From: US GIO

From: US GIO To: Undisclosed recipients:; Subject: J.P. Morgan Macro Skinny: more signs of stabilization in the global cycle Date: Wed, 03 Oct 2012 22:24:48 +0000 Importance: high Attachments: 2012-10-03_Stabilization_in_the_global_cycle.pdf Inline-Images: image001.jpg; image002.png; image003.png; image004.png; image005.png; image006.png; image007.png; image008.png; image009.png; image010.png; image01 1.png; image012.png Macro Skinny J.P.Morgan October 3, 2012 More signs of stabilization in the global cycle 1/ Back in July, we were looking for more signs of stabilization in two of the macro risk factors we regularly watch. First, we argued that the ECB policy shift had the potential of reversing some of the cyclical damage from the European crisis. Second, we thought the substantial drag on US growth from domestic-related manufacturing (largely from the auto sector) was about to fade( II. As for the third risk factor—China—we argued that the case for a hard landing would weaken substantially once the damage to Chinese manufacturing from the European crisis waned. We have seen important progress: a modest ECB-led improvement in global manufacturing is finally visible on the chart, and independently, domestic US activity is bottoming out as well. These moves are still small, but very important nonetheless. EFTA01181637 Sill on track for a modest ECB-led sentiment recovery Manufacturing PMI. 50+=expansion 65 60 55 50 45 40 35 30 2005 2006 2007 2008 2009 2010 Source MorganSecurkiesLLC,Markit. 2011 2012 Sentiment improving in most of the Euro Area Manufacturing PRI'. 50+=expansion 60 55 50 45 40 35 30 2005 2006 2007 Source: M. Morgan Private Bank, HaverAnalytics —Older Core Periphery —Inner Core 2008 2009 2010 2011 2012 2/ European business indicators are still 'all over the place', but with a generally better undertone. September PMIs indicate a meaningful recovery in sentiment within the 'inner core' (Germany and Netherlands) and the periphery. However, the 'outer core' (France and Austria) shows a material deterioration in business sentiment (second chart above). Germany sentiment appears to be mixed as well—the Ifo index, a competing indicator to the PMI—has continued to fall. But there are good reasons to discount the negatives: the German Ifo tends to lag the German PMI around turning points[2], and sentiment in France was probably held back by recent tax hikes, rather than reflecting a deepening slowdown. On the whole, ECB policy is finally starting to lift European business sentiment from very depressed levels. The state of European growth should gradually emerge from 'recession' to 'anemic'. 3/ US data are equally messy, but here too things look slightly better beneath the surface. On the negative side, durable goods orders have now collapsed to recessionary levels, and hiring remains very weak. A closer look, however, suggests that the weakness in these two key areas is not domestic-related but largely a reflection of weak external demand caused by the European crisis[3]. Based on the September ISM surveys, domestic-related manufacturing, as well as domestic services and construction are all improving at a moderate pace. And as Europe normalizes somewhat, external demand will likely provide an extra lift to US manufacturing going forward. The labor market stands to benefit too. Bottom line: US activity will likely be stronger in the coming months, without the help of Europe (yet). Growth however is unlikely to move sustainably above 2%—our notion of trend growth, particularly as fiscal cliff issues still loom. EFTA01181638 US: new orders were held back by foreign demand Manufacturing PMI, 50+=expansion 70 Domestic orders 65 60 55 50 45 40 35 30 25 20 2007 2008 2009 Source:ISM,. Morgan Private Bank. 2010 2011 2012 Export orders Housing and other non-mfgr. sectors have softened the drag Purchasing Managers Index, 50+=expansion 65 Manufacturing 60 55 50 45 40 35 30 25 2005 2006 2007 Source: Institute for Supply Management. 2008 2009 2010 2011 2012 Nonmanufacturing 4/At some point the fiscal cliff will move to the forefront and start interfering with the ECB-led cyclical improvement. Our baseline is that after the elections a lame duck congress will push the cliff out from year-end to the March-June period. Clearly one cannot guarantee that this process will be smooth enough to keep markets calm around year-end; we will just have to live with a chance of political brinkmanship. Unlike late last year, when congressional discord was partly motivated by the upcoming elections, we may see less political posturing after November 6th. Our baseline scenario calls for a meaningful fiscal drag on US growth in the second half of next year. On this basis, we anticipate growth will average around 1.5% in 2013. 5/ Cyclical markets, such as industrial metals and emerging markets (fic and equities) have started to price a bottoming out scenario for the global industrial cycle. This move is consistent with recent signals of improving momentum from depressed levels of economic activity. Interestingly though, US equities are somewhat more hesitant in interpreting the recent macro news as the start of a `cyclical lift', though they should continue to benefit from the `monetary lift'. On Monday, Bernanke reiterated the importance of purchasing high-duration securities as a means of pushing investors to rebalance towards corporate bonds, stocks and housing. Financial wealth is the new `Fed Funds Rate', it appears. Not surprisingly, our models suggest that in recent quarters the outperformance of the US stock market, above and beyond what was justified by the cyclical picture, has been predominantly explained by the amount of duration `scooped up' by the Fed. EFTA01181639 100 The S&P 500 has decoupled from its own growth view... Index. 911/2010:100 140 130 120 110 100 90 80 Sep-2010 Source:Bloomberg. Data as of Sep-28-2012.•longcychcats short defensrves Mar-2011 Sep-2011 Mar-2012 Sep-2012 and this divergence is very large in a historical context Index (both axes) 160 1800 140 1600 S&P 500 1400 1200 1000 80 40 20 0 1998 2000 2002 2004 2006 2008 2010 2012 Sou cc Bloomberg. Data as of Sep-28-2012. Michael Vaknin Chief Economist, Morgan Private Bank Paul Eitelman Associate Economist, Morgan Private Bank Jeff Greenberg Associate Economist, Morgan Private Bank Acronyms: ECB — European Central Bank ISM - Institute for Supply Management LTCM — Long-Term Capital Management PMI — Purchasing Managers Index QE — Quantitative Easing [I] The auto sector geared up production earlier this year, `unaware' that most of the auto demand was related to last years' supply shortage (due to the Japanese earthquake). The resulting boom-bust in auto production generated a significant growth drag in Q2/early•Q3, which is now turning (see charts below). EFTA01181640 Car sales moving beyond the soft patch Light weight vehicle sales, millions of units 15.0 14.5 14.0 13.5 13.0 12.6 12.0 11.5 Sep-11 Jan-11 May-11 Sou ce: BE4/Ward's. Jan-12 May-12 Sep-12 US auto sector to lift GDP growth again Contribution of motor vehicle output to GDP growth, 96 points 0.8 - 0.7 - 0.6 - 0.5- 0.4 - 03 - 0.2 - 0.1 - 0.0 2011:03 2011:04 2012:01 2012:02 2012:Q3 Source: BEA/Ward's, 1.1 Morgan Private Bank. (est.) [2) The mixed signal from the German Ifo and the German PMI (left chart) is hard to reconcile as these two sentiment indicators are equally 'credible' over the long sample. That said, around turning points, the PMI appears to lead the Ifo (the post-Lehman trough is excluded, but there too, the PMI led the Ifo). EFTA01181641 German PMI moves higher in September, bucking the IFO Manufacuring PMI, 50+=expansion Index, 2005=100 65 60 55 50 45 40 35 30 25 2005 2006 2007 2008 2009 2010 2011 Source: Mark it, Institut fur Winschaftsforschung. 2012 German PMI moves faster than the IFO in recoveries Index, average of LTCM, 2001 and 2005 recoveries (both axes) 56 54 52 50 48 46 44 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 Months sincetroughin PMI Source: Mark it, In stitut fur Wirtschaltsforschung. [3] The slowdown in US manufacturing goods exports in July supports this thesis, but the August export data am not yet available to confirm it. The more-timely Korean trade data offers a good hint: Korean imports from the United States plummeted in August, broadly in line with the sharp decline in durable goods (chart below). This too supports our thesis that the cyclical weakness in the US was largely 'imported'. The collapse in core durable goods orders is consistent with weak external demand, Billions of USD (both axes), 3m avg 70 4.5 130 125 120 115 110 106 100 95 90 85 80 103 t02 101 100 99 98 97 96 Core durable goods orders 48-4.0 3.5 3.0 2.5 2.0 45 1.5 2002 2004 2006 2008 2010 Source: Census Bureau, Korea Customs Service. 2012 IRS Circular 230 Disclosure: iPMorgan Chose & Co. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax marten contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with !Morgan Chose & Co. of any of the marten addressed herein or for the purpose of avoiding U.S. tax-reloted penalties. Note that. Morgan is not a licensed insurance provider. The material contained herein is intended as a general market commentary. Opinions expressed herein ore those of Michael Voknin and may differ from those of other. 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