gitf 20130102

Global In the Flow2012 in Review

M O R G A N S T A N L E Y R E S E A R C H

January 2, 2013

GLOBAL CROSS-ASSET STRATEGY

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aware that the firm may have a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment decision.

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Note: Total returns in USD, positive currency indicates appreciation

Source: Bloomberg, The Yield Book, Morgan Stanley Research

Global Cross-Asset Strategy Group

Morgan Stanley & Co. LLCGregory Peters +1 212 761-1488

Jason Draho +1 212 761-7893

Brennan Leong +1 212 761-9729

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Katie Hill

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Global Cross-Asset Directory

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Risk markets broadly ended the year in the green. Japanese equities rallied in December but European and EM equities led over 2012. EM and US HY bonds also performed well over the year while the USD fell.

Markets endured a year of macro ups and downs. Valuations shifted higher and tighter into year-end, driven by policy-makers’

removal of tail risks. Volatility ended lower while risk sentiment is mixed at 2012’s close.

The global economy ended the year weak. The US is gradually picking up as housing improves and the labor market heals. Europe is headed for a deeper recession before recovery, and Japan’s near-term uncertainties are high but policy may ease. China’s growth is on the mend while other EM economies are showing some improvements.

MSCI Japan 5.3 8.4 MSCI EM 4.9 18.6

MSCI Europe 2.8 19.9

MSCI World 1.9 16.5

S&P 500 0.9 16.0

EUR 1.6 1.8 EM 0.8 2.6 DXY -0.5 -0.5

Oil -0.1 3.5 S&P GSCI -0.6 0.1 Gold -2.1 7.0

Bunds 2.2 6.1 Gilts 0.9 7.4 Emerging Markets 0.7 17.6

Treasuries -0.4 2.0 TIPS -0.6 7.2

EUR BIG Index 1.9 11.6 US Corp HY 1.6 15.2

US BIG Index -0.1 4.2

December 2012 (%) 2012 (%)

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2

Global In the FlowJanuary 2, 2013

Table of Contents

Markets Review

1. Returns 5Equity

Rates

Credit

FX

Commodities

2. Performance 20Sector Performance

Trading Volumes

Credit Comparisons

Sovereign CDS, Yields

EM vs. DM

Funding, Liquidity

Inflation Pricing

Currencies

Commodities

3. Valuation 59

Yield Curves

US Debt, Equity Issuance

P/Es

Earnings Revisions

Consensus Estimates

Financial Conditions

Cross-Asset Relationships

4. Risk Measures 71Implied, Realized Volatility

Volatility Skew, Term Structure

Correlation

5. Sentiment 76Put-Call

AAII

GRDI

6. Positioning 77Dealer Holdings

Net Protection

Speculative Positioning

US, EM Fund Flows

Global Economics Review

1. Global Economy Ends Year Weak 84Global Industrial Production

Global PMIs

Global Policy Rates

Global Inflation

Global Trade

2. US Gradually Picking Up 88Labor Market

Housing

Inflation

Trade

Durable Goods

Consumers

Industrial Production

3. Europe Facing a Hard Winter 93PMI

Sentiment


Investor Sentiment

Money

Inflation

4. Japan Waiting for Recovery 100Sentiment

Machinery Orders

Consumer Confidence

Production

Trade

Inflation

5. China’s Recovery Supported 105Production

Trade

Inflation

Investment Lending

Money

Policy

6. EM Continues to Be Mixed 110PMI

Production

Trade

Inflation

Internal Demand

M O R G A N S T A N L E Y R E S E A R C HGlobal In the Flow

January 2, 2013

Markets Review

What Happened Last Month


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1. Returns

2. Performance

3. Valuation

4. Risk Measures

5. Sentiment

6. Positioning

•

Risk assets broadly rounded out the year with gains –

Japanese equities rallied in December but European and EM equities led over 2012. In December, Chinese stocks outperformed in EM and Japanese in DM. Financials topped sector performance in DM over the year. In bonds, Bunds outperformed in December but EM and US HY returned most over 2012; Asian IG sold off the most over 4Q12. CCCs

outperformed in corporate credit over the year, while financials were the best-performing sector in synthetic credit. The JPY depreciated against the USD in December while other G10 currencies rose, and most global currencies appreciated against the USD over the year. Commodities ended December roughly flat, while precious metals and agriculture outperformed other sectors over 2012.

•

Markets endured a year of macro ups and downs –

EM caught up to DM after earlier softness, and SPX ended 2012 about 3% below its high while Eurostoxx

ended at 2012 highs. Spanish and Italian equities fell notably from YTD highs but also rose the most from YTD lows, but outperformance still goes to the core. Financial conditions have loosened further and sovereign auctions have improved over the course of the year. Diminished market, funding, and political pressures mean Spain has yet to request aid. Meanwhile, Japan has been struggling to recover after its earthquake, with the BoJ

expanding its asset purchase program in December. Markets reflect China moving away from hard-landing fears and the USD/CNY reached 19-year lows on better data and positive fundamentals. The safe-haven USD lost support as risk rallied, while the EUR recovered in 2H12. The AUD reversed out of weakness but USD/BRL remains high. Markets diverged from economic fundamentals this year, but a China recovery could boost EM. Gold has been kept on the defensive despite the Fed’s extended accommodation, but was lifted by fiscal cliff concerns and a weak USD. Financials turned around in 2012 after substantially lagging the market in 2011.

•

Risk valuations higher and tighter into year-end –

Shiller

P/Es shifted higher and tighter, with European credit spreads nearing 1-year tights. Equities remain more attractive than bonds on dividend and forward earnings yields. Globally, P/Es remain below historical averages, particularly in DM. Relative to history, NTM P/E is slightly higher in EM vs. DM. Outside of the US, dividend yields are generally well above historical averages. Earnings revisions are still negative and consensus earnings trended lower over the year. US corporate debt and equity issuance surpassed that in 2011. Sovereign curves shifted down significantly in Italy and Germany in 2012. The EUR strengthened

while front-end Bund yields remain below Treasury yields.

•

Volatility ended the year lower –

Volatility trended lower across the year, particularly in FX. Interest rate volatility spiked slightly in December as rates responded to a strong NFP and fiscal cliff resolution expectations. Corporate credit volatility has also subsided over the course of the year, with European credit easing further in December. Equity volatility is at highly subdued levels compared to 2010 and 2011.

•

Risk sentiment is mixed at the year’s close –

Equity put/call has pushed back up in the US and especially in Europe. Risk demand has similarly faltered, but the AAII Bulls-Bears measure is favoring the bulls.

•

Positioning ultimately favored risk assets in 2012 –

Fixed income saw strong fund flows throughout the year, in contrast to equity. Primary dealers have increased their US Treasury holdings in the last few weeks of the year. Net speculative positions in the S&P 500 have risen over 2012, and similarly, speculative positioning in the EUR has been reversing away from lows.


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In USD Total Returns, European Equities Led in 4Q12 and 2012; EM Was a Close Second

1. Returns

Note: Total returns in USD, positive currency indicates appreciation

Source: Bloomberg, The Yield Book, Morgan Stanley Research

MSCI Europe 7.1 19.9

MSCI Japan 5.8 8.4 MSCI EM 5.6 18.6

MSCI World 2.6 16.5

S&P 500 -0.4 16.0

EUR 2.6 1.8 EM 0.7 2.6 DXY -0.2 -0.5

Oil -1.1 3.5 S&P GSCI -3.3 0.1 Gold -5.4 7.0

Bunds 3.6 6.1 Emerging Markets 3.2 17.6

TIPS 0.6 7.2 Gilts 0.2 7.4 Treasuries -0.1 2.0

EUR BIG Index 4.4 11.6 US Corp HY 3.1 15.2

US BIG Index 0.2 4.2

4Q12 (%) 2012 (%)


6


Note: Price return

Source: Datastream, Morgan Stanley Research

In December, Chinese Stocks Outperformed in EM and Japanese in DM

1. Returns

USD Local USD LocalWorldMSCI EM 4.8 3.8 15.1 13.9Euro Stoxx 3.8 2.4 15.6 13.8MSCI AC World 2.1 2.0 13.4 13.2MSCI World 1.7 1.8 13.2 13.1S&P 500 0.7 0.7 13.4 13.4

Developed Markets Japan Nikkei 225 5.0 10.0 9.4 22.9Italy FTSE MIB 4.4 2.9 9.5 7.8Spain IBEX 35 4.3 2.9 -3.2 -4.7Germany DAX 4.2 2.8 31.1 29.1France CAC 40 3.8 2.4 17.0 15.2Netherlands AEX 3.2 1.8 11.4 9.7Singapore FTSE 3.1 3.2 27.0 19.7Hong Kong Hang Seng 2.8 2.8 23.2 22.9Australia ASX All Ordinaries 2.7 3.2 14.9 13.5UK FTSE 100 2.0 0.5 10.7 5.8Canada S&P/TSX Composite 1.3 1.6 6.4 4.0Switzerland SMI 1.2 0.0 17.4 14.9

Emerging Markets China Shanghai SE Composite 14.5 14.6 4.2 3.1Brazil Bovespa 9.2 6.1 -2.2 7.4South Africa JSE 7.8 3.0 16.8 22.7Turkey ISE National 100 7.1 7.0 61.4 52.6

Russia RTS 6.3 6.3 10.5 10.5Thailand SET 100 5.5 5.2 37.5 33.3Korea KOSPI Composite 4.5 3.3 18.4 9.4Mexico IPC 4.0 4.5 26.7 17.9Taiwan TAIEX 1.6 1.6 13.5 8.9Indonesia SE Composite 0.4 0.9 6.2 12.9India SENSEX -0.3 0.4 21.8 25.7

December 2012 (%) 2012 (%)


7


Note: Price return

Source: Datastream, Morgan Stanley Research

Equities in Europe Climbed the Most in DM Over 4Q12 While Turkey Is Ahead Over 2012

1. Returns

USD Local USD LocalWorldEuro Stoxx 10.1 7.4 15.6 13.8MSCI EM 5.2 5.0 15.1 13.9MSCI AC World 2.5 2.8 13.4 13.2MSCI World 2.1 2.5 13.2 13.1S&P 500 -1.0 -1.0 13.4 13.4

Developed Markets France CAC 40 11.2 8.5 17.0 15.2Italy FTSE MIB 10.5 7.8 9.5 7.8Hong Kong Hang Seng 8.7 8.7 23.2 22.9Netherlands AEX 8.7 6.0 11.4 9.7Spain IBEX 35 8.6 6.0 -3.2 -4.7Germany DAX 8.1 5.5 31.1 29.1Switzerland SMI 7.8 5.0 17.4 14.9Australia ASX All Ordinaries 5.7 5.9 14.9 13.5Japan Nikkei 225 5.4 17.2 9.4 22.9Singapore FTSE 3.9 3.5 27.0 19.7UK FTSE 100 3.4 2.7 10.7 5.8Canada S&P/TSX Composite -0.2 0.9 6.4 4.0

Emerging Markets Turkey ISE National 100 18.5 17.8 61.4 52.6

China Shanghai SE Composite 9.7 8.8 4.2 3.1Thailand SET 100 8.0 7.3 37.5 33.3South Africa JSE 6.7 9.8 16.8 22.7Mexico IPC 5.9 6.9 26.7 17.9Korea KOSPI Composite 3.9 0.0 18.4 9.4Russia RTS 3.5 3.5 10.5 10.5Brazil Bovespa 2.1 3.0 -2.2 7.4Taiwan TAIEX 0.7 -0.2 13.5 8.9Indonesia SE Composite 0.7 1.3 6.2 12.9India SENSEX -0.3 3.5 21.8 25.7

4Q12 (%) 2012 (%)


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Note: Total return in USDSource: MSCI, Datastream, Morgan Stanley Research

In December as Well as Over 2012, Financials Topped Sector Performance in DM

1. Returns

MSCI World

Financials 4.5 30.1Materials 4.4 11.8Industrials 3.3 16.7Cons Disc 2.6 24.9MSCI World 1.9 16.5Utilities 1.4 2.9Energy 0.8 2.5Tech 0.6 13.8Health Care 0.4 18.4Telecom -0.3 7.6Cons Staples -1.2 14.2

December 2012 (%) 2012 (%)

MSCI EM

Materials 8.2 10.4Financials 6.2 25.9Industrials 5.9 17.2Energy 5.3 6.4Health Care 5.0 33.5MSCI EM 4.9 18.6Utilities 4.1 6.8Cons Disc 3.5 16.5Telecom 3.4 14.5Cons Staples 3.1 25.6Tech 2.0 29.0

December 2012 (%) 2012 (%)

MSCI USA

Financials 4.5 28.1Materials 3.2 15.3Industrials 2.6 16.0MSCI USA 1.0 16.1Cons Disc 0.9 24.7Energy 0.8 3.9Utilities 0.1 1.7Tech 0.0 14.8Health Care -0.2 18.5Telecom -0.7 18.9Cons Staples -2.2 11.0

December 2012 (%) 2012 (%)

MSCI Europe

Materials 6.3 19.5Financials 4.0 34.1Cons Disc 3.9 35.6Industrials 3.6 24.7Tech 3.5 28.6Utilities 3.3 7.8MSCI Europe 2.8 19.9Health Care 2.5 20.7Energy 0.8 0.8Telecom 0.4 -2.8Cons Staples 0.1 19.3

December 2012 (%) 2012 (%)


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Note: Total return in USDSource: MSCI, Datastream, Morgan Stanley Research

Financials and Other Cyclicals Generally Dominated in 4Q12 and Over 2012

1. Returns

MSCI World

Financials 8.5 30.1Cons Disc 6.5 24.9Industrials 6.1 16.7Materials 5.0 11.8MSCI World 2.6 16.5Health Care 0.9 18.4Cons Staples 0.7 14.2Utilities -0.6 2.9Energy -2.1 2.5Tech -3.2 13.8Telecom -4.7 7.6

4Q12 (%) 2012 (%)

MSCI EM

Financials 10.1 25.9Cons Staples 7.6 25.6Materials 6.0 10.4MSCI EM 5.6 18.6Tech 5.4 29.0Industrials 5.3 17.2Health Care 5.0 33.5Cons Disc 4.0 16.5Utilities 1.6 6.8Energy 1.0 6.4Telecom 0.7 14.5

4Q12 (%) 2012 (%)

MSCI USA

Financials 5.5 28.1Industrials 3.9 16.0Materials 2.9 15.3Cons Disc 2.7 24.7Health Care 0.0 18.5MSCI USA -0.2 16.1Cons Staples -1.6 11.0Utilities -2.7 1.7Energy -2.8 3.9Tech -5.4 14.8Telecom -5.7 18.9

4Q12 (%) 2012 (%)

MSCI Europe

Tech 14.5 28.6Cons Disc 14.1 35.6Financials 13.7 34.1Industrials 10.1 24.7Materials 9.1 19.5MSCI Europe 7.1 19.9Cons Staples 4.7 19.3Health Care 3.9 20.7Utilities 0.6 7.8Energy -0.8 0.8Telecom -4.4 -2.8

4Q12 (%) 2012 (%)


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In December and Over 2012, Small Caps Beat Large Caps in DM

1. Returns

Note: Total return in USD Source: MSCI, Datastream, Morgan Stanley Research

MSCI USAGrowthMid Cap 2.7 16.4Small Cap 2.3 16.7Large Cap -0.7 17.5Value

Small Cap 3.2 19.8Mid Cap 2.9 17.3Large Cap 1.8 14.7

Small Cap 2.8 18.2Large Cap 0.6 16.0

December 2012 (%) 2012 (%)

MSCI EuropeGrowthSmall Cap 4.0 29.2

Large Cap 2.0 20.1

Mid Cap 1.9 21.1

Value

Small Cap 6.2 29.6

Mid Cap 5.1 25.7

Large Cap 3.5 18.5

Small Cap 5.1 29.5

Large Cap 2.8 19.3

December 2012 (%) 2012 (%) MSCI EMGrowthMid Cap 4.5 19.6 Small Cap 4.3 22.2

Large Cap 4.2 21.1

Value

Mid Cap 6.3 22.9

Large Cap 5.5 15.4 Small Cap 5.3 22.9


December 2012 (%) 2012 (%)

MSCI WorldGrowthSmall Cap 2.4 16.3 Mid Cap 2.2 15.7 Large Cap 0.8 16.9 Value

Mid Cap 4.2 18.8 Small Cap 4.1 20.0

Large Cap 2.6 16.1

Small Cap 3.2 18.1 Large Cap 1.7 16.5

December 2012 (%) 2012 (%)


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Small Cap Value Stocks Did Best in DM Over 4Q12 and 2012

1. Returns

Note: Total return in USD Source: MSCI, Datastream, Morgan Stanley Research

MSCI USAGrowthMid Cap 2.3 16.4Small Cap 1.9 16.7Large Cap -2.0 17.5Value

Mid Cap 3.8 17.3Small Cap 3.8 19.8Large Cap 0.3 14.7

Small Cap 2.8 18.2Large Cap -0.8 16.0

4Q12 (%) 2012 (%)

MSCI EuropeGrowthLarge Cap 6.4 20.1

Small Cap 5.9 29.2

Mid Cap 5.8 21.1

Value

Mid Cap 10.6 25.7

Small Cap 10.2 29.6

Large Cap 7.5 18.5

Small Cap 8.1 29.5

Large Cap 7.0 19.3

4Q12 (%) 2012 (%) MSCI EMGrowthLarge Cap 6.7 21.1


Value

Mid Cap 6.1 22.9

Small Cap 5.5 22.9

Large Cap 4.5 15.4


4Q12 (%) 2012 (%)

MSCI WorldGrowthMid Cap 2.7 15.7 Small Cap 2.2 16.3 Large Cap 1.4 16.9 Value


Large Cap 3.2 16.1

Small Cap 3.7 18.1 Large Cap 2.3 16.5

4Q12 (%) 2012 (%)


12


Source: The Yield Book, Morgan Stanley Research

Bunds Outperformed in December but EM and US HY Bonds Returned Most Over 2012Total Returns

Duration-Adjusted Returns

1. Returns

USD Local USD Local

Bunds 2.2 0.8 6.1 4.5 Europe BIG Index 1.9 0.6 11.6 9.5 High Yield 1.6 1.6 15.2 15.2 Gilts 0.9 -0.5 7.4 2.7 Emerging Markets 0.7 0.7 17.6 17.6 Mortgages 0.2 0.2 2.6 2.6 Corporates 0.1 0.1 10.0 10.0 Sov. & Prov. 0.1 0.1 9.5 9.5 Supranationals 0.0 0.0 3.7 3.7 US BIG Index -0.1 -0.1 4.2 4.2 ABS -0.2 -0.2 3.5 3.5 Agencies -0.2 -0.2 2.5 2.5 World BIG Index -0.2 0.1 4.1 5.6 Treasuries -0.4 -0.4 2.0 2.0 TIPS -0.6 -0.6 7.2 7.2 Asia BIG Index -4.5 -0.3 -8.1 2.2

December 2012 (%) 2012 (%)

USD Local USD Local

Bunds 2.7 1.3 3.9 2.2 Europe BIG Index 2.3 1.0 9.5 7.5 High Yield 1.9 1.9 13.7 13.7 Gilts 1.6 0.2 4.0 -0.7 Emerging Markets 1.2 1.2 15.2 15.2 Corporates 0.6 0.6 7.7 7.7 Sov. & Prov. 0.5 0.5 7.5 7.5 Mortgages 0.3 0.3 1.9 1.9 US BIG Index 0.3 0.3 2.6 2.6 Supranationals 0.2 0.2 2.6 2.6 World BIG Index 0.2 0.6 2.1 3.6 ABS 0.1 0.1 2.3 2.3 Agencies 0.1 0.1 1.2 1.2 TIPS -0.2 -0.2 5.4 5.4 Asia BIG Index -3.9 0.3 -10.7 -0.5

December 2012 (%) 2012 (%)


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In 4Q12, Asian IG Bonds Sold Off the Most While European IG and Bunds GainedTotal Returns

Duration-Adjusted Returns

1. Returns

USD Local USD Local

Europe BIG Index 4.4 2.3 11.6 9.5Bunds 3.6 1.1 6.1 4.5Emerging Markets 3.2 3.2 17.6 17.6High Yield 3.1 3.1 15.2 15.2Sov. & Prov. 1.2 1.2 9.5 9.5Corporates 1.1 1.1 10.0 10.0TIPS 0.6 0.6 7.2 7.2Supranationals 0.3 0.3 3.7 3.7Gilts 0.2 -0.4 7.4 2.7US BIG Index 0.2 0.2 4.2 4.2Agencies 0.1 0.1 2.5 2.5ABS 0.1 0.1 3.5 3.5Treasuries -0.1 -0.1 2.0 2.0Mortgages -0.2 -0.2 2.6 2.6World BIG Index -0.3 0.9 4.1 5.6Asia BIG Index -9.2 0.0 -8.1 2.2

4Q12 (%) 2012 (%)

USD Local USD Local

Europe BIG Index 4.5 2.4 9.5 7.5 Bunds 3.7 1.2 3.9 2.2 Emerging Markets 3.3 3.3 15.2 15.2 High Yield 3.1 3.1 13.7 13.7 Sov. & Prov. 1.3 1.3 7.5 7.5 Corporates 1.2 1.2 7.7 7.7 TIPS 0.7 0.7 5.4 5.4 Gilts 0.4 -0.3 4.0 -0.7 Supranationals 0.3 0.3 2.6 2.6 US BIG Index 0.3 0.3 2.6 2.6 Agencies 0.2 0.2 1.2 1.2 ABS 0.2 0.2 2.3 2.3 Mortgages -0.2 -0.2 1.9 1.9 World BIG Index -0.2 1.0 2.1 3.6 Asia BIG Index -9.1 0.1 -10.7 -0.5

4Q12 (%) 2012 (%)


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In Corporate Credit, CCCs Outperformed in December, 4Q12, and 2012

1. Returns

US BBB 0.4 10.9US IG 0.1 10.0US A 0.0 10.0US AAA/AA -0.2 6.7

US CCC 2.7 20.1US HY 1.6 15.2US B 1.6 15.9US BB 1.2 12.8

EUR BBB 1.1 14.7EUR IG 0.8 12.5EUR A 0.7 12.1EUR AAA/AA 0.5 10.1

Dec 2012 (%) 2012 (%)


US BBB 1.5 10.9 US IG 1.1 10.0 US A 1.0 10.0 US AAA/AA 0.5 6.7

US CCC 3.5 20.1

US B 3.4 15.9 US HY 3.1 15.2 US BB 2.5 12.8

EUR BBB 3.8 14.7 EUR IG 2.7 12.5 EUR A 2.2 12.1 EUR AAA/AA 1.8 10.1

4Q12 (%) 2012 (%)


15


Source: Bloomberg, Morgan Stanley ResearchNote: Spread returns, positive indicates spread tightening.

In Synthetic Credit, Financials Were the Best-Performing Sector Over the Month and Year

1. Returns

iTraxx Sub Fin 16.0 54.0

iTraxx Sr Fin 11.8 49.3ABX AAA (price) 9.8 53.0iTraxx Main 4.7 32.1iTraxx Japan 3.8 14.2CMBX AJ (price) 3.5 18.7CDX IG 3.2 20.5iTraxx XOver 2.9 36.1CDX HY 1.9 27.8CMBX AAA (price) 0.8 6.0iTraxx AxJ -1.8 44.8

2012 (%)December 2012 (%)

iTraxx Sub Fin 31.3 54.0

iTraxx Sr Fin 30.6 49.3iTraxx Japan 29.7 14.2iTraxx AxJ 16.2 44.8iTraxx XOver 15.1 36.1iTraxx Main 13.7 32.1ABX AAA (price) 13.7 53.0CMBX AJ (price) 7.0 18.7CDX IG 3.8 20.5CDX HY 2.7 27.8CMBX AAA (price) 2.1 6.0

2012 (%)4Q12 (%)


16


Source: Thomson Reuters, Morgan Stanley Research

The JPY Depreciated Against the USD in December and 2012; Other G10 Currencies Rose

1. Returns

Per USD Per USDG10 LATAMSEK 2.4 5.9 BRL 4.2 -9.1

NOK 1.9 7.3 COP 2.8 9.7

EUR 1.6 1.8 MXN 0.9 8.5

GBP 1.5 4.6 CLP 0.5 8.5

CHF 1.4 2.6 ARS -1.6 -12.4NZD 1.0 6.6

CAD 0.2 3.0 Per EUR

AUD -0.3 1.8 SEK 0.8 4.0

JPY -4.9 -11.3 NOK 0.4 5.5

ASIA DKK -0.1 -0.4

KRW 1.7 9.1 GBP -0.1 2.8

THB 0.5 3.2 CHF -0.2 0.7

TWD 0.1 4.3 ISK -3.3 -5.9

HKD 0.0 0.2 JPY -6.4 -12.9CNY -0.1 1.1

SGD -0.1 6.2

IDR -0.3 -5.5

MYR -0.7 3.6

PHP -0.7 6.8

INR -0.8 -3.1

CEEMEA

ZAR 5.1 -4.5

PLN 2.3 11.5

CZK 2.2 3.9

ILS 2.1 2.0

RUB 1.1 5.3

TRY 0.2 6.0

HUF -1.9 10.2

December 2012 (%) 2012 (%) December 2012 (%) 2012 (%)


17


Source: Thomson Reuters, Morgan Stanley Research

Most Global Currencies Appreciated Against the USD Over the Year

1. Returns

Per USD Per USDG10 LATAMNOK 2.9 7.3 COP 1.9 9.7

CHF 2.7 2.6 MXN 0.0 8.5

EUR 2.6 1.8 CLP -0.8 8.5

SEK 1.0 5.9 BRL -1.1 -9.1

GBP 0.5 4.6 ARS -4.4 -12.4AUD 0.2 1.8

NZD -0.2 6.6 Per EUR

CAD -0.8 3.0 NOK 0.3 5.5

JPY -10.1 -11.3 CHF 0.1 0.7

ASIA DKK -0.1 -0.4

KRW 4.6 9.1 SEK -1.6 4.0

PHP 1.5 6.8 GBP -2.0 2.8

TWD 0.9 4.3 ISK -5.4 -5.9

CNY 0.9 1.1 JPY -12.4 -12.9THB 0.9 3.2

SGD 0.5 6.2

HKD 0.1 0.2

MYR 0.0 3.6

IDR -0.5 -5.5

INR -3.6 -3.1

CEEMEA

ILS 5.0 2.0

PLN 3.7 11.5

CZK 2.8 3.9

RUB 2.1 5.3

TRY 0.8 6.0

HUF 0.4 10.2

ZAR -1.9 -4.5

4Q12 (%) 2012 (%) 4Q12 (%) 2012 (%)


18


Source: Bloomberg, Morgan Stanley Research

Commodities Ended December Roughly Flat, with Energy in the Lead

1. Returns

S&P GSCIEnergy 0.6 -1.4S&P GSCI -0.6 0.1Industrial Metals -1.0 1.4Precious Metals -3.2 6.2Agriculture -5.7 6.5

CommodityCotton 3.4 -18.1Live Cattle 2.5 5.7Coffee 1.2 -36.6Sugar 0.9 -16.3Heating Oil 0.1 3.8Brent Crude -0.1 3.5Copper -0.8 4.4Aluminum -1.0 2.6CRB Futures Index -1.3 -3.4Soybeans -1.4 18.4Gold -2.1 7.0DJ AIG Commodity Index -2.6 -0.9Platinum -4.1 9.9Coal -5.9 -16.8Natural Gas -5.9 12.1Corn -6.7 8.0Silver -9.1 8.2Cocoa -11.9 6.0

December 2012 (%) 2012 (%)


19



Precious Metals and Agriculture Outperformed Other Commodity Sectors Over 2012

1. Returns

S&P GSCIEnergy -1.9 -1.4S&P GSCI -3.3 0.1Industrial Metals -3.4 1.4Precious Metals -6.7 6.2Agriculture -10.1 6.5

CommodityCotton 8.7 -18.1Coal 6.7 -16.8Live Cattle 6.4 5.7Natural Gas 0.9 12.1Sugar -0.4 -16.3Brent Crude -1.1 3.5Aluminum -1.8 2.6Copper -3.3 4.4Heating Oil -3.9 3.8CRB Futures Index -4.6 -3.4Gold -5.4 7.0DJ AIG Commodity Index -6.4 -0.9Platinum -7.6 9.9Corn -7.7 8.0Cocoa -11.1 6.0Soybeans -11.4 18.4Silver -12.7 8.2Coffee -17.1 -36.6

4Q12 (%) 2012 (%)


20



SPX Ended 2012 About 3% Below its High While Eurostoxx Ended at 2012 Highs

Expectations of a fiscal cliff resolution gave US stocks upside momentum in December

The Eurostoxx

recovered from sovereign debt concerns as Greece received additional aid, but eurozone recovery may not yet be sustainable

2. Performance

S&P 500 Sector Returns (%)


SPX, Eurostoxx

-25-20-15-10

-505

101520

Util

ities

Stap

les

Hea

lthca

re

Tele

com

Dis

cret

iona

ry

Tech

nolo

gy

Ene

rgy

Indu

stria

ls

Mat

eria

ls

Fina

ncia

ls

2011 Dec 2012

1240

1280

1320

1360

1400

1440

1480

Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-121900

2000

2100

2200

2300

2400

2500

2600

2700

SPX (left)

Eurostoxx (right)


21


EM Equities Outperformed DM Equities After Earlier Softness

EM equities rose above DM equities by the end of the year

Stocks may go higher on the back of an EM economic recovery

2. Performance

Source: MKE, Bloomberg, Morgan Stanley Research

Korean Exports, MSCI World (YoY %)Source: Bloomberg, Morgan Stanley Research

Equity Indices (2012=100)

-60

-40

-20

0

20

40

60

2000 2002 2004 2006 2008 2010 2012

Korean Exports (left)

MSCI World (right)

95

100

105

110

115

120


DM EM

US China


22




Measures of Market Breadth Supported the Earlier Rally and Now Reflect More Caution

Net new highs rose over the year and tapered off as Washington failed to reach a budget deal before year-end

Cumulative advance-decline ascended through most of December

2. Performance

NYSE Net New Highs, SPX

NYSE Cumulative Advance-Decline

-500

-400

-300

-200

-100

0

100

200

300

400

Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-121100

1150

1200

1250

1300

1350

1400

1450

1500# New Highs - New Lows (10d ma, left)SPX (right)

30000

32000

34000

36000

38000

40000

42000

44000

46000

48000

Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12


23



Spain and Italy Fell Notably from YTD Highs but Also Rose the Most from YTD Lows

Equity markets that fell the most from YTD highs include Brazil, Spain and Italy…

…but in Spain and Italy, stocks have also risen the most from YTD lows

2. Performance

Index Return (%)


Index Return (%)

-15

-10

-5

0

5

10

15

AS51

NKY

CAC

SX5

E

HS

I

UK

X

DA

X

AEX

MEX

BO

L

OM

X

SM

I

SPTS

X

SPX

IND

U

FTSE

MIB

CC

MP

IBE

X

IBO

VChg from YTD High (%)

20-day Chg (Dec MTD %)

-15

-5

5

15

25

35

45

IND

U

SPT

SX

SPX

CC

MP

UKX

IBO

V

AS51

OM

X

MEX

BOL

SMI

AEX HSI

NK

Y

CA

C

DAX

SX5E

FTSE

MIB

IBEX

Chg from YTD Low (%)

20-day Chg (Dec MTD %)


24


European Sovereign Yields Relaxed into Year-End; Core Outperformed the Periphery

European sovereign rates ended the year near lows as tail risks diminished

The core outperformed the periphery in risk markets over 2012

2. Performance


European Equities (2012=100)Source: Bloomberg, Morgan Stanley Research

Italy, Spain 2y, 10y Sovereign Yields (%)

65

75

85

95

105

115

125

135


Germany DAX France CAC 40Italy FTSE MIB Spain IBEX 35

1

2

3

4

5

6

7

8


Spain 2y Italy 2ySpain 10y Italy 10y


25


Source: Conference Board, Bloomberg, Morgan Stanley Research

Financial Conditions Have Loosened Again and European Sovereign Auctions Decent

Policy actions loosened financial conditions Peripheral sovereign auction results have improved over the course of the year

2. Performance

Financial Conditions, Economic Leading Indicator


Average Auction Yield (%)

-3

-2

-1

0

1

2

3Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0MS FCI (left) Conf Board ECLI (MoM, right)

tighter conditions

-1

0

1

2

3

4

5

6

7

8

Sep-11 Dec-11 Mar-12 Jun-12 Oct-12

Spain 3y Italy 2y

France 2y Germany 2y


26




Bund Yields Remained Low as Credit and Equity Climbed Higher

Bund yields stayed low while credit spreads tightened…

…and equities rallied

2. Performance

Bunds, Credit

Bunds, Equities

1.0

1.5

2.0

2.5

3.0

3.5

4.0


50

70

90

110

130

150

170

190

210

230

Bund 10y (%, left)CDX IG (inverted bp, right)iTraxx Main (inverted bp, right)

1.0

1.5

2.0

2.5

3.0

3.5

4.0


75

80

85

90

95

100

105

110

115Bund 10y (%, left)S&P 500 (level, right)Eurostoxx (level, right)


27




Diminished Market, Funding, and Political Pressures Mean Spain Has Yet to Request Aid

Spain is rebalancing at a fast pace, but diminished market, funding, and political pressures mean a formal request for aid has yet to come

Bund yields are at low levels while iTraxx continued to trend higher

2. Performance

IBEX, Spain Gov’t 10y

Bund 10y, iTraxx Main

6000

6500

7000

7500

8000

8500

9000

9500


4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

IBEX (left)Spain 10y Gov't (inverted %, right)

1.1

1.3

1.5

1.7

1.9

2.1

2.3

Dec-11 Mar-12 Jun-12 Sep-12 Dec-12

90

110

130

150

170

190

210

Bund 10y (%, left)iTraxx Main (inverted bp, right)


28



Japan Has Been Struggling to Recover After its Earthquake

The BoJ

expanded its asset purchase program by ¥10tn, bringing the total fund size to ¥101tn

The LDP won the absolute majority in the Diet, with a policy suggestion of reaching its growth target by raising inflation expectations, possibly through currency devaluation

2. Performance

Nikkei, JGB 10y


JPY, UST-JGB 2y

75

77

79

81

83

85

87

Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-120.05

0.10

0.15

0.20

0.25

0.30USD/JPY (left)

UST-JGB 2y Spread(%, right)

75

77

79

81

83

85

87


0.10

0.15

0.20

0.25

0.30USD/JPY (left)

UST-JGB 2y Spread(%, right)


29


Source: TSI, Bloomberg, Morgan Stanley Research


Markets Reflect China Moving Away from Hard-Landing Fears

Iron ore recovered from its earlier slump, pointing to a rebound in China’s steel sector

After selling off for most of the year, Chinese equities came back in December as growth worries continued to subside

2. Performance

Iron Import Prices ($/MT)

Shanghai SE, China 2s10s

80

90

100

110

120

130

140

150

160


1900

2100

2300

2500

2700

2900

3100

3300

Dec-10 Jun-11 Dec-11 Jun-12 Dec-12-0.20

0.00

0.20

0.40

0.60

0.80

1.00

1.20Shanghai Composite (level, left)China 2s10s (%, right)


30



USD/CNY Reached 19-Year Lows in 2012, Boosted by Data and Positive Fundamentals

USD/CNY is trading near the floor of the PBoC’s

fixing on external and domestic demand improvements and capital inflows

The Hang Seng

and A Shares diverged, with the latter retail-driven and more subject to valuation and sentiment swings

2. Performance

CNY, TWD


Hang Seng, A Shares

6.206.256.306.356.406.456.506.556.606.656.70

Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-1228.0

28.5

29.0

29.5

30.0

30.5

31.0USD/CNY (left) USD/TWD (right)

1500016000170001800019000200002100022000230002400025000

Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-122000

2200

2400

2600

2800

3000

3200

3400

3600

3800Hang Seng (left)

A Shares (right)


31




The Safe-Haven USD Lost Support as Risk Rallied; The EUR Recovered in 2H12

The USD sold off as sentiment remained buoyed through the second half of the year

The EUR weakened on the back of eurozone break-up fears and accommodative ECB policy, then recovered as tail risks diminished

2. Performance

DXY, USD/EM

EUR, Spain CDS

77

78

79

80

81

82

83

84

85


9697

9899100

101102103

DXY (left)

USD/EM (right)

1.20

1.22

1.24

1.26

1.28

1.30

1.32

1.34

1.36


200250300350400450500550600650700

EUR/USD (left)

Spain 5y CDS (inverted bp, right)


32


The AUD Reversed Out of Weakness but USD/BRL Remains High

The AUD lost strength on the back of Asia’s growth slowdown and a dovish RBA, but has been reversing higher as Asia improves

The BCB was biased towards BRL weakness over the year

2. Performance


EM FX, INR, BRL, TRY (2012=100)Source: Bloomberg, Morgan Stanley Research

AUD, CAD, EUR (2012=100)

90

95

100

105

110

115

120


USD/EM

USD/INR

USD/BRL

USD/TRY

92

94

96

98

100

102

104

106

108


AUD/USD

CAD/USD

EUR/USD


33




Measures of Funding Stress Ended the Year Much Lower

EM funding stress was kept subdued through year-end by ongoing global liquidity provisions

EUR/USD XCCY basis swaps are far from last year’s stressed levels, though the 3y swap showed more stress mid-year

2. Performance

EM Funding Stress, Spain CDS

Spain CDS, EUR/USD 3m XCCY Basis Swap

10

15

20

25

30

35

40

45

50


89

91

93

95

97

99

101

103MS EM Funding Stress Index (left)USD/EM Index (right)

-160

-140

-120

-100

-80

-60

-40

-20

0


3m

1y

3y


34


Source: JP Morgan, MSCI, Bloomberg, Morgan Stanley Research

Markets Diverged from Economic Fundamentals in 2012

2012 saw a divergence between policy-

driven markets and economic fundamentals

EM markets’

move higher might be supported by a China recovery

2. Performance

Global Mfg PMI, Global Equities (level)

Source: CFLP, Bloomberg, Morgan Stanley Research

China Mfg PMI, MSCI EM

30

35

40

45

50

55

60

Jan-09 Jul-09 Feb-10 Aug-10 Mar-11 Sep-11 Apr-12 Nov-12600

700

800

900

1000

1100

1200

1300

1400

Global Mfg PMI (left)

MSCI World (right)

48

49

50

51

52

53

54

Jan-11 Apr-11 Jun-11 Sep-11

Dec-11

Mar-12

Jun-12 Sep-12

Dec-12

35000

37000

39000

41000

43000

45000

47000

49000

51000China Mfg PMI (left)

MSCI EM (right)


35


Gold Has Been Kept on the Defensive Despite the Fed’s Extended Accommodation

Gold has been kept defensive by fiscal cliff uncertainties and the US economic recovery…

…while crude has rallied on growing geopolitical risk, better Chinese data and prospects of further US stimulus

2. Performance


Brent Crude, SPXSource: Bloomberg, Morgan Stanley Research

USD TWI, Gold

90

95

100

105

110

115

120

125

130


1250

1300

1350

1400

1450

1500Brent Crude ($/bbl, left)

SPX (right)

78.0

78.579.079.580.0

80.5

81.081.582.082.5

83.0Dec-11 Mar-12 Jun-12 Sep-12 Dec-12

1500

1550

1600

1650

1700

1750

1800

1850USD TWI (inverted, left)

Gold ($/troy oz, right)


36




Gold Was Lifted by Fiscal Concerns and a Weak USD, but Fell Back Recently

Gold was lifted by fiscal cliff concerns and a weak USD…

…then fell as inflation expectations rose from slumped levels in 4Q12

2. Performance

SPX, Gold

2y Breakeven, Gold

1170

1220

1270

1320

1370

1420

1470

1520


1550

1600

1650

1700

1750

1800

1850SPX (left)

Gold ($/troy oz, right)

0.7

0.9

1.1

1.3

1.5

1.7

1.9

2.1

2.3

2.5


1550

1600

1650

1700

1750

1800

18502y Breakeven (%, left) Gold ($/troy oz, right)


37


Financials Turned Around in 2012 After Substantially Lagging the Market in 2011

Financials beat the market in 2012…

…after substantially lagging in 2011

2. Performance


Equity Indices (2011=100)Source: Bloomberg, Morgan Stanley Research

Equity Indices (2012=100)

70

75

80

85

90

95

100

105

110

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

SPX

DJ Transports

Financials

95

100

105

110

115

120

125

130


SPX

DJ Transports

Financials


38



Equity Trading Volumes Ended the Year Lower in Both the US and Europe

SPX volumes ended the year slightly lower than where they started, but higher than September lows

Eurostoxx

volumes thinned over the year as the sovereign debt crisis rendered the region less attractive

2. Performance

SPX Volume, SPX


Eurostoxx Volume, Eurostoxx

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12

10001050110011501200125013001350140014501500

SPX Volume (bn shares 20d ma, left)

SPX (inverted, right)

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

Nov-10 Feb-11May-11Aug-11 Nov-11 Feb-12May-12Aug-12Nov-12

2000

2200

2400

2600

2800

3000

3200Eurostoxx Volume (bn shares 20d ma, left)Eurostoxx (inverted, right)


39



Source: FINRA, Bloomberg, Morgan Stanley Research

Treasury and Corporate Bond Volumes Picked Up Over the Year

US Treasury volumes ended the year higher than where they were last December

Corporate bond volumes rose and fell over the month but are significantly higher than last December’s levels

2. Performance

UST Volume, UST

Corporate Bond Volume, CDX IG

150

200

250

300

350

400

Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-121.3

1.8

2.3

2.8

3.3

3.8

4.3ICAP UST Volume ($bn 20d ma, left)UST 10y Yield (%, right)

7

9

11

13

15

17

19

21

23


70

80

90

100

110

120

130

140

150

160

IG+HY TRACE Volumes ($bn, left)CDX IG (inverted bp, right)


40



Risk Demand Rose Through the Year and the Put/Call Ratio Is Now Relatively Optimistic

Risk demand plunged mid-month as Bernanke said the Fed’s ability to ease further is not unlimited

Put/call ended the year on a more optimistic note than it began

2. Performance

SPX, MS GRDI


SPX, Put/Call

1050

1100

1150

1200

1250

1300

1350

1400

1450

1500

Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-1295

100

105

110

115

120

125

SPX (left)MS Risk Demand Index (right)

10001050110011501200125013001350140014501500

Dec-10 Apr-11 Aug-11 Dec-11 Apr-12 Aug-12 Dec-12

0.7

0.8

0.9

1.0

1.1

1.2

1.3

SPX (left)

Put/Call (inverted 10d ma, right)


41




US Equities Correlation with EUR Has Been Falling, While More Volatile with Gold

EUR and SPX correlation has been on a falling trend since late 2011, suggesting less systemic risk

The correlation between gold and US equities has become more volatile but generally remains high

2. Performance

EUR/USD, SPX 30-day Return Correlation

Gold, SPX 30-day Return Correlation

EUR/USD and S&P 500: 30-day Return Correlation

-1.00-0.80-0.60-0.40-0.200.000.200.400.600.801.00

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

Gold and S&P 500: 30-day Return Correlation

-1.00-0.80-0.60-0.40-0.200.000.200.400.600.801.00

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011


42



Higher Oil Prices Would Be Negative for Growth and Thus Equities

UST 10y and SPX correlation remains highly negative, suggesting a shift towards risk-on

The correlation between oil and US equities fell recently, dipping in September

2. Performance

UST 10y, SPX 30-day Return Correlation


WTI, SPX 30-day Return Correlation

UST 10y and S&P 500: 30-day Return Correlation

-1.00-0.80-0.60-0.40-0.200.000.200.400.600.801.00

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

WTI and S&P 500: 30-day Return Correlation

-1.00-0.80-0.60-0.40-0.200.000.200.400.600.801.00

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012


43


Equity Trading Volumes Were Low Into Year-End

2. Performance


S&P 500 Monthly Advance/Decline


Total Equity Volume Traded on US Exchanges (bn shares)


ETF Volume (bn shares)


S&P 500 Volume on Up, Down Days (20d ma, mm shares)

8

9

10

11

12

13

14

15

16

17

18


US Exchange Volume20d Moving Avg

400

600

800

1000

1200

1400

1600

Dec-10 Jun-11 Dec-11 Jun-12 Dec-12

Up Days

Down Days

0.5

0.7

0.9

1.1

1.3

1.5

1.7


Monthly Advance/DeclineBenchmark

0.0

0.1

0.2

0.3

0.4

0.5

0.6

Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12

SPDR ETFs

20d ma


44


Stock Markets Rose Above Various Trailing Averages, Particularly in EM and Europe

2. Performance


Equity Index and Moving Averages: US


Equity Index and Moving Averages: DM


Equity Index and Moving Averages: Europe


Equity Index and Moving Averages: EM

1000

1050

1100

1150

1200

1250

1300

1350

1400

1450

Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12

MSCI World20d ma50d ma200d ma

35000

37000

39000

41000

43000

45000

47000

49000

51000


MSCI EM20d ma50d ma200d ma

1000

1050

1100

1150

1200

1250

1300

1350

1400

1450

1500


SPX20d ma50d ma200d ma

1900

2100

2300

2500

2700

2900

3100

3300


Eurostoxx20d ma50d ma200d ma


45


US Financials Outperformed European Financials

2. Performance


EM Asia, Latam (2012=100)


MSCI World, EM (2012=100)


US, European Financials (2012=100)


S&P 500, Euro Stoxx (2012=100)

85

90

95

100

105

110

115

120

125


DM

EM

70

80

90

100

110

120

130

140


S&P 500

Euro Stoxx

80

85

90

95

100

105

110

115

120

125

130


EM Asia

EM Latam

80

90

100

110

120

130

140


US

Europe


46


Despite the SPX Falling in 4Q12, Economic Surprise Has Been Favorable

2. Performance

Source: Citigroup, Bloomberg, Morgan Stanley Research

Economic Surprise, Equities: US


Economic Surprise, Equities: DM


Economic Surprise, Equities: Europe


Economic Surprise, Equities: EM

-80

-60

-40

-20

0

20

40

60


1050

1100

1150

1200

1250

1300

1350

1400

DM Surprise (left)

MSCI World (right) -50

-40

-30

-20

-10

0

10

20

30


38000

40000

42000

44000

46000

48000

EM Surprise (left)

MSCI EM (right)

-80

-60

-40

-20

0

20

40

60

80

100


1100

1150

1200

1250

1300

1350

1400

1450

1500

US Surprise (left)

SPX (right)-120

-100

-80

-60

-40

-20

0

20

40

60


1900

2000

2100

2200

2300

2400

2500

2600

2700

Europe Surprise (left)

Eurostoxx (right)


47


Cyclicals Outperformed Consumers and Dividends Outperformed Defensives in 2012

2. Performance


Morgan Stanley Cyclical, Consumer Indices (2012=100)


S&P 500 Growth, Value Total Return (2012=100)


Morgan Stanley Discretionary Baskets (2012=100)


Morgan Stanley Defensive, Dividend Baskets (2012=100)

75

85

95

105

115

125

135


Consumer Discretionary

High-Beta Discretionary

85

90

95

100

105

110

115

120


Defensives

High & Stable Divs

80

90

100

110

120

130

140


Cyclicals

Consumer

80

85

90

95

100

105

110

115

120

125


Growth

Value


48


Credit Spreads Tightened Over 2012, More So in HY than in IG

2. Performance


CDX HY, CMBX (price)


SPX, CDX IG


CDX HY, ABX (price)


CDX IG, HY (bp, 2012=100)

60

70

80

90

100

110

120

130


CDX IG

CDX HY

1050

1100

1150

1200

1250

1300

1350

1400

1450

1500


70

80

90

100

110

120

130

140

150

160

SPX (level, left)

CDX IG (inverted bp, right)

85

87

89

91

93

95

97

99

101

103

105


50

55

60

65

70

75

CDX HY (left)

CMBX AJ S4 (right)

80

85

90

95

100

105


40

45

50

55

60

65

CDX HY (left)

ABX AAA 2006-2 (right)


49


Credit Quality Curves Bull-Flattened Slightly Over December

2. Performance

Source: The YieldBook, Morgan Stanley Research

Europe IG Corp Credit Quality Curve (bp)


US IG Corp Credit Quality Curve (bp)


US, Europe IG Corp Credit Quality Curves (bp)


US HY Corp Credit Quality Curve (bp)

0

50

100

150

200

250

300

AAA AA A BBB

28-Dec-1230-Nov-1231-Dec-11

300

500

700

900

1100

1300

1500

BB B CCC

28-Dec-1230-Nov-1231-Dec-11

0

50

100

150

200

250

300

350

400

AAA AA A BBB

28-Dec-1230-Nov-1231-Dec-11

0

50

100

150

200

250

AAA AA A BBB

US

Europe


50


Sovereign Credit Spreads Came in Over the Course of the Year

2. Performance


Sovereign 2s5s, European Financial CDS (bp)

Source: DTCC, Bloomberg, Morgan Stanley Research

CDS Net Notional Outstanding ($bn)

Note: Drop in Western Europe series due to Greek defaultSource: Bloomberg, Morgan Stanley Research

iTraxx SovX (bp)


Sovereign 5y CDS (bp)

100

150

200

250

300

350

400


CEEMEA

Western Europe

0

100

200

300

400

500

600

700

Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12

Italy France

Spain Germany

50

70

90

110

130

150

170

190

210

230

May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12

100

150

200

250

300

350

Spain (left)Belgium (left)Italy (left)iTraxx Snr Fin (right)

11

13

15

17

19

21

23

25


Germany France

Italy Spain


51


Government Yields Are Sitting Low in the European Core

2. Performance


European 1y Government Yield (%)


European 10y Government Yield (%)


UST 2y (%)


UST 2y, Fed Funds Effective (%)

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45


0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45


UST 2y

Fed Funds Effective

-1

0

1

2

3

4

5

6

7

8

9


Germany

France

Spain

Italy

0

1

2

3

4

5

6

7

8


Germany FranceSpain Italy


52


Financials Followed the Rally, Closing the Gap Between Financial and Industrial Spreads

2. Performance


US, Europe Financial Cash Credit (bp)


US Financial, Industrial Cash Credit (bp)

Source: The Yield Book, Bloomberg, Morgan Stanley Research

US Financial Equity, Cash Credit

Source: The Yield Book, Bloomberg, Morgan Stanley Research

Europe Financial Equity, Cash Credit

140150160170180190200210220230240


110

120

130

140

150

160

170

180

190

200

S&P Financials (level, left)

US Fins Credit (inverted bp, right)

180

190

200

210

220

230

240

250

260


125

175

225

275

325

375

425

Stoxx Financials (level, left)

Europe Fins Credit (inverted bp, right)

0

50

100

150

200

250

300

350

Dec-08 Dec-09 Dec-10 Dec-11 Dec-120

10

20

30

40

50

60Fins - Indus Spread (left)

(Fins - Indus) / Fins % (right)

80

180

280

380

480

580

680

780

880

Dec-08 Dec-09 Dec-10 Dec-11 Dec-12

US

Europe


53


The Front End of Treasury and Bund Curves Flattened Over the Year

2. Performance


US Butterfly Spread (bp)


US Spread Curve (bp)


Germany Butterfly Spread (bp)


Germany Spread Curve (bp)

0

50

100

150

200

250

300

350


US 2s10s US 10s30s

0

50

100

150

200

250


GE 2s10s GE 10s30s

-100

-50

0

50

100

150

200

250


5s10s30s 2s5s10s 2s10s30s

-100

-50

0

50

100

150

200


5s10s30s 2s5s10s 2s10s30s


54


In the US, Real Rates Remain Negative While Breakevens Are Higher Over 2012

2. Performance


US 10y Breakeven, Real Rate (%)


US Nominal Rate (%)


US Breakeven Spread (%)


US Real Rate (%)

0

1

2

3

4

5

6

Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12

5Y 10Y 30Y

-2

-1

0

1

2

3

4


5Y 10Y 30Y

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

Dec-10 Jun-11 Dec-11 Jun-12 Dec-121.01.21.41.61.82.02.22.42.62.83.0

Real (left)

Breakeven (right)-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6


5s10s 10s30s


55


The JPY Depreciated Significantly and May Increasingly Be Seen as a Funding Currency

2. Performance


FX Cross and Moving Averages: CHF


FX Index and Moving Averages: USD


FX Cross and Moving Averages: JPY


FX Cross and Moving Averages: EUR/USD

72

74

76

78

80

82

84

86

Nov-10 Feb-11 May-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12

DXY 20d ma

50d ma 200d ma

1.15

1.20

1.25

1.30

1.35

1.40

1.45

1.50


EUR/USD 20d ma

50d ma 200d ma

0.70

0.75

0.80

0.85

0.90

0.95

1.00

1.05

1.10


USD/CHF 20d ma

50d ma 200d ma

75

77

79

81

83

85

87

89

91


USD/JPY 20d ma

50d ma 200d ma


56


The EUR Weakened and Recovered Over the Year While the SPX Moved Up

2. Performance


Asian Currencies, DXY (level)


DXY, SPX

Source: JP Morgan, Bloomberg, Morgan Stanley Research

EM Currencies, Volatility (level)


EUR, SPX

1.20

1.22

1.24

1.26

1.28

1.30

1.32

1.34

1.36

1.38

1.40


1150

1200

1250

1300

1350

1400

1450

1500EUR/USD (left)

SPX (right)

75

76

77

78

79

80

81

82

83

84

85


1150

1200

1250

1300

1350

1400

1450

1500

DXY (left)

SPX (right)

95

96

97

98

99

100

101

102Dec-11 Mar-12 Jun-12 Sep-12 Dec-12

76

77

78

79

80

81

82

83

84

USD/AxJ Currencies(inverted, left)

DXY (inverted, right)

94

95

96

97

98

99

100

101

102

103


7

8

9

10

11

12

13

14

15

16USD/EM (left) EM FX Volatility (right)


57


Commodities Ended 2012 Flat; Agriculture Spiked Mid-Year on Tight Fundamentals

2. Performance


GSCI, SPX

Source: CRB, Bloomberg, Morgan Stanley Research

Brent, Commodity Index


GSCI Indices (2012=100)


Gold, Real Rates

0

20

40

60

80

100

120

140

160


200

300

400

500

600

700Brent ($/bbl)

CRB Index (level, right)

4050

4250

4450

4650

4850

5050

5250

5450

5650


1130

1180

1230

1280

1330

1380

1430

1480

1530

GSCI (left)

SPX (right)

80

90

100

110

120

130

140


AgricultureEnergyIndustrial MetalsPrecious Metals

800

1000

1200

1400

1600

1800

2000


-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

Gold ($/oz, left)

10y TIPS (inverted %, right)


58


Liquidity and Funding Conditions Are Accommodative

2. Performance


MS EM Funding Stress Index


MS Financial Conditions Index, SPX


Funding Markets, European Financial Credit Spreads (bp)

Source: Citigroup, St. Louis Federal Reserve, Bloomberg, Morgan Stanley Research

Citi Liquidity Index, St. Louis Fed Stress Index

0

50

100

150

200

250

300

350

400


Libor-OISEUR Basis Swap 1miTraxx Snr Fin

0

10

20

30

40

50

60

70

80


EMFSI

20d ma

50d ma

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12-1

0

1

2

3

4

5

6

Citi Liquidity Index (left;+ = less liquidity)

St. Louis Fed FinancialStress Index (right)

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0


700

800

900

1000

1100

1200

1300

1400

1500

1600

MS Financial ConditionsIndex (left)



59


Risk Valuations Moved Higher and Tighter Into Year-End

3. Valuation

Note: 1-year range Source: YieldBook, Bloomberg, Morgan Stanley Research

US Credit (Low, Spot, High)

Note: 1-year range Source: S&P, Shiller, MSCI, NBER, Bloomberg, Morgan Stanley Research

Global Shiller P/Es (Low, Spot, High)

Note: 1-year range Source: Bloomberg, Morgan Stanley Research

US and European Rates (Low, Spot, High)

Note: 1-year rangeSource: iBoxx, Bloomberg, Morgan Stanley Research

European Credit (Low, Spot, High)

241

253

1.31

1.71

99

142

1.17

1.39

353

332

2.06

2.3810y Treasuries(%)

10y Bunds (%)

Italy 2s10s (bps)

Spain 2s10s(bps)

159

119

117

479

159

114

109

444

356

189

184

761

€ Financials(bps)

€ Non-Fins(bps)

Main (bps)

XOver (bps)

494

95

153

136

444

83

148

117

709

127

345

182US Financials(bps)

US Industrials(bps)

CDX IG (bps)

CDX HY (bps)

12.6

13.2

21.1

11.0

12.1

20.5

12.5

13.7

22.4S&P 500

FTSE All-Share

MSCI Europe


60


Source: Federal Reserve, Haver Analytics, Datastream, Morgan Stanley Research

Source: BLS, Haver Analytics, IBES, Datastream, The Yield Book, Morgan Stanley Research

Equities Are More Attractive than Bonds on Yields

Equity dividend yields are greater than nominal Treasury yields

Forward earnings yield remains above real corporate bond yields

3. Valuation

S&P 500 Dividend Yield, UST 10y Yield (%)

S&P 500 Forward Earnings Yield, Corp BBB Real Bond Yield (%)

-2

0

2

4

6

8

10

12

14

16

18

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

SpreadUST 10Y YieldS&P 500 Dividend Yield

0

2

4

6

8

10

12

1986 1991 1996 2001 2006 2011-6

-4

-2

0

2

4

6Spread (right)Corp BBB Real Bond YieldS&P 500 Forward Earnings Yield


61


Global P/Es Remain Below Historical Averages, Particularly in DM

3. Valuation

Source: IBES, MSCI, Datastream, Morgan Stanley Research

NTM P/E: DM vs. EM

Source: MSCI, Datastream, Morgan Stanley Research

Trailing P/E: DM vs. EM


NTM P/E: US vs. Europe


Trailing P/E: US vs. Europe

5

10

15

20

25

30

35

40

45

Dec-87 Dec-90 Dec-93 Dec-96 Dec-99 Dec-02 Dec-05 Dec-08 Dec-11

DM

EM

5

10

15

20

25

30

35

40


USA

Europe

5

10

15

20

25

30


DM

EM

5

10

15

20

25

30


USA

Europe


62


Trailing P/E Multiples Are Around One Standard Deviation Below Historical Averages

3. Valuation


Trailing P/E: US


Trailing P/E: DM


Trailing P/E: Europe


Trailing P/E: EM

5

10

15

20

25

30

35

40


10

15

20

25

30

35

40


5

10

15

20

25

30

35

40


10

15

20

25

30

35

40



63


NTM P/E Is Slightly Higher in EM than in DM, Compared to Each Region’s History

3. Valuation


NTM P/E: US


NTM P/E: DM


NTM P/E: Europe


NTM P/E: EM

5

10

15

20

25

30


10

15

20

25

30


5

10

15

20

25

30


7

9

11

13

15

17

19

21

23

25



64


Outside of the US, Dividend Yields Are Generally Well Above Historical Averages

3. Valuation


Dividend Yield: US


Dividend Yield: DM


Dividend Yield: Europe


Dividend Yield: EM

0

1

2

3

4

5

6


1

2

3

4

5

6


0

1

2

3

4

5

6


2

3

4

5

6

7



65


Earnings Revisions Ended the Year Negative

3. Valuation


US NTM Earnings Revisions Ratio (%)


DM NTM Earnings Revisions Ratio (%)


Europe NTM Earnings Revisions Ratio (%)


EM NTM Earnings Revisions Ratio (%)

-100

-80

-60

-40

-20

0

20

40

60

2000 2002 2004 2006 2008 2010 2012

DM 3m ma

-100

-80

-60

-40

-20

0

20

40

60

2000 2002 2004 2006 2008 2010 2012

EM 3m ma

-100

-80

-60

-40

-20

0

20

40

60

2000 2002 2004 2006 2008 2010 2012

US 3m ma

-100

-80

-60

-40

-20

0

20

40

60

2000 2002 2004 2006 2008 2010 2012

Europe 3m ma


66


Consensus Earnings for 2012 and 2013 Have Trended Lower Over the Year

3. Valuation


US FY Consensus EPS


DM FY Consensus EPS


Europe FY Consensus EPS


EM FY Consensus EPS

5

10

15

20

25

30

35

40

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

2002 20032004 20052006 20072008 20092010 20112012 2013

10

30

50

70

90

110

130

150

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

2002 20032004 20052006 20072008 20092010 20112012 2013

304050607080

90100110120130

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

2002 20032004 20052006 20072008 20092010 20112012 2013

30507090

110130

150170190210230

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

2002 20032004 20052006 20072008 20092010 20112012 2013


67


US Corporate Debt and Equity Issuance Amounts Surpassed That in 2011

3. Valuation


US Equity IPO ($bn)


US IG Corporate Debt Issuance ($bn)


US Equity IPO (# issues)


US HY Corporate Debt Issuance ($bn)

0

20

40

60

80

100

120

140

160


20122011

0

10

20

30

40

50

60


20122011

0

5

10

15

20

25

30

35

40

45


20122011

0102030405060708090

100


20122011


68


Sovereign Curves Bull-Flattened in Germany, Italy and Spain; Bear-Steepened in the US

3. Valuation


Italy Yield Curve (%)


US Yield Curve (%)


Spain Yield Curve (%)


Germany Yield Curve (%)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

3M 1Y 3Y 5Y 7Y 10Y

15Y

20Y

25Y

30Y

Current

1 Month Prior

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3M 1Y 3Y 5Y 7Y 10Y

15Y

20Y

25Y

30Y

Current

1 Month Prior

0

1

2

3

4

5

6

3M 1Y 3Y 5Y 7Y 10Y

15Y

20Y

25Y

30Y

Current

1 Month Prior

0

1

2

3

4

5

6

7

3M 1Y 3Y 5Y 7Y 10Y

15Y

20Y

25Y

30Y

Current

1 Month Prior


69


Over 2012, Curves Shifted Down Substantially in Italy and Germany

3. Valuation


Italy Yield Curve (%)


US Yield Curve (%)


Spain Yield Curve (%)


Germany Yield Curve (%)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

3M 1Y 3Y 5Y 7Y 10Y

15Y

20Y

25Y

30Y

Current

1 Year Prior

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3M 1Y 3Y 5Y 7Y 10Y

15Y

20Y

25Y

30Y

Current

1 Year Prior

0

1

2

3

4

5

6

7

8

3M 1Y 3Y 5Y 7Y 10Y

15Y

20Y

25Y

30Y

Current

1 Year Prior

0

1

2

3

4

5

6

7

3M 1Y 3Y 5Y 7Y 10Y

15Y

20Y

25Y

30Y

Current

1 Year Prior


70


The EUR Strengthened While Front-End Bund Yields Remain Below Treasury Yields

3. Valuation


EUR, SPX


EUR, 2y Yield Differential

Source: CRB, Bloomberg, Morgan Stanley Research

EUR, Commodities


EUR, Economic Surprise

1.20

1.22

1.24

1.26

1.28

1.30

1.32

1.34

1.36

Dec-11 Mar-12 Jun-12 Sep-12 Dec-12-0.4

-0.3

-0.2

-0.1

0.0

0.1

0.2

0.3EUR/USD (left)

Bund 2y - UST 2y (%, right)

1.20

1.22

1.24

1.26

1.28

1.30

1.32

1.34

1.36


-150

-100

-50

0

50

100

150

EUR/USD (left)Citi Surprise: US (inverted, right)Citi Surprise: Europe (inverted, right)

1.20

1.22

1.24

1.26

1.28

1.30

1.32

1.34

1.36


1000

1050

1100

1150

1200

1250

1300

1350

1400

1450

1500

EUR/USD (left)


1.20

1.22

1.24

1.26

1.28

1.30

1.32

1.34

1.36


470

480

490

500

510

520EUR/USD (left)

CRB Commodity Index (right)


71


Volatility Ended the Year Lower, Particularly FX; 3m Skew Jumped in December

4. Risk Measures

Source: Bloomberg, Morgan Stanley Research, Quantitative & Derivative Strategies

Skew (90-110) by Maturity

Note: Indexed 3m ATM implied volatility. Equity includes S&P, EuroStoxx, Nikkei, Kospi, Bovespa, Hang Seng. Commodity includes gold, oil. FX includes EURUSD, JPYUSD, USDKRW, AUDUSD. Rates includes USD Libor, Euribor, JPY Libor. Credit includes CDX IG, iTraxx Main.Source: Bloomberg, Market1, Morgan Stanley Research

Volatility (indexed)


Realized vs. Implied Equity Volatility


3m Implied, Realized Volatility

40

50

60

70

80

90

100

110


Equity RatesFX CreditCommodity

5%

10%

15%

20%

25%

30%

35%

40%

Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%3m Imp Vol - 3m Rlzd Vol3m Rlzd Vol3m Imp Vol

3%4%5%6%7%8%9%

10%11%12%13%14%15%

Nov-09 May-10 Nov-10 May-11 Nov-11 May-12 Nov-12

3m 6m 9m

1y 2y

0%

5%

10%

15%

20%

25%

30%

35%

Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12

Imp Vol 10D Rlzd

1m Rlzd 3m Rlzd

6m Rlzd


72



FX and Interest Rate Volatility Are Both Around 5-Year Lows

G7 FX volatility came off 5-year lows as investors look towards next year

Interest rate volatility spiked slightly in December as rates responded to a strong NFP and fiscal cliff resolution expectations

4. Risk Measures

FX Volatility (%)

Source: BofA Merrill Lynch, Bloomberg, Morgan Stanley Research

Rate Volatility, VIX

6

11

16

21

26

31


G7 EM

50

60

70

80

90

100

110


15

20

25

30

35Treasury 1m Implied Vol(normalized bp, left)

VIX (right)


73


Source: Morgan Stanley Research


Corporate Credit Volatility Has Also Subsided Over the Course of the Year

In December, IG credit volatility rose in the US but continued to ease in Europe…

…and similarly in high yield

4. Risk Measures

IG Credit Volatility (%)

HY Credit Volatility (%)

30

40

50

60

70

80

90

100

Nov-11 Feb-12 May-12 Aug-12 Nov-12

CDX IG

iTraxx Main

30

40

50

60

70

80

90

Nov-11 Feb-12 May-12 Aug-12 Nov-12

CDX HY

iTraxx Xover


74


Stock Volatility is At Highly Subdued Levels Compared to 2010 and 2011

4. Risk Measures


DXY, SPX


SPX, Volatility


VIX, EUR/USD


Euro Stoxx, Volatility

10

15

20

25

30

35

40

45

50

55

60


800

900

1000

1100

1200

1300

1400

1500

Volatility (left)


10

15

20

25

30

35

40

45

50

55

60


1500

1700

1900

2100

2300

2500

2700

2900

3100

3300

Volatility (left)

Euro Stoxx (inverted, right)

72

74

76

78

80

82

84

86

88

90


600

700

800

900

1000

1100

1200

1300

1400

1500

DXY (level, left)


10

15

20

25

30

35

40

45

50

55

60


1.10

1.15

1.20

1.25

1.30

1.35

1.40

1.45

1.50

1.55

VIX (left) EUR/USD (inverted, right)


75


The Spread Between Implied Volatility in EEM and SPY Has Narrowed Over the Year

4. Risk Measures


MSCI EM, S&P 500 ETF Implied Volatility

Source: CBOE, Bloomberg, Morgan Stanley Research

S&P 500 Implied Correlation


MSCI Germany, EAFE ETF Implied Volatility

Note: Peripheral Sovereign Avg includes Ireland, Italy, Portugal, Spain

Source: MSCI, Bloomberg, Morgan Stanley Research

European Banks Relative Performance, Peripheral CDS

40

50

60

70

80

90

100


2013

2012

201445

55

65

75

85

95

105


0

100

200

300

400

500

600

700

800

900

Banks Relative Performance vs.MSCI Europe (left)

Peripheral Sovereign Avg 5yCDS (inverted bp, right)

0

10

20

30

40

50

60

70

80

90

100


Spread EEM SPY

-10

0

10

20

30

40

50

60

70

80


Spread MSCI Germany MSCI EAFE


76


AAII Bulls-Bears Is Optimistic but Put/Call and Risk Demand Suggest the Opposite

5. Sentiment

Source: AAII, Bloomberg, Morgan Stanley Research

AAII Bulls-Bears

Source: CBOE, Bloomberg, Morgan Stanley Research

US Equity Put/Call Ratio

Note: Global Risk Demand Index –

US Pat. No. 7,617,143


Morgan Stanley Standardized Global Risk Demand Index


Europe Equity Put/Call Ratio

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5


Put/Call Composite

20D ma

0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

2.1

2.3

2.5


Put/Call 20D ma

-6

-5

-4

-3

-2

-1

0

1

2

3

4

Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12-50-40-30-20-10

0102030405060



77


Fixed Income Saw Strong Fund Flows Throughout the Year, in Contrast to Equity

6. Positioning

Source: ICI, Morgan Stanley Research

US Hybrid Fund Flows, Weekly ($bn)


US Fixed Income Fund Flows, Weekly ($bn)


US Money Market Fund Flows, Weekly ($bn)


US Equity Fund Flows, Weekly ($bn)

-10

-5

0

5

10

15

Jan-10 Apr-10 Aug-10Dec-10 Mar-11 Jul-11 Nov-11 Feb-12 Jun-12 Oct-12-35

-30

-25

-20

-15

-10

-5

0

5

10

Jan-10 Apr-10 Aug-10Dec-10 Mar-11 Jul-11 Nov-11 Feb-12 Jun-12 Oct-12

-8-7-6-5-4-3-2-101234

Jan-10 Apr-10 Aug-10 Dec-10 Mar-11 Jul-11 Nov-11 Feb-12 Jun-12 Oct-12-80

-60

-40

-20

0

20

40

60

Jan-10 Apr-10 Aug-10Dec-10 Mar-11 Jul-11 Nov-11 Feb-12 Jun-12 Oct-12


78


Cumulative Flows Continue to Favor Bond Over Equity, Long-Term Over Money Market

6. Positioning

Source: ICI, Fund Flows Database, Morgan Stanley Research

Cumulative US Equity Fund Flows ($bn)


Cumulative US Fixed Income and Equity Fund Flows ($bn)


Cumulative Money Market and Long-Term Fund Flows ($bn)

-300

-100

100

300

500

700

900

Jan-10 May-10 Sep-10 Feb-11 Jun-11 Oct-11 Feb-12 Jun-12 Oct-12

EquityBond

-400

-300

-200

-100

0

100

200


EquityDomestic EquityForeign Equity

-800

-600

-400

-200

0

200

400

600


Total Long-TermTotal Money Market


79


Primary Dealers Have Increased Their US Treasury Holdings

6. Positioning

Source: Federal Reserve, Bloomberg, Morgan Stanley Research

Primary Dealer Positions ($bn)


UST Investor Sentiment, 10y Yield


Primary Dealer Positions in US Treasuries ($bn)


Primary Dealer Positions in Corporate Securities ($bn)

-30

-20

-10

0

10

20

30

Dec-10 Jun-11 Dec-11 Jun-12 Dec-121.0

1.5

2.0

2.5

3.0

3.5

4.0Treasury Sentiment (left) 10Y UST Yield (%, right)

0

50

100

150

200

250

300


<1y >1y

-300

-200

-100

0

100

200

300

400

500

600


Corp MBS Gov't Agency Net

-50

0

50

100

150

200


Bills <3y 3-6y 6-11y>11y TIPS Net


80


Net Speculative Positions in the S&P 500 Have Risen Over the Year

6. Positioning

Source: CFTC, Haver Analytics, Morgan Stanley Research

Net Speculative Positions in Gold (k contracts)


Net Speculative Positions in S&P 500 (k contracts)


Net Speculative Positions in WTI (k contracts)


Speculative Positions in S&P 500 (k contracts)

Average

+2 σ

-2 σ

-150

-100

-50

0

50

100

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012-100

-50

0

50

100

150

200

Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12

Net Speculative Positions on S&P 500Open LongOpen Short

Average

+2 σ

-2 σ0

50

100

150

200

250

300

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012-50

0

50

100

150

200

250

300

350

2003 2004 2005 2006 2007 2008 2009 2010 2011 201220

40

60

80

100

120

140

160Net Speculative Positions in WTI (left)

WTI front-end contract (right)


81


Speculative Positioning in the EUR Has Been Reversing Away from Lows

6. Positioning

Note: Morgan Stanley’s FX strategy team combines IMM positioning on the AUD, CAD, CHF, EUR, GBP, JPY, MXN and NZD to calculate an aggregate USD index to measure overall net positioning. Source: CFTC, Haver Analytics, Morgan Stanley Research

Net Speculative Positions in USD (bn contracts)


Net Speculative Positioning in EUR (bn contracts)


Net Speculative Positions in AUD, NZD (k contracts)


Speculative Positions in CHF (k contracts)

-60

-40

-20

0

20

40

60

80

100

120

2007 2008 2009 2010 2011 2012-10

-5

0

5

10

15

20

25

30AUD (left)NZD (right)

Average

+2 σ

-2 σ

-100

-80

-60

-40

-20

0

20

40

60

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Net Speculative Positions in CHF (left)

Average

+2 σ

-2 σ

-250

-200

-150

-100

-50

0

50

100

150

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Average

+2 σ

-2 σ-50-40-30-20-10

01020304050

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

M O R G A N S T A N L E Y R E S E A R C HGlobal In the Flow

January 2, 2013

Global Economics Review



83



2. US Gradually Picking Up

3. Europe Facing a Hard Winter

1. Global Economy Ends Year Weak

5. China’s Recovery Supported

4. Japan Waiting for Recovery

6. EM Continues to Be Mixed

Global growth remains stuck in the ‘Twilight Zone’ –

Our economists believe global growth won’t change much during 2013, but the US and European periphery could accelerate over the year. Global PMIs

suggest a manufacturing recovery is under way in EM, though not so much in

DM. A handful of EM central banks cut rates in December, but fewer in DM. Inflation pressures receded around the world, particularly in DM. On the whole, global trade is still fragile as the year comes to a close; DM import growth continues to follow a lackluster trend.

The US economy is gradually picking up, but uncertainties remain –

In the bull case, structural improvements could help growth start to normalize in 2014: household deleveraging is continuing and corporations could unlock cash from balance sheets with greater policy clarity. The housing market is improving on low mortgage rates and a gradually healing labor market. Key drivers of core inflation have steadied, but other categories may drag the measure lower. Meanwhile, manufacturing is still challenged by weak global trade and sluggish demand.

Europe is headed for a deeper recession before recovery –

Europe faces many risks and policy challenges, but restructuring benefits in the periphery offer hope. Peripheral labor costs are falling and exports are higher than pre-

crisis in parts of the periphery. The Bundesbank

slashed its 2013 growth projections and sees recession this winter, in line with our economists, as Germany’s industrial production slumped. Forward-looking business sentiment improved in Germany, but near-term worries are still present. Inflation pressures eased further on lower spending.

Japan’s near-term uncertainties are high but policy may ease –

Corporates were positively affected by yen weakness and the recent stock rally, but sentiment remains tough

and sustainability is still in question. Industrial production faltered on weak exports and orders edged up but regained little ground on sub-par domestic private sector demand. The Cabinet Office downgraded its orders assessment and firms may hold off on capex. Retail sales ticked up but consumer confidence is still lackluster, while the struggle against deflation continues.

China’s growth is on the mend, helped by accommodative policy –

Manufacturing data suggest growth momentum has bottomed and is rebounding. Industrial production continues to improve, driven by strengthening domestic demand and inventory restocking; fixed asset investment

stayed flat and should be steady, bolstered by new urbanization initiatives and accelerating project launches. Domestic consumption gained traction, supported by wage growth, but external demand is not yet firm. CPI inflation bottomed and the PBoC

will maintain liquidity.

EM economics showed improvements in some areas –

PMIs

continue to print higher in various EM countries, including Korea, India, Brazil and Mexico. Industrial production

may be turning around, as Korea posted upside surprise on better export sales that offset weaker domestic consumption. Korea’s trade surplus hit a 5-month high but Taiwan’s were below expectations. Hong Kong’s trade activity picked up while India’s deficit remains high. Price pressures remain subdued, giving policy-makers room to act. Domestic demand is not yet in stable recovery.


84


Source: Morgan Stanley Research forecasts

Global Growth Stuck in ‘Twilight Zone’ but Key Markets Should See Uptrend

Overall global growth likely won’t change much during 2013…

…but the US and European periphery could accelerate over the year


GDP (YoY %)


GDP (YoY %)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

4Q12E 1Q12E 2Q12E 3Q12E 4Q12E 1Q13 2Q13E 3Q13E 4Q13E

Real GDP, QoQ, SAAR, %

-4

-3

-2

-1

0

1

2

3

4

1Q12 3Q12 1Q13 3Q13 1Q14 3Q14

US

Spain & Italy Avg

Real GDP (QoQ %, SAAR)


85


Source: IMF, Markit, national sources, Haver Analytics, Morgan Stanley Research

Source: IMF, national sources, Haver Analytics, Morgan Stanley Research

Global PMIs Suggest Manufacturing Recovery Is Under Way in EM but Not So in DM

Global PMIs

diverged further as EM continued to recover while DM sank deeper into contraction territory

A handful of EM central banks cut rates, but fewer in DM

PMI (level)

Policy Rate (%)

30

35

40

45

50

55

60

Jan-03 Jan-05 Jan-07 Jan-09 Jan-11

DM EM

0

1

2

3

4

5

6

7

8

9

Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

DM EM



86


Source: IMF, national sources, Haver Analytics, Morgan Stanley Research

Inflation Pressures Receded Around the World, Particularly in DM

Inflation slowed in various DM countries, including the US

Metal price depreciation is slowing while global industrial production is struggling to improve

CPI (YoY %)

Note: IMF base metals export prices, data reported with a lagSource: IMF, CPB, Morgan Stanley Research

Metal Prices, Industrial Production (YoY %)

-2

0

2

4

6

8

10

Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

DM EM

-150

-100

-50

0

50

100

150

Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-11-15

-10

-5

0

5

10

15

Metal Prices (left)

Global IP (right)



87


Source: Various national sources, Haver Analytics, Morgan Stanley Research

Source: Various national sources, Haver Analytics, Morgan Stanley Research

On the Whole, Global Trade Is Still Fragile as the Year Comes to a Close

EM export growth faltered in AxJ

countries overall

DM import growth continues to follow a lackluster trend

EM Exports (YoY %)

DM Imports (YoY %)

-50-40-30-20-10

0102030405060


AxJLatamCEEMEA

-40

-30

-20

-10

0

10

20

30

40


US

Europe



88


Economic Dashboard: US

Source: National sources, Bloomberg, Haver Analytics, Morgan Stanley Research

6-mo 6-moTrend Prev. Latest Trend Prev. Latest

Leading Indicators Labor MarketOECD Leading Indicator (index) (Oct) N 100.8 100.9 Initial Jobless Claims (weekly k) (Dec) N 371 350Conf. Board Leading Indicator (YoY %) (Nov) N 2.3 1.8 Initial Claims 4w ma (k) (Dec) N 408 357

Continuing Claims (weekly k) (Dec) N 3213 3206Business Conditions

ISM Mfg PMI (index) (Nov) N 51.7 49.5 Non-Farm Payrolls (MoM k) (Nov) N 138 146ISM Non-Mfg PMI (index) (Nov) N 54.2 54.7 Avg Weekly Hours, Private (Nov) N 34.4 34.4

Chicago Fed Nat'l Activity (index, 3m avg) (Nov) N -0.6 -0.2 Challenger Job Cuts (YoY %) (Nov) N 11.6 34.4Philly Fed Bus. Conditions (index) (Dec) N -10.7 8.1 ADP Employment (MoM k) (Nov) N 157 118Empire Mfg Bus. Conditions (index) (Dec) N -5.2 -8.1 Avg Hourly Earnings (YoY %) (Nov) N 1.6 1.7Richmond Fed Mfg Conditions (index) (Dec) N 9.0 5.0Chicago PMI (index) (Dec) N 50.4 51.6 Personal Income (YoY %) (Nov) N 3.2 4.1

Personal Savings Rate (%) (Nov) N 3.4 3.6Economic Activity

Industrial Production (YoY %) (Nov) N 1.6 2.5 Consumer ConfidenceConference Board (index) (Dec) N 71.5 65.1

Capacity Utilization (%) (Nov) N 77.7 78.4 University of Michigan (index) (Dec) N 82.7 72.9Factory Orders (MoM %) (Oct) N 4.5 0.8

Retail SectorDurable Goods Orders (YoY %) (Nov) N 5.9 0.5 Retail Sales (YoY %) (Nov) N 3.7 3.7Durable Goods Inventories (YoY %) (Nov) N 5.2 4.8 ICSC Chain Stores Sales (YoY %) (Nov) N 2.3 -0.1

Auto Sales (m) (Nov) N 14.2 15.5Trade Personal Expenditure (YoY %) (Nov) N 3.3 3.5

Exports (YoY %) (Oct) N 3.7 1.0Imports (YoY %) (Oct) N 1.1 -0.8 Housing Market

Housing Starts (SAAR k) (Nov) N 888 861Prices New Home Sales (SAAR k) (Nov) N 361 377

CPI (YoY %) (Nov) N 2.2 1.8CPI ex Food & Energy (YoY %) (Nov) N 2.0 1.9 Existing Home Sales (SAAR m) (Nov) N 4.8 5.0PPI (YoY %) (Nov) N 2.3 1.5 S&P/Case-Shiller 20-City Index (YoY %) (Oct) N 3.0 4.3PPI ex Food & Energy (YoY %) (Nov) N 2.1 2.2 MBA Mortgage Applications (weekly %) (Dec) N 4.5 -12.3Core PCE (YoY %) (Nov) N 1.6 1.5



89


Source: PLACEHOLDER

In the Bull Case, Structural Improvements Could Help Growth Start to Normalize in 2014

Household deleveraging is continuing Corporations could unlock cash from balance sheets with greater policy clarity

Household Debt to Disposable Income (%)

Source: FactSet, Morgan Stanley Research

Cash Balances (Top 1,500 Stocks, ex-Fin, $tn)

50

60

70

80

90

100

110

120

130

140

Mar-80 Mar-84 Mar-88 Mar-92 Mar-96 Mar-00 Mar-04 Mar-08 Mar-120.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009



90


Source: BLS, Bloomberg, Morgan Stanley Research

Housing Market Improving on Low Mortgage Rates and Gradually Healing Labor Market

The jobs report was mixed, with a good deal of monthly volatility from unusual weather conditions and other factors

Housing starts fell but are still strong, while permits rose to a four-year high

Non-Farm Payrolls, Unemployment Rate

Source: Census Bureau, Bloomberg, Morgan Stanley Research

Housing Starts, Permits (SAAR k)

-1000

-800

-600

-400

-200

0

200

400

600

Nov-08 Aug-09 May-10 Feb-11 Nov-11 Aug-125

6

7

8

9

10

11

Non-Farm Payrolls (k, left)

Unemployment Rate (%, right)

400

500

600

700

800

900

1000

Nov-08 May-09 Nov-09 May-10 Nov-10 May-11 Nov-11 May-12 Nov-12

Starts

Permits



91



Key Drivers of Core Inflation Have Steadied but Other Categories May Drag Lower

Headline CPI inflation was dragged down by a plunge in gasoline prices, while the core only gained slightly

PPI inflation similarly fell from a big drop in energy costs

CPI (YoY %)


PPI (YoY %)

-3

-2

-1

0

1

2

3

4

5


Headline

Core-8

-6

-4

-2

0

2

4

6

8


Headline

Core



92



Source: Census Bureau, Bloomberg, Morgan Stanley Research

Manufacturing Still Challenged by Weak Global Trade and Sluggish Domestic Demand

Industrial production was much stronger than expected, largely due to recoveries in industries impacted by Hurricane Sandy

Retail sales beat expectations, with upside in sectors including clothing and electronics & appliances offsetting hurricane disruptions

Industrial Production, Capacity Utilization

Retail Sales (MoM %)

-20

-15

-10

-5

0

5

10


65

70

75

80

85

Industrial Production (YoY %, left)

Capacity Utilization (%, right)

-4

-3

-2

-1

0

1

2

3


Headline

Ex Auto



93


Economic Dashboard: Europe


DATE(RIGHT(HLOOKUP($B5,$A 6-mo 6-moTrend Prev. Latest Trend Prev. Latest

PMI Mfg Inflation (YoY %)¹Eurozone (Nov) N 45.5 46.2 Eurozone (Nov): CPI N 2.5 2.2Germany (Nov) N 46.0 46.8France (Nov) N 43.7 44.5 Germany (Nov): HICP N 2.1 1.9Italy (Nov) N 45.5 45.1 France (Nov): HICP N 2.1 1.6Spain (Nov) N 43.5 45.4 Italy (Nov): HICP N 2.8 2.6Greece (Nov) N 41.0 41.8 Spain (Nov): HICP N 3.5 3.0U.K. (Nov) N 47.3 49.1 Greece (Nov): HICP N 0.9 0.4

Industrial Production (YoY %) Business Confidence

Eurozone (Oct) N -2.8 -3.6 Belgium: NBB Bus. Confidence (Aug) N -11.3 -11.8Germany (Oct) N -0.8 -3.7 France: INSEE Bus. Confidence (Dec) N 88 89France (Oct) N -2.5 -3.6 Italy: ISAE Bus. Confidence (Dec) N 89 89Italy (Oct) N -5.0 -6.2 Germany: Ifo Business Survey (Dec) N 101 102Spain (Oct) N -12.1 0.6Greece (Oct) N -7.2 1.8 Economic SentimentU.K. (Oct) N -3.2 -3.0 Eurozone: ZEW Econ. Sentiment (Dec) N -2.6 7.6

Greece: Economic Sentiment (Nov) N 75.8 79.0Imports (YoY %) Germany: ZEW Econ. Sentiment (Dec) N -15.7 6.9

Eurozone (Oct) N -4.5 6.9Germany (Oct) N -0.6 2.7 Retail Sales (YoY %) France (Oct) N -0.2 0.6 Eurozone (Oct) N -1.6 -3.6Italy (Oct) N -6.2 -3.7 Germany (Oct) N -3.4 -0.8Spain (Oct) N -7.4 -2.0 France (Oct) N 0.8 0.7Greece (Oct) N 1.9 7.7 Italy (Oct) N -1.6 -3.8U.K. (Oct) N -3.4 -1.1 Spain (Nov) N -8.4 -7.8

U.K. (Nov) N 1.4 2.0Exports (YoY %)

Eurozone (Oct) N 1.3 14.3 Orders (YoY %)² Germany (Oct) N 1.4 5.3 Germany: Manufacturing Orders N -3.9 -2.4France (Oct) N 5.0 4.9Italy (Oct) N 2.7 5.5 Lending and Money Supply (YoY %)³ Spain (Oct) N 0.5 8.7 Eurozone: M3 (Oct) N 2.6 3.9Greece (Oct) N -16.9 -9.2 Eurozone: Lending to Priv. Sector (Oct) N 0.5 0.5U.K. (Oct) N -1.0 -6.1

¹Harmonized inflation (HICP) is shown for member countries ²Orders are working day adjusted³Eurozone M3 growth rates no longer account for portfolio shifts



94



Europe Faces Many Risks and Policy Challenges…

Fiscal tightening should ease for most of Europe in 2013

Sovereign bond issuance is also likely to fall significantly

% GDP


(€bn)

-40-20

020406080

100120140

Germany France Italy Spain Portugal Ireland Greece2009 2010 2011 2012E 2013E

-0.1 -0.2

-0.6

-1.1 -1.2-1.5 -1.5 -1.6

-2.3

-2.7 -2.8-3.1

-0.3-0.6

-0.1

-0.9

-2

-0.7 -0.8-1.1

-2.6

-1.2

-3.6

-1.5

-4.0

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0FI AT DE NL FR BE IE EA17 PT ES GR IT

Fiscal Tightening 2012Fiscal Tightening 2013



95


Source: ECB, Haver, Morgan Stanley Research

Source: Eurostat, Morgan Stanley Research

…but Restructuring Benefits in the Periphery Offer Hope

Labor costs are falling in the eurozone periphery

Exports are higher than pre-

crisis in parts of the periphery

Relative Unit Labor Costs (Jan 99 = 100)

Exports of Goods & Services (1Q 2000 = 100)

Exports of Goods & Services (1Q 2000 = 100)

80

100

120

140

160

180

200

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

DE FR

IT ES

IE GR

PT

80

90

100

110

120

130

1999 2001 2003 2005 2007 2009 2011Germany Spain France Italy IrelandGreece Portugal Netherlands Belgium



96


Source: Deutsche Bundesbank, Ifo Institute, Bloomberg, Morgan Stanley Research

Source: INSEE, Bloomberg, Morgan Stanley Research

The Bundesbank Slashed its 2013 Growth Projections and Sees Recession This Winter

Germany’s industrial production was much weaker than expected, driven by a slump in capital goods

France’s industrial production also fell, as demand remains feeble

Germany Industrial Production, Output Plans

France Industrial Production (YoY %)

-25-20-15-10

-505

10152025

Oct-08 Jul-09 Apr-10 Jan-11 Oct-11 Jul-12-50-40-30-20-1001020304050


IFO Mfg ex Food Output Plans (right)

-25

-20

-15

-10

-5

0

5

10

15

Oct-00 Oct-02 Oct-04 Oct-06 Oct-08 Oct-10 Oct-12


3m ma



97


Source: Deutsche Bundesbank, Bloomberg, Morgan Stanley Research

Germany’s Orders Rebounded Due to Improved Demand from Abroad

Germany’s orders jumped to erase prior falls, though data may be volatile

Sweden’s PMI rose marginally as forward-

looking production and new orders improved, though employment dropped

Germany Manufacturing Orders (YoY %)

Source: Swedbank, Bloomberg, Morgan Stanley Research

Sweden PMI Mfg

-50

-40

-30

-20

-10

0

10

20

30

40

Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12

Manufacturing OrdersDomesticForeign

20

30

40

50

60

70

80


HeadlineNew OrdersProduction



98


Source: ZEW, Ifo Institute, Bloomberg, Morgan Stanley Research

Source: INSEE, Bloomberg, Morgan Stanley Research

Forward-Looking Business Sentiment Improved, but Near-Term Risks Are Present

Germany’s ZEW improved substantially and Ifo

climbed, But near-term risks still exist

France’s INSEE improved modestly but remains at a very low level; forward-looking components still deteriorating

Germany Business Expectations

France Business Expectations

-80

-60

-40

-20

0

20

40

60

80

100

Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-1275

80

85

90

95

100

105

110

115

ZEW (left)

Ifo (right)

60

70

80

90

100

110

120

Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12-80

-60

-40

-20

0

20

40Current Sentiment (leftProduction Expectations (right)



99


Source: Destatis, Eurostat, Bloomberg, Morgan Stanley Research

Inflation Pressures Ease Further as Consumers Spend Less

Germany’s headline CPI eased down, partly driven by lower energy prices, while core CPI remained flat

France’s headline CPI was similarly pulled down by energy

Germany CPI (YoY %)

Source: INSEE, Eurostat, Bloomberg, Morgan Stanley Research

France CPI (YoY %)

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Nov-00 Nov-02 Nov-04 Nov-06 Nov-08 Nov-10 Nov-12

Headline

Core

-1.0-0.50.00.51.01.52.02.53.03.54.0

Nov-00 Nov-02 Nov-04 Nov-06 Nov-08 Nov-10 Nov-12

Headline

Core



100


Economic Dashboard: Japan6-mo 6-moTrend Prev. Latest Trend Prev. Latest

Indicators PricesLeading Indicator (Oct) N 91.8 92.8 CGPI (YoY %) (Nov) N -1.0 -0.9Coincident Indicator (Oct) N 91.3 90.7 CPI (YoY %) (Nov) N -0.4 -0.2

Core CPI (YoY %) (Dec) N -0.9 -1.0Business Conditions

Eco Watchers: Current (Nov) N 39.0 40.0 Labor Market Eco Watchers: Outlook (Nov) N 41.7 41.9 Jobless Rate (%) (Nov) N 4.2 4.1

Job-to-Applicant Ratio (Nov) N 0.8 0.8Tankan Mfg: Current (Dec) N -19.0 -18.0 Tankan Non-Mfg: Current (Dec) N 1.0 5.0 Consumer Tankan Mfg: Outlook (Dec) N -17.0 -16.0 Consumer Confidence (Nov) N 39.7 39.4Tankan Non-Mfg: Outlook (Dec) N 3.0 4.0 Household Spending (YoY %) (Nov) N -0.1 0.2

All Industry Index (Oct) N -0.4 0.2 Retail Small Business Confidence (Dec) N 43.3 43.8 Vehicle Sales (YoY %) (Nov) N -9.0 -3.3PMI (Dec) N 46.5 45.0 Deptartment Store Sales (YoY %) (Nov) N -2.4 2.2

Convenience Store Sales (YoY %) (Nov) N -2.1 -2.5Economic Activity

Industrial Production (MoM %) (Nov) N 1.6 -1.7 Housing Industrial Production (YoY %) (Nov) N -4.5 -5.8 Tokyo Condo Sales (YoY %) (Nov) N -14.4 -15.1Vehicle Production (YoY %) (Nov) N -12.4 -8.4 Construction Orders (YoY %) (Nov) N -13.8 -2.1

Housing Starts (YoY %) (Nov) N 25.2 10.3Machinery Orders (YoY %) (Oct) N -7.8 1.2 Tokyo Avg Office Vacancies (%) (Nov) N 8.7 8.8Machine Tool Orders (YoY %) (Nov) N -6.7 -21.3 Capacity Utilization (MoM %) (Oct) N -5.5 1.6 Financial

Bank Lending ex-Trusts (YoY %) (Nov) N 1.1 1.3Trade M2 (YoY %) (Nov) N 2.3 2.1

Current Account Balance (¥bn) (Oct) N 503.6 377 Target Rate (%) (Dec) N 0.1 0.1

Merch Trade Balance (¥bn) (Nov) N -554.6 -955Merch Trade Imports (YoY %) (Nov) N -1.5 0.9Merch Trade Exports (YoY %) (Nov) N -6.5 -4.1




101


Source: ESRI, Bloomberg, Morgan Stanley Research

Corporates Were Positively Affected by Yen Weakness and the Recent Stock Rally

Eco Watchers’

recovery is slow and sustainability still in question; households were supported by seasonal demand

The manufacturing Tankan is up slightly; sentiment remains tough but is helped by recent yen weakness and the stock rally

Economy Watchers Survey (level)

Source: Reuters, Datastream, Morgan Stanley Research

Reuters Tankan (level)

10

15

20

25

30

35

40

45

50

55


Household

Corporate-25

-20

-15

-10

-5

0

5

10

15

20


ManufacturingNon-ManufacturingManufacturing OutlookNon-Manufacturing Outlook



102


Source: METI, Bloomberg, Morgan Stanley Research


Cabinet Office Downgraded Orders Assessment; Expect Firms to Hold Off on Capex

Industrial production faltered, dragged down by weak exports

Orders edged up for the first time in three months but regained little ground on sub-par domestic private-sector demand

Industrial Production, Inventory/Shipment

Machinery Orders (MoM %)

-50

-40

-30

-20

-10

0

10

20

30

40

Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-1280

90

100

110

120

130

140

150

160


Inventory/Shipment Ratio (right)

-20

-10

0

10

20

30

40

50

60

70

80

Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12

Core Machinery Orders

Overseas



103


Source: MIC, METI, Bloomberg, Morgan Stanley Research

Retail Sales Ticked Up but Consumer Confidence Is Still Lackluster

Retail sales were up, in a recovery from the prior month’s tumble

Consumer confidence worsened marginally, with the income component flat but others falling

Household Spending, Retail Sales (YoY %)


Consumer Confidence (level)

-10

-5

0

5

10

15


Retail Sales

Real Household Spending

15

20

25

30

35

40

45


Consumer Confidence

Employment

Income Growth



104


Source: MIC, Bloomberg, Morgan Stanley Research

Source: MOF, Bloomberg, Morgan Stanley Research

A Continuing Struggle Against Deflation While Exports Still Lack Strength

Japan’s core inflation slid further; the incoming coalition is pushing for the BoJ

to adopt a higher inflation target

Exports still lack strength, widening the deficit yet again

Core CPI (YoY %)

Merchandise Trade

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0


Tokyo Nationwide

-80

-60

-40

-20

0

20

40

60

80

Nov-10 Feb-11 May-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12-1000

-800

-600

-400

-200

0

200

400

600

800

1000Trade Balance (¥bn, right)Exports to US (YoY %, left)Exports to EU (YoY %, left)Exports to Asia (YoY %, left)



105


Economic Dashboard: China



Indicators PricesLeading Indicator (Oct) N 100.4 100.4 CPI (YoY %) (Nov) N 1.7 2.0Coincident Indicator (Oct) N 97.2 97.7 PPI (YoY %) (Nov) N -2.8 -2.2

Business Conditions Consumer

CFLP PMI Mfg (Nov) N 50.2 50.6 Consumer Confidence (Nov) N 106.1 105.1CFLP PMI Non-Mfg (Nov) N 55.5 55.6 HSBC PMI Mfg (Nov) N 49.5 50.5 Retail HSBC PMI Services (Nov) N 53.5 52.1 Retail Sales (YoY %) (Nov) N 14.5 14.9

Passenger Car Sales (YoY %) (Nov) N 6.4 8.8Economic Activity

Val-Added of Industry (YoY %) (Nov) N 9.6 10.1 Housing FAI ex-Rural (YTD YoY %) (Nov) N 20.7 20.7 70-City Property Price Index Avg (Oct) N 103.3 103.4

Trade Financial

Trade Balance ($bn) (Nov) N 32.1 19.6 M2 (YoY %) (Nov) N 14.1 13.9Imports (YoY %) (Nov) N 2.3 0.0 New Loans (RMB bn) (Nov) N 505.2 522.9Exports (YoY %) (Nov) N 11.6 2.9 Total Loan Growth (YoY %) (Nov) N 15.9 15.7

FDI (YoY %) (Nov) N -0.2 -5.4 Policy Rate (%) (Dec) N 6.0 6.0

RRR (%) (Dec) N 20.0 20.0



106


Source: NBS, Haver Analytics, Morgan Stanley Research

Manufacturing Data Suggests Growth Momentum Has Bottomed and Is Rebounding

Industrial production continued to improve, driven by strengthening domestic demand and inventory restocking

Fixed asset investment stayed flat and should stay steady, underpinned by new urbanization initiatives and accelerating project launches

Industrial Production (YoY %)


Fixed Asset Investment (YoY %)

0

5

10

15

20

25

Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Industrial ProductionLight IndustryHeavy Industry

0

20

40

60

80

100

120

140

160


FAI: Tertiary

FAI: Secondary

FAI: Primary



107



Source: CEInet, Bloomberg, Morgan Stanley Research

Domestic Consumption Gained Traction but External Demand Not Yet on Firm Footing

Retail sales were higher than expected as discretionary consumption gained traction and should pick up ahead of holidays, supported by wage growth

Export growth fell short of expectations by a wide margin while imports registered zero YoY

growth

Retail Sales (YoY %)

Trade Balance

8

10

12

14

16

18

20

22

24

26


-40

-30

-20

-10

0

10

20

30

40

50

Nov-08 Nov-09 Nov-10 Nov-11 Nov-12-80

-60

-40

-20

0

20

40

60

80

100

Trade Balance ($bn, left)

Imports (YoY %, right)

Exports (YoY %, right)



108



CPI Inflation Bottomed; Recovering Domestic Demand May Gradually Lift Non-Food

CPI inflation remains well-anchored but saw an uptick mainly due to gains in food prices, while non-food edged down

PPI inflation found further relief due to a low base

CPI (YoY %)

Source: CEInet, CFLP, Bloomberg, Morgan Stanley Research

PPI, Input Prices

-4

-2

0

2

4

6

8

10

12

14

16

Nov-08 Nov-09 Nov-10 Nov-11 Nov-12

Headline

Non-Food

Food

-15

-10

-5

0

5

10


30

40

50

60

70

80

PPI (YoY %, left)

PMI Input Prices (level, right)



109



Source: PBoC, Bloomberg, Morgan Stanley Research

The PBoC Will Actively Maintain the Current Liquidity Level

New RMB loans posted modest gains in November while total social financing remains resilient

Money supply edged down due to less aggressive government spending

Lending

Money Supply (YoY %)

0

200

400

600

800

1000

1200

1400

1600

1800

2000

Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 Nov-1210

15

20

25

30

35

40New Loans (RMBbn, left)

Total Loan Growth(YoY %, right)

0

5

10

15

20

25

30

35

40

45

Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 Nov-12

M1

M2



110


Economic Dashboard: EM



PMI Mfg CPI (YoY %)India (Nov) N 52.9 53.7 India (WPI) (Nov) N 7.5 7.2Korea (Nov) N 47.4 48.2 Korea (Nov) N 2.1 1.6Taiwan (Nov) N 47.8 47.4 Taiwan (Nov) N 2.3 1.6Brazil (Nov) N 50.2 52.2 Brazil (Nov) N 5.5 5.5Mexico (Nov) N 52.1 52.5 Mexico (Nov) N 4.6 4.2Turkey (Nov) N 52.6 51.6 Turkey (Nov) N 7.8 6.4Poland (Nov) N 47.3 48.2 Poland (Nov) N 3.4 2.8

Industrial Production (YoY %) Retail (YoY %)

India (Oct) N -0.7 8.2 India: Auto Sales (Nov) N 23.1 -8.3Korea (Nov) N -0.8 2.9 Korea: Dept Store Sales (Nov) N -0.4 9.1Taiwan (Nov) N 4.8 5.9 Taiwan: Comm Sales (Nov) N -0.7 1.3Brazil (Oct) N -3.6 2.3 Brazil: Retail Sales (Oct) N 8.5 9.1Mexico (Oct) N 2.3 3.6 Mexico: Retail Sales (Oct) N 3.8 3.5Turkey (Oct) N 6.2 -0.9 Turkey: Auto Sales (Nov) N -13.7 11.7Poland (Nov) N 4.6 -0.8 Poland: Retail Sales (Nov) N 3.3 2.4

Imports (YoY %) Policy Rate (%)

India (Nov) N 7.4 6.4 India (Dec) N 7.0 7.0Korea (Nov) N 1.6 0.9 Korea (Dec) N 2.8 2.8Taiwan (Nov) N -1.8 0.1 Taiwan (Dec) N 1.9 1.9Brazil (Oct) N -16.6 -2.3 Brazil (Dec) N 7.3 7.3Mexico (Nov) N 16.4 4.7 Mexico (Dec) N 4.5 4.5Turkey (Nov) N -5.7 12.5 Turkey (Dec) N 5.8 5.5Poland (Oct) N -3.0 7.6 Poland (Dec) N 4.5 4.3

Exports (YoY %)

India (Nov) N -1.6 -4.2Korea (Nov) N 1.0 3.8Taiwan (Nov) N -1.9 0.9Brazil (Nov) N 8.2 -54.1Mexico (Nov) N 13.0 1.3Turkey (Nov) N 11.0 24.8Poland (Oct) N -0.3 15.5



111


Source: HSBC, Markit, Bloomberg, Morgan Stanley Research

PMIs Continue to Print Higher in Various EM Economies

PMIs

improved in India and Korea even though Korea’s remains in contraction

PMIs

also improved in Brazil, Mexico and Poland

PMI Mfg (level)

Source: HSBC, Markit, Bloomberg, Morgan Stanley Research

PMI Mfg (level)

35

40

45

50

55

60

65


India Korea

Singapore Taiwan

30

35

40

45

50

55

60

Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12

Brazil Mexico

Turkey Poland



112


Industrial Production May Be Turning Around in EM

Korea’s industrial production posted upside surprise as better export sales offset weaker domestic consumption

India’s industrial production accelerated sharply partly due to base effect and pre-Diwali

sales

Source: CSO, Bloomberg, Morgan Stanley Research

India Industrial Production (YoY %)Source: KNSO, MOEA, Bloomberg, Morgan Stanley Research

Korea, Taiwan Industrial Production (YoY %)

-10

-5

0

5

10

15

20

25

Oct-06 Oct-07 Oct-08 Oct-09 Oct-10 Oct-11 Oct-12


3m ma

-60

-40

-20

0

20

40

60

80


Korea

Taiwan



113


Source: MOEA, Bloomberg, Morgan Stanley Research

Source: MKE, ISM, Bloomberg, Morgan Stanley Research

Korea’s Surplus Hit a 5-Month High but Taiwan’s Exports Were Below Expectations

Taiwan’s exports grew significantly below expectations, dragged down by weak demand from DM

Korea’s surplus is at a 5-

month high on improving AxJ

demand, though import growth is slow due to weakness in consumer goods

Taiwan Exports (YoY %)

Korea Exports, US ISM New Orders

-75

-55

-35

-15

5

25

45

65

85

105

125


Exports US

Europe Asia

-50

-40

-30

-20

-10

0

10

20

30

40

50


30

40

50

60

70

80

Korea Exports (YoY %, left)

US ISM Mfg New Orders (level, right)



114


Hong Kong’s Trade Activity Picked Up While India’s Deficit Remains High

Hong Kong’s export growth picked up, but fluctuations are linked to the continued unsteadiness in DM

India’s export growth faltered as external demand continues to be challenged

Source: DGCI&S, Bloomberg, Morgan Stanley Research

India TradeSource: C&SD, Bloomberg, Morgan Stanley Research

Hong Kong Trade

-40

-20

0

20

40

60

80

100

Nov-08 May-09 Nov-09 May-10 Nov-10 May-11 Nov-11 May-12 Nov-12-25

-20

-15

-10

-5

0

Trade Balance ($bn, right)Imports (YoY %, left)Exports (YoY %, left)

-40

-30

-20

-10

0

10

20

30

40

50

Nov-08 Aug-09 May-10 Feb-11 Nov-11 Aug-12-60

-50

-40

-30

-20

-10

0

Trade Balance ($bn, right)Imports (YoY %, left)Exports (YoY %, left)



115


Source: MCI, Haver Analytics, Morgan Stanley Research

Price Pressures Remain Subdued in AxJ, Giving Policy-Makers Room to Act

India’s WPI inflation was lower than expected on lower global commodity prices, lagging the impact of rupee appreciation

CPI inflation slowed in various AxJ

countries, giving policy-makers room to act

India WPI (YoY %)

Source: National sources, Bloomberg, Morgan Stanley Research

Korea, Singapore, Taiwan CPI (YoY %)

-5

0

5

10

15

20

25


WPI

Food

Non-Food Manufactured(Core)

-4

-2

0

2

4

6

8

Oct-07 Oct-08 Oct-09 Oct-10 Oct-11 Oct-12

KoreaSingaporeTaiwan



116


Source: SIAM, C&SD, Bloomberg, Morgan Stanley Research

Source: KNSO, MOEA, Bloomberg, Morgan Stanley Research

India’s Car Sales Slumped While Korea’s Department Store Sales Jumped

India’s car sales slumped as the prior month’s jump failed to extend, with rates and fuel prices high and sentiment low

Korea department store sales jumped, boosted by cold weather

India Car Sales, Hong Kong Retail Sales (YoY %)

Korea Department Store Sales, Taiwan Retail Sales (YoY %)

-30

-20

-10

0

10

20

30

40

50

60

70


India Passenger Car Sales

Hong Kong Retail Sales

-15

-10

-5

0

5

10

15

20

25

30


Korea Department Store Sales

Taiwan Retail Sales



117


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118


Disclosure section (cont.)

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