% 6.2% 29% -4% 6% -12% -5% -12% 4% 4% 6% -6%

252020 Leisure Equipment & Products 73% 30% -22% 7% 16.3 16.6 11.0 9% 3.0% 2.5% 5.5% 5.6% 53% -2% -13% -27% 2% 10% -15% 0% -3% 2%

252030 Textiles, Apparel & Luxury Goods 153% 54% 10% 12% 28.5 24.1 15.4 5% 1.2% 2.7% 3.9% 3.2% 41% -6% -6% -35% 0% 6% 18% 5% 7% -5%

253010 Hotels, Restaurants & Leisure 122% 35% 7% 16% 26.4 23.1 13.3 13% 2.3% 2.1% 4.4% 2.6% 49% -13% -26% -35% 9% 21% -14% -1% -5% -26%

253020 Diversified Consumer Services -14% 11% 23% 2% 20.8 17.6 9.4 2% 2.8% -0.2% 2.6% 1.2% 10% -14% -14% 2% 14% 14% 15% -3% -3% 10%

254010 Media 218% 122% 16% 18% 20.0 18.8 10.4 11% 1.2% 5.2% 6.4% 3.5% 20% 3% 8% -35% 3% -6% -13% 8% 10% -18%

255010 Distributors 171% 69% 25% 13% 22.9 22.4 13.4 5% 2.6% 1.0% 3.6% 4.0% 18% -17% -20% -24% 15% 18% 0% -7% -7% -20%

255020 Internet & Catalog Retail 310% 117% -13% 12% 15.2 50.1 25.2 0% 0.0% 0.3% 0.3% 3.6% 49% 1% 1% -1% -1% 1% -11% 6% 6% 0%

255030 Multiline Retail 70% 45% 16% 10% 21.1 19.2 9.6 9% 1.9% 2.6% 4.5% 4.8% 1% -12% -9% -43% 6% 11% 9% 2% 1% -1%

255040 Specialty Retail 178% 102% 18% 16% 21.4 20.9 11.6 10% 1.8% 4.6% 6.4% 3.4% 10% -18% -21% -43% 7% 13% 4% 3% 2% 0%

30 Consumer Staples 251% 49% 17% 6% 20.9 20.2 13.0 6% 2.7% 1.8% 4.5% 1.8% 41% -21% -36% -25% 12% 36% -30% -16% -24% -52%

301010 Food & Staples Retailing 107% 75% 16% 8% 20.3 20.0 10.6 10% 2.1% 1.4% 3.4% 2.3% 17% -17% -32% -48% 17% 35% -8% -9% -18% -33%

302010 Beverages 81% 45% 17% 7% 22.1 21.5 15.1 5% 2.4% 1.8% 4.2% 1.2% 53% -17% -28% -4% 7% 25% -29% -13% -20% -37%

302020 Food Products 104% 55% 15% 5% 21.5 19.8 12.8 1% 2.2% 1.7% 3.9% 2.5% 40% -14% -24% -8% 7% 28% -14% -15% -21% -31%

302030 Tobacco 120% 35% 17% 9% 18.5 18.4 12.8 6% 4.6% 2.2% 6.9% 1.3% 46% -10% -19% 0% 0% 15% -31% -7% -16% -37%

303010 Household Products 65% 41% 7% 2% 21.4 21.0 15.2 5% 3.0% 2.3% 5.4% 1.3% 62% -18% -34% -23% 12% 34% -26% -15% -21% -49%

303020 Personal Products 17% 5% -14% 11% 22.2 20.9 13.8 5% 1.1% 3.4% 4.6% 4.1% 64% -3% 1% -7% -3% -10% -26% -7% -5% -31%

35 Health Care 189% 103% 28% 10% 21.7 19.5 14.5 4% 1.6% 1.7% 3.3% 2.1% 40% -19% -39% -25% 7% 26% 18% -13% -21% -14%

351010 Health Care Equipment & Supplies 85% 82% 27% 5% 21.7 19.9 15.4 2% 1.4% 1.8% 3.2% 3.0% 50% -17% -32% -29% 6% 15% 0% -8% -12% -20%

351020 Health Care Providers & Services 190% 102% 28% 13% 18.8 17.3 10.1 10% 0.9% 4.0% 5.0% 2.6% 3% -10% -19% -26% 3% 12% 2% -5% -7% -13%

351030 Health Care Technology 418% 109% 11% 21% 40.5 38.8 22.3 0% 0.0% 0.9% 0.9% 4.8% 12% -6% -6% 3% 6% 6% 25% -2% -2% -7%

352010 Biotechnology 299% 236% 41% 23% 25.4 21.5 19.8 4% 0.4% 1.1% 1.5% 2.3% 36% -11% -30% -9% 6% 20% 7% -9% -19% -21%

352020 Pharmaceuticals 117% 79% 24% 5% 20.9 19.2 14.8 3% 2.6% 1.4% 4.0% 1.4% 51% -17% -33% -17% 7% 24% 23% -14% -21% 10%

352030 Life Sciences Tools & Services 143% 120% 19% 14% 19.2 19.7 15.6 14% 0.4% -3.5% -3.1% 1.3% 56% -4% -4% 4% 4% 4% 29% -3% -3% -3%

40 Financials 180% 90% 16% 12% 23.2 15.3 7.7 12% 1.8% 0.8% 2.6% 1.5% 20% -3% 5% -23% -3% -13% 45% 7% 15% 50%

401010 Commercial Banks 84% 82% 17% 12% 18.4 12.6 3.2 15% 1.7% -0.4% 1.3% 1.2% 16% -4% 0% 2% 0% -3% 47% 6% 13% 58%

401020 Thrifts & Mortgage Finance -15% 34% 2% -1% 24.4 26.6 0.0 -10% 2.9% 1.3% 4.2% 4.8% 0% -8% -10% -14% 8% 10% 6% 7% 9% 16%

402010 Diversified Financial Services 44% 144% 24% 13% 23.1 22.6 7.0 5% 0.9% 0.6% 1.5% 1.4% 24% -25% -32% -13% 32% 39% -26% -19% -24% -53%

402020 Consumer Finance 185% 109% 13% 36% 14.1 13.4 14.6 31% 1.3% 4.1% 5.4% 1.0% 17% -4% 1% -14% 2% -7% 10% 5% 11% 32%

402030 Capital Markets 43% 113% 17% 8% 17.5 15.6 21.7 7% 1.3% 2.1% 3.5% 1.4% 28% 5% 5% -1% -10% -11% 53% 18% 20% 72%

403010 Insurance 81% 81% 8% 8% 12.5 11.9 1.3 10% 1.7% 3.9% 5.5% 1.6% 30% -13% -5% 0% -1% -12% 25% 3% 10% 37%

404020 Real Estate Investment Trusts (REITs) 115% 41% 26% 11% 57.2 41.5 21.1 10% 3.3% -1.9% 1.4% 2.5% 7% -4% -3% -25% -11% -10% -31% -1% 2% -67%

404030 Real Estate Management & Development 180% 116% 36% 34% 19.6 19.4 14.3 0% 0.0% 0.1% 0.1% 1.0% 39% 15% 15% 9% -13% -13% -1% 18% 18% 7%

45 Information Technology 191% 71% 25% 13% 20.7 16.9 11.2 22% 1.6% 3.7% 5.3% 2.1% 58% 1% -4% -10% 2% 4% 16% 8% 6% 19%

451010 Internet Software & Services 138% 88% 12% 8% 23.7 24.7 18.0 0% 0.0% 1.4% 1.4% 1.8% 51% 2% 6% 6% 0% 1% 14% 7% 6% -2%

451020 IT Serv ices 310% 43% 14% 14% 21.5 13.1 12.7 19% 1.3% 5.3% 6.6% 2.7% 47% -20% -32% -13% 26% 39% -26% -14% -24% -53%

451030 Software 99% 82% 24% 8% 26.0 18.3 11.7 13% 1.8% 2.2% 4.1% 1.6% 50% -6% -17% 9% 8% 12% 22% 3% 0% 10%

452010 Communications Equipment 33% 42% 14% 14% 14.6 14.0 10.3 21% 2.4% 4.6% 7.0% 1.4% 64% 3% 4% 9% 0% -1% 10% 5% 0% 8%

452020 Computers & Peripherals 165% 88% 42% 21% 16.9 14.3 9.1 55% 1.9% 5.8% 7.7% 1.6% 64% 2% 1% -18% -3% 0% -18% 5% 3% -1%

452030 Electronic Equipment, Instruments & Components77% 82% 23% 7% 19.0 16.8 11.3 20% 1.8% 4.9% 6.7% 1.4% 71% 0% 10% 15% -4% -12% 15% 10% 14% 35%

453010 Semiconductors & Semiconductor Equipment100% 74% 45% 15% 18.3 16.6 10.2 7% 2.5% 2.1% 4.6% 4.3% 77% 4% 2% 4% 2% -3% 18% 9% 7% 34%

50 Telecommunication Services 53% 20% 0% 4% 16.1 14.3 5.4 1% 4.8% 1.0% 5.8% 3.3% 1% -5% -16% 1% 5% 19% -5% -8% -12% -15%

501010 Diversified Telecommunication Services 38% 15% 0% 4% 16.1 14.3 5.4 1% 4.8% 1.0% 5.8% 3.3% 1% -6% -16% 1% 5% 18% -4% -8% -12% -14%

55 Utilities 78% 27% 21% 3% 17.3 17.3 10.0 3% 4.1% -0.7% 3.3% 3.3% 5% 0% -8% -9% 1% 12% -21% -14% -19% -47%

551010 Electric Utilities 40% 19% 22% 3% 16.7 16.7 9.9 1% 4.4% -0.9% 3.4% 3.6% 3% -2% -10% -10% 2% 12% -25% -15% -19% -49%

551020 Gas Utilities 190% 59% 26% 8% 12.5 13.0 7.9 2% 4.0% -0.5% 3.5% 3.7% 0% 20% 25% -3% -12% -21% -18% -6% -8% -44%

551030 Multi-Utilities 83% 36% 20% 3% 19.3 18.7 10.4 3% 3.9% -0.7% 3.2% 2.9% 2% -2% -12% -8% 5% 19% -16% -4% -20% -46%

551050 Independent Power Producers & Energy Traders0% 0% 0% 0% 5.6 13.9 9.6 41% 1.4% 2.0% 3.4% 2.1% 64% 14% 14% 11% -14% -14% 3% -4% -4% 5%

Correl vs Oil Correl vs USD Correl vs 2Yr Yld

56



Discretionary (OW): Rises on Higher Consumer Spending

The Consumer Discretionary sector is the most levered way to play the lift in expected consumer spending in 2015. We believe the sector offers superior fundamentals, greater return of shareholder capital and an attractive entry point.

Sector Thesis: (1) direct way to play improving labor market and expected rise in wages—more jobs and rising wages mean higher disposable income to spend on both necessary and discretionary items. Even considering higher wages this should be a net positive; (2) the rise in the dollar and tame inflation are windfallsfor US consumers, especially for those companies that import from abroad and sell in the US (Multi-line and Specialty Retail); (3) an improving job outlook and rising confidence could be the catalysts to unleash wealth effect and potentially lower savings rate; (4) lower gas prices are a tax relief for consumers,especially in the lower-to-middle income tax brackets, which should drivespending across sectors and industries; (5) there is evident pent-up demand after years of under consumption driven by post-recession blues and much needed household deleveraging; and (6) the sector has become increasingly shareholder friendly.

Fundamentals: Discretionary offers investors a diverse list of business models ranging from Autos to Lodging/Gaming to Retail to Media. Despite the diversity, all twelve industries are expected to generate double-digit earnings growth (NTM)—the strongest earnings growth is expected from the durable goods sectors like Autos (48%) and Household Durables (21%). Leisure/Hotels/Restaurants are expected to grow at a lower but still healthy rate of 9-18%. Given the significant operating leverage in the sector, margin expansion is expected to drive a significant portion of NTM EPS growth of 17.3% on revenue of 9.2%.

Sub-industries: Autos to benefit from higher consumer confidence, potentially higher household leverage, aging auto fleet and easier year-over-year earnings comparisons. With lower gasoline prices and rising incomes, Lodging and Gaming (Domestic Las Vegas exposure rather than Foreign) is likely to outperform as US consumers take more frequent domestic trips. While most industries within this sector are labor intensive, Media and Internet Retail rank among the highest on revenue per employee metric and continue to benefit from strong secular trends. Multi-national Restaurants are a relative underweight within the sector as the stronger dollar and potentially higher wages are likely to weigh on margins. Additionally, given the strengthening dollar we prefer Multiline and Specialty Retail, with production abroad and sales in the US, over Textiles, Apparel & Luxury Goods due to their higher foreign revenue exposure.

Valuation: On EV/EBITDA, the sector trades inline with the S&P 500 but at a significant discount to most Defensive sectors. Autos fits our tilt toward valuewith the sector trading at 4.7x EV/EBITDA—while the US dollar is a headwind, declining gasoline prices and improving real estate market favor light-truck categories, where the US Autos have a higher market share compared to competitors abroad.

Risks: due to higher labor intensity, the Discretionary sector is more likely to face headwinds from rising labor costs. The sector should underperform if inflation was to sharply reverse or a global shock causes deterioration in US consumer confidence.

Sector Stats: Discretionary

as of 12/05/2014

Source: J.P. Morgan and FactSet.

Note: The above metrics were calculated using

current constituents weighted by market-cap,

which may differ from the bottom-up

aggregation of real-time constituents.

Basic Stats (Avg):

Market Cap 12%

Revenue (LTM) 15%

Foreign Exposure 29.0%

1Yr Performance 9.9%

Perf since 3/9/2009 450.3%

Fundamentals:

Sales Growth (5Yr CAGR) 9.2%

Sales Growth (NTM) 7.6%

EPS (5Yr CAGR) 14.9%

EPS (NTM) 17.3%

Balance Sheet:

Cash as % of Total Assets 10.9%

Debt as % of Total Assets 29.3%

Debt to Equity 1.3x

EBIT/Interest Expense 16.8x

Use of Capital:

Capex as % Mkt Cap 3.4%

Net Buyback Yield 3.3%

Dividend Yield 1.4%

Technical/Sentiment:

Short Interest as % of Float 3.4%

Analyst Rating: 1=Buy, 5=Sell 4.0

Price from 52Wk High 93.0%

RSI (30D) 58.6

Beta 1.1

Valuation:

EV/Sales 1.6x

EV/EBTIDA 11.3x

P/E (NTM) 20.6x

PEG Ratio 1.2x

CF Yield 3.9%

57



Fundamentals: mid-single digit revenue growth giving rise to double-digit profit

As shown below, the consensus bottom-up revenue growth is expecting consistent top-line growth between 5-6% to drive 12-19% quarterly (YoY) earnings growth in 2015. Given the significant operating leverage in the model, margins are expected to contribute a significant portion of the earnings growth.

Earnings Growth: the sector is expected to deliver revenue and earnings growth in 2015.

Figure 92: Consensus Quarterly Sales GrowthYoY Growth

Source: J.P. Morgan and IBES Consensus Estimates

Figure 93: Consensus Quarterly Net Income GrowthYoY Growth Rate


It may surprise some investors that Shareholder Yield at 4.7% (Dividend + Buybacks as % of market cap) is now higher than Utilities at 3.3%.

On a P/E (NTM) basis, Discretionary stocks trade at a slight premium to long-term averages. However, on an EV/EBITDA, the sector trades at 13.3x, which is roughly inline with the market but closer to its +1STDev. More so, on a cash flow basis the sector does not look expensive and is trading inline with historical average.

Figure 94: Total Shareholder Yield (Dividend + Net Buybacks)Since 1998


Figure 95: Valuation: FCF YieldSince 1990


10.5

%15

.4%

12.1

%9.

2%7.

5%-0

.5%

3.0%

5.4%

4.1%

6.9%

5.9%

3.0% 4.

2%4.

5%3.

8%3.

7% 4.8% 5.3% 6.

4%5.

7%

-5%

0%

5%

10%

15%

20%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Discretionary S&P 500 (ex-financial)

18% 21

%

15%

9%

2%

-17%

3%

13%

8%

26%

22%

1%

6% 5%

-5%

5%

12% 15

% 19%

19%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Discretionary S&P 500 (ex-financial)

4.7%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

$0

$5

$10

$15

$20

$25

$30

$35

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Consumer DiscretionaryDividends ($Bn, Left)



4.6%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

'90 '94 '98 '02 '06 '10 '14

FC

F Y

ield

FCF Yield Avg +1 STD -1 STD

58



Technology (OW): Stronger Growth at Market Multiple

Technology carries the heaviest weight at ~20% of total S&P 500 market capitalization. As for performance, the average stock in the index has outperformed the S&P 500 over the last twelve months and since the start of the recovery. We recommend investors overweight Technology over Industrials, New over Old Technology, and Security over Equipment.

Sector Thesis: (1) the growth rate for investment expenditures has a higher beta to the overall economic growth—this is expected to drive strongest organic revenue growth of all sectors at 8.4% NTM; (2) Technology by definition has higher pricing power and this is evidenced by higher EBIT margins of 21.2% vs. Industrials at 11.7% and S&P 500 at 12.5%; (3) trades at a cheaper multiple when adjusted for growth—like PEG at 1.1x (vs. S&P 500 at 1.2x); and (4) supportive technical drivers—a high shareholder yield of 4.5%.

Fundamentals: more than any sector, Technology has had the highest sustainable organic revenue growth over the last five years with CAGR at 14% (compared to S&P 500 at 8.1%) and margin expansion driving a smaller part of total earnings growth so far. There is margin expansion potential broadly for the Technology sector, and especially for Semis.

Sub-industries: Internet and Semis/Semi-Equipment are expected to generate strongest consensus earnings growth between 12-15%. There are pockets of secular growth areas within Applied Technologies: in particular, Solar, Solid-state Lighting, and Big Data. At this point in the economic recovery, we favor companies with offerings that help improve productivity or provide greater network/data security—regardless of what the dollar is doing or stage of the economic life-cycle, there is sustainable and more inelastic demand for products that pay for themselves in a short period of time (high ROI).

Valuation: Though the sector trades mostly inline on P/E, when adjusted for growth it is cheaper than the market and most sectors. Additionally, the sector has a growing cash flow yield of 6.0%, which is above that of S&P 500 at 5.0%.

Risks: given the strengthening dollar, the largest headwind for the sector is its highest foreign revenue exposure (57.9%) of all sectors. This risk is partially countered by tech companies having significant production abroad coupled withpatent protection legally limiting cheaper substitutes. In fact, since 1989, Technology has had a similar correlation to the dollar as Utilities, which is a pure domestic play.

Sector Stats: Technology

as of 12/05/2014






Basic Stats (Avg):

Market Cap 20%

Revenue (LTM) 11%



Perf since 3/9/2009 351.2%.

Fundamentals:




EPS (NTM) 15.1%

Balance Sheet:



Debt to Equity 0.5x


Use of Capital:



Dividend Yield 1.6%





RSI (30D) 56.2

Beta 1.0

Valuation:

EV/Sales 3.1x

EV/EBTIDA 11.2x

P/E (NTM) 16.9x

PEG Ratio 1.1x

CF Yield 6.0%

59



Strong revenue growth despite currency headwinds

The technology sector is relatively sensitive to foreign exchange dynamics as more than half of its revenue is derived abroad. We believe the recent strengthening of the dollar will put pressure on earnings. We expect the net effect is single digit revenue growth, which will be below the double digit growth seen over the last five years.



Figure 97: Consensus Quarterly Net Income GrowthYoY Growth


Though multiples have expanded over the last two years technology remains attractive on PEG. EV/EBITDA is in line with the historical average at 11.2x and the sector boasts the second highest total yield at 4.5%.



Figure 99: Valuation: EV/EBITDASince 1990


15.9

%15

.3%

10.9

%11

.9%

11.2

%7.

6%5.

7%7.

9%5.

7%2.

6%5.

0% 6.3%

4.3%

7.3%

6.3%

4.6%

6.8%

5.8% 6.

8%6.

2%

-5%

0%

5%

10%

15%

20%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Technology S&P 500 (ex-financial)

21%

20%

10%

15% 18

%

8%

1%

2%

0%

-5%

9% 8%

6%

12%

9%

7%

10% 12

%

11%

9%

-10%

-5%

0%

5%

10%

15%

20%

25%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Technology S&P 500 (ex-financial)

4.5%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

$0

$10

$20

$30

$40

$50

$60

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Information TechnologyDividends ($Bn, Left)



11.2x

0.0x

5.0x

10.0x

15.0x

20.0x

25.0x

'90 '94 '98 '02 '06 '10 '14

EV

/EB

ITD

A (L

TM

)


60



Financials (OW): A Play on Rising Rates and Employment

Even though Financials make up only 16% of the S&P 500 market cap, the sector is expected to drive 36% of the earnings growth in 2015. Given that J.P. Morgan has a more hawkish view on interest rates than the Street, we believe this sector should outperform. Additionally Financials benefit from higher domestic exposure and relatively attractive valuations.

Sector Thesis: (1) a play on rising rates: historically Financials are among the strongest performers ±6 months around the initial Fed rate hike—J.P. Morgan forecasts first hike mid-2015; (2) sector is sensitive to an improving labor market(declining unemployment rate improves loan growth as more people qualify); (3) a domestic play with 80% of revenue coming from the US, (4) third cheapestamongst sectors with a P/E (NTM) of 15.3x vs. the S&P 500 P/E (NTM) of 17.3x; the only cheaper sectors are Energy at 13.4x and Telecom at 14.3x.Relative to its own history, currently Financials is trading at a slight P/E (NTM) premium and at a discount on a P/B basis.

Fundamentals: the investor sentiment remains poor for Banks given the expected anemic loan growth and continued negative rhetoric from the regulators. Rising credit costs (loan reserves) could become a headwind; however, keep in mind that lenders have remained disciplined after the last financial crisis and the labor markets are expected to improve further. Overall, the industry should benefit from higher rates (given the current zero Fed fund rate) with potentially higher loan growth volume due to more relaxed credit standards and potentially higher household leverage. While rising rates should benefit Life Insurance, J.P. Morgan has a neutral view on the industry as organic growth remains pressured.

Sub-industries: Exchanges should benefit from rising volumes due to expected higher market volatility driven by rising rates. Similar to Money Center Banks, Regional Banks benefit from rising rates, have mostly domestic exposure, face fewer regulatory hurdles, and rising M&A activity should support their valuations. The bond-proxy REITs are likely to suffer a rare underperformanceduring this cycle. REITs have been among the strongest performers as investors rewarded stocks with low volatility and high income—with ZIRP likely in the rear-view window by year-end, we believe the double-digit returns are also likely to be the thing of the past.

Valuation: The cheapest industries within Financials are Insurance, Commercial Banks and Consumer Finance, all trading several turns cheaper on P/E (NTM) at around 12-13x. The most expensive by far is REITs at 42x (caution: the industry has heavy non-cash D&A expense and it is traditionally valued on dividend yield) followed by Thrifts and Mortgage at 27x (depressed earnings suffering from poor mortgage volume).

Risks: interest-rate sensitive Financials may underperform in an environment where the anticipated hikes are pushed down a few quarters due to slowing growth abroad and/or sharp rise in the dollar. Even worse would be a scenario where short-term rates rise while long-end of the curve remains flat to slightlylower. In this bear flattener, the Money Center and Regional Banks are likely to suffer the most.

Sector Stats: Financials

as of 12/05/14






Basic Stats (Avg):

Market Cap 16%

Revenue (LTM) 12%



Perf since 3/9/2009 398.5%

Fundamentals:




EPS (NTM) 28.6%

Balance Sheet:



Debt to Equity 1.7x


Use of Capital:



Dividend Yield 1.8%





RSI (30D) 56.9

Beta 1.1

Valuation:

EV/Sales 4.3x

EV/EBTIDA 7.7x

P/E (NTM) 15.3x

PEG Ratio 0.5x

CF Yield 7.7%

61



Fundamentals: low revenue growth evident in consensus numbers

As shown below, the consensus bottom-up revenue growth is expected to be flat for most quarters going into 2015. As for earnings growth, the consensus is expecting double-digit earnings growth on lower expenses and likely higher NIM.

Earnings Growth: Commercial Banks are expected to see the strongest earnings growth over the next twelve months.

Short interest remains most elevated in the Thrifts and Mortgage given the negative revenue and earnings growth expectation.





Due to higher capital requirements, the Financials sector has returned a smaller percentage of capital back to shareholders at a current run rate of 2.8% of market cap. Prior to the last recession, the total shareholder yield was over 5%.

Financials trade at a discount on Price to Book ratio, which is below historical median of 1.7x.



Figure 103: Valuation: P/BSince 1990


-0.5

%-0

.3%

2.3%

-4.2

% 0.3%

-0.6

% 2.5%

22.2

%2.

5%6.

3%-1

.5%

-11.

0%-1

.5%

0.5%

4.5%

1.2% 2.

8%2.

6%2.

6% 4.6%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Financials S&P 500 (ex-financial)

15%

-24%

1% 3%

23%

62%

32%

17%

7%

34%

-4%

24%

-5%

-11%

16%

5%

13% 17

%

13%

11%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Financials S&P 500 (ex-financial)

2.8%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

$0

$10

$20

$30

$40

$50

$60

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

FinancialsDividends ($Bn, Left)



1.43x

0.5x

1.0x

1.5x

2.0x

2.5x

3.0x

3.5x

'90 '94 '98 '02 '06 '10 '14

P/B

P/B Avg +1 STD -1 STD

62



Healthcare (OW): Strong demographics but richer multiples

The strong demographic trend makes a case for the sector. Since 1950’s, Healthcare has accounted for a larger share of the wallet, rising from 6% of total personal consumption to 16.7% (see Figure 19). A surprising fact is that spending on Healthcare is almost equivalent to total Housing expenditures (actual or imputed rent + utilities). Tactically, there might be a better entry point based on valuation, but we recommend the sector as a long-term strategic holding for its superior fundamentals and supporting technical factors.

Healthcare should continue to gain a larger share of the consumer wallet with aging population and declining number of uninsured people. However, a move away from all-you-can-eat buffet model to an a la carte pricing may have a counter-effect on healthcare spending.

Thesis: Healthcare is our weakest overweight but the following trends keep us from turning neutral: aging population, declining uninsured people, new product launches, and M&A becoming an important theme in 2015. The long-term thesis for the sector is unmatched, in our view, but there could be a better entry point in the short term—healthcare outperformed the market by 28% YTD. On a tactical basis, investors may find an entry point based on valuation, but our strategic view is positive on the sector.

Fundamentals: the underlying fundamental drivers remain strong with above-GDP growth for the Healthcare sector driven by aging population and a declining number of uninsured people. Over the last five years, the earnings CAGR has averaged closer to 10%. The growth is expected to increase to 16% NTM, inline with the 17.3% earnings growth expected for Discretionary.

Sub-industries: with richer valuation, themes and stock selection will play an increasing role for the sector. Pharma over Biotech: new product launches, M&A activity, and cheaper valuation favors Pharma. Specialty Pharma over Large-Pharma: as the consolidation theme gains momentum for Specialty stocks. Healthcare Facilities are likely to remain in a limbo until the Supreme Court decision on exchange subsidies.

Valuation: similar to other defensive sectors, Healthcare has seen valuation multiples expand with one year gains nearing 30%. The sector has the lowest dividend yield at 1.4% and the buyback yield at 1.3%.

Risks: the largest risk to the sector are the uncertainties around regulations, M&A activity premium is lost if the markets get increasingly volatile, and the risks associated with the reversal of ZIRP and rising yields.

Sector Stats: Healthcare

as of 12/05/2014






Basic Stats (Avg):

Market Cap 14%

Revenue (LTM) 13%



Perf since 3/9/2009 322.7%

Fundamentals:




EPS (NTM) 16.3%

Balance Sheet:



Debt to Equity 0.7x


Use of Capital:



Dividend Yield 1.6%





RSI (30D) 61.6

Beta 1.0

Valuation:

EV/Sales 2.1x

EV/EBTIDA 14.5x

P/E (NTM) 19.5x

PEG Ratio 1.2x

CF Yield 4.8%

63



Fundamentals: Healthcare is the fastest growing sector by revenue

Based on consensus estimates, Healthcare sector is positioned to become the fastest growing sector in the S&P in terms of revenue in 2015.

Earnings Growth: Consensus estimates double-digit EPS growth with the bulk of that coming from Biotechnology and Healthcare Technology.

Healthcare Equipment & Supplies, Life Science Tools & Diagnostics and Pharmaceuticals all expected to grow at a lower rate than the sector.





Growth doesn’t come cheap and at 19.5x forward earnings, which is close to its historical long-term average.



Figure 107: Valuation: P/E (NTM)Since 1990


6.5% 8.

4%10

.5%

1.3%

6.2%

8.6%

4.8% 6.

7%4.

6%2.

2%5.

6%5.

7%7.

9%12

.3%

12.4

%9.

1%8.

5%4.

9%5.

0% 5.5%

-5%

0%

5%

10%

15%

20%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates HealthCare S&P 500 (ex-financial)

9%

11%

10%

-4%

3% 4%

6%

2%

-1%

-1% 0%

1%

9%

17%

16% 18

%

13%

7%

11% 14

%

-10%

-5%

0%

5%

10%

15%

20%

25%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates HealthCare S&P 500 (ex-financial)

3.3%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

$0

$5

$10

$15

$20

$25

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

HealthcareDividends ($Bn, Left)



19.5x

8x

13x

18x

23x

28x

33x

38x

43x

'90 '94 '98 '02 '06 '10 '14

P/E

(N

TM

)

P/E (NTM) Avg +1 STD -1 STD

64



Staples (N): A more expensive play on Consumer

With rich valuations, Staples is not a preferred way to play the lift in consumer spending. While macro drivers are supportive for the sector, the expected earnings growth is lower and valuation richer compared to Consumer Discretionary and the S&P 500.

Positives: Similar to Discretionary, the sector stands to benefit from the stronger consumer: rising disposable income, declining inflation, potential wealth effect and declining savings rate. Also, the recent commodity price declines should be felt in earnings as margin expansion over the next two quarters.

Negatives: (1) strongest negative correlation of all sectors to rising interest rates; (2) less pent-up demand in the inelastic Staples categories like Food/Beverages/Household goods than the discretionary durable goods categories; (3) run-up in the sector has forced shareholder yields lower at 4.5%(dividend + buybacks); now it is lower than Discretionary at 4.7%; and (4) greater exposure to EM where growth has been below trend and where the local currencies have been declining—it typically takes around one year for companies to see the full impact from changes in currency.

Fundamentals: the sector had a strong year even with relatively weaker fundamentals in 2014. With the rerating seen across industries, we wonder if much of the expected improvement is already priced in for Staples. The top-line growth is expected to be mediocre at best (consensus estimate at 3.7%) with margin expansion through increased productivity and buybacks driving 7.6% NTM EPS growth.

Sub-industries: based on J.P. Morgan equity analysts, the fundamentals for Beverages should improve in 2015 but the weakness in EM and currency pressures remain for the industry. Healthier Foods & Retailer trade continues to generate stronger relative growth in an anemic growth sector. Tobacco andPersonal Products are expected to see the lowest consensus earnings growth (NTM) with Food Products & Staples expected to see the strongest at ~10%.

Valuation: The valuation multiples are rich compared to its history with EV/EBITDA multiple now over 1STdev and approaching peaks last seen in 1990’s, P/E (NTM) is almost two turns more expensive than the S&P 500, and richer compared to Healthcare, which has stronger demographic trends.

Risks: the largest risk to our neutral stance for the sector is more technical than fundamental and it is related to the changes in interest rates. If rates were to decline further in 2015, the sector could see additional capital flow from income investors. While Telecom and Utilities rank higher in the food chain for income investors, these provide lower liqudity (combined market caps for these two sectors is only 5.5% of total S&P 500 index) than Staples at 11% of total index weight.

Sector Stats: Staples

as of 12/01/2014, median






Basic Stats (Avg):

Market Cap 11%

Revenue (LTM) 14%



Perf since 3/9/2009 251.0%

Fundamentals:



EPS (5Yr CAGR) 6.5%

EPS (NTM) 7.6%

Balance Sheet:



Debt to Equity 0.9x


Use of Capital:



Dividend Yield 2.7%





RSI (30D) 59.2

Beta 0.8

Valuation:

EV/Sales 1.5x

EV/EBTIDA 13.0x

P/E (NTM) 20.2x

PEG Ratio 2.7x

CF Yield 4.6%

65



Fundamentals: Low growth, high yield

Staples is expected to have below average revenue (3.7%) and EPS growth (7.6%)with buybacks contributing to the bottom-line.

Food & Staples retailing is the most attractive from a growth perspective with double digit consensus earnings growth in 2015.





Total shareholder yield for the Staples sector sits at 4.6% (dividend + buybacks as % of market cap), which is also significantly higher than Utilities at 3.3%.





9.8% 11

.3%

13.0

%3.

4%7.

1%3.

3%1.

8% 3.6%

0.9%

1.1% 2.

0%1.

0% 1.6% 3.

3%2.

9%3.

0%3.

3%5.

6% 6.1%

6.1%

-5%

0%

5%

10%

15%

20%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Staples S&P 500 (ex-financial)

10% 12

%

9%

-9%

2%

0% 0%

15%

2%

0%

4%

-2%

1%

5%

0% 1%

7% 8%

10%

9%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Staples S&P 500 (ex-financial)

4.6%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

$0

$5

$10

$15

$20

$25

$30

$35

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Consumer StaplesDividends ($Bn, Left)



17.3x

8x

10x

12x

14x

16x

18x

20x

22x

24x

26x

28x

'90 '94 '98 '02 '06 '10 '14

P/E

(N

TM

)


66



Industrials (N): Selective Opportunities within Sector

Similar to Technology, Industrials are impacted by the ebb and flow of capital expenditure decisions by corporations. Our less constructive neutral view for Industrials is predicated on very important differences between the two sectors—its higher exposure to the Energy Exploration & Production industry and greater sensitivity to the stronger dollar and interest rates. Given the wide diversity of companies within Industrials, we suggest pair trades within the sector as the performance should be highly bifurcated from industry to industry.

Sector Thesis: we have a balanced view for the sector with meaningful tailwinds and headwinds. Let us start with the positive drivers for the sectors. As we discussed in the Macro section of the report, investment spending growth is expected at a healthy clip of 5.8% with residential investment expected to be a significant driver at growth rate of 8.7% in 2015. Looking at the investment categories a bit further, Equipment spending has already bounced back to levels above pre-recession levels and are likely to continue rising at an above GDP growth rate. While Residential and Commercial structures have seen less than robust growth, it is an area that could see a pick-up in demand in the coming quarters (especially if the positive view on Residential Housing materializes).

Industrials offer fewer sustainable growth stories other than Technology. The shale boom was a significant growth driver, but with oil below $70 this exposure is becoming a headwind. Further, the sector is more sensitive to the rising dollar due to inferior pricing power compared to Tech. Lastly, the rising rates make products more expensive for the end-user but more often the companies absorb the rise in financing cost (negative for margins).

Fundamentals: the consensus expected NTM earnings growth rate of 14% for the sector is at risk of downward revisions—the sector grew at a similar growth rate over the last five years even though the capital spending by E&Ps was stronger and the recovery from post-recession low was larger. At the industry level, the growth ranges from a low of +10% for Electrical Equipment to high as 38.0% for the Airlines and 34% for the Building Products companies—we favor these higher growth industries with secular growth trends (please refer to our write-up on Airlines Theme).

Sub-industries: we believe there are interesting pair-trade opportunities within the sector: we favor late-cycle Airlines with domestic exposure with sensitivity to consumer spending over early-cycle Machinery/Farming Equipment(interest rate and dollar sensitive). Generally, we favor Capital Users (i.e., Trucking/Air Freight with lower oil prices over Capital Producers (i.e., Industrial Conglomerate and Electrical Equipment). With 8.7% expected growth in residential investment, Homebuilders and Builders should clearly benefit from this increased activity, in our view. We believe the best defense is Defense,as Government receipts improve and spending improves on a YoY basis.

Valuation: Industrials trade at a P/E (NTM) of 17.9x, which is slightly higher than S&P 500. Compared to Technology, Industrials trade at a premium on PEG multiple of 1.3x and higher than the S&P 500 trades at 1.2x.

Risks: the sector has significantly higher foreign revenue exposure at 38% compared to the S&P 500 at 33%—a major dollar move in either direction is likely a risk to our neutral view for the sector.

Sector Stats: Industrials







Basic Stats (Avg):

Market Cap 10%

Revenue (LTM) 11%



Perf since 3/9/2009 369.2%

Fundamentals:




EPS (NTM) 13.8%

Balance Sheet:



Debt to Equity 1.0x


Use of Capital:



Dividend Yield 2.0%





RSI (30D) 57.8

Beta 1.1

Valuation:

EV/Sales 1.8x

EV/EBTIDA 10.7x

P/E (NTM) 17.9x

PEG Ratio 1.3x

CF Yield 4.8%

67



Fundamentals: We expect significant divergence within the sector

Airlines are positioned most favorably within industrials with consensus estimating 40% EPS growth in 2015 with expected consumer and business spending lift supporting top line growth and cheap fuel expanding margins.

Manufacturing linked to the Energy sector could see meaningful decline in production in 2015.

Figure 112: Consensus Quarterly Revenue GrowthYoY Growth




Though industrials as a whole is trading relatively expensive at 17.9x NTM P/E (versus an average of 16.4x), the sector’s above average shareholder yield of 5.2% (100 bp above average for the S&P) is attractive.





11.1

%8.

7%8.

7%6.

5% 6.9%

5.1%

1.5%

1.5%

0.1% 1.

2%1.

3% 2.1%

0.2% 1.

7% 3.0%

2.5% 3.

7%3.

3%3.

3% 3.9%

-5%

0%

5%

10%

15%

20%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Industrials S&P 500 (ex-financial)

38%

18%

18%

14% 16

%

12%

3%

-2%

3%

1%

7%

12%

1%

9% 10%

7%

9%

5% 6%

10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Industrials S&P 500 (ex-financial)

5.2%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

$0

$5

$10

$15

$20

$25

$30

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

IndustrialsDividends ($Bn, Left)



17.9x

8x

10x

12x

14x

16x

18x

20x

22x

24x

26x

28x

'90 '94 '98 '02 '06 '10 '14

P/E

(N

TM

)


68



Energy (N): Low Visibility Keeps Us Sidelined

The poor earnings visibility and high/rising oil volatility keep us sidelined on Energy (N). The risk/reward should improve as production volumes are recalibrated with global demand, which could be a few weeks to quarters away. The catalyst here could be either OPEC cutting supply or the credit markets forcing some E&Ps to curtail exploration activities. Energy is oversold, has a stronger long-term fundamental story, and is a better value compared to the underweight Materials, in our view. At the sub-industry level, Refiners, Pipelines, and Natural Gas should outperform given the higher domestic exposure.

Sector Thesis: we are sidelined at the sector level, but interesting pair opportunities exist at the industry level. The high and rising VIX level for oil keeps our enthusiasm contained for the highest risk/reward industries: Drilling Equipment and Service Providers should be impacted most by drilling curtailment while E&Ps (especially offshore companies) are exposed to the commodity price fluctuation.

On a relative basis, we prefer lower risk Refiners that are tied to spread income and network of Pipelines that store and push volume throughout the country—volume consumption has historically increased with lower energy prices, which would be a positive for these industries. These sub-industries along with Natural Gas producers are consistent with our Domestic over Foreign exposure theme.

Fundamentals: the NTM earnings growth is expected at -9.9% for the sector compared to much a stronger 5Yr CAGR of 11.3%. At the industry level, the consensus is expecting strongest growth from Pipelines. Drillers have the highest short interest as % of float at 9.2% (compared to S&P 500 at 2.2%) and lowest analyst stock ratings, implying significant fundamental headwinds for the industry.

Valuation: after the recent decline, the sector is slowly becoming a value sector within S&P 500 with the cheapest P/E (NTM) of 13.4x, and the EV/EBITDA multiple is also low at 8.8x. With the RSI (30) quickly approaching levels indicative of seller exhaustion, the sector could see a near-term bounce if oil price shows signs of stabilization. The average P/E (NTM) for Drillers is now in single-digits after the 45% decline seen by the industry.

Risks: since the recent decline in the sector is driven by excess supply, a positive scenario would likely play out for the sector if OPEC decides to decrease production. A much more negative scenario would likely transpire if a spike in default rates shuts down the functioning of credit markets and the contagion quickly spreads out to other sectors.

Sector Stats: Energy







Basic Stats (Avg):

Market Cap 8%

Revenue (LTM) 14%


1Yr Performance -6.5%

Perf since 3/9/2009 190.3%

Fundamentals:


Sales Growth (NTM) -1.7%


EPS (NTM) -9.3%

Balance Sheet:



Debt to Equity 0.5x


Use of Capital:



Dividend Yield 2.2%





RSI (30D) 42.8

Beta 1.1

Valuation:

EV/Sales 1.4x

EV/EBTIDA 7.2x

P/E (NTM) 13.4x

PEG Ratio -1.4x

CF Yield 1.6%

69



Fundamentals: Revenue and EPS growth negative Y/Y in 2015

Oil price is the obvious driver of uncertainty across the sector with WTI continuing its slide into the low $60s. While consensus is expecting top-line to contract by around 14% in early 2015, it is also estimating positive comps by year end 2015.

Low oil prices will put pressure on the high yield market (~18% of which is energy). Oil below $75, if sustained, could trigger higher defaults and contagion risk to other sectors, such as banks with exposure to E&P debt.





Due to the recent decline, Energy is one of the cheapest sectors but may be a value trap as the sector heavily depends on oil price—correlation of energy to oil at 90%.

Additionally, while the sector has been paying healthy yields, this may come under pressure with as earnings decline.



Figure 119: Valuation: PE (NTM)Since 1990


38.8

%46

.5%

40.8

%-7

.5%

4.9%

-11.

9%-1

4.0%

-9.8

%-1

4.7%

-4.9

% 1.7%

-3.4

%0.

7% 3.3%

-2.6

%-1

3.6%

-13.

0%-1

3.5% -8.1

% 1.5%

-20%

-10%

0%

10%

20%

30%

40%

50%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Energy S&P 500 (ex-financial)

46%

45%

62%

14%

-2%

-18% -17%

0% -2%

-8%

-9%

-7% -2

%13

%7%

-15%

-17% -15% -8

%16

%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Energy S&P 500 (ex-financial)

4.2%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

$0

$5

$10

$15

$20

$25

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

EnergyDividends ($Bn, Left)



13.4x

8x

10x

12x

14x

16x

18x

20x

22x

'90 '94 '98 '02 '06 '10 '14

P/E

(N

TM

)


70



Materials (UW): Weighed Down by Global Headwinds

The Materials sector has foreign revenue exposure at 48%; however, one can argue that the sector actually has an even larger exposure since prices for most raw materials are set globally (not locally). As long as shipping remains economically viable for hard commodities and industrial chemicals, the price will remain tied to global supply and demand. Therefore, with unimpressive global economic growth, the sector is likely to see headwinds except for a few industries that have demand tied to US Housing or Autos.

Thesis: our negative stance for the sector is based on: (1) stronger dollar places pressure on domestic producers due to cheaper imports. The sector has the strongest negative correlation with the US dollar, even more than Energy; (2) rising rates are a negative for capital intensive businesses; (3) on a secular basis, significant demand for the sector is driven by China, where investment spending as % of GDP is high and expected to decline steadily; (4) there are fewer available levers to rationalize cost and improve productivity; and (5) Materials is an early-cycle sector, where economic slowdowns are severe due to the large operating leverage. We are passed the early cycle stage.

Fundamentals: Materials are expected to generate earnings growth of 16.5%, which is likely to be revised down. Construction Materials are expected to generate strongest growth, and the lowest growth rate is expected for Containers & Packaging and Chemicals. Rigid Packagingnames have significant exposure outside of the US (mainly Europe).

Sub-industries: There is an interesting way to play our domestic over foreign theme: Aluminum (US Autos) over Steel (China Slowdown). We recommend investors stay clear of Metals and Mining, unless a major fiscal stimulus is announced by China (a tactical trade). Materials linked to Housing investment (timber and building products) should outperform materials used by Industrials or Farming.

Valuation: The sector trades at a richer valuation than the S&P 500 with richest multiples seen in industries with higher construction exposure (this is consistent with the J.P. Morgan view for a significant pick-up in residential structures). Activist investors in the Chemical space should give valuation support to the industry.

Risks: The largest risk to our underweight view is if the dollar begins to decline, the sector could outperform.

Sector Stats: Materials







Basic Stats (Avg):

Market Cap 3%

Revenue (LTM) 4%



Perf since 3/9/2009 286.4%

Fundamentals:




EPS (NTM) 20.0%

Balance Sheet:



Debt to Equity 0.9x


Use of Capital:



Dividend Yield 2.1%





RSI (30D) 55.0

Beta 1.0

Valuation:

EV/Sales 1.9x

EV/EBTIDA 11.3x

P/E (NTM) 18.4x

PEG Ratio 0.9x

CF Yield 3.2%

71



Fundamentals: Strong USD and sluggish China demand weigh on growth

Consensus is suggesting low single-digit sales growth in 2015; however, sluggish EM growth coupled with stronger dollar is likely to weigh on the sector’s growth prospect.

From a growth perspective Construction Materials is the brightest spot within the sector as housing construction picks up (consensus estimate revenue growth of 24.1%) though valuations for the industry remain high.





Despite the 6% shareholder yield, we view the slightly higher than average P/E multiples as rich in the current environment. Further dollar strengthening or weakened demand from abroad would likely weigh on the multiple.





16.8

% 20.2

%16

.4%

6.6%

4.6%

-3.0

%-5

.9%

0.6%

-2.5

%-0

.6% 2.

7%3.

2%1.

2% 3.3%

2.4%

-0.8

% 3.1%

2.6% 3.3% 5.

7%

-10%

-5%

0%

5%

10%

15%

20%

25%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Materials S&P 500 (ex-financial)

64%

-32%

24%

-18%

-8%

-13%

-19%

17%

2%-7

%

6%16

%-3

%8%

18%

-4%

14%

16%

10% 18

%

-40%

-20%

0%

20%

40%

60%

80%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Materials S&P 500 (ex-financial)

6.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

$0

$2

$4

$6

$8

$10

$12

$14

$16

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

MaterialsDividends ($Bn, Left)



18.4x

8x

13x

18x

23x

28x

'90 '94 '98 '02 '06 '10 '14

P/E

(N

TM

)


72



Telecom (UW): Hanging Up on the Sector in 2015

The six names in the sector contribute only 2% to the S&P 500 by market cap. In other words, it is more important to have a view on a mega-cap tech name like Apple (4% S&P 500’s market-cap weight) than Telecom (2.4% weight). Other than the 4.8% dividend yield there is little to be excited about this capital intensive sector ahead of the looming rate hikes. We are negative on the sector and believe there are better defensive growth opportunities outside of Telecom.

With the sector engaged in one price war after another, the earnings growth has been more or less inflationary. Then again, bond-proxy investors are typically less concerned about the future growth prospect and more about principal protection and income. But what if income investors were to leave for greener pastures? The sector would likely need to de-rate a bit before Value investors step up to the plate.

Thesis: (1) higher interest rates a clear negative for capital intensive businesses; (2) alternative assets are looking more attractive with yields on HY bonds quickly approaching 7%; (3) already high saturation rates; (4) price deflation seen across most product offerings with data slowly becoming a commodity; (5) the sector offers little diversification with two companies making up ~90% of the sector market cap; (6) a low beta to rising consumer spending due to inelastic demand; and (7) the threat of data going down the similar path as voice is legitimate.

On a more positive note, historically there has been little correlation with the US dollar, which is explained by its 0% foreign exposure. And the obvious and important distinction is that cheaper goods can be shipped from abroad, while telecom services cannot be imported without bidding on spectrum licenses and building out a vast capital intensive infrastructure.

Fundamentals: if data was the only product offering, the sector would be in secular growth. Since the sector does have baggage from days prior, the bottom-line growth remains at inflationary levels. And if it were not for 1% stock buyback yield, the 5Yr EPS CAGR would be even lower than the reported 3.8%.

Sub-industries: as mentioned earlier, the sector is composed of six companies with 90% of the weight held by two companies. The sector offers a variety of style based investing opportunities ranging from Growth(SBA Communications/SBAC/$115.65/OW), Value (TDS Inc/TDS/$24.84/OW), and Income (Crown Castle/CCI/$79.95/N), based on J.P. Morgan fundamental analyst.

Valuation: On almost every metric, the sector is actually cheaper vs. history due to lower growth. On EV/EBITDA, the sector trades at 5.4x, below its 25yr average at 6.6x.

Risks: If the economic recovery were to stall next year (not the base-case J.P. Morgan view), the defensive trade and flows would likely favor Telecom, especially with the dividend yield support.

Sector Stats: Telecom







Basic Stats (Avg):

Market Cap 2%

Revenue (LTM) 3%



Perf since 3/9/2009 177.4%

Fundamentals:



EPS (5Yr CAGR) 3.8%

EPS (NTM) 9.9%

Balance Sheet:



Debt to Equity 4.0x


Use of Capital:



Dividend Yield 4.8%





RSI (30D) 44.4

Beta 0.8

Valuation:

EV/Sales 2.1x

EV/EBTIDA 5.4x

P/E (NTM) 14.3x

PEG Ratio 1.4x

CF Yield 8.1%

73



Fundamentals: Industry faces growth headwinds

As shown below, revenue growth will likely continue the low single digit trend into 2015 as companies have little pricing power in the competitive environment.





Telecom looks cheap relative to longer-term history, but the industry has gone through major structural changes that have impacted long-term growth, justifying lower multiples. However, it is hard to deny the sector’s attractive dividend at north of 5%.





2.4%

8.2%

6.6%

10.1

%8.

3%2.

7%2.

3% 2.8%

0.8% 2.

3% 2.7%

2.1% 3.

6%3.

1%2.

9% 3.8%

2.8%

2.6%

2.6%

2.2%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Telecom S&P 500

-5%

2%

6%

-14%

11%

9% 10%

-5%

4%

-2% 2%

19%

17% 22

%

20%

37%

12%

5% 5%

10%

-20%

-10%

0%

10%

20%

30%

40%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Telecom S&P 500

5.5%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

$0

$2

$4

$6

$8

$10

$12

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Telecommunication ServicesDividends ($Bn, Left)



14.3x

8x

13x

18x

23x

28x

33x

38x

43x

'90 '94 '98 '02 '06 '10 '14

P/E

(N

TM

)


74



Utilities (UW): Rising Rates Risk and Peak Valuation

A trivia question before we get serious about Utilities: how many Cyclical sectors have outperformed Utilities YTD? The answer is zero out of four. In fact, three out of the four sectors that are outperforming the S&P 500 come from the Defensive sectors. At the start of the year, the Cyclicals over Defensives was probably the most recommended trade. With the market going against the grain on the consensus trade, we think this disappointment has to be one of the largest surprises for 2014—the only bigger surprise was the unexpected decline in US 10Yr bond yields.

If you think about it, these surprises may seem distinct but the two may have a common link: the income investor. With the 10yr risk-free rate approaching long-term average CPI, this likely drove income investors into Utilities that promise relatively lower volatility, superior earnings quality, and pure domestic exposure. If the sector benefited from declining rates in 2014, a rising rate environment would likely drive an underperformance in 2015.

Sector Thesis: (1) Utilities typically underperform in a rising rate environment as income investors rotate into higher yielding assets; (2) capital intensive businesses usually suffer with rising cost of capital for expansion and maintenance projects. During the last twelve months, Utilities invested 13.9% of market cap on capex; and (3) richest valuations with multiples at or above 1 STDev with dividend yield shrinking to 4.3%—about 5% of S&P 500 stocks (ex-utilities) have similar or higher dividend yields than the sector.

Fundamentals: the sector has the lowest revenue and earnings growth of all ten sectors. In fact, the US economy is expected to grow at a faster rate than the earnings growth over the next twelve months. The sector has low organic growth and minimal margin expansion opportunities. Financial engineering opportunities come with higher credit risks.

Valuation: the sector suffers from rich valuation on most valuation multiples. As shown below, the trailing EV/EBITDA is now at 10.0x for the sector, which is well above the +1 STDev. This multiple is also similar to the level last seen in 2001 before the multiple contracted by three turns to around 7.0x.

Figure 128: EV/EBITDA (LTM) Valuation: Mutliples near Peak Level on EV/EBITDA

S&P 500 Utilities since 1990


Risks: the most significant risk to our underweight thesis is if the rates decline further or the Fed pushes the date for the rate hikes down a few more quarters. If demand for new housing improves due to household formation, this could drive higher organic growth for the sector.

2/9/2001, 10.1x

10.0x

5.0x

6.0x

7.0x

8.0x

9.0x

10.0x

11.0x

12.0x

'90 '94 '98 '02 '06 '10 '14

EV

/EB

ITD

A (L

TM

)


Sector Stats: Utilities







Basic Stats (Avg):

Market Cap 3%

Revenue (LTM) 3%



Perf since 3/9/2009 203.7%

Fundamentals:



EPS (5Yr CAGR) 2.7%

EPS (NTM) 2.7%

Balance Sheet:



Debt to Equity 1.4x


Use of Capital:


Net Buyback Yield -0.7%

Dividend Yield 4.1%





RSI (30D) 55.7

Beta 0.7

Valuation:

EV/Sales 2.9x

EV/EBTIDA 10.0x

P/E (NTM) 17.3x

PEG Ratio 6.4x

CF Yield -0.5%

75



Fundamentals: valuation likely to come under pressure as rates rise

The sector has been very disciplined at steadily growing dividends currently at 3.0% relative to S&P 500’s 1.9%. Given global yield scarcity, it should not be of a surprise that its valuation is trading at a solid premium—attracting various types of investors, from income seeking to low vol. However, we believe a rising rate environment may easily interrupt this trade.





Valuation: The steady recent decline in the sector’s dividend yield suggests price has been outpacing the growth in dividend, questioning the sustainability of this trade.



Figure 132: Valuation: Dividend YieldSince 1990


-2.3

%7.

9%2.

0% 3.1%

-3.1

%-1

.8% 1.

4%5.

5% 6.9% 8.

2%2.

5%2.

6%17

.8%

4.0% 4.6%

0.7%

-4.3

%1.

0%4.

4%4.

7%

-10%

-5%

0%

5%

10%

15%

20%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Utilities S&P 500

7%

11%

1%

4%

-10%

-10%

1%

17%

6% 4% 4%

-4%

27%

3%

6%

16%

-8%

3% 2%

15%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15

Estimates Utilities S&P 500

3.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

$0

$2

$4

$6

$8

$10

$12

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

UtilitiesDividends ($Bn, Left)



3.4%

0.8%

1.8%

2.8%

3.8%

4.8%

5.8%

6.8%

7.8%

8.8%

'90 '94 '98 '02 '06 '10 '14

Div

iden

d Y

ield

Dividend Yield Avg +1 STD -1 STD

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Style Outlook

With the ever changing global macro environment and shifting monetary policies, we expect 2015 to be an active year in terms of style rotation.

Our top-down framework marries phases of the economic cycle with optimal investment style returns. Our J.P. Morgan composite macro indicator points toward a US economy that is in "expansion" stage. See Table 9 detailing top stock picks for the Expansion stage of the business cycle.

Using empirical analysis and historical back-tests from 1970s, the desired positioning in this phase of the cycle advocates for a balanced portfolio approach (i.e., GARP, QARP), with tilts toward stocks exhibiting strong earnings growth and price momentum as well as attractive valuation.

Moreover, seasonal style effects can be quite pronounced especially in the first and last quarter of a year. Momentum effects tend to be the strongest starting in September and typically recede by November as investors take profit and start positioning for next year. Value has a tendency of achieving strong relative gains starting in December, accelerating in January, and lasting through April. This coincides with investors rebalancing their portfolios and bottom-fishing for new opportunities.

With that in mind, we currently recommend tilting toward Value and away from Momentum. However, as we get closer to the initial expected Fed rate hike (J.P. Morgan forecasts first hike mid-2015) we urge investors to rotate away from Value and toward earnings and price Momentum.

We expect this period to coincide with higher volatility, which likely may not bode well for Value and high Beta stocks. In addition, Quality exposure may be desirable as it can provide insurance against initial adverse market reactions to Fed policy.

Our base case still sees continued cyclical growth in the second half of the year, albeit a bit softer than the first half. Value may make a comeback later in the year subsequent to the first rate hike.

On the whole, we do not see a large divergence in style performance by close of 2015. A balanced 2014 is likely to be followed by a balanced 2015 with unexpected twists and turns, in our view.

Look Back at 2014: A More Balanced Style Performance

Style performance has been unusual compared to the norm during the recovery from the financial crisis, a reflection of the atypical depth of the downturn and the subsequent fitful recovery. Style performance is driven by the phase of the economic cycle, the degree of uncertainty surrounding the future growth and investor perception regarding how others are likely to position their portfolio going forward.

Our J.P. Morgan Composite Macro Indicator (CMI) points

toward a US economy that is in

Expansion stage. See Table 9detailing top stock picks for this

stage of the business cycle.

Recent style performance reflects the atypical nature of the

economic cycle

US Equity and Quantitative Strategy

Sang (David) H. HanAC

(1-212) 622-6424

[email protected]


77



Table 3 summarizes the performance of investment styles in the past four years7. The current year is remarkable in how balanced performance has been across styles despite a reasonably strong market return, particularly when many thought the market would take a breather after an exceptionally strong last year. Compare this balanced performance with that of 2013 when the market jumped 30% and both Value and Growth outperformed. Low Volatility was not rewarded, High Volatility benefited handsomely and Quality was ignored. By contrast in 2011, when economic recovery was still fragile, Eurozone debt crisis was peaking and the US government debt was downgraded, Quality and Low Volatility strongly outperformed while Value underperformed. Also, it is notable that both Growth and Momentum have held up nicely in the last four years.

Table 3: A More Balanced Style Performance Within S&P 500 in 2014

Relative to Cap Market Return*

S&P500JPM

ValueJPM

GrowthJPM

QualityJPM

MomentumJPM

Low VolJPM

High VolYTD 2014 9% 2% 4% 1% 3% 4% 0%

2013 30% 13% 5% -3% 2% -1% 10%2012 13% 13% 3% -1% 3% -2% 3%2011 0% -10% 6% 6% -1% 8% -17%

*Note: Style performance shown above is based on the capitalization weighted performance of the top 100 stocks of S&P 500 Index

by style portfolios. The factor composition of the styles is shown below.

Source: J.P. Morgan Quantitative and Derivatives Strategies

Table 4: Factor Composition of US JPM Styles

Momentum-12M Price Momentum-3M Fwd Earnings Momentum

Value-Book-to-Price-1Y r Fwd Earnings Yield -Sales Yield

Low Volatility-Large Capitalization-Low Beta-Financial Distress Risk (Altman)

Growth-Sales Growth (1Yr, 3Yr)-Free Cash Flow Growth (1Yr, 3Yr)

Quality-ROE-ROA-Earnings Quality (Piotroski)

High Volatility-High Beta


Risk appetite, as captured by VIX, has been U-shaped in 2014 with low risk and optimistic global growth expectations in the middle of the year flanked by growth scare in the beginning and late in the year. This could be construed as typical mid-cycle jitters by some, though in our opinion, it is a reflection of fragility of the economic recovery outside the US, in both Europe and the Emerging markets. For a recovery that is supposedly five years old this is not how it should typically be. Value performance, historically the most persistent, has been erratic getting, periodic boosts from quantitative easing (QE1, QE2, and QE3).

As risk-on/risk-off fatigue has set in, many investors have been seeking low volatility investments. It has led to Quality and Low Volatility holding up better than they probably should at this stage of the cycle. Peculiar to this cycle, interest rates have been kept low much longer than typically. The search for higher yield has led to demand for high dividend stocks. For example, High Dividend Yield stocks have handsomely outperformed Low Dividend stocks. As the chart on left shows, the Outperformance was especially sharp between 2009 and 2011. Lately the strategy

7 An in-depth discussion about Styles or Equity Factor Classification can be found in Equity Risk Premia Strategies: Risk Factor Approach to Portfolio Management, 2014.

Style Performance in a Nutshell

2014 Balanced Performance

(slight Growth over Value)

2013 Value over Growth

High Vol over Low Vol

2012 Value over Growth

High Vol over Low Vol

2011 Growth over Value

High Quality

Low Vol over High Vol

Source: Bloomberg

Source: Bloomberg

10

20

30

40

50

1/11 1/12 1/13 1/14

VIX

2011: Euro

area Crisis, US downgrade

70

80

90

100

110

120

130

1/04 1/06 1/08 1/10 1/12 1/14

Long-Short Dividend Yield Performance

https://jpmm-internal.jpmchase.net/#research.article_page&action=open&doc=GPS-1486191-0

78



has moved sideways but that is probably because many firms are using Share Buybacks to return capital to investors. Using Total Yield (Dividends + Net Buyback) as a factor gives better results in the last couple of years.

Table 11 and Table 12 shows top stock picks for each of the JPM investment styles.

Framework for Style Investing

Figure 133 shows a stylized economic cycle along with the associated preferred reference positioning of the investment styles. The reference positioning of styles provides a coherent framework for managing style tilts as the views about the economy and linked investor behavior go through a cycle. Our framework uses the concept of understanding changes in the 2nd derivative of macroeconomic data to highlight, where are we in the cycle?

Figure 133: J.P. Morgan Style Investing - Marrying Phases of the Economic Cycle with Style Returns


Cycle investing is quite intuitive. For instance, we underweight Value relative to Growth in a Slowdown, since it is unlikely to shelter the portfolio in a severe slowdown or contraction. Also, Growth is scarce in this stage of the cycle and is preferred. If the Slowdown sinks into a Contraction investors would likely rotatefrom Growth to Value as volatility and dispersion of valuations rises. During the subsequent Recovery and Expansion, we stay neutral Growth (it is no longer scarce) but continue to overweight Value though be more selective in terms of sector and themes as the Cycle matures.

We overweight Quality, on the other hand, during Slowdown and Contraction when it is in short supply and provides insurance. Quality may be least desirable duringRecovery when it is likely to expensive and less needed. Momentum is the most potent during Expansion when the economy is humming and specific themes dominate the market. Momentum becomes most hazardous during Contraction when the trends that have driven the market higher until then start to crumble and even reverse. Rules for handling Volatility are relatively straightforward though timing Volatility is challenging. During Slowdown and Contraction, aversion toward risk generally intensifies and it makes sense to prefer the Lower Volatility and financially sound balance sheet. Conversely, once Recovery is in place, High Volatility stocks are preferable over Low Volatility ones.

Overweight ValueNeutral GrowthNeutral Quality

Overweight MomentumPrefer High Vol over Low Vol

Overweight ValueNeutral Growth Overweight Quality

Underweight MomentumPrefer Low Vol over High Vol

Underweight ValueOverweight Growth Overweight Quality

Overweight MomentumPrefer Low Vol over High Vol

Overweight ValueNeutral Growth Underweight Quality

Neutral MomentumPrefer High Vol over Low Vol

Table 11 and Table 12 shows top

stock picks for each of the JPM

investment styles

The J.P. Morgan ‘Cycle

Investing’ framework marries phases of the economic cycle

with investment style returns.

The aim is to time the cycle by rotating before major draw-

downs occur, and indirectly

managing the changing environment for risk vs. reward

as we move around the cycle.

79



In passing we also note that other aspects of investment styles, like relative valuation, momentum, fear/greed rotation and the crowdedness of a trade, may influence one’s style preference during a specific stage of the economic cycle.

Table 5 presents the performance of various styles during the economic cycle. To remove sector biases in underlying style factors, we used sector normalized z-scores to construct the portfolios. However, the results discussed below continue to hold also for non-sector normalized portfolios as well.

Table 5: Performance of Styles in Different Phases of the Economic Cycle 1980-2014(Monthly Returns, Equal Weighted Long Portfolios, Stock Selection is Sector Normalized)

Value Growth Quality MomentumLow

VolatilityHigh

Volatility

Equal Weighted

Style

Market (Equal Wtd S&P 500)

Market (Cap Wtd S&P 500)

Absolute Return (Annualized)

Expansion 17.6% 13.1% 12.0% 13.9% 10.0% 16.9% 13.4% 11.7% 10.4%

Slowdown 12.6% 16.9% 15.8% 15.5% 13.2% 13.2% 14.5% 13.0% 14.4%

Contraction 9.8% 6.2% 6.2% 2.1% 3.9% -3.4% 5.0% 4.6% -1.2%

Recovery 22.7% 16.7% 14.9% 16.3% 12.1% 15.0% 16.9% 15.8% 8.6%

Standard Deviation (Annualized)Expansion 17.0% 14.9% 14.5% 15.7% 14.1% 17.9% 15.2% 14.6% 13.2%Slowdown 18.6% 16.9% 15.7% 16.2% 14.0% 19.9% 16.4% 15.8% 14.5%

Contraction 30.7% 24.3% 22.3% 20.5% 18.3% 35.2% 23.8% 23.5% 19.3%

Recovery 20.6% 15.8% 14.5% 15.5% 12.1% 25.7% 16.3% 16.4% 15.0%

Sharpe Ratio

Expansion 1.04 0.88 0.83 0.88 0.71 0.94 0.88 0.80 0.78Slowdown 0.68 1.00 1.01 0.95 0.95 0.66 0.88 0.82 0.99Contraction 0.32 0.25 0.28 0.10 0.22 -0.10 0.21 0.19 -0.06Recovery 1.10 1.06 1.03 1.05 1.00 0.58 1.04 0.96 0.58

Avg Sharpe 0.78 0.80 0.79 0.75 0.72 0.52 0.75 0.70 0.57

The Style Performance shown above is based on the capitalization weighted performance of the top 100 stocks by style portfolios.

Source: J.P. Morgan

The only period Value underperforms Growth in this analysis is during Slowdown (12.6% versus 16.9% annualized returns). Value’s sins in Slowdown are compounded by higher volatility of the style resulting in a larger dispersion of Sharpe ratios (return per unit of risk, Value's 0.68 versus Growth’s 1.00) between Value and Growth over the whole cycle. Outside Slowdown, Value dominates Growth though on a risk adjusted basis the dominance is less overwhelming.

Quality takes the lead during Slowdown with a strong return (15.8%) and the lowest volatility among styles (15.7%) other than the Low Volatility portfolio whose risk unsurprisingly is the lowest in any phase of the cycle. Quality posts the least impressive relative return during Recovery (14.9%)—it makes intuitive sense to stay underweight Quality during Recovery.

Momentum works best during Expansion and Slowdown—we overweight it during these phases of the cycle. Usually the trends driving the cycle are intact in these two phases and our back-test confirms this hypothesis—Momentum returns and Sharpe ratio exceeds market in these two phases. As mentioned earlier, during Contraction trends can reverse and Momentum style can be perilous. Indeed the return of Momentum style lags the market and most other styles during Contraction.

On average, Low Volatility outperforms High Volatility during Slowdown and Contraction and High Volatility does better in Expansion and Recovery (albeit not

80



necessarily on a risk-adjusted basis). This is consistent with our Cycle Investing recommendations. However, the striking fact about performance of Volatility styles is the divergence in the volatility of their performance during Contraction and Recovery. Highlighted figures in Table 5 above show that the volatility of High Volatility style is twice that of Low Volatility during this period. The result is that during Recovery despite the outperformance of High Volatility strategy, the Sharpe ratio of Low Volatility strategy is higher. Given the huge volatility spread, in our opinion, it is probably prudent not to take large tilts among Volatility styles.

Where Are We in the Economic Cycle?

In real time, data are noisy—some indicators say the economy is improving, some may point to deterioration and other indicators may be equivocal. For example, the 2014 November ISM Manufacturing Index surprised positively pointing to continuing improvement, while the Initial Jobless Claims released a few days earlier was negative showing more claims than expected.

The way to reduce uncertainty about where we stand in the economic cycle is to consistently combine the various indicators that have historically shown a decent track record in tracking the cycle. To do that we tested a long list of indicators that we believed may have leading information about the state of the cycle. A dozen indicators were selected to construct a proprietary J.P. Morgan Composite Macro Indicator (CMI), which attempts to predict the state of the cycle 3 to 6 months out. We discuss how we view the economic cycle and various indicators that go into constructing CMI later in this section.

Based on the JPM CMI we expect the economy to continue on an Expansion mode over the next 3-6 months—as mentioned before, visibility beyond that is hazy but based on the prognostication of J.P. Morgan’s economics team we may see periods of Slowdown as we approach the second half of 2015. Table 9 details top stock picks for the J.P. Morgan investment styles.

Selecting a reference series to define the cycle: historically, economic cycles have one or more mini cycles of less extreme amplitude embedded between an upturn and a recession. Figure 134 shows a stylized business cycle with two mini economic cycles before entering a full blown recession. For example, the 1982 upturn in the USwas followed by dip in economic activity in 1985 preceding the 1990 recession; the long economic boom of 1990s had two mini-slowdowns in 1993 and 1995 before the recession in 2001.

Figure 134: Economic Cycles Are Rarely Clean Up, Down and Up: There Is Usually Considerable Uncertainty

Source: J.P. Morgan

Recovery

Mid-Cycle Scare

Mid-Cycle Pause

Economic indicators rarely line

up nicely to give an

unambiguous view of the state of the economic cycle.

Expansion is the likely state of

the cycle for the US in the next 3 to 6 months, according to our

Composite Macro Indicator. See

Table 9 with top stock picks for the Expansion state

Economic cycles do not follow a

clean script – recovery,

expansion, slowdown and contraction.

In between recovery and

contraction are mid-cycle scares and pauses—these have real

impact on the financial markets.

81



Making decisions in an uncertain world requires action before all the facts are in, so it is not surprising that investors may react quite strongly to a mid-cycle slowdown as they would to a slowdown that is truly a precursor to a recession. For instance, the stock market was flat in 1984 in anticipation of 1985 slowdown and similarly fell 2% in 1994 before the 1995 pause. In the current cycle, the year 2011 certainly felt like a precursor to a recession—the stock market ended the year flat but reached -17% in the interim.

We take the Conference Board’s Economic Coincident Index as a reference for the current state of the cycle since it is based on monthly series and is sufficiently reactive to mid-cycle ups and downs. The Coincident Index is composed of four indicators: Employees on nonagricultural payrolls; Personal income less transfer payments; Industrial production, and Manufacturing and trade sales. Figure 135shows the year-on-year change in Coincident Index and the phases of business cycles based on the level of change and its second derivative (acceleration and deceleration in the change).

Figure 135: State of the Economic Cycle: Conference Board’s Coincident Index

Source: J.P. Morgan

It is interesting that prior to 2000 whenever the Coincident Index was heading south and crossed the 2% threshold it was highly likely that the downward momentum would take the cycle into contraction territory. However, in the last two cycles (starting 2002 and 2009) the amplitude of the cycle has been suppressed and the Coincident Index has threatened to breach the 2% threshold on several occasions. In 2011, for example, the index headed south from a peak of 3.3% in Jan to 2.0% in May before bouncing up.

To get a robust Composite Macro Indicator it is necessary to include diverse andrelatively uncorrelated information from different parts of the economy. Indicators that directly tell us about the phase of the economic cycle are classified as Growthindicators. There are three other indicators that indirectly interact with the cycle: Liquidity, Inflation and Sentiment. As suggested these indicators carry information about the cycle: Inflation indicators typically fall when growth is weak, rise when growth picks up; improvement in Liquidity indicators due to faster money growth,lower interest rates or easier credit conditions tend to boost growth; and Sentiment indicators can be harbinger of consumption spending, corporate earnings and credit conditions.

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

1/60 1/64 1/68 1/72 1/76 1/80 1/84 1/88 1/92 1/96 1/00 1/04 1/08 1/12

Slowdown

Expansion

Recovery

Contraction

Coincident Indicator

One should not underestimate

the impact of these mid-cycle scares and pauses on stock

market performance.

The components of the JPM Composite Macro Indicator (CMI)

are sourced from four areas:

Growth, Liquidity, Inflation and Sentiment

82



The JPM Composite Macro Indicator (CMI) is an equal weighted combination of indicators from the four groups mentioned above. The resulting indicator leads the Coincident Index by 3 to 6 months. The chart on the left shows correlation between the Coincident Index and JPM CMI with a lead and lag applied to the CMI. Figure 136 below plots CMI and Coincident Index over the same time period—the CMI turns up or down a few months before the Coincident Index. The peak correlation of 0.83 at 4 months is a confirmation that CMI can potentially be used to anticipate changes in the economic cycle.

Figure 136: JPM Composite Macro Indicator Predicts State of the Economy 3 to 6 Months Ahead: Currently Calls for Continued Expansion

Source: J.P. Morgan

Figure 137: Selected Components of Composite Macro IndicatorRising ISM Purchasing Manager’s Index: Positive for Growth Improving Consumer Sentiment: Positive for Growth

Bank Lending Survey: Easy Credit Conditions Helpful PPI: Weakness May Be a Negative For Growth

Source: J.P. Morgan, Bloomberg

-8.0

-6.0

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1.0

1.5

2.0

12/79 12/82 12/85 12/88 12/91 12/94 12/97 12/00 12/03 12/06 12/09 12/12

Composite Macro Indicator (LHS)

Coincident Indicator, 12M% (RHS)

30.0

35.0

40.0

45.0

50.0

55.0

60.0

65.0

70.0

75.0

1/80 1/83 1/86 1/89 1/92 1/95 1/98 1/01 1/04 1/07 1/10 1/13

ISM Manufacturing PMI

Rising Purchasing Managers Index is a positive sign for growth

Index, 50 = Neutral

50

60

70

80

90

100

110

120

1/80 1/83 1/86 1/89 1/92 1/95 1/98 1/01 1/04 1/07 1/10 1/13

Michigan Index of Consumer Sentiment

Improving ConsumerSentiment

Index

-40.0

-20.0

0.0

20.0

40.0

60.0

80.04/90 4/93 4/96 4/99 4/02 4/05 4/08 4/11 4/14

Bank Lending Survey, axis order reversed

LooseningCredit

TighteningCredit

Percent Balance

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

1/80 1/83 1/86 1/89 1/92 1/95 1/98 1/01 1/04 1/07 1/10 1/13

Producer Price Index, 12-Month Change

Weakness in inflation may be a negative sign for growth

Correlation: Coincident Index

and Composite Macro Indicator


0.40

0.45

0.50

0.55

0.60

0.65

0.70

0.75

0.80

0.85

-12 -10 -8 -6 -4 -2 0 2 4 6

Months

Correlation

Max correlation

Composite IndicatorLeads Coincident Index

83



Figure 136 shows that JPM CMI is above trend and is increasing. We associate this with the Expansion phase of the cycle. Below in Figure 137 we show a few selected factors that are used to construct the CMI. Three of these factors, ISM, Bank Lending Survey and Consumer Sentiment support the Expansion thesis while one (namely Inflation) does not. However, that is the whole point of having diversified components in the CMI—they are not expected to agree all the time.

Putting it All Together: Back-test of Cycle Investing

The Composite Macro Indicator (CMI) acts as a guide in determining the phase of the business cycle. Using a rule-based approach we map the CMI to one of the four states and position the style portfolio according to the cycle investing framework. Figure 138 depicts a schematic flow connecting macroeconomic cycle to style selection and finally to the construction of a style rotation portfolio.

Figure 138: From Economic Cycle to Style Rotation Portfolio

Source: J.P. Morgan

Figure 139 shows the performance of the top quintile of the Style Rotation portfolio against that of equal-weighted S&P 500 Index (a difficult benchmark to beat) and the traditional capitalization-weighted S&P 500 Index.

Figure 139: Style Rotation Portfolio Typically Outperforms the Market Portfolio (S&P 500)

The Style Rotation Portfolio consists of the top 100 stocks in S&P 500 based on equal-weighted average scores of Value, Growth,

Quality, Momentum and Volatility. Stocks are weighted equally in calculating the performance. No transaction cost is assumed. Past

performance is not a guarantee of future performance.

Source: J.P. Morgan

Overweight ValueNeutral GrowthNeutral Quality

Overweight MomentumPrefer High Vol

Overweight ValueNeutral Growth Overweight Quality

Underweight MomentumPrefer Low Vol over High Vol

Underweight ValueOverweight Growth Overweight Quality

Overweight MomentumPrefer Low Vol over High Vol

Overweight ValueNeutral Growth Underweight Quality

Neutral MomentumPrefer High Vol over Low Vol

Composite Macro Indicator

State of the Cycle

StyleRotationPortfolio

Growth(ISM PMI ...)

Liquidity(Bank LendingSurvey ...)

Sentiment(Consumer Sentiment...)

Inflation(PPI ...)

0

1000

2000

3000

4000

5000

6000

7000

1/80 1/83 1/86 1/89 1/92 1/95 1/98 1/01 1/04 1/07 1/10 1/13

Style Rotation (Absolute Return)

Market (Equal Wtd S&P 500)

Market (Cap Wtd S&P 500)

Style Rotation

Portfolio

S&P Equal

Weighted

S&P Cap

Weighted

Average Return 13.7% 11.7% 9.5%

Standard Deviation 17.7% 17.1% 15.2%

Sharpe Ratio 0.8 0.7 0.6

84



We also compare the Style Rotation portfolio’s performance with an equal weighted Value, Growth, Quality, Momentum and Volatility style portfolio. Since the individual styles can be considered equity risk premia strategies, a style rotation should ideally pass an extra hurdle—be able to outperform a simple average of the individual risk strategies. Figure 140 tracks the Style Rotation portfolio’s performance versus that of equal-weighted Style portfolio and shows that Style Rotation historically has added value. The performance gap widened more during the past ten years suggesting the increased importance of style rotation recently.

Figure 140: Style Rotation Portfolio Historically Outperforms Equal Weighted Style Portfolio, More So Recently

The Style Rotation Portfolio consists of the top 100 stocks in S&P 500 based weighted average scores of Value, Growth, Quality,

Momentum and Volatility. Stocks are weighted equally in calculating the performance. The Equal Weighted style portfolio is equal

weighted average performance of the individual style portfolios. No transaction cost is assumed. Past performance is not a guarantee

of future performance.

Source: J.P. Morgan

Glamour, E-Motion and Complacency: Deciphering Market Mood Using Style Alignment

Just as ancient astrologers looked at the configuration of planets to try to predict terrestrial events from celestial movements, the alignment of stocks by style factors can tell us a lot about the “mood” of the market. Here we consider three distinct alignments—Glamour, Complacency and E-Motion—and what these alignments can tell us about market sentiment.

Currently they suggest:

Buying Glamour: In an environment where Growth is scarce, investors are prepared to forego Value premium just to get exposure to Growth.

Acting on E-Motion: Investors are recklessly chasing Growth, and the interaction between Growth and Momentum is above average. This does raise risk to Growth but the risk is not extreme as yet.

Rising Complacency: Investors are increasingly taking on risk for a lower expected premium. We are still far from 2007 peak, but the trend may be a cause for some concern.

Glamour: Classic Growth investors look for stocks whose price is low relative to their future earnings potential with the expectation that the price of these stocks will

90

110

130

150

170

190

210

1/80 1/83 1/86 1/89 1/92 1/95 1/98 1/01 1/04 1/07 1/10 1/13

Style Rotation (Excess Return)

Equal Weighted Style (Excess Return)

Style Rotation

Portfolio

Equal

Weighted

Style Portfolio

Average Return 2.0% 1.3%

Standard Deviation 2.1% 1.9%

Sharpe Ratio 0.9 0.7

Alignment of stocks by style factors can tell us a lot about the

“mood” of the market

Buying Glamour…

Acting on E-Motion…

Rising Complacency…

85



rise as growth materializes. Unlike Value-seekers, Growth-seekers do not expect P/E multiple expansion to be the main driver of returns, although they would welcome it as well. To them earnings Growth will ultimately take the price higher. In a Growth-seeking environment, less attention is paid to Value. We call that environment Glamour—when investors are buying Growth at a Premium. Figure 141 shows the Glamour index over time.

Glamour index could rise if investors have over-inflated view of future growth. They may believe that no price is too high. This would typically be expected toward the end of a long economic recovery. In hindsight this could reflect unrealistic predictions. Another reason the Glamour index may go higher is if investors find growth to be relatively scarce—shortage of growth stocks could bid up their price. We believe we have been in such an environment in the recent period.

Figure 141: Glamour Index: Paying Premium for Growth

Source: J.P. Morgan

E-Motion: Yearning for Growth can sometimes become very strong. This sentiment can be captured by the interplay between Growth and Momentum. We call this as E-Motion Index. The E-Motion index shows cyclical behavior with higher frequency than the other two market sentiment indicators discussed here. This suggests that it is difficult for the Growth-Momentum marriage to last for a long duration. When E-Motion Index is relatively high, Growth and Momentum risk diverges. As Figure 142shows we are above average but not an extreme level for this index.

Figure 142: E-Motion: Growth Chasing - Risk of Reversal Is Higher but Not Extreme

Source: J.P. Morgan

0

500

1000

1500

2000

2500

-0.2

-0.1

0.0

0.1

0.2

5/86 5/89 5/92 5/95 5/98 5/01 5/04 5/07 5/10 5/13

Glamour Index

Paying Premium For Growth

0

0.5

1

1.5

2

2.5

-0.1

0.0

0.1

0.2

0.3

0.4

5/86 5/89 5/92 5/95 5/98 5/01 5/04 5/07 5/10 5/13

E-Motion IndexChasing Growth

86



Complacency: Classic Value investing is buying stocks whose price does not reflect their fundamental value currently. A Value investor expects returns to come from P/E multiple expansion – unlike Growth investor, the Value investor is not waiting for strong growth to lift the earnings and price. Typically a Value stock is perceived to be risky. The return coming from holding Value stock is the premium earned from taking stock specific risk. This suggests that stock specific risk and anti-Value should be inversely related. One should take risk only if there is sufficient expected reward or premium—if there isn't one could argue the market is becoming complacent.

Figure 143 suggests that investors are at an average but rapidly rising level of complacency, suggesting investors are increasingly taking on risk for a lower expected premium.

Figure 143: Complacency: Taking Risk for Low Premium

Source: J.P. Morgan.

Looking to 2015: Balanced Style Performance over the Year with Unexpected Twists and Turns

Based on the JPM CMI it seems likely that the economic cycle will remain in the Expansion phase over the next few months. Value typically outperforms Growth in this phase of the cycle.

However, by the middle of the year Valuation will probably struggle as we get closer to the first rate hike in the US since June 2006. Based on the Overnight Index Swap (OIS) the market appears to be pricing in a rate hike in October 2015. The J.P.Morgan house view is a bit more hawkish, expecting a rate hike by June 2015.

If either of these expectations is realized we expect the market volatility to rise. The pick-up in volatility will likely not be due to a “rate hike surprise” since Fed tightening is now widely expected. More plausibly, after the expected rate hike, market participants are likely to "discover" many leveraged actors who are on the wrong side of trades as the interest rates rise. For example, high yield debtors may become source of volatility in case they have difficulty meeting their obligations in a rising rate environment. It will be these kinds of unexpected sources of turbulence that will cause financial volatility to spike, in our view.

Under this plausible scenario we may see our CMI oscillate between Expansion and Slowdown. Recall that during Slowdown our analysis shows that Value should be underweight while Quality and Growth should be overweight. So we might see

0

500

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1500

2000

2500

-0.5

-0.4

-0.3

-0.2

-0.1

0.0

0.1

0.2

5/86 5/89 5/92 5/95 5/98 5/01 5/04 5/07 5/10 5/13

Complacency Index

Buying Risk For Low Premium

We believe that Value will likely

outperform Growth in the early

part of 2015.

However, as we near the much

anticipated rate hike rotate away

from Value and towards Growth and Quality.

Source: Bloomberg

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

12/14 6/15 12/15 6/16 12/16

OIS

87



periods of Value underperformance, and Growth, Low Volatility and Qualityoutperformance.

Another way to see the impact of rising Volatility is by conditioning performance of styles on rising / falling VIX regimes. Table 6 shows style returns (relative to market returns) in the two regimes.

Table 6: Rising VIX: Bad for Value and High Risk Styles; Good for Quality, Low Risk, MomentumStyle Performance in Excess of Market

Value Growth Quality Momentum Low Risk High Risk Market

Rising VIX

Average -3.7% 1.7% 4.4% 2.7% 4.0% -4.9% -9.7%

Stdev 8.1% 4.1% 3.9% 6.0% 5.4% 8.8% 20.4%

Sharpe -0.46 0.42 1.14 0.45 0.73 -0.55 -0.47

Falling VIX

Average 7.0% 1.7% -0.6% 0.6% -4.0% 4.6% 21.3%

Stdev 6.4% 3.4% 3.8% 6.3% 5.3% 7.7% 14.1%

Sharpe 1.09 0.52 -0.16 0.10 -0.75 0.60 1.51

Performance of investment styles is for equal-weighted S&P 500 top quintile portfolio. Returns are in excess of equal-weighted S&P

500 index. Period covered: Jan 1987 - Oct 2014.

Source: J.P. Morgan

Clearly Value does not typically flourish in rising VIX environment. However, once VIX has peaked and is declining, Value tends to come to life as investors gather the courage to invest in more risky stocks. Historically (1987-present) months of rising VIX (36%) are dwarfed by periods of falling VIX (64%).

Why do we prefer Value in the early part of the year? Not because of price momentum of Value stocks—Value has underperformed Growth this year. As perTable 7, price momentum has favored Growth and Quality over the past 12 months.

Table 7: Comparative Price Momentum and Earnings Momentum of Investment Style Portfolios

Price Momentum Earnings Momentum

CurrentMedian

10-Year Median

SpreadCurrentMedian

10-Year Median

Spread

Value 12.9% 6.1% 6.9% -0.2% 0.4% -0.6%

Growth 16.8% 15.9% 0.9% 0.5% 1.2% -0.7%

Quality 14.5% 14.4% 0.1% 0.3% 1.1% -0.8%

Momentum 32.5% 37.4% -4.8% 3.6% 7.7% -4.1%

Low Volatility 13.2% 10.4% 2.8% 0.2% 0.7% -0.6%

High Volatility 15.3% 11.9% 3.4% 0.0% 1.0% -1.0%

S&P 500 14.0% 11.6% 2.4% 0.0% 0.7% -0.7%

Price Momentum and Earnings Momentum (3M change in fwd EPS are median values of S&P 500 index top quintile stocks ranked by

style. The top quintile portfolio is sector normalized.

Source: J.P. Morgan

However, we believe there are good reasons to prefer Value in the early part of 2015. For one, as mentioned above, during the Expansion phase of the economic cycle, Value typically does reasonably well as investors are more willing to embrace risk. The second reason is a seasonal effect. Figure 144 shows the excess performance of styles by month. Value tends to outperform in the first quarter while Growth underperforms. One possible reason for this could be late year “window

If volatility rises in mid-2015, it

may temporarily dent Value, Growth may be affected less.

Quality and Low Risk will benefit

Why do we think Value might do

better in early part of 2015?

1) Economic cycle, 2) Seasonal effect, 3) Growth is expensive

relative to its history

88



dressing” when managers may sell value, buy stocks that have done well earlier in the year boosting the performance of Momentum and Growth style particularly in September and October when Value underperforms the most.

Figure 144: Excess Returns of Styles by Month: First Quarter Effect

Source: J.P. Morgan

In the first quarter, Value historically receives a boost as managers rebalance their portfolios and look for stocks that appear cheap particularly if we are not in a period of rising volatility. Simultaneously, Growth typically underperforms in the first quarter and Momentum has its worst month of the year in January.

Three, Growth looks a bit stretched on valuations. Growth is currently trading at a 17.8x P/E (NTM) versus its historical median of 15.1x, having one of the largest historical premium spreads amongst the various style. Also, the increase in Dividend Yield has been relatively small for Growth; however, its Net Buyback Yield has increased more than for any other style over the last 2 years, currently at 2.2% while that of S&P 500 is at 2.3%.

Table 8: Comparative Valuation of Investment Style Portfolios

Price-to-Book P/E (NTM) Dividend Yield Operating Cash Flow Yield

Current10-Yr

MedianSpread Current

10-Yr Median

Spread Current10-Yr

MedianSpread Current

10-Yr Median

Spread

Value 1.8 1.5 0.3 12.3 11.3 1.0 1.8% 1.4% 0.4% 11.4% 14.3% -2.8%

Growth 3.9 2.9 1.0 17.8 15.1 2.7 1.0% 0.8% 0.1% 6.9% 8.9% -2.0%

Quality 5.9 4.4 1.5 16.9 14.9 2.1 2.0% 1.6% 0.4% 7.1% 8.3% -1.1%

Momentum 4.0 3.1 0.9 18.6 16.9 1.7 1.5% 0.9% 0.5% 6.7% 7.5% -0.8%

Low Volatility 4.2 3.3 0.9 18.0 14.8 3.3 2.2% 1.9% 0.4% 7.0% 8.6% -1.5%

High Volatility 2.9 2.2 0.6 15.3 15.3 0.0 1.2% 0.9% 0.3% 7.0% 9.3% -2.3%

S&P 500 3.2 2.7 0.5 16.8 15.2 1.6 1.77 1.46 0.32 7.4% 8.8% -1.5%

Book-to-Price, 1-Year Forward Earnings Yield, Dividend Yield and Operating Cash Flow Yield shown above are the median values of

the stocks in the top 100 stocks ordered by style with in the S&P 500 universe. The portfolio is sector normalized – stock ranking takes

sector membership into account.

Source: J.P. Morgan

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

Jan

Feb

Mar

Apr

May Jun

Jul

Aug

Sep Oct

Nov

Dec

Value

-2.5%-2.0%-1.5%-1.0%-0.5%0.0%0.5%1.0%1.5%

Jan

Feb

Mar

Apr

May Jun

Jul

Aug

Sep Oct

Nov

Dec

Growth

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

Jan

Feb

Mar

Apr

May Jun

Jul

Aug

Sep Oct

Nov

Dec

Quality

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

Jan

Feb

Mar

Apr

May Jun

Jul

Aug

Sep Oct

Nov

Dec

Momentum

-1.0%

-0.8%

-0.6%

-0.4%

-0.2%

0.0%

0.2%

0.4%

Jan

Feb

Mar

Apr

May Jun

Jul

Aug

Sep Oct

Nov

Dec

Low Volatility

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

Jan

Feb

Mar

Apr

May Jun

Jul

Aug

Sep Oct

Nov

Dec

High Volatility

Net Buyback Yield by style

Source: J.P. Morgan

Net Buyback Yield

Current 2 Years Ago Change +/-

Value 2.2% 1.6% +0.6%

Growth 2.2% 0.6% +1.6%

Quality 3.1% 2.3% +0.8%

Momentum 2.6% 1.5% +1.1%

Low Volatility 2.6% 1.5% +1.0%

High Volatility 1.8% 1.4% +0.4%

S&P 500 2.3% 1.6% +0.6%

89



Despite the favorable environment for Value in the early part of the year, investors will have to be selective about sectors and themes in which to look for Value—see Sector and Investment Themes sections of this report, where we highlight various Value opportunities that we deem interesting (i.e., Airlines, selective parts of Energy).

As Figure 145 illustrates, the choice in Value is somewhat limited compared to three years ago. At end-November 2014, the S&P 500 price index was 64% above its end-2011 level. Most of the easy Value opportunities are taken. The dispersion of Earnings Yield (NTM) is at its lowest level in 35 years. The dispersion of Book-to-Price is not as extreme but is below average at this point.

Figure 145: Dispersion of Valuations Is Compressed: Investors Have to Be Selective in Finding Value Opportunities


In summary, we expect 2015 to be an active year in terms of style rotation. After relative gains in Value and perhaps High Beta stocks in the early part of the year we expect investors to rotate into a more balanced or even defensive portfolio as we near the first rate hike. We think it is possible that Growth outperforms Value mid-2015, especially if volatility picks up.

Our base case still sees continued cyclical growth in the second half of the year,albeit a bit softer than the first half. Value may make a comeback later in the year subsequent to the first rate hike. Momentum might show more consistent performance in this environment as it is likely to pick up stocks that show both value and quality characteristics (Quality at a Reasonable Price—QARP portfolio). Even though we expect significant style rotations within the year, on balance we do not seelarge divergence in style performance by next year end. A balanced 2014 is likely to be followed by a balanced 2015.

1

2

2

3

0%

2%

4%

6%

8%

10%

1/79 1/82 1/85 1/88 1/91 1/94 1/97 1/00 1/03 1/06 1/09 1/12

Dispersion of Earnings Yield (NTM) for S&P 500 …

0

1

1

2

2

0%

10%

20%

30%

40%

50%

60%

1/79 1/82 1/85 1/88 1/91 1/94 1/97 1/00 1/03 1/06 1/09 1/12

Dispersion of Book-to-Price Yield for S&P 500 …

90



Table 9: Top 40 Stock Picks for the “Expansion” State Based on the J.P. Morgan Top-down Framework

as of 12/5/2014

Source: J.P. Morgan

Top Stock Picks During Expansion StagePrice Sales Gr EPS Gr P/E EV/ Div Buyback Short Foreign JPM

Ticker Name Sector (12/5/2014) 1-mo 3-mo YTD (NTM) (NTM) (NTM) EBITDA Yield Yield (Net) ROE Interst Exposure Rating Composite Value Growth Momentum Quality Low Risk High Risk

MU Micron Technology Inc Technology $36.49 8.0% 9.4% 69.1% 15.4% 21.4% 9.3x 7.1x — 0.0% 14.1% 8.9% 84.4% OW 1.97 1.11 3.00 1.89 2.40 -0.80 1.30

DAL Delta Air Lines Inc Industrials $47.28 10.3% 20.7% 74.1% 5.1% 29.8% 11.3x 6.6x 0.9% 1.9% 221.6% 2.0% 30.0% OW 1.82 1.57 0.71 3.00 1.96 -2.04 2.03

GILD Gilead Sciences Inc Health Care $104.59 -1.3% 0.2% 40.6% 39.1% 59.7% 10.6x 12.5x — 2.1% 29.6% 3.6% 50.4% OW 1.39 0.42 3.00 2.75 0.36 -0.01 1.49

TSO Tesoro Corp Energy $76.15 1.0% 10.2% 29.8% -15.8% 15.3% 11.6x 5.4x 1.7% 0.0% 9.2% 7.0% 0.0% N 1.34 1.10 0.85 0.08 2.96 1.05 0.66

VLO Valero Energy Corp Energy $49.78 -4.2% -9.2% -1.1% -18.3% -9.6% 8.1x 3.7x 1.8% 2.9% 14.5% 2.1% 27.3% N 1.32 1.96 0.97 1.18 1.36 1.49 0.21

ADM Archer-Daniels-Midland Co Staples $53.25 5.0% 4.2% 20.1% 3.6% 13.0% 14.6x 9.8x 1.8% 2.1% 7.0% 0.8% 53.9% N 1.14 2.24 0.00 0.60 0.34 -0.65 1.35

LYB LyondellBasell Industries NV Materials $80.77 -10.0% -32.2% -2.2% 0.7% 6.4% 8.6x 8.5x 3.0% 13.0% 32.7% 2.4% 50.2% OW 1.05 1.48 1.52 1.96 -0.04 1.16 0.32

DHI DR Horton Inc Discretionary $24.89 8.6% 16.1% 13.6% 32.8% 26.8% 13.0x 11.9x 1.2% 0.0% 12.1% 3.9% 0.0% OW 1.04 1.20 0.34 -0.62 2.04 -1.73 2.32

URI United Rentals Inc Industrials $114.54 -2.6% -6.5% 44.0% 13.6% 31.5% 13.3x 7.6x — 3.7% 22.6% 4.5% 13.9% n/c 1.03 -0.09 2.06 -0.19 1.78 -2.68 2.55

LUV Southwest Airlines Co Industrials $41.12 11.0% 28.3% 123.7% 6.9% 50.1% 16.0x 7.6x 0.8% 2.2% 10.5% 2.9% 0.0% N 1.00 -0.09 0.70 0.34 3.00 -0.42 0.22

EW Edwards Lifesciences Corp Health Care $129.71 6.9% 33.6% 101.2% 11.2% 18.4% 33.3x 8.4x — 1.7% 25.8% 1.4% 54.1% N 0.99 -1.33 1.84 2.19 2.26 0.39 0.07

MNST Monster Beverage Corp Staples $106.69 6.0% 19.4% 57.1% 19.4% 27.3% 33.5x 20.1x — 0.2% 41.4% 2.3% 23.0% OW 0.91 -1.57 1.38 1.82 2.30 0.22 1.40

JEC Jacobs Engineering Group Inc Industrials $46.31 -6.2% -15.7% -27.2% 7.0% 11.8% 12.2x 9.9x — 0.6% 10.7% 1.3% 40.8% n/c 0.87 3.00 0.77 -0.80 0.12 -0.06 0.27

TSN Tyson Foods Inc Staples $41.65 -0.5% 9.0% 23.0% 13.0% 16.9% 12.0x 11.2x 0.8% 0.0% 13.9% 8.6% 9.5% OW 0.85 2.57 -0.71 -1.21 1.95 -0.14 -0.40

STX Seagate Technology PLC Technology $66.40 5.9% 8.0% 17.2% 4.8% 7.9% 12.0x 7.5x 3.0% 8.3% 52.6% 5.5% 73.0% N 0.83 0.78 1.22 1.39 0.00 -0.66 1.52

MPC Marathon Petroleum Corp Energy $92.15 -4.7% -3.2% 0.2% — 8.2% 10.0x 5.9x 1.8% 7.5% 18.7% 2.5% 0.0% OW 0.82 1.17 0.53 0.41 1.37 1.87 -0.50

AIZ Assurant Inc Financials $68.79 1.0% 3.6% 4.3% 2.0% 0.3% 10.5x — 1.5% 4.3% 9.8% 3.7% 13.9% N 0.78 2.01 1.31 0.18 -0.14 -0.23 0.04

EA Electronic Arts Inc Technology $46.66 12.8% 22.1% 101.0% -2.3% -14.1% 20.1x 14.0x — 0.6% 4.1% 5.2% 57.8% n/c 0.78 -0.41 1.67 0.14 2.10 -0.25 -0.08

AMAT Applied Materials Inc Technology $25.04 7.3% 6.5% 38.6% 10.5% 26.4% 18.1x 12.9x 1.8% 0.0% 3.6% 6.0% 80.4% OW 0.77 -0.12 0.58 0.59 1.99 -0.25 0.57

PCG PG&E Corp Utilities $50.95 5.2% 8.0% 28.9% 2.5% 0.3% 15.3x 7.8x 4.5% 0.0% 5.9% 2.0% 0.0% N 0.77 0.67 -0.39 0.30 2.17 -0.20 0.14

TXT Tex tron Inc Industrials $42.32 -1.5% 8.5% 14.2% 11.3% 25.7% 16.2x 9.2x 0.2% 2.4% 13.5% 2.6% 37.9% OW 0.76 0.81 1.91 -0.32 0.20 -1.76 2.12

ABC AmerisourceBergen Corp Health Care $92.21 5.9% 18.5% 31.5% 8.5% 15.3% 20.2x 17.8x 1.2% 3.1% 20.7% 3.6% 3.8% N 0.75 0.67 1.19 -0.12 1.71 2.62 -0.98

AET Aetna Inc Health Care $90.62 6.4% 7.4% 32.2% 9.6% 5.4% 12.6x 6.6x 1.2% 4.7% 15.7% 1.3% 0.0% OW 0.75 2.13 1.12 0.07 -0.14 0.09 -0.17

PSX Phillips 66 Energy $73.02 -8.6% -21.2% -7.7% — 15.9% 9.4x 12.4x 2.0% 6.2% 17.2% 1.9% 32.8% OW 0.70 1.32 -0.67 0.73 1.13 1.35 0.18

NRG NRG Energy Inc Utilities $28.27 -15.2% -10.4% -3.4% -1.1% - to + 16.7x 12.1x 1.7% 0.0% -3.8% 3.0% 51.0% n/c 0.70 1.85 2.00 -3.00 0.59 -1.24 2.33

KORS Michael Kors Holdings Ltd Discretionary $77.63 5.3% -0.3% -5.5% — 23.1% 16.3x 10.7x — 0.0% 52.9% 5.2% 16.3% OW 0.69 -0.52 3.00 2.28 -0.28 1.38 -0.60

TRV Travelers Cos Inc/The Financials $105.20 3.9% 12.3% 17.2% 2.7% -8.0% 11.3x — 2.2% 8.9% 14.6% 2.1% 4.0% n/c 0.69 0.74 0.95 1.35 0.46 0.68 -0.64

AVGO Avago Technologies Ltd Technology $103.99 14.9% 14.6% 91.1% — — 13.8x 23.5x 1.5% 0.0% 20.8% 1.3% 85.4% N 0.66 -0.51 1.13 -1.52 3.00 -1.11 0.59

GMCR Keurig Green Mountain Inc Staples $134.21 -14.0% 0.2% 74.6% 16.4% 10.6% 30.3x 17.0x 0.8% 0.0% 19.7% 4.9% 14.6% n/c 0.66 -1.27 0.57 0.15 3.00 -0.56 0.60

AGN Allergan Inc/United States Health Care $213.35 7.7% 27.3% 91.9% 12.9% 46.8% 24.9x 24.5x 0.2% 0.7% 20.6% 1.0% 39.1% NR 0.66 -1.21 1.09 0.34 2.60 0.09 0.20

EMN Eastman Chemical Co Materials $80.51 -3.4% -4.5% -0.4% 13.6% 14.3% 10.3x 7.7x 1.7% 4.5% 34.6% 1.9% 54.1% N 0.65 0.64 1.78 0.42 -0.02 -0.69 0.93

FTI FMC Technologies Inc Energy $47.01 -19.8% -22.1% -13.0% 8.5% 19.1% 13.5x 10.7x — 1.7% 24.1% 4.2% 72.8% n/c 0.65 -0.68 1.44 1.56 0.89 0.41 0.51

AAPL Apple Inc Technology $115.00 3.4% 13.6% 41.9% 17.1% 23.7% 14.1x 7.8x 1.9% 6.7% 30.6% 1.3% 64.3% OW 0.64 -0.27 0.59 0.99 2.21 1.93 -1.90

MET MetLife Inc Financials $56.35 4.0% 2.0% 5.3% 3.2% 6.1% 9.3x — 2.0% 0.7% 5.3% 1.7% 30.4% OW 0.64 1.80 -0.03 0.20 -0.17 -1.65 1.85

AN AutoNation Inc Discretionary $59.79 1.2% 8.7% 17.4% 7.7% 16.3% 15.2x 11.5x — 6.0% 20.0% 3.5% 0.0% n/c 0.64 1.57 0.71 -0.65 0.52 0.07 0.67

GD General Dynamics Corp Industrials $145.15 2.4% 15.6% 52.4% 1.5% 12.8% 17.4x 9.7x 2.3% 5.4% 19.2% 1.0% 20.4% OW 0.63 -0.16 0.32 0.65 1.85 0.24 -0.07

HAL Halliburton Co Energy $40.37 -27.4% -42.8% -23.4% 9.2% 15.7% 8.9x 8.6x 1.2% 1.6% 14.4% 1.6% 51.3% n/c 0.63 0.13 1.49 1.10 -0.03 -0.02 1.45

WDC Western Digital Corp Technology $105.07 7.3% 4.1% 25.7% 0.2% 5.4% 12.3x 6.6x 1.7% 2.8% 12.6% 1.7% 77.8% OW 0.63 1.33 0.07 0.80 0.21 0.31 0.55

LNC Lincoln National Corp Financials $57.41 2.0% 4.7% 11.1% 4.6% 7.7% 9.2x — 0.9% 3.3% 8.8% 2.3% 0.0% N 0.63 1.41 0.60 -0.32 0.07 -2.10 1.93

ALL Allstate Corp/The Financials $68.68 4.6% 12.7% 27.5% 5.6% 7.1% 12.0x — 1.8% 4.4% 10.8% 1.9% 3.1% n/c 0.63 1.15 0.57 0.43 0.72 0.73 -0.73

Price Performance IBES Estimates Valuation Other Z-Score Ranking (prefer high over low)

91



Table 10: Top 40 Stock Picks for the “Slowdown” State Based on the J.P. Morgan Top-down Framework

as of 12/5/2014"

Source: J.P. Morgan

Top Stock Picks During Slowdown StagePrice Sales Gr EPS Gr P/E EV/ Div Buy back Short Foreign JPM

Ticker Name Sector (12/5/2014) 1-mo 3-mo YTD (NTM) (NTM) (NTM) EBITDA Yield Yield (Net) ROE Interst Ex posure Rating Composite Value Grow th Momentum Quality Low Risk High Risk

MU Micron Technology Inc Technology $36.49 8.0% 9.4% 69.1% 15.4% 21.4% 9.3x 7.1x — 0.0% 14.1% 8.9% 84.4% OW 1.97 1.11 3.00 1.89 2.40 -0.80 1.30

GILD Gilead Sciences Inc Health Care $104.59 -1.3% 0.2% 40.6% 39.1% 59.7% 10.6x 12.5x — 2.1% 29.6% 3.6% 50.4% OW 1.39 0.42 3.00 2.75 0.36 -0.01 1.49

EW Edw ards Lifesciences Corp Health Care $129.71 6.9% 33.6% 101.2% 11.2% 18.4% 33.3x 8.4x — 1.7% 25.8% 1.4% 54.1% N 0.99 -1.33 1.84 2.19 2.26 0.39 0.07

DAL Delta Air Lines Inc Industrials $47.28 10.3% 20.7% 74.1% 5.1% 29.8% 11.3x 6.6x 0.9% 1.9% 221.6% 2.0% 30.0% OW 1.82 1.57 0.71 3.00 1.96 -2.04 2.03

KORS Michael Kors Holdings Ltd Discretionary $77.63 5.3% -0.3% -5.5% — 23.1% 16.3x 10.7x — 0.0% 52.9% 5.2% 16.3% OW 0.69 -0.52 3.00 2.28 -0.28 1.38 -0.60

MNST Monster Bev erage Corp Staples $106.69 6.0% 19.4% 57.1% 19.4% 27.3% 33.5x 20.1x — 0.2% 41.4% 2.3% 23.0% OW 0.91 -1.57 1.38 1.82 2.30 0.22 1.40

FB Facebook Inc Technology $76.36 1.7% -1.0% 42.5% — 27.3% 40.1x 31.6x — 0.0% 11.0% 1.7% 53.1% OW 0.31 -1.69 2.81 1.00 0.93 1.69 -1.91

VLO Valero Energy Corp Energy $49.78 -4.2% -9.2% -1.1% -18.3% -9.6% 8.1x 3.7x 1.8% 2.9% 14.5% 2.1% 27.3% N 1.32 1.96 0.97 1.18 1.36 1.49 0.21

TSO Tesoro Corp Energy $76.15 1.0% 10.2% 29.8% -15.8% 15.3% 11.6x 5.4x 1.7% 0.0% 9.2% 7.0% 0.0% N 1.34 1.10 0.85 0.08 2.96 1.05 0.66

HCN Health Care REIT Inc Financials $73.99 6.6% 9.4% 39.9% 11.6% 69.2% 49.6x 18.3x 5.7% 0.0% 0.9% 3.7% 13.6% OW 0.51 -1.03 3.00 -0.63 1.95 1.86 -1.87

CHRW CH Robinson Worldw ide Inc Industrials $74.63 3.5% 9.3% 27.2% 8.4% 16.9% 21.8x 13.6x 2.4% 2.0% 34.0% 9.8% 12.6% n/c 0.46 -0.30 1.66 1.29 0.63 3.00 -1.83

AAPL Apple Inc Technology $115.00 3.4% 13.6% 41.9% 17.1% 23.7% 14.1x 7.8x 1.9% 6.7% 30.6% 1.3% 64.3% OW 0.64 -0.27 0.59 0.99 2.21 1.93 -1.90

LYB Ly ondellBasell Industries NV Materials $80.77 -10.0% -32.2% -2.2% 0.7% 6.4% 8.6x 8.5x 3.0% 13.0% 32.7% 2.4% 50.2% OW 1.05 1.48 1.52 1.96 -0.04 1.16 0.32

AVB Av alonBay Communities Inc Financials $160.62 3.7% 4.5% 37.4% 11.3% -36.3% 42.1x 23.6x 3.6% 0.0% 0.8% 4.5% 0.0% OW 0.45 -1.09 1.93 0.03 1.97 1.60 -1.64

LUV Southw est Airlines Co Industrials $41.12 11.0% 28.3% 123.7% 6.9% 50.1% 16.0x 7.6x 0.8% 2.2% 10.5% 2.9% 0.0% N 1.00 -0.09 0.70 0.34 3.00 -0.42 0.22

ABC AmerisourceBergen Corp Health Care $92.21 5.9% 18.5% 31.5% 8.5% 15.3% 20.2x 17.8x 1.2% 3.1% 20.7% 3.6% 3.8% N 0.75 0.67 1.19 -0.12 1.71 2.62 -0.98

FTI FMC Technologies Inc Energy $47.01 -19.8% -22.1% -13.0% 8.5% 19.1% 13.5x 10.7x — 1.7% 24.1% 4.2% 72.8% n/c 0.65 -0.68 1.44 1.56 0.89 0.41 0.51

MCO Moody 's Corp Financials $98.59 -1.5% 2.4% 24.6% 10.1% 17.1% 21.1x 13.7x 1.3% 3.9% 222.8% 2.7% 45.3% n/c 0.61 -1.21 0.73 2.42 1.02 0.10 1.00

RHI Robert Half International Inc Industrials $56.46 1.3% 9.4% 33.5% 12.4% 22.3% 21.6x 12.3x 1.5% 2.2% 28.6% 2.7% 24.2% OW 0.57 -1.05 0.47 1.78 1.46 1.02 0.49

EA Electronic Arts Inc Technology $46.66 12.8% 22.1% 101.0% -2.3% -14.1% 20.1x 14.0x — 0.6% 4.1% 5.2% 57.8% n/c 0.78 -0.41 1.67 0.14 2.10 -0.25 -0.08

AGN Allergan Inc/United States Health Care $213.35 7.7% 27.3% 91.9% 12.9% 46.8% 24.9x 24.5x 0.2% 0.7% 20.6% 1.0% 39.1% NR 0.66 -1.21 1.09 0.34 2.60 0.09 0.20

AIV Apartment Inv estment & Management CoFinancials $36.88 4.1% 7.3% 43.1% 3.3% -83.6% 86.2x 16.6x 3.7% 0.0% 4.8% 2.4% 0.0% N 0.48 -1.36 -0.85 1.59 3.00 0.98 -1.13

UA Under Armour Inc Discretionary $69.43 3.5% -5.4% 57.9% 30.8% 42.1% 57.1x 39.9x — 0.0% 17.4% 7.6% 5.9% N 0.27 -1.71 2.25 -0.35 1.85 1.09 -1.25

MHFI McGraw Hill Financial Inc Financials $93.71 2.0% 8.6% 18.3% 5.4% 14.8% 21.2x 13.3x 1.4% 1.1% 78.5% 1.2% 40.7% n/c 0.42 -1.10 0.28 3.00 0.38 0.62 0.16

MPC Marathon Petroleum Corp Energy $92.15 -4.7% -3.2% 0.2% — 8.2% 10.0x 5.9x 1.8% 7.5% 18.7% 2.5% 0.0% OW 0.82 1.17 0.53 0.41 1.37 1.87 -0.50

SHW Sherw in-Williams Co/The Materials $246.87 7.0% 14.3% 36.9% 8.2% 23.1% 23.0x 15.4x 1.1% 5.3% 42.2% 2.6% 20.9% N 0.29 -1.34 1.30 1.31 0.72 1.26 -0.23

TEG Integry s Energy Group Inc Utilities $74.87 4.4% 10.3% 38.9% -18.4% 11.0% 20.8x 10.0x 5.0% 0.4% 11.0% 2.9% 0.0% n/c 0.51 0.36 2.04 0.86 -0.47 2.16 0.11

TRV Travelers Cos Inc/The Financials $105.20 3.9% 12.3% 17.2% 2.7% -8.0% 11.3x — 2.2% 8.9% 14.6% 2.1% 4.0% n/c 0.69 0.74 0.95 1.35 0.46 0.68 -0.64

LMT Lockheed Martin Corp Industrials $189.87 0.0% 8.7% 29.2% -0.9% 10.3% 16.5x 9.9x 3.6% 2.6% 119.0% 1.5% 17.1% N 0.38 -0.44 0.23 2.67 0.18 0.89 -0.86

GMCR Keurig Green Mountain Inc Staples $134.21 -14.0% 0.2% 74.6% 16.4% 10.6% 30.3x 17.0x 0.8% 0.0% 19.7% 4.9% 14.6% n/c 0.66 -1.27 0.57 0.15 3.00 -0.56 0.60

AMAT Applied Materials Inc Technology $25.04 7.3% 6.5% 38.6% 10.5% 26.4% 18.1x 12.9x 1.8% 0.0% 3.6% 6.0% 80.4% OW 0.77 -0.12 0.58 0.59 1.99 -0.25 0.57

COST Costco Wholesale Corp Staples $143.25 3.8% 12.1% 19.8% 10.2% 14.8% 26.6x 12.0x 1.2% 0.5% 17.6% 0.8% 28.6% OW 0.54 -0.12 0.71 0.87 1.07 1.04 -0.05

HD Home Depot Inc/The Discretionary $99.64 3.2% 9.6% 22.6% 5.4% 19.6% 19.4x 12.1x 2.0% 5.6% 25.4% 0.9% 10.8% OW 0.34 -0.61 -0.03 2.06 0.58 1.35 -0.28

GD General Dy namics Corp Industrials $145.15 2.4% 15.6% 52.4% 1.5% 12.8% 17.4x 9.7x 2.3% 5.4% 19.2% 1.0% 20.4% OW 0.63 -0.16 0.32 0.65 1.85 0.24 -0.07

WEC Wisconsin Energy Corp Utilities $50.14 3.3% 11.6% 23.0% -0.9% 1.2% 18.8x 9.5x 3.7% 0.7% 13.7% 6.8% 0.0% n/c 0.14 -1.15 1.06 2.16 -0.29 0.80 -0.58

SLB Schlumberger Ltd Energy $87.16 -13.2% -21.1% -5.6% 6.1% 9.3% 14.2x 10.4x 1.4% 3.4% 18.3% 1.1% 69.0% n/c 0.30 -0.63 0.63 1.40 0.54 1.30 -0.55

FFIV F5 Netw orks Inc Technology $133.26 4.9% 6.1% 46.1% 16.9% 20.5% 20.0x 15.0x — 6.4% 19.3% 6.0% 44.7% N 0.62 -0.79 0.69 0.27 2.08 -0.05 1.01

URI United Rentals Inc Industrials $114.54 -2.6% -6.5% 44.0% 13.6% 31.5% 13.3x 7.6x — 3.7% 22.6% 4.5% 13.9% n/c 1.03 -0.09 2.06 -0.19 1.78 -2.68 2.55

IFF International Flav ors & Fragrances IncMaterials $103.42 3.6% 1.1% 19.3% 3.7% 10.9% 18.8x 12.9x 1.8% 0.8% 26.1% 1.8% 83.9% N 0.22 -0.93 1.29 1.26 0.14 1.01 -0.28

EIX Edison International Utilities $63.63 4.3% 8.7% 39.6% 1.2% -16.0% 17.9x 8.2x 3.1% 0.0% 8.6% 1.7% 0.5% n/c 0.62 -0.33 0.31 0.16 2.41 -0.19 -0.39

IBES Estimates Valuation Z-Score Ranking (prefer high over low)OtherPrice Performance

92



Table 11: Top Stock Picks by Investment Style: Value, Growth, and Momentum

as of 12/5/2014

Source: J.P. Morgan

Value Growth Momentum

Ticker Name Sector Z-Score

Price

(12/5/2014)

JPM

Rating Ticker Name Sector Z-Score

Price

(12/5/2014)

JPM


Price

(12/5/2014)

JPM

Rating

JEC Jacobs Engineering Group Inc Industrials 3.00 $46.31 n/c MU Micron Technology Inc Technology 3.00 $36.49 OW DAL Delta Air Lines Inc Industrials 3.00 $47.28 OW

GM General Motors Co Discretionary 3.00 $33.93 OW GILD Gilead Sciences Inc Health Care 3.00 $104.59 OW MHFI McGraw Hill Financial Inc Financials 3.00 $93.71 n/c

GNW Genworth Financial Inc Financials 3.00 $8.63 N KORS Michael Kors Holdings Ltd Discretionary 3.00 $77.63 OW GILD Gilead Sciences Inc Health Care 2.75 $104.59 OW

XRX Xerox Corp Technology 2.91 $14.32 N HCN Health Care REIT Inc Financials 3.00 $73.99 OW LMT Lockheed Martin Corp Industrials 2.67 $189.87 N

GME GameStop Corp Discretionary 2.86 $37.42 n/c FB Facebook Inc Technology 2.81 $76.36 OW BEN Franklin Resources Inc Financials 2.63 $58.30 N

ANTM Anthem Inc Health Care 2.62 $127.91 N REGN Regeneron Pharmaceuticals Inc Health Care 2.66 $423.23 N YUM Yum! Brands Inc Discretionary 2.56 $78.30 N

TSN Ty son Foods Inc Staples 2.57 $41.65 OW CRM salesforce.com inc Technology 2.52 $58.85 OW MJN Mead Johnson Nutrition Co Staples 2.47 $103.38 OW

FSLR First Solar Inc Technology 2.54 $46.91 OW STZ Constellation Brands Inc Staples 2.49 $95.09 N MCO Moody's Corp Financials 2.42 $98.59 n/c

SPLS Staples Inc Discretionary 2.54 $14.38 N WFM Whole Foods Market Inc Staples 2.42 $48.29 N KORS Michael Kors Holdings Ltd Discretionary 2.28 $77.63 OW

F Ford Motor Co Discretionary 2.53 $15.70 OW UA Under Armour Inc Discretionary 2.25 $69.43 N LLTC Linear Technology Corp Technology 2.24 $47.12 UW

GT Goody ear Tire & Rubber Co/The Discretionary 2.48 $27.58 OW VTR Ventas Inc Financials 2.06 $71.06 n/c EW Edwards Lifesciences Corp Health Care 2.19 $129.71 N

LUK Leucadia National Corp Financials 2.42 $23.07 n/c URI United Rentals Inc Industrials 2.06 $114.54 n/c CL Colgate-Palmolive Co Staples 2.18 $69.37 N

HPQ Hew lett-Packard Co Technology 2.35 $39.55 OW ALXN Alex ion Pharmaceuticals Inc Health Care 2.05 $198.61 OW WEC Wisconsin Energy Corp Utilities 2.16 $50.14 n/c

PWR Quanta Services Inc Industrials 2.35 $30.02 n/c ADT ADT Corp/The Industrials 2.05 $34.82 n/c TROW T Rowe Price Group Inc Financials 2.15 $84.49 OW

ADM Archer-Daniels-Midland Co Staples 2.24 $53.25 N TEG Integry s Energy Group Inc Utilities 2.04 $74.87 n/c UPS United Parcel Service Inc Industrials 2.11 $110.98 n/c

OI Ow ens-Illinois Inc Materials 2.20 $26.44 N NRG NRG Energy Inc Utilities 2.00 $28.27 n/c MA MasterCard Inc Technology 2.09 $89.08 OW

AES AES Corp/VA Utilities 2.18 $13.68 N ICE Intercontinental Exchange Inc Financials 1.93 $224.77 OW HD Home Depot Inc/The Discretionary 2.06 $99.64 OW

AET Aetna Inc Health Care 2.13 $90.62 OW AVB Av alonBay Communities Inc Financials 1.93 $160.62 OW LYB Ly ondellBasell Industries NV Materials 1.96 $80.77 OW

FLR Fluor Corp Industrials 2.12 $62.39 n/c TXT Textron Inc Industrials 1.91 $42.32 OW ABBV AbbVie Inc Health Care 1.91 $69.71 OW

FE FirstEnergy Corp Utilities 2.12 $37.00 n/c NEE NextEra Energy Inc Utilities 1.89 $102.93 NR WYNN Wynn Resorts Ltd Discretionary 1.91 $163.90 OW

RIG Transocean Ltd Energy 2.03 $18.72 n/c EXPE Ex pedia Inc Discretionary 1.89 $91.35 N MU Micron Technology Inc Technology 1.89 $36.49 OW

AIZ Assurant Inc Financials 2.01 $68.79 N TRIP TripAdvisor Inc Discretionary 1.87 $77.14 N TJX TJX Cos Inc/The Discretionary 1.88 $65.58 OW

NBR Nabors Industries Ltd Energy 1.97 $12.21 n/c CAM Cameron International Corp Energy 1.87 $50.09 n/c MNST Monster Beverage Corp Staples 1.82 $106.69 OW

CSC Computer Sciences Corp Technology 1.96 $65.57 N EW Edwards Lifesciences Corp Health Care 1.84 $129.71 N SBUX Starbucks Corp Discretionary 1.81 $83.57 OW

VLO Valero Energy Corp Energy 1.96 $49.78 N EMN Eastman Chemical Co Materials 1.78 $80.51 N AMG Affiliated Managers Group Inc Financials 1.81 $206.00 n/c

SWY Safeway Inc Staples 1.94 $34.70 N MDLZ Mondelez International Inc Staples 1.69 $38.50 OW ACN Accenture PLC Technology 1.80 $86.19 OW

AVP Av on Products Inc Staples 1.92 $9.70 n/c EA Electronic Arts Inc Technology 1.67 $46.66 n/c RHI Robert Half International Inc Industrials 1.78 $56.46 OW

UNM Unum Group Financials 1.91 $33.66 N CHRW CH Robinson Worldwide Inc Industrials 1.66 $74.63 n/c BIIB Biogen Idec Inc Health Care 1.73 $340.87 OW

PRU Prudential Financial Inc Financials 1.90 $88.34 OW ECL Ecolab Inc Materials 1.66 $109.04 OW DLPH Delphi Automotive PLC Discretionary 1.73 $73.39 OW

NRG NRG Energy Inc Utilities 1.85 $28.27 n/c AMZN Amazon.com Inc Discretionary 1.62 $312.63 N SPG Simon Property Group Inc Financials 1.71 $180.83 OW

MET MetLife Inc Financials 1.80 $56.35 OW PX Prax air Inc Materials 1.57 $129.53 N VZ Verizon Communications Inc Telecom 1.69 $48.61 OW

HUM Humana Inc Health Care 1.75 $144.32 OW CINF Cincinnati Financial Corp Financials 1.56 $51.53 n/c XOM Ex x on Mobil Corp Energy 1.68 $93.82 N

BBY Best Buy Co Inc Discretionary 1.70 $35.63 OW PCLN Priceline Group Inc/The Discretionary 1.55 $1,135.97 OW MAS Masco Corp Industrials 1.63 $24.87 OW

ESV Ensco PLC Energy 1.66 $31.07 n/c LYB Ly ondellBasell Industries NV Materials 1.52 $80.77 OW PX Prax air Inc Materials 1.59 $129.53 N

DAL Delta Air Lines Inc Industrials 1.57 $47.28 OW GLW Corning Inc Technology 1.50 $21.34 N IBM International Business Machines Corp Technology 1.59 $163.27 N

AN AutoNation Inc Discretionary 1.57 $59.79 n/c HAL Halliburton Co Energy 1.49 $40.37 n/c AIV Apartment Investment & Management CoFinancials 1.59 $36.88 N

JOY Joy Global Inc Industrials 1.54 $51.38 N AMT American Tower Corp Financials 1.45 $100.54 OW MMC Marsh & McLennan Cos Inc Financials 1.57 $58.23 n/c

JNPR Juniper Networks Inc Technology 1.53 $22.34 OW CMG Chipotle Mexican Grill Inc Discretionary 1.45 $660.57 OW FTI FMC Technologies Inc Energy 1.56 $47.01 n/c

CI Cigna Corp Health Care 1.52 $104.71 OW FTI FMC Technologies Inc Energy 1.44 $47.01 n/c CLX Clorox Co/The Staples 1.56 $98.86 UW

AIG American International Group Inc Financials 1.51 $55.33 N HAR Harman International Industries Inc Discretionary 1.43 $106.18 OW ZTS Zoetis Inc Health Care 1.50 $43.98 OW

93



Table 12: Top Stock Picks by Investment Style: Quality, Low Risk, and High Risk

as of 12/5/2014

Source: J.P. Morgan

Quality Low Risk High Risk

Ticker Name Sector Z-Score

Price

(12/5/2014)

JPM


Price

(12/5/2014)

JPM


Price

(12/5/2014)

JPM

Rating

AIV Apartment Investment & Management CoFinancials 3.00 $36.88 N CHRW CH Robinson Worldwide Inc Industrials 3.00 $74.63 n/c AES AES Corp/VA Utilities 3.00 $13.68 N

LUV Southw est Airlines Co Industrials 3.00 $41.12 N IBM International Business Machines Corp Technology 2.81 $163.27 N FSLR First Solar Inc Technology 3.00 $46.91 OW

GMCR Keurig Green Mountain Inc Staples 3.00 $134.21 n/c FDO Family Dollar Stores Inc Discretionary 2.77 $79.78 NR NFX Newfield Ex ploration Co Energy 3.00 $25.85 OW

AVGO Avago Technologies Ltd Technology 3.00 $103.99 N ABC AmerisourceBergen Corp Health Care 2.62 $92.21 N SNDK SanDisk Corp Technology 2.72 $104.47 N

MNK Mallinckrodt PLC Health Care 3.00 $95.61 N SIAL Sigma-Aldrich Corp Materials 2.58 $136.79 NR GNW Genworth Financial Inc Financials 2.65 $8.63 N

AA Alcoa Inc Materials 3.00 $16.95 OW XOM Ex x on Mobil Corp Energy 2.36 $93.82 N URI United Rentals Inc Industrials 2.55 $114.54 n/c

TSO Tesoro Corp Energy 2.96 $76.15 N PETM PetSmart Inc Discretionary 2.22 $78.20 NR AVP Av on Products Inc Staples 2.49 $9.70 n/c

AGN Allergan Inc/United States Health Care 2.60 $213.35 NR TEG Integrys Energy Group Inc Utilities 2.16 $74.87 n/c REGN Regeneron Pharmaceuticals Inc Health Care 2.36 $423.23 N

EIX Edison International Utilities 2.41 $63.63 n/c UNH UnitedHealth Group Inc Health Care 2.14 $100.33 OW NRG NRG Energy Inc Utilities 2.33 $28.27 n/c

MU Micron Technology Inc Technology 2.40 $36.49 OW DLTR Dollar Tree Inc Discretionary 2.10 $68.41 NR DHI DR Horton Inc Discretionary 2.32 $24.89 OW

EQR Equity Residential Financials 2.38 $70.29 N CAH Cardinal Health Inc Health Care 2.02 $82.23 N PHM PulteGroup Inc Discretionary 2.25 $21.54 N

MNST Monster Beverage Corp Staples 2.30 $106.69 OW INTU Intuit Inc Technology 1.99 $93.68 N TXT Tex tron Inc Industrials 2.12 $42.32 OW

EW Edwards Lifesciences Corp Health Care 2.26 $129.71 N MCD McDonald's Corp Discretionary 1.95 $96.31 OW TRIP TripAdv isor Inc Discretionary 2.07 $77.14 N

AAPL Apple Inc Technology 2.21 $115.00 OW AAPL Apple Inc Technology 1.93 $115.00 OW DAL Delta Air Lines Inc Industrials 2.03 $47.28 OW

PCG PG&E Corp Utilities 2.17 $50.95 N SYY Sy sco Corp Staples 1.91 $39.93 N ALXN Alex ion Pharmaceuticals Inc Health Care 1.95 $198.61 OW

VNO Vornado Realty Trust Financials 2.12 $112.85 OW MPC Marathon Petroleum Corp Energy 1.87 $92.15 OW LNC Lincoln National Corp Financials 1.93 $57.41 N

EA Electronic Arts Inc Technology 2.10 $46.66 n/c HCN Health Care REIT Inc Financials 1.86 $73.99 OW CELG Celgene Corp Health Care 1.92 $114.13 N

FFIV F5 Networks Inc Technology 2.08 $133.26 N GWW WW Grainger Inc Industrials 1.78 $252.83 n/c ATI Allegheny Technologies Inc Materials 1.91 $34.20 UW

DHI DR Horton Inc Discretionary 2.04 $24.89 OW VTR Ventas Inc Financials 1.77 $71.06 n/c FLR Fluor Corp Industrials 1.90 $62.39 n/c

PLL Pall Corp Industrials 2.04 $98.41 N EQR Equity Residential Financials 1.73 $70.29 N LVLT Lev el 3 Communications Inc Telecom 1.87 $48.41 OW

COL Rockwell Collins Inc Industrials 2.00 $85.16 OW BBBY Bed Bath & Beyond Inc Discretionary 1.71 $72.31 N MET MetLife Inc Financials 1.85 $56.35 OW

AMAT Applied Materials Inc Technology 1.99 $25.04 OW FB Facebook Inc Technology 1.69 $76.36 OW ABBV AbbVie Inc Health Care 1.84 $69.71 OW

AVB AvalonBay Communities Inc Financials 1.97 $160.62 OW MCK McKesson Corp Health Care 1.67 $212.63 OW NFLX Netflix Inc Discretionary 1.83 $350.92 OW

MAR Marriott International Inc/DE Discretionary 1.97 $78.99 OW EXPD Ex peditors International of Washington IncIndustrials 1.66 $45.56 n/c GT Goodyear Tire & Rubber Co/The Discretionary 1.81 $27.58 OW

DAL Delta Air Lines Inc Industrials 1.96 $47.28 OW HPQ Hew lett-Packard Co Technology 1.66 $39.55 OW PH Parker-Hannifin Corp Industrials 1.69 $129.95 N

HCN Health Care REIT Inc Financials 1.95 $73.99 OW HCP HCP Inc Financials 1.62 $44.30 N CCE Coca-Cola Enterprises Inc Staples 1.69 $44.20 N

TSN Tyson Foods Inc Staples 1.95 $41.65 OW AVB Av alonBay Communities Inc Financials 1.60 $160.62 OW GM General Motors Co Discretionary 1.63 $33.93 OW

WMB Williams Cos Inc/The Energy 1.85 $50.04 OW SPG Simon Property Group Inc Financials 1.60 $180.83 OW AMG Affiliated Managers Group Inc Financials 1.61 $206.00 n/c

GD General Dynamics Corp Industrials 1.85 $145.15 OW TXN Texas Instruments Inc Technology 1.56 $55.58 OW PRU Prudential Financial Inc Financials 1.60 $88.34 OW

UA Under Armour Inc Discretionary 1.85 $69.43 N SO Southern Co/The Utilities 1.56 $47.54 n/c MS Morgan Stanley Financials 1.57 $37.24 n/c

HST Host Hotels & Resorts Inc Financials 1.79 $23.54 OW BRK/B Berkshire Hathaway Inc Financials 1.55 $150.68 n/c KMX CarMax Inc Discretionary 1.56 $59.07 n/c

URI United Rentals Inc Industrials 1.78 $114.54 n/c VLO Valero Energy Corp Energy 1.49 $49.78 N AMP Ameriprise Financial Inc Financials 1.55 $135.15 n/c

DIS Walt Disney Co/The Discretionary 1.78 $93.76 OW CVX Chev ron Corp Energy 1.44 $110.87 N BEN Franklin Resources Inc Financials 1.54 $58.30 N

PLD Prologis Inc Financials 1.76 $42.58 OW CMG Chipotle Mexican Grill Inc Discretionary 1.41 $660.57 OW BLK BlackRock Inc Financials 1.53 $364.40 OW

ABC AmerisourceBergen Corp Health Care 1.71 $92.21 N KORS Michael Kors Holdings Ltd Discretionary 1.38 $77.63 OW STX Seagate Technology PLC Technology 1.52 $66.40 N

FTR Frontier Communications Corp Telecom 1.64 $6.90 N TJX TJX Cos Inc/The Discretionary 1.38 $65.58 OW SEE Sealed Air Corp Materials 1.51 $40.32 n/c

AZO AutoZone Inc Discretionary 1.57 $587.95 N MSFT Microsoft Corp Technology 1.36 $48.42 OW JCI Johnson Controls Inc Discretionary 1.49 $49.60 N

KMI Kinder Morgan Inc/DE Energy 1.54 $41.12 OW PSX Phillips 66 Energy 1.35 $73.02 OW GILD Gilead Sciences Inc Health Care 1.49 $104.59 OW

RHI Robert Half International Inc Industrials 1.46 $56.46 OW UPS United Parcel Service Inc Industrials 1.35 $110.98 n/c CMI Cummins Inc Industrials 1.48 $150.86 N

COV Cov idien PLC Health Care 1.42 $103.68 OW HD Home Depot Inc/The Discretionary 1.35 $99.64 OW BSX Boston Scientific Corp Health Care 1.48 $12.91 N

94



Small-cap Outlook

Small-caps have been a painful trade in a rising 2014 market with the Russell 2000 significantly underperforming its larger S&P 500 peers by 10.7%. This magnitude of underperformance has occurred before; however, it is more commonly seen during a multi-year period of Small-cap underperformance.

We have a positive tone for Small-caps going into next year as we believe a convergence trade is likely to materialize but the ultimate fate of small-caps will be closely tied to High Yield spreads. Given that we expect rising rates coupled with higher volatility, we recommend investors the following style tilts within Small-caps: Low Volatility, Quality, Momentum, and avoid High P/E multiples.

One year does not make a trend—a similar underperformance of -10.3% occurred in 2002, but this was followed by two years of strong outperformance.

Small-caps are sensitive to HY spreads, which are expected to tighten in 2015. Some reasons why Small-caps and HY spreads tend to move together: (1) higher spreads imply rising cost of capital; (2) rising default rates reduce investor appetite for riskier Small-caps; and (3) tighter credit means faster growing companies need to scale back growth plans. However, the J.P. Morgan view for HY spreads is to tighten 90bp next year with yield-to-worst at 6.75% and default rate at 2.5%. More importantly, debt issuance activity is expected to remain buoyant and robust in 2015.

M&A activity picks up with rising CEO confidence and low organic growth. In the later innings of the recovery, large-caps seek strategic acquisitions (90% of all transactions happen in SMid) as top-line growth becomes more difficult. The target P/E multiple of 30.1x this year is much higher than 22.6x paid in 2013—we see this trend persisting. Russell 2000 currently trades at P/E (NTM) of 22.7x.

Small-caps have a much smaller global footprint than Large-caps and should benefit from its higher exposure to domestic growth.

Risk: the largest risk that we see for Small-caps is the increased volatility andrising rates. Small-caps rely on shorter-term bank debt—typically ~5yrs.

Figure 146: Size Performance Cycles: Small-Caps underperformed Large-Caps by 11% YTD

Annual performance since 1928, YTD as of 12/5/2014

Source: J.P. Morgan, Ibbotson and Bloomberg. Note: small-cap underperformance (orange) and outperformance (green) cycles

-4%

-43%

-13%

-6%

3%

26%

-7%

31%

-23%

2% 1% 5% 3%

24%

34% 37%

-4%

-5%

-8%

1%7%

-16%

-15%

-5%

8%-1

1%-2

%-4

%22

%4%

-4%

5%-3

%1

%7

%29

%3%

25%

-17%

-21%

2%-1

5%-1

6%7%

16%

34%

33%

17%

26%

8% 8% 6%9%

-11%

2%-1

2%-1

7%13

%-1

%-3

1%28

%8%

13%

-11%

-4% -2%

-26% -2

3%16

%3%

17%

-10.

3%

28%

10%

-4% -2%

6%0%

4%

13%

-5%

1%7%

-10.

7%

-80%

-65%

-50%

-35%

-20%

-5%

10%

25%

40%

'28 '32 '36 '40 '44 '48 '52 '56 '60 '64 '68 '72 '76 '80 '84 '88 '92 '96 '00 '04 '08 '12

Rel

ativ

e P

erfo

rman

ce (%

)

Small-Cap Relative Perf Current LevelSimilar Decline in 2002 followed by two years of strong outperformance

Small vs. Large Trade:

— Small-caps over Large-caps in the US as a tactical trade.

— Long Low Volatility, Quality and

Momentum stocks. Avoid high P/Es, in Q1 due to seasonal effects

— Look for a divergence in High

Yield Spreads and Russell 2000 performance

— US SMid over EM SMid

— European SMid over US

95



Explaining the Underperformance YTD by Style Factors

Small-caps suffered a severe underperformance vs. Large-caps YTD, which is explained by investors punishing small-cap stocks with rich P/Es, negative earnings momentum, and lower quality. For example, stocks sporting high multiples are down 22% versus cheap stocks that are up 4%, giving a +25% return differential YTD based on valuation.

Small stocks showing declining earnings momentum saw severe declines—this is captured by the 1m&3m EMOM metric in Figure 147 below. As shown, stocks with poor earnings momentum are down -12% YTD, while companies with positive earnings momentum are up 8%—a 20% return spread;

The market does not like Low Quality (ROE) with the long bucket up slightly, while the short bucket is down 15%.

Lastly, the small underperforming large trend is also seen within the Russell 2000 index—Micro-caps are down on average -5% compared to flat returns for higher market cap small-cap companies in the Russell 2000. There has been a global macro rotation out of smaller market capitalization in the US and some countries abroad like Canada, Brazil, China, and Emerging EMEA. We recommend investors benchmarked to the Russell 2000 or need small-cap exposure do so by names in the Low Vol space. We see Low Vol as the silver lining within a higher risk Small-cap universe, especially given that we are expecting rising rates and volatility next year.

Figure 147: Style Performance for Russell 1000 and Russell 2000as of 12/5/13

Source: J.P. Morgan. Note: The long portfolio (L) consists of the top decile of the universe.

96



Russell 2000 sector composition is closer to our broader sector calls

To start, there are notable differences in the sector composition between Russell 2000 and S&P 500. This difference, however, is more inline with our broader sector recommendations for S&P 500: Discretionary at +229bp, Financials at +846bp, and Healthcare at +26p, but it has a lower Technology exposure at -202bp.

Cyclicals (ex Financials and Energy) account for 50% of the market cap weight of the Russell 2000. This exposure is almost 400bps higher than the S&P 500's cyclical weight of 45.9%. The slightly higher exposure gives Russell 2000 more leverage to domestic growth. Also, the index has significantly lower exposure to the Defensive sectors at 22.3% of the market cap vs. 30.4% for the S&P 500.

M&A targets are usually hidden in the Technology and Healthcare space. In our view, Small-caps are more likely to be targets than their larger peers due to size and growth—Healthcare and Technology sectors are a source of M&A targets for larger companies and could see these sectors re-rate further.

Even though Financials make up almost 25% of the Russell 2000, 8.5% ofthat are REITs, which will face headwind in a rising rate environment.

Figure 148: Russell 2000 sector weights bias closer to our sector call

Russell 2000 vs. S&P 500


Figure 149 below shows bottom-up earnings growth and valuation multiples across sectors for the Russell 2000 and S&P 500. While consensus growth estimates for next twelve months need to be revised down, Small-caps offer much larger earnings growth potential and trade at P/E (NTM) of 22.7x.

Marekt Cap Weights

Sector Russell S&P

Recommendation 2000 500 Delta

Energy N 3.7% 8.2% -450bp

Materials UW 4.4% 3.3% 106bp

Industrials N 13.2% 10.5% 274bp

Discretionary OW 14.3% 12.0% 229bp

Staples N 3.7% 10.6% -692bp

Health Care N 14.7% 14.4% 26bp

Financials OW 23.9% 15.5% 846bp

Technology OW 18.2% 20.2% -202bp

Telecom UW 0.9% 2.2% -134bp

Utilities UW 3.0% 3.1% -3bp

Russell 2000 sector weightings

are more consistent with our sector views for S&P 500…

97



Figure 149: EPS Growth and P/E Multiples

S&P 500 and Russell 2000


The relative P/B multiple for the Russell 2000 (vs. S&P 500) is near its 15yr median. As shown in the chart below, Russell 2000 saw a significant re-rating prior to 2006 and since then there has been little change to the multiple. The Russell 2000 trades about six turns more expensive on P/E (NTM) than S&P 500, but it trades 0.6x cheaper on P/B and closer to historical average.

Figure 150: Relative P/B ValuationRussell 2000 vs S&P 500 since 1999


Russell 2000 Relative Growth and Valuation

Russell 2000 S&P 500 Russell 2000 less S&P 500

P/E

NTM

EPS

Growth

NTM PEG

P/E

NTM

EPS

Growth

NTM PEG

P/E

NTM

EPS

Growth

NTM PEG

Index 22.7x 51.4% 0.4x 16.3x 10.6% 1.5x 6.4x 40.8% -1.1x

Index (ex-financials) 25.4x 77.7% 0.3x 16.8x 9.3% 1.8x 8.6x 68.3% -1.5x

Defensives 85.7x -465.4% -0.2x 17.6x 10.6% 1.7x 68.1x -476.0% -1.8x

Staples 19.8x 37.5% 0.5x 18.9x 6.9% 2.7x 1.0x 30.6% -2.2x

Healthcare -178.7x -72.9% 2.5x 17.7x 15.2% 1.2x -196.5x -88.0% 1.3x

Telecom 42.1x 80.6% 0.5x 13.6x 9.2% 1.5x 28.6x 71.3% -1.0x

Utilities 17.3x 39.4% 0.4x 16.8x 4.6% 3.6x 0.5x 34.7% -3.2x

Cyclicals 19.8x 55.0% 0.4x 16.7x 14.9% 1.1x 3.1x 40.2% -0.8x

Materials 18.4x 102.5% 0.2x 16.2x 15.1% 1.1x 2.3x 87.4% -0.9x

Industrials 17.1x 38.8% 0.4x 16.4x 12.4% 1.3x 0.7x 26.3% -0.9x

Discretionary 20.5x 114.4% 0.2x 18.3x 19.4% 0.9x 2.1x 95.0% -0.8x

Technology 22.3x 31.0% 0.7x 16.0x 13.8% 1.2x 6.3x 17.1% -0.4x

Other 16.9x 18.8% 0.9x 14.4x 4.4% 3.3x 2.5x 14.4% -2.4x

Energy 19.4x 71.8% 0.3x 14.6x -13.7% -1.1x 4.7x 85.5% 1.3x

Financials 16.6x 13.6% 1.2x 14.3x 16.4% 0.9x 2.2x -2.8% 0.3x

-0.6x

-3.0x

-2.5x

-2.0x

-1.5x

-1.0x

-0.5x

0.0x

4/99 4/02 4/05 4/08 4/11 4/14

Rel

ativ

e P

/B

P/B Median P/B

98



For the Global Manager—Stay UW US SMid

Our base case assumptions remain unchanged since 2009: Global GDP will continue to grow over the coming years but very anaemically, with deceleration in EMs and with Europe coming out of its crisis closing the growth differential against the US & the UK.

In this low growth environment, we expect SMid EPS growth will bring investors a mere 5-15% upside/yr (5-10% in DMs), while some regions offer >30% rerating upside—so, value matters.

How do we define value and where do we find it? The answer to this depends on whether we are talking DMs (where low yields/low inflation and a recovering macro argue for high equity multiples), or EMs (where high yields/high inflation and a decelerating macro argue for some kind of risk premium vs DMs, in our opinion).

OW US SMid vs EM SMid. Looking at the world of SMid under this prism, the first surprising realisation is that EM SMid valuations seem not to factor in any risk premia vs their DM counterparts, sporting valuations that exceed those of Continental Europe and Japan, while being in-line with those of the US. This is true even on a trailing basis (which we believe highlights the relative value hidden in DM SMids as these economies are still in recovery mode, while EMs come from having had a very stellar decade). Note that the numbers in Figure 152 and Figure 153 below are equal weighted averages ex-outliers, which provide a normalized and realistic picture of SMid-Caps, in our opinion.

We would understand EM trading at a premium to DM if there was a meaningful EPS growth gap between EM and DM SMid. However, the fact is that US SMid-Caps posted 11.3% EPS growth last year (beating most of Asia ex-J and CEEMEA,which grew at c.7%). While it is always hard to predict what the future may bring, we have little conviction on the ability of EM economies to accelerate faster than that of the US in 2015 given the current state of three of the most high profile BRICs (Brazil, Russia, and China). It is for this reason that we would overweight US vs EM SMids.

UW US SMid vs Continental Europe. Within the world of DM SMid, US would not be our top pick for 2015. In keeping up with our preference for value (over growth) given that we see anemic growth all around, we gravitate to ContinentalEurope as our #1 overweight SMid universe for 2015. As we can see in Figure 152and Figure 153 below, Cont. European SMid-Caps are currently trading at >1.5x their historical discount to US SMids on EV/Sales, EV/EBITDA, Fwd P/E, P/B and FCF Yld. Again, we have to note that such a discount on trailing valuations is most surprising when considering that SMid earnings are up 46% in the US from '06 to '13, while they have barely started to recover in Europe (up just 9% during the same time frame—see Figure 171figure below). For this valuation gap to grow from here, one likely has to believe that the US and Europe will be in a very different and sustainable growth curve for years to come—something we don't believe given the increasing globalization the world is facing and the already highly internationally-intertwined nature of these economies.

Small/Mid-Cap Strategy

Eduardo Lecubarri AC*

(44-20) 7134-5916

[email protected]

Bloomberg JPMA LECUBARRI <GO>

Patrick J Pitcaithly

(44-20) 7134-8451

[email protected]

J.P. Morgan Securities plc

99



Figure 151: Economic and SMid Earnings Growth (2007 to 2013)

Figure 152: SMid-Cap Scorecard (hist avgs calculated from ‘97-‘13, excluding ‘00/’01 Tech Bubble)

Figure 153: SMid Cap Valuations: US premium to W. Europe relative to historical average (excluding ‘00/’01 Tech Bubble)

Source for all charts on this page: Bloomberg, DataStream, FactSet and J.P. Morgan

What has happened since 2007?

US EURO UK

# of Yrs with…

-- Neg Real GDP Grw 2 3 2

-- Neg Nomnial GDG Grw 1 2 2

Cummulative Impact of…

-- Inflation +16% +15% +23%

-- Nominal GDP Grw +21% +10% +19%

Actual EPS Grw*

- SMid (Ex-Out) +46% +9% +54%

% of Cos with Pos EPS Grw 64% 53% 68%

- Large (Ex-Out) +30% -14% +16%

% of Cos with Pos EPS Grw 66% 47% 63%

* Excludes top and bo ttom 5% o f Net Income delta ('06-'13). IBES estimates (excludes

non-covered cos)

Growth Valuations

# of

Stocks

IBES

EPS

Grw

13A

IBES

EPS

Grw

14E P/E

Hist

Avg

vs

Hist

Avg PEG

Hist

Avg

vs

Hist

Avg

(x) P/B

Hist

Avg

vs

Hist

Avg

FCF

Yld

Hist

Avg

vs

Hist

Avg

US 2968 11.2% 11.4% 25.7x 22.2x 3.5x 1.6x 1.1x 0.5x 3.3x 2.7x 0.6x 0.6% 1.7% (1.0%)

Cont. Europe 1576 5.2% 15.9% 20.3x 17.6x 2.7x 1.3x 0.9x 0.4x 2.3x 2.2x 0.1x 4.0% 3.1% 0.8%

Emerging Mkts 8940 8.1% 21.4% 30.0x 19.7x 10.2x 1.7x 0.9x 0.8x 3.0x 2.4x 0.6x 0.5% (0.0%) 0.5%

EV/Sales (ex-Fin), 1.7x

EV/EBITDA (ex-Fin), 1.5x

Trailing P/E (IBES), 1.2x

Fw P/E (IBES), 1.7x

P/B, 2.0x

PEG, 0.6x

FCF Yld (ex-Fin), 2.2x

-1.5x

-1.0x

-0.5x

0.0x

0.5x

1.0x

1.5x

2.0x

2.5x

3.0x

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

EV/Sales (ex-Fin) EV/EBITDA (ex-Fin) Trailing P/E (IBES) Fw P/E (IBES)P/B PEG FCF Yld (ex-Fin)

100



Figure 154: Global SMid-Cap Scorecard (Lower Rankings = More Favorable Outlooks)

Source: Bloomberg, Datastream, Factset and J.P. Morgan Calculations

Revisions Growth Valuations (last reported unless otherwise stated) Balance Sheet Price Momentum Country Risk

# of

Stocks

Qu

anti

tati

ve

Ran

k* -3M

EPS

Rev's

14E Rev

isio

n R

ank

IBES

EPS

Grw

13A Ran

k (1

=Hig

hest

)

IBES

EPS

Grw

14E Ran

k (1

=Low

est)

Avg

Gro

wth

. Ran

k

P/E Ran

k

PEG Ran

k

P/B Ran

k FCF

Yld Ran

k

Avg

Val

. Ran

k

Net

Debt/

EBITDA Bal

ance

She

et R

ank

From

10-Yr

High Ran

k (1

=Wor

st P

erf)

3

Mth Ran

k (1

=Bes

t Per

f)

Avg

Mom

ent.

Ran

k

5 Yr

Sov

CDS** Ran

k

-3M

Chg

5 Yr

Sov

CDS Ran

k

Avg

Ris

k R

ank

W. Europe 2201 4 -2.3% 5 6.2% 5 14.2% 3 3 19.8x 3 1.6x 4 2.5x 4 3.6% 2 3 1.2x 4 -40.7% 2 -2.2% 6 3 50 3 7 4 3

Continental Europe 1556 -2.8% 5.2% 15.9% 20.3x 1.5x 2.3x 3.9% 1.3x -41.3% -1.6% 48 7

UK 625 -1.2% 7.7% 10.6% 18.7x 1.8x 2.9x 2.8% 0.9x -39.4% -3.8% 20 0

US/Can 3457 2 -2.1% 3 10.3% 3 12.1% 2 1 25.5x 6 1.6x 5 3.2x 7 0.5% 6 6 1.4x 6 -37.3% 4 -0.9% 4 3 19 1 2 1 1

US 2968 -1.4% 11.2% 11.4% 25.7x 1.6x 3.3x 0.6% 1.4x -36.4% 0.6% 19 2

Canada 489 -6.5% 3.6% 16.7% 24.1x 1.7x 2.6x -0.5% 1.6x -42.2% -9.8% NA NA

Japan 1842 1 -0.1% 1 26.2% 1 14.9% 4 1 20.3x 4 1.1x 2 1.5x 1 3.7% 1 1 0.2x 1 -36.8% 5 4.5% 2 1 59 4 21 5 5

Australia/NZ 435 2 -2.3% 4 2.7% 7 9.9% 1 3 17.7x 2 1.8x 6 2.7x 5 1.9% 4 5 1.0x 3 -42.9% 1 -5.4% 7 3 33 2 4 2 2

Australia 361 -2.5% 2.2% 11.0% 17.4x 1.8x 2.7x 1.8% 0.9x -46.5% -7.8% 33 4

New Zealand 74 -1.2% 4.2% 5.8% 18.7x 1.8x 2.4x 2.5% 1.3x -26.0% 5.6% 32 4

CEEMEA 1519 5 -1.3% 2 5.8% 6 15.9% 5 6 17.3x 1 1.3x 3 2.2x 3 3.6% 3 2 1.3x 5 -40.7% 3 -0.9% 5 3 213 6 25 6 6

Russia 139 4.2% -1.1% 26.3% 12.9x 0.3x 1.4x 6.5% 1.8x -59.8% -2.5% 300 48

CEE & Turkey 387 -0.6% 1.0% 17.0% 17.6x 0.8x 1.9x 3.5% 1.2x -40.1% 3.6% 124 15

MENA 690 -2.4% 9.4% 13.0% 18.6x 1.5x 2.2x 3.9% 1.5x -43.2% -3.1% 124 6

Sub-Saharan Africa 289 -2.1% 9.3% 15.2% 15.6x 1.6x 2.6x 2.0% 0.9x -28.3% -1.4% 167 -4

Countries:

Russia 139 4.2% -1.1% 26.3% 12.9x 0.3x 1.4x 6.5% 1.8x -59.8% -2.5% 300 48

Poland 121 -1.0% -4.3% 15.1% 21.1x 0.9x 2.0x 4.2% 1.1x -43.0% 4.5% 61 -5

Turkey 149 -0.9% 7.7% 27.1% 16.1x 0.8x 2.2x 0.7% 1.3x -32.4% 5.1% 166 -16

South Africa 143 -2.0% 9.3% 10.6% 16.6x 1.7x 2.5x 2.4% 1.0x -23.7% 2.5% 167 -4

Asia ex-J 6984 6 -5.5% 7 8.2% 4 22.7% 7 6 33.3x 7 1.8x 7 3.2x 6 -0.1% 7 7 0.8x 2 -36.5% 6 5.8% 1 1 93 5 6 3 4

China (A Sh) 2225 -5.7% 9.2% 32.3% 50.9x 2.2x 4.4x -1.3% 1.0x -30.6% 17.6% 78 7

China (B Sh) 83 -2.0% -5% 15.1% 24.9x 0.9x 2.4x -0.2% 0.8x -38.6% 6.7% 78 7

Hong Kong 1000 -4.6% 7.8% 14.5% 19.1x 1.0x 2.4x -0.4% 0.3x -50.0% 0.9% 46 1

India 644 -1.5% 7.9% 19.2% 29.3x 2.0x 3.6x -0.5% 1.6x -31.4% 8.6% NA NA

ASEAN 1292 -5.7% 7.0% 11.0% 21.2x 1.5x 2.6x -0.1% 1.1x -34.4% -3.1% 114 -1

Taiwan 803 -4.8% 8.3% 23.6% 20.5x 1.2x 2.2x 2.8% -0.1x -42.0% -6.9% NA NA

South Korea 708 -7.6% 6.0% 25.4% 24.2x 1.2x 2.3x 0.9% 0.7x -42.1% -1.3% 50 0

Other 213 -1.9% 15.8% 13.3% 16.8x 1.6x 2.8x 2.6% 0.5x -32.3% 9.5% NA NA

LatAm 437 7 -4.4% 6 14.3% 2 19.4% 6 3 21.2x 5 0.9x 1 2.1x 2 1.3% 5 3 1.8x 7 -34.7% 7 -0.5% 3 7 334 7 134 7 7

Brazil 122 -5.1% 18.8% 20.7% 21.7x 1.0x 2.2x 0.4% 2.0x -48.7% -8.5% 152 21

Chile 102 -4.4% -0.6% 6.8% 17.3x 1.1x 1.8x 2.5% 2.2x -35.2% 1.2% 72 11

Central Am 91 -3.6% 18.9% 19.0% 21.8x 0.8x 2.1x 0.3% 1.4x -20.9% 1.1% 83 15

Mexico 83 -3.5% 18.7% 18.2% 21.8x 0.8x 2.1x 0.1% 1.5x -19.7% 0.8% 83 15

South Am ex Brazil 217 -4.2% 8.3% 18.3% 18.1x 0.8x 2.0x 2.5% 1.8x -32.0% 3.8% 931 466

Global -3.3% 10.2% 17.5% 26.4x 1.6x 2.8x 1.3% 1.0x -37.8% 2.2% 80 17

* Equal Wtd rank of Revison, Growth, Valuations, Balance Sheet, Price Momentum and Country Risk Ranking, ** GDP Weighted Sovereign CDS Spreads.

101



J.P. Morgan SMid Themes — Investing with Style ScreenFigure 155: Investing with Style Screen —SMid-Caps with a) PEG LTM in Bottom 2 Qtls, and b) EPS vs 5yr High in Bottom 50%


Summary Stats Price Perf (%) JPM Coverage Consensus Estimates (IBES) Valuations (last rptd unless otherwise stated) Balance Sheet

Sector / Sub-Industry Company Name BBG Price

Mkt

Cap

($MM)

Free

Float

(%)

Avg

Daily

Vol

($MM)

From

10-Yr

High YTD 1 Mth Analyst Rec

Upside

to

Price

Target

# of

Recs

Mean

Rec

% Buy

Recs

Sales

Grw

14E

EPS

Grw

14E

EPS

Grw

15E

EPS

vs 5yr

High

-3M

EPS

Revis

14E

EV/

EBITDA

P/E

13A

P/E

14E PEG

FCF

Yield

Div

Yield P/B

Net

Debt/

Assets

Net

Debt/

EBITDA

ST

Debt/

Tot

Debt

1 Energy Exterran Partners, L.P. EXLP US $25.86 1,491 65% 4.0 -35 -14 -6 Tonet N 28% 8 2.00 50% 25% -13% 27% -91% 6% 11.2x 22.7x 26.0x 0.6 -1% 8.1% 2.6x 55% 3.8x 0%

2 GulfMark Offshore, Inc. Class A GLF US $29.34 835 92% 11.8 -57 -38 5 12 3.00 25% 9% -7% 1% -88% -28% 7.8x 12.5x 13.4x 0.1 -16% 3.2% 0.8x 25% 2.7x 0%

3 Hornbeck Offshore Services, Inc.HOS US $30.00 1,167 86% 26.1 -49 -39 12 14 2.14 50% 18% 3% 29% -77% -9% 7.7x 13.3x 12.9x 0.1 -27% 0.0% 0.9x 22% 2.7x 0%

4 Tidewater Inc. TDW US $35.55 1,926 99% 27.9 -55 -40 3 15 2.47 40% 10% 10% 6% -62% 9.2x 11.0x 10.0x 0.4 -25% 2.6% 0.7x 30% 3.9x 1%

5 Oil & Gas Exploration & ProductionAbraxas Petroleum Corporation AXAS US $3.97 457 93% 10.2 -55 22 9 11 1.36 82% 58% 267% 19% -123% -8% 6.9x 36.2x 9.9x 0.0 -9% 0.0% 5.3x 17% 0.5x 5%

6 Approach Resources Inc. AREX US $11.41 506 90% 19.2 -70 -41 23 Allman UW 58% 22 2.18 45% 48% 75% -8% -84% -10% 3.4x 27.8x 15.9x 0.1 -34% 0.0% 0.7x 17% 0.9x 0%

7 Gran Tierra Energy Inc. GTE US $4.40 1,361 99% 6.7 -54 -40 -4 Dos Santos OW 105% 7 1.57 71% -14% 2% 14% -22% -24% 11.2x 11.0x 0.4 -23% -0.8x

8 Memorial Production Partners LPMEMP US $15.08 1,327 98% 14.3 -38 -31 -29 Tonet OW 72% 11 1.55 73% 51% -100% 13.1x 11.9x 0.0 -1% 13.5% 2.3x 50% 4.8x 0%

9 Resolute Energy Corporation REN US $2.73 222 93% 5.9 -85 -70 -20 12 2.17 42% -4% -34% 3.0x 0.0 -175% 0.0% 0.4x 52% 4%

10 Sanchez Energy Corporation SN US $16.01 1,039 90% 37.4 -58 -35 0 17 1.12 94% 121% -24% 22% -607% -38% 9.4x 19.5x 25.5x 0.1 -28% 0.0% 1.2x 27% 2.2x 0%

11 SM Energy Company SM US $52.17 3,666 98% 83.4 -43 -37 -8 Allman N 90% 21 1.76 62% 11% 41% -6% -121% -13% 4.2x 12.9x 9.1x 0.0 -8% 0.2% 2.3x 28% 1.1x 0%

12 VAALCO Energy, Inc. EGY US $6.27 385 92% 6.7 -38 -9 -10 1 1.00 100% -16% -16% -5% -98% -15% 2.6x 9.0x 10.7x 0.0 2% 0.0% 1.5x -47% -1.5x

13 Warren Resources, Inc. WRES US $2.51 244 88% 4.4 -86 -20 -23 5 2.20 40% 23% -36% 20% -63% -30% 4.2x 6.4x 10.0x 0.1 3% 0.0% 1.1x 22% 1.1x 2%

14 Oil & Gas Storage & TransportationAegean Marine Petroleum Network Inc.ANW US $10.13 448 65% 1.8 -79 -10 26 4 1.00 100% 10% 22% 33% -59% -2% 15.6x 13.9x 11.4x 0.7 5% 0.4% 0.8x 44% 9.6x 47%

15 Enbridge Energy Management, L.L.C.EEQ US $38.00 2,595 88% 6.3 -1 42 8 5 3.40 20% 5% -37% 28% -42% 3% 23.3x 36.7x 0.3 1.3% 2.3x 0%

16 NuStar GP Holdings, LLC NSH US $37.07 1,577 80% 6.3 -17 32 -10 8 2.75 13% 41% 13% -97% -2% 35.1x 24.8x 0.0 5.9% 4.5x 6% 100%

17 Coal & Consumable Fuels Alliance Resource Partners, L.P.ARLP US $47.85 3,570 57% 7.3 -7 24 7 Bridges OW 2% 9 1.89 56% 4% 31% 6% -25% 4% 6.1x 13.3x 10.1x 0.7 11% 5.1% 3.2x 37% 1.1x 4%

18 Materials Calgon Carbon Corporation CCC US $20.74 1,119 99% 5.9 -10 1 4 9 1.89 56% 1% 10% 20% -45% -3% 11.6x 25.0x 22.8x 0.2 3% 0.0% 2.7x 0% 0.0x 6%

19 Diversified Chemicals Olin Corporation OLN US $25.40 2,006 99% 24.3 -16 -12 8 9 2.56 22% -9% -34% 21% -23% -11% 5.6x 11.6x 17.6x 0.6 11% 3.1% 1.8x 13% 0.9x 2%

20 Fertilizers & Agricultural ChemicalsScotts Miracle-Gro Company Class ASMG US $60.81 3,709 74% 18.7 -4 -2 6 Zekauskas OW 9% 12 2.67 25% 2% 15% 8% -25% 1% 11.4x 20.8x 18.1x 0.6 2.9% 5.2x 34% 1.8x 12%

21 Specialty Chemicals Cytec Industries Inc. CYT US $49.14 3,527 94% 25.2 -9 5 8 11 1.91 55% 4% 21% 11% -57% -3% 12.2x 20.4x 16.8x 0.3 -8% 0.8% 3.0x 22% 1.7x 0%

22 Ferro Corporation FOE US $13.39 1,166 99% 8.9 -48 4 5 Zekauskas N -10% 10 2.20 40% -29% 25% 72% -503% -1% 8.4x 28.5x 22.9x 0.1 -1% 0.0% 4.5x 29% 1.6x 14%

23 OM Group, Inc. OMG US $27.43 835 98% 5.7 -58 -25 22 4 1.00 100% -12% -25% 22% -131% -12% 30.8x 22.6x 30.0x 0.3 1% 1.1% 0.7x -6% -4.9x 0%

24 Paper Packaging Avery Dennison Corporation AVY US $49.19 4,397 100% 40.4 -29 -2 9 Zekauskas N -4% 8 2.50 38% 4% 13% 12% -54% 0% 8.1x 18.0x 16.0x 0.6 4% 2.8% 2.9x 15% 1.1x 7%

25 Paper Products KapStone Paper and Packaging CorporationKS US $29.59 2,881 87% 27.8 -11 6 6 8 1.50 75% 33% 44% 14% -43% -6% 12.9x 21.1x 14.7x 0.2 7% 0.0% 4.3x 45% 3.8x 0%

26 Resolute Forest Products Inc. RFP US $17.08 1,697 100% 5.5 -43 7 -2 3 3.00 33% -5% -71% 151% -99% -40% 11.2x 15.9x 54.4x 0.4 3% 0.0% 0.6x 7% 1.6x 0%

27 Industrials Alliant Techsystems Inc. ATK US $114.37 3,641 99% 49.9 -27 -6 -10 Nadol OW 31% 10 2.20 40% 8% 15% 9% -11% 7.7x 11.8x 10.2x 0.7 7% 1.1% 1.9x 32% 2.6x 12%

28 Curtiss-Wright Corporation CW US $71.56 3,382 91% 19.8 -2 15 5 7 1.29 86% -9% 21% 16% -30% -3% 11.7x 24.5x 20.2x 0.6 5% 0.7% 2.2x 23% 2.2x 0%

29 GenCorp Inc. GY US $16.94 982 92% 9.5 -19 -6 1 3 1.67 67% 17% -109% 22.4x 9.5x 0.0 1% 0.0% 19.7x 32% 7.6x 0%

30 Building Products Insteel Industries, Inc. IIIN US $22.70 410 92% 1.3 -24 0 6 2 2.00 50% 15% 47% 48% -74% 10% 11.4x 31.0x 21.1x 0.2 5% 0.5% 2.3x -1% -0.1x

31 Owens Corning OC US $35.22 4,268 90% 56.9 -24 -14 14 Rehaut N 2% 21 2.43 29% 1% -9% 37% -108% -9% 8.8x 19.5x 21.5x 0.3 2% 0.0% 1.1x 28% 2.8x 0%

32 Trex Company, Inc. TREX US $42.48 1,356 99% 16.7 -4 7 8 7 1.57 71% 13% -11% 31% -82% 5% 33.1x 30.2x 34.0x 0.4 2% 0.0% 12.7x -2% -0.1x

33 Construction & Engineering Comfort Systems USA, Inc. FIX US $15.03 548 97% 3.0 -27 -22 1 4 2.00 50% 4% -24% 57% -72% -15% 7.5x 22.3x 29.4x 0.2 4% 1.5% 1.9x -8% -0.8x 100%

34 Furmanite Corporation FRM US $6.74 250 96% 2.0 -46 -37 -7 2 1.00 100% 25% -20% 56% -96% -36% 7.8x 17.9x 22.5x 0.0 -7% 0.0% 1.9x 11% 0.9x 3%

35 Tutor Perini Corporation TPC US $26.00 1,255 78% 6.4 -65 -1 -2 3 1.00 100% 9% 30% 21% -252% 2% 7.5x 14.3x 11.0x 0.6 1% 0.0% 1.0x 17% 2.3x 16%

36 Electrical Components & EquipmentEncore Wire Corporation WIRE US $37.88 781 92% 4.3 -34 -30 4 1 3.00 0% 5% -12% 16% -57% -5% 8.7x 16.7x 18.9x 0.1 0% 0.2% 1.7x -7% -0.4x

37 Generac Holdings Inc. GNRC US $43.93 3,010 97% 51.0 -28 -22 -2 9 2.33 33% -5% -27% 9% -38% -14% 11.0x 10.1x 13.9x 0.3 8% 0.0% 9.5x 61% 2.8x 2%

38 Heavy Electrical Equipment PowerSecure International, Inc. POWR US $10.75 227 96% 7.6 -57 -37 9 6 1.33 83% -9% -75% 12.7x 23.1x 0.2 -5% 0.0% 1.4x -9% -1.5x 17%

39 Construction Machinery & Heavy TrucksDouglas Dynamics, Inc. PLOW US $24.00 510 97% 2.4 -3 43 17 4 2.50 25% 44% 205% -35% -72% 30% 17.0x 43.2x 14.2x 0.4 6% 3.6% 3.3x 29% 2.9x 11%

40 Federal Signal Corporation FSS US $15.23 960 99% 5.1 -21 4 15 3 1.67 67% 6% -5% 17% -56% 6% 13.5x 16.0x 16.9x 0.1 6% 0.6% 2.7x 11% 0.9x 8%

41 Manitowoc Company, Inc. MTW US $21.36 2,888 99% 65.9 -58 -8 13 Duignan N -6% 18 2.44 33% -3% -17% 22% -71% -23% 9.7x 14.7x 17.7x 0.2 7% 0.4% 3.7x 37% 3.3x 3%

42 Oshkosh Corp OSK US $46.67 3,813 99% 36.3 -29 -7 4 Duignan N -4% 15 1.67 67% -10% 0% 12% -61% 2% 7.0x 12.9x 12.8x 0.3 1% 0.6% 1.9x 13% 0.9x 2%

43 Terex Corporation TEX US $30.29 3,334 96% 72.5 -68 -28 3 Duignan N -1% 22 2.00 55% 4% 3% 20% -87% -11% 8.5x 13.8x 13.3x 0.7 3% 0.7% 1.5x 24% 2.7x 4%

44 Industrial Machinery Mueller Water Products, Inc. Class AMWA US $9.85 1,521 97% 9.6 -49 5 7 13 2.08 46% 6% 60% 42% -52% -4% 12.3x 45.3x 28.4x 0.3 0.7% 4.6x 29% 2.5x 0%

45 Rexnord Corporation RXN US $27.91 2,739 98% 17.2 -9 3 3 10 1.60 80% 3% 18% 17% -43% 18.0x 20.9x 17.7x 0.7 5% 0.0% 4.9x 48% 6.7x 1%

46 Commercial Printing Ennis, Inc. EBF US $13.71 360 97% 1.4 -51 -23 -1 1 1.00 100% 6% 3% -45% 9.8x 10.8x 10.4x 0.4 8% 5.1% 1.0x 19% 2.1x 0%

47 Human Resource & Employment ServicesKelly Services, Inc. Class A KELYA US $15.67 600 82% 3.6 -53 -37 -6 2 2.00 50% 3% -75% 229% -27% -42% 7.0x 9.8x 38.8x 0.5 16% 1.3% 0.7x -6% -1.4x 100%

48 Korn/Ferry International KFY US $27.22 1,358 99% 10.0 -16 4 2 5 1.80 60% 9% 21% 10% -44% 8.0x 18.8x 15.6x 0.7 8% 1.8x -29% -2.7x

49 TrueBlue, Inc. TBI US $23.15 978 98% 6.2 -26 -10 -4 7 1.86 57% 31% 32% 3% -16% 7% 10.6x 20.7x 15.7x 0.6 7% 0.0% 2.5x -15% -1.3x 7%

50 Cons. Disc. Federal-Mogul Holdings Corp FDML US $15.59 2,259 100% 3.5 -47 -21 9 4 2.50 25% 9% -15% 42% -149% -19% 7.9x 14.1x 16.5x 0.1 2% 0.0% 1.5x 26% 3.5x 65%

51 Gentherm Incorporated THRM US $37.87 1,420 93% 21.3 -27 41 -8 Chatterjee OW 64% 8 1.50 75% 23% 96% 16% -12% 4% 18.0x 42.3x 21.6x 0.3 2% 0.0% 6.1x 6% 0.3x 26%

52 Modine Manufacturing CompanyMOD US $12.33 593 98% 3.1 -67 -4 3 3 1.67 67% 5% 2% 25% -164% 7.2x 19.1x 18.8x 0.7 9% 1.4x 9% 0.9x 19%

53 Stoneridge, Inc. SRI US $11.10 310 92% 1.4 -42 -13 -5 6 2.33 33% -24% -17% 104% -67% -20% 6.0x 19.6x 23.8x 0.1 6% 0.0% 2.1x 23% 1.8x 6%

54 Tower International, Inc. TOWR US $25.66 520 96% 5.6 -30 20 14 Brinkman N 21% 5 2.20 40% 4% 36% 1% -148% 1% 6.7x 11.0x 8.1x 0.1 11% 0.0% 7.0x 31% 2.8x 8%

55 Household Appliances iRobot Corporation IRBT US $36.22 1,028 96% 30.2 -20 4 5 Coster N 5% 9 1.89 56% 15% 32% 17% -58% 8% 18.9x 37.0x 28.0x 0.7 3% 0.0% 3.1x -46% -4.2x

102



J.P. Morgan SMid Themes — Investing with Style Screen (Cont.)Figure 156: Investing with Style Screen —SMid-Caps with a) PEG LTM in Bottom 2 Qtls, and b) EPS vs 5yr High in Bottom 50%




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56 Apparel Accessories & Luxury GoodsIconix Brand Group, Inc. ICON US $40.51 1,913 94% 22.7 -8 2 7 9 2.11 44% 6% 15% 10% -10% 3% 10.9x 16.7x 14.5x 0.4 12% 0.0% 1.9x 38% 4.0x 4%

57 Footwear Skechers U.S.A., Inc. Class A SKX US $60.38 2,439 98% 34.1 -6 82 16 8 1.50 88% 27% 135% 29% -93% 7% 16.0x 50.7x 21.6x 0.1 2% 0.0% 2.6x -17% -1.8x 9%

58 Textiles Unifi, Inc. UFI US $28.16 496 84% 1.7 -8 3 12 1 1.00 100% 52% 19% -37% 11.4x 26.0x 17.1x 0.2 8% 0.0% 1.7x 17% 1.6x 7%

59 Hotels Resorts & Cruise Lines Belmond Ltd. Class A #N/A Invalid Security $11.22 1,131 87% 6.1 -83 -26 -3 Greff N 7% 6 1.67 67% 0% -73% 298% -113% -13% 24.1x 57.3x 209.2x 0.3 0% 0.0% 1.2x 27% 7.5x 11%

60 Interval Leisure Group, Inc. IILG US $21.97 1,237 68% 5.8 -31 -29 8 5 1.40 80% 15% -1% 11% -39% 7% 9.2x 15.8x 16.0x 0.2 8% 2.0% 3.6x 19% 1.3x 0%

61 Marriott Vacations Worldwide CorporationVAC US $73.17 2,328 80% 11.2 0 39 9 8 1.75 63% 2% 22% 15% -67% 1% 13.9x 30.9x 25.4x 0.5 6% 0.4% 1.9x 16% 2.2x 16%

62 Restaurants Ruth's Hospitality Group, Inc. RUTH US $12.88 454 96% 2.9 -43 -9 14 3 1.00 100% 2% 5% 11% -266% -2% 9.7x 18.3x 17.5x 0.7 7% 1.6% 4.5x 4% 0.2x 0%

63 Wendy's Company WEN US $8.60 3,123 93% 52.2 -61 -1 7 Ivankoe N 5% 17 2.76 24% -17% 13% 14% -93% -3% 11.9x 28.5x 25.2x 0.4 3% 2.4% 1.6x 18% 2.4x 3%

64 Broadcasting CTC Media, Inc. CTCM US $6.22 972 36% 7.5 -80 -55 3 Gogolev UW 16% 11 3.18 18% -11% -27% -7% -39% -2% 5.4x 7.4x 0.3 -22% -0.8x 100%

65 Cable & Satellite Cablevision Systems Corporation Class ACVC US $20.20 4,225 96% 52.4 -48 13 10 Cusick N -11% 22 2.73 27% 4% 107% -21% -78% 6% 7.6x 35.6x 17.2x 0.1 10% 3.1% 131% 5.1x 3%

66 Distributors VOXX International Corporation Class AVOXX US $8.56 185 90% 2.4 -55 -49 7 4 2.00 50% -2% -43% 11% -13% 6.8x 11.8x 0.3 28% 0.4x 14% 5%

67 Internet Retail Nutrisystem, Inc. NTRI US $18.96 536 98% 8.3 -75 15 16 7 1.57 71% 13% 61% 21% -106% 5% 25.7x 45.5x 28.2x 0.4 5% 3.8% 10.3x -26% -1.3x

68 Apparel Retail Stein Mart, Inc. SMRT US $14.31 632 63% 1.4 -44 6 11 5 1.40 80% 4% 1% 10% -43% 8.2x 19.7x 19.6x 0.6 1% 1.1% 2.4x -13% -1.0x

69 Specialty Stores Big 5 Sporting Goods CorporationBGFV US $13.37 299 93% 3.1 -55 -33 27 6 3.00 17% -1% -41% 24% -34% -1% 5.0x 10.4x 17.5x 0.1 1% 3.0% 1.6x 9% 0.5x 3%

70 Cons. Staples SUPERVALU INC. SVU US $9.37 2,397 78% 27.1 -81 29 16 13 3.00 15% 3% 26% 4% -144% 7.1x 18.5x 14.7x 0.2 -4% 66% 3.7x 2%

71 Packaged Foods & Meats Boulder Brands, Inc. BDBD US $10.83 643 95% 9.2 -40 -32 35 11 1.91 55% 13% -26% 13% -73% -40% 14.8x 32.8x 44.2x 0.5 1% 0.0% 1.8x 36% 4.5x 1%

72 Cal-Maine Foods, Inc. CALM US $41.84 1,850 66% 10.0 -13 39 0 2 3.00 0% 6% 44% 6% -37% 8.5x 22.3x 15.5x 0.5 3% 2.1% 3.1x -18% -0.7x 17%

73 Omega Protein Corporation OME US $10.25 233 96% 2.3 -39 -17 -22 4 2.00 50% 18% -32% -3% -79% -17% 3.2x 6.3x 9.3x 0.0 1% 0.0% 0.9x -3% -0.1x 13%

74 Sanderson Farms, Inc. SAFM US $87.15 1,979 88% 31.9 -15 20 10 Goldman N 2% 9 2.78 22% 3% 65% -7% -61% 2% 7.2x 13.2x 8.0x 0.1 10% 1.0% 2.9x -4% -0.1x 22%

75 Household Products Orchids Paper Products CompanyTIS US $27.83 243 85% 1.7 -18 -15 5 3 1.00 100% 21% -28% 60% -37% -16% 9.4x 16.0x 22.2x 0.4 4% 5.1% 2.9x 2% 0.1x 8%

76 Personal Products Avon Products, Inc. AVP US $9.71 4,290 100% 69.0 -79 -44 -13 14 2.57 21% -10% -19% 8% -90% 2% 11.7x 9.7x 11.9x 0.5 10% 2.4% 3.9x 29% 3.2x 7%

77 Healthcare Natus Medical Incorporated BABY US $34.90 1,089 96% 8.5 0 55 6 4 1.00 100% 3% 21% 14% -80% 2% 23.2x 32.5x 26.8x 0.5 3% 0.0% 3.6x -4% -0.4x 28%

78 Health Care Supplies Haemonetics Corporation HAE US $37.37 1,903 99% 14.5 -18 -11 3 11 2.64 27% 0% -5% 7% -55% 16.6x 17.9x 18.9x 0.7 3% 2.3x 16% 1.9x 10%

79 Health Care Distributors PharMerica Corporation PMC US $22.14 740 95% 6.7 -26 3 -19 8 2.00 63% 6% -8% 13% -41% 9% 10.5x 12.7x 13.8x 0.3 17% 0.0% 1.6x 23% 2.3x 5%

80 Health Care Services Addus HomeCare Corporation ADUS US $22.93 243 91% 1.9 -29 2 27 5 1.40 80% 18% 6% 17% -60% 0% 12.7x 21.6x 20.5x 0.5 11% 0.0% 2.1x -9% -0.9x

81 AMN Healthcare Services, Inc. AHS US $17.27 781 98% 4.1 -39 17 6 7 1.29 86% 1% 1% 18% -68% 1% 11.7x 24.3x 24.1x 0.5 6% 0.0% 3.6x 23% 1.7x 6%

82 Providence Service CorporationPRSC US $37.08 574 94% 4.8 -23 44 -9 4 1.00 100% 25% 1% 67% -64% -27% 11.2x 25.7x 25.3x 0.2 8% 0.0% 4.0x 5% 0.4x 39%

83 Managed Health Care Health Net, Inc. HNT US $51.38 3,945 97% 35.8 -13 73 13 Lake N -5% 17 2.53 35% 29% 4% 41% -90% 1% 7.2x 22.9x 22.0x 0.2 1% 0.0% 2.4x -38% -4.3x 5%

84 Molina Healthcare, Inc. MOH US $50.88 2,404 69% 26.5 0 46 13 Lake N 8% 17 2.18 41% 47% 40% 96% -86% -31% 6.8x 51.8x 37.0x 0.1 4% 0.0% 2.7x -28% -3.8x 23%

85 Biotechnology BioSpecifics Technologies Corp.BSTC US $38.86 254 65% 1.0 -6 79 -4 2 1.00 100% 1% -11% 253% -22% 1% 30.0x 51.4x 57.9x 0.7 2% 0.0% 11.4x -58% -1.6x

86 Ligand Pharmaceuticals IncorporatedLGND US $53.70 1,062 98% 22.1 -35 2 -1 4 1.50 75% 33% 142% 53% -126% 0% 76.1x 84.2x 34.7x 0.1 2% 0.0% 21.4x -1% -0.1x 80%

87 Pharmaceuticals SciClone Pharmaceuticals, Inc. SCLN US $8.53 438 90% 2.0 -2 69 10 2 2.00 50% 3% 115% 25% -66% 14% 25.0x 33.2x 15.4x 0.5 2% 0.0% 3.0x -47% -5.9x 100%

88 Life Sciences Tools & Services Albany Molecular Research, Inc.AMRI US $15.85 512 74% 8.2 -32 57 -31 Peterson OW 39% 2 1.00 100% 13% -4% 30% -120% -26% 12.5x 22.4x 23.2x 0.1 3% 0.0% 2.1x -12% -1.4x 1%

89 ICON Plc ICLR US $55.05 3,357 98% 24.3 -5 36 -2 Peterson N -6% 15 2.07 53% 13% 56% 15% -40% 5% 30.8x 19.7x 0.4 -22% -1.8x

90 Financials First BanCorp (Puerto Rico) FBP US $5.15 1,063 70% 4.3 -99 -17 9 5 1.40 80% 3% 88% 9% -99% -6% 22.7x 12.1x 0.4 31% 0.0% 0.9x 63%

91 OFG Bancorp OFG US $15.04 669 98% 6.0 -48 -13 3 4 1.00 100% 0% -15% 29% -61% -6% 8.7x 10.1x 0.0 25% 2.3% 0.8x 90%

92 Pinnacle Financial Partners, Inc.PNFP US $38.11 1,337 94% 5.6 -4 17 5 10 1.80 60% 10% 20% 14% -24% 1% 22.4x 18.6x 0.4 9% 0.9% 1.8x 27%

93 S&T Bancorp, Inc. STBA US $28.28 817 98% 1.3 -30 12 11 5 2.20 40% 3% 13% 1% -48% 2% 16.1x 14.2x 0.4 10% 2.5% 1.4x 72%

94 Southside Bancshares, Inc. SBSI US $32.78 609 91% 2.6 -5 26 5 3 3.00 0% 9% -29% 40% -25% -25% 14.1x 19.8x 0.7 9% 2.6% 2.3x 12%

95 Thrifts & Mortgage Finance Federal Agricultural Mortgage Corporation Class CAGM US $31.63 304 98% 1.0 -16 -8 2 3 1.00 100% -48% -6% -11% -50% 5% 50.7x 6.1x 6.5x 0.5 1.6% 0.9x 100% 49.4x 10%

96 Specialized Finance GAIN Capital Holdings, Inc. GCAP US $9.10 372 41% 2.6 -36 21 37 5 1.80 60% 19% -15% 14% -92% 65% -5.9x 11.2x 13.3x 0.0 -7% 2.2% 1.6x -64% -12.3x

97 Consumer Finance Nelnet, Inc. Class A NNI US $45.92 1,578 70% 4.0 -4 9 2 2 1.00 100% -11% 4% 0% -27% -1% 35.5x 7.8x 7.5x 0.2 23% 0.9% 1.1x 93% 33.4x 0%

98 Asset Management & Custody BanksAllianceBernstein Holding L.P. AB US $27.23 2,595 92% 8.4 -71 28 5 8 2.25 38% 0% 1% 12% -82% -1% 15.0x 14.9x 0.4 7.1% 1.7x 0%

99 Fortress Investment Group LLC Class AFIG US $7.81 1,627 90% 11.7 -76 -9 14 6 1.67 67% -6% -5% 13% -80% -10% 5.7x 9.8x 10.2x 0.1 26% 4.1% 2.0x -16% -1.6x

100 Och-Ziff Capital Management Group LLC Class AOZM US $11.98 2,034 72% 14.7 -61 -19 9 WorthingtonOW 25% 7 1.57 71% -41% -50% 66% -292% -21% 3.8x 6.3x 12.7x 0.1 14.6% 54% 2.4x 8%

101 Walter Investment Management Corp.WAC US $18.81 708 95% 20.4 -97 -47 -11 11 3.00 27% -19% -48% -20% -140% -5% 6.8x 1.9x 3.8x 0.0 -261% 0.0% 0.6x 27% 5.9x 21%

102 Investment Banking & BrokerageFXCM Inc. Class A FXCM US $16.22 746 86% 7.5 -18 -9 8 WorthingtonOW 11% 10 1.80 70% -6% -56% 135% -60% 205% -5.7x 20.8x 47.1x 0.7 13% 1.5% 2.9x -68% -12.3x 6%

103 Investment Technology Group, Inc.ITG US $19.90 682 96% 5.1 -66 -3 12 Worthington N 11% 5 2.60 20% 5% 45% 4% -347% 13% 5.3x 20.2x 13.9x 0.1 2% 0.0% 1.6x -7% -1.6x 71%

104 Life & Health Insurance American Equity Investment Life Holding CompanyAEL US $27.34 2,038 96% 13.2 -2 4 12 3 2.33 33% 11% 5% 2% -58% 16% 12.4x 11.8x 0.4 42% 0.7% 1.5x 14%

105 FBL Financial Group, Inc. Class AFFG US $51.98 1,247 40% 1.6 -1 16 9 3 3.00 0% 85% 6% -2% -13% 6% 13.0x 12.2x 0.4 14% 2.8% 1.4x 0%

106 StanCorp Financial Group, Inc. SFG US $66.59 2,764 99% 12.9 -4 1 -3 8 3.00 13% -3% -3% 7% -38% 8% 12.3x 12.7x 0.2 10% 2.0% 1.3x 0%

107 Multi-line Insurance Kemper Corporation KMPR US $35.75 1,879 78% 6.8 -33 -13 2 6 2.67 17% -11% -49% 91% -45% -27% 12.8x 25.3x 0.1 6% 2.7% 0.9x 0%

108 Property & Casualty Insurance AMERISAFE, Inc. AMSF US $42.74 780 98% 2.6 -3 1 4 4 1.50 75% 13% 15% 17% -46% 3% 17.5x 15.2x 0.3 16% 4.8% 1.9x

109 Argo Group International Holdings, Ltd.AGII US $57.35 1,414 98% 5.7 -77 23 8 7 1.86 57% 3% 19% 9% -53% 0% 18.0x 15.1x 0.1 -2% 1.3% 0.9x 0%

110 Assured Guaranty Ltd. AGO US $25.71 4,074 98% 49.9 -16 9 14 6 1.00 100% -28% -10% -16% -83% 17% 7.7x 8.6x 0.5

111 Hanover Insurance Group, Inc. THG US $71.64 3,102 98% 12.9 0 20 11 5 1.80 60% 5% -4% 19% -70% -2% 13.9x 14.5x 0.0 12% 1.9% 1.2x 0%

112 Infinity Property and Casualty CorporationIPCC US $73.48 840 96% 2.2 -2 2 7 4 2.50 50% 2% 66% 14% -67% 11% 29.8x 17.9x 0.0 15% 2.0% 1.3x 5%

103



J.P. Morgan SMid Themes — Investing with Style Screen (Cont.)Figure 157: Investing with Style Screen —SMid-Caps with a) PEG LTM in Bottom 2 Qtls, and b) EPS vs 5yr High in Bottom 50%




Mkt

Cap

($MM)

Free

Float

(%)

Avg

Daily

Vol

($MM)

From

10-Yr


Upside

to

Price

Target

# of

Recs

Mean

Rec

% Buy

Recs

Sales

Grw

14E

EPS

Grw

14E

EPS

Grw

15E

EPS

vs 5yr

High

-3M

EPS

Revis

14E

EV/

EBITDA

P/E

13A

P/E

14E PEG

FCF

Yield

Div

Yield P/B

Net

Debt/

Assets

Net

Debt/

EBITDA

ST

Debt/

Tot

Debt

113 Mercury General Corporation MCY US $55.38 3,007 49% 6.5 -11 11 7 5 3.80 0% 7% 34% -7% -34% 4% 25.1x 18.8x 0.4 6% 4.5% 1.7x 0%

114 RLI Corp. RLI US $46.64 2,123 90% 6.0 -10 -4 -1 6 3.33 0% 8% -2% -7% -14% 5% 19.2x 19.7x 0.7 5% 1.4% 2.6x 0%

115 Selective Insurance Group, Inc. SIGI US $27.01 1,494 97% 3.5 -7 0 12 4 2.00 50% 6% 25% 11% -52% 15% 16.0x 12.8x 0.1 22% 2.0% 1.4x 4%

116 Reinsurance Endurance Specialty Holdings Ltd.ENH US $59.08 2,589 95% 14.0 0 1 4 7 2.71 14% -2% 1% -9% -65% 3% 9.0x 8.9x 0.0 0%

117 Enstar Group Limited ESGR US $147.29 2,296 64% 3.4 -4 6 7 2 1.00 100% -19% 23% -20% -8% 10.8x 13.2x 0.1 49%

118 Greenlight Capital Re, Ltd. Class AGLRE US $31.98 997 96% 4.4 -9 -5 1 3 1.67 67% -42% -61% 83% -93% -47% 5.3x 13.7x 0.0 100%

119 Maiden Holdings, Ltd. MHLD US $13.28 924 71% 4.8 0 22 9 4 1.00 100% 10% 26% 22% -38% 1% 10.7x 8.5x 0.1 0%

120 Validus Holdings, Ltd. VR US $41.47 3,600 95% 26.4 0 3 4 10 1.80 60% -6% -8% -1% -27% 0% 7.7x 8.4x 0.1 2.9% 1.0x 0%

121 Diversified REITs PS Business Parks, Inc. PSB US $81.51 2,168 72% 7.1 -6 7 -2 Mueller N 4% 3 3.00 0% 6% -11% 13% -71% 4% 14.0x 45.5x 51.0x 0.4 2% 2.5% 1.3x 10% 0.9x

122 Mortgage REITs Chimera Investment Corporation CIM US $3.39 3,442 94% 18.3 -83 9 10 8 3.25 0% 20% 9% 15% -53% 6% 13.5x 9.1x 8.3x 0.6 10.7% 1.0x 41% 6.1x 57%

123 Hotel & Resort REITs Sunstone Hotel Investors, Inc. SHO US $16.02 3,241 97% 23.4 -49 20 7 Greff N 0% 15 2.47 27% 23% 33% 21% -124% 17% 18.8x 54.4x 40.9x 0.5 -9% 3.2% 1.7x 35% 5.0x 2%

124 Office REITs Brandywine Realty Trust BDN US $15.48 2,731 98% 21.7 -57 10 2 Paolone OW 10% 17 2.06 47% 7% -93% 2060% -189% -67% 14.2x 101.7x 1,526x 0.7 -4% 3.9% 1.4x 49% 6.5x 9%

125 DuPont Fabros Technology, Inc.DFT US $32.43 2,041 99% 16.4 0 31 10 14 2.00 50% 11% 59% 10% -43% 1% 16.4x 39.7x 25.0x 0.4 2% 3.1% 1.6x 31% 4.2x 0%

126 Highwoods Properties, Inc. HIW US $43.13 3,852 98% 27.1 -8 19 2 12 2.17 42% 9% -41% 0% -43% 14% 17.4x 29.3x 49.5x 0.2 -9% 4.0% 2.6x 51% 5.8x 7%

127 Residential REITs Associated Estates Realty CorporationAEC US $22.37 1,265 96% 7.0 0 39 16 11 2.82 36% 7% 95% -87% -100% 18% 21.9x 18.8x 9.6x 0.2 -20% 3.5% 2.3x 57% 8.5x 6%

128 Retail REITs Ramco-Gershenson Properties TrustRPT US $17.95 1,364 98% 6.9 -54 14 5 Mueller N 0% 8 2.25 50% 24% -46% 122% -100% 22.1x 76.5x 140.7x 0.7 -22% 4.4% 1.8x 46% 7.5x 5%

129 Weingarten Realty Investors WRI US $36.27 4,393 92% 21.8 -30 32 3 Mueller N -1% 11 2.45 36% 2% -2% -49% -89% 55% 18.7x 24.0x 24.3x 0.3 1% 3.6% 3.2x 61% 6.9x 14%

130 Specialized REITs EPR Properties EPR US $56.24 3,181 98% 17.9 -18 14 1 Paolone OW 3% 10 2.40 50% 15% -14% 12% -27% -3% 16.0x 17.2x 19.9x 0.3 -3% 5.7% 1.9x 45% 5.1x 1%

131 Potlatch Corporation PCH US $41.80 1,692 99% 8.1 -29 0 -2 7 3.00 29% 7% 22% -3% -49% -1% 14.5x 24.1x 19.7x 0.4 4% 3.1% 8.3x 40% 1.9x

132 Technology Monster Worldwide, Inc. MWW US $4.46 402 94% 10.9 -92 -37 17 7 2.71 14% -4% -39% 15% -60% 9% 4.4x 10.1x 16.6x 0.5 0% 0.0% 0.5x 0% 0.0x 7%

133 Perion Network Ltd PERI US $5.39 389 48% 1.7 -63 -55 -6 3 1.67 67% 275% -13% -13% -63% 4% 3.6x 4.2x 0.1 -16% -1.2x 35%

134 Web.com Group, Inc. WWWW US $17.36 933 97% 19.6 -54 -45 -8 Auty N 15% 12 2.17 42% 6% 13% 1% -348% -2% 21.4x 8.3x 7.4x 0.2 9% 0.0% 5.5x 43% 7.9x 1%

135 Data Processing & Outsourced ServicesMoneyGram International, Inc. MGI US $8.78 474 54% 4.9 -97 -58 -27 Huang N 14% 14 2.71 21% -1% -16% -9% -178% -16% 8.7x 6.6x 7.8x 0.2 119% 0.0% 18% 4.6x 5%

136 Application Software Aspen Technology, Inc. AZPN US $39.08 3,448 100% 25.8 -18 -7 0 Auty N 19% 6 2.33 33% 18% 52% 17% -23% 23.8x 50.1x 33.0x 0.2 6% 0.0% 41.2x -68% -2.0x

137 Compuware Corporation CPWR US $10.29 2,266 99% 25.5 -18 -4 2 2 3.00 0% -7% -2% 36% -80% 17.0x 23.3x 23.7x 0.5 6% 2.1x -15% -2.6x

138 Net 1 UEPS Technologies, Inc. UEPS US $12.76 593 60% 2.9 -62 46 9 2 1.00 100% 18% 45% 2% -86% 33% 8.7x 6.0x 0.3 3% 0.3x 15%

139 SS&C Technologies, Inc. SSNC US $50.91 4,240 85% 11.2 0 15 12 Auty N -8% 8 1.75 63% 7% 19% 9% -48% 1% 17.1x 25.7x 21.7x 0.7 5% 0.2% 3.4x 30% 2.4x 3%

140 Tangoe, Inc. TNGO US $13.24 504 89% 5.3 -48 -26 -4 6 2.00 50% 13% 7% 19% -71% -6% 27.0x 20.0x 18.7x 0.7 4% 0.0% 3.1x -21% -2.4x 90%

141 TiVo Inc. TIVO US $11.94 1,497 97% 23.0 -36 -9 -6 Coster N 26% 20 1.70 65% 16% -77% -4% -104% 5.5x 7.1x 31.1x 0.0 33% 0.0% 2.7x -67% -6.8x 0%

142 Systems Software Progress Software Corporation PRGS US $25.91 1,290 97% 7.2 -17 0 4 5 2.20 40% 0% 23% 2% -56% 5% 21.2x 17.3x 0.7 0% 0.0% 2.5x -35%

143 Home Entertainment Software Take-Two Interactive Software, Inc.TTWO US $28.16 2,262 96% 45.5 -4 62 27 19 2.05 47% -19% -38% -31% -118% 2.6x 8.2x 13.2x 0.0 30% 2.8x -26% -0.7x 2%

144 Communications Equipment ARRIS Group, Inc. ARRS US $30.56 4,165 90% 59.6 -13 26 11 9 1.67 67% 47% 56% 9% -55% 3% 24.1x 17.3x 11.1x 0.2 12% 0.0% 3.2x 29% 5.5x 3%

145 Brocade Communications Systems, Inc.BRCD US $11.25 4,968 100% 50.8 -4 27 9 Hall OW 16% 22 3.00 14% 0% 10% 3% -38% 6% 8.0x 14.1x 12.9x 0.7 8% 0.0% 2.1x -11% -0.7x 0%

146 Calix, Inc. CALX US $10.75 535 80% 3.5 -53 12 25 8 1.50 75% 4% -25% 86% -231% 9% 38.9x 26.8x 35.6x 0.2 6% 0.0% 2.0x -22% -7.1x

147 Finisar Corporation FNSR US $17.38 1,731 98% 53.7 -60 -27 9 14 1.86 57% 15% 2% 8% -104% 7.8x 14.1x 13.9x 0.2 -2% 1.7x -17% -1.4x 16%

148 Electronic Equipment & InstrumentsGSI Group Inc. GSIG US $12.91 418 90% 1.0 -68 15 5 3 1.67 67% 7% 22% 16% -23% 7% 19.4x 15.9x 0.1 3% 0.3x 10%

149 Electronic Components Belden Inc. BDC US $74.38 3,114 98% 20.0 -6 6 13 8 1.50 75% 11% 14% 18% -65% 0% 13.5x 19.7x 17.2x 0.6 4% 0.3% 3.7x 28% 2.6x 0%

150 DTS, Inc. DTSI US $32.60 556 95% 2.5 -35 36 16 Coster UW -17% 6 2.33 50% 14% 43% 13% -165% 16% 22.3x 30.2x 21.2x 0.1 3% 0.0% 3.0x -18% -1.8x 0%

151 Semiconductor Equipment Amkor Technology, Inc. AMKR US $7.02 1,616 45% 12.9 -57 15 -6 5 1.80 60% 3% 20% 13% -78% -16% 4.1x 12.2x 10.1x 0.6 -1% 0.0% 1.7x 30% 1.6x 4%

152 Ultra Clean Holdings, Inc. UCTT US $8.81 251 86% 3.2 -55 -12 12 6 1.00 100% 15% 48% 8% -77% -7% 9.8x 16.0x 10.8x 0.2 11% 0.0% 1.5x -2% -0.2x 68%

153 Semiconductors Cavium, Inc. CAVM US $56.81 2,925 98% 35.7 0 65 26 Sur OW -3% 22 1.64 73% 23% 43% 26% -305% 1% 92.5x 53.2x 37.2x 0.4 2% 0.0% 10.2x -22% -2.6x 65%

154 Diodes Incorporated DIOD US $26.81 1,251 78% 6.4 -23 14 13 10 1.20 90% 8% 34% 26% -72% -3% 10.4x 25.0x 18.7x 0.3 5% 0.0% 1.8x -3% -0.3x 4%

155 Integrated Device Technology, Inc.IDTI US $18.86 2,708 99% 37.6 0 85 34 7 1.86 71% 9% 68% 20% -97% 14.3x 42.6x 25.3x 0.6 2% 3.7x -55% -2.9x

156 MaxLinear, Inc. Class A MXL US $7.35 220 97% 1.7 -61 -30 12 7 1.29 86% 11% -1% 49% -266% -37% 22.7x 22.9x 0.2 4% 0.0% 2.5x -50%

157 OmniVision Technologies, Inc. OVTI US $28.15 1,560 99% 24.7 -23 64 6 Coster NR 11 2.45 27% 0% 5% -15% -68% 8.4x 14.0x 13.4x 0.5 14% 1.6x -31% -3.1x 11%

158 Power Integrations, Inc. POWI US $51.65 1,485 97% 15.6 -23 -7 3 5 1.00 100% 0% -5% 8% -160% -8% 16.3x 20.5x 21.5x 0.6 6% 0.9% 3.4x -41% -2.6x

159 RF Micro Devices, Inc. RFMD US $14.89 4,140 99% 90.6 0 189 39 16 1.25 88% 22% 146% 29% -131% 38.2x 36.5x 14.8x 0.3 2% 6.1x -17% -1.5x 100%

160 Silicon Image, Inc. SIMG US $5.60 435 98% 3.4 -69 -9 20 6 1.33 83% -8% -8% 1% -125% 12% 10.5x 19.3x 20.9x 0.6 8% 0.0% 2.3x -56% -4.9x

161 SunPower Corporation SPWR US $29.43 3,862 40% 90.1 -80 -1 -3 Coster OW 36% 15 1.67 67% 0% -22% 9% -232% 0% 16.1x 17.5x 22.5x 0.0 3% 0.0% 3.5x 3% 0.5x 52%

162 Telecom Atlantic Tele-Network, Inc. ATNI US $68.82 1,090 61% 3.7 -6 22 13 3 2.33 33% 13% -85% 1% -46% 30% 6.4x 3.6x 24.5x 0.0 -17% 1.5% 1.7x -46% -3.7x

163 Consolidated Communications Holdings, Inc.CNSL US $27.35 1,332 97% 6.3 -4 39 0 6 3.00 17% 7% -8% -2% -89% -2% 9.4x 26.2x 28.5x 0.1 4% 5.9% 9.0x 70% 4.5x 1%

164 Wireless Telecommunication ServicesNTELOS Holdings Corp. NTLS US $8.51 192 78% 5.4 -86 -58 -13 Cusick N 41% 7 2.43 43% -2% -98% -71% -50% 4.0x 7.9x 444.5x 0.3 24% 18.9% 4.4x 56% 2.7x 1%

165 Shenandoah Telecommunications CompanySHEN US $30.57 732 94% 2.3 -9 19 22 4 1.50 75% 6% 10% 14% -35% -3% 7.8x 24.7x 22.3x 0.3 -3% 1.5% 3.1x 32% 1.6x 3%

166 Utilities AmeriGas Partners, L.P. APU US $47.57 4,400 70% 16.4 -7 7 2 Tonet N 3% 9 3.22 22% 12% 12% 1% -40% -3% 18.7x 16.7x 0.2 7.3% 3.2x

167 Suburban Propane Partners, L.P.SPH US $45.46 2,748 99% 7.7 -23 -3 1 Tonet N 8% 10 3.60 0% 8% 14% 7% -73% 0% 26.1x 22.9x 0.1 7.7% 2.4x

168 Multi-Utilities Avista Corporation AVA US $34.29 2,110 99% 11.3 -4 22 -1 6 3.33 0% 0% 3% 4% -23% 1% 9.3x 18.3x 17.8x 0.5 -3% 3.7% 1.6x 34% 3.8x 12%

Average 1,696 89% 16.0 -33 3 5 15% 8 2.01 54% 9% 10% 35% -86% -2% 13.7x 21.4x 32.7x 0.3 2% 1.8% 3.1x 10% 1.5x 17%

104



J.P. Morgan SMid Themes — Grown Cheap Screen

Figure 158: Grown Cheap Screen — SMid-Caps with a) EV/EBITDA De-Rating Since 2007 in Top Tercile, b) Pos EBITDA Grw 2006-2013, c) PEG <1x and d) Net Debt/EBITDA <2x


Summary Stats Price Perf (%) JPM Coverage Consensus Estimates (IBES) Valuations (last rptd unless otherwise stated) Balance Sheet Other


Mkt

Cap

($MM)

Avg

Daily

Vol

($MM)

From

10-Yr


Upside

to

Price

Target

# of

Recs

Mean

Rec

% Buy

Recs

EPS

Grw

14E

EPS

Grw

15E

-3M

EPS

Revis

14E

EV/

EBITDA

P/E

14E PEG

FCF

Yield

Div

Yield P/B

Net

Debt/

Assets

Net

Debt/

EBITDA

EV/

EBITDA

De-

Rating

'07-'14

EBITDA

Grw '06-

'13

1 Energy Geospace Technologies CorporationGEOS US $28.27 388 14.0 -75 -70 0 5 1.80 60% -45% -37% -19% 3.4x 11.4x 0.2 -25% 0.0% 1.3x -1% 0.0x -82% 519%

2 Matrix Service Company MTRX US $23.33 627 7.9 -37 -5 1 6 1.33 83% 27% 19% -11% 7.3x 16.7x 0.7 9% 0.0% 2.2x -12% -0.9x -46% 220%

3 Oil & Gas Exploration & ProductionSM Energy Company SM US $52.17 3,666 83.4 -43 -37 -8 Allman N 90% 21 1.76 62% 41% -6% -13% 4.2x 9.1x 0.0 -8% 0.2% 2.3x 28% 1.1x -33% 158%

4 VAALCO Energy, Inc. EGY US $6.27 385 6.7 -38 -9 -10 1 1.00 100% -16% -5% -15% 2.6x 10.7x 0.0 2% 0.0% 1.5x -47% -1.5x -41% 16%

5 Warren Resources, Inc. WRES US $2.51 244 4.4 -86 -20 -23 5 2.20 40% -36% 20% -30% 4.2x 10.0x 0.1 3% 0.0% 1.1x 22% 1.1x -94% 836%

6 Materials Calgon Carbon Corporation CCC US $20.74 1,119 5.9 -10 1 4 9 1.89 56% 10% 20% -3% 11.6x 22.8x 0.2 3% 0.0% 2.7x 0% 0.0x -52% 632%

7 Specialty Chemicals FutureFuel Corp. FF US $11.83 529 3.5 -45 -25 -1 1 3.00 0% -54% 26% 5% 3.1x 15.5x 0.1 8% 4.0% 1.6x -46% -1.8x -83% 863%

8 Industrials Sparton Corporation SPA US $25.28 246 1.4 -24 -10 6 3 1.00 100% 18% 15% 1% 9.8x 15.2x 0.6 -11% 0.0% 2.2x 17% 1.2x -95% 7825%

9 Construction & Engineering Argan, Inc. AGX US $33.74 478 3.4 -17 22 6 2 2.00 50% -24% 1% 2.9x 16.1x 0.2 20% 0.0% 3.1x -84% -3.9x -71% 5392%

10 Furmanite Corporation FRM US $6.74 250 2.0 -46 -37 -7 2 1.00 100% -20% 56% -36% 7.8x 22.5x 0.0 -7% 0.0% 1.9x 11% 0.9x -74% 449%

11 MasTec, Inc. MTZ US $26.50 2,012 33.8 -40 -19 2 10 1.20 90% -18% 31% -1% 6.6x 15.9x 0.5 3% 0.0% 2.0x 27% 1.9x -51% 631%

12 Heavy Electrical Equipment PowerSecure International, Inc. POWR US $10.75 227 7.6 -57 -37 9 6 1.33 83% 12.7x 0.2 -5% 0.0% 1.4x -9% -1.5x -26% 48%

13 Construction Machinery & Heavy TrucksAlamo Group Inc. ALG US $48.97 530 1.9 -19 -19 26 3 1.00 100% 12% 29% 8% 7.6x 14.2x 0.8 3% 0.6% 1.5x -15% -1.0x -22% 91%

14 American Railcar Industries, Inc. ARII US $67.73 1,406 16.7 -18 48 0 9 3.22 0% 12% 7% 4% 8.2x 13.8x 0.4 -1% 2.4% 3.2x 11% 0.5x -34% 243%

15 Oshkosh Corp OSK US $46.67 3,813 36.3 -29 -7 4 Duignan N -4% 15 1.67 67% 0% 12% 2% 7.0x 12.8x 0.3 1% 0.6% 1.9x 13% 0.9x -35% 73%

16 Agricultural & Farm Machinery AGCO Corporation AGCO US $43.61 4,133 71.4 -38 -26 -2 Duignan N 1% 18 3.22 6% -31% -20% -14% 3.8x 10.8x 0.5 10% 1.0% 1.0x 2% 0.2x -58% 220%

17 Industrial Machinery Valmont Industries, Inc. VMI US $137.63 3,357 41.6 -16 -8 4 11 2.82 18% -22% 7% -9% 5.8x 15.9x 0.5 9% 0.7% 2.2x -4% -0.2x -47% 281%

18 Office Services & Supplies Kimball International, Inc. Class BKBALB US $9.58 299 1.8 -63 -19 -28 1 3.00 0% -11% -31% 2.2x 15.9x 0.2 12% 2.1% 0.7x -19% -1.8x -78% 20%

19 Human Resource & Employment ServicesBarrett Business Services, Inc. BBSI US $22.58 162 8.5 -78 -76 -49 2 1.00 100% 4% 12% -5% 2.0x 7.7x 0.1 41% 3.3% 2.2x -34% -4.0x -76% 13%

20 Cons. Disc. Gentherm Incorporated THRM US $37.87 1,420 21.3 -27 41 -8 Chatterjee OW 64% 8 1.50 75% 96% 16% 4% 18.0x 21.6x 0.3 2% 0.0% 6.1x 6% 0.3x -42% 1243%

21 Home Furnishings LaZBoy Incorporated LZB US $25.90 1,317 10.9 -17 -16 19 6 1.00 100% 27% 19% 9.9x 19.9x 0.6 4% 0.9% 2.5x -23% -1.5x -19% 48%

22 Household Appliances iRobot Corporation IRBT US $36.22 1,028 30.2 -20 4 5 Coster N 5% 9 1.89 56% 32% 17% 8% 18.9x 28.0x 0.7 3% 0.0% 3.1x -46% -4.2x -82% 1079%

23 Leisure Products Arctic Cat Inc. ACAT US $33.29 428 8.5 -45 -42 3 7 2.43 29% -24% 4% 4.6x 15.0x 1.0 5% 1.4% 2.3x -24% -1.1x -37% 36%

24 Smith & Wesson Holding CorporationSWHC US $9.69 510 20.0 -56 -28 -2 8 1.75 75% -22% -7% 3.2x 8.7x 0.1 5% 3.1x 10% 0.2x -78% 803%

25 Sturm, Ruger & Company, Inc. RGR US $39.16 745 21.8 -54 -46 -21 3 3.67 0% -44% -9% -29% 3.5x 12.4x 0.1 9% 4.2% 4.2x -20% -0.3x -93% 4714%

26 Apparel Accessories & Luxury GoodsMovado Group, Inc. MOV US $27.94 494 7.4 -41 -37 -16 6 2.33 33% -9% 4% 3.7x 14.3x 0.5 8% 1.0% 1.1x -34% -2.3x -48% 26%

27 Publishing Morningstar, Inc. MORN US $66.98 2,995 6.5 -21 -14 2 2 3.00 0% -3% 14% -3% 12.2x 26.1x 1.0 5% 1.0% 4.3x -29% -1.4x -42% 138%

28 Apparel Retail Urban Outfitters, Inc. URBN US $32.48 4,229 82.8 -27 -12 7 Boss OW 17% 33 2.27 36% -11% 15% 6.6x 19.0x 0.9 6% 0.0% 2.5x -24% -0.9x -63% 127%

29 Specialty Stores Outerwall Inc. OUTR US $69.20 1,202 42.2 -6 3 24 Coster UW -31% 10 2.40 50% 3% 8% 4% 3.5x 10.4x 0.5 14% 0.0% 2.3x 21% 0.9x -59% 342%

30 Homefurnishing Retail Haverty Furniture Companies, Inc.HVT US $21.20 475 2.8 -32 -32 -2 4 1.50 75% -15% 18% -8% 5.4x 17.8x 0.1 8% 1.5% 1.6x -18% -1.0x -39% 76%

31 Cons. Staples Omega Protein Corporation OME US $10.25 233 2.3 -39 -17 -22 4 2.00 50% -32% -3% -17% 3.2x 9.3x 0.0 1% 0.0% 0.9x -3% -0.1x -72% 204%

32 Sanderson Farms, Inc. SAFM US $87.15 1,979 31.9 -15 20 10 Goldman N 2% 9 2.78 22% 65% -7% 2% 7.2x 8.0x 0.1 10% 1.0% 2.9x -4% -0.1x -95% 6583%

33 Household Products Orchids Paper Products CompanyTIS US $27.83 243 1.7 -18 -15 5 3 1.00 100% -28% 60% -16% 9.4x 22.2x 0.4 4% 5.1% 2.9x 2% 0.1x -52% 480%

34 Personal Products Nu Skin Enterprises, Inc. Class ANUS US $41.83 2,440 134.2 -70 -70 -12 Faucher N 20% 9 2.33 44% -31% 1% -1% 3.4x 10.0x 0.1 14% 3.4% 2.8x -23% -0.7x -70% 414%

35 USANA Health Sciences, Inc. USNA US $105.66 1,326 10.9 -11 40 24 3 2.33 33% 6% 15% 6% 9.4x 18.3x 0.8 7% 0.0% 5.1x -40% -1.2x -32% 85%

36 Healthcare CryoLife, Inc. CRY US $10.12 274 1.3 -38 -9 -6 3 1.67 67% -33% 42% 20% 7.9x 40.9x 1.0 5% 1.2% 1.9x -27% -1.5x -68% 257%

37 Health Care Supplies Anika Therapeutics, Inc. ANIK US $41.58 589 14.4 -18 9 6 3 1.00 100% 71% -35% 1% 14.1x 17.1x 0.6 4% 0.0% 4.3x -41% -1.7x -19% 543%

38 Managed Health Care Molina Healthcare, Inc. MOH US $50.88 2,404 26.5 0 46 13 Lake N 8% 17 2.18 41% 40% 96% -31% 6.8x 37.0x 0.1 4% 0.0% 2.7x -28% -3.8x -31% 133%

39 Biotechnology PDL BioPharma, Inc. PDLI US $8.14 1,263 24.7 -75 -4 -2 1 3.00 0% 28% 1% 4% 3.7x 3.7x 0.3 21% 7.6% 11.1x 55% 0.7x -97% 1786%

40 Technology Blucora, Inc. BCOR US $14.57 584 12.9 -71 -50 -8 6 2.00 50% -16% -25% -1% 6.4x 7.5x 0.0 15% 0.0% 1.1x -3% -0.4x -53% 391%

41 Perficient, Inc. PRFT US $17.67 586 3.6 -28 -25 21 3 1.00 100% 15% 10% -2% 13.9x 13.3x 0.7 7% 0.0% 2.3x 4% 0.3x -33% 100%

42 Stamps.com Inc. STMP US $47.38 731 5.3 -2 13 36 4 1.50 75% -1% 12% 8% 17.7x 19.4x 0.5 4% 0.0% 4.3x -50% -2.0x -26% 157%

43 Data Processing & Outsourced ServicesHeartland Payment Systems, Inc.HPY US $54.69 1,926 18.3 0 10 6 Huang N 4% 19 2.26 37% 1% 28% -1% 9.1x 22.7x 0.6 3% 0.6% 7.4x -4% -0.2x -29% 135%

44 NeuStar, Inc. Class A NSR US $27.43 1,495 35.1 -51 -45 9 Auty N 9% 7 2.43 29% 19% -8% 7% 5.0x 6.5x 0.5 16% 0.0% 2.5x 26% 1.0x -69% 159%

45 Application Software Interactive Intelligence Group, Inc.ININ US $44.88 928 8.8 -45 -33 4 6 1.33 83% 31.0x 1.0 1% 0.0% 4.9x -28% -3.7x -45% 293%

46 Mentor Graphics Corporation MENT US $22.41 2,490 13.5 -7 -7 13 Auty N 12% 8 1.25 88% 8% 8% 10.5x 12.6x 0.9 5% 0.8% 2.1x -3% -0.3x -32% 120%

47 Communications Equipment Alliance Fiber Optic Products, Inc.AFOP US $12.84 237 9.0 -44 -15 2 3 1.67 67% 16% -10% -11% 9.5x 11.1x 0.2 5% 1.2% 2.9x -46% -2.3x -96% 6839%

48 Brocade Communications Systems, Inc.BRCD US $11.25 4,968 50.8 -4 27 9 Hall OW 16% 22 3.00 14% 10% 3% 6% 8.0x 12.9x 0.7 8% 0.0% 2.1x -11% -0.7x -38% 321%

49 Finisar Corporation FNSR US $17.38 1,731 53.7 -60 -27 9 14 1.86 57% 2% 8% 7.8x 13.9x 0.2 -2% 1.7x -17% -1.4x -81% 407%

50 Technology Hardware Storage & PeripheralsNCR Corporation NCR US $29.58 4,961 77.3 -46 -13 12 Coster OW 45% 7 2.14 43% -6% 13% -12% 7.7x 11.2x 0.8 2% 0.0% 2.8x 22% 2.0x -32% 37%

51 Electronic Components DTS, Inc. DTSI US $32.60 556 2.5 -35 36 16 Coster UW -17% 6 2.33 50% 43% 13% 16% 22.3x 21.2x 0.1 3% 0.0% 3.0x -18% -1.8x -42% 168%

105



J.P. Morgan SMid Themes — Sunken Treasures Screen

Figure 159: Sunken Treasures Screen —SMid-Caps with a) FCF Yld in Highest Quintile, b) Capex > Depreciation, and c) Net Debt/EBITDA <1.5x




Mkt

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($MM)

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Float

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Avg

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10-Yr

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Since

09 Mar

2009 YTD Analyst Rec

# of

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Mean

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-3M

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Revis

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Net

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ST

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Capex

/Depn

1 Energy Patterson-UTI Energy, Inc. PTEN US $20.40 3,168 99% 91.0 -47 153 -19 26 1.77 17% 34% 34% 1% 3.9x 18.2x 13.6x 7% 1.8% 1.1x 9% 0.5x 1% 1.1x

2 Oil & Gas Equipment & ServicesMatrix Service Company MTRX US $23.33 627 97% 7.9 -37 271 -5 6 1.33 27% 27% 19% -11% 7.3x 21.1x 16.7x 9% 0.0% 2.2x -12% -0.9x 0% 1.5x

3 Newpark Resources, Inc. NR US $11.69 1,043 97% 8.3 -13 400 -5 11 2.09 -1% 13% 23% 12% 8.5x 17.5x 15.4x 8% 0.0% 1.8x 12% 0.9x 7% 2.3x

4 Oil States International, Inc. OIS US $54.41 3,056 98% 42.2 -50 720 -6 14 2.00 -30% -39% 4% 4% 4.3x 9.3x 15.2x 8% 0.0% 1.2x 9% 0.5x 0% 1.7x

5 Oil & Gas Refining & Marketing CVR Refining LP CVRR US $23.53 3,483 32% 11.5 -33 4 Tonet N 6 2.67 3% 14% -20% 3% 5.1x 6.8x 6.0x 11% 12.4% 2.3x 12% 0.4x 0% 1.8x

6 Renewable Energy Group, Inc. REGI US $10.15 448 73% 6.1 -37 -11 3 2.33 -20% -100% 3950% 1.7x 2.1x 530.0x 22% 0.0% 0.7x -15% -0.5x 33% 4.0x

7 Coal & Consumable Fuels Alliance Resource Partners, L.P.ARLP US $47.85 3,570 57% 7.3 -7 282 24 Bridges OW 9 1.89 4% 31% 6% 4% 6.1x 13.3x 10.1x 11% 5.1% 3.2x 37% 1.1x 4% 1.3x

8 Materials Westlake Chemical Partners LP $28.45 405 88% 6.7 -15 6 2.33 18% 0.7x 23.1x 94% 0.6% 0.9x 24% 0.3x 0% 3.9x

9 Fertilizers & Agricultural ChemicalsCVR Partners, LP UAN US $11.01 828 46% 4.5 -64 -33 Zekauskas N 5 3.00 -8% -42% -2% -13% 5.7x 7.0x 12.1x 10% 12.5% 1.9x 7% 0.3x 0% 1.8x

10 Specialty Chemicals FutureFuel Corp. FF US $11.83 529 50% 3.5 -45 175 -25 1 3.00 -25% -54% 26% 5% 3.1x 7.1x 15.5x 8% 4.0% 1.6x -46% -1.8x 1.8x

11 Rayonier Advanced Materials Inc $25.09 1,085 99% 32.7 -42 3 3.67 -23% -10% 3.0x 10.2x 15% 0.6% 1.1x 0% 0.0x 1.3x

12 Paper Packaging Sonoco Products Company SON US $41.82 4,180 98% 19.4 -7 147 0 14 3.00 2% 9% 10% 1% 8.8x 17.9x 16.5x 9% 3.1% 2.4x 19% 1.4x 4% 1.0x

13 Industrials Argan, Inc. AGX US $33.74 478 76% 3.4 -17 184 22 2 2.00 -24% 1% 2.9x 12.3x 16.1x 20% 0.0% 3.1x -84% -3.9x 2.1x

14 KBR, Inc. KBR US $18.97 2,867 99% 50.4 -57 60 -41 18 2.00 -11% -97% 1650% -61% 4.4x 9.1x 267.0x 7% 1.6% 1.1x -21% -2.8x 1.4x

15 MYR Group Inc. MYRG US $26.60 556 97% 2.6 -3 91 6 9 1.67 4% -16% 10% -1% 5.7x 15.9x 19.0x 9% 0.0% 1.9x -15% -0.9x 1.5x

16 Electrical Components & EquipmentRegal Beloit Corporation RBC US $73.18 3,255 99% 20.3 -14 184 -1 13 1.92 5% 1% 13% 0% 10.4x 16.7x 16.6x 7% 1.2% 1.6x 8% 0.8x 21% 1.1x

17 Agricultural & Farm Machinery AGCO Corporation AGCO US $43.61 4,133 87% 71.4 -38 181 -26 Duignan N 18 3.22 -10% -31% -20% -14% 3.8x 7.5x 10.8x 10% 1.0% 1.0x 2% 0.2x 25% 1.9x

18 Lindsay Corporation LNN US $88.51 1,061 97% 13.8 -31 295 7 10 3.20 -8% -20% 5% 2% 9.5x 17.5x 21.8x 7% 1.2% 2.8x -33% -1.8x 1.6x

19 Industrial Machinery Briggs & Stratton Corporation BGG US $20.59 929 97% 8.4 -51 79 -5 4 2.50 2% 14% 32% 9.6x 23.4x 20.4x 7% 2.4% 1.4x 2% 0.3x 0% 1.3x

20 Hyster-Yale Materials Handling, Inc. Class AHY US $76.30 943 66% 5.6 -28 -18 3 2.33 5% 0% 8% -1% 5.1x 13.2x 13.2x 12% 1.4% 2.1x -10% -0.7x 90% 1.3x

21 Kadant Inc. KAI US $40.81 446 97% 1.5 -4 515 1 2 1.00 17% 9.9x 19.8x 8% 1.2% 1.7x -3% -0.3x 2% 1.2x

22 Valmont Industries, Inc. VMI US $137.63 3,357 97% 41.6 -16 221 -8 11 2.82 -4% -22% 7% -9% 5.8x 12.4x 15.9x 9% 0.7% 2.2x -4% -0.2x 4% 1.7x

23 Commercial Printing Deluxe Corporation DLX US $58.94 2,916 99% 17.1 -4 846 13 3 2.33 5% 6% 7% 1% 8.6x 15.2x 14.3x 8% 2.0% 5.3x 33% 1.3x 40% 2.1x

24 Diversified Support Services Performant Financial CorporationPFMT US $6.99 345 69% 2.7 -50 -32 9 2.56 -23% -61% 11% -14% 4.7x 8.0x 20.8x 14% 0.0% 4.6x 20% 0.6x 8% 2.6x

25 Human Resource & Employment ServicesKelly Services, Inc. Class A KELYA US $15.67 600 82% 3.6 -53 148 -37 2 2.00 3% -75% 229% -42% 7.0x 9.8x 38.8x 16% 1.3% 0.7x -6% -1.4x 100% 1.1x

26 TrueBlue, Inc. TBI US $23.15 978 98% 6.2 -26 285 -10 7 1.86 31% 32% 3% 7% 10.6x 20.7x 15.7x 7% 0.0% 2.5x -15% -1.3x 7% 839x

27 Research & Consulting ServicesICF International, Inc. ICFI US $39.52 715 97% 3.2 -4 75 14 5 1.80 11% 15% 17% 2% 8.8x 18.9x 16.4x 9% 0.0% 1.5x 5% 0.4x 3% 1.3x

28 Cons. Disc. China XD Plastics Co., Ltd. CXDC US CNY6.08 273 34% 1.7 -80 35 16 0 0.3x 212% 0.0% 0.1x -7% -0.3x 100% 1.0x

29 Dana Holding Corporation DAN US $21.31 3,593 100% 46.3 -13 10,555 9 Brinkman N 14 2.14 -2% 9% 8% 3% 5.8x 12.0x 11.0x 10% 0.9% 2.7x 5% 0.4x 4% 1.2x

30 Consumer Electronics ZAGG Incorporated ZAGG US $5.73 174 96% 1.8 -66 270 32 5 2.20 6% -77% 871% -89% 7.6x 38.3x 164.3x 19% 0.0% 1.4x 2% 0.1x 0% 1.1x

31 Leisure Products LeapFrog Enterprises, Inc. Class ALF US $5.58 370 98% 7.9 -63 389 -30 10 2.40 -18% 3.7x 4.7x 15% 0.0% 0.9x -36% -3.1x 7.7x

32 Sturm, Ruger & Company, Inc. RGR US $39.16 745 99% 21.8 -54 278 -46 3 3.67 -22% -44% -9% -29% 3.5x 6.9x 12.4x 9% 4.2% 4.2x -20% -0.3x 2.7x

33 Apparel Accessories & Luxury GoodsColumbia Sportswear Company COLM US $44.40 3,018 40% 8.2 0 251 13 14 2.29 22% 26% 15% 2% 14.4x 30.1x 23.9x 7% 1.3% 2.4x -33% -3.1x 2.5x

34 Movado Group, Inc. MOV US $27.94 494 96% 7.4 -41 494 -37 6 2.33 3% -9% 4% 3.7x 13.0x 14.3x 8% 1.0% 1.1x -34% -2.3x 1.4x

35 Vera Bradley, Inc. VRA US $21.99 923 54% 12.3 -58 -9 11 2.27 -2% -30% 16% 7.9x 14.8x 21.0x 7% 0.0% 3.6x -18% -0.5x 1.5x

36 Footwear Steven Madden, Ltd. SHOO US $33.97 2,135 88% 19.7 -13 745 -7 14 2.00 2% -6% 12% -9% 8.7x 16.9x 18.0x 6% 0.0% 3.1x -23% -0.9x 2.2x

37 Hotels Resorts & Cruise Lines Interval Leisure Group, Inc. IILG US $21.97 1,237 68% 5.8 -31 500 -29 5 1.40 15% -1% 11% 7% 9.2x 15.8x 16.0x 8% 2.0% 3.6x 19% 1.3x 0% 1.1x

38 Education Services American Public Education, Inc. APEI US $34.14 604 92% 5.0 -31 -6 -21 Volshteyn OW 8 2.50 6% -7% 8% 1% 6.3x 14.9x 16.0x 6% 0.0% 2.9x -35% -1.2x 1.6x

39 Specialized Consumer Services Liberty Tax, Inc. Class A #N/A Invalid Security $38.64 499 55% 1.1 -1 59 2 1.00 12% 11% 23% 10.7x 25.9x 23.4x 7% 4.5x -9% -0.4x 24% 2.4x

40 Steiner Leisure Limited STNR US $43.14 588 91% 3.1 -29 131 -12 5 1.40 1% -16% 17% -7% 7.3x 12.8x 15.2x 11% 0.0% 1.5x 2% 0.2x 1.7x

41 Advertising Harte-Hanks, Inc. HHS US $6.31 382 69% 1.4 -80 34 -19 2 2.00 0% -26% 34% -29% 6.7x 13.4x 18.1x 11% 5.5% 1.1x 1% 0.2x 16% 1.0x

42 Internet Retail 1-800-FLOWERS.COM, Inc. Class AFLWS US $8.70 231 85% 1.2 -35 574 61 4 1.50 28% 51% 34% 31% 5.2x 36.7x 24.4x 8% 0.0% 1.3x -2% -0.1x 100% 1.3x

43 Liberty TripAdvisor Holdings Inc Class A $25.71 1,876 100% 23.0 -32 3 1.67 45% 6.0x 42.1x 15% 1.6x -1% -0.3x 25% 5.0x

44 Apparel Retail Children's Place, Inc. PLCE US $54.80 1,179 97% 21.8 -23 178 -4 Boss N 21 2.24 -1% -6% 12% 6.7x 16.8x 17.9x 9% 1.0% 1.9x -25% -1.7x 1.1x

45 Destination Maternity CorporationDEST US $15.66 212 89% 2.1 -52 468 -48 1 1.00 -37% 32% -48% 3.8x 10.4x 16.5x 13% 5.2% 1.7x -13% -0.5x 1.2x

46 DSW Inc. Class A DSW US $34.65 2,706 98% 51.0 -27 939 -19 18 2.11 4% -14% 12% 7.7x 17.8x 20.6x 8% 1.4% 2.7x -24% -1.1x 1.4x

47 Express, Inc. EXPR US $14.92 1,247 86% 27.1 -43 -20 16 2.13 -2% -33% 15% 4.0x 10.7x 15.9x 7% 0.0% 2.6x -10% -0.4x 0% 1.6x

48 Automotive Retail Murphy USA, Inc. MUSA US $62.78 2,877 95% 19.4 -3 51 Boss N 4 2.00 1% 6% -16% 25% 9.1x 18.8x 17.7x 7% 0.0% 4.4x 14% 0.8x 2% 2.2x

49 Cons. Staples Medifast, Inc. MED US $29.64 373 79% 5.7 -19 571 13 4 2.50 -13% -2% 5% -4% 6.7x 17.9x 18.3x 8% 0.0% 3.8x -51% -1.5x 32% 1.1x

50 Nu Skin Enterprises, Inc. Class ANUS US $41.83 2,440 97% 134.2 -70 420 -70 Faucher N 9 2.33 -19% -31% 1% -1% 3.4x 6.9x 10.0x 14% 3.4% 2.8x -23% -0.7x 37% 6.8x

106



J.P. Morgan SMid Themes — Sunken Treasures Screen (cont.)

Figure 160: Sunken Treasures Screen —SMid-Caps with a) FCF Yld in Highest Quintile, b) Capex > Depreciation, and c) Net Debt/EBITDA <1.5x




Mkt

Cap

($MM)

Free

Float

(%)

Avg

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Vol

($MM)

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10-Yr

High

Since

09 Mar


# of

Recs

Mean

Rec

Sales

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14E

EV/

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Capex

/Depn

51 Healthcare Halyard Health Inc $39.10 1,828 100% 64.2 -5 1 3.00 -30% 6.0x 13.4x 10% 0.9x -1% -0.1x 100% 1.2x

52 Health Care Services Addus HomeCare Corporation ADUS US $22.93 243 91% 1.9 -29 2 5 1.40 18% 6% 17% 0% 12.7x 21.6x 20.5x 11% 0.0% 2.1x -9% -0.9x 1.1x

53 Chemed Corporation CHE US $109.59 1,824 96% 21.0 0 220 43 4 2.50 3% 6% 6% 1% 11.2x 19.1x 17.9x 7% 0.8% 4.1x 11% 0.6x 100% 1.1x

54 Providence Service Corporation PRSC US $37.08 574 94% 4.8 -23 1,413 44 4 1.00 25% 1% 67% -27% 11.2x 25.7x 25.3x 8% 0.0% 4.0x 5% 0.4x 39% 1.3x

55 Biotechnology China Biologic Products, Inc. CBPO US CNY68.87 1,665 39% 1.9 -1 3,726 139 3 1.00 19% 38% 28% 3% 1.6x 20% 0.0% 1.2x -27% -1.1x 25% 3.4x

56 Myriad Genetics, Inc. MYGN US $33.20 2,363 100% 52.2 -28 -11 58 Peterson UW 18 2.67 13% 2% -1% 7.5x 16.1x 15.7x 7% 0.0% 3.3x -23% -0.6x 1.6x

57 Life Sciences Tools & Services PAREXEL International CorporationPRXL US $58.04 3,152 98% 33.0 -10 681 28 16 2.00 10% 26% 20% 11.5x 29.7x 23.6x 7% 0.0% 5.5x 3% 0.2x 4% 1.1x

58 Technology Bankrate, Inc. RATE US $11.83 1,262 56% 11.4 -53 -34 Anmuth N 4 3.00 20% 28% 21% 0% 19.1x 22.8x 17.8x 7% 0.0% 1.5x 5% 1.0x 2.6x

59 Blucora, Inc. BCOR US $14.57 584 94% 12.9 -71 178 -50 6 2.00 0% -16% -25% -1% 6.4x 6.3x 7.5x 15% 0.0% 1.1x -3% -0.4x 63% 1.7x

60 Conversant Inc. CNVR US $34.93 2,260 93% 25.5 -1 522 49 14 3.00 6% 4% 22% -7% 11.2x 22.5x 21.5x 7% 0.0% 4.5x 7% 0.3x 0% 1.1x

61 Demand Media, Inc. #N/A Invalid Security $5.73 111 52% 1.4 -95 -50 6 3.00 -56% 1.1x 4.4x 45% 0.0% 0.2x -7% -1.1x 16% 1.3x

62 j2 Global Inc JCOM US $56.94 2,671 95% 16.8 0 230 14 6 1.67 14% 19% 11% 0% 12.8x 19.8x 16.7x 7% 2.0% 3.8x -5% -0.3x 0% 1.9x

63 Perficient, Inc. PRFT US $17.67 586 97% 3.6 -28 337 -25 3 1.00 19% 15% 10% -2% 13.9x 15.3x 13.3x 7% 0.0% 2.3x 4% 0.3x 0% 1.4x

64 IT Consulting & Other Services Luxoft Holding, Inc. Class A LXFT US $40.47 349 92% 4.9 -7 7 Gogolev OW 7 1.29 21% 4.7x 19.0x 11% 2.3x -8% -0.2x 100% 1.6x

65 ManTech International Corporation Class AMANT US $30.15 710 100% 5.2 -51 -30 1 7 3.57 -22% -41% 20% -1% 12.0x 13.8x 23.2x 25% 2.9% 0.6x -4% -1.3x 0% 1.3x

66 Science Applications International Corp.SAIC US $50.03 2,320 85% 12.4 -1 51 Nadol OW 5 2.20 13% 13.1x 17.6x 7% 1.1% 6.2x 17% 1.3x 3% 1.5x

67 Data Processing & Outsourced ServicesCSG Systems International, Inc. CSGS US $25.49 867 97% 4.8 -20 104 -13 2 1.00 1% -6% 4% -2% 7.1x 11.4x 12.2x 11% 1.8% 2.4x 6% 0.4x 6% 1.6x

68 Genpact Limited G US $18.00 3,866 68% 18.9 -15 148 -2 Huang N 13 2.23 7% -10% 14% -3% 9.4x 15.8x 17.6x 7% 0.0% 2.9x 3% 0.2x 1% 1.5x

69 NeuStar, Inc. Class A NSR US $27.43 1,495 96% 35.1 -51 83 -45 Auty N 7 2.43 7% 19% -8% 7% 5.0x 7.7x 6.5x 16% 0.0% 2.5x 26% 1.0x 2% 1.1x

70 TeleTech Holdings, Inc. TTEC US $23.75 1,158 35% 3.0 -41 176 -1 6 2.00 2% -6% 16% -10% 7.6x 15.3x 16.3x 8% 0.0% 2.5x -7% -0.4x 3% 1.3x

71 Application Software EnerNOC, Inc. ENOC US $15.03 437 90% 7.1 -70 43 -13 Coster N 8 1.75 22% -51% 93% -24% 5.3x 19.7x 40.4x 10% 0.0% 1.6x -36% -2.8x 1.8x

72 NetScout Systems, Inc. NTCT US $38.72 1,569 90% 10.4 -18 274 31 8 2.00 15% 17% 16% 14.4x 25.8x 22.0x 6% 3.8x -29% -1.8x 1.1x

73 TiVo Inc. TIVO US $11.94 1,497 97% 23.0 -36 94 -9 Coster N 20 1.70 16% -77% -4% 5.5x 7.1x 31.1x 33% 0.0% 2.7x -67% -6.8x 0% 1.2x

74 Home Entertainment Software Take-Two Interactive Software, Inc.TTWO US $28.16 2,262 96% 45.5 -4 369 62 19 2.05 -19% -38% -31% 2.6x 8.2x 13.2x 30% 2.8x -26% -0.7x 2% 2.3x

75 Communications Equipment InterDigital, Inc. IDCC US $50.85 1,860 98% 17.2 -33 141 72 4 2.50 27% 175% -30% 11% 12.4x 54.4x 19.8x 11% 0.8% 3.5x -45% -4.4x 0% 1.3x

76 Electronic Manufacturing ServicesPlexus Corp. PLXS US $39.83 1,328 99% 7.0 -15 279 -8 9 1.89 8% 16% 12% -1% 8.5x 16.3x 14.0x 7% 0.0% 1.9x -6% -0.5x 1% 2.3x

77 Technology Distributors Ingram Micro Inc. Class A IM US $27.29 4,185 97% 32.7 -11 178 16 10 1.20 6% 8% 19% 0% 6.9x 11.3x 10.4x 9% 0.0% 1.1x 1% 0.2x 6% 1.2x

78 Semiconductor Equipment Kulicke & Soffa Industries, Inc. KLIC US $14.08 1,074 98% 7.3 -6 1,124 6 3 2.33 6% 4% 6% -8% 5.4x 17.7x 17.1x 7% 0.0% 1.4x -61% -6.3x 0% 1.2x

79 Semiconductors First Solar, Inc. FSLR US $51.53 4,986 73% 211.4 -83 -52 -6 Coster OW 17 2.53 11% -37% 66% 5% 5.6x 11.4x 18.2x 12% 0.0% 1.1x -24% -2.5x 27% 1.2x

80 MagnaChip Semiconductor CorporationMX US $12.33 397 100% 3.7 -48 -37 5 2.20 3% -6% 19% -1% 2.2x 5.0x 5.3x 15% 0.0% 1.3x 5% 0.2x 10% 2.6x

81 Telecom IDT Corporation Class B IDT US $17.25 371 77% 1.5 -65 3,941 -3 1 3.00 2% 16% -1% 3.8x 14.0x 12.1x 8% 4.0% 3.7x -46% -5.1x 68% 1.0x

82 Wireless Telecommunication ServicesSpok Holdings, Inc. #N/A Invalid Security $16.22 351 97% 1.6 -59 61 14 0 4.3x 11% 3.1% 1.3x -30% -1.5x 0% 1.1x

83 NA California Resources Corp $8.75 2,788 0% 24.8 -4 0 1.1x 29% 0.3x 0% 0.0x 1.5x

Average 1,532 84% 19.9 -32 577 0 8 2.16 3% -7% 99% -6% 6.9x 15.8x 29.4x 15% 1.3% 2.3x -9% -0.7x 21% 11.9x

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J.P. Morgan SMid Themes — Better than Bonds Screen

Figure 161: Better than Bonds Screen —SMid-Caps with a) Div Yld >2.5%; b) FCF Yld >5%; c) Net Debt / EBITDA <1.5x; d) Positive EBITDA Grw '06-'13; and e) Trailing Capex as & of Mkt Cap <1% below 6yr avg




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1 Materials Sonoco Products Company SON US $41.82 4,180 98% 19.4 -7 147 0 14 3.00 2% 9% 10% 1% 8.8x 17.9x 16.5x 9% 3.1% 2.4x 19% 1.4x 10% (0.9%)

2 Industrials Barrett Business Services, Inc. BBSI US $22.58 162 97% 8.5 -78 180 -76 2 1.00 19% 4% 12% -5% 2.0x 8.0x 7.7x 41% 3.3% 2.2x -34% -4.0x 13% (0.2%)

3 Cons. Disc. Collectors Universe, Inc. CLCT US $22.30 192 76% 1.0 -12 558 30 0 12.5x 6% 6.0% 9.3x -60% -1.4x 194% 0.0%

4 Cons. Staples Nu Skin Enterprises, Inc. Class ANUS US $41.83 2,440 97% 134.2 -70 420 -70 Faucher N 9 2.33 -19% -31% 1% -1% 3.4x 6.9x 10.0x 14% 3.4% 2.8x -23% -0.7x 414% (0.2%)

5 Healthcare Owens & Minor, Inc. OMI US $34.18 2,102 98% 16.4 -11 67 -7 Gill N 9 3.89 3% -8% 10% -4% 8.9x 17.5x 19.0x 5% 3.0% 2.1x 5% 0.5x 94% 0.0%

6 Health Care Technology Quality Systems, Inc. QSII US $14.48 869 73% 7.9 -71 -23 -31 Weiss N 22 3.18 6% -25% 11% 14.5x 18.7x 24.8x 11% 4.9% 2.9x -27% -2.3x 30% 0.1%

7 Biotechnology PDL BioPharma, Inc. PDLI US $8.14 1,263 90% 24.7 -75 31 -4 1 3.00 41% 28% 1% 4% 3.7x 4.7x 3.7x 21% 7.6% 11.1x 55% 0.7x 1786% (0.1%)

Average 1,601 90% 30.3 -46 197 -22 8 2.73 9% -4% 8% -1% 7.7x 12.3x 13.6x 15% 4.5% 4.7x -9% -0.8x 363% (0.2%)

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Investment Themes

Recommended Investment Strategies and Themes for 2015

1) Get on Board the Airlines Industry (JPAMAIRL Index) —although the domestic Airlines sector has been a strong performer over the last 3 months (top US Airlines +13%, Transports +14%, Industrials +6%, SPX +4.5%), we see a number of reasons, both fundamental and technical, for the sector to continue its upward march in 2015.

2) Contrarian Energy Picks in a Low Oil Environment (JPAMENRG Index) — heading into a year in which oil is expected to remain low and range-bound, we suggest going long a basket of Energy stocks that we believe are best positioned for a depressed oil environment. Contrarians who believe the overall sector is due for a rebound can consider call spreads on the Energy Sector ETF.

3) Consumer Spending Beneficiaries— favorable US and global market dynamics (i.e., higher disposable personal income driven by expected pickup in wage growth, lower energy and food costs driven by lower oil prices and tame inflation, lower financing costs given low 10-year treasury yield) should result in higher cash flow to the US consumer and propel consumer spending, in our view. With US being a consumer driven economy, any pick-up in consumer spending should bode well for equity markets and especially consumer-basedindustries.

4) Most Levered Financial Plays to Rising Interest Rates (JPAMFINL Index) — the Financials sector is (ex bond-proxy REITs) is one of our highest overweight conviction ideas on the expectation that rising interest rates will be a significant catalyst for performance due to two main reasons: 1) the space should benefit as rates rise from current depressed levels, and 2) valuation should normalize as interest rates normalize and investors grow less concerned about banking system assets and financial system risk.

5) Sustainable Shareholder Yield (JPAMSYLD Index) — with rates expected to remain low, search for yield to continue, and a cautious investor base, we expectshareholder-friendly companies with attractive total yields and strong cash flow generation should benefit from the current market environment.

6) Domestic Firms over US Multi-nationals (JPAMDREV Index) — S&P 500 has 33.2% of its revenue derived from abroad. Given that J.P. Morgan forecastsa strengthening US dollar, we prefer domestic firms over US multi-nationals, especially those with domestic production and high foreign exports. Additionally, there is more room for domestic stocks to re-rate higher given stronger expected earnings growth. On the contrary, US multi-nationals are already seeing multiple contraction and weaker earnings growth.

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Theme #1: Get on Board the Airlines Industry

Thesis: Although the domestic Airlines industry has been a strong performer over the last three months (Top US Airlines +25%, Transports +13%, Industrials +6%, SPX +4.2%), the industry appears cheaper today than at summer’s end – a time before Atlantic capacity was trimmed, domestic fares rose, and fuel began its precipitous price decline. We believe there are a number of reasons, both fundamental and technical, for the sector to continue its upward march in 2015.

Key Drivers Key Risks Attractive valuation – Airlines 2016 P/E (8.8x), Transports

(19.9x), Industrials (17.9x), SPX (17.3x)

Shareholder-friendly yield - $3B in cash expected to be returned in the form of dividends and buybacks in 2015

Lower oil prices lead to lower input costs – oil down 30% in 2H'14, current spot yields $10B in savings for the industry

Companies with roughly 85% domestic exposure; should be relative beneficiaries in a rising USD environment

Strong US consumer, expected rise in consumer spending

Strong corporate confidence

Domestic growth disappoints

Overcapacity

Sharp uptick in oil prices

Ebola fears resurge

Airline-related acts of terrorism

Figure 162: 2016 P/E multiples reveal Airlines are cheaper than other high quality, large industrial transports

Source: Bloomberg, J.P. Morgan estimates

How to trade this theme? 1) Cash: go long the J.P. Morgan US Airlines Basket (JPAMAIRL <Index> on Bloomberg)to gain exposure to US airlines, 2) Call option on basket: currently, 6M ATM calls on the basket can be indicatively bought for 11% of notional, 3) Stock replacements: following the recent rally, consider replacing long shares with long calls on individual names where implied volatility is still relatively cheap compared to historical levels, or 4) Put writes: sell 3M out-of-the-money puts on DAL and UAL as a target buy strategy or to collect upfront premium income on each (3M 90-110 skew on each is trading higher than their median value measured over the last year).

Figure 163: Composition of the J.P. Morgan US Airlines Basket – JPAMAIRL <Index>, as of December 5th 2014

Source: Bloomberg, J.P. Morgan estimates. Note on non-covered companies: This basket has been created to leverage the theme of this research report. It includes companies that are not

covered by J.P. Morgan Research (marked “NC”) and should not be viewed as a recommendation with respect to these companies.

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ALK ALASKA AIR GROUP Jamie Baker UW $57.3 $62.0 5.1% $7,595 $84 4.7% 22.0% 58.4% 12.1 10.9 16.6% 0.9% 1.8%

ALGT ALLEGIANT TRAVEL N/A NC $142.6 N/A 1.7% $2,492 $21 6.6% 13.4% 36.1% 18.2 15.8 33.3% 1.6% 3.2%

AAL AMERICAN AIRLINE Jamie Baker OW $51.0 $80.5 24.5% $36,588 $731 18.3% 34.0% N/A 6.7 6.8 33.8% 0.4% N/A

DAL DELTA AIR LI Jamie Baker OW $47.3 $73.0 26.5% $39,571 $714 11.4% 22.1% 69.9% 11.4 10.0 28.2% 0.6% N/A

JBLU JETBLUE AIRWAYS Jamie Baker N $15.2 $18.5 3.0% $4,433 $140 23.9% 24.8% 87.7% 13.6 10.7 68.1% N/A -0.2%

LUV SOUTHWEST AIR Jamie Baker N $41.1 $52.0 18.7% $27,910 $385 10.6% 28.7% 132.8% 16.1 13.7 34.9% 0.5% 1.5%

SAVE SPIRIT AIRLINES N/A NC $84.3 N/A 4.1% $6,131 $105 10.1% 16.2% 92.7% 18.9 15.9 38.6% N/A 0.0%

UAL UNITED CONTINENT Jamie Baker OW $63.0 $95.5 15.6% $23,263 $413 19.1% 26.2% 75.6% 9.1 8.7 41.2% N/A -0.1%

VA VIRGIN AMERICA I N/A NC $35.7 N/A 1.0% $1,534 $154 N/A N/A N/A N/A N/A N/A N/A N/A

SPX S&P 500 1.6% 3.4% 16.5% 1.9% 2.3%

S5INDU S&P 500 INDUSTRIALS 0.9% 4.7% 14.2% 2.0% 3.1%

S5TRAN S&P 500 TRANSPTN 1.6% 11.8% 33.1% 1.5% 3.8%

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110



Sector still looks cheap – As Figure 162 shows, based on 2016 estimates, Airlines currently trade at a P/E multiple of less than 9x, roughly half the earnings multiple of companies in the rail, parcel, truckload, intermodal, forwarder, and LTL sectors. As Airlines increasingly behave in the manner of and achieve the returns normally reserved for high-quality industrial transport companies, we believe they should increasingly be valued as such. In our view, the multiple discount vs. other transports seems unjustified and should narrow in coming years as the sector continues to show discipline and cash flow growth/ efficiency.

Operating margins of 17-18% could be attained in 2015-16e – In the eight years since the consolidation cycle began (America West-US Airways was announced in 2005 and closed in 2006), margins are expected to rise nearly 700 bps by 2014e, less than half of what the rails have achieved over a thirteen-year period. Margins can plausibly expand a further ~650 bps in 2014-16e to nearly 18%, driven mostly by lower jet fuel prices, before potentially hitting structural limits. While margins of this magnitude would fail to overtake broader industrial transports as a group, it would reflect a significantly diminished deficit that should, in our view, result in an improved airline multiple.

Figure 164: Airlines are not as profitable as Transports, but they are making progress…

Source: Company reports, Bloomberg, J.P. Morgan estimates. Note that margins reflect rolling

12-month periods ending in the period specified

Figure 165: … and we project continued airline operating margin improvement into 2015

Source: Company reports, Bloomberg, J.P. Morgan estimates

Capacity growth is not to be feared – The recent earnings season highlighted that analysts and investors remain concerned over profit intoxication leading to reckless capacity behavior. Historically, however, our analysis reveals that margin reversal has been a function of external events (Gulf Wars, recessions, terrorism, etc.) and not management’s capacity decisions. Margins typically have held up until suddenly they haven’t, and JPM analyst Jamie Baker could not find a single instance going back as far as 1984 in which capacity decisions in one year meaningfully impacted profit margins the next.

Figure 166: Airline margins have proven volatile, but capacity doesn’t seem to be the reason

Source: J.P. Morgan estimates. Prior to 1995, operating margins are based on DOT Form 41 data

Fuel provides a healthy tailwind – If current spot prices were to hold flat for 2015, then the industry would realize a fuel savings of roughly $10 billion, before adjusting for capacity growth, when compared to spot prices as recent as late August. As of late, one of the most frequent investor questions has been whether airlines will simply pass along fuel savings to passengers in the form of lower fares. However, the industry’s successful system-wide domestic fare increase in Octoberdemonstrates that shareholders (and not passengers) are the disproportionate beneficiaries of lower jet fuel prices.

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111



Shareholder-friendly focus on dividends and buybacks to continue – Managements that previously engaged in fare wars and capital destructive behavior, in our view, are today competing in terms of buyback schemes and dividends. Both AAL and UAL surprised investors with $1B share buyback programs earlier this year, joining the likes of ALK, DAL and LUV. On the dividend front, AAL announced a quarterly dividend, DAL and LUV raised their quarterly dividend in Q1'14, while ALK raised its dividend in Q4’13. We expect at least $3B in cash returned to shareholders in the form of dividends and share buybacks in 2015, given the sector’s newfound ability to generate significant cash and a more long-only shareholder base demanding these policies.

How to trade this theme? Since no liquid ETF or other investment vehicle tracking these stocks exists, we launched the J.P. Morgan US Airlines Basket to provide exposure to top US Airlines stocks. Potential investors can consider buying calls on the basket via the options market. Currently, 6M ATM calls on the basket can be indicatively bought for 11% of notional. Investors who are concerned with the swift rise in Airlines stocks can consider booking profits on the underlying shares and replacing them with long calls – a strategy that looks most attractive in DAL, where 3M ATM implied vol is trading lower than its median value measured over the last 2 years. Alternatively, if one believes the sector is due for a near-term pullback but still holds a long-term positive view, consider selling 3M out-of-the-money puts on DAL and UAL as a target buy strategy or to collect upfront premium income (3M 90-110 skew on each is trading higher than their median value measured over the last year).

J.P. Morgan US Airlines Basket – JPAMAIRL <Index>

The J.P. Morgan US Airlines Basket provides exposure to a portfolio of Airlines companies that derive the majority of their revenues domestically. Underlying constituents need to be greater than $1B in market-cap and trade at least $10M in ADV, measured over the last three months. The basket contains 9 companies, and the weights are optimized to replicate as closely as possible a market-cap weighted basket, subject to a maximum of 10% of ADV traded in any single name within a $50M basket. The basket can be accessed on Bloomberg via ticker JPAMAIRL <Index>.

There are broad Airlines indices like the NYSE Arca Airline Index (XAL) and the Bloomberg US Airlines Index (BUSAIRL) that could be viewed as ways to gain exposure to the Airlines sector. However, these indices are too broad to fit the domestic bias we outline above and include companies like Avianca, for instance, that derive the majority of their revenues internationally. In addition, these indices include small-cap companies like SkyWest that do not pass the liquidity criteria for our basket. Note: we include Alaska Air in the basket even though it is rated an Underweight, as we expect it to relatively underperform other Airlines, yet still appreciate on an absolute basis along with the overall sector (as it did in 2014).

Basket Performance

In this section, we examine the hypothetical performance of the J.P. Morgan US Airlines Basket over the last two years8. The basket – JPAMAIRL <Index> – would have outperformed the NYSE Arca Airline Index (XAL Index) over the past two years. The annualized return of the J.P. Morgan US Airlines Basket would have been 55.6% (while the annualized XALIndex return during the same time period was 43.2%). The correlation of the basket to the XAL Index was 90%, and the recent 6M realized volatility of the basket is 32.2% (the realized volatility of the XAL Index over the same time frame was 24%). The figures below show the performance and volatility of the J.P. Morgan US Airlines Basket vs. that of the XALIndex. The historical beta and correlation of the basket to the XAL Index is also shown in the charts below.

8 Not all stocks in the basket have 2 years of price history (AAL, VA). In such cases, we have replaced the stock with an equivalent quantity of cash prior to its listing for the purpose of the back-test.

112



Figure 167: Hypothetical performance of the J.P. Morgan US Airlines Basket and XAL Index (over past 2 years)

Source: J.P. Morgan Equity Derivatives Strategy, Bloomberg. Note: All price performance excludes commissions and fees. Past performance is not indicative of future returns

Figure 168: Daily Returns of the J.P. Morgan US Airlines Basket vs. XAL Index return


Figure 169: 6M Realized Volatility of the J.P. Morgan US Airlines Basket vs. XAL Index


Figure 170: 6M Beta and 6M Correlation of the J.P. Morgan US Airlines Basket vs. XAL Index


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113



Theme #2: Contrarian Energy Picks in a Low Oil Environment

Thesis: Heading into a year in which oil is expected to remain low and range-bound, we suggest going long a basket of Energy stocks that we believe are best positioned for a depressed oil environment. Contrarians who believe the overall sector is due for a rebound can consider call spreads on an Energy Sector ETF.

Key Drivers Key Risks

High-quality/ turn-around companies whose selloff is overdone due to broader Energy sector weakness

Companies whose input "breakeven" cost of oil can withstand further oil price decline

Companies with roughly 85% domestic exposure; should be relative beneficiaries in a rising USD environment

Further decline in oil prices could spur OPEC to cut output

Seasonal effects (early year Value anomaly) should help

Discord between OPEC members continues

Further decline in shale production costs

Libyan and Iraqi supply increases

Economic data surprises to the downside

Figure 171: WTI oil futures price vs. investor positioning

Source: J.P. Morgan Equity Derivatives Strategy, Bloomberg

Figure 172: Energy Beta-adjusted returns and Value seasonality


How to trade this theme? 1) Cash: go long the J.P. Morgan US Energy Basket (JPAMENRG <Index> on Bloomberg)to gain exposure to Energy companies that declined along with broader Energy sector weakness, and that J.P. Morgan equity analysts believe are best positioned to outperform in a depressed oil environment, 2) Pair trade: long Energy Sector ETF vs. short Utilities Sector ETF as a pair trade given the deviations in their recent performance versus prior periods of rising USD/falling oil, 3) Options: given elevated sector vol and cheap upside skew, buy call spreads on Energy Sector ETF.

Figure 173: Composition of the J.P. Morgan US Energy Basket – JPAMENRG <Index>, as of December 5th 2014


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APC ANADARKO PETROLE Oil Comp-Explor&Prodtn Joseph D Allman OW $79.1 $95.0 19.0% $40,040 $479 -18.6% -28.2% -10.5% 21.8 15.2 -26.7% 1.3% -0.2%

BWP BOARDWALK PIPELI Pipelines Jeremy Tonet OW $16.2 $24.0 1.9% $3,930 $19 -9.6% -18.8% -37.1% 15.3 14.4 6.5% 2.6% N/A

XEC CIMAREX ENERGY C Oil Comp-Explor&Prodtn Joseph D Allman OW $104.8 $156.0 4.3% $9,145 $154 -15.8% -26.3% 4.3% 22.5 15.4 -26.1% 0.6% N/A

DM DOMINION MIDSTRE Pipelines Jeremy Tonet OW $34.1 $43.0 1.0% $2,181 $18 -3.1% N/A N/A 41.2 36.3 22.7% N/A N/A

EOG EOG RESOURCES Oil Comp-Explor&Prodtn Joseph D Allman OW $90.4 $109.0 23.5% $49,513 $550 -11.7% -13.2% 10.4% 20.2 15.7 -18.2% 0.6% N/A

EQM EQT MIDSTREAM PA Pipelines Jeremy Tonet OW $88.3 $109.0 2.6% $5,471 $27 -10.4% -15.5% 52.8% 19.1 17.6 17.9% 2.5% N/A

NBL NOBLE ENERGY INC Oil Comp-Explor&Prodtn Joseph D Allman OW $50.6 $60.0 8.7% $18,321 $151 -15.7% -32.3% -30.7% 19.7 14.6 -3.4% 1.4% -0.3%

NS NUSTAR ENERGY LP Pipelines Jeremy Tonet OW $55.3 $74.0 2.0% $4,310 $34 -12.2% -19.6% 13.0% 21.2 18.9 19.7% 8.3% N/A

PSX PHILLIPS 66 Oil Comp-Integrated Phil M Gresh OW $73.3 $89.0 19.2% $40,573 $335 -7.2% -20.4% -1.0% 9.5 8.6 14.3% 2.7% 4.8%

PXD PIONEER NATURAL Oil Comp-Explor&Prodtn Joseph D Allman OW $143.6 $201.0 10.1% $21,377 $320 -25.1% -33.1% -25.3% 25.7 19.6 -1.4% 0.1% N/A

PAGP PLAINS GP HOLD-A Pipelines Jeremy Tonet OW $26.4 $35.0 7.7% $16,218 $47 -6.1% -21.0% 3.6% 40.4 33.0 31.0% 2.7% N/A

SPX S&P 500 1.7% 3.6% 16.6% 1.9% 2.3%

S5ENRS S&P 500 Energy -11.3% -17.5% -8.0% 2.8% 2.7%

Buyback

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114



Oil could move lower before it moves higher – Following the recent reaffirmation of the 30 million bpd production target by OPEC, J.P. Morgan oil analysts believe prices could weaken further in the coming weeks and think OPEC needs to cut output to avoid excessive stock builds that could weigh on prices. However, cuts appear more likely in February and March as an agreement may not be reached until sometime in January. We believe the prospect of prices moving materially lower should serve as the catalyst for OPEC members to resolve their differences in opinion.

Figure 174: Detailed J.P. Morgan Crude Oil Price Forecast (US$/bbl)

Source: ICE, NYMEX, Bloomberg, J.P. Morgan Commodities Research. Note: LT means long term forecast. All forecasts are period averages. Actual to date prices are as of Nov 25th, 2014.

Weakest S&P 500 sector in 2014 – Energy is the only S&P 500 sector in negative territory this year, underperforming the broader market by over 23%. Interestingly, the ratio of the Energy sector (S5ENRS) compared to the S&P 500 just reached a pre-crisis low of 0.29, measuring back to 2007 (see Figure 5 below). Notice how this ratio looks like a typical oscillator (range-bound); when rising, it means that the Energy sector is outperforming, and when falling, it means the opposite. The same chart also shows the forward 12-month performance of the Energy sector once reaching a low. Each time this happened, the forward 12-month return of the Energy sector has been between 25-40% annualized. Monthly returns for the sector dating back to 1990 also reveal strong seasonality of positive returns in the first half of the year.

Figure 175: Recent double whammy of weakening demand and strengthening supply hurting oil prices

Source: Bloomberg, Energy Intelligence Group

Figure 176: Energy sector has typically returned 25-40% annualized 12 months following a new low in S5ENRS to SPX ratio


Sector performance during rising USD/falling oil –Figure 177 shows the performance of the S&P 500 and individual sectors during and after selloffs in Oil, which also coincided with a USD rally, a scenario we envision in 2015. Not surprisingly, Energy is one of the weakest sectors during the USD/Oil move. However, as Figure 178 reveals, the underperformance of the Energy sector over the last 4 months is typically worse than the average performance during prior periods of rising USD/falling oil. In contrast, underweight-rated Utilities is one sector that has done markedly better this time versus past performance, and so a long S&P 500 Energy and short Utilities trade might be attractive given their deviations from past USD/oil episodes, a trade we highlighted in a recent Market and Volatility Commentary report. This trade is also supported by relatively low valuations in Energy (P/E = 13.9) and high valuations in the Utilities sector (P/E = 17.6).

1Q14 2Q14 3Q14 4Q14 2014 1Q15 2Q15 3Q15 4Q15 2015 1Q16 2Q16 3Q16 4Q16 2016 LT

Brent Forecast 80.0 100.3 75.00 80.00 85.00 88.00 82.00 85.00 88.00 90.00 88.00 87.75 90.00

Brent Actual To Date 107.9 109.8 103.5 85.5 103.6 ... … … … … ... … … … … …

WTI Forecast 76.0 93.7 72.00 76.00 80.00 81.00 77.25 78.00 81.00 83.00 81.00 80.75 80.00

Actual To Date 98.6 103.0 97.2 81.6 96.7 ... … … … … ... … … … …

Brent-WTI spread 9.56 6.77 6.21 4.00 6.56 3.00 4.00 5.00 7.00 4.75 7.00 7.00 7.00 7.00 7.00 10.00

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Figure 177: Sector performance during and after periods where both Oil falls and the USD rallies


Figure 178: Average returns during USD rallies and Oil sell-offs


Buy call spreads on major Energy Sector ETF – Recent weakness in the Energy space and uncertainty around OPEC’s next move have caused Energy sector volatility to spike over the last three months. With 6M ATM implied vol on the major Energy Sector ETF currently trading in its 94th percentile (measured over the last 2 years), it is relatively expensive for contrarian investors to buy calls to position for a rebound in the Energy sector. As a result, we recommend cheapening the upfront premium outlay via call spreads. Upside skew (as measured by the 6M 100/110 skew) is currently flat and trading close to its cheapest point over the last two years, which makes call spreads attractive. Currently, a 6M 100/115 call spread on a major Energy Sector ETF can indicatively be bought for 4.5% of notional, offering a maximum reward/risk of nearly 4x. Investors who prefer to focus on individual stocks vs. buying calls on the overall sector can consider a basket of our analysts' top overall picks.

J.P. Morgan US Energy Basket – JPAMENRG <Index>

The J.P. Morgan US Energy Basket provides exposure to high-quality/ turn-around Energy companies that declined along with the broader Energy sector weakness, and which J.P. Morgan fundamental equity analysts believe are best positioned to outperform in a depressed oil environment. The basket contains 11 names, and the weights are optimized to replicate as closely as possible a market-cap weighted basket, subject to a maximum of 10% of ADV traded in any single name within a $50M basket. The basket can be accessed on Bloomberg via ticker JPAMENRG <Index>.

The underlying companies fit our domestic exposure bias with roughly 85% of revenues, on average, derived within the US (vs. 65% for companies in the Energy Select Sector Index). While there is no one breakeven price of crude for US shale oil, assuming $4/MMBtu natural gas in 2015 and a 15% minimum required RoR, the estimated breakeven oil price for each of the E&P companies included in the basket sits comfortably below our oil price forecast for next year. In spite of this, the five E&P companies in the basket declined in line with the broader SIG Oil Exploration & Production Index (EPX) over the last three months (~30%). The MLP companies in the basket declined by ~14% over the last three months, significantly underperforming the broader Alerian MLP Index (AMZ) by ~320 bps. In addition to the E&Ps and MLPs, the basket also contains refining company PSX, which we think should benefit from any widening of the WTI-Brent spread in 2015 (our oil commodity strategists model for this spread to widen every successive quarter next year).

Basket Performance

In this section, we examine the hypothetical performance of the J.P. Morgan US Energy Basket over the last two years9. The basket – JPAMENRG <Index> – would have outperformed the Energy Select Sector Index (IXE Index) over the past twoyears. The annualized return of the J.P. Morgan US Energy Basket would have been 13.6% (while the annualized IXE Index

9 Not all stocks in the basket have 2 years of price history (DM, PAGP). In such cases, we have replaced the stock with an equivalent quantity of cash prior to its listing for the purpose of the back-test.

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S&P 500 5.2% -1.9% -4.4% -6.6% 9.4%

Financials 8.5% -1.9% -10.4% -12.9% 16.9%

Technology 9.6% -4.5% -4.9% -6.5% 14.9%

Health C. 14.6% 0.2% 2.3% -0.1% 13.8%

Utilities 6.1% -2.4% -6.2% -8.3% 11.7%

Industrials 5.2% -0.8% -6.2% -8.6% 10.4%

Materials -0.9% -6.6% -9.2% -14.2% 9.1%

C. Discretion 5.1% 0.4% -1.8% -4.5% 7.1%

C. Staples 7.6% 0.8% 2.7% 0.4% 6.3%

Telecoms -1.8% -3.7% -2.8% -4.7% 1.9%

Energy -19.0% -4.7% -9.7% -12.3% -10.1%

Historical Performance During

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return during the same time period was 6%). The correlation of the basket to the IXE Index was 93%, and the recent 6M realized volatility of the basket is 26.6% (the realized volatility of the IXE Index over the same time frame was 20.4%). The figures below show the performance and volatility of the J.P. Morgan US Energy Basket vs. that of the IXE Index. The historical beta and correlation of the basket to the IXE Index is also shown in the charts below.

Figure 179: Hypothetical performance of the J.P. Morgan US Energy Basket and IXE Index (over past 2 years)


Figure 180: Daily Returns of the J.P. Morgan US Energy Basket vs. IXE Index return


Figure 181: 6M Realized Volatility of the J.P. Morgan US Energy Basket vs. IXE Index


Figure 182: 6M Beta and 6M Correlation of the J.P. Morgan US Energy Basket vs. IXE Index


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Theme #3: Consumer Spending Beneficiaries

Thesis: Favorable US and global market dynamics (i.e., higher disposable personal income driven by expected pickup in wage growth, lower energy and food costs driven by lower oil prices and tame inflation, lower financing costs given low 10-year treasury yield) should result in higher cash flow to the US consumer and propel consumer spending, in our view. With US being a consumer-driven economy, any pick-up in consumer spending should bode well for equity markets and especially the consumer-based industries.


Tightening labor market and expected rise in wage growth

Solid growth coupled with low inflation

Weak commodity prices, stronger USD and low 10-year treasury yield

Expect “wealth effect” to start materializing

J.P. Morgan forecasts a pickup in housing, which should impact consumer confidence and spending

Savings rate should move lower, given high wealth/income ratio, supporting consumer spending

Inflation surprises to upside/downside leading to hyperinflation/outright deflation

Oil reverses its recent slump leading to sticker shock at gas station

Housing continues to disappoint

Rising healthcare costs eat into savings

Growth disappoints leading to weaker consumer confidence and spending

Figure 183: US Household Wealth and Savings Rate


Figure 184: Expected drivers of higher consumer spending in 2015

Source: J.P. Morgan

How to trade this theme? 1) Cash: increase exposure to industries that should benefit from a pickup in consumer spending. Figure 7 below lists such industries, with the largest companies in each industry highlighted.

Figure 185: Industries most correlated to an increase in consumer spending, measured quarterly over the last 20 years


DISPOSABLE PERSONAL INCOME(i.e. expected rise in wage growth)

ENERGY & FOOD COSTS(i.e. weaker China, lower oil prices…)

FINANCING COSTS(i.e. weaker Eurozone and lower Bund Yield, thus low

Treasury Yields…)

CASH FLOW TO US CONSUMER(i.e. increasing consumer spending)

Industry Prominent companies Correlation

IT Services Visa (V), MasterCard (MA) 55.6%

Specialty Retailing Home Depot (HD), Lowe's (LOW), TJX Co. (TJX), Best Buy (BBY) 53.5%

Automobiles Ford (F), General Motors (GM) 51.5%

Consumer Finance American Express (AXP), Capital One (COF), Discover (DFS) 50.1%

Computers & Peripherals Apple (AAPL), Hewlett-Packard (HPQ) 48.8%

Food & Staples Retailing Wal-Mart (WMT), Costco (COST), CVS (CVS), Walgreen (WAG) 47.7%

Textiles & Apparel Nike (NKE), VF Corp (VFC) 47.5%

Airlines Delta Airlines (DAL), Southwest Airlines (LUV) 47.1%

Software Microsoft (MSFT), Electronic Arts (EA) 46.6%

Multiline Retailing Target (TGT), Macy's (M) 45.5%

Auto Components Johnson Controls (JCI), Delphi (DLPH) 42.4%

Media Walt Disney (DIS), Time Warner (TWX) 40.3%

Internet Software & Services Facebook (FB), Google (GOOGL), eBay (EBAY), Yahoo! (YHOO) 37.3%

Hotels, Restaurants & Leisure Marriott (MAR), Chipotle (CMG), Carnival (CCL) 34.5%

Internet & Catalog Retail Amazon (AMZN), Priceline (PCLN), Netflix (NFLX) 31.8%

Household Durables Whirlpool (WHR), Newell Rubbermaid (NWL) 25.2%

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Expect the “wealth effect” to start materializing – a stronger US consumer should provide a lift to the equity market– while “wealth” creation has been strong thus far in this recovery, the absence of wage growth and stubbornly high savings rate has limited the wealth “effect” from materializing. An already strong labor market that is expected to further tighten should drive wage growth. In turn, this should help the "wealth effect" materialize and further support consumer spending. Additionally, global market dynamics should benefit the US consumer. Weaker China is driving oil prices lower, thus providing savings through lower inflation. Weaker Eurozone and a lower Bund yield is exerting downward pressure on US treasury yields, thus providing prolonged cheaper financing. Bottom line, these trends should result in higher cash flow to the US consumer (e.g., higher disposable personal income, lower energy and food costs, lower financing costs) and propel spending. With US being a consumer-driven economy, any pick-up in consumer spending should bode well for equity markets and especially consumer-based industries.

For further details on the rationale for increasing consumer spending, please see pages 14 of this report.

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Theme #4: Most Levered Financial Plays to Rising Interest Rates

Thesis: The Financials sector (ex bond-proxy REITs) is one of our highest overweight conviction ideas on the expectation that rising interest rates will be a significant catalyst for performance due to two main reasons: 1) the space should benefit as rates rise from current depressed levels, and 2) valuation should normalize as interest rates normalize and investors grow less concerned about banking system assets and financial system risk.


J.P. Morgan forecasts a rate hike in June 2015 and expects rates to rise to 1% by year-end

Low OIS spreads suggest the market is not pricing in a rate hike until later in 2015, providing potential upside

Bulk of litigation risks seem to be behind Banks

Higher rates should result in faster loan growth and continued strong credit quality

Growth disappoints and ZIRP continues

New litigation and regulatory risks resurface (SIFI capital requirements increase)

Figure 186: Net interest margin of FDIC-insured institutions vs. cash as % of bank assets

Source: FDIC, Federal Reserve H.8, J.P. Morgan Fixed Income Strategy

Figure 187: OIS Spreads and FOMC MedianMarket expectation for interest rate by YE2016 vs. the Fed


How to trade this theme? 1) Cash: go long the J.P. Morgan US Financials Basket (JPAMFINL <Index> on Bloomberg) to gain exposure to Financial companies that J.P. Morgan fundamental equity analysts believe are best positioned to outperform in a rising interest rate environment, 2) Call option on basket: currently, Jan’16 ATM calls on the basket can be indicatively bought for 9.2% of notional.

Figure 188: Composition of the J.P. Morgan US Financials Basket – JPAMFINL <Index>, as of December 5th 2014


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ARCC ARES CAPITAL COR Asset Management & Custody Ban Richard Shane Jr OW $54.8 $18.5 7.0% $5,067 $35 -2.2% -4.3% -4.2% 0.94 0.92 7.8% 10.2% N/A

BK BANK NY MELLON Asset Management & Custody Ban Vivek Juneja N $133.1 $39.0 7.8% $44,556 $201 5.9% 4.9% 24.8% 1.17 1.13 10.7% 1.6% 1.6%

BAC BANK OF AMERICA Diversified Banks Vivek Juneja OW $44.1 $18.0 7.8% $176,571 $1,312 1.9% 8.2% 14.2% 0.78 0.73 2.5% 0.7% 1.7%

COF CAPITAL ONE FINA Consumer Finance Richard Shane Jr OW $44.5 $95.0 7.8% $45,762 $243 0.4% 1.4% 16.0% 0.97 0.92 0.9% 1.4% 1.8%

CME CME GROUP INC Specialized Finance Kenneth B Worthington N $13.2 $84.0 7.8% $28,500 $135 4.4% 17.7% 17.6% 1.37 1.38 13.5% 5.0% N/A

CMA COMERICA INC Diversified Banks Steven Alexopoulos OW $39.3 $56.0 7.8% $8,127 $72 -3.0% -6.0% 4.0% 1.07 1.01 2.3% 1.6% 3.0%

DFS DISCOVER FINANCI Consumer Finance Richard Shane Jr N $75.6 $65.0 7.8% $29,590 $160 -1.8% 2.4% 24.8% 2.39 2.23 4.9% 1.4% 4.4%

LNC LINCOLN NATL CRP Life & Health Insurance Jimmy S Bhullar N $57.5 $62.0 7.8% $14,447 $108 2.1% 5.2% 12.2% 0.86 0.80 6.0% 1.1% 2.8%

LPLA LPL FINANCIAL HO Investment Banking & Brokerage Kenneth B Worthington OW $13.2 $50.0 7.5% $4,146 $37 6.8% -6.5% 4.7% 4.01 3.54 11.0% 2.1% 4.2%

MET METLIFE INC Life & Health Insurance Jimmy S Bhullar OW $39.3 $63.0 7.8% $61,801 $325 3.2% 3.5% 12.0% 0.88 0.80 5.1% 2.4% N/A

RF REGIONS FINANCIA Regional Banks Vivek Juneja N $75.6 $10.0 7.8% $13,448 $157 1.9% 2.5% 8.3% 0.82 0.79 1.9% 1.5% 2.4%

SCHW SCHWAB (CHARLES) Investment Banking & Brokerage Kenneth B Worthington N $57.5 $36.0 7.8% $36,118 $205 5.0% 4.2% 22.0% 3.11 2.80 19.0% 0.8% -0.7%

SIVB SVB FINANCIAL GR Regional Banks Steven Alexopoulos OW $33.2 $140.0 7.8% $5,143 $39 -2.4% -1.5% 7.5% 1.84 1.65 3.7% N/A N/A

SPX S&P 500 1.7% 3.6% 16.6% 1.9% 2.3%

S5FINL S&P 500 FINANCIALS 3.2% 6.7% 18.5% 1.7% 1.6%


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Fundamentals support the case for higher rates in 2015 – J.P. Morgan forecasts the Fed to start hiking rates in June 2015on the back of solid growth and tighter labor markets in the US. Although the strength in the USD is eventually expected to restrain growth, our economists expect this to be offset by the decline in oil prices and call for 3% growth in 1H15, followed by 2.5% in 2H15.

Figure 189: We look for growth to remain solid in 1H15, prompting the Fed to start tightening in June

Source: Actual data and J.P. Morgan economic and Fed forecast summary; units as indicated

Despite improving economic conditions supporting the case for higher rates, forward rates continue to price in a much lower trajectory for interest rates and are currently implying a first rate hike in September, and a level of 80bps by year-end, which is below J.P. Morgan estimates and FOMC dots. So what could delay the Fed? If the recent drop in oil and the strength of the US dollar are sustained, inflation could remain below the Fed’s 2% target, which we believe would delay any policy action later into 2H 2015. Even a moderate pickup in wage growth (as most of the slack in the labor market has dissipated) may not be enough to mitigate these deflationary effects. The market seems to agree given the recent slip in OIS spreads, which continue to diverge from the FOMC’s own forecast.

Likely Financials sector winners in a rising rate environment – The six-year zero interest rate policy experiment coupled with de-risking in the banking sector have made banks better capitalized and less leveraged, but they have also made them less profitable. The profitability of these companies is tied to short-term rates as well as the term structure of the yield curve, and should benefit greatly as interest rates normalize. In addition to the expected benefits to net interest margin (NIM) from higher overall rates, our Banks analysts also see a rates-up scenario as the key ingredient to drive improved loan growth. As short-term rates eventually rise, many companies currently on the sidelines could be prompted to draw on lines once the cost to borrow starts increasing.

Large Cap Banks (Analyst Vivek Juneja) – We believe bank earnings will be a key beneficiary of rising interest rates, led by increase in net interest revenues, primarily due to benefit of asset sensitive balance sheets. In addition, earnings would likely benefit from other factors such as elimination of drag from money market fund fee waivers and higher mortgage servicing revenues. Furthermore, higher interest rates should follow a stronger economic recovery, which should result in faster loan growth and continued strong credit quality. This should keep loan losses and provisions low, and offset negativessuch as lower mortgage origination revenues. We expect net interest income will rise as banks have a large amount of loans as well as some other earning assets (liquid assets, securities) tied to the short end of the yield curve, which would likely benefit immediately from Fed rate hikes, while deposit funding costs typically lag rise in rates. Key beneficiaries include: 1) Bank of America (BAC) – will likely benefit due to large share of retail deposits and floating rate loans, 2) Bank of New York Mellon (BK) – will benefit due to a large amount of liquid assets, plus loans and shorter duration securities, as well as recovery of money market fee waivers, 3) Regions Financial (RF) – expected to benefit from a large amount of floating rate loans as well as a high share of retail deposits and low loan to deposit ratio vs. peers.

Mid and Small Cap banks (Analyst Steve Alexopoulos) – Mid and small-cap banks are levered toward rising short-term interest rates given a high proportion of earning assets pricing off of short-term rates, such as prime and LIBOR. For example, banks under our coverage have 65% of loans being variable rate, with a large component related to commercial and industrial lending. This implies significant upward movement in loan yields when rates move higher. Banks that are also sitting on excess cash will have better reinvestment opportunities. The flip side of higher short-term rates has typically meant higher deposit costs. Banks with a high proportion of non-interest bearing funding will typically see the greatest expansion in margins. That said, we find that money market funds that have been a key alternative for banks deposits in past cycles are far less competitive this time around given significant contraction in the investable assets thatprovide yield for these funds, such as commercial paper and the repo market. Money market reform will also likely weigh on the competitive ability for these funds to attract institutional funds. As such, we see lower deposit betas in this rising rate cycle. We believe SVB Financial (SIVB) and Comerica (CMA) are best positioned for higher short-term rates in our coverage.

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Real GDP (% q/q, saar) 3.9 2.5 3.0 3.0 2.5 2.5

Unemployment rate (% ; qtr avg) 6.1 5.7 5.5 5.4 5.3 5.2

Core CPI (% q/q, saar) 1.3 1.7 1.8 1.9 2.0 2.0

IOER (top of Fed funds target range; %) 0.25 0.25 0.25 0.50 0.75 1.00


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Insurance (Analyst Jimmy Bhullar) – Life insurers derive over a third of their revenues from investment income, primarily interest income from corporate bond investments. Higher interest rates lift yields on new investments and boost overall investment income and revenues. Key beneficiaries in a rising rate environment include MetLife (MET)and Lincoln National (LNC). Among major life insurers, LNC is one of the most exposed to interest rates given its business mix. Lincoln derives about 46% of its earnings from interest rate sensitive products (fixed annuities, individual life, stable value/GIC, etc.), and so a gradual increase in interest rates should be beneficial for returns and topline growth.

Specialty & Consumer Finance (Analyst Richard Shane) – Within the specialty finance sector, we believe credit card issuers and BDCs will be the greatest beneficiaries of a rising rate environment. Post CARD Act, Capital One (COF)and Discover Financial (DFS) shifted their loan portfolios to floating rate assets. Both companies are asset sensitive and will likely experience NIM expansion in a rising rate environment. Within the BDC space, Ares Capital (ARCC) has been strategically preparing for a higher rate environment for the past three years. The company is concentrated in floating rates assets and fixed rate liabilities.

Brokers, Asset Managers & Exchanges (Analyst Ken Worthington) – Charles Schwab (SCHW), a leading broker with an operating bank, is well positioned to benefit from higher Fed Funds and Libor rates. Schwab has waived fees in its very large money market business. In a normalized rate environment the drag from these waivers can be eliminated. In addition, Schwab operates a bank where net interest margin is particularly compressed in the low rate environment. We believe LPL Financial (LPLA), an independent advisor platform, should also enjoy higher earnings should interest rates rise. The benefit would be seen in LPL’s cash management operations where it oversees client investments into both insured and non-insured cash management products as yields have been particularly depressed. Within the exchanges, CME Group (CME), a leading derivatives exchange, stands to see a climb in trading volumes across its major products driven by higher rates. Here, rising rates should increase participation in hedging activities, driving volumes and earnings meaningfully higher.

J.P. Morgan US Financials Basket – JPAMFINL <Index>

The J.P. Morgan US Financials Basket provides exposure to Financial companies that J.P. Morgan fundamental equity analysts believe are best positioned to outperform in a rising interest rate environment. The basket contains 13 names, and the weights are optimized to replicate as closely as possible an equally-weighted basket, subject to a maximum of 20% of ADV traded in any single name within a $100M basket. The basket can be accessed on Bloomberg via ticker JPAMFINL <Index>.

There are ETFs like the Financial Select Sector SPDR Fund (XLF) or the Bank ETF (KBE) that could be viewed as providing exposure to the Financials sector. However, these indices are too broad to fit the interest-rate sensitive theme that we recommend, or contain REITs stocks that we think should underperform in a rising rate environment. Higher interest rates provide more alternatives to yield-seeking investors and so we recommend avoiding the bond-proxy REITs sector.

Basket Performance

In this section, we examine the hypothetical performance of the J.P. Morgan US Financials Basket over the last two years. The basket – JPAMFINL <Index> – would have outperformed the Financials Select Sector Index (IXM Index) over the past two years. The annualized return of the J.P. Morgan US Financials Basket would have been 26.1% (while the annualized IXM Index return during the same time period was 21.7%). The correlation of the basket to the IXM Index was 92%, and the recent 6M realized volatility of the basket is 15% (the realized volatility of the IXM Index over the same time frame was 11.5%). The figures below show the performance and volatility of the J.P. Morgan US Financials Basket vs. that of the IXMIndex. The historical beta and correlation of the basket to the IXM Index is also shown in the charts below.

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Figure 190: Hypothetical performance of the J.P. Morgan US Financials Basket and IXM Index (over past 2 years)


Figure 191: Daily Returns of the J.P. Morgan US Financials Basket vs. IXM Index return


Figure 192: 6M Realized Volatility of the J.P. Morgan US Financials Basket vs. IXM Index


Figure 193: 6M Beta and 6M Correlation of the J.P. Morgan US Financials Basket vs. IXM Index


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Theme #5: Sustainable Shareholder Yield

Thesis: With rates expected to remain low, search for yield to continue, and a cautious investor base, shareholder-friendly companies with attractive total yields and strong cash flow generation should benefit from the current market environment.


Search for yield continues in 2015 where rates are expected to rise but remain low in historical terms

Healthy corporate balance sheets—active buyback programs to continue supporting equity values

Yields move substantially higher, financing costs increase, buyback activity slows down

High dividend payers (bond proxies) come under pressure in a rising rate environment

Figure 194: Cash levels near record high at 13.7% of total assets

Source: J.P. Morgan, FactSet

Figure 195: Buybacks for S&P 500 picked up in Q3 after Q2 decline


How to trade this theme? Cash: go long J.P. Morgan US Sustainable Shareholder Yield Basket (JPAMSYLD<Index> on Bloomberg) to gain exposure to S&P 500 companies with attractive total yields and strong cash flow generation, 2) Call overwrites: further enhance income by overwriting JPAMSYLD Basket with 1Y 10% out-of-the-money calls, 3) Pair Trade: short 10Y Treasuries to hedge a long position in JPAMSYLD Basket.

Figure 196: Composition of the J.P. Morgan US Sustainable Shareholder Yield Basket – JPAMSYLD <Index>, as of December 5th 2014


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ACN ACCENTURE PLC-A Technology Tien-Tsin Huang OW $86.2 $90.0 4.0% $57,408 $254 3.2% 6.9% 17.0% 0.0 5.8% 2.2% 3.3% 5.5%

AFL AFLAC INC Financials Jimmy S Bhullar N $59.5 $69.0 4.0% $26,814 $140 1.7% -1.9% -8.5% 0.3 29.4% 2.5% 4.3% 6.8%

T AT&T INC Telecom Philip Cusick N $33.9 $34.0 4.0% $176,047 $734 -2.8% -1.8% 3.6% 0.8 6.4% 5.4% 2.0% 7.4%

AVY AVERY DENNISON Materials Jeffrey J Zekauskas N $49.8 $47.0 4.0% $4,540 $48 5.1% 2.9% 3.1% 0.9 5.7% 2.6% 6.1% 8.7%

COH COACH INC C. Discretionary Matthew Boss OW $34.5 $39.0 4.0% $9,508 $149 3.5% -6.7% -35.8% 0.1 7.8% 3.9% 3.2% 7.1%

GLW CORNING INC Technology Rod Hall N $21.3 $21.0 4.0% $27,355 $173 4.3% 1.6% 27.2% 0.2 13.2% 1.9% 10.3% 12.2%

EMR EMERSON ELEC CO Industrials Steve Tusa N $64.9 $67.0 4.0% $45,003 $230 0.8% 0.6% -0.8% 0.6 6.5% 2.7% 2.3% 5.0%

GPS GAP INC/THE C. Discretionary Matthew Boss N $40.7 $44.0 4.0% $17,716 $210 4.9% -7.8% 5.4% 0.5 7.6% 2.1% 7.4% 9.5%

HPQ HEWLETT-PACKARD Technology Rod Hall OW $39.6 $38.0 4.0% $73,811 $476 9.2% 6.5% 46.1% 0.7 11.6% 1.9% 3.3% 5.2%

INTC INTEL CORP Technology Harlan Sur OW $37.7 $39.0 4.0% $182,134 $1,196 12.2% 7.3% 56.6% 0.2 5.3% 2.4% 3.1% 5.6%

IVZ INVESCO LTD Financials Kenneth B Worthington OW $41.2 $46.0 4.0% $17,729 $111 0.3% 1.1% 19.1% 0.6 6.2% 2.4% 3.1% 5.4%

LLL L-3 COMM HLDGS Industrials Joseph B Nadol Iii OW $124.6 $135.0 4.0% $10,607 $136 2.9% 10.8% 25.0% 0.7 10.0% 1.9% 6.0% 7.9%

MRK MERCK & CO Health Care Christopher T Schott OW $61.5 $66.0 4.0% $175,300 $653 3.6% 1.5% 28.5% 0.6 6.1% 2.9% 2.6% 5.5%

MSFT MICROSOFT CORP Technology Mark Murphy OW $48.4 $53.0 4.0% $399,119 $1,707 0.1% 4.9% 29.7% 0.3 6.6% 2.4% 1.7% 4.1%

NOC NORTHROP GRUMMAN Industrials Joseph B Nadol Iii N $147.7 $122.0 4.0% $29,833 $175 9.0% 16.4% 36.8% 0.6 7.3% 1.9% 9.6% 11.5%

PBCT PEOPLE'S UNITED Financials Steven Alexopoulos N $14.9 $15.0 4.0% $4,593 $46 0.7% 0.6% 5.2% 1.0 5.9% 4.4% 2.8% 7.3%

PFE PFIZER INC Health Care Christopher T Schott OW $32.0 $35.0 4.0% $201,558 $796 6.9% 9.8% 5.0% 0.5 7.9% 3.2% 3.0% 6.2%

PRU PRUDENTL FINL Financials Jimmy S Bhullar OW $88.3 $105.0 4.0% $40,460 $229 4.2% -0.2% 1.9% 0.9 36.1% 2.4% 1.5% 4.0%

RTN RAYTHEON CO Industrials Joseph B Nadol Iii N $107.6 $87.0 4.0% $33,187 $195 3.1% 9.9% 27.3% 0.4 6.2% 3.1% 3.6% 6.7%

SPLS STAPLES INC C. Discretionary Christopher Horvers N $14.4 $13.0 4.0% $9,197 $140 11.2% 15.0% -6.4% 0.2 8.4% 3.3% 1.9% 5.2%

TXN TEXAS INSTRUMENT Technology Harlan Sur OW $55.6 $56.0 4.0% $58,709 $384 9.2% 15.4% 31.3% 0.4 5.8% 2.2% 3.6% 5.8%

UTX UNITED TECH CORP Industrials Joseph B Nadol Iii OW $111.3 $120.0 4.0% $101,458 $484 2.6% 3.0% 2.3% 0.6 5.9% 2.1% 1.1% 3.2%

UNM UNUM GROUP Financials Jimmy S Bhullar N $33.7 $40.0 4.0% $8,482 $57 0.2% -5.2% -0.1% 0.3 14.9% 2.7% 4.0% 6.7%

VLO VALERO ENERGY Energy Phil M Gresh N $49.8 $54.0 4.0% $25,948 $399 -1.3% -6.5% 9.1% 0.3 12.1% 1.9% 2.7% 4.6%

XLNX XILINX INC Technology Harlan Sur OW $47.2 $47.0 4.0% $12,472 $170 8.2% 10.7% 9.0% 0.6 5.6% 2.3% 2.7% 5.0%

SPX S&P 500 2.3% 4.2% 17.3% 1.0 5.0% 1.9% 2.3% 4.2%

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S&P 500 companies balance sheets are healthy and flush with cash – S&P 500 companies are flush with cash, hoarding $4.1 trillion, of which $2.7 trillion is held by Financial companies (putting this into perspective, there is enough cash held by non-Financials to buyout 75% of the Russell 2000). As shown in Figure 197, Cash as % of Total Assets measures 13.7% and sits near record highs (excluding Financials this metric is closer to 11%). While one prudent use of this cash would be to pay down a company’s debt obligations, S&P 500 Debt as % of Total Assets is currently at a trough level of 23% (driven primarily by Financials deleveraging after the last recession). Overall, the high level of cash and low debt supports our view for continued strong stock repurchases, dividend payouts and M&A activity in 2015.

Figure 197: Cash levels near record high at 13.7% of total assets…


Figure 198: …while Debt as % of Total Assets is at 23%


Buybacks increasingly favored over dividends – Since the adoption of Rule 10b-18 in 1982 (Safe Harbor for Issuer Repurchases), there has been a precipitous decline in dividends paid in favor of stock buybacks. The current S&P 500 dividend yield is 1.9%, which is less than half compared to pre-1982 levels — the average dividend from 1871 until 1982 was 5.0%. While dividends have declined, the trend in the amount of cash deployed for stock repurchases has been increasing over the last five years and approaching pre Financial Crisis levels (see Figure 200).

Figure 199: S&P 500 dividend yield

Source: J.P. Morgan, Shiller data

Figure 200: Excess cash is increasingly being used to fund buybacks


Sustainable Shareholder Yield Strategy—We think investors would be best served in 2015 by considering not just dividend yield, or buyback yield, but should look at “sustainable shareholder yield” as a strategy. We define the factor as follows: Sustainable Shareholder Yield = Net Buyback Yield + Dividend Yield + 3 Yr Dividend Growth + 3 Yr Cash Flow Growth.

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Figure 201: Sustainable Shareholder Yield Strategy – Excess returns S&P 500, Top Quintile, Excess Cumulative Returns since 1990

Source: J.P. Morgan

Figure 202: Strategy provided 2.9% active annual risk over S&P 500

Source: J.P. Morgan

Our analysis reveals that since 1990, the Sustainable Shareholder Yield strategy has outperformed the market consistently, apart from the period in the late 1990’s, when growth massively outperformed. We also note the correlation of this strategy to the 10 Yr Treasury Yield is negative (-11%), suggesting some headwinds in a rising rate environment. However, although the correlation is negative, it is still mild and we expect the strategy to continue to do well in 2015, as rates are rising from very low levels. For investors looking to increase exposure to this strategy, we suggest the J.P. Morgan US Sustainable Shareholder Yield Basket (JPAMSYLD <Index> on Bloomberg). If yields move higher than expected, investors can hedge a long position in JPAMSYLD <Index> with a short position in 10 Yr Treasuries.

J.P. Morgan US Sustainable Shareholder Yield Basket – JPAMSYLD <Index>

The J.P. Morgan US Sustainable Shareholder Yield Basket provides exposure to a portfolio of shareholder-friendly S&P 500 companies with attractive total yields and strong cash flow generation. Basket constituents satisfy the following criteria: 1) S&P 500 constituent, 2) dividend yield higher than S&P 500 dividend yield, 3) flat or growing dividends over the last 1, 3 and 5 years, 4) repurchased more common shares than issued over the last 12 months, 5) free cash flow yield higher than 5%, 6) debt/equity ratio lower than S&P 500 debt/equity ratio, and 7) rated Overweight or Neutral by a J.P. Morgan fundamental equity analyst. The basket contains 25 equally-weighted names, and can be accessed on Bloomberg via ticker JPAMSYLD <Index>.

The underlying basket constituents provide 2.7% dividend yield, in addition to 3.8% net buyback yield, for a total yield of 6.5%, on average. Investors can increase the yield further by selling 1Y 10% out-of-the-money calls on the basket for 3.7% additional upfront income, which enhances the total yield to 10.2%. Investors who overwrite these calls should be comfortable getting called away on their individual shares if they advance more than 10% from current levels, and forgoing any additional upside.

Basket Performance

In this section, we examine the hypothetical performance of the J.P. Morgan US Sustainable Shareholder Yield Basket over the last two years. The basket – JPAMSYLD <Index> – would have outperformed the S&P 500 (SPX Index) over the past two years. The annualized return of the J.P. Morgan US Sustainable Shareholder Yield Basket would have been 19.5% (while the annualized SPX Index return during the same time period was 18.7%). The correlation of the basket to the SPXIndex was 94%, and the recent 6M realized volatility of the basket is 11.2% (the realized volatility of the SPX Index over the same time frame was 10.6%). The figures below show the performance and volatility of the J.P. Morgan US Sustainable Shareholder Yield Basket vs. that of the SPX Index. The historical beta and correlation of the basket to the SPX Index is also shown in the charts below.

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Figure 203: Hypothetical performance of the J.P. Morgan USSustainable Shareholder Yield Basket and SPX Index (past 2 years)


Figure 204: Daily Returns of the J.P. Morgan US Sustainable Shareholder Yield Basket vs. SPX Index return


Figure 205: 6M Realized Volatility of the J.P. Morgan US Sustainable Shareholder Yield Basket vs. SPX Index


Figure 206: 6M Beta and 6M Correlation of the J.P. Morgan USSustainable Shareholder Yield Basket vs. SPX Index


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Theme #6: Domestic Firms over US Multi-nationals

Thesis: S&P 500 has 33.2% of its revenue derived from abroad. Given the expectations of a strengthening US dollar, we prefer domestic firms over US multi-nationals (especially those with domestic production and high foreign exports). Additionally, there is more room for domestic stocks to re-rate higher given stronger expected earnings growth.


Rising USD favors domestic firms over US multi-nationals

Stronger USD typically inflates equity multiples, particularly for firms that derive the bulk of their revenues domestically

US centric companies have higher earnings visibility and less uncertainty

US growth disappoints; Fed postpones rate hike cycle; USD weakens

How to trade this theme? Cash: go long the J.P. Morgan Domestic Revenue Exposure Basket (JPAMDREV <Index> on Bloomberg) to gain diversified exposure to S&P 500 companies that derive at least 75% of their revenues domestically, 2) Call option on basket: currently, Jan’16 ATM calls on the basket can be indicatively bought for 9.7% of notional.

Figure 207: Composition of the J.P. Morgan Domestic Revenue Exposure Basket – JPAMDREV <Index>, as of December 5th 2014


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ADS ALLIANCE DATA Technology Reginald L Smith 77% N $278.2 $290.0 2.0% $16,531 $174 -1.7% 8.7% 12.1% N/A 1.3%

ADP AUTOMATIC DATA Technology Tien-Tsin Huang 81% N $85.8 $75.0 5.1% $41,370 $165 1.2% 16.5% 25.2% 2.3% 1.1%

BBY BEST BUY CO INC C. Discretionary Christopher Horvers 84% OW $35.6 $43.0 1.5% $12,498 $213 3.5% 14.0% -9.6% 1.9% N/A

BSX BOSTON SCIENTIFC Health Care Michael N Weinstein 83% N $12.9 $14.5 2.1% $17,125 $176 -2.6% 4.6% 8.8% N/A 2.5%

BRCM BROADCOM CORP-A Technology Harlan Sur 96% OW $43.9 $48.0 3.2% $25,989 $246 6.2% 6.1% 59.8% 1.1% 0.2%

COF CAPITAL ONE FINA Financials Richard Shane Jr 94% OW $82.9 $95.0 5.7% $46,112 $245 0.6% 1.6% 16.3% 1.5% 1.8%

CBS CBS CORP-B C. Discretionary Alexia S Quadrani 87% OW $55.1 $65.0 3.5% $28,568 $432 5.3% -8.5% -7.5% 0.9% 7.3%

CNP CENTERPOINT ENER Utilities Jeremy Tonet 100% OW $23.6 $27.0 1.2% $10,122 $101 -6.0% -4.5% 4.7% 4.1% 0.0%

CTL CENTURYLINK INC Telecom Philip Cusick 100% OW $39.7 $45.0 2.8% $22,646 $133 2.6% -0.3% 36.2% 5.4% 1.1%

CERN CERNER CORP Health Care Lisa C Gill 88% OW $64.0 $72.0 2.7% $21,868 $98 1.8% 7.1% 11.7% N/A 0.6%

CMG CHIPOTLE MEXICAN C. Discretionary John W Ivankoe 99% OW $660.6 $730.0 2.5% $20,486 $277 1.0% -3.4% 24.7% N/A 0.2%

XEC CIMAREX ENERGY C Energy Joseph D Allman 100% OW $104.9 $156.0 1.1% $9,150 $154 -13.9% -24.7% 6.6% 0.6% N/A

CMA COMERICA INC Financials Steven Alexopoulos 86% OW $48.2 $56.0 1.1% $8,661 $81 -1.1% -4.2% 6.0% 1.6% 3.0%

CCI CROWN CASTLE INT Financials Philip Cusick 95% N $79.3 $90.0 3.3% $26,465 $264 -0.7% -1.2% 6.6% 1.3% N/A

DVA DAVITA HEALTHCAR Health Care Justin Lake 100% OW $75.6 $85.0 2.0% $16,253 $89 2.0% 2.1% 30.5% N/A N/A

EOG EOG RESOURCES Energy Joseph D Allman 93% OW $90.8 $109.0 6.1% $49,732 $553 -11.7% -13.2% 10.4% 0.6% N/A

FIS FIDELITY NATIONA Technology Tien-Tsin Huang 80% N $61.6 $63.0 2.1% $17,485 $74 5.0% 5.5% 22.6% 1.5% 1.9%

FSLR FIRST SOLAR INC Technology Paul T Coster 86% OW $46.9 $68.0 0.6% $4,701 $118 -10.2% -37.1% -22.2% N/A N/A

FISV FISERV INC Technology Tien-Tsin Huang 84% N $71.4 $67.0 2.1% $17,412 $79 2.0% 8.2% 27.4% N/A 3.1%

GNW GENWORTH FINANCI Financials Jimmy S Bhullar 75% N $8.6 $11.0 0.5% $4,286 $87 0.8% -36.2% -44.2% N/A N/A

HSY HERSHEY CO/THE C. Staples Kenneth Goldman 83% OW $99.8 $105.0 2.7% $22,043 $107 4.0% 9.1% 4.8% 2.0% 0.7%

KEY KEYCORP Financials Steven Alexopoulos 100% OW $13.8 $16.0 1.5% $11,938 $147 3.4% 0.6% 8.4% 1.8% 3.9%

KR KROGER CO C. Staples Kenneth Goldman 100% OW $61.0 $67.0 3.7% $29,947 $203 7.0% 18.6% 54.7% 1.1% 1.5%

LH LABORATORY CP Health Care Lisa C Gill 100% N $106.1 $119.0 1.1% $8,969 $112 5.4% -2.0% 6.0% N/A 9.4%

MAR MARRIOTT INTL-A C. Discretionary Joseph R Greff 83% OW $79.0 $90.0 2.8% $22,383 $212 4.8% 11.3% 72.7% 1.0% 2.8%

MAS MASCO CORP Industrials Michael Rehaut 81% OW $24.9 $28.5 1.1% $8,860 $111 6.0% 3.4% 16.0% 1.3% N/A

MCK MCKESSON CORP Health Care Lisa C Gill 89% OW $212.6 $240.0 6.1% $49,305 $213 7.2% 7.0% 31.8% 0.5% N/A

KORS MICHAEL KORS HOL C. Discretionary Matthew Boss 84% OW $77.6 $86.0 2.0% $15,985 $305 9.0% -0.4% -4.3% N/A N/A

MNST MONSTER BEVERAGE C. Staples John A Faucher 77% OW $106.7 $120.0 2.2% $17,885 $126 -1.8% 18.4% 68.8% N/A 0.2%

NFLX NETFLIX INC C. Discretionary Douglas Anmuth 84% OW $350.9 $450.0 2.6% $21,142 $874 -10.7% -28.4% -3.2% N/A N/A

NUE NUCOR CORP Materials Michael F Gambardella 100% OW $54.5 $58.0 2.1% $17,370 $117 0.0% -1.6% 6.7% 2.7% N/A

PRGO PERRIGO CO PLC Health Care Christopher T Schott 81% OW $157.1 $190.0 2.7% $22,120 $152 1.5% 9.1% 1.8% 0.3% 0.0%

PXD PIONEER NATURAL Energy Joseph D Allman 100% OW $143.0 $201.0 2.6% $21,292 $318 -24.0% -32.1% -24.1% 0.1% N/A

PCL PLUM CREEK TIMBR Financials Tyler Langton 96% OW $41.6 $46.0 0.9% $7,308 $52 1.4% 1.7% -3.3% 4.2% N/A

RHI ROBERT HALF INTL Industrials Andrew C Steinerman 76% OW $56.5 $63.0 0.9% $7,676 $56 0.8% 10.4% 45.3% 1.3% 1.7%

SCHW SCHWAB (CHARLES) Financials Kenneth B Worthington 100% N $30.0 $36.0 4.8% $39,134 $227 6.1% 5.3% 23.3% 0.8% -0.7%

LUV SOUTHWEST AIR Industrials Jamie N Baker 100% N $41.1 $52.0 3.4% $27,910 $385 10.1% 28.1% 131.9% 0.5% 1.6%

TSCO TRACTOR SUPPLY C. Discretionary Christopher Horvers 100% OW $78.6 $90.0 1.3% $10,681 $97 5.3% 21.7% 8.7% 0.8% 0.9%

TSN TYSON FOODS-A C. Staples Kenneth Goldman 91% OW $41.7 $50.0 1.9% $15,647 $179 0.5% 7.8% 22.9% 0.8% 1.5%

UNM UNUM GROUP Financials Jimmy S Bhullar 93% N $33.7 $40.0 1.0% $8,482 $57 1.0% -4.4% 0.7% 1.8% 3.6%

URBN URBAN OUTFITTER C. Discretionary Matthew Boss 87% OW $31.2 $38.0 0.5% $4,186 $85 0.4% -19.8% -13.0% N/A -0.6%

ZION ZIONS BANCORP Financials Steven Alexopoulos 100% N $28.6 $31.5 0.7% $5,804 $72 -4.2% -1.9% -4.0% 0.6% -13.7%

SPX S&P 500 66.8% 2.3% 4.2% 17.3% 1.9% 2.3%


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Rising dollar typically inflates equity multiples – Since 1995, our analysis reveals that P/Es have expanded/contracted with the rise/fall of the US dollar. This might be related to a steady decrease in capital restrictions and a broader economic liberalization during this post-globalization period. In particular, firms that derive a greater share of their revenue domestically will be the largest relative beneficiaries of a rising dollar, at the expense of their more global counterparts. The relative valuations of the more domestic subset of the S&P 500 (versus the more global) have historically tracked changes in the dollar index fairly closely. In addition, EPS (NTM) of domestic firms is starting to outpace that of US multi-nationals.

Figure 208: Companies with greater domestic exposure tend to re-rate more than global multinationalsPost globalization: US dollar vs. S&P 500


Figure 209: Change in EPS (NTM) for Domestic Firms vs US Multi-nationals3 Month and YTD Change in EPS (NTM)

S&P 500 Revenue ExposureYTD

Change3 Month Change

100% Domestic (1st Quartile) 7.6% 2.0%

>50% Foreign (4th Quartile) 8.2% 1.2%

S&P 500 9.0% 2.3%


J.P. Morgan US Domestic Revenue Exposure Basket – JPAMDREV <Index>

The J.P. Morgan US Domestic Revenue Exposure Basket provides exposure to a diversified portfolio of S&P 500 companies that derive the bulk of their revenues domestically. Basket constituents satisfy the following criteria: 1) S&P 500 constituent, 2) at least 75% of total revenues derived domestically, 3) rated Overweight or Neutral by a J.P. Morgan fundamental equity analyst, and 4) at least 10% or more upside to J.P. Morgan fundamental equity analyst’s price target. The basket contains 42 names, and the weights are optimized to replicate as closely as possible a market-cap weighted basket, subject to a maximum of 10% of ADV traded in any single name within a $100M basket. The basket can beaccessed on Bloomberg via ticker JPAMDREV <Index>.

In addition to the screening criteria above, we applied a proprietary weighting scheme to achieve overall sector weights close to S&P 500 GICS Level I sector weights. As a result, Technology companies BRCM, ADS, FIS, FISV and ADP were included in the basket in spite of their individual upside to the analyst’s price target being less than 10% as of the basket creation date. We also included Materials company NUE, and Consumer Staples companies KR and HSY to achieve this balance. Each of these companies satisfied all of the other criteria and hence were considered for inclusion.

Basket Performance

In this section, we examine the hypothetical performance of the J.P. Morgan US Domestic Revenue Exposure Basket over the last two years. The basket – JPAMDREV <Index> – would have outperformed the S&P 500 (SPX Index) over the past two years. The annualized return of the J.P. Morgan US Domestic Revenue Exposure Basket would have been 26.1% (while the annualized SPX Index return during the same time period was 18.7%). The correlation of the basket to the SPX Index was 93%, and the recent 6M realized volatility of the basket is 12.2% (the realized volatility of the SPX Index over the same time frame was 10.6%). The figures below show the performance and volatility of the J.P. Morgan US Domestic Revenue Exposure Basket vs. that of the SPX Index. The historical beta and correlation of the basket to the SPX Index is also shown in the charts below.

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Figure 210: Hypothetical performance of the J.P. Morgan US Domestic Revenue Exposure Basket and SPX Index (past 2 years)


Figure 211: Daily Returns of the J.P. Morgan US Domestic Revenue Exposure Basket vs. SPX Index return


Figure 212: 6M Realized Volatility of the J.P. Morgan US Domestic Revenue Exposure Basket vs. SPX Index


Figure 213: 6M Beta and 6M Correlation of the J.P. Morgan US Domestic Revenue Exposure Basket vs. SPX Index


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Additional Basket Methodology Information

In order to keep the basket relevant to the investment theme, J.P. Morgan reserves the right to review the following at any time:

Basket methodology. This is to ensure the rules of the basket remain relevant following any structural changes to the theme. This may include ensuring that the sector exposure of the basket remains broadly consistent with the investment theme.

Basket change implementation. J.P. Morgan will consider extending the implementation of changes to the basket composition from one trading session to any period up to five trading sessions in the event that a material increase in the liquidity or capacity of the basket is required to minimize market impact.

Corporate actions may affect the JPAMAIRL, JPAMENRG, JPURFINL, JPAMSYLD and JPAMDREV baskets. The composition of a custom basket is typically adjusted in the following manner:

Cash Merger. The divisor is adjusted and we remove the merging company from the basket on the day of merger and redistribute gains into remaining companies according to recalculated market cap weights of surviving constituents in the basket.

Stock Merger. If the acquirer is a member of the basket, then the weight allocated to the acquired will transfer to the surviving entity on the close of the last day it trades. If the acquirer is not a part of the basket, then proceeds (losses) from the acquired company will be redistributed to the surviving basket constituents based on the recalculated weighting on the close of its last trading day.

Spinoffs. The spinoff company and parent will be included in the basket and both the spinoff and parent company weights will be readjusted according to new market capitalizations after the spinoff date.

Tender Offers & Share Buybacks. The company remains in the basket and its weight is adjusted according to the impact the tender/buyback has on the stock’s market value.

Delisting/Insolvency/Bankruptcy. The company is removed from the basket as of the close of the last trading day, and the proceeds (losses) will be redistributed into remaining companies according to re-calculated weights of remaining companies in the basket. If a stock trades on “pink sheets” it will not be included in the basket.

131



Appendix I: Equity Returns around Initial Rate Hikes

Figure 214: S&P 500 performance during previous tightening cycles

Since 1961, some periods excluded based on rate hike magnitude and other factors

Source: Bloomberg, J.P. Morgan

0.50

0.75

1.00

1.25

1.50

1.75

2.00

-1 0 1 2 3 4 5

S&

P 5

00 P

rice

Ret

urn

(inde

xed

to d

ate

of in

itial

rate

hik

e)

Years

1958

1963

1967

1972

1976

1980

1983

1986

1994

1999

2004

Tightening Average

Tightening Median

S&P LT Average

Initial Rate Hike

1994

1983

1999

1972

2004

Average 12-month S&P 500 Return since 1950: 7.7% Average return in the 12 months surrounding initial ratehikes: 13.8%

132



Appendix II: Expenditures by GDP Category

Components of GDP: C (see Macro section) + I + G + X

Figure 215: Investment Trend by Category

Since 1950


% of Total Private fixed investment Avg monthly since 1999

PRIVATE FIXED INVESTMENT: 200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

Late

st

Med

ian

STD

ev

+/-

STD

ev

from

Av

g

Structures 23% 23% 20% 18% 17% 16% 17% 20% 22% 22% 18% 17% 18% 17% 17% 18% 18% 2.6% -0.2

Commercial and health care 9% 9% 8% 7% 7% 6% 6% 7% 8% 6% 5% 4% 4% 4% 4% 4% 7% 1.7% -1.4

Manufacturing 2% 2% 1% 1% 1% 1% 1% 2% 2% 3% 2% 2% 2% 2% 2% 2% 2% 0.5% 0.1

Power and communication 3% 3% 3% 3% 2% 2% 2% 3% 4% 5% 4% 3% 4% 3% 4% 4% 3% 0.7% 0.5

Mining exploration, shafts, and wells 3% 4% 3% 3% 3% 4% 4% 4% 4% 4% 4% 5% 5% 5% 5% 5% 4% 0.7% 2.0

Other structures 4% 4% 4% 3% 3% 3% 3% 4% 4% 4% 3% 3% 3% 3% 2% 2% 3% 0.7% -1.1

Equipment 31% 31% 30% 30% 30% 31% 33% 34% 34% 32% 36% 39% 38% 38% 39% 39% 32% 3.4% 2.0

Information processing equipment 8% 8% 8% 8% 8% 9% 9% 11% 12% 13% 14% 13% 12% 12% 12% 12% 10% 2.3% 1.1

Industrial equipment 9% 8% 8% 8% 7% 7% 7% 8% 8% 8% 7% 8% 8% 8% 8% 9% 8% 0.5% 1.4

Transportation equipment 9% 8% 8% 7% 7% 8% 8% 8% 6% 3% 7% 8% 9% 9% 10% 10% 8% 1.6% 1.1

Other equipment 7% 7% 8% 8% 8% 8% 8% 8% 8% 8% 9% 9% 9% 9% 9% 8% 8% 0.6% 0.4

Intellectual property products 18% 19% 19% 19% 19% 19% 19% 21% 23% 27% 27% 27% 25% 25% 25% 25% 20% 3.5% 1.4

Software 8% 8% 8% 8% 9% 8% 9% 9% 11% 13% 12% 12% 12% 12% 12% 12% 9% 2.0% 1.4

Research and development 8% 9% 9% 8% 8% 8% 8% 9% 10% 11% 11% 11% 10% 10% 10% 10% 9% 1.2% 1.2

Entertainment, literary, and artistic originals 3% 3% 3% 3% 3% 3% 3% 3% 3% 3% 4% 3% 3% 3% 3% 3% 3% 0.3% 1.0

Residential 28% 28% 31% 33% 34% 33% 30% 25% 20% 19% 19% 18% 18% 20% 19% 19% 27% 6.0% -1.3

Structures 27% 28% 31% 32% 33% 33% 30% 25% 20% 19% 18% 17% 18% 19% 19% 19% 27% 6.0% -1.4

Equipment 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0.0% 0.9

Residual -1% -1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0.7% -0.1


133



Figure 216: Government Spending Trend by Category

Since 1950


Figure 217: Net Exports Trend by Category

Since 1950


% of Total Private fixed investment Avg monthly since 1999

Federal & State/Local Spending 199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

Lat

est

Me

dian

ST

De

v

ST

De

v

fro

m A

vg

Total: Consumption Expenditure 80% 80% 80% 79% 79% 79% 79% 79% 79% 79% 79% 79% 79% 80% 81% 81% 81% 79% 0.7% 2.5

Total: Gross investment 20% 20% 20% 21% 21% 21% 21% 21% 21% 21% 21% 21% 21% 20% 19% 19% 19% 21% 0.7% -2.5

Structures 12% 12% 12% 12% 12% 12% 11% 11% 11% 11% 10% 10% 10% 9% 9% 8% 9% 11% 1.3% -1.8

Equipment 3% 3% 3% 3% 4% 4% 4% 4% 4% 5% 5% 5% 5% 5% 5% 4% 4% 4% 0.7% 0.3

Software 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 0.1% 2.2

Research and development 4% 4% 4% 4% 4% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 0.3% -0.7

Federal Portion: 33% 33% 33% 34% 35% 36% 37% 37% 37% 38% 39% 41% 41% 41% 40% 39% 39% 37% 3.0% 0.6

Consumption expenditures 26% 26% 26% 26% 27% 28% 28% 28% 28% 29% 30% 32% 32% 32% 31% 31% 30% 28% 2.1% 1.0

Structures 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 0.2% -1.8

Equipment 2% 2% 2% 2% 2% 3% 3% 3% 3% 3% 3% 4% 3% 3% 3% 3% 3% 3% 0.6% 0.2

Intellectual property products 4% 4% 4% 4% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 5% 0.3% -0.6

National defense 21% 21% 20% 21% 22% 23% 24% 24% 24% 25% 26% 26% 27% 26% 25% 24% 24% 24% 2.1% 0.2

Nondefense 12% 12% 12% 13% 13% 13% 13% 13% 13% 13% 14% 15% 15% 15% 15% 15% 15% 13% 1.0% 1.4

State and Local Portion: 67% 68% 68% 67% 65% 64% 63% 63% 63% 62% 61% 59% 59% 59% 60% 61% 61% 63% 3.1% -0.6

Residual -1% -1% -1% -1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0.3% 0.4


Net Exports (Exports less Imports) YoY of Change, $'s in billions

Goods & Services 12/99 12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/10 12/11 12/12 12/13 LTM

Foods, feeds, and beverages $1.9 $1 $2 ($1) ($1) ($6) ($10) ($10) $1 $18 $11 $15 $18 $22 $20 $22

Industrial supplies and materials ($78) ($133) ($120) ($115) ($147) ($214) ($297) ($334) ($332) ($412) ($176) ($222) ($280) ($252) ($195) ($182)

Capital goods except automotive $15 $9 $23 $6 ($4) ($19) ($24) ($19) ($16) ($1) $17 ($3) ($19) ($24) ($23) ($34)

Automotive vehicles, parts, and engines ($103) ($115) ($113) ($124) ($129) ($138) ($140) ($149) ($137) ($112) ($77) ($114) ($122) ($152) ($157) ($165)

Consumer goods except food and automotive ($163) ($195) ($199) ($227) ($249) ($275) ($298) ($319) ($334) ($325) ($281) ($320) ($341) ($338) ($346) ($352)

Other general merchandise ($9) ($15) ($16) ($15) ($14) ($14) ($16) ($12) ($9) ($8) ($9) ($10) ($13) ($16) ($19) ($17)

Net exports of goods under merchanting $0 $0 $0 $1 $1 $2 $1 $1 $2 $1 $1 $0 $1 $1 $1 $1

Nonmonetary gold ($1) $0 $1 $0 $1 $0 $1 $3 $4 $5 $4 $3 $17 $18 $17 $9

Maintenance and repair services n.i.e. $3 $2 $4 $4 $3 $3 $4 $3 $4 $4 $6 $7 $6 $7 $9 $11

Transport ($6) ($12) ($12) ($10) ($16) ($21) ($23) ($21) ($13) ($9) ($2) ($3) ($2) ($1) ($3) ($4)

Travel (for all purposes including education) /1/ $33 $34 $26 $22 $18 $18 $21 $21 $30 $41 $38 $50 $61 $61 $68 $71

Insurance services ($6) ($8) ($13) ($18) ($19) ($22) ($21) ($30) ($37) ($46) ($49) ($47) ($41) ($37) ($34) ($33)

Financial services $11 $11 $12 $16 $19 $25 $28 $33 $42 $46 $50 $57 $61 $60 $65 $67

Charges for the use of intellectual property n.i.e. $34 $35 $33 $34 $38 $43 $49 $59 $71 $73 $67 $75 $87 $86 $90 $91

Telecommunications, computer, and information services ($1) ($0) $0 $1 $1 $1 ($0) ($3) ($2) ($2) ($2) ($4) ($4) ($0) $1 ($0)

Other business serv ices $17 $16 $19 $19 $19 $21 $22 $20 $27 $25 $27 $30 $29 $33 $31 $29

Government goods and serv ices n.i.e. ($6) ($5) ($7) ($11) ($14) ($14) ($11) ($8) ($6) ($9) ($10) ($11) ($7) ($4) ($1) ($0)


134



Appendix III: J.P. Morgan Top Stock Picks

J.P. Morgan US 2015 Top Stock Picks

The J.P. Morgan US 2015 Top Picks Basket (JPUSTP15 <Index> on Bloomberg) provides exposure to a selection of US stocks that J.P.Morgan Equity Research analysts have chosen as their top pick for investors in 2015. The rationale for each stock’s selection is provided by the analysts in their individual sector pages in U.S. Year Ahead 2015: Stocks for Every Strategy. For liquidity reasons, we only included those companies that trade at least $5M in ADV, measured over the last three months.

Figure 218: Composition of the J.P. Morgan US 2015 Top Picks Basket – JPUSTP15 <Index>


Ticker Name Industry Group Analyst Wgt (%) PriceMkt. Cap

($M)

3M ADV

($M)

AA ALCOA INC Materials Michael F Gambardella 2.09% 17.21$ 20,288$ 341$

AAL AMERICAN AIRLINE Transportation Jamie N Baker 2.09% 48.24$ 34,601$ 694$

AAP ADVANCE AUTO PAR Retailing Christopher Horvers 2.09% 152.04$ 11,098$ 124$

ALLY ALLY FINANCIAL I Diversified Financials Richard Shane Jr 2.09% 22.70$ 10,892$ 83$

ALSN ALLISON TRANSMIS Capital Goods Ann Duignan 2.09% 33.61$ 5,967$ 66$

ALXN ALEXION PHARM Pharmaceuticals, Biotechnology Anupam Rama 2.09% 198.88$ 39,435$ 225$

BA BOEING CO/THE Capital Goods Joseph B Nadol Iii 2.09% 131.97$ 94,085$ 524$

BMRN BIOMARIN PHARMAC Pharmaceuticals, Biotechnology Cory William Kasimov 2.09% 91.10$ 13,434$ 107$

BMY BRISTOL-MYER SQB Pharmaceuticals, Biotechnology Christopher T Schott 2.09% 59.03$ 97,918$ 392$

BRCM BROADCOM CORP-A Semiconductors & Semiconductor Harlan Sur 2.09% 43.25$ 25,604$ 244$

BWP BOARDWALK PIPELI Energy Jeremy Tonet 2.00% 16.76$ 4,076$ 20$

CAR AVIS BUDGET GROU Transportation Kevin Milota 2.09% 59.81$ 6,355$ 144$

CIEN CIENA CORP Technology Hardw are & Equipmen Rod Hall 2.09% 16.55$ 1,764$ 55$

CMG CHIPOTLE MEXICAN Consumer Services John W Ivankoe 2.09% 651.27$ 20,198$ 274$

D DOMINION RES/VA Utilities Christopher Turnure 2.09% 72.58$ 42,380$ 187$

DIS WALT DISNEY CO Media Alexia S Quadrani 2.09% 93.11$ 157,888$ 653$

FB FACEBOOK INC-A Softw are & Services Douglas Anmuth 2.09% 74.88$ 209,406$ 2,652$

FEYE FIREEYE INC Softw are & Services Sterling Auty 2.09% 30.55$ 4,595$ 232$

FL FOOT LOCKER INC Retailing Matthew Boss 2.09% 57.51$ 8,265$ 130$

GG GOLDCORP INC Materials John Bridges 2.09% 20.63$ 16,824$ 165$

GM GENERAL MOTORS C Automobiles & Components Ryan Brinkman 2.09% 33.34$ 54,049$ 484$

HCA HCA HOLDINGS INC Health Care Equipment & Servic Justin Lake 2.09% 70.60$ 30,610$ 286$

HUM HUMANA INC Health Care Equipment & Servic Justin Lake 2.09% 141.71$ 21,729$ 174$

ILMN ILLUMINA INC Pharmaceuticals, Biotechnology Tycho W Peterson 2.09% 191.25$ 27,158$ 231$

IR INGERSOLL-RAND Capital Goods Steve Tusa 2.09% 63.81$ 16,940$ 135$

JAH JARDEN CORP Consumer Durables & Apparel John A Faucher 2.09% 44.98$ 8,653$ 70$

JAZZ JAZZ PHARMACEUTI Pharmaceuticals, Biotechnology Jessica Fye 2.09% 178.68$ 10,809$ 144$

KLAC KLA-TENCOR CORP Semiconductors & Semiconductor Harlan Sur 2.09% 71.02$ 11,681$ 142$

LPLA LPL FINANCIAL HO Diversified Financials Kenneth B Worthington 2.09% 42.89$ 4,238$ 38$

MAN MANPOWERGROUP IN Commercial & Professional Serv Andrew C Steinerman 2.09% 69.89$ 5,531$ 62$

MAR MARRIOTT INTL-A Consumer Services Joseph R Greff 2.09% 78.14$ 22,142$ 208$

MDT MEDTRONIC INC Health Care Equipment & Servic Michael N Weinstein 2.09% 74.84$ 73,666$ 672$

MGM MGM RESORTS INTE Consumer Services Joseph R Greff 2.09% 22.13$ 10,868$ 203$

MHK MOHAWK INDS Consumer Durables & Apparel Michael Rehaut 2.09% 152.88$ 11,144$ 111$

MNST MONSTER BEVERAGE Food Beverage & Tobacco John A Faucher 2.09% 106.96$ 17,931$ 126$

MOS MOSAIC CO/THE Materials Jeffrey J Zekauskas 2.09% 45.84$ 17,021$ 151$

N NETSUITE INC Softw are & Services Mark R Murphy 2.09% 103.48$ 7,941$ 49$

PCL PLUM CREEK TIMBR Real Estate Tyler Langton 2.09% 41.56$ 7,310$ 51$

PLD PROLOGIS INC Real Estate Michael W Mueller 2.09% 42.71$ 21,355$ 115$

PSX PHILLIPS 66 Energy Phil M Gresh 2.09% 74.83$ 41,419$ 347$

PXD PIONEER NATURAL Energy Joseph D Allman 2.09% 150.73$ 22,443$ 341$

SBAC SBA COMM CORP-A Telecommunication Services Philip Cusick 2.09% 116.34$ 15,019$ 126$

SCTY SOLARCITY CORP Capital Goods Paul T Coster 2.09% 51.74$ 4,967$ 214$

SIVB SVB FINANCIAL GR Banks Steven Alexopoulos 2.09% 106.23$ 5,402$ 41$

TRMB TRIMBLE NAVIG Technology Hardw are & Equipmen Paul T Coster 2.09% 28.75$ 7,446$ 50$

TSN TYSON FOODS-A Food Beverage & Tobacco Kenneth Goldman 2.09% 41.50$ 15,590$ 179$

VNTV VANTIV INC -CL A Softw are & Services Tien-Tsin Huang 2.09% 34.22$ 5,001$ 54$

VRX VALEANT PHARMACE Pharmaceuticals, Biotechnology Christopher T Schott 2.09% 145.27$ 48,458$ 383$



135



J.P. Morgan Top Growth Stock Picks

The J.P. Morgan US 2015 Growth Pick Basket (JPUSGP15 <Index> on Bloomberg) provides exposure to a selection of US stocks that J.P.Morgan Equity Research analysts have chosen as their top Growth picks for investors in 2015. The rationale for each stock’s selection is provided by the analysts in their individual sector pages in U.S. Year Ahead 2015: Stocks for Every Strategy. For liquidity reasons, we only included those companies that trade at least $5M in ADV, measured over the last three months.

Figure 219: Composition of the J.P. Morgan US 2015 Growth Picks Basket – JPUSGP15 <Index>



($M)

3M ADV

($M)

AAL AMERICAN AIRLINE Transportation Jamie N Baker 2.14% 48.24$ 34,601$ 694$

AAP ADVANCE AUTO PAR Retailing Christopher Horvers 2.14% 152.04$ 11,098$ 124$

ALXN ALEXION PHARM Pharmaceuticals, Biotechnology Anupam Rama 2.14% 198.88$ 39,435$ 225$

BA BOEING CO/THE Capital Goods Joseph B Nadol Iii 2.14% 131.97$ 94,085$ 524$

BMRN BIOMARIN PHARMAC Pharmaceuticals, Biotechnology Cory William Kasimov 2.14% 91.10$ 13,434$ 107$

ALKS ALKERMES PLC Pharmaceuticals, Biotechnology Cory William Kasimov 2.14% 57.04$ 8,341$ 50$

BMY BRISTOL-MYER SQB Pharmaceuticals, Biotechnology Christopher T Schott 2.14% 59.03$ 97,918$ 392$

CAR AVIS BUDGET GROU Transportation Kevin Milota 2.14% 59.81$ 6,355$ 144$

CMG CHIPOTLE MEXICAN Consumer Services John W Ivankoe 2.14% 651.27$ 20,198$ 274$

D DOMINION RES/VA Utilities Christopher Turnure 2.14% 72.58$ 42,380$ 187$

DD DU PONT (EI) Materials Jeffrey J Zekauskas 2.14% 72.25$ 65,455$ 371$

DIS WALT DISNEY CO Media Alexia S Quadrani 2.14% 93.11$ 157,888$ 653$

ESNT ESSENT GROUP LTD Banks Richard Shane Jr 0.99% 24.98$ 2,311$ 10$

FB FACEBOOK INC-A Softw are & Services Douglas Anmuth 2.14% 74.88$ 209,406$ 2,652$

FEYE FIREEYE INC Softw are & Services Sterling Auty 2.14% 30.55$ 4,595$ 232$

GG GOLDCORP INC Materials John Bridges 2.14% 20.63$ 16,824$ 165$

HAR HARMAN INTL Consumer Durables & Apparel Ryan Brinkman 2.14% 107.49$ 7,365$ 84$

HUM HUMANA INC Health Care Equipment & Servic Justin Lake 2.14% 141.71$ 21,729$ 174$

ILMN ILLUMINA INC Pharmaceuticals, Biotechnology Tycho W Peterson 2.14% 191.25$ 27,158$ 231$

INFN INFINERA CORP Technology Hardw are & Equipmen Rod Hall 2.14% 14.62$ 1,832$ 36$

JAZZ JAZZ PHARMACEUTI Pharmaceuticals, Biotechnology Jessica Fye 2.14% 178.68$ 10,809$ 144$

LRCX LAM RESEARCH Semiconductors & Semiconductor Harlan Sur 2.14% 84.02$ 13,384$ 159$

MAR MARRIOTT INTL-A Consumer Services Joseph R Greff 2.14% 78.14$ 22,142$ 208$

MCK MCKESSON CORP Health Care Equipment & Servic Lisa C Gill 2.14% 211.50$ 49,043$ 212$

CVS CVS HEALTH CORP Food & Staples Retailing Lisa C Gill 2.14% 89.14$ 102,189$ 393$


WYNN WYNN RESORTS LTD Consumer Services Joseph R Greff 2.14% 169.57$ 17,186$ 321$

MHK MOHAWK INDS Consumer Durables & Apparel Michael Rehaut 2.14% 152.88$ 11,144$ 111$

CSTE CAESARSTONE SDOT Materials Michael Rehaut 1.32% 60.55$ 2,111$ 13$

MNST MONSTER BEVERAGE Food Beverage & Tobacco John A Faucher 2.14% 106.96$ 17,931$ 126$

MU MICRON TECH Semiconductors & Semiconductor Harlan Sur 2.14% 36.10$ 38,752$ 912$

N NETSUITE INC Softw are & Services Mark R Murphy 2.14% 103.48$ 7,941$ 49$

NAV NAVISTAR INTL Capital Goods Ann Duignan 2.14% 37.59$ 3,059$ 26$

NKE NIKE INC -CL B Consumer Durables & Apparel Matthew Boss 2.14% 98.50$ 84,859$ 375$

TJX TJX COS INC Retailing Matthew Boss 2.14% 65.86$ 45,637$ 274$

VFC VF CORP Consumer Durables & Apparel Matthew Boss 2.14% 74.25$ 32,205$ 122$

PAGP PLAINS GP HOLD-A Energy Jeremy Tonet 2.14% 25.99$ 15,985$ 46$

PAY VERIFONE SYSTEMS Softw are & Services Tien-Tsin Huang 2.14% 35.81$ 4,049$ 58$

PLD PROLOGIS INC Real Estate Michael W Mueller 2.14% 42.71$ 21,355$ 115$

CBG CBRE GROUP INC-A Real Estate Anthony Paolone 2.14% 32.96$ 10,971$ 59$

PRGO PERRIGO CO PLC Pharmaceuticals, Biotechnology Christopher T Schott 2.14% 159.58$ 22,465$ 155$

PXD PIONEER NATURAL Energy Joseph D Allman 2.14% 150.73$ 22,443$ 341$

SBAC SBA COMM CORP-A Telecommunication Services Philip Cusick 2.14% 116.34$ 15,019$ 126$

SCTY SOLARCITY CORP Capital Goods Paul T Coster 2.14% 51.74$ 4,967$ 214$

SIVB SVB FINANCIAL GR Banks Steven Alexopoulos 2.14% 106.23$ 5,402$ 41$

SPNC SPECTRANETICS Health Care Equipment & Servic Christopher Pasquale 1.41% 31.08$ 1,303$ 14$

UHS UNIVERSAL HLTH-B Health Care Equipment & Servic Justin Lake 2.14% 105.86$ 10,478$ 134$

VRSK VERISK ANALYTI-A Commercial & Professional Serv Andrew C Steinerman 2.14% 62.66$ 10,334$ 35$


136



J.P. Morgan Top Value Stock Picks

The J.P. Morgan US 2015 Value Picks Basket (JPUSVP15 <Index> on Bloomberg) provides exposure to a selection of US stocks that J.P.Morgan Equity Research analysts have chosen as their top Value picks for investors in 2015. The rationale for each stock’s selection is provided by the analysts in their individual sector pages in U.S. Year Ahead 2015: Stocks for Every Strategy. For liquidity reasons, we only included those companies that trade at least $5M in ADV, measured over the last three months.

Figure 220: Composition of the J.P. Morgan US 2015 Value Picks Basket – JPUSVP15 <Index>



($M)

3M ADV

($M)

AA ALCOA INC Materials Michael F Gambardella 2.50% 17.21$ 20,288$ 341$

ALLY ALLY FINANCIAL I Diversified Financials Richard Shane Jr 2.50% 22.70$ 10,892$ 83$

ALSN ALLISON TRANSMIS Capital Goods Ann Duignan 2.50% 33.61$ 5,967$ 66$

AMAT APPLIED MATERIAL Semiconductors & Semiconductor Harlan Sur 2.50% 24.59$ 29,930$ 332$

APOL APOLLO EDUCATION Consumer Services Jeffrey Y Volshteyn 2.50% 32.21$ 3,496$ 41$

ATO ATMOS ENERGY Utilities Christopher Turnure 2.50% 54.46$ 5,467$ 32$

BRCM BROADCOM CORP-A Semiconductors & Semiconductor Harlan Sur 2.50% 43.25$ 25,604$ 244$

BVN BUENAVENTURA-ADR Materials John Bridges 1.86% 10.38$ 2,861$ 19$

BWP BOARDWALK PIPELI Energy Jeremy Tonet 2.00% 16.76$ 4,076$ 20$

CCK CROWN HOLDINGS I Materials Tyler Langton 2.50% 51.23$ 7,117$ 52$

CFG CITIZENS FINANCI Banks Vivek Juneja 2.50% 24.23$ 13,222$ 71$

CI CIGNA CORP Health Care Equipment & Servic Justin Lake 2.50% 104.03$ 27,212$ 168$

CIEN CIENA CORP Technology Hardw are & Equipmen Rod Hall 2.50% 16.55$ 1,764$ 55$

CNK CINEMARK HOLDING Media Tow nsend Buckles 1.64% 35.36$ 4,091$ 16$

CNX CONSOL ENERGY Energy Joseph D Allman 2.50% 37.69$ 8,675$ 114$

ESRX EXPRESS SCRIPTS Health Care Equipment & Servic Lisa C Gill 2.50% 84.30$ 61,869$ 307$

FL FOOT LOCKER INC Retailing Matthew Boss 2.50% 57.51$ 8,265$ 130$

GM GENERAL MOTORS C Automobiles & Components Ryan Brinkman 2.50% 33.34$ 54,049$ 484$

HCA HCA HOLDINGS INC Health Care Equipment & Servic Justin Lake 2.50% 70.60$ 30,610$ 286$

IR INGERSOLL-RAND Capital Goods Steve Tusa 2.50% 63.81$ 16,940$ 135$

JAH JARDEN CORP Consumer Durables & Apparel John A Faucher 2.50% 44.98$ 8,653$ 70$

KEY KEYCORP Banks Steven Alexopoulos 2.50% 13.32$ 11,539$ 143$

LPLA LPL FINANCIAL HO Diversified Financials Kenneth B Worthington 2.50% 42.89$ 4,238$ 38$

LQ LA QUINTA HOLDIN Consumer Services Joseph R Greff 1.88% 22.19$ 2,901$ 19$

MAN MANPOWERGROUP IN Commercial & Professional Serv Andrew C Steinerman 2.50% 69.89$ 5,531$ 62$

MCD MCDONALDS CORP Consumer Services John W Ivankoe 2.50% 95.50$ 92,941$ 582$


MIK MICHAELS COS INC Retailing Christopher Horvers 1.44% 23.56$ 4,805$ 14$

MOS MOSAIC CO/THE Materials Jeffrey J Zekauskas 2.50% 45.84$ 17,021$ 151$

MSFT MICROSOFT CORP Softw are & Services John Difucci 2.50% 48.08$ 396,316$ 1,688$

PFE PFIZER INC Pharmaceuticals, Biotechnology Christopher T Schott 2.50% 31.75$ 200,046$ 795$

PSX PHILLIPS 66 Energy Phil M Gresh 2.50% 74.83$ 41,419$ 347$

CVE CN CENOVUS ENERGY Energy Phil M Gresh 2.50% 22.95$ 17,370$ 101$

PTC PTC INC Softw are & Services Sterling Auty 2.50% 38.72$ 4,491$ 29$

SPR SPIRIT AEROSYS-A Capital Goods Joseph B Nadol Iii 2.50% 43.73$ 6,176$ 51$

TDS TELEPHONE & DATA Telecommunication Services Philip Cusick 1.23% 24.84$ 2,680$ 12$

TRMB TRIMBLE NAVIG Technology Hardw are & Equipmen Paul T Coster 2.50% 28.75$ 7,446$ 50$

TSN TYSON FOODS-A Food Beverage & Tobacco Kenneth Goldman 2.50% 41.50$ 15,590$ 179$

VNTV VANTIV INC -CL A Softw are & Services Tien-Tsin Huang 2.50% 34.22$ 5,001$ 54$

VRX VALEANT PHARMACE Pharmaceuticals, Biotechnology Christopher T Schott 2.50% 145.27$ 48,458$ 383$

XEC CIMAREX ENERGY C Energy Joseph D Allman 2.50% 108.17$ 9,438$ 160$

YHOO YAHOO! INC Softw are & Services Douglas Anmuth 2.50% 50.28$ 47,633$ 1,896$


137



J.P. Morgan Top Income Stock Picks

The J.P. Morgan US 2015 Income Picks Basket (JPUSIP15 <Index> on Bloomberg) provides exposure to a selection of US stocks that J.P.Morgan Equity Research analysts have chosen as their top Income picks for investors in 2015. The rationale for each stock’s selection is provided by the analysts in their individual sector pages in U.S. Year Ahead 2015: Stocks for Every Strategy. For liquidity reasons, we only included those companies that trade at least $5M in ADV, measured over the last three months.

Figure 221: Composition of the J.P. Morgan US 2015 Income Picks Basket – JPUSIP15 <Index>


Appendix IV: Recoveries and Market Peaks

This recovery has some further room to go. Examining 100+ years of history and all of the macro data available to us, 19 of the largest bull market peaks were preceded by a macro environment different from the one we are in today. Various indicators were examined, including short-term and long-term rates, yield curve behavior, inflation, oil price, profit margins and growth indicators. On average, a significant majority of these indicators were raising a red flag at previous market peaks. Today, however, of those indicators only the yield curve spread (narrow in historical terms and has been flattening) is worrisome for US equities. While that typically is seen as a negative for equity markets, technicals may be causing this dynamic currently—global yield scarcity (e.g. very low Bund yield exerting downward pressure on the US 10Yr yield). - See table Figure 222.


($M)

3M ADV

($M)

ACN ACCENTURE PLC-A Softw are & Services Tien-Tsin Huang 4.45% 86.52$ 57,627$ 254$

AMGN AMGEN INC Pharmaceuticals, Biotechnology Geoffrey Meacham 4.45% 168.07$ 127,846$ 664$

BBT BB&T CORP Banks Vivek Juneja 4.45% 37.96$ 27,343$ 155$

CCI CROWN CASTLE INT Real Estate Philip Cusick 4.45% 79.90$ 26,675$ 269$

DIN DINEEQUITY INC Consumer Services John W Ivankoe 4.03% 97.90$ 1,856$ 20$

DNR DENBURY RESOURCE Energy Joseph D Allman 4.45% 7.74$ 2,729$ 67$

DUK DUKE ENERGY CORP Utilities Christopher Turnure 4.45% 81.97$ 57,977$ 288$

GLW CORNING INC Technology Hardw are & Equipmen Rod Hall 4.45% 21.54$ 27,611$ 178$

GPC GENUINE PARTS CO Retailing Mark Becks 4.45% 103.45$ 15,837$ 62$

HON HONEYWELL INTL Capital Goods Steve Tusa 4.45% 99.97$ 78,258$ 298$

IRM IRON MOUNTAIN Real Estate Andrew C Steinerman 4.45% 37.50$ 7,264$ 95$

KLAC KLA-TENCOR CORP Semiconductors & Semiconductor Harlan Sur 4.45% 71.02$ 11,681$ 141$

MDT MEDTRONIC INC Health Care Equipment & Servic Michael N Weinstein 4.45% 74.84$ 73,666$ 672$

NS NUSTAR ENERGY LP Energy Jeremy Tonet 4.45% 56.26$ 4,382$ 35$

OMC OMNICOM GROUP Media Alexia S Quadrani 4.45% 77.92$ 19,338$ 120$

PCAR PACCAR INC Capital Goods Ann Duignan 4.45% 70.76$ 25,056$ 141$

PCL PLUM CREEK TIMBR Real Estate Tyler Langton 4.45% 41.56$ 7,310$ 51$

PEP PEPSICO INC Food Beverage & Tobacco John A Faucher 4.45% 98.32$ 147,146$ 451$

PG PROCTER & GAMBLE Household & Personal Products John A Faucher 4.45% 90.00$ 243,191$ 723$

STAG STAG INDUSTRIAL Real Estate Michael W Mueller 2.44% 23.82$ 1,720$ 12$

EPR EPR PROPERTIES Real Estate Anthony Paolone 4.45% 56.32$ 3,219$ 24$

TXN TEXAS INSTRUMENT Semiconductors & Semiconductor Harlan Sur 4.45% 55.62$ 58,751$ 390$

WAG WALGREEN CO Food & Staples Retailing Lisa C Gill 4.45% 67.38$ 63,708$ 367$


138



Figure 222: Market cycle risk factors at market peaks

Since 1909

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

Since the Financial Crisis trough the S&P 500 is up 207% over almost 6 years, and since the European Debt Crisis trough the market is up 89% over little more than 3 years. In comparison, all recoveries since 1900 have yielded a mean return of 109% with a mean duration of 46 months. However, recoveries characterized by lower inflation and solid growth, similar to that of today, have on average been higher in magnitude at 140% return and longer in duration at almost 6 years. While it is premature to draw any substantial conclusion from such simplistic observations, we understand the concern of investors who wonder how close the equity market is to its cyclical peak. - See Figure 223.

Figure 223: Historical bull market statistics

Month-end data since 1907

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

Nov

- 19

09

Nov

- 19

16

Nov

- 19

19

Sep

- 19

29

Mar

- 19

37

Nov

- 19

38

May

- 19

46

Jul -

195

7

Dec

- 19

61

Feb

- 196

6

Nov

- 19

68

Jan

- 197

3

Sep

- 19

76

Nov

- 19

80

Aug

- 19

87

Jul -

199

0

Mar

- 20

00

Oct

- 20

07

Apr

- 20

11

Today

Indicator

Strength

Fed Funds Rate high or rising ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ 75%

10 Yr Bond Yield above trend ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ 68%

Flat or Flattening Yield Curve ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ 93%

High or Negative Inflation (CPI) ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ 68%

Spike in Oil Price (inflation-adjusted) ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ 74%

Declining EPS / GDP, Y/Y ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ 68%

ISM declining or at extremes ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ 67%

Hit % (Average = 72%) 75% 75% 100% 25% 40% 60% 80% 57% 57% 71% 71% 86% 100% 100% 71% 100% 86% 86% 29% 14%

Valuation (CAPE) 14.7x 12.1x 6.5x 32.6x 22.0x 16.1x 16.0x 13.0x 22.0x 23.7x 22.2x 18.7x 11.8x 9.1x 18.3x 17.7x 43.2x 27.3x 21.8x 27.3x

She

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Ant

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WW

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infla

tion

Gre

at D

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Pos

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Uni

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Rec

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Cub

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Forg

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Oil

Cris

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tnam

Tig

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Iran

Ene

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Bla

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Bub

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Glo

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risis

Peak of bull market cycle

= data not available / not comparable

Duration Price At At At At At At At At At At

Start End (mos) Return (%) Start End Start End Start End Start End Start End

Nov 1907 Nov 1909 24 +63% 9.4x 13.7x +4.3x 10.6x 14.7x +4.1x 1.1% -3.2% -428 bp 1.1% -3.2% -428 bp 2.1% 10.6% +851 bp

Dec 1914 Nov 1916 23 +39% 14.1x 6.9x -7.2x 10.2x 12.1x +1.9x 1.0% 16.6% +1560 bp 1.0% 16.6% +1560 bp -7.6% 11.7% +1927 bp

Dec 1917 Nov 1919 23 +35% 5.3x 9.8x +4.5x 6.4x 6.5x +0.1x 18.1% -8.9% -2700 bp 18.1% -8.9% -2700 bp 1.9% 13.1% +1119 bp

Aug 1921 Sep 1929 97 +385% 14.0x 20.2x +6.1x 5.2x 32.6x +27.4x -12.8% 7.4% +2021 bp -12.8% 7.4% +2021 bp -1.1% 1.2% +233 bp

Jul 1932 Mar 1937 56 +261% 10.2x 16.3x +6.1x 5.8x 22.0x +16.2x -9.9% 5.7% +1563 bp -9.9% 5.7% +1563 bp -14.6% 2.2% +1685 bp

Mar 1938 Nov 1938 8 +27% 10.6x 20.6x +10.0x 12.4x 16.1x +3.7x -0.7% -2.7% -200 bp -0.7% -2.7% -200 bp -5.4% -4.1% +125 bp

Apr 1942 May 1946 49 +139% 7.7x 21.7x +14.1x 8.5x 16.0x +7.5x 12.6% -2.9% -1549 bp 12.6% -2.9% -1549 bp 13.9% 3.4% -1045 bp

Jun 1949 Jul 1957 97 +87% 5.8x 10.9x +5.0x 9.1x 13.0x +3.9x -0.4% 5.4% +582 bp -0.4% 5.4% +582 bp -1.0% 3.3% +430 bp

Oct 1957 Dec 1961 50 +74% 12.0x 22.5x +10.5x 14.1x 22.0x +7.9x 2.9% 6.4% +349 bp 2.9% 6.4% +349 bp 3.1% 0.7% -240 bp

Jun 1962 Feb 1966 44 +67% 16.0x 17.5x +1.5x 16.8x 23.7x +6.9x 1.3% 8.5% +716 bp 1.3% 8.5% +716 bp 6.7% 1.9% -480 bp

Oct 1966 Nov 1968 25 +37% 14.0x 18.4x +4.4x 18.8x 22.2x +3.4x 3.5% 5.3% +182 bp 3.5% 5.3% +182 bp 6.1% 4.7% -140 bp

May 1970 Jan 1973 32 +56% 13.7x 18.1x +4.4x 14.0x 18.7x +4.7x 6.0% 6.9% +86 bp 6.0% 6.9% +86 bp 0.3% 3.4% +310 bp

Oct 1974 Sep 1976 23 +52% 7.7x 11.0x +3.4x 8.7x 11.8x +3.1x 11.9% 5.0% -695 bp 11.9% 5.0% -695 bp -0.6% 5.5% +610 bp

Mar 1978 Nov 1980 32 +30% 8.1x 7.6x -0.5x 9.0x 9.1x +0.1x 6.4% 1.3% -513 bp 6.4% 1.3% -513 bp 4.1% 12.6% +850 bp

Aug 1982 Aug 1987 60 +200% 8.0x 21.4x +13.4x 6.6x 18.3x +11.7x 6.4% 3.4% -304 bp 6.4% 3.4% -304 bp -1.2% 4.3% +550 bp

Oct 1987 Jul 1990 33 +28% 17.1x 16.8x -0.3x 15.5x 17.7x +2.2x 4.5% 2.5% -203 bp 4.5% 2.5% -203 bp 3.3% 4.8% +150 bp

Oct 1990 Mar 2000 113 +370% 14.2x 28.3x +14.1x 14.8x 43.2x +28.4x 6.2% 4.2% -196 bp 6.2% 4.2% -196 bp 1.7% 3.8% +210 bp

Oct 2002 Oct 2007 60 +80% 29.0x 20.7x -8.4x 22.0x 27.3x +5.3x 1.5% 2.3% +79 bp 1.5% 2.3% +79 bp 2.3% 2.8% +50 bp

Mar 2009 Apr 2011 25 +58% 110.4x 19.0x -91.4x 13.3x 21.8x +8.5x 0.2% 1.6% +136 bp 0.2% 1.6% +136 bp -3.5% 3.2% +670 bp

Average 46 109% 17.1x 17.0x -0.1x 12.1x 18.5x +6.4x 3.2% 3.4% +117 bp 3.2% 3.4% +117 bp 0.6% 4.7% +360 bp

Median 36 65% 12.8x 18.0x +5.1x 11.5x 18.0x +6.5x 3.2% 3.8% +239 bp 3.2% 3.8% +239 bp 1.5% 3.4% +159 bp

Mar 2009 Dec 2014 69 207% 110.4x 17.9x -92.5x 13.3x 27.2x +13.9x 0.2% 2.4% +216 bp 0.2% 2.4% +216 bp -3.5% 1.7% +520 bp

Oct 2011 Dec 2014 38 89% 13.9x 17.9x +4.0x 20.1x 27.2x +7.1x 3.9% 2.4% -147 bp 3.9% 2.4% -147 bp 1.2% 1.7% +50 bp

Bull Market Period Inflation - CPI (Y/Y)US GDP (Real, Y/Y)CAPE

+/-

Change

+/-

Change

+/-

Change

US GDP (Real, Y/Y)

+/- Change

P/E (LTM)

+/- Change

139



Appendix V: History of Shiller’s CAPE

Figure 224: Decomposition of Shiller CAPE

Since 1880

Source: Shiller, Bloomberg, J.P. Morgan

Figure 225: Shiller CAPE Period Detail1880-1899


Figure 226: Shiller CAPE Period Detail1900-1951


27.1x44.0x

32.4x

y = 20.09xR² = 0.73

80

800

8 80

Rea

l Pric

e

Cyclically Adjusted Real Earnings

2000-Present

1980-1999

1960-1979

1940-1959

1920-1939

1900-1919

1880-1899

1929

1987

2000

2008

Average inflation = 6.0% (1969 - 1992)

Average inflation = 2.4% (1993 - Present)

Average inflation = 2.0% (1960 - 1968)

2.94%

0

1

2

3

4

5

6

7

8

5

10

15

20

25

30

35

40

45

50

-15% -10% -5% 0% 5% 10% 15% 20% 25%

CA

PE

Inflation (CPI)

Average deflation = -0.5% (1880 - 1889)

From hyper-inflation (max CPI 23.7%) to hyper-deflation (min CPI -15.8%) (1905 - 1950)

Current

120

140

160

180

200

220

240

8.20

Rea

l Pri

ce


1898-1899

1896-1897

1894-1895

1892-1893

1890-1891

1888-1889

1886-1887

1884-1885

1882-1883

1880-1881

1880

1899

80

240

720

9.50

Rea

l Pri

ce


1948-1951

1944-1947

1940-1943

1936-1939

1932-1935

1928-1931

1924-1927

1920-1923

1916-1919

1912-1915

1908-1911

1904-1907

1900-1903

19511900

140



Risks of Common Option Strategies

Risks to Strategies: Not all option strategies are suitable for investors; certain strategies may expose investors to significant potential losses. We have summarized the risks of selected derivative strategies. For additional risk information, please call your sales representative for a copy of “Characteristics and Risks of Standardized Options.” We advise investors to consult their tax advisors and legal counsel about the tax implications of these strategies. Please also refer to option risk disclosure documents.

Put Sale: Investors who sell put options will own the underlying asset if the asset’s price falls below the strike price of the put option. Investors, therefore, will be exposed to any decline in the underlying asset’s price below the strike potentially to zero, and they will not participate in any price appreciation in the underlying asset if the option expires unexercised.

Call Sale: Investors who sell uncovered call options have exposure on the upside that is theoretically unlimited.

Call Overwrite or Buywrite: Investors who sell call options against a long position in the underlying asset give up any appreciation in the underlying asset’s price above the strike price of the call option, and they remain exposed to the downside of the underlying asset in the return for the receipt of the option premium.

Booster : In a sell-off, the maximum realized downside potential of a double-up booster is the net premium paid. In a rally, option losses are potentially unlimited as the investor is net short a call. When overlaid onto a long position in the underlying asset, upside losses are capped (as for a covered call), but downside losses are not.

Collar: Locks in the amount that can be realized at maturity to a range defined by the put and call strike. If the collar is not costless, investors risk losing 100% of the premium paid. Since investors are selling a call option, they give up any price appreciation in the underlying asset above the strike price of the call option.

Call Purchase: Options are a decaying asset, and investors risk losing 100% of the premium paid if the underlying asset’s price is below the strike price of the call option.

Put Purchase: Options are a decaying asset, and investors risk losing 100% of the premium paid if the underlying asset’s price is above the strike price of the put option.

Straddle or Strangle: The seller of a straddle or strangle is exposed to increases in the underlying asset’s price above the call strike and declines in the underlying asset’s price below the put strike. Since exposure on the upside is theoretically unlimited, investors who also own the underlying asset would have limited losses should the underlying asset rally. Covered writers are exposed to declines in the underlying asset position as well as any additional exposure should the underlying asset decline below the strike price of the put option. Having sold a covered call option, the investor gives up all appreciation in the underlying asset above the strike price of the call option.

Put Spread: The buyer of a put spread risks losing 100% of the premium paid. The buyer of higher-ratio put spread has unlimited downside below the lower strike (down to zero), dependent on the number of lower-struck puts sold. The maximum gain is limited to the spread between the two put strikes, when the underlying is at the lower strike. Investors who own the underlying asset will have downside protection between the higher-strike put and the lower-strike put. However, should the underlying asset’s price fall below the strike price of the lower-strike put, investors regain exposure to the underlying asset, and this exposure is multiplied by the number of puts sold.

Call Spread: The buyer risks losing 100% of the premium paid. The gain is limited to the spread between the two strike prices. The seller of a call spread risks losing an amount equal to the spread between the two call strikes less the net premium received. By selling a covered call spread, the investor remains exposed to the downside of the underlying asset and gives up the spread between the two call strikes should the underlying asset rally.

Butterfly Spread: A butterfly spread consists of two spreads established simultaneously – one a bull spread and the other a bear spread. The resulting position is neutral, that is, the investor will profit if the underlying is stable. Butterfly spreads are established at a net debit. The maximum profit will occur at the middle strike price; the maximum loss is the net debit.

Pricing Is Illustrative Only: Prices quoted in the above trade ideas are our estimate of current market levels, and are not indicative trading levels.

141



Corrected Note: Update: Naming convention for the Americas baskets in the report was updated.

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General: Additional information is available upon request. Information has been obtained from sources believed to be reliable but JPMorgan Chase & Co. or its affiliates and/or subsidiaries (collectively J.P. Morgan) do not warrant its completeness or accuracy except with respect to any disclosures relative to JPMS and/or its affiliates and the analyst's involvement with the issuer that is the subject of the research. All pricing is as of the close of market for the securities discussed, unless otherwise stated. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. The recipient of this report must make its own independent decisions regarding any securities or financial instruments mentioned herein. JPMS distributes in the U.S. research published by non-U.S. affiliates and accepts responsibility for its contents. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information. Clients should contact analysts and execute transactions through a J.P. Morgan subsidiary or affiliate in their home jurisdiction unless governing law permits otherwise.

"Other Disclosures" last revised November 29, 2014.

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