key trade and risk june 21 2010

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Emerging MarketsEquity Research21 June 2010

Key Trades and RisksEmerging Markets Equity Strategy

Emerging Markets Equity Strateg

Adrian MowatAC

(852) 2800-8599

[email protected]

J.P. Morgan Securities (Asia Pacific) Limite

Ben Laidler(1-212) 622-5252

[email protected]

J.P. Morgan Securities Inc.

Deanne Gordon(27-21) 712-0875

[email protected]

J.P. Morgan Equities Ltd.

Rajiv Batra

(91-22) 6157-3568

[email protected]

J.P. Morgan India Private Limited

Sanaya Tavaria

(91-22) 6157-3312

[email protected]


Ankita Kochar

(91-22) 6157-3263

[email protected]


See page 90 for analyst certification and important disclosures, including non-US analyst disclosures.J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm mhave a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making thinvestment decision.

Figure 1: MSCI EM relative performan

20

40

60

80

100

120

140

96 98 00 02 04 06 08 10

vs USA

vs World

Source: Bloomberg, 14 June 2010.

Equities are fundamentally attractive. Global growth in our view issustainable. This growth is combined with low inflation and interestrates.

This is likely to be a volatile summer. Markets will focus on PMI datafor evidence of financial market weakness feeding through to the realeconomy. We believe investors are over estimating their influence on thereal economy. Regulatory reform and fiscal policy are additional sourcesof volatility.

The rebalancing of the Chinese economy from investment toconsumption is healthy. But mind the gap, the near term impact would

be lower commodity prices and potentially lower profit margins. Weexpect that commodity prices will correct this summer which couldpotentially lead to weaker EM equities.

Our key trades ranked by conviction are:

CEMBI Surfers; OverweightIndia and Turkey

Growth surprise from developed, not emerging,economies. Overweight Mexico, Taiwan and Turkeyplus technology and transportation.

Macro policy and rising inflation - QR not QE in EM:

Underweight Brazil, China, energy and commodities

The main risk to our view is that financial market stress results inweaker European growth than a bearish consensus. For more on riskssee page 8.

Key asset allocation calls:OW: Taiwan, Korea, India, Mexico, South Africa, Turkey and thePhilippines

OW: Technology and industrial cyclicals (i.e. transportation)

UW: China and Brazil

UW: Commodities, energy, telecoms and Utilities

For our Key Trade stock ideas,click hereto download the Bloombergsheet.
http://pull.jpmorgan-research.com/p/2-178F/582529/JPM_Key_Trades_bloomberg_updatable_EM.xlshttp://pull.jpmorgan-research.com/p/2-178F/582529/JPM_Key_Trades_bloomberg_updatable_EM.xlshttp://pull.jpmorgan-research.com/p/2-178F/582529/JPM_Key_Trades_bloomberg_updatable_EM.xls


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Emerging Markets Equity Research21 June 2010

Adrian Mowat(852) [email protected]

Table of ContentsSummer Swings........................................................................3

Risks to our strategy................................................................8

Global emerging markets model portfolio by country ........14Global emerging markets model portfolio by sector...........15

Key Trades ..............................................................................16

China: Mind the gap ...............................................................26

Brazil: Better Outlook for Domestics ....................................28

South Korea: Buying opportunity.........................................30

Taiwan: Potentially Oversold ................................................32

Russia: Strong balance sheet and earnings ........................34

India: Global concerns drag Indian equities ........................36

South Africa: A low beta equity market ................................38

Mexico: Cyclical Macro Momentum......................................40

Malaysia: Reform agenda keeping the buzz ........................42

Thailand: Resilient despite turmoil .......................................44

Indonesia: An eye on politics................................................46

Turkey: Cyclical view secular trend ..................................48

Philippines: Market re-rating likely .......................................50

Extended markers ..................................................................53

Consensus Asset Allocation.................................................55

Hindsight trades: What has worked......................................56

Composite valuation indicators ............................................58

EMBIG100................................................................................62

Emerging Markets Strategy Dashboards .............................70

In this report, we highlight:

Our top trade ideas

Risks

Our model portfolio

Valuation stress test

Key ratios for EMBIG 100

Consensus country weights

We have two pages on each

significant emerging market. The

first page has a qualitative

review of events driving the past

12 months, the outlook and a

comment on valuations; the

second page displays the

scorecard, which presents key

economic and equity marketdata

The extended markers: This

report contains 36 pages of data

designed to help track emerging

economies and markets

The emerging market

dashboards efficiently display

key economic, equity and debt

data, demonstrating change and

perspective.


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Summer Swings

There is a conflict in our strategy. This is a serious

conflict that could damage performance. Investors in our

view are too, and increasingly pessimistic, on thesustainability of the recovery. Our base case remains that

the global recovery is led by the private sector and is

sustainable. Economic growth combined with falling

core inflation is a strong fundamental backdrop for

equities. Note that J.P. Morgan's economists just pushed

out the first increase in Fed Funds rate to 4Q11 (SeeA

change to our Fed call, Michael Feroli et al, 17 June

2010). But EM investors need to consider the risk of the

correlation between EM equities and commodities. In our

view commodity investors are not pricing in China's

changing growth model.

Recognizing the conflict and risk, we are setting anartificial time limit on the fear of a correction in

commodities. The time limit is September 2010. By then

we believe that the decline in bulk commodity prices will

"scare" the new investors in commodities to redeem,

generating a broader correction.

Market confidence in a sustainable economic recovery is

waning. It is the risk of too rapid a fiscal consolidation

that is hitting confidence. We agree this risk has

increased but we also believe that financial investors are

over estimating their influence on the real economy. Post

the sub-prime crisis, business and consumer respect for

financial institutions and markets has declined. In

responding to the conflicting signals of weaker capital

markets and stronger than expected demand (see Figure

2) manufacturers should be more influenced by their

customer orders than stock market levels. This is

particularly true when investors appear shell-shocked in

their over-reaction to poor fundamental data.

Our expectation is that manufacturing PMIs will decline

from their post recovery highs but remain in an

expansionary range. Growth should hopefully broaden to

the service sectors. If this occurs then investor

confidence in a sustainable recovery would increase.

China's economic and policy dynamics are changing.

Consumption as a percentage of GDP declined in the last

decade. This is partly a function of the decline in the

share of household income as a percentage of GDP. The

tacit support for recent wage disputes may indicate a

more proactive policy to boost household income and

thus consumption (see Figure 4). Reducing China's

export competitiveness through higher wages, rather than

a stronger Renminbi, has a number of political and

economic advantages. It helps address Chinas strained

social contract by increasing household income as a share

of GDP at the expense of corporate profits (see risksection on page 8). There is a leveraged impact on

discretionary income. Economists may argue that a

stronger currency would indirectly boost real income due

to lower inflation but there are higher tangible benefits to

workers of higher wages rather than a lower cost of

imported goods.

Figure 2: Monitor European PMIs

25

30

35

40

45

50

55

60

65

Jun-07 May -08 Apr-09 Mar-10

Euro area

Germany

GreeceSpain

Source: J.P. Morgan Economics, May 2010

Figure 3: Domestic Savings as a percent of GDP in China

13

13

21

18

1

9

22

0

5

10

15

20

25

Enterprises

Financial

Institutions

Government

Households

1997-99 2005-07

Source: IMF

Figure 4: China consumption as a % of GDP

35

40

45

50

55

78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08

Source: J.P. Morgan economics, 2008.


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With such a clear policy to boost consumption investors

will desire exposure. But only 11% of MSCI China is

consumer companies. High growth and low free floatsresult in high relative valuations. There is a similar trend

in US where the EPS CAGR, since 1973, for consumer

discretionary at 10.5% is a premium to the market's

7.5%. Its long term average PE at 20 is also a premium to

the market average of 15.

A recentXinhau news article was critical of state owned

enterprises. It noted that SoEs scale and influence on the

Chinese economy may hinder economic growth. The

government controls these companies and can accelerate

the shift of GDP from corporate to household. Note that

80% of MSCI China is SoEs.

There is a Mexican stand-off in the property market.

Successive anti-asset-price-inflation measures have

discouraged buyers who now expect prices to fall. But

cash rich property companies and home owners mean a

lack of forced sellers. The result is a sharp decline in

property transactions. This in turn would lead to a fall in

construction activity. Infrastructure spending is

decelerating. Bank loans funded the bulk of last years

stimulus program. Greater regulatory scrutiny of lending

to local government funding vehicles is likely to lead to

less capital for infrastructure. These measures are

consistent with a policy to rebalance growth from

investment to consumption.

The demand for bulk commodities and energy is

declining as the growth driver shifts from fixed asset

investment to consumption in China. There is renewed

focus on energy efficiency. The five year plan target to

reduce energy use per unit of GDP by 20% has not been

met. Beijing is putting pressure on energy intensive and

polluting industries to close capacity. The market is also

applying pressure with steel prices declining while

contract iron ore and coking coal prices increase. Chinese

steel mills could make a loss in 3Q10.

Weak steel and aluminum prices may already be

indicating a slowdown in FAI. If our rebalancing thesis is

correct then steel prices should continue to fall. It is this

signal that we believe could lead to a broader correction

in commodity markets. The numerous presentations on

Chinas significant demand for commodities at our China

conference this month reflects Chinas key role in the

commodity super-cycle debate. Evidence of slowing

Chinese demand when combined with increased supply

could lead to disproportionate corrections in commodity

prices.

Commodity markets are technically weak. Investor

confidence in the asset class is falling due to poor returns

and a diminished diversification benefit. A broadcorrection in commodity prices would require these

investors to reverse a long standing trend to increase

asset allocation to commodities (See Figure 15 and

Figure 16).

Figure 5: China iron ore spot and contract prices

0

50

100

150

200

Apr 02 Apr 04 Apr 06 Apr 08 Apr 10

China iron ore spot price

Landed cost of contract iron ore in China

Source: Bloomberg. Note: The landed cost of contract iron ore are Vale's SSF cost +

freight costs from Brazil to China. For 3Q10 forecasts, Vale's SSF costs are calculated as

the average of the spot prices from Mar 10 to May 10. The freight costs in 3Q10 are

assumed to remain unchanged at today's levels.

Figure 6: MSCI EM Energy relative to MSCI EM

80

90

100

110

120

130

Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10

Source: Bloomberg. Note: Index rebased to 100 from January 2007.

Figure 7: MSCI EM Materials relative to MSCI EM

80

90

100

110

120

130

140


Source: Bloomberg. Note: Index rebased to 100 from January 2007.


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If the commodity market corrects then EM equities are

likely to decline led by Brazil and Russia. This

potentially would lead to redemptions in EM fundsleading to a broader correction (See Figure 11and Figure

12). We would view this event as an exceptional buying

opportunity.

Upgrading Korea to overweight

We upgraded Korea to overweight from neutral on 2

June in both Asian and Emerging Market portfolios. The

market has underperformed EM by 3% since 3

September 2009. Prior to that, from 26 February 2008 to

9 March 2009, MSCI Korea outperformed MSCI EM by

26%.

Our upgrade was opportunistic. On 20 May, the South

Korean government released a multinational combined

intelligence report that concluded that the South Korean

navy ship Cheonan was torpedoed by a DPRK

submarine. The report accelerated the correction in the

market and currency.

The Won declined by 9% in May. The result is that

MSCI Korea is the cheapest market in APxJ (PE 9.3) and

one of the most undervalued currencies in EM (REER).

We are more positive on global growth than the

pessimistic consensus. This, plus a competitive currencyis positive for exporters (note Yen and NT dollar cross

rates). Banks are inexpensive, in our view. The end of

price controls should boost domestic margins.

Our preferred sectors are exporters, banks and domestics.

Our top picks include Hyundai Mobis, HMC, Kia

Motors, Hyundai Department Store, Shinsegae, Lotte

Shopping, KB Financial, Hynix and SEC.

The risks to our view are: (1) a further deterioration in

the North Korean situation, (2) weaker global demand,

(3) price controls remaining, and (4) excessive tech

capex.

Figure 8: MSCI Korea Forward PE relative to MSCI EM

0.7

0.8

0.9

1.0

1.1

1.2

1.3

May -05 Jan-06 Sep-06 May -07 Jan-08 Sep-08 May -09 Jan-10

Avg

+1SD

-1SD

Source: IBES, MSCI, Datastream, 31 May 2010.

Figure 9: REER deviation from long term mean since 1975 -An

undervalued Won

-60

-40

-20

0

20

40

60

80

100

BRL

RUB

CLP

CZK

AUD

CNY

CHF

ZAR

TRY

PHP

PLN

HUF

IDR

MXN

THB

EUR

USD

TWD

KRW

Source: J.P. Morgan.

Figure 10: Performance of KRW/USD

800

1000

1200

1400

1600

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

05-07 Average FX rate: 969



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Conclusion

Equities are fundamentally attractive with a backdrop of

sustainable growth and low core inflation. We wish toadd EM equity risk but fear a correction in commodity

prices. A change in Chinas perceived demand for

commodities as its economy rebalances is the catalyst for

the correction in commodity prices. We hope this will

provide an outstanding buying opportunity. Evidence of

China's slowing commodity demand should appear over

the next few months. If no correction occurs before

September we will review our thesis and are likely to add

risk then.

Few investors share J.P. Morgan's optimism on

sustainable growth. European PMIs are forecast to

decline from recovery highs but remain above 50.

Key asset allocation calls

OW: Taiwan, Korea, India, Mexico, South Africa,

Turkey and the Philippines

OW: Technology and industrial cyclicals (i.e.transportation)

UW: China and Brazil

UW: Commodities, energy, telecoms and Utilities

Our key trades ranked by conviction are:

1. CEMBI Surfers; OW India and Turkey

2. Growth surprise from developed, not emerging,economies. OW Mexico, Taiwan and Turkey plus

technology and transportation

3. Macro policy and rising inflation QR not QE in

EM: UW Brazil, China, energy and commodities

For more details on these key trades, please see page 16

Please see pages 13,14,15 for our Global Emerging

Markets model portfolio and descriptions of changes

made this month.

Risks are many:

1. Strained social contract

2. Underestimating euro sovereign stress contagion risk

3. Rising economic risks

4. EM inflation and speed of policy normalization

5. Lack of G3 policy flexibility

6. Central banks target asset prices

7. Commodity EM equities feedback loop

8. Trade friction

9. Tension between the two Koreas

10.Thai political unrest

11.Bond market volatility

12.Election-induced volatility

For more details on these risks, please see page 8.

Please see pages 26 to 50 for our detailed country views.

Figure 11: S&P GSCI Industrial Metals Index

500

1000

1500

2000

2500


Source: Bloomberg

Figure 12: Cumulative inflows into commodity fund by year (US4billion)

50.4

8.911.8

18.4

16.016.3

5.7-10

0

10

20

30

40

50

60

Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

2004 2005 20062007 2008 20092010

Source: J.P. Morgan, May 2010


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Focus on sectors within countries rather than country recommendations

The table below provides a level summary of our views on sectors within countries. Financials is 25%, Materials is 15% and

Energy is 14% of EM. All recommendations are relative to EM. The Industrials sector consists of an eclectic group ofstocks. We are overweight technology and transportation.

Table 1: Key country and sector recommendations

Country/Sector Weight Reco US$ Return (%) PE 09 PE10E

PE11E

EPSGrowth

09

EPSGrowth

10E

EPSGrowth

(%)

DY10E

ROE10E

ROE

1 yr 3 yr 5 yr X X X (%) (%) CAGR05-10E

% % 03-08Avg

EM 100 -- 18 (3) 86 14.3 11.2 9.6 2 28 8.8 2.9 15.3 16.2China 18.7 UW 5 10 157 15.8 12.6 10.7 17 25 13.3 2.9 16.2 16.1China Financials 7.1 N 7 23 265 14.5 11.5 9.4 25 25 28.5 3.2 17.8 13.3China Energy 3.2 UW 10 14 161 13.4 10.6 9.6 (5) 26 8.3 3.8 17.8 21.4China Telecom 2.5 UW (6) 11 174 12.3 12.1 11.5 (4) 1 14.8 3.6 15.0 18.2China Industrials 1.4 n/a (10) (25) 55 20.3 13.3 11.8 58 53 5.4 2.1 11.0 12.8Brazil 16.1 UW 20 28 243 13.5 11.2 9.0 7 20 6.1 3.4 16.1 18.8Brazil Materials 4.3 UW 31 29 308 19.2 9.3 6.6 (40) 106 10.1 3.2 19.2 27.9Brazil Energy 3.7 N (0) 62 310 10.3 10.8 9.5 (5) (5) 2.8 2.5 15.5 25.3Brazil Financials 3.8 OW 27 21 243 11.9 11.5 9.5 45 4 5.9 3.6 16.1 22.4Korea 13.1 OW 23 (22) 47 13.8 9.5 9.1 56 45 8.4 1.2 15.4 14.3Korea IT 4.0 OW 40 3 38 18.1 10.0 11.1 (2,217) 81 13.7 0.2 18.1 17.0Korea Financials 2.2 OW 16 (43) 32 15.6 8.8 7.6 (31) 77 3.0 2.2 11.7 13.3Korea Industrials 1.8 n/a (3) (49) 71 14.9 11.4 10.4 26 30 10.6 1.3 11.4 12.0Korea Materials 1.7 N 27 0 173 10.7 8.9 8.2 (2) 20 7.7 1.2 32.1 17.6Korea CD 1.8 OW 50 23 72 9.3 8.1 7.8 125 15 16.9 0.8 20.2 13.4Korea CS 0.6 N 12 (25) 46 15.0 13.7 11.8 7 9 11.3 1.7 14.4 14.9Taiwan 10.7 OW 12 (12) 15 24.6 12.8 11.3 36 92 5.1 3.8 13.5 13.3Taiwan IT 6.5 OW 16 (17) 12 29.1 12.0 10.9 9 143 11.5 3.6 16.9 14.3Taiwan Financials 1.5 N (4) (21) (19) 19.6 13.2 10.6 859 48 9.3 3.3 8.7 6.6Taiwan Materials 1.3 UW 16 7 78 17.1 14.5 12.0 NM 18 (7.8) 4.8 10.5 20.7India 8.0 OW 15 9 143 21.4 17.2 13.6 3 25 13.4 1.3 16.3 21.0India Financials 2.0 OW 14 3 148 23.5 19.3 15.3 0 22 13.7 1.2 12.3 14.9

India Energy 1.2 N (7) 12 285 20.5 14.4 12.0 (0) 42 14.7 1.2 16.3 21.1India IT 1.3 OW 54 3 104 24.2 21.1 17.4 5 15 16.1 1.2 24.4 31.3South Africa 7.4 OW 21 4 93 16.6 12.3 9.8 (18) 35 10.7 3.2 16.3 19.1SA Materials 2.1 OW 15 (13) 97 47.0 16.8 11.9 (54) 179 22.2 2.1 13.5 9.9SA Financials 1.9 OW 36 8 82 13.1 10.7 8.8 (15) 23 5.9 4.5 15.0 19.6SA Telecom 0.9 UW (2) (1) 95 12.3 10.2 8.7 (10) 20 10.2 3.0 20.0 28.9SA Cons Discr 0.9 N 50 25 119 16.2 13.2 10.5 10 23 10.9 2.4 17.0 23.1SA Energy 0.7 UW (5) 18 59 11.9 9.9 7.7 (22) 20 6.3 3.6 17.2 23.8Russia 6.5 N 11 (31) 56 8.2 6.4 5.1 (21) 29 9.1 2.2 13.8 16.6Russia Energy 3.8 N (2) (33) 34 5.7 5.0 4.6 (12) 14 6.0 2.3 13.7 16.6Mexico 4.8 OW 38 (14) 102 18.0 14.4 12.1 2 25 7.7 2.7 16.7 19.1Mexico Telecom 1.9 UW 33 (13) 154 14.3 12.4 10.9 (2) 15 16.4 4.1 36.5 31.2Mexico CS 1.1 N 52 21 133 18.9 19.0 15.8 54 (0) 14.1 1.7 15.1 16.0Mexico Materials 0.8 OW 45 (41) 32 30.8 14.6 10.9 (16) 111 (8.8) 1.6 8.0 15.8Malaysia 2.9 N 28 7 96 18.2 14.8 12.7 (1) 23 7.5 3.5 12.5 13.2Indonesia 2.3 N 44 53 206 16.3 13.8 11.9 21 18 16.4 3.0 23.8 25.4Turkey 1.6 OW 56 7 88 11.0 9.5 8.3 3 16 12.8 3.1 17.4 17.2

Turkey Financials 1.0 OW 74 29 129 9.7 8.8 7.8 30 11 18.4 2.4 18.1 16.6Chile 1.5 n/a 26 25 127 18.7 16.2 13.5 NM 15 19.1 2.3 11.2 10.1Thailand 1.5 N 25 23 79 12.8 11.2 9.6 33 14 (0.9) 4.0 15.1 19.4Poland 1.4 N 22 (39) 28 15.2 13.2 11.0 (26) 15 (1.4) 3.7 11.7 17.0Hungary 0.4 N 11 (40) (8) 12.1 10.9 8.5 (37) 11 (2.7) 3.6 11.9 23.8Philippines 0.5 OW 25 (6) 114 17.3 15.4 13.4 25 13 5.5 3.9 15.6 14.4

Source: J.P. Morgan Asian strategy team, MSCI, Datastream. Table sorted by descending weight in index, countries first followed by country-sectors, 10 June 2010.


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Risks to our strategy

Strained social contract

Political and regulatory risk is high. The corporate sector

has emerged from the global recession and credit crunch

stronger than the households. Note the profits as a shareof GDP are near cycle highs but unemployment is 10%.

Policy makers constrained by high fiscal deficits are

likely to redress this imbalance through higher taxes and

increased regulation.

As is the case in the US, Chinese corporates share of

GDP increased while the household share decreased.

Labour disputes and subsequent large pay increases may

start to reverse this trend. This rebalancing is healthy and

should move China to a more sustainable growth model.

But near term the result is lower profit margins.

Underestimating Euro sovereign stress contagion risk

After Greece, there is speculation that Spain might reach

out to the EU or IMF for financial support. The Spanish

banking system is under significant pressure to address

its solvency issues, especially among its saving banks.

These concerns have impaired the ability of Spanish

banks to raise market funding, and increased the

possibility of seeking external liquidity support. If this

were to be true, Spanish bond yields which have already

increased by 50 bps in the last one week would likely rise

further and issuance become more difficult.

Euro sovereign stress generates both economic andmarket risk. The economic risk is that business in core

Europe slows investment decisions. As we witnessed in

2008, rational individual risk reduction results in a

destructive downward spiral in risk assets.

In Emerging Markets Outlook and Strategy, June 8,

2010, Joyce Chang, our Global head of Emerging

Markets and Credit Research , notes two scenarios.

Scenario 1: Deeper economic and financial crisis, but

contained to peripheral Europe. Scenario2: Crisis spreads

to core Europe due to contagion from the periphery,

pushing the Euro area into a double dip recession. If the

crisis were to spread to core Europe, it could have asignificant impact on emerging markets. In such a

scenario, emerging markets would reverse incipient

tightening. Emerging markets may also have to resort to

greater fiscal stimulus to offset the weakness in the

private sector. (Please see Page 23 for more details)

The feedback loop between banks struggling to fund and

a subsequent reduction in the availability of credit is

another key risk.Nikolaos Panigirtzoglou in his weekly,

Flows and Liquidity, 4 June 2010 notes that: European

banks continue to face a difficult funding environment.

The primary market for unsecured bank debt remains in

hibernation. The contraction in the CP/CD issued by

European banks in the US is accelerating. Note thatEuropean banks need to refinance nearly $130bn per

month for the remainder of the year.

Rising economic risks

Private payrolls at 41K for the month of May were

disappointing. Note that firms are using their existing

workers more intensively as they lengthen the work

week, and companies cannot increase work hours

indefinitely. Private sector job creation should improve

over the rest of the year. However, if the job data

continues to be below expectations, it could adversely

impact consumer spending and a sustained economic

recovery.

Figure 13: Strained social contract: US profit share andunemployment

8

10

12

14

16

18

20

22

70 75 80 85 90 95 00 05 10

0

3

6

9

12

% sa

Unemploym ent rate (inv erted)

Profit share

Source: J.P. Morgan. Note: Chart shows % share of gross value added, JPMorgan

forecast for 2010.

Figure 14: Spread between Spanish and German 10 year bondyield

0

50

100

150

200

250

Jan 08 Jul 08 Jan 09 Jul 09 Jan 10

Source: Bloomberg


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EM inflation and speed of policy normalization

Our base case is that inflation plateaus mid-year as the

base effect becomes more favorable. If we are wrong and

inflation continues to rise then this is bearish for equities.

The EM dashboard has a sheet designed to help monitor

inflation across EM countries. Remember modelinginflation in emerging economies is difficult due to the

short history of floating exchange rates and large

weighting of food and other primary products.

Lack of G3 policy flexibility

High fiscal deficits and record-low interest rates limit

policymakers ability to respond to a relapse in growth. A

growth relapse is not our base case. If it occurred, it

would be a serious blow to risk assets. Credit spreads

could widen and equities would fall.

Central banks target asset prices

Central banks are targeting asset prices in EM, notably inChina. These policies introduce economic and sector

specific risk. Note how poorly real estate stocks have

performed in EM despite low interest rates.

Commodity EM equities feedback loop

Commodity markets are in our view vulnerable. Investors

are frustrated by low to negative returns due to the high

roll cost in forward markets in contango. In 2009, net

retail inflows into commodity funds were $50billion; this

year, subscriptions have slowed sharply. A combination

of negative momentum and Chinese economic

rebalancing could be a catalyst for significant

redemptions. The liquidation of contango arbitrageinventory (i.e. leasing supertankers to buy spot and sell

forward) adds to the downside risk for commodities.

Weak commodity prices will drive Brazilian, Russian

and Indonesian markets lower, in our view. It is

reasonable to expect redemptions in BRIC funds.

Trade friction

It is no fun being a politician today. High fiscal deficits

in the developed economies and rising inflation in

emerging economies will mean uncomfortable policy

choices. In this environment it is appealing to look for

others to blame. A building risk is trade sanctions against

China. The rhetoric on the Renminbi is heating up.

China's priority is to manage a rebalancing economy. We

doubt Beijing wishes to add currency volatility to the

mix. Hopefully this war will be fought in the media

rather than with sanctions. Our overweight exporters is

very exposed to a trade war.

Tension between the two Koreas

On 20 May, the South Korean government released a

multinational combined intelligence task force report that

concluded that the South Korean navy warship was

torpedoed by a DPRK submarine on 26 March. The

Korean Won has weakened by 5% in the last one month

to KRW/USD1213.

Thai political unrest

The Thai market and baht are remarkably resilient

considering the violence in Bangkok.

Figure 15: Oil forward curve ($/bbl)

70

75

80

85

90

95

Jul-10 Jul-12 Jul-14 Jul-16 Jul-18

Crude Oil, WTI : 6/9/2010

Source: Bloomberg. 9 June 2010.

Figure 16: Underperformance of TR Crude Oil Index and Energyvs WTI

70

100

130

160

190

220

Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10

WTI JPM Crude Oil TR JPM Energy TR

Source: Bloomberg.


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Bond market volatility

The end of QE plus banks unwillingness to add to

duration risk is a dangerous technical situation for

government bonds. Risk assets typically struggle as bond

yields rapidly increase to normal levels. EM equities

typically correct when bond market volatility rises. Ourwork on quantifying the relationship between the

direction of US Treasury yields and EM equity returns

suggests that the probability of such a correction in 2010

is high if UST yields rise rapidly and increases the risk of

a rapid adjustment. We advise investors to monitor the

pace of change in 10-year UST yields in 2010.

Election-induced volatility

Brazilian elections in October 2010 are likely to be a

source of volatility rather than a change in macro-

economic policy.

Figure 17: Global bond supply ($tr)

$0

$1

$2

$3

$4

$5

$6

$7

2009 2010

Gov ernment Agencies, Supra, Muni, etc

Corporates incl Govt Guranteed Securitized

Source: J.P. Morgan. Global bond supply and demand 2009 and 2010 in $tr, demand and

supply figures are annualized, supply is calculated by the change in bond out standings at

face value, demand is calculated by the change in bond out standings at market value.

Figure 18: Global bond demand ($tr)

$0

$1

$2

$3

$4

$5

$6

$7

2009 2010

QE BanksFX Reserv es Retail Bond FundsInsurance + Pension Other

Source: J.P. Morgan. Global bond supply and demand 2009 and 2010 in $tr, demand andsupply figures are annualized, supply is calculated by the change in bond out standings at

face value, demand is calculated by the change in bond out standings at market value.


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Figure 19: Public Debt and Fiscal Balance as a % of GDP for EM and DM in 2010

Turkey

S Africa

Russia

Poland

HungaryCzech

Thai

Phil

Malaysia

Korea

Indonesia

India

ChinaPeru

Mexico

Chile

BrazilEM

Australia

UK

Portugal

Ireland

Greece

Spain

Italy

France

Germany

Euro area

Japan

US

DM

-14

-12

-10

-8

-6

-4

-2

0

0 50 100 150 200 250Public Debt

FiscalBalance

Source: J.P. Morgan estimates


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Model portfolio changes

This months model portfolio reflects the changes made

in the Regional model portfolio in Off Balance to

Rebalance', Perspectives and Portfolios, Mowat et al, 3

June 2010

In Russia, we replaced VTB with Sberbank. Sberbanks

1Q10 earnings beat consensus estimates owing to

resilient net interest margin as well as other revenue

items. We believe that the stabilization of asset yield and

asset mix is in the offing creating conditions for

stabilization of NIM.

In South Africa, we booked profits in Firstrand, Foschini

and JD Group. We are rebalancing our portfolio in South

Africa in favor of high conviction, defensive names.

In China, we added Belle International Holdings Ltd.

We like consumer discretionary in China as the Chinese

economy prepares itself for rebalancing towards

consumption. Belles valuations are relatively high, but

still below big cap peers.

In Malaysia, we replaced Digi.Com with Genting BHD.

Genting had strong first quarter results, with 14% yoy

increase in revenue. We expect gaming revenue to

benefit from the improving economy and cyclical

recovery through increased consumer spending. Its

Singapore resort (RWS), which begun operations in mid

February 2010, is already experiencing slot wins that are

3-5x that of Macau. VIP revenue also surprised on theupside, coming in at 50% of overall gaming revenue.

In Off Balance to Rebalance, Perspectives and

Portfolios, Mowat et al, 6 May 2010, we added Hyundai

Department Stores, Hyundai Mobis, and KB

Financial in Korea and dropped Korean Air as we

upgraded the market to overweight.

In India, we added DLF as the stock looked attractive

post the recent correction. We expect the stock to benefit

from an improvement in the commercial business and

volume growth returning back in the affordable homes

segment. We dropped BHEL.

Table 2: Country asset allocation relative to MSCI EM

Country Deviation

Taiwan 4.1India 4.0Mexico 3.8Turkey 3.5South Africa 3.3Korea 3.1Philippines 2.3Russia 0.7Thailand -0.3Malaysia -1.1Indonesia -1.3CE3 -1.3Brazil -8.4China -8.7


Table 3: Sector asset allocation relative to MSCI EM

Sector DeviationFinancials 10.6Information Technology 9.1Consumer Discretionary 5.3Industrials 4.7Utilities 0.0Health Care -2.4Consumer Staples -3.3Materials -5.5Telecommunication Services -8.5Energy -10.2


Figure 20: Performance of GEM Model Portfolio vs. MSCI EM

-5

5

15

25

35

1M 3M 12M

GEMs Model Portfolio MSCI EM

Source: J.P. Morgan Strategy, Bloomberg, 15 June 2010. Note: This is capital only return

i.e. no reinvestment of divs.

Please see pages 14 and 15 for our Global EmergingMarkets Model Portfolio.

Please note: Source for Data in Global emerging

market portfolio is: Bloomberg, MSCI, J.P. Morgan

estimates. Prices and valuations are as of 15 June 2010.


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Global emerging markets model portfolio by countryTicker Price JPM Change Change Portfolio MSCI Deviation P/E P/E DY ROE

LC Rating 4 Wk (%) YTD (%) Weight(%) Weight(%) (%) 10E (x) 11E (x) 10E (%) 10E (%)China 59.5 3.0 -6.7 10.1 18.7 -8.7 13.6 11.5 2.7 16.2Bank of Communications 3328 HK 8.4 OW 7.3 -7.3 2.1 0.2 1.9 10.7 8.9 3.1 21.1Belle International Holdings 1880 HK 10.7 OW 7.8 18.3 2.0 0.2 1.8 28.5 27.2 1.2 19.4

China High Speed Transmission 658 HK 16.9 OW -9.9 -11.1 1.4 0.1 1.3 15.6 12.5 2.1 27.6China Shipping Container Lines 2866 HK 2.7 OW -10.7 -5.0 2.1 0.0 2.1 NM 24.0 0.0 0.4Lenovo 992 HK 4.4 N -23.9 -10.3 1.3 0.1 1.3 37.1 15.0 0.1 9.8Xinao Gas 2688 HK 16.5 N -31.5 -17.3 1.1 0.1 1.0 16.4 12.5 1.5 15.0Brazil 219,725.3 0.1 -11.0 7.6 15.9 -8.4 11.3 9.0 3.4 18.0BM&F Bovespa BVMF3 BZ 11.9 OW 3.5 -2.8 3.3 0.4 2.9 14.3 12.3 na naPDG Realty PDGR3 BZ 16.0 OW 10.4 -7.8 1.7 0.2 1.6 12.8 8.4 1.4 14.2Petrobras PBR/A US 32.0 N -4.0 -24.6 2.6 3.1 -0.5 8.5 6.7 2.8 15.2Korea 481.8 -3.1 -3.3 16.6 13.5 3.1 10.4 9.4 1.2 13.4Cheil Worldwide 030000 KS 13,050 NR 1.6 3.6 1.1 0.0 1.1 15.1 14.1 2.8 16.8Hynix Semiconductor 000660 KS 27,100 N 1.9 17.1 2.0 0.4 1.6 6.7 10.0 0.0 33.8Hyundai Department Stores 069960 KS 115,000 OW 11.1 2.2 1.6 0.0 1.5 10.6 9.6 0.5 13.8Hyundai Mobis 012330 KS 200,500 OW 3.4 17.3 1.5 0.4 1.1 10.2 9.2 0.5 19.3KB Financial 105560 KS 51,200 OW 1.2 -14.2 2.0 0.5 1.6 8.1 6.8 2.0 11.7LG Chem 051910 KS 295,000 OW -0.2 29.1 2.0 0.4 1 .6 11.0 10.8 1.2 27.5Samsung Electronics 005930 KS 798,000 N -1.5 -0.1 4.4 2.4 1.9 10.0 11.4 0.0 18.0SEMCO 009150 KS 146,500 OW -3.0 36.3 2.1 0.2 1.8 19.8 16.9 0.4 18.3Taiwan 262.6 -4.1 -12.0 14.9 10.8 4.1 13.6 11.7 3.7 14.1China Airlines 2610 TT 15.8 OW 18.4 39.2 2.1 0.0 2.1 NM 17.6 0.0 1.3Fubon Financial Holdings 2881 TT 37.1 OW -3.4 -5.6 1.9 0.2 1.7 11.9 9.9 5.2 11.7Hon Hai 2317 TT 121.0 OW -15.7 -20.1 1.8 1.0 0.9 12.3 10.9 1.7 17.6Mediatek 2454 TT 516.0 N -1.7 -7.5 1.9 0.5 1.5 12.7 11.1 5.0 36.2Nanya Technology Corporation 2408 TT 25.4 OW -6.6 -22.3 1.4 0.0 1.4 16.3 7.0 0.0 13.3TSMC 2330 TT 61.4 OW 0.3 -4.8 2.1 1.5 0.5 10.8 10.7 4.9 27.6UMC 2303 TT 14.7 OW -3.3 -14.5 1.9 0.2 1.8 10.6 11.0 3.5 8.0Yuanta FHC 2885 TT 17.4 OW -7.2 -26.0 1.7 0.1 1.6 10.5 8.9 5.3 11.4India 702.9 0.5 0.1 12.0 8.1 4.0 17.2 13.7 1.1 17.7DLF DLFU IN 272.5 OW -8.7 -24.6 1.8 0.1 1.7 25.5 18.2 0.0 7.2HDFC Bank HDFCB IN 1,963.9 OW 0.6 15.4 1.5 0.4 1.1 30.5 22.5 0.7 16.1IDFC IDFC IN 165.3 OW 0.0 7.1 1.6 0.1 1.5 20.2 17.6 1.0 16.1Infosys INFO IN 2,734.7 OW 3.1 5.1 1.9 0.9 1.0 25.2 22.5 0.9 28.8Kotak Mahindra Bank KMB IN 770.7 OW 1.7 -4.5 2.0 0.1 1.9 21.8 17.9 0.2 16.7Larsen & Toubro LT IN 1,724.5 OW 12.8 2.8 1.6 0.2 1.4 29.7 24.1 0.0 19.4TCS TCS IN 766.1 OW 0.3 2.1 1.7 0.3 1.5 21.8 20.2 3.1 36.8South Africa 708.1 -2.0 -2.3 10.6 7.3 3.3 12.1 9.7 3.3 17.5

ABSA Group Ltd ASA SJ 125.8 OW -6.8 -2.1 1.9 0.2 1.7 8.8 7.3 4.5 19. African Rainbow Minerals ARI SJ 172.1 OW -5.3 -1.0 2.2 0.1 2.1 4.8 4.5 2.5 25.7 Anglo Platinum AMS SJ 778.0 OW 4.0 1.0 2.0 0.2 1.8 21.6 16.2 1.4 25Shoprite SHP SJ 85.0 OW 8.0 30.3 2.5 0.1 2.4 18.8 15.6 2.6 40.1Standard Bank SBK SJ 105.6 N -3.8 3.5 2.0 0.5 1.5 10.9 8.7 3.6 16.4Russia 722.9 -4.9 -7.7 7.0 6.4 0.7 6.5 5.2 2.2 14.8Globaltrans Investments GLTR LI 13.2 OW 8.0 33.3 2.7 0.0 2.7 13.0 8.5 0.0 24.7MRSK Holding MRKH RU 0.1 OW -16.0 8.8 1.3 0.0 1.3 NA NA NA NARosneft ROSN LI 6.9 OW -5.6 -20.3 1.5 0.4 1.1 6.2 6.8 1.5 19.4Sberbank SBER RU 2.4 OW -7.3 -15.8 1.5 0.0 1.5 9.8 5.1 8.5 18.8Mexico 29,852.0 3.1 4.0 8.4 4.6 3.8 14.8 12.4 2.6 18.5Cemex CX US 10.9 OW 2.2 -8.0 1.8 0.0 1.8 35.1 15.8 NA NAFirst Cash Financial FCFS US 21.6 OW 0.6 -2.6 1.8 0.0 1.8 13.5 11.7 NA 18.0ICA ICA* MM 30.1 OW -3.1 -1.2 1.5 0.0 1.5 28.1 20.4 0.0 3.6Ternium TX US 35.6 OW 3.1 0.4 1.8 0.0 1.8 9.3 8.5 1.4 13.6Urbi URBI* MM 24.0 OW -12.7 -18.5 1.4 0.0 1.4 11.0 9.0 0.0 12.9Malaysia 472.7 -3.5 7.2 1.8 2.9 -1.1 13.7 11.8 3.5 14.8Genting BHD GENT MK 7.2 OW 2.1 -2.3 1 .8 0.2 1.6 22.3 13.7 1.0 8.3

Indonesia 3,810.4 -0.1 8.7 1.0 2.3 -1.3 15.0 12.9 3.0 25.9Bank Danamon BDMN IJ 5,150.0 OW -1.9 13.2 1.0 0.1 0.9 15.1 11.3 2.2 16.7Thailand 316.9 2.5 10.5 1.2 1.5 -0.3 11.6 10.0 3.6 16.0Siam Commercial Bank SCB TB 82.0 N -2.4 -5.5 1.2 0.1 1.1 12.5 10.9 3.0 15.2Turkey 811,914.4 -1.1 2.2 5.2 1.7 3.5 9.6 8.4 3.1 18.4Sabanci SAHOL TI 6.5 NR 4.8 13.0 2.2 0.1 2.1 8.3 6.9 1.2 13.6Vakifbank VAKBN TI 3.5 OW -1.1 -17.4 1.1 0.1 1.0 6.4 5.0 4.7 17.5Yapi Kredi YKBNK TI 4.3 OW 4.9 31.1 1.9 0.1 1.8 9.5 6.4 0.0 20.7CE3 NA NA NA 0.9 2.2 -1.3 11.9 10.0 4.4 13.6Erste Bank EBS AV 28.5 OW -8.7 9.3 0.9 0.0 0.9 9.8 6.5 1.4 9.3Philippines 615.6 -3.3 4.6 2.8 0.5 2.3 15.5 13.4 4.2 16.0

Ayala Corp AC PM 320.0 OW -0.8 5.8 1.6 0.0 1.6 18.8 15.3 1.3 8PNOC-EDC EDC PM 4.6 OW -13.2 -2.1 1.2 0.0 1.1 12.2 12.4 8.2 24.2Emerging Markets 41,339.3 -0.7 -4.9 100.0 100.0 0.0 11.4 9.7 2.8 16.1

Source: J.P. Morgan, MSCI, Datastream, IBES estimates for NR stocks


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Global emerging markets model portfolio by sectorTicker Price JPM Change Change Portfolio MSCI Deviation P/E P/E DY ROE

LC Rating 4 Wk (%) YTD (%) Weight(%) Weight(%) (%) 10E (x) 11E (x) 10E (%) 10E (%)

Consumer Discretionary 525.6 3.3 4.4 11.0 5.7 5.3 12.4 10.7 1.8 16.8Belle International Holdings Ltd. 1880 HK 10.7 OW 7.8 18.3 2.0 0.2 1.8 28.5 27.2 1.2 19.4

PDG Realty PDGR3 BZ 16.0 OW 10.4 -7.8 1 .7 0.2 1.6 12.8 8.4 1.4 14.2Cheil Worldwide 030000 KS 13,050.0 NR 1.6 3.6 1.1 0.0 1.1 15.1 14.1 2.8 16.8Hyundai Department Stores 069960 KS 115,000.0 OW 11.1 2.2 1.6 0.0 1.5 10.6 9.6 0.5 13.8Hyundai Mobis 012330 KS 200,500.0 OW 3.4 17.3 1.5 0.4 1.1 10.2 9.2 0.5 19.3Urbi URBI* MM 24.0 OW -12.7 -18.5 1.4 0.0 1.4 11.0 9.0 0.0 12.9Genting BHD GENT MK 7.2 OW 2.1 -2.3 1.8 0.2 1.6 22.3 13.7 1.0 8.3Consumer Staples 442.3 4.0 6.9 2.5 5.8 -3.3 18.0 15.4 2.3 16.5Shoprite SHP SJ 85.0 OW 8.0 30.3 2.5 0.1 2.4 18.8 15.6 2.6 40.1Energy 891.4 3.4 2.9 4.0 14.2 -10.2 9.1 8.1 2.5 14.6Petrobras PBR/A US 32.0 N -4.0 -24.6 2.6 3.1 -0.5 8.5 6.7 2.8 15.2Rosneft ROSN LI 6.9 OW -5.6 -20.3 1.5 0.4 1.1 6.2 6.8 1.5 19.4Financials 407.0 5.4 6.1 34.9 24.3 10.6 12.8 10.5 2.7 14.4Bank of Communications 3328 HK 8.4 OW 7.3 -7.3 2.1 0.2 1.9 10.7 8.9 3.1 21.1BM&F Bovespa BVMF3 BZ 11.9 OW 3.5 -2.8 3.3 0.4 2.9 14.3 12.3 NA NAKB Financial 105560 KS 51,200.0 OW 1.2 -14.2 2.0 0.5 1.6 8.1 6.8 2.0 11.7Fubon Financial Holdings 2881 TT 37.1 OW -3.4 -5.6 1.9 0.2 1.7 11.9 9.9 5.2 11.7Yuanta FHC 2885 TT 17.4 OW -7.2 -26.0 1.7 0.1 1.6 10.5 8.9 5.3 11.4DLF DLFU IN 272.5 OW -8.7 -24.6 1.8 0.1 1.7 25.5 18.2 0.0 7.2HDFC Bank HDFCB IN 1,963.9 OW 0.6 15.4 1.5 0.4 1.1 30.5 22.5 0.7 16.1IDFC IDFC IN 165.3 OW 0.0 7.1 1.6 0.1 1.5 20.2 17.6 1.0 16.1Kotak Mahindra Bank KMB IN 770.7 OW 1.7 -4.5 2.0 0.1 1.9 21.8 17.9 0.2 16.7

ABSA Group Ltd ASA SJ 125.8 OW -6.8 -2.1 1.9 0.2 1.7 8.8 7.3 4.5 19.Standard Bank SBK SJ 105.6 N -3.8 3.5 2.0 0.5 1.5 10.9 8.7 3.6 16.4Sberbank SBER RU 2.4 OW -7.3 -15.8 1.5 0.0 1.5 9.8 5.1 8.5 18.8First Cash Financial FCFS US 21.6 OW 0.6 -2.6 1.8 0.0 1.8 13.5 11.7 NA 18.0Bank Danamon BDMN IJ 5,150.0 OW -1.9 13.2 1.0 0.1 0.9 15.1 11.3 2.2 16.7Siam Commercial Bank SCB TB 82.0 N -2.4 -5.5 1.2 0.1 1.1 12.5 10.9 3.0 15.2Sabanci SAHOL TI 6.5 NR 4.8 13.0 2.2 0.1 2.1 8.3 6.9 1.2 13.6Vakifbank VAKBN TI 3.5 OW -1.1 -17.4 1.1 0.1 1.0 6.4 5.0 4.7 17.5Yapi Kredi YKBNK TI 4.3 OW 4.9 31.1 1.9 0.1 1.8 9.5 6.4 0.0 20.7

Ayala Corp AC PM 320.0 OW -0.8 5.8 1.6 0.0 1.6 18.8 15.3 1.3 8Erste Bank EBS AV 28.5 OW -8.7 9.3 0.9 0.0 0.9 9.8 6.5 1.4 9.3Health Care 542.3 2.0 11.0 0.0 2.4 -2.4 19.9 16.6 1.2 16.8Industrials 218.7 4.0 7.7 11.5 6.8 4.7 13.2 11.2 2.0 12.6China High Speed Transmission 658 HK 16.9 OW -9.9 -11.1 1.4 0.1 1.3 15.6 12.5 2.1 27.6

China Shipping Container Lines 2866 HK 2.7 OW -10.7 -5.0 2.1 0.0 2.1 NM 24.0 0.0 0.4China Airlines 2610 TT 15.8 OW 18.4 39.2 2.1 0.0 2.1 NM 17.6 0.0 1.3Larsen & Toubro LT IN 1,724.5 OW 12.8 2.8 1.6 0.2 1.4 29.7 24.1 0.0 19.4Globaltrans Investments GLTR LI 13.2 OW 8.0 33.3 2.7 0.0 2.7 13.0 8.5 0.0 24.7ICA ICA* MM 30.1 OW -3.1 -1.2 1.5 0.0 1.5 28.1 20.4 0.0 3.6Information Technology 225.3 5.6 5.0 22.6 13.5 9.1 12.3 11.5 2.5 19.4Lenovo 992 HK 4.4 N -23.9 -10.3 1.3 0.1 1.3 37.1 15.0 0.1 9.8Hynix Semiconductor 000660 KS 27,100.0 N 1.9 17.1 2.0 0.4 1.6 6.7 10.0 0.0 33.8Samsung Electronics 005930 KS 798,000.0 N -1.5 -0.1 4.4 2.4 1.9 10.0 11.4 0.0 18.0SEMCO 009150 KS 146,500.0 OW -3.0 36.3 2.1 0.2 1.8 19.8 16.9 0.4 18.3Hon Hai 2317 TT 121.0 OW -15.7 -20.1 1.8 1.0 0.9 12.3 10.9 1.7 17.6Mediatek 2454 TT 516.0 N -1.7 -7.5 1.9 0.5 1.5 12.7 11.1 5.0 36.2Nanya Technology Corporation 2408 TT 25.4 OW -6.6 -22.3 1.4 0.0 1.4 16.3 7.0 0.0 13.3TSMC 2330 TT 61.4 OW 0.3 -4.8 2.1 1.5 0.5 10.8 10.7 4.9 27.6UMC 2303 TT 14.7 OW -3.3 -14.5 1.9 0.2 1.8 10.6 11.0 3.5 8.0Infosys INFO IN 2,734.7 OW 3.1 5.1 1.9 0.9 1.0 25.2 22.5 0.9 28.8TCS TCS IN 766.1 OW 0.3 2.1 1.7 0.3 1.5 21.8 20.2 3.1 36.8Materials 595.3 7.2 11.0 9.8 15.4 -5.5 12.6 9.9 2.4 15.3

LG Chem 051910 KS 295,000.0 OW -0.2 29.1 2.0 0.4 1.6 11.0 10.8 1.2 27.5 African Rainbow Minerals ARI SJ 172.1 OW -5.3 -1.0 2.2 0.1 2.1 4.8 4.5 2.5 25.7 Anglo Platinum AMS SJ 778.0 OW 4.0 1.0 2.0 0.2 1.8 21.6 16.2 1.4 25Cemex CX US 10.9 OW 2.2 -8.0 1.8 0.0 1.8 35.1 15.8 NA NATernium TX US 35.6 OW 3.1 0.4 1.8 0.0 1.8 9.3 8.5 1.4 13.6Telecommunication Services 278.5 3.1 6.2 0.0 8.5 -8.5 12.3 11.1 4.3 18.6Utilities 351.0 2.7 4.3 3.6 3.5 0.0 12.9 11.0 3.3 9.5Xinao Gas 2688 HK 16.5 N -31.5 -17.3 1.1 0.1 1.0 16.4 12.5 1.5 15.0MRSK Holding MRKH RU 0.1 OW -16.0 8.8 1.3 0.0 1.3 NA NA NA NAPNOC-EDC EDC PM 4.6 OW -13.2 -2.1 1.2 0.0 1.1 12.2 12.4 8.2 24.2Emerging Markets 41,339.3 -0.7 -4.9 100.0 100.0 0.0 11.4 9.7 2.8 16.1Source: J.P. Morgan, MSCI, Datastream, IBES estimates for NR stocks


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Key TradesGrowth Surprise from DM not EM

Confidence in a sustainable economic growth has declined. Investors fear that theEuro sovereign stress will lead to excessive fiscal consolidation in developed

economies. We believe the market is exaggerating this risk. The key economic datapoints still support a sustainable recovery driven by private sector demand.Werecommend investors buy exporters, technology, transportation, Korea andMexico. The drivers are:

1. Sustainable US and a better core Europe. Private sector is driving US andcore European growth. Acceleration in business spending and recovering job growthare generating strong lift in global demand. J.P. Morgans proxy of global final salesgrew at 9.7% saar in 1Q10, its fastest gain in over a decade. G-3 capital goods ordersand shipments are booming. Global capital spending is expected to rise at its fastestpace in 25 years. Despite financial market stress, economic data from core Europe isimpressive. Core Europe has a good fiscal position and is benefiting from a weakeuro. Germanys manufacturing PMI has risen to 58.4 from 52.7 at end-2009. Euroarea industrial output was up 16% QoQ saar in the first quarter, after 8.8% in 4Q09.

2. Delayed monetary stimulus.

3. A turn toward inventory restocking. The inventory cycle is turning from adrag on GDP to a contributor to growth. The global economy was poorly preparedfor the 2008 demand shock. IP growth exceeded final demand from 2006, as risinginflation hit real purchasing power. The result was high inventories ahead of thesynchronized global recession. It was a painful adjustment with global IP decliningby 21% peak to trough and many quarters of inventory de-stocking. With demandand production each rising at a rapid pace during 1Q10, inventories remain lean andthe restocking cycle has only just begun. We think the consensus is underestimatingthe impact of this tailwind.

4. Strong recovery in exports (see table of 3M SAAR exports by country).

5. This is not a jobless recovery. The non-farm-payroll and working hours are

now expanding; the result is a growth.

Table 5: Growth surprise from developed & emerging economiesStock Ticker JPM Mkt cap Price P/E DY ROE

Rating (US$B) (LC) 10E 11E 10E 10E

OW ITSamsung Electronics 005930 KS N 94.0 793000 9.8 11.2 0.0 16.7TSMC 2330 TT OW 48.3 60.3 10.6 10.5 5.0 25.9Hon Hai 2317 TT OW 31.4 118.5 11.0 9.2 2.1 17.7Mediatek 2454 TT OW 17.6 521.0 12.0 9.8 5.0 33.9Hynix Semiconductor 000660 KS N 12.3 26000 6.4 9.5 0.0 28.9Lg Display 034220 KS OW 11.8 41000 5.3 5.6 1.8 21.5Lg Electronics 066570 KS N 11.0 94400 5.7 5.2 0.9 21.7SEMCO 009150 KS OW 8.6 143000 19.1 16.4 0.4 17.0Chimei Innolux 3481 TT OW 8.5 34.1 9.3 7.9 0.0 8.8

Au Optronics 2409 TT N 8.3 30.3 11.3 23.2 0.0 7

UMC 2303 TT OW 5.7 14.3 10.4 10.7 3.6 8.0 Advanced Semicondctr 2311 TT OW 4.4 26.0 8.7 7.8 2.1 18Inotera Memories 3474 TT N 2.7 19.2 22.4 7.6 0.0 6.0Nanya Technology 2408 TT OW 2.6 25.1 16.1 6.9 0.0 12.5OW Transportation

Air China Ltd-H 753 HK OW 16.9 8.1 14.0 12.6 0.0 17Lan Airlines LFL US OW 6.5 19.1 20.5 15.9 1.6 NAChina Shipping Container 2866 HK OW 5.5 2.5 230.1 19.9 0.0 0.4Korean Air Lines 003490 KS N 4.4 76800 93.4 23.5 0.0 2.0Embraer ERJ US UW 4.0 21.4 15.4 11.9 2.7 10.0China Airlines Ltd 2610 TT OW 2.1 14.8 118.8 16.5 0.0 1.3Copa Holdings CPA US N 2.1 47.5 8.8 7.7 1.4 22.7Eva Airways Corp 2618 TT OW 1.6 17.6 NM 14.8 0.0 -1.6

Source: Bloomberg, IBES, J.P. Morgan estimates. Share prices as of 11 June 2010.

Figure 21: European PMIs

20

30

40

50

60

70

J un-07 Jun-08 Jun-09

Greece

Spain

Euro Area

Source: J.P. Morgan economics, May 2010.

Table 4: Recovering exports

Country 3M/3MSAAR

Current%oya

Brazil 111.9 47.7India 94.0 54.5Taiwan 84.7 57.9Korea 65.7 41.9Mexico 46.4 43.2SA 27.5 24.7Philippines 23.8 43.8Thailand 21.9 34.6Malaysia 20.4 41.3Turkey 14.0 25.1Indonesia 3.1 42.6Chile (12.3) 27.4Russia (12.6) 61.3Poland (14.0) 27.0China (30.9) 30.4Hungary (33.0) 20.5

Source: Bloomberg.

Figure 22: Non farm vs. Temporaryemployment

-800-600

-400

-200

0

200

400

600

00 02 04 06 08 10

-150

-100

-50

0

50

100Temp. employment

(RHS)

Non-farm

pay roll (LHS)

Source: Bloomberg, 31 May 2010. Note: Chart

shows mom net change in non farm payrolls and

temporary employment.


17/95

17



OW Mexico Leveraged to the US

Our bullish equity strategy case for Mexico remains unchanged, and we still see

robust upside to our year-end Mexbol target of 38,500. The three key drivers are:

Broadening Macro Recovery

Mexicos beta to US economic growth is two times. J.P. Morgan's 2010 US GDPgrowth forecast is 3.5%; this would suggest upside risk to the current forecast of

4.5% growth for Mexico. Based on the forecast the swing in GDP 09/10E is the third

largest. The macro recovery is manufacturing and auto led. March IP was up an

above-consensus 7.6% oya. Construction is now showing positive growth, after

seven months. We have changed our monetary policy call to a low-for-long view; no

change in expecting no rate hike before 2H 2011, as inflation expectations remain

well anchored, the output gap remains wide, and we expect Banxico to wait for

developed market rates to rise first.

Undervalued Mexican Peso

The Mexican peso is still 15% below its pre-credit crunch level.

Mexico is under-owned by global and local investors

Non-dedicated global investors are few, especially relative to larger EMs, such as

Brazil. This is partly understandable given the markets relatively small size (4.7% of

EM, 7 stocks make up 75% of index), but also odd, given the clear leverage to a

rebounding US. Local investors pension funds and mutual funds also remain UW

their own market. We do not see them as upside drivers, but as a defensive floor as

inflows remain robust, weightings low, and regulatory change pushing for greater

equity involvement. This is notwithstanding the upcoming end of the voluntary afore

agreement to not invest inflows outside Mexico.

Table 6: OW MexicoStock Ticker JPM Mkt cap Price P/E DY ROE


Cemex CX US OW 10.7 10.2 32.9 14.8 0.0 0.7Ternium TX US OW 7.0 34.8 9.1 8.3 1.3 12.0Urbi URBI* MM OW 1.8 23.9 11.0 9.0 0.0 12.9ICA ICA* MM OW 1.5 29.9 27.9 20.2 0.0 3.6First Cash Finl Svcs FCFS US OW 0.6 21.4 13.4 11.5 na 18.0


Figure 23: Correlation of Bolsa withS&P 500 Index

15%

30%

45%

60%

75%

90%

95 97 99 01 03 05 07 09

1 Year Rolling

Correaltion of

Weekly Returns


Figure 24: GDP Swing 09/10e

(1.0) 4.0 9.0 14.0

Russia

Taiwan

Mexico

TurkeyJapan

Argentina

Brazil

Chile

UK

DW

USA

EM

Peru

Korea

Euro

S. Africa

Colombia

ChinaIndonesia

Ecuador

India

Source: J.P. Morgan


18/95

18



Macro policy and rising inflation - QR not QE in EM

Underweight: Brazil, China, commodities and energy

China and Brazil are booming. GDP in China expanded at 13.1%q/q saar in 1Q10;

with strong contribution from domestic private-sector demand and a significant

upturn in exports. Brazil is leading LatAm growth. J.P. Morgan has increased the

2010 GDP growth forecast to 7.5%; the highest growth in 25 years. Consistent with

higher growth they have brought forward the timing of higher interest rates; the Selic

overnight rate is forecast to touch 12.5% by end 2010. Latin America is now

expected to grow 4.9% in 2010, nearly 2% above its estimated potential growth rate.

The exit from aggressive pro-growth policies and rising headline inflation are macro

headwinds for the consensus overweight EM consumption trade. Higher inflation

slows the growth in discretionary income this is the opposite trend to 2009.

QR not QE in EM

QR= quantitative restrictions; this is the use of administrative policies to manage theallocation of capital. The asset inflation trade (a consensus position in 2009) is

battling policymakers who are fighting asset inflation with quantitative restrictions in

EM. We have been underweight simple asset inflation trades for some time e.g.

property. Capital controls/taxes could slow EM F/X appreciation. After significant

underperformance we would not short these stocks.

Figure 25: Domestic consumerdiscretionary relative to MSCI EM

90

100

110

120

130

Dec-08 May-09 Oct-09 Mar-10

Source: Datastream, 9 June 2010. Note: Chart

shows the performance of J.P. Morgan index of

domestic consumer discretionary relative to EM.

Figure 26: Valuation of Domesticconsumer discretionary relative toMSCI EM

9

13

17

21

25

29

00 01 02 03 04 05 06 07 08 09

Source: Datastream. Note: Chart shows the PE

of J.P. Morgan index of domestic consumer

discretionary relative to EM, 31 May 2010.

Figure 27: Performance of Chinaproperty and EM real estate rel EM

50556065707580859095

100105

Jul-09 Oct-09 Jan-10 Apr-10

China Property

rel EM

EM Real Estate rel

EM



19/95

19



Underweight Brazil and China

So we are bullish on growth assets yet underweight the booming economies of

Brazil and China. The track record of these countries economic management is

good. These economies do not need low interest rates or fiscal stimulus. In our viewthe market is too complacent on the pace of normalization and eventualtightening. In China it seems reasonable that Beijing will continue to concentrate

efforts to slow growth in investment, rather than exports or consumption, as they

attempt to rebalance growth. The 1H10 record commodity demand from China is

consistent with peak implementation of FAI. We are not willing to extrapolate this

growth. Chinas share of world steel and iron demand is six times its share of global

GDP demand. Per capita consumption when adjusted for purchasing power is also

excessive. Evidence of economic rebalancing in China is already building. Property

transactions are slowing. Steel prices are falling. Recent wage increases suggest a

growing share of labor income to GDP (stronger consumption but less currency

appreciation). This is good for long-term sustainable growth but bad for bulk

commodities and manufacturers margins. Economic rebalancing in China has

implications for Brazilian commodity exports.

Brazils link with China

China is Brazil's largest customer. As noted earlier we believe that China will

continue to slow fixed asset investment; both infrastructure and real estate. This

makes us nervous on iron ore demand from China.

The Presidential election

The October presidential race is yet another source of volatility regardless of the two

candidates, with greater market awareness as campaigning really starts, political

platforms are debated, and coalitions formed.

An overvalued Real

We remain somewhat concerned by the risk/reward for the BRL. Our base-casescenario is the real trading in a range. Aggressive FX intervention, deteriorating

current account deficit and fundamental BRL over valuation should set a ceiling to

BRL appreciation. Balancing these forces, however, the case for appreciation is that

terms of trade are at historical highs, growth-related capital inflows remains resilient,

and increasing interest rates all set a cap to depreciation.

Figure 30: J.P. Morgan REER: Deviation (%) from long term meansince 1975

-40

-20

0

20

40

60

80

100

BRL

RUB

CLP

CZK

AUD

CNY

CHF

ZAR

TRY

PHP

PLN

HUF

IDR

MXN

THB

EUR

USD

TWD

KRW

Source: J.P. Morgan estimates.

Figure 31: Brazil CPI (%oya) and SELIC overnight rate

0

4

8

12

16

20

24

28

00 02 04 06 08 10

Selic ov ernight target rate

CPI


With the downgrade of Brazil to

underweight (19 April 2010), we

are now predicting that the two

largest markets will

underperform MSCI EM.

Figure 28: China: Squeezing thesteel margin

250

350

450

550

650

750

850

950

07 08 09 10

Iron Ore + Coking coalHRC Price

Source: Bloomberg. Note: Iron ore + coking coal

is the spot price of iron X 1.6 and spot coking

coal price X 0.6

Figure 29: China FAI & Retail Sales

510

15

20

25

30

35

40

04 05 06 07 08 09

Retail Sales

FAI

Source: Bloomberg, April 2010. Chart shows

%yoy growth in FAI and retail sales.


20/95

20



CEMBI surfers OW India, Turkey, South Africa

CEMBI is J.P. Morgans emerging market corporate bond index. CEMBI yield

(JCBYBLYD Index) is 6.5% (year low 6.1% end April). Since 3 May, CEMBI

spreads (JCBSBLSD Index) have increased by 93bp to 367bp reflecting the current

uncertainty in global financial markets. Supply is on hold. New issues from EM

corporates slowed to USD3.3 bn in May vs. an average of 16bn per month over Jan-April. J.P. Morgans full year supply target is 127.5 bn out of which 68bn has been

issued YTD. This forecast is at risk as we believe EM corporates will prefer to stay

out of the market rather than pay generous concessions to get investors in from the

sidelines.

J.P. Morgan forecasts CEMBI spreads to range between 350 to 400bp through mid

year. However, we remain confident in EM growth fundamentals and believe

that as the market stabilizes, spreads will recover to 300 bps by year-end. This is

also a function of the treasury yield which is forecast to increase from 3.26%

currently to 4% by Dec 10.

CEMBI is particularly important to India as the Indian private sector funds the

current account deficit. India's nominal GDP growth could be 17% this year. Longterm borrowing costs are half the level of nominal GDP (Indian 10Y bonds 7.6% and

CEMBI yields 6.5%). Many Indian companies will view today's monetary conditions

as supportive of growth.

In the past ECB data has been fairly volatile and does not seem to be affected from

the change in CEMBI spreads. The exception is the blowout after Oct-08 when ECBs

fell in line with the spike in spreads. In the current CEMBI spread rise so far, there

has not been much impact on ECB approvals/ utilization of pre-approved ECBs.

There might be a larger impact in the 2H. We are monitoring our OW on India

closely. In the recent past, corporate India has been borrowing substantial amounts

overseas and the relative importance of ECBs has also been increasing. Annual net

ECB borrowing rose from USD2 bn in 2005 to 23bn in 2008. It was 8bn in 2009 and

is forecast to be 11bn in 2010. Typically the spreads and markets are concurrentlynegatively correlated.

Turkey is also a beneficiary of lower borrowing costs due to its reliance on external

financing. Its current account deficit is forecast to widen from 3.4% to 4.2% of GDP

in 2010. Nominal GDP growth is forecast to be 15% in 2010 versus 10 year bond

yields of 10% and 6.5% CEMBI. Turkish corporates should benefit from the delayed

monetary stimulus.

Table 7: Yields for government and corporate bonds plus earnings yield for US & EM equitymarkets

High Low Avg 05-07 Spot DiffUS EARNINGS YIELD 11.4 6.1 6.6 7.9 1.3US High Yield 21.0 7.5 8.4 9.5 1.1EM EARNINGS YIELD 17.3 6.8 8.7 9.6 0.9CEMBI 14.3 5.7 6.4 6.5 0.1EMBI 12.0 6.2 7.0 6.5 (0.4)JULI 8.7 4.8 5.7 5.1 (0.6)US 10 Yr 5.2 2.1 4.6 3.2 (1.3)1 Month T-Bill 5.2 (0.1) 4.0 0.0 (4.0)


Figure 32: CEMBI Yield and India10Y Govt Yield

4

8

12

16

Apr 06 Oct 07 Apr 09

Indian 10

Year yields

CEMBI

Yields



21/95

21



OW South Africa

The drivers of our overweight on South Africa are:

1. Positive SA growth surprises:The South African economy is finally starting todeliver positive growth surprises. Leading economic indicators are positive. SA realGDP growth surprised on the upside at 4.6%q/q saar in 1Q10. This was the fastest

growth pace in seven quarters as low interest rates worked through to boost domesticdemand. The MPC adopted a decidedly more upbeat tone on growth in the JuneMPC meeting than at the last meeting and disclosed a growth forecast of 3.6% for2011, but kept its growth projection for 2010 broadly unchanged at 2.6%y/y. J.P.Morgans SA economics team forecast SA real GDP growth to surprise on the upsideat c3% in 2010.

2. Countercyclical accommodative monetary policy: The SARB kept the repo rate

unchanged at 6.5% in the Monetary Policy meeting in May. J.P. Morgan economists

now expect the first hike in the second quarter of 2011, given risks to the global

recovery and the likely delay in the start of the hiking cycle in many developed

markets. In the Q&A session, the Governor indicated that the outlook for rates is to

remain steady at 6.5% as inflation is expected to be contained below 6% throughout

the forecast period. J.P. Morgan economists agree with the SARBs benign view oninflation in 2010, but highlight that relatively high wage settlements and base effects

from low food prices pose some risks that inflation could exceed the upper end of the

target band in the second half of 2011.

3. Earnings recovery off a decimated base in 2009: The fall in SA earnings growth

in 2009 was the biggest on record (-29% vs. an average of -9.3% during previous

cyclical lows). We forecast EPS growth of c30-35% in both 2010 and 2011, one of

the highest in EM. This relative earnings growth outperformance of SA vs EM into

2011 should drive the SA catch-up trade.

4. Relatively attractive valuations: SA offers a combination of low relative

valuations with high earnings growth.

5. The Rand - risk and reward: The Rand remains the wildcard, having appreciated

3% 2010-to-date. Our valuation tools suggest that the Rand is some 10% overvalued.

However, given the demand for carry as a function of global liquidity (J.P. Morgan

expectations of a first Fed hike in 2Q11), we expect the Rand to stay stronger-for-

longer underpinned by an environment of high growth, strong commodity prices

and healthy risk appetite.

Our preferred domestic cyclical sectors are banks, food, retailers and General

Industrials. We are overweight banks for six reasons: (1) Sustained low SA interest

rates through 2010 vs. tightening elsewhere in EM; (2) Recovery in loan growth; (3)

Unwinding of bad debts; (4) Strongest forecast earnings growth rebound in EM in

2010/11; (5) Attractive relative valuations; and (6) SA Banks are under-owned. Ourtop stock picks include ABSA, Standard Bank, Shoprite, ARM and AngloPlat.

Table 8: OW South Africa

Stock Ticker JPM Mkt cap Price P/E DY ROE


African Rainbow ARI SJ OW 4.6 16866 4.7 4.4 3.0 2 Anglo Platinum AMS SJ OW 25.7 75700 21.0 15.7 1.4 25Standard Bank Gr SBK SJ N 20.5 10218 10.6 8.4 3.9 16.4

Absa Group Ltd ASA SJ OW 11.4 12365 8.7 7.2 4.6 19Shoprite Hldgs SHP SJ OW 5.6 8008 18.1 15.0 2.8 40.1


Figure 33: SA Real GDP growth%yoy

-2

-1

0

1

2

3

4

5

6

00 02 04 06 08 10

Source: J.P. Morgan economics. Grey are

denotes forecasts till 2011.

Figure 34: Record low SA policy

rates for now

4

6

8

10

12

14

16

00 02 04 06 08 10

SA

EM


Figure 35: SA rates on hold vstightening for rest of EM

-100 0 100 200

HungaryRussiaCzech

IndonesiaMexico

SAPhilippines

MalaysiaTaiwan

ThailandKoreaChinaIndia

TurkeyBrazil

Source: J.P. Morgan estimates. Note: Chart

shows forecasted change in policy rates from

now till 4Q10.


22/95

22



Country asset allocation changes

Table 9: Summary of country asset allocation changes from 2007Country From To Recommendation Relative return from the date of

RecommendationYTD relative return

Taiwan 20-Feb-07 27-Aug-07 N (6.2)Thailand 21-Mar-07 20-Jul-09 OW 2.8

Turkey 21-Mar-07 24-Sep-07 N 14.3Poland 18-Apr-07 17-Jan-08 N (26.0)Russia 18-May-07 27-Jul-08 N 3.3Brazil 18-May-07 31-Jan-08 OW 22.4Malaysia 14-Jun-07 24-Aug-07 N (7.3)South Africa 14-Jun-07 24-Aug-07 N (8.0)Malaysia 24-Aug-07 14-Mar-08 OW (0.8)South Africa 24-Aug-07 5-Feb-08 OW (11.3)Taiwan 24-Aug-07 28-Feb-08 UW 9.6Turkey 27-Sep-07 27-Jul-08 UW 16.6India 2-Nov-07 17-Jan-08 N 15.7India 18-Jan-08 7-Jan-09 UW 15.3Poland 18-Jan-08 18-Aug-09 UW 15.7Mexico 1-Feb-08 26-Feb-09 OW (2.4)Brazil 1-Feb-08 16-Jun-08 N 16.9South Africa 6-Feb-08 16-Jun-08 N 2.1Taiwan 29-Feb-08 2-Apr-08 OW 6.0Malaysia 17-Mar-08 14-May-09 N 8.8Taiwan 3-Apr-08 17-Apr-08 N 3.3Taiwan 18-Apr-08 19-Nov-08 OW 0.2China 16-May-08 16-Jun-08 N (4.7)Brazil 17-Jun-08 22-Sep-08 UW 7.9China 17-Jun-08 14-May-09 OW 14.1South Africa 17-Jun-08 27-Jul-08 UW (7.7)Russia 28-Jul-08 14-May-09 UW 21.0Turkey 28-Jul-08 5-Oct-08 OW 7.0South Africa 28-Jul-08 14-May-09 N 8.2Brazil 23-Sep-08 16-Apr-10 N 4.6Turkey 6-Oct-08 1-Dec-09 N (16.2)Indonesia 3-Nov-08 30-Mar-09 UW (5.3)Taiwan 19-Nov-08 30-Mar-09 N 3.9India 8-Jan-09 5-Aug-09 N 27.0South Korea 26-Feb-09 3-Sep-09 OW 25.6

Mexico 27-Feb-09 23-Mar-09 N 2.0Philippines 16-Mar-09 3-Sep-09 N (2.0)Mexico 23-Mar-09 18-Aug-09 OW 6.5Taiwan 30-Mar-09 - OW (24.2) (24.2)Indonesia 30-Mar-09 14-May-09 N 11.1Russia 15-May-09 18-Oct-09 N 4.1South Africa 15-May-09 17-Sep-09 UW (6.1)China 15-May-09 17-Sep-09 N (3.3)Indonesia 15-May-09 3-Sep-09 OW 21.2Malaysia 15-May-09 2-Feb-10 UW 4.8Thailand 20-Jul-09 17-Sep-09 N 0.3India 6-Aug-09 - OW 7.8 7.8Poland 19-Aug-09 25-Oct-09 OW 8.2Mexico 19-Aug-09 1-Dec-09 N (3.1)Indonesia 3-Sep-09 - N 18.2 18.2Philippines 3-Sep-09 - OW 4.2 4.2South Korea 3-Sep-09 6/1/2010 N (3.8)

South Africa 17-Sep-09 16-Apr-10 N (6.1)China 17-Sep-09 - UW 7.3 7.3Thailand 17-Sep-09 14-Dec-09 OW (8.2)Russia 19-Oct-09 7-Dec-09 OW (8.2)Poland 26-Oct-09 - N (12.9) (12.9)Turkey 2-Dec-09 - OW 15.6 15.6Mexico 2-Dec-09 - OW 7.2 7.2Russia 8-Dec-09 - N 2.8 2.8Thailand 15-Dec-09 - N 17.0 17.0Malaysia 2-Feb-10 - N 6.8 6.8South Africa 19-Apr-10 - OW 3.1 3.1Brazil 19-Apr-10 - UW 2.6 2.6South Korea 2-Jun-10 - OW 1.6 1.6

Source: J.P. Morgan, 16 June 2010.


23/95

23



Stress testing our current baseline forecasts for EM : Resiliancy to hold

Joyce ChangAC

, Global Head of Emerging Markets & Credit Research

Thus far, positive cyclical growth trends in the US and

EM have not been disrupted by financial market

volatility or concerns about growth in Europe. Beyond a

modest downward revision to the Euro area growthforecast, J.P. Morgans economists have not materially

altered their global outlook in the face of the latest wave

of financial market stress. For the past year, forecasting

global growth has been relatively easy given the

consistency in activity indicators in the US and Emerging

Asia. Our G-3 economists do acknowledge that the

financial shock emanating from Europe still has the

capacity to temper growth, and may prompt downward

forecast revisions at some point. There is a growing risk

that the positive feedback loop between markets and the

economy could shift into reverse. To be sure, there are

important offsets to the fall in price of risk assets

notably lower energy prices and risk-free interest rates.While growth momentum across EM countries remains

largely positive, there are also signs the Emerging Asia is

downshifting in responses to a policy induced cooling in

China.

We stress-test our growth, FX and policy rate forecasts

by considering two alternative scenarios for Europe. In

considering alternative scenarios we note that the direct

effects of lower growth in Europe on the US are fairly

minimal since US exports of goods and services to all of

Europe account for only about 2% of US GDP. The

major effect would occur through financial market

contagion, i.e. sharply lower stock prices or a muchstronger dollar or both. Indeed, the usual rule-of-thumb

about effects of US exchange rates say that a 10%

decrease in EUR/USD would push up the trade-weighted

dollar 1.8% and would take about 0.4% off of US real

GDP, spread over two years, or 0.2% per year. Taking

these considerations into account, we contemplate two

alternative scenarios for Europe to assess the impact on

EM.

The potential negative spillovers to growth are obviously

greatest in the Euro area, which is the epicenter of the

financial shock. For now, our European economists viewthe financial shock as sufficient to limit the regional

upturn to around 2% growth in the coming quarters; J.P.

Morgan pencils in full-year growth forecasts for the Euro

area at 1.3%oya in 2010 and 1.9% in 2011. Looking to

the second half of the year, growth prospects will

certainly be diminished by the latest developments even

if near term cyclical forces are still positive. In judging

the magnitude of the drag, it is important to recognize

two points about the current position of the regional

economy. First, following three quarters in which GDP

growth averaged less than 1% annualized, a powerful

cyclical tailwind is pushing up economic activity into

midyear. Second, fiscal policy is actually neutral for

2010. Indeed, despite the additional actions taken on theperiphery, the fiscal easing in Germany, the Netherlands,

Austria, and Finland leaves the regions fiscal thrust

roughly neutral this year. However, fiscal tightening

becomes a large drag next year, with our forecast

pointing to a tightening of a little more than 1% of GDP.

Scenario 1: Deeper economic and financial crisis, but

contained to peripheral Europe. We assume a slowdown

in Euro area growth to less than 0.5% this year and less

than 1% in 2011 (i.e., one full %-pt below our current

forecasts of 1.4% and 1.9%, respectively), and a

sustained fall in oil prices to an average of $65-75/bbl in

2010-2011. EUR/USD drops to 1.10-1.15 in thisscenario. The impact on US growth is of around 1/2% to

3/4%-pts of lower US growth relative to J.P. Morgans

current forecasts of 3.5%oya this year and 3.1% in 2011,

taking into account the impact of both the lower Euro

area growth and the appreciation of the USD.

Scenario 2: Crisis spreads to core Europe due to

contagion from the periphery, pushing the Euro area into

a double-dip recession. In this case, the Euro area growth

goes down to -0.5% this year (implying a 5.5% pace of

contraction in 2H10) and -1% in 2011 (despite being still

negative in %oya terms, this implies a relevant recovery

in sequential terms next year). EUR/USD reaches parityin this scenario, and the impact on US growth is of

around 1% to 1.5%-pts of lower growth relative to our

current 2010 and 2011 forecasts (given the stronger

growth momentum in the US, maybe it avoids a double-

dip recession itself, but the economy at least displays flat

growth for a couple of quarters). This produces a

sustained fall in oil prices to an average of $50-60/bbl in

2010-2011.

Our current projections call for EM growth to reach an

above-potential pace of 6.9%oya in 2010 (Latin America

5.1%, CEEMEA 4.1%, Emerging Asia 8.9%) and tomoderate to 5.8% in 2011 (Latin America 3.8%,

CEEMEA 4.8%, Emerging Asia 7.2%). Under Scenario

1, EM growth performance remains above potential, with

no material impact on Latin America and Emerging Asia

in particular. Under Scenario 2, the impact is material

and the Euro sovereign and bank crisis is no longer a

regional issue. Incipient tightening would be reversed

and EM currencies would need to weaken considerably.

EM countries would likely resort to greater fiscal

stimulus to offset weakness in the private sector.


24/95

24




25/95

25



Emerging

Markets:Outlook&

Scorecard

s


26/95

26



JPM Mkt cap P/E EPS Div Yld. ROE

Price Code Rating (US$B) 10E 11E 10E 11E 10E 10E(CNY) (x) (x) (CNY) (CNY) (%) (%)

Top picksChina Resources Power Holdings 16.0 836 HK OW 9.6 12.6 9.9 1.3 1.6 2.5 15.1Huaneng Power 4.2 902 HK N 9.6 11.0 10.8 0.4 0.4 2.1 9.8China Mengniu Dairy 23.5 2319 HK OW 5.2 30.1 22.5 0.8 1.0 0.7 14.9Zhejiang Expressway 7.1 576 HK OW 4.0 15.1 13.5 0.5 0.5 4.4 14.1Huabao International 9.3 336 HK N 3.7 21.6 17.7 0.4 0.5 0.0 39.7Stocks to avoidGuangzhou R&F 10.0 2777 HK OW 4.1 7.9 6.3 1.3 1.6 5.1 22.6

Aluminum Corp of China 6.1 2600 HK N 17.6 19.0 NA 0.3 NA 1.1 6.4

Source: Datastream, J.P. Morgan estimates. Note: The share price and valuations are as of 10 June 2010.

ChinaMarket Strategy China: Mind the gap

Frank LiAC

(852) [email protected]

Recommendation

OW: (1) new economy stocks; (2)

expressways; (3) consumer staples;

(4) menswear; (5) IPPs

UW: (1) property; (2)

commodities; (3) home appliances;

(4) energy

Key drivers

Undemanding valuations for

MSCI-China, more pro-

consumption measures for the

remainder of the year, and solid

balance sheet conditions

Key risks

Downside earnings risk to MSCI

China and policy risks

Market Statistics (%)

MSCI China Index 58.2Weightings in Region (%) 18.9CNY/US$ 6.83

Avg. Daily Turnover (US$MM) 3652MSCI Total Mkt. Cap (US$B) 551

Source: Datastream. Prices as of 10 June 2010.

Issues over the last 12 months

China led both equity and the economic recovery in EM and the world in 2009. Late 2008s

aggressive monetary and fiscal stimuli brought about a strong economic recovery, which in

turn, translated into strong stock market performance (+52%) in FY09. Entering 2010,

Chinas stock market underperformed major stock markets this year because of (1) the

expected sharp fall in Chinas excess liquidity growth (M2growh minus nominal GDP

growth) from 21% in FY09 to 5% in FY10 due to the combined effect of the drop in M2

growth and the rise in nominal GDP growth; (2) a series of policy tightening risks as

reflected in the three 50bp RRR hikes, the window guidance for banks to strictly follow the

quarterly lending quota, and the recent crackdown on the housing sector. YTD 2010, the

MSCI China index declined -8.9%, underperforming MSCI EM by 3.5%.

Outlook

We stay cautious on MSCI China in the coming months, despite possible technical rebound

because: (1) We see downside earnings risk to MSCI China due to the economic

deceleration on the back of the combined ripple effect of the crack-down on property sector

and slowdown in banks lending to local government-funded investment projects. (2)

Policy risks, such as the resource tax, which may hurt the earnings of and de-rate the

multiples of the energy and upstream resources companies. (3) Tight liquidity situation in

China, as reflected in the recent rise in short-term interest rate in the repo market as well as

inter-bank market. (4) Possible additional tightening measures in the property and FAI

areas, such as raising share capital funds requirement for investment projects, and property

tax on tier one cities on a pilot basis, etc. We recommend investors to wait for a better entry

point until the above-listed concerns are addressed before buying Chinas secular growth

sectors. We firmly believe in Chinas bright medium-term growth prospects: (1) Strong

balance sheet at the country, household, and consumer level. (2) Favorable demographics.

(3) Sectors with low penetration rates and solid secular growth. (4) Powerful central

government with strong execution capability to carry on the necessary economic reforms.

Recommendations

We are bullish on: (1) consumer staples; (2) expressways with good dividend yields; (3)

new economy plays such as high-tech manufacturing and strategic new industries, such as

new materials, and new energy etc; (4) menswear with strong secular growth; (5) IPPs. We

stay cautious on commodities, property, home appliances, and energy.
mailto:[email protected]:[email protected]


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China scorecardKey Financial Data Summary Local Interest Rates and Inflation Trend

EPS Growth P/E ROE Yield Spot -3M +3M 2008 -10.9 18.3 14.4 2.2 3 Month 3.3 1.1 -0.8

2009E 13.6 16.1 15.0 2.4 Long Bond 3.3 -0.2 0.72010E 21.3 13.3 16.2 2.8 Inflation 2.7 0.3 0.92011E 18.3 11.2 17.1 3.3 Real 3 Month 0.6 0.8 -1.7

Economic Forecasts Risk AppetiteGDP (YoY) Forecast -3M - EMF - Cons US$ Spread Spot -3M +3M 2008 9.6 0.7 4.7 0.0 BAA 2.9 0.4 na2009E 10.8 0.8 3.9 0.7 EMBI 3.3 0.7 0.72010E 9.4 0.0 3.6 0.2 Country 0.7 0.0 na

Country Relative -2.6 -0.7 naEconomic Momentum Foreign Fund Flows (US$ mils)

GDP Q1 10E Q2 10E Q3 10E Q4 10E Month 09 YTD Avg 12-Mo AvgGDP SAAR 13.1 9.4 9.3 9.0 EM Funds* -4,759 2,095 3,840

Asia ex Japan* -2,251 438 880China -576 -513 394

MSCI China Absolute and Relative (vs EMF) Index MSCI Fair value Range

0

100

200

300

400

500

600

700

800

Jan-03 Dec-03 Nov-04 Oct-05 Sep-06 Aug-07 Jul-08 Jun-09 May-10

Absolute Relativ e to MSCI EMF

(28)

(46)

(29)

(46)

(59)

(56)

(57)

(70)

(81)

(80)

10 30 50 70 90 110 130 150

FWD PER

PER

PBR

DY

BY/EY

BY/DY

Currency Outlook (CNY/USD) EPS Integer over Time

6.0

6.5

7.0

7.5

8.0

8.5

Dec 04 Jul 06 Feb 08 Sep 09 Mar 11

Spot Forecast Consensus

J.P. Morgan

J.P. M organ forecast:

end Jun 10: 6.65

end Sep 10: 6.58

end Dec 10: 6.50

Consensus

90

100

110

120

130

140

Feb 09 May 09 Aug 09 Nov 09 Feb 10 May 10

2010 2011

Source: MSCI, Bloomberg, IBES, Datastream, CEIC, J.P. Morgan, Consensus Economics. Unless stated all forecasts are J.P. Morgans. The scorecards are designed to assis t in tracking trends

and expectations. -3M refers to the change in this factor over the past three months and +3M refers to the forecast change in this factor over the next three months. The Economic Forecast

table contains J.P. Morgans real GDP forecasts, the change in these forecasts over the past three months, the difference between these forecasts and the average for emerging markets and the

final column is the difference between J.P. Morgans forecast and consensus expectations. The MSCI Fair Value chart is designed to show current valuations relative 10 year valuation history. The

vertical dotted line is the current index level. The five horizontal bars show a +/- one standard deviation range for these valuation measures. A dotted line to the left indicates a market that is cheap

relative to history. *US Mutual fund subscriptions.


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JPM Mkt cap P/E EPS Div Yld. ROE

Price Code Rating (US$B) 10E 11E 10E 11E 10E 10E

(BRL) (x) (x) (BRL) (BRL) (%) (%)

Top picksBM&F Bovespa 12.0 BVMF3 BZ OW 13.6 14.4 12.4 0.8 1.0 na naBradesco 29.9 BBDC4 BZ OW 51.4 11.3 9.7 2.7 3.1 2.9 20.3Gafisa 10.8 GFSA3 BZ OW 2.6 12.9 9.7 0.8 1.1 1.5 13.1Stocks to AvoidCSN 15.0 SID US UW 22.7 8.5 6.4 1.8 2.3 10.3 43.9Sabesp 35.1 SBSP3 BZ UW 4.4 6.5 7.1 5.4 5.0 5.4 10.2

Source: Datastream, J.P. Morgan estimates. Note: The share price and valuations are as of 10 June 2010.

BrazilMarket Strategy Brazil: Better Outlook for Domestics

Emy ShayoAC

(5511) 3048-6684

[email protected]

Recommendation

OW: Financials, Homebuilders

Key drivers

Strong portfolio and FDI inflows

7%+ growth driven by domestic

demand

Commodity prices

Key risks

Large Petrobras Capitalization

China slowdown/ hard landing

October 2010 presidential elections

Market Statistics (%)MSCI Brazil Index 219577Weightings in Region (%) 15.8BRL/US$ 1.80

Avg. Daily Turnover (US$MM) 2899MSCI Total Mkt. Cap (US$B) 461

Source: Datastream. Prices as of 10 June 2010.

Issues over th

key trade and risk june 21 2010

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