JP Morgan Emerging markets

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% of global consumption Stock Ideas for 2010 Emerging Equity Markets Year Ahead Emerging Markets Equity Research 02 December 2009 J.P. Morgan Securities (Asia Pacific) Limited See page 396 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Emerging Markets Equity Research Adrian Mowat AC (852) 2800-8599 [email protected] For a full list of authors please refer to the sector and country head list on the back page Source: J.P. Morgan Economics. The chart shows emerging economies and US consumption as a percentage of global consumption.

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Emerging Markets Equity Research 02 December 2009

Emerging Equity Markets Year AheadStock Ideas for 2010Emerging Markets Equity Research Adrian MowatAC(852) 2800-8599 [email protected] For a full list of authors please refer to the sector and country head list on the back page

% of global consumption

The chart shows emerging economies and US consumption as a percentage of global consumption. Source: J.P. Morgan Economics.

J.P. Morgan Securities (Asia Pacific) Limited

See page 396 for analyst certification and important disclosures, including non-US analyst disclosures.

J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

Emerging Market Year Ahead - Stocks for 2010What to own What to avoid Banks: China, Korea, Taiwan, Thailand, Brazil, Mexico, Telcos: China, India, Korea, Brazil, Mexico, Central Europe Turkey, Russia, South Africa, MENA Consumer Discretionary: Brazil, Mexico Technology: ex-PC ODMs Transportation: especially, airlines Other Industrials: India capex and investment cycle Telecom capital management: Malaysia, Taiwan Energy: Brazil, Russia Smaller sectors in country: China internet, China gas, China food inflation, Indonesian interest rate sensitive, Abu Dhabi Real Estate, South African Platinum Focus on sectors within countries rather than country recommendations A detailed view on our country and sector recommendations within EM is available on Page 11. For more detail please see country and sector pages. Utilities Cement: China, India Consumer Discretionary: South Africa Smaller sectors in country: Taiwan Insurance, Dubai Property

Internet & Media: China, Turkey, South Africa, Russia Consumer Staples: India, Indonesia, Brazil, Mexico

97 Top PicksSee pages 109 to 287Examples of top picksCode VAKBN TI GAZP RU CTCM US 006400 KS ASYAB TI 2610 TT LH TB TOP TB QTEL QD LSRG LI Top Picks Vakifbank Gazprom CTC Media Samsung SDI Bank Asya China Airlines Land & Houses Thai Oil Public Company Qtel LSR County Turkey Russia Russia South Korea Turkey Taiwan Thailand Thailand Qatar Russia To PT (%) 73 71 69 67 66 60 60 56 55 54 Code TII US 2498 TT TMX US USIM5 BZ 762 HK 2338 HK 857 HK MER PM PCU US HUVR IN

48 Stocks to AvoidSee pages 289 to 371Examples of stocks to avoidStocks to avoid Telmex Internacional HTC Corp Telmex Usiminas China Unicom Weichai Power PetroChina Manila Electric Co Southern Copper Hindustan Unilever County Mexico Taiwan Mexico Brazil Hong Kong China China Philippines United States India To PT (%) (34) (31) (26) (23) (22) (22) (21) (21) (21) (20)

Source: J.P. Morgan. Note: To PT = Returns to analyst price target from 27 Nov 2009.

Source: J.P. Morgan. Note: To PT = Returns to analyst price target from 27 Nov 2009.

The Year Ahead ProcessThe goal of this document is to present our key strategy themes for 2010 using most and least favored stocks from J.P. Morgans team of analysts. Both J.P. Morgan EM equity research analysts and our macroeconomic team have been involved in the production of this document. The process started with the Strategy Team briefing analysts on our key themes and macroeconomic forecasts for 2010. Analysts then reviewed their earnings models and presented their top picks and stocks to avoid to both their sector and country strategists. The sector and country teams then produced their list of top long and short ideas, which were then compiled by the regional strategy teams. These ideas form the core of this document.

Table of contentsInvestment strategy ............................................................ 4 Surprises for 2010 ............................................................26 Rates outlook....................................................................27 Economic outlook ............................................................32 Economic forecasts ..........................................................42 Country strategy ...............................................................47 Sector strategy ..................................................................77 Summary tables of stock ideas .........................................93 Top picks........................................................................109 Stocks to avoid ...............................................................289 Strategy dashboards........................................................373

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Emerging Markets Equity Research 02 December 2009

Higher Markets with Higher VolatilityThe drivers three steps to heaven1. Compression in risk premiums 2. Economic and earnings recovery 3. Overshoot as risk-free rates remain low for long (See page 4 for details)

Potential returnsMSCI EM end-2010 target 1300 (+30%) Implied end-2010 forward P/E of 14x (J.P. Morgan estimate) Currency, earnings estimate revisions, and low riskfree rates provide upside. (See page 4 for details)

Investment themes1. Stay high beta for now front-loaded returns 2. Economic growth surprises pessimistic expectations

Risks are high for year-one of recovery Investor driven correction in commodity prices G3 bond volatility Lack of G3 policy flexibility Rapid rise in EM inflation resulting in faster tightening Risk appetite fades, driving investors back into low beta defensive markets like SA, Israel and Malaysia

3. 2010 is the year of G3 monetary stimulus no change in G3 rates in 2010 4. Earnings estimate revisions drive markets 5. Focus on sectors in countries 6. Policy normalization outside G3 source of volatility rather than a cap on returns 7. Inflation ends the party in emerging markets before developed markets. Enjoy the party until inflation exceeds central bank target zone 8. M&A 9. BRIC consumers (See page 4)

Dubai World debt moratorium impacts ability to raise EM corporate debt (For more risks please see page 12)

Key issues for 2010 briefing notes1. A longer perspective on asset performance 2. The policy risk to the asset inflation trade 3. And now the monetary stimulus 4. The rolling recovery trade of 2009: and settling the decoupling debate 5. Potential bond market volatility 6. Now is the time for earnings estimate revisions 7. Falling inflation with growth 8. Fiscal outlook 9. South Africa - 2010 Soccer World Cup Winners (See page 15)

Market performanceFigure 1: MSCI EM and MSCI World1400 1200 1000 800 600 400 200 0 88 90 92 94 96 98 00 02 04 06 08 MSCI EM MSCI World

Source: Bloomberg. Chart rebased to 100 in 1988

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Emerging Markets Equity Research 02 December 2009

Emerging Market Equity StrategyFor now we remain positive on EM equities. The factors supporting the powerful recovery from the October 2008 lows remain in place. These conditions are: compression in excessive risk premiums, economic and earnings recovery trade, and overshoot as risk-free rates remain low. MSCI EM could retest its all-time high. Our end-2010 index target for MSCI EM is 1300, +30%. This implies an end-2010 forward PE of 14. The return is 10% in excess of consensus earnings forecasts. In our view, the difference will be made up of currency appreciation and earnings revisions. The low for EM was 454 on 27 October 2008. The index has more than doubled since then. To retest its high the index would need to increase by 38%. The low in developed markets was on 9 March. The MSCI World index has rallied 70% from its 2009 low. Stay high beta, for now front-loaded returns Early 2010 conditions should continue to be very favourable for EM equities in our view, with strong growth, positive earnings estimate revisions, acceptable inflation, and ongoing rally in credit markets. The stage three of the bull market is an overshoot in valuations as risk-free rates stay low for long. A less favourable base effect for inflation plus a potential slowing in earnings estimate revisions may make 2H10 more challenging. P/Es could decline in this phase.Figure 2: Bungee jump or slingshot?310 280 250 220 190 160 130 100 70 -24m -18m -12m -6m Trough +6m +12m +18m +24m Gulf War Mex ican crisis Asian crisis Tech bubble Credit crisis

Figure 3: Beta versus PE18.0 16.0 14.0 12.0 10.0 8.0 0.4 0.6 0.8 1.0 1.2 1.4 Taiw an Malay sia Phil China Mex ico Poland Indonesia Brazil India

Thailand S Africa

Hungary Czech Korea Turkey

Russia

Source: Bloomberg. Note: Two year weekly beta for MSCI indices vs. MSCI EM. Forward PE on y-axis and Beta on the x-axis.

Figure 4: EM consumption exceeded US consumption in 2008!40 36 32 28 24 20 16 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 US EM

Source: J.P. Morgan economics. Note: Chart shows EM and US consumption as % of global consumption.

Source: Datastream, 27 October 2009. Note: Chart shows the performance of MSCI EM US$ index two years pre and post crisis lows. Note: MSCI EM (USD) is indexed to 100 at the trough of each crisis.

A quick review EM survived the big ugly experiment: a combination of a severe financial shock, the deepest developed consumer recession since WWII, the lagged impact of anti-inflation policies, and a sharp drop in commodity prices. The main conclusion of the experiment is that the domestic inflation/monetary cycles were more dominant than external demand. This economic decoupling during the stress test supports a higher relative valuation of EM equities versus developed world equities. But global capital flows do link EM monetary policy to record low G3 rates resulting in the risk of a boom bust cycle and asset bubbles. Policymakers in EM are moving to restrict capital flows and non-conventional measures to control asset prices. A combination of higher economic and asset volatility, with policy risk, may be negative for equity valuations.

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Emerging Markets Equity Research 02 December 2009

Risks are high for the first year of the global recovery The bulk of the risks are global rather than EM centric. Please see page 12 for risks. The three key risks or sources of volatility are: G3 bond volatility Commodity volatility Policy risks Post the synchronized global recession and the credit crunch, EM has earned a lower risk premium. Emerging economies led the global recovery. Decoupling proved? Decoupling in a global economy and capital markets was literally impossible. But EMs did prove they can generate their own recovery rather than rely on the developed world consumer. EM consumption exceeded US consumption in 2008. An overweight in EM equities vs DM is consensus; as is an OW in BRICs vs EM. Both have been successful strategies. However, EM was led by sectors driven by global growth, not local; note the performance of our demand classification indices, global consumer +97% , global price taker +95%, ahead of domestic consumption +58% (these indices are published in our weekly dashboards). Bungee jump or slingshot? EM equities have recovered 115% from their 2008 lows. EMBI spreads have tightened from a peak of 865bp to 310bp. But the threeyear CAGR for EM equities is just 4% and EMBI spreads averaged 195bp in 06/07. The catalyst for the rally from March was the evidence of stabilization in developed world end-demand. Cyclical sectors outperformed: technology, materials, consumer discretionary and energy. Extreme volatility in equities, currencies, commodities and bonds makes assessment of fair value very difficult. Many investors struggled to join the rally this year as they anchored on the lows and were reluctant to buy after sharp gains. To provide a longer perspective please see the briefing note, a longer perspective on asset performance. This reviews three, five and eight year CAGR. The five-year CAGR for MSCI BRIC is 22%, ahead of MSCI EM CAGR of 14% and significantly ahead of MSCI Worlds +1%. The material and energy bull market partly explains the outperformance of BRIC,

although non-commodity sectors have also done well. Within EM, the previously important markets of Korea, Malaysia, Mexico, Taiwan and South Africa underperformed. This is consistent with the underperformance of nominal GDP in these countries. BRIC nominal GDP is 60% of EM nominal GDP. Will non-BRIC markets drop off the radar screen? Yes, unless they offer a premium growth rate or acceleration in trend growth. There are strong arguments in favour of Indonesia joining the BRIC grouping. But the country needs to demonstrate to long-term direct investors that there is sufficient effective protection of their legal interest in order to be permanently promoted to the BRIC league. An overweight BRIC consumer is consensus. This has been a good trade with strong relative returns from BRIC financials and consumer discretionary. The valuations relative to history and market are high; Brazil, Brazil Materials, Brazil Energy, Brazil Financials, India Financials, Mexico Materials, SA Materials and Indonesia are more than one standard deviation above their long-term average relative to history and EM. However, the premium in these sectors is modest compared to the actual returns achieved (for more see page 9).Figure 5: Performance of BRIC vs MSCI EM160

130

100

70 Jan-02

Jan-04

Jan-06

Jan-08

Source: Datastream, 24 November 2009.

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Emerging Markets Equity Research 02 December 2009

Economic growth surprises low expectations In our view, the consensus is skeptical of sustainable growth. This supports a cyclical bias even with the ISM above 50. Our base case is: No change in G3 interest rates in 2010 Above-consensus US and European 2010 GDP growth of 3.3% and 2.6% respectively The three drivers of economic growth in 2010 are: Industrial production/inventory cycle Exports Delayed monetary stimulus The relationship between final sales and production indicates substantial de-stocking in the past three quarters. As end demand slowly recovers, production needs to increase faster due to low inventories. The turn in IP is typically durable and sustained for 13 months on average. This is a normal feature of a recovery. Global growth of 3.5% in 2010 should support a recovery in external demand for most economies. Sequential trends are consistent with 2010 oya% export growth. 2010 is the year of G3 monetary stimulus Three conditions are required for a monetary stimulus: available credit; low market rates; and willing borrowers. If credit markets continue to rally and J.P. Morgan economic growth numbers are correct, these conditions will be met in 2010. Counter-intuitively exit strategies signal that the monetary stimulus is building. Note, this is primarily a developed market event. China monetary stimulus fed through rapidly. Current account deficit economies will benefit from this delayed stimulus into 2010, i.e., India, Turkey, South Africa, etc. (See page 17 for more on the delayed monetary stimulus.) Earnings estimate revisions will now drive stocks Stocks are driven primarily by earnings estimate revisions rather than a compression in risk premiums. This argues for a cyclical bias. Potentially scarred and overworked analysts are even slower to upgrade. In this phase, markets trade expensive. Please see Steve Malins briefing on page 19 for more on the power of earnings estimate revisions after the economic recovery.

Figure 6: Tracking inventory - Global IP and final sales proxy115 110 105 100 95 90 85 00 01 02 03 04 05 06 07 08 09 10Source: J.P. Morgan, September 2009.

J.P.Morgan final sales proxy Industrial production

Figure 7: Sequential recovery in exports growth (% oya)40 30 20 10 0 -10 -20 -30 -40 -50 Oct-07 Feb-08 Jun-08 Taiwan Korea China

Oct-08

Feb-09

Jun-09

Oct-09

Source: J.P. Morgan, October 2009.

Figure 8: Emerging markets can rise with interest rates (%)1500 1200 900 600 300 0 88 90 92 94 96 98 00 02 04 06 08Source: Datastream, MSCI, IBES, J.P. Morgan economics

MSCI EM Index (LHS) Fed Funds target rate (RHS)

10 8 6 4 2 0

Focus on sectors in countries The rolling country-by-country growth recovery trade is done. Economic decoupling occurred with the global recovery led by India, Indonesia and China. The balance of EM Asia, Brazil, Russia and Turkey recovered a quarter before DM (see page 18 for more on the rolling recovery). Country asset allocation needed to lead the economic recovery by a quarter. Thus country relative performance changed during the year. Sector strategy was more stable with a bias towards cycles.

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Emerging Markets Equity Research 02 December 2009

Now that the rolling recovery trade is done, the confidence in country calls is lower. Focus on key sectors within countries that offer: (1) High probability of positive EPS revisions (2) High secular and/or defensive growth The Secular and Cyclical Trade Overweight Turkey: We believe that Turkey could outperform EM and CEEMEA as structurally lower inflation and interest rates result in higher trend; India in the mid-90s is good example of this trend. The IMF standby program, if signed, should ease Turkeys reliance on external financing and reduce the crowding out of the private sector. These improved fundamentals are neither reflected in valuations nor relative performance. Turkeys forward PE of 9 is at a significant discount to MSCI EM's 13. The index has marginally underperformed MSCI EM year to date. Since midMarch 2009, the local currency index is in line with MSCI EM. Higher trend growth and lower interest rates are positive for Turkish banks, a large part of the benchmark. We forecast an acceleration of earnings growth from 10-20% in 2010 to 20-30% in 2011. Deterioration in global credit markets and/or delays in negotiating a deal with the IMF are a threat. J.P. Morgan forecasts a 2010 current account deficit of 2% of GDP. Overweight Mexico Catalysts are clear. A robust 3.3% - around 100bps above consensus - US economic recovery, led by manufacturing (+4.5% in 2010), which is the key linkage between the US and Mexico. IP is 30% of Mexico GDP, and 80% of exports go to the US. Mexicos historical beta to global GDP recovery is over 2.0x. This drives a forecast 11 point Mexico GDP swing into next year, the second highest globally and arguably with upside risks. The currency also offers short-term upside, as a clear EM underperformer YTD, and with oil prices (1/3 fiscal revenue) set to remain high. In this context, fiscal and rating concerns are overdone and likely well-priced short term, though remain real long term, as fiscal revenue/GDP is low (22% GDP), and poorly structured (off falling oil production). The market is under-owned by foreign investors; local pension funds only have 8% in domestic equities, and EM investors are OW, but focused on the defensive 2/3 of the market. We focus on the 1/3 cyclical portion of the market for cheaper asset values, and stronger earnings

leverage. We are also bullish the S+P 500, and the correlation with the Mexbol is very high. The market is trading below its 5-year average multiple, and earnings momentum is positive (Q3 index EPS +20% oya).Figure 9: Turkey Structurally low policy rates and inflation50 40 30 20 10 0 03 04 05 06 07 08 09Source: J.P. Morgan economics, October 2009.

CPI

Policy Rate

Figure 10: Mexico - second highest GDP swing (11pt) in 201015% 12% 9% 6% 3% 0% South Africa Korea Chile India Russia Taiwan Mexico Turkey China Brazil

Source: J.P. Morgan economics. Note: Chart shows the difference between 2009 and 2010 GDP growth forecast.

Figure 11: Secular decline in interest ratesTurkey Brazil Mex ico Philippines Indonesia India Thailand Korea South Africa Taiw an Malay sia China Russia -3 -1 2 5 7 10

Source: J.P. Morgan economics. Difference between 5 year average policy rate (2004-08) and Average forecasted policy rate in 2009-10, ranked by greatest difference.

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Emerging Markets Equity Research 02 December 2009

Policy normalization outside G3 Not all countries will be subject to the same disinflationary forces. A number of smaller economies, quasi peripheral to the G3, have suffered much less during the recession, and are thus likely to normalize monetary policy earlier. Israel and Australia have started increasing policy rates and are set to continue. Other countries will likely follow suit in coming months Norway, Czech, Korea, and Brazilby our forecast, an earlier start of the rate normalization cycle should benefit their currencies and hurt their bond markets. The impact on their equity markets is less obvious but will likely be a small negative. Inflation ends the party in EM before DM The inflation cycle could be desynchronized. EM inflation models are unlikely to be accurate due to the short history of post pegged exchange rate inflation. Asia is more at risk due to limited currency appreciation relative to LATAM and EMEA. All one can do is monitor the data. The table below is published in both Perspectives and Portfolios and Key Trades and Risks every two weeks. The table monitors inflation relative to central bank target zones. Inflation today is benign but base effects in 2010 will be less favorable. The message from the previous inflation cycle was to sell equities when the inflation rate breached the central banks target zone. Conditions supportive for M&A activity Low funding costs and generally healthy balance sheets provide supportive financial conditions for corporate activity. Improvement in the global economic situation is increasing the confidence of business and financial investors. The diversity of potential participants makes

todays situation unusual. At the simplest level companies are returning capital to investors either via higher dividends or through capital reduction. EM companies continue to expand regionally and globally. Private equity funds are far more developed and disciplined compared to the past. Most of the large private equity funds will continue to lead deals. This is not a one-way trend, with EM companies now acquiring developed-world businesses.Figure 12: MSCI EM PE and US interest rates (%)40 35 30 25 20 15 10 5 88 90 92 94 96 98 00 02 04 06 08Source: Datastream, MSCI, IBES, J.P. Morgan economics

MSCI EM Fw d PE (LHS) Fed Funds target rate (RHS)

10 8 6 4 2 0

Figure 13: EM average policy rates (%)25 20 15 10 5 0 -5 98 99 00 01 02 03 04 05 06 07 08 09Source: J.P. Morgan economics, September 2009.

Nominal Real

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Emerging Markets Equity Research 02 December 2009

Table 1: Monetary policy and inflation% US core PPI US core CPI US Unit Labor Costs Inflation Data Japan CPI Malaysia CPI Taiwan CPI China CPI Czech CPI Chile CPI Thailand CPI Philippines CPI India Wholesale Price Index South Korea CPI Indonesia CPI Colombia CPI Poland CPI Israel CPI Brazil CPI Mexico CPI Hungary CPI Turkey CPI South Africa CPI Russia CPI Venezuela CPI Inflation Target (Central Bank) na na na 2.5 - 3.0 2.0 4.8 2.0-4.0 3.0 (1.0) 0-3.5 3.0-5.0 5.5 2.5 - 3.5 4.0-6.0 3.5 - 4.5 1.5 - 3.5 1.0 - 3.0 4.5 (2) 3 (1) 2.0-4.0 7.5(2) 3.0 - 6.0 10.5 19.5 Current CPI 1.8 1.5 (1.4) -2.2 -2.0 -0.9 -0.8 -0.3 0.2 0.4 0.7 1.5 2.0 2.6 3.2 3.4 3.8 4.3 4.9 4.9 5.1 6.1 15.1 28.9 Food CPI na na na -0.5 -19.5 1.4 1.5 -5.8 1.0 1.6 2.2 15.7 4.6 4.8 2.2 4.5 1.6 3.5 7.0 3.0 5.8 4.9 8.4 na Change in CPI in last 12 months (2.2) (1.0) 0.0 -4.3 -10.2 -4.0 -5.4 -6.7 -8.6 -3.5 -11.1 -9.3 -2.8 -9.2 -4.4 -1.1 0.5 -1.9 -0.6 -0.8 -6.9 -7.0 6.6 -7.1 CPI Forecast 2009 end (J.P. Morgan) 2.7 1.7 na -1.3 0.2 -0.8 -0.6 1.2 1.5 -0.9 2.0 8.2 2.8 4.7 4.5 3.5 na 5.1 5.4 4.2 6.1 7.2 12.0 na J.P. Morgan forecast 2009 On Hold On Hold On Hold On Hold On Hold On Hold On Hold On Hold On Hold On Hold On Hold On Hold On Hold On Hold On Hold On Hold On Hold On Hold On Hold Easing Easing On Hold On Hold Accommodating

Source: Bloomberg, J.P. Morgan Economics. 4 November 2009. Inflation targets are extracted from EM Inflation: Trouble Beyond the Headlines, Hensley et al, 7 July 2008.

Check the valuation signalExpensive (more than 1sd above 10 year average PE) Cheap (At or less than 10 year average PE) Relative to country/sector history Relative to country/sector history Brazil, Mexico, India and Indonesia Turkey, Israel, Chile, Thailand Energy: Brazil and China IT: Korea, Taiwan and India Materials: Mexico, SA, Brazil, Korea, Taiwan Telecom: SA and China Financials: Brazil, Korea, India, SA, Taiwan Russia energy, Israel Healthcare, Turkey financials China Industrials and Mexico CS Relative to EM Brazil and Indonesia Financials: Brazil and India Materials: Mexico, Brazil, SA Energy: Brazil Relative to EM Russia, Turkey, SA, Korea, Poland, China, Hungary Israel, Chile, Taiwan, Malaysia, Philippines, Thailand IT: Korea, Taiwan, India Telecom: SA, China, Mexico CD: Korea and SA Financials: Turkey, China Korea Industrials, Russia energy, Israel Healthcare

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Emerging Markets Equity Research 02 December 2009

Table 2: Hindsight sector valuationsSector Current 13.2 6.9 13.0 8.7 13.6 8.1 9.6 10.8 16.5 9.5 18.9 12.7 13.8 9.0 13.5 14.6 21.2 15.0 11.9 10.0 17.7 15.1 10.2 12.4 18.4 8.7 20.1 12.0 10.4 12.5 9.9 14.4 14.8 15.7 10.9 11.7 15.2 9.7 14.0 16.8 10.9 18.5 17.1 15.6 20.2 12.5 13.0 14.9 12m Forward PE 10yr Average +1sd 9.4 11.4 7.2 9.6 6.8 9.7 8.1 10.5 7.8 10.1 9.5 13.2 8.3 10.1 8.0 10.1 8.2 10.6 8.4 11.6 12.5 15.7 12.4 14.8 10.5 14.5 9.6 12.4 11.2 15.1 12.0 13.7 12.4 18.9 8.0 10.0 10.0 11.4 9.1 11.0 14.1 17.5 12.9 16.0 11.2 16.2 21.5 32.5 15.0 17.5 7.9 10.0 25.3 48.5 10.3 12.4 14.7 25.7 15.8 23.6 8.3 9.8 14.1 19.0 13.5 18.2 18.2 30.7 9.9 11.9 15.9 19.6 15.6 17.7 7.3 9.6 9.1 12.3 14.9 19.1 13.9 34.6 13.5 17.3 11.6 14.7 14.4 16.4 14.5 17.1 9.4 11.9 11.1 13.0 14.0 16.3 12m Forward PE relative to EM 10yr Average +1sd 0.9 1.0 0.7 0.9 0.6 0.8 0.7 0.9 0.7 0.8 0.9 1.2 0.7 0.9 0.7 0.9 0.7 1.0 0.8 1.0 1.1 1.4 1.1 1.3 1.0 1.3 0.9 1.1 1.0 1.4 1.1 1.2 1.1 1.6 0.7 0.9 0.9 1.0 0.8 1.0 1.3 1.5 1.2 1.4 1.0 1.6 1.9 3.0 1.4 1.6 0.7 0.9 2.2 3.7 0.9 1.1 1.3 2.0 1.4 2.0 0.8 0.9 1.3 1.7 1.2 1.6 1.7 3.0 0.9 1.0 1.5 1.8 1.4 1.6 0.7 0.8 0.8 1.0 1.4 1.8 1.2 2.4 1.2 1.5 1.1 1.3 1.3 1.5 1.3 1.6 0.8 1.1 1.3 1.5

Brazil Financials Russia Energy Brazil Energy Russia Brazil Turkey Financials South Africa Energy Korea Financials Mexico Materials Korea Industrials South Africa Materials Mexico Telecommunication Services India Energy Turkey Korea Consumer Staples Mexico India Financials Brazil Materials South Africa Korea India Poland Korea Information Technology Israel Health Care Mexico Consumer Staples Korea Consumer Discretionary India Information Technology South Africa Consumer Discretionary South Africa Telecommunication Services China Telecommunication Services* South Africa Financials China Financials China Taiwan Information Technology Hungary Israel Chile Korea Materials Indonesia Taiwan Thailand China Industrials Taiwan Materials Malaysia Taiwan Financials China Energy* EM Philippines

-1sd 7.4 4.8 4.0 5.8 5.5 5.8 6.5 5.9 5.7 5.2 9.2 10.1 6.4 6.9 7.3 10.3 5.8 6.0 8.6 7.2 10.8 9.8 6.2 10.6 12.4 5.9 2.2 8.1 3.7 8.1 6.7 9.3 8.7 5.6 8.0 12.1 13.4 5.0 6.0 10.7 -6.9 9.6 8.5 12.4 11.9 6.9 9.1 11.7

Current 1.0 0.5 1.0 0.7 1.0 0.6 0.7 0.8 1.3 0.7 1.5 1.0 1.1 0.7 1.0 1.1 1.6 1.2 0.9 0.8 1.4 1.2 0.8 1.0 1.4 0.7 1.5 0.9 0.8 1.0 0.8 1.1 1.1 1.2 0.8 0.9 1.2 0.7 1.1 1.3 0.8 1.4 1.3 1.2 1.6 1.0 1.1

-1sd 0.7 0.5 0.4 0.5 0.6 0.5 0.5 0.6 0.5 0.5 0.9 1.0 0.6 0.7 0.7 1.0 0.6 0.6 0.8 0.7 1.1 1.0 0.5 0.9 1.1 0.6 0.7 0.8 0.6 0.7 0.6 0.9 0.9 0.4 0.8 1.1 1.2 0.5 0.6 1.0 0.0 1.0 0.8 1.2 1.1 0.6 1.1

Source: IBES, Datastream. Red (dark grey) denotes expensive ie more than 1sd, Green (light grey) denotes at or less than 10 year average. Note: * China Energy and China Telecom averages are from June 2000.

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Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

Focus on sectors within countries rather than country recommendationsThe table below provides a level summary of our views on sectors within countries. Financials are 25%, Materials is 15% and Energy is 16% of EM. All recommendations are relative to EM. The Industrials sector consists of an eclectic group of stocks. We do not rate the sector. We are overweight early cyclicals and transportation sub-sectors.Table 3: Key country and sector recommendationsCountry/Sector EM Brazil Brazil Materials Brazil Energy Brazil Financials China China Financials China Energy China Telecommunication China Industrials Hungary India India Financials India Energy India IT Indonesia Israel Israel Health Care Korea Korea IT Korea Financials Korea Industrials Korea Materials Korea CD Korea Consumer Staples Malaysia Mexico Mexico Telecommunication Mexico Consumer Staples Mexico Materials Philippines Poland Russia Russia Energy South Africa South Africa Materials South Africa Financials SA Telecommunication SA Consumer Discretionary South Africa Energy Taiwan Taiwan IT Taiwan Financials Taiwan Materials Thailand Turkey Turkey Financials Wts 100 16.8 4.8 4.6 3.7 18.3 7.2 3.2 2.4 1.6 0.6 7.5 1.9 1.3 1.2 1.8 2.7 1.5 12.6 3.5 2.4 1.9 1.8 1.4 0.7 2.7 4.4 1.8 1.0 0.7 0.4 1.3 6.6 4.0 6.9 1.9 1.8 0.9 0.8 0.7 11.1 6.6 1.7 1.4 1.2 1.3 0.8 Reco -N N OW OW UW OW UW UW n/a N OW OW OW N N UW UW N OW OW n/a N N N UW OW UW N OW OW N OW OW N UW OW UW N UW OW OW OW UW OW OW OW US$ Return (%) 1 yr 3 yr 106 22 155 97 174 124 199 150 156 72 103 53 120 67 131 50 20 20 97 37 109 (6) 124 25 145 30 105 60 114 (1) 209 57 57 47 32 68 128 (1) 135 (6) 172 (12) 108 (10) 182 76 164 19 52 (3) 65 41 69 4 51 17 63 22 199 (26) 86 23 55 (10) 103 (26) 84 (34) 91 19 106 (1) 80 18 63 44 150 38 83 27 92 5 118 (3) 93 (8) 62 44 94 16 96 23 127 35 09E 5 yr 119 371 393 581 490 191 270 201 197 86 43 184 219 367 117 207 94 103 84 58 101 174 215 79 101 85 127 189 153 59 125 76 72 57 89 69 70 116 125 139 37 43 (4) 89 61 87 128 X 15.8 16.6 20.8 15.1 15.9 17.5 17.4 15.4 12.3 22.2 12.5 20.7 25.1 17.4 21.5 15.8 15.3 15.9 13.7 18.2 16.0 11.2 12.0 10.5 13.9 18.1 18.1 13.2 22.4 48.4 16.8 16.8 11.3 7.9 14.9 34.6 11.7 11.9 14.8 12.0 30.5 33.2 29.2 27.3 12.4 9.7 8.3 PE 10E X 12.7 13.3 14.1 13.0 12.9 14.3 13.6 13.1 12.4 17.1 10.9 17.0 20.7 12.7 18.5 14.5 11.8 11.9 11.2 14.2 11.6 9.7 10.0 9.5 13.6 15.6 14.9 12.4 18.1 20.5 15.1 14.6 8.6 6.8 11.6 17.9 9.7 10.3 12.1 9.4 19.1 18.8 19.5 21.5 11.2 8.8 7.9 EPS Growth 11E 09E 10E (%) X (%) (%) CAGR 05 10E 10.8 (4) 24 7.2 11.4 (11) 25 4.8 11.5 (40) 48 2.9 12.3 (22) 16 3.2 10.6 6 24 5.8 12.2 9 22 13.5 11.1 18 29 29.3 11.6 (11) 17 6.6 11.8 (14) (0) 14.8 13.9 56 29 3.9 8.6 (41) 15 (1.5) 13.9 3 22 14.0 17.1 (2) 21 13.3 11.4 7 37 18.3 15.6 2 16 17.9 12.2 7 10 14.2 10.1 19 30 10.7 NA 8 34 16.6 9.3 44 22 4.6 10.9 NM 28 3.9 9.3 (27) 38 0.2 8.5 55 15 15.4 8.7 (12) 20 5.8 7.9 56 10 8.6 12.0 9 2 11.9 13.1 0 16 6.4 12.1 9 22 7.0 11.2 24 7 16.3 14.5 23 24 13.9 10.1 (48) 136 (13.7) 13.2 24 11 5.5 11.3 (34) 15 (3.0) 6.5 (33) 32 4.5 5.5 (24) 15 2.3 9.4 (13) 29 11.8 13.7 (45) 93 20.6 7.8 (14) 21 7.4 9.0 2 16 13.8 9.8 11 22 12.0 7.4 (18) 28 9.4 13.4 8 60 (0.7) 12.3 (13) 77 4.0 15.2 NM 50 6.0 16.2 (17) 27 (13.0) 9.3 28 10 (2.4) 7.4 6 11 11.1 6.6 23 5 16.4 ROE DY 10E % 10E% 2.2 13.0 2.7 14.6 2.4 11.9 2.3 37.3 2.3 15.7 2.2 14.2 2.4 15.6 2.7 14.7 3.5 14.9 1.4 8.0 1.8 11.1 1.0 15.0 0.9 11.3 1.1 15.6 1.3 27.0 2.7 23.7 1.4 12.9 0.9 NA 1.2 10.3 0.2 10.4 1.0 7.8 1.3 12.8 1.6 11.7 1.4 12.0 1.7 16.9 2.7 10.9 2.3 15.2 3.3 39.4 1.3 14.9 2.0 2.6 3.8 14.3 3.3 9.6 1.3 10.5 1.4 11.9 2.8 14.7 1.4 7.8 4.1 13.3 2.4 19.2 2.0 16.5 3.0 16.7 3.0 6.4 2.9 6.7 2.7 5.0 3.1 6.8 3.3 13.7 2.8 16.6 2.0 18.3 03-08 Avg 15.6 18.6 28.2 27.1 21.9 15.5 10.8 21.0 18.1 11.7 22.3 20.9 15.9 20.7 30.0 24.8 12.6 16.1 13.7 17.2 10.9 10.7 16.9 13.6 14.9 12.9 18.2 30.4 15.3 14.4 13.2 15.6 15.8 16.0 18.4 10.3 19.2 26.7 20.9 23.7 12.4 13.3 6.1 19.7 19.4 17.4 17.1

Source: J.P. Morgan Asian strategy team, MSCI, Datastream. Table sorted by descending weight in index, countries first followed by country-sectors. 10 November 2009.

11

Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

Risks to our strategyBond market volatility The end of QE plus banks unwilling to add to duration risk is a dangerous technical situation for government bonds. Risks assets typically struggle as bond yields rapidly increase to "normal" levels. Please see Mercury Rising on page 22 which highlights the relationship between bond market volatility and EM corrections. Dubai World debt moratorium Our base case is that this is a Dubai-specific rather than pan-EM issue. The risk is that we underestimate the damage to investor confidence in the region. 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 expand and equities fall. Please see page 23 for a review of the impact of fiscal stimulus on growth and potential fiscal drag in 2011. Central banks target asset prices We are in a post Greenspan world; central banks target asset prices and the common wisdom is that the market cannot be trusted. Brazil "got away with" market intervention. The Brazilian market outperformed last week despite implementing a 2% tax on speculative inflows. This tax is politically appealing as it targets international "speculators" who are viewed to be behind the credit crunch and putting at risk Brazilian manufacturing jobs (and they do not get a vote in the 2010 Brazilian presidential election). China and India already have capital controls. It is now open season for non-market policies as central banks attempt to manage conflicting policy goals. Be careful in the consensus asset inflation trade. More rapid increase in Asian inflation With the exception of Thailand, J.P. Morgan's inflation forecasts for 2010 are within the central bank target zones. Modeling inflation in emerging economies is difficult due to the short history of floating exchange rates and large weighting to food and other primary products. The base effect for commodities is notably unfavourable in 1H10. There is a risk that inflation increases faster than our forecast. This would be negative for equities. The lack of a valuation cushion Valuations in EM and DM are mid a wide and statistically debatable valuation range. If news flow remains incrementally positive then it is not a challenge to performance, but there is no valuation cushion.Figure 14: Global Bond Supply ($tr)$7 Gov ernment Corporates incl Gov t Guranteed $6 $5 Agencies, Supra, Muni, etc Securitized

$4

$3

$2 $1

$0 2009 2010

Source: J.P. Morgan. Global bond supply and demand 2009 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. 2010 forecast $tr, demand and supply figures are annualized.

Figure 15: Global Bond Demand ($tr)QE $7 $6 $5 $4 Banks FX Reserv es Retail Bond Funds Other

$3 $2 $1 $0 2009 2010

Source: J.P. Morgan. Global bond supply and demand 2009 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. 2010 forecast $tr, demand and supply figures are annualized.

12

Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

Uncertain outlook for commodity Financial investors influence on commodity prices is now substantial .Commodities rallied prior to the recovery rather than typically lagging the recovery. With zero interest rates investor flows could remain strong, pushing up commodity prices which would be negative for growth. It is also possible that flows reverse. Upwardly sloping forward curves result in a negative roll or high cost of carry for financial investors. Investors may become discouraged by the low returns available due to the negative carry.Figure 16: Oil forward curve ($/bbl)100 95 90 85 80 75 10 11 12 13 14 15 16 17Source: Bloomberg.

Renminbi and Asian currencies The RMB effectively re-pegged to the US dollar 15 months ago. With headline inflation and exports down year over year, we see no catalyst for Beijing to change policy until mid 2010. The RMB is anchoring other Asian currencies as they try to maximize export competitiveness. Election-induced volatility Several emerging markets go into election in 2010. This could be a source of volatility for the markets. Koreas regional election in June 2010 is going to be the last nation-wide election before the presidential election in 2012, meaning the current ruling party is likely to put every effort to win the election. Brazil elects a new president in October 2010. The base case is the current PT-led centre-left coalition remains in power. With fewer macro issues in play this time around, the potential outcome is less dramatic, though pre-election volatility is likely, and sectoral and micro risks are on the rise. Colombia elects a new President in May 2010, with uncertainty as to whether current President Uribe can run again.Table 4: 2010 Election CalendarJan Feb Mar Colombia Legislative election 14 Mar Jul Apr Hungary Parliamentary election Aug

Crude Oil, WTI : 11/24/2009

Figure 17: The financial investor is also driving commodities Cumulative inflows into commodity fund by year (US$ billion)45 40 35 30 25 20 15 10 5 0 2004 2006 2008 2005 2007 2009 39.9

20.1 17.5 13.0 12.1 8.9 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

May Philippines Legislative & Presidential election, 10 May Colombia Presidential election, 30 May Sep

Jun Czech Republic Parliamentary, First Round Hungary Presidential election

Source: J.P. Morgan, up to October 2009.

Carry trade volatility The carry trade is a poorly defined term. We use it as shorthand for investors desire to generate a return when cash returns are zero. This may simply be the switch from cash to higher risk asset. It will also include currency forwards as investors search for higher yielding FX. Invariably momentum in risk assets will attract the leveraged investor. The correction in carry trades can be sharp.

Korea Regional election Oct Nov Poland Presidential election, First Round Brazil Presidential election, First Round 3 Oct

Dec

Source: IFES.

13

Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

Managing RisksRisks for the first year of recovery are high. Investors should consider protecting their portfolios. Option implied volatility has fallen from the highs in 2008, it is reasonable to buy portfolio insurance by going long index puts. Recent research from J.P. Morgan's Equity Derivatives and Delta one strategy team shows that investors who want to protect their portfolios beyond a three-month period had to bear a 30% annualized cost of rolling the long VIX futures position. The research suggests that the recent increase in correlation between the USD, VIX and equity prices can be used as a more efficient way to achieve diversification and portfolio insurance. While we believe that investors should not overemphasize this casual relationship between asset markets and the USD, we recommend building a small USD long in portfolios to protect against sharp market corrections. This tail risk is particularly important for investors reporting performance in USD terms; if equity markets were to drop 20%, and the USD appreciates by 17%, a dollardenominated foreign portfolio would fall in value by

35%. Since January 2009, on average, the VIX tended to increase by 1.2 points for every 1% strengthening in the Dollar and this was strongly negatively correlated with equity markets. Our base case assumes emerging market FX appreciation. Hedging the portfolio with a position in USD is an inexpensive way to diversify sudden EM FX depreciation when risk aversion spikes.Figure 18: Correlation between DXY and EM FX index - Very Negative0.2 0.0 -0.2 -0.4 -0.6 -0.8 -1.0 93 95 97 99 01 03 05 07 09Source: Bloomberg.

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Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

A longer perspective on asset performanceTo avoid being drowned by an anchor and provide an objective perspective of asset performance, we look back at three, five and eight-year US$ returns. The three-year CAGR for EM equities is just 4.3%. This is higher than -6.8% CAGR return from DM equities. MSCI EM outperformed the DM world index over these years. More recently, BIC has driven returns as Russia underperformed by 16% over three years and 4% over three years. Note the divergence in performance of oil and Russian equities and ruble. At a sector level, Commodities have outperformed, along with consumer stocks. Financials managed to outperform only marginally. IT has been the worst performing sector. Currency returns are a meaningful part of the US$ returns on equity indices. The currency bloc matters, as shown in Table 6. CE3 currencies have appreciated the most, along with the Euro. Interestingly, Asian currencies ex the RMB and Thai Baht, have been laggards. The Mexican Peso is a notable underperformer in Latam.Table 5: MSCI EM Sector performance (% for US$ indices)MSCI EM Sector EM Energy EM Materials EM Cons Disc EM Cons Staples EM Utilities EM Financials EM Industrials EM Telecoms EM IT Weight 15.0 6.6 5.4 2.2 0.0 12.9 5.3 3.5 8.9 3yr CAGR 5 10 5 11 7 5 0 2 -3 5yr CAGR 19 18 11 19 17 15 11 13 7 8yr CAGR 24 22 18 17 17 16 16 12 8

Table 7: Major EM country index performance (% for US$ indices)Country Colombia Egypt Peru Indonesia Czech Republic Brazil India BRIC China Hungary Russia Thailand South Africa Chile Turkey EM Morocco Mexico Korea Poland Philippines Malaysia Israel Taiwan World Weight 0.6 0.5 0.7 1.8 0.4 16.8 7.5 49.1 18.3 0.6 6.5 1.2 7.0 1.3 1.3 100 0.3 4.4 12.6 1.3 0.4 2.7 2.7 11.1 3yr CAGR 17 0 28 11 2 21 6 8 13 -7 -13 1 2 10 2 4 7 -1 -3 -8 3 8 10 -4 -7 5yr CAGR 27 25 31 21 15 30 21 21 21 3 8 6 9 15 9 13 19 15 11 7 14 9 11 2 0 8yr CAGR 40 34 33 32 30 26 22 21 19 17 17 17 16 16 16 16 15 15 13 12 12 11 9 4 2

Source: MSCI. Sorted descending 8 year CAGR. Grey line separates perf rel to EM

Table 8: Major EM country sector CAGR returns (%)Country Sector Brazil Materials India Energy Brazil Energy S Africa Cons Disc China Energy India Financials S Africa Telecoms Brazil Financials Korea Materials Korea Industrials Korea Cons Discr Mexico Telecoms India IT Korea Cons Staples Turkey Financials China Financials Israel Health Care Russia Energy Taiwan Materials Korea IT Mexico Cons Staples China Industrials S Africa Financials China Telecoms S Africa Materials Mexico Materials Korea Financials Taiwan Financials South Africa Energy Taiwan IT Weight 4.8 1.3 4.6 0.8 3.3 1.9 0.9 3.7 1.8 1.9 1.4 1.8 1.2 0.7 0.7 7.2 1.5 3.9 1.4 3.5 1.0 1.6 1.8 2.3 1.9 0.7 2.3 1.7 0.7 6.6 3 year CAGR 27 16 32 9 12 8 12 17 19 -5 5 4 -2 -2 8 17 18 -15 7 -3 6 9 2 4 -2 -11 -6 -5 6 -4 5 year CAGR 32 35 41 13 21 25 13 37 22 20 11 21 15 14 16 28 14 8 6 9 18 11 6 21 8 7 13 -3 16 5 8 year CAGR 38 35 33 31 30 30 29 28 24 21 20 20 18 18 18 18 17 16 16 16 15 15 14 12 12 10 8 4 3 1

Source: MSCI. Sorted descending 8 year CAGR. Grey line separates perf rel to EM

Table 6: Currency and commodity performance (%)Currency WTI Crude GSCI Industrial Metals Czech Koruna GSCI Agricultural Index Euro Hungarian Forint Polish Zloty Brazilian Real S African Rand Thai Baht Chinese Yuan EM Currency Basket Israeli Shekel Malaysian Ringgit Philipine Peso Indonesian Rupiah Korean Won Taiwanese Dollar Russian Ruble Indian Rupee Turkish Lira Mexican Peso Dollar Index 3yr CAGR 10 -8 7 9 5 4 2 8 -1 3 5 0 5 2 2 -1 -7 1 -3 -1 -1 -5 -4 5yr CAGR 9 10 6 14 3 1 3 10 -5 4 4 1 3 2 4 -1 -2 0 0 -1 -1 -3 -2 8yr CAGR 19 13 10 10 7 6 5 5 4 4 2 2 2 1 1 1 1 1 0 0 0 -4 -6

Source: MSCI. Sorted descending 8 year CAGR. Grey line separates perf rel to EM .

Source: Bloomberg. Sorted descending 8 year CAGR. Grey line separates perf rel to EM . J.P. Morgan. The EM Currency Basket is calculated using the difference in the returns in the MSCI EM local and USD indices. All performance versus the US$ except Dollar Index

15

Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

The Policy Risk to the Asset Inflation TradeOn 19 October 2009, the Brazil government announced a 2% upfront charge for foreign investors making portfolio investments in local fixed income and equities (IOF). The government was concerned about the pace of Real (BRL) appreciation; +35% ytd. If BRL resumes its appreciation trend further measures are possible. Minister Mantega said that the FX floating regime remains in place and he is supportive of capital markets, but the intention is to avoid excessive BRL appreciation. Brazilian authorities have voiced concern about the exchange rate, and the more the BRL appreciates the greater the policy risks. We believe that with Brazils successful experiment last week, there is the risk that other central banks attempt non-market policies to manage conflicting policy goals. The Brazil government's move was not a surprise as they were vocal about their concerns with BRL appreciation. The size and breadth of the move, however, was a surprise. Between March and October 2008, Brazil imposed a 1.5% IOF on fixed income investments by foreigners. The currency continued to appreciate until July 2008. MSCI Brazil underperformed MSCI EM by only 1% in the week post the imposition of IOF (19-23 October 2009). Brazil has gotten away with the capital control. This is in sharp contrast the Thai experience (see below) Policy risks growing The lack of a sustained negative response to Brazils capital control measure may encourage other central banks to implement non-conventional policies. This, we believe, is a risk to the consensus asset inflation trade. Learning from the Thai experience In December 2006, the Thai government imposed FX controls on all inbound portfolio capital. The initial rules implied that foreigners would have to deposit 30% of the funds brought into the country as a reserve with the central bank and only the remaining 70% could be invested. For withdrawing capital within one year, only two-thirds of the amount would be refunded. The stock market dropped 17% the following day. This pushed the government to change their stance and limit the controls to inflows in bonds and commercial paper.Figure 19: A muted response from Brazil116 112 108 104 100 01-Oct 07-Oct 13-Oct 19-Oct 25-OctSource: MSCI, Bloomberg, J.P. Morgan. The Brazilian Real index is inverted. Indices rebased to 100 on 1 October 2009. The red line shows the announcement of the IOF tax.

MSCI Brazil

BRL Currency

Figure 20: Relative performance post knee-jerk reaction positive108 107 106 105 104 103 102 101 100 01-Oct 07-Oct 13-Oct 19-Oct 25-OctSource: MSCI, Bloomberg, J.P. Morgan.

MSCI Brazil relativ e to MSCI EM

Figure 21: The Thai experienceImpact on currency37.5 36.5 35.5 34.5 33.5 32.5 1-Dec-06Source: Bloomberg.

Thai Baht Onshore

Thai Baht Offshore 22-Dec-06 12-Jan-07 2-Feb-07 23-Feb-07

Figure 22: The Thai experience Impact on the stock market330 310 290 270 250 230 1-Dec-06 22-Dec-06 12-Jan-07 2-Feb-07 23-Feb-07Source: MSCI, Bloomberg.

16

Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

And now the monetary stimulusMonetary stimulus requires three conditions: available credit, at an attractive interest rate, and willing borrowers. An ongoing rally in the credit markets provides the first two conditions. By mid-2010 several quarters of economic expansion should boost business confidence. Initially the effect will be a reduction in borrowers propensity to repay loans. This is a developed world event. The monetary stimulus in EM, particularly in China, fed through rapidly in 2009. The technical position in investment-grade bonds may get more favorable. The negative carry between shortterm working capital loans and long term interest rates should discourage further bond issuance. The momentum of returns in credit markets is likely to continue to attract investors. This combination results in further spread reduction and absolute decline in yields. Higher risk bonds are likely to follow this trend. The irony of the post-credit-crunch interest-rate dynamic is that the improvement in credit markets allows central banks to move away from emergency interest rates. Investors should view this as a bullish sign. As we highlighted in our guide to monetary policy in EM (26 August 2009, Mowat et al) the nominalization of interest rates is concurrent with strong markets and economies. It is only when higher inflation drives central bank policy action, that investors should sell equities. Please see our extended markers for a summary of inflation and central bank target ranges.

Figure 23: Compression in excessive risk premium Yields for government and corporate bonds plus earnings yield for US and emerging equity markets22 20 18 16 14 12 EMBI 10 8 6 4 US 10 y r 2 0 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 1 month T-Bill Negativ e Yields Juli Av g : 6% JULI

US High Yield CEMBI US EARNINGS YIELD EMBI JULI US 10 Yr EM EARNINGS YIELD 1 Month T-Bill

High 21.0 14.3 11.4 12.0 8.7 5.2 17.3 5.2

Low 7.5 5.7 6.1 6.3 4.9 2.1 6.8 (0.1)

Avg 05-07 8.4 6.4 6.6 7.0 5.7 4.6 8.7 4.0

Spot 9.8 7.0 6.9 6.7 5.3 3.5 7.6 0.1

Diff 1.4 0.6 0.3 (0.3) (0.4) (1.1) (1.2) (4.0)

US HY US Earnings EM Earnings y ield y ield CEMBI

Source: J.P. Morgan, Bloomberg, 6 November 2009.Note: JULI = J.P. Morgan high grade bond index, CEMBI = emerging market corporate bond index

17

Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

The rolling recovery trade of 2009: And settling the decoupling debateThe debate on economic decoupling is settled. Emerging economies led the recovery out of the synchronized recession in 4Q08. Growth remains robust despite weak exports. Domestic inflation and monetary conditions appear to be the dominant drivers of EM growth. The evidence of capital market decoupling is more limited. Correlation between DM and EM is a function of common investors. That said, the low in EM equities was on 27 October 2008, four months ahead of the developed equity markets. China, India and Indonesia led the economic recovery in 1Q09. This recovery broadened to the balance of Asia, Brazil, Russia and Turkey in 2Q09. Developed economies returned to growth in 3Q09. Finally Hungary and South Africa return to growth in 4Q09. Markets typically outperformed in the three months prior to their recovery. Within EM exporters started to outperform in 2Q09. The rolling recovery trade is now mature. For the past two years, stock price movements have been dominated by macro factors. In 2010, we would expect a more normal balance of stock specific factors and macro factors driving share prices.

Table 9: Rolling with the decoupled recovery Real GDP growth (QoQ SAAR) in key Emerging markets; recession in red, recovery in greenQoQ saar EM Asia China India Indonesia Korea Malaysia Philippines Taiwan Thailand Lat Am Brazil Colombia Mexico EMEA Czech Hungary Poland Russia South Africa Turkey USA Euro area Japan Australia Hong Kong Singapore Avg 20032007 8.4 11.1 9.3 5.8 4.4 6.1 5.7 5.1 5.8 5.2 4.1 6.4 3.5 6.4 5.6 3.4 5.5 7.4 4.7 6.8 2.9 2.1 2.1 3.4 6.8 7.7 1Q08 7.6 10.7 6.9 5.9 4.4 7.2 0.4 3.6 4.7 5.4 7.5 -1.4 4.5 6.1 0.5 3.5 6.1 7.2 1.7 7.7 -0.7 3.1 3.5 3.0 4.1 12.2 2Q08 4.9 8.7 5.9 6.8 1.7 2.3 7.1 -2.3 0.3 4.7 6.2 2.9 1.1 5.1 5.0 -0.9 4.1 7.1 5.0 -4.5 1.5 -1.3 -2.8 1.4 -3.9 -7.7 3Q08 3.8 5.8 7.7 5.2 1.0 0.6 3.0 -2.9 2.2 1.4 5.5 0.0 -2.7 3.4 1.8 -3.8 1.6 5.9 0.2 -5.6 -2.7 -1.5 -5.1 1.3 -3.2 -2.1 4Q08 -5.3 2.4 1.6 1.9 -18.8 -8.8 1.1 -27.2 -21.5 -8.5 -12.8 -5.6 -9.2 -9.3 -5.0 -7.4 -0.4 -14.2 -1.8 -21.6 -5.4 -7.1 -12.8 -2.8 -7.4 -16.4 1Q09 2.5 8.4 8.2 4.9 0.5 -17.7 -8.1 -10.2 -7.2 -10.0 -3.8 1.1 -21.2 -20.2 -17.9 -10.0 0.4 -33.6 -6.4 -14.4 -6.4 -9.6 -12.4 1.6 -16.1 -12.2 2Q09 12.6 14.8 6.7 4.3 11.0 12.8 10.0 20.7 9.6 0.8 7.8 2.7 -4.4 2.2 0.4 -7.9 2.8 4.9 -3.0 19.1 -0.7 -0.7 2.3 2.5 13.9 20.7 3Q09E 9.8 10.0* 9.0 5.3 12.3 6.1 4.0 11.5 7.0 6.0 7.2 1.9 10.1 6.6 4.5 -2.0 5.5 9.5 0.5 11.7 3.5 3.0 3.0 1.2 9.0 14.9 4Q09E 5.3 9.1 -1.0 3.5 4.0 4.5 4.0 4.2 5.3 5.6 6.7 3.2 7.5 5.0 5.0 2.5 3.0 6.5 3.4 4.5 3.5 2.5 2.5 3.8 5.0 -2.0 1Q10E 6.8 9.0 10.0 5.5 2.0 1.6 5.0 3.8 4.9 4.7 4.3 3.5 3.7 3.5 2.8 2.0 2.5 4.5 4.4 0.0 3.0 3.0 2.5 2.1 4.2 4.1 2Q10E 7.0 9.5 7.0 6.0 3.5 4.9 5.0 4.0 5.7 3.2 5.0 4.3 -0.6 3.3 2.5 2.0 3.0 4.0 3.8 3.6 4.0 3.0 1.5 2.4 4.0 7.4 3Q10E 7.3 9.3 9.6 6.0 3.5 4.9 5.0 3.8 7.0 3.9 4.0 5.5 3.3 3.4 2.2 2.5 3.5 4.0 3.6 8.2 4.0 3.0 1.5 4.4 3.8 8.2 4Q10E 7.0 8.7 9.0 6.0 3.5 4.9 5.0 3.8 7.0 2.3 4.0 4.5 -0.9 3.6 2.0 2.5 3.5 4.5 4.1 8.2 3.5 2.5 2.0 6.2 3.5 8.2

Source: Actual data plus J.P. Morgan estimates, 11 November 2009. *Reported for China.

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Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

Reiterating our overweight on earnings revisionsSteve MalinAC, Head of Quant Research Those familiar with our research may detect a sense of irony in our title because the reality is that there are very few periods when we would not advocate being overweight on earnings revisionsit is after all one of the most consistent quant strategies for alpha delivery. Occasionally earnings revisions do fail, as they did last year and early this year. The severity of the underperformance was dramatic and enough to make some ask the question Is it broken for good? We believe not. Based on the strength of the recovery from prior failure periods we believe that now is exactly the time to focus on changes in earnings estimates. Why do earnings revisions work? Earnings revisions belong to the momentum family of alpha drivers. Research into momentum is extensive and while the jury is still out as to why it works, even the most ardent advocates of efficient markets struggle to deny that it exists. Whilst this isnt the forum for a detailed discussion, arguably the most convincing arguments for why earnings revisions work stem from behavioral finance. In this field the behavior and reaction of analysts to events that make them acknowledge their under/overstated opinion about a companys future have been studied in depth. In a nutshell earnings revisions trend and are serially correlated (i.e. when one analyst upgrades others follow), the market typically underreacts to these changes and this makes the signal systematically exploitable. Do they work in emerging markets? Using our extensive global back-testing infrastructure we have investigated the performance of various forms of earnings momentum in numerous universes. The conclusion is invariably the same. Earnings revisions have been a strong driver of returns over the long term in emerging markets indeed it is one of the strongest universes for observing the phenomena globally.Figure 24: The L/S return to Earnings Revisions in GEM800 700 600 500 400 300 200 100 0 Nov-94 Nov-95 Nov-96 Nov-97 Nov-98 Nov-99 Nov-00 Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Base

Source: Thomson, J.P. Morgan calcs.

Why did they fail recently? During the crisis and subsequent recovery macro drivers, not micro drivers such as earnings revisions were driving markets. The rapid deterioration in the economic data took analysts by surprise and for most of 2008 and part of 2009 analysts simply played catch-up. As far as the market was concerned EPS changes were at best not relevant and at worst behind the curve resulting in the strategy generating negative returns. Have they failed before? The recent period was a record period of underperformance but earnings revisions have failed before; notably in 97 and 01 (See below). Remember, momentum relies on serial correlation. That is, what has worked in the past is most likely to continue to work in the future. Conditions of rapid changes in risk appetite plus limited guidance from companies have contributed to the underperformance of the strategy. The period 97/98 was the Asia financial crisis and 01/02 was the fallout from the Tech sell-off as well as Sep 11th. This was followed by a slight recovery before the Asia region lurched into SARS. What happened next? The point that we would most like to stress is that in both previous failure cases when revisions started to work again they did extremely well. Whilst this is observable on the 12-month rolling return chart above, for clarity we also demonstrate this in the annotated draw-down chart and success rate (i.e. the number of positive L/S return months in the rolling year) chart below.

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Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

From March 1998 Earnings Revisions generated +32% of alpha on a long/short basis as it recovered very quickly. Similarly Jan 02 to Aug 03 saw a +28% L/S return. What has happened this time? (So far) The drought in the performance of earnings revisions was finally broken at the end of May. Subsequently investing in earnings revisions has been a winning strategy five months in succession (and it is again up this month at the time of writing). In summary we continue to be very optimistic about the earnings revisions based strategies in the current environment. The speed and magnitude of previous recoveries in performance are evident and we are already seeing effectiveness improve. In addition the fundamental support for earnings revisions is strong. The correlation between stocks and markets continues to drop back suggesting that micro is getting the better of macro and hence stock picking opportunities are likely to continue to improve. With the revisions environment having normalized and all the easy yards already accomplished for valuations it seems reasonable that attention will remain on earnings going forwards. With clarity returning as each reporting period passes and the endorsement of most market strategists (who are suggesting the economic picture will continue to improve), the stage appears set. How do you find revisions for stocks? We calculate earnings revision rankings for stocks and sectors globally on a daily basis. Please contact Steve Malin or Rob Smith at [email protected] for more in formation on accessing the latest information via our web portal or to receive latest changes direct to your inbox.

Figure 25: The 12-month rolling return to Earnings Revisions in GEM50% 40% 30% 20% 10% 0% -10% -20% -30% Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07Jun-07 Jun-08

Source: Thomson, J.P. Morgan Calcs.

Figure 26: Draw-down analysis Recovery periods are strongJun-94 Jun-95 Jun-96 Jun-97 Jun-98 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-09

0% -5% -10% -15% -20% -25%

+28% Jan 02 to Aug 03

+32% March 98 to March 99 +8% Since Jun 09

Source: Thomson, J.P. Morgan Calcs.

Figure 27: Strategy success rate (rolling year)120% 100% 80% 60% 40% 20% 0% Nov-94 Nov-95 Nov-96 Nov-97 Nov-98 Nov-99 Nov-00 Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08

Average success rate > 70% of months in any rolling 12 month period

Sharp Recovery following Sharp fall in effectiveness

Source: Thomson, J.P. Morgan Calcs.

Figure 28: Recent returns back on track4% 2% 0% -2% -4% -6% -8% Nov-08 Jul-08 Jun-08 Jan-09 Dec-08 Oct-08 Jun-09 Jul-09 Mar-08 May-08 Mar-09 May-09 Aug-08 Sep-08 Feb-09 Aug-09 Sep-09 Oct-09 Apr-08 Apr-09

Source: Thomson, J.P. Morgan Calcs.

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Dec-08

Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

The odd couple: Above-trend growth and falling core inflation(David Hensley AC and Joseph LuptonAC extracts from Global core inflation falling fast, GDW 21 August 2009) J.P. Morgans global economic outlook stands apart from the consensus. The forecast is for a sustained return to above-trend growth beginning this quarter and a continued slide in core inflation to near zero in the developed economies (DM) by late next year (see Slack Attack, Global Issues, May 29, 2009). This sounds incongruous; however a resumption of above trendgrowth accompanied by falling core inflation is standard operating procedure after deep economic downturns. Developed market core inflation is now at 1.1% oya, down from the peak at 1.9% oya in August last year. The current level is equal to the previous low in 2003. This is accompanied by depressed wage growth. The output gap and the death of the pricing power Our core inflation forecast is underpinned by the huge output gap in the economy. This large and growing amount of resource slack is a reflection of the extraordinarily low levels of aggregate demand and resource utilization. Global output gap is estimated to reach -4.9% of GDP in 2Q09. The measure of resource utilization, which is a weighted average of the rates of unemployment and manufacturing capacity utilization, was 3.8 standard deviations below its norm. In the past, economic recessions and the accompanying buildup of slack consistently have delivered a significant decline in core inflation and wage growth (see Slack Attack). Core inflation tends to move slowly in the developed world, meaning that the full transmission of resource slack to pricing tends to occur with a lag. The large decline in core inflation to date was magnified by passthrough from energy prices in 2H08. The death of pricing power is apparent when looking at core inflation and energy prices in 1H09 casually. This shows little a pass through of the bounce in energy prices into core inflation. Either businesses were unable to pass through higher energy costs because of the weak economy, or this was offset by disinflationary pressure elsewhere. Either way, it appears that the surging output gap already is taking a toll on pricing power. EM decline limited to Asia The shallower recession in EM suggests a smaller reduction in core inflation for the group. However, the actual reduction has been more dramatic with core inflation falling 1.5% to 2.4% from last years peak. This decline is entirely due to EM Asia, especially China. Core inflation has plateaued in Latam and CEEMEA.Figure 29: Developed market core inflation (US core ex tobacco)%oya

1.9

1.6

1.3

1.0 03 04 05 06 07 08 09 10

Source: J.P. Morgan.

Figure 30: Resource utilization and core CPI, developed economies2 1 0 -1 -2 -3 -4 -5 90 92 94 96 98 00 02 04 06 08 10 Resource utilization Core CPI Std. dev . from 1990-2007 av g %-pt; 8 qtr chg in %oy a inflation rate 2 1 0 -1 -2 -3 -4

Source: J.P. Morgan.

Figure 31: EM consumer prices excluding food and energy% change over 12 months

8 6 4 2 0 -2 Jan 03 Jan 04 Jan 05 Jan 06 Jan 07 Jan 08

CEEMEA Latam EM EM Asia

Jan 09

Jan 10

Source: J.P. Morgan.

21

Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

Fear bond market volatility Mercury may rise in 2010EM equities typically correct when bond market volatility rise. Statically this is when the 10-year UST yield exceeds two standard deviations versus its three month moving average. Since 2004, the mercury rising indicator has correctly signaled corrections in seven out of 10 occasions. Yields are low but the curve is steep The current 10-year UST yield of 3.5% is low relative to the long term history. But the yield is steep; the average curve is 1.75%. The curve steepness rewards duration risk and banks have rapid accumulated USTs. The appetite is finite. US fiscal deficit The US Fiscal deficit is estimated at US$1.35 trillion in 2010 following a deficit of US$1.6 trillion for 2009. The net US treasury paper issuance in 2010 is estimated at US$1.8 trillion; this is larger than the US$1.6 trillion estimated to be issued in 2009. Potentially, the markets inability to digest the large sustained fiscal deficits and issuance of treasury papers may cause UST yields to rise rapidly in 2010. End of quantitative easing Reinforced by the FOMC statement in November, we expect the Fed to continue with its already scheduled purchases, concluding purchases in 1Q10. Our baseline does not expect any further announcements of new purchasing programs, nor does it expect the Fed to alter the already announced amounts of purchases. The end of quantitative easing could result in higher bond yields in 2010. The mercury rising indicator We define a rapid adjustment in 10-year UST yields as a change in the yields that is greater than 2 standard deviations relative to the three-month moving average. We emphasize that this indicator does not identify market tops. Note that in March 2006 the indicator signaled a sell, and although three-month forward returns were -5% in EM equities, the MSCI EMF rallied a further 15% from March levels before peaking in May 2006. As a result, we interpret the signal as an early warning sign to begin reducing risk. We believe that emerging markets are susceptible to sharp corrections as volatility spikes in global markets. Our work 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.

Figure 32: The mercury rising indicator MSCI EM and UST # of standard deviations from three-month moving average3 2 1 0 -1 -2 -3 Jan-04 MSCI EM (Log scale RHS) Jul-04 Jan-05 Jul-05 10 y r UST Yield # of SD relativ e to 3mma

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Jul-08

Jan-09

Jul-09

Source: Bloomberg, MSCI, J.P. Morgan.

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Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

The manic-depressive's guide to the fiscal outlookOriginally from the GDW, 11 September 2009 The fiscal impetus from the economic stimulus package ramped up earlier this year. More recently, the overall flow of spending is starting to level off and, looking ahead a few quarters, spending will decline incrementally. This prospect has raised fears of a double-dip recession as the boost to growth from the stimulus turns into a drag. Given the most likely path for spending, these fears appear greatly overblown. The reason is that spending ramped up much more quickly than it will ramp down. As such, the drag from waning stimulus over the course of the next year should be relatively modest: By our calculations the drag should be less than 1% point on average. A more significant hit could come in early 2011, when not only do most of the stimulus measures come off, but some of the Bush-era tax cuts are set to expire. While that prospect poses downside risk to 2011, much political uncertainty remains regarding how much stimulus will roll off versus be renewed. While the likelihood of a stimulus-induced double-dip in 2010 looks comfortably low, the longer-term budget outlook remains uncomfortably perilous. We project that the federal budget deficit for FY2010 will come in at $1,350bn, an improvement from the $1,600bn projected for FY2009 but not a huge improvement given how terrible the backdrop was for the last fiscal year. Looking further ahead, the stream of deficits in either the administrations or the CBOs estimates looks very worrying. As bad as that is, estimates that also realistically incorporate current policies look terrifying. There have been episodes in the past when deficit projections looked awfulsuch as the early 1990sbut the outcome turned out better. That said, the challenges look much greater this time around and will require even more political will to be resolved. Stimulus so far Through September 4, $96bn of stimulus funds have been paid out, which is about 19% of the $500B allocated to spending measures. The bar chart presents our estimates of how much the stimulus has contributed, and will contribute, to overall growth. According to our estimates, the stimulus has contributed, or will contribute, about 2-3%-pts to GDP growth, on average, in each of the last three quarters of the year.Figure 33: Estimated contribution of fiscal policy to GDP growth4 3 2 1 0 -1 -2 -3 2009 2010 2011

Source: J.P. Morgan. % saar. Includes

After that, going into next year we expect that stimulus support will decline and subtract from GDP growth, on average in the magnitude of about 0.5%-pt per quarter. The growth rate drag in 2010 is expected to be smaller than the growth rate boost in 2009 because the stimulus spending should decline at a slower pace than it increased. That holds true at least until the beginning of 2011, at which point things get interesting. Currently, not only should much of the stimulus spending begin to dry up in 2011, but the Making Work Pay tax credit for lower-income households and the Bush-era tax cuts for upper-income households are both scheduled to expire at the beginning of 2011. Fiscal challenge for DM The deficit for the 2009 fiscal year is likely to come in a little under $1,600bn. We project a deficit for FY2010 of $1,350bn. Considering how dire the economic and financial situation was in the 2009 fiscal year, the improvement in 2010 does not look all that impressive. We do not have official deficit projections for years further out, though it is safe to project an incredibly gloomy fiscal outlook. Our best guess for FY2011 is a deficit of around $1,100bnthat is, after incorporating the expiration of the Bush tax cuts. (In the event, the expiration of upper-income Bush tax cuts should add about $30bn to FY2011 revenue). For years beyond 2011 the improvement in the deficits is likely to be only modest and nowhere near enough to bring the deficit anywhere close to balance. Over the next 10 years, even the administrations assessment of the budget outlook sees the deficit never falling below $700bn, and the cumulative deficits over that period are projected to be $9tn. While the CBO has yet to update its estimate of the administrations budget, when it does it will likely add $1tn to the administrations 10-year deficit total. A similarly gloomy picture emerges from analysis conducted by the Committee for a Responsible Federal23

Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

Budget, which realistically extends current policies such as the AMT patchto arrive at a $12.6tn 10-year deficit estimate. Another case in point is Japan. The latest OECD data (June 2009) showed that gross financial liabilities (debt) of Japans general government were 172% of GDP in 2008, and are expected to exceed 200% by 2010, by far the highest level among major countries One grim point should be noted to connect the comments earlier in this note to the immediately preceding discussion. As we noted regarding early 2011, even modest fiscal restraint coming from a starting point of 11% of GDP deficits will be a hit to economic growth. If, at some point, the political establishment shows the will to return the deficit to a more reasonable 2-3% of GDP, the cumulative drag of a fiscal rebalancing of up to 8% of GDP poses a long run cyclical drag; the implications of the political establishment not showing that will, however, is even more depressing. Fiscal Cushion in EM Public sector debt to GDP ratios in Emerging markets are much better developed markets. The public sector debt as a percent of GDP is the largest in Brazil and India among the emerging markets, and we expect it to be around 70% for Brazil and 46% for India in 2010. This makes for good comparison with the G3 countries where the public debt is as much as the GDP itself or even more. For more, see Key Trades and Risks, Mowat et al, October 21, 2009, and JGB challenge: Exploding public debt amid falling domestic saving, October 21, 2009.

Table 10: General Government Fiscal Deficit (% of GDP)Fiscal Position 2008 2009 -2.6 -6.8 -3.1 -7.7 -3.2 -10.2 -6.0 -9.7 -2.0 -4.0 -5.9 -9.1 -0.8 -3.5 -0.6 -3.3 -1.3 -2.5 8.7 -4.5 -1.4 -3.0 -1.8 -3.9 2.4 -1.6 -1.4 -3.6 -0.5 -3.0 -5.0 -6.0 -6.5 -6.3 -1.3 -2.4 1.5 -2.0 -4.8 -7.0 -1.3 -1.5 5.0 -2.0 -1.2 -3.6 -2.5 -5.0 0.8 -3.6 -2.0 -5.0 -3.0 -2.6 -0.3 -3.0 -2.5 -3.2 5.7 -4.0 1.0 -3.8 -1.3 -2.3 Change 2008 to 2009 Cyclical Disc -2.5 -1.7 -2.9 -1.7 -5.0 -2.0 -1.7 -2.0 -1.0 -1.0 -1.6 -1.6 -1.3 -1.5 -1.7 -1.0 -0.9 -0.3 -10.6 -2.6 -1.6 0.0 -0.7 -1.4 -1.5 -2.5 -0.1 -2.1 -0.4 -2.1 2.0 -3.0 5.2 -5.0 -1.1 0.0 -2.4 -1.1 -1.0 -1.2 -0.2 0.0 -7.0 0.0 -1.8 -0.6 -1.1 -1.4 -3.8 -0.5 -3.0 0.0 0.4 0.0 -2.7 0.0 -0.7 0.0 -8.6 -1.1 -3.2 -1.6 -1.0 0.0 Public debt (% of GDP) 2010 F na na 227 na 82 na na 70 9 44 36 25 Na 20 Na 46 35 44 44 62 na na 39 na 38 80 na 53 7 38 50

Global Developed US1 Japan Euro area UK Emerging Latam Brazil Chile Colombia Mexico Peru Em Asia China2 Hong Kong India Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand CEEMEA Czech Rep Hungary Israel Poland Russia South Africa Turkey

Source: J.P. Morgan economics 'Priming the Pump, Lupton and Hensley, 13 February 09 1: Discretionary stimulus for the US only includes spending and tax measures related to boosting economic activity and not the measures being undertaken to support financial markets. Consequently, roughly $400bn of financial support is included as cyclical. 2: Chinas widely announced stimulus plan amounted to roughly 7% of GDP in 2009. However, we only show the 30% of this, that is expected to be financed by the public sector.

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Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

South Africa - 2010 Soccer World Cup WinnersFigure 34 summarizes the average outperformance of equity market sectors relative to MSCI World in the previous three World Cups (earlier historical analysis constrained by data availability). IT, Telcos and Consumer Discretionary were the stand-out sector winners during previous World Cups. We expect similar benefits for these sectors in SA with MTN, in particular, appearing very well-placed given that it is the first African World Cup Sponsor, making it a direct beneficiary from increased sales and awareness. We expect accommodation, transportation, food, beverage, and leisure sectors to benefit from soccerrelated consumption. SABMiller, City Lodge, Sun International, Comair, 1Time, Naspers, Rainbow, Famous Brands and Imperial would be our top strategy picks in these sectors. A beneficiary in the banking sector is likely to be FirstRand given that it is an official sponsor and via the Visa link benefits from tapping into that customer base. Construction was an early beneficiary of the World Cup spending given the capex on new soccer stadiums, transport links etc, but much of this has largely occurred and we believe for this sector to be rejuvenated it requires new private sector capex to be forthcoming, in particular, new mining capex. Our favourite SA Soccer World Cup strategy picks include MTN, Vodacom, SABMiller, City Lodge, Sun International, Naspers, FirstRand, Rainbow, Famous Brands, Comair, 1Time, Imperial and Bidvest .

Figure 34: Hosting countries equity sector performance relative to MSCI World sectors

40 35 30 25 20 15 10 5 0

Health.Care

Utilities

Industrials

Cons.Stap.

Cons. Disc

Telecoms

Financials

Materials

IT

Source: MSCI, Datastream, J.P. Morgan calculations. Chart shows the % rel. performance versus MSCI World, six months in the run-up to World Cup

Table 11: SA Soccer World Cup strategy picksMTN Vodacom SABMiller City Lodge Sun International Naspers FirstRand Rainbow Famous Brands Comair 1Time Imperial Bidvest Bloomberg Ticker MTN SJ VOD SJ SAB SJ CLH SJ SUI SJ NPN SJ FSR SJ RBW SJ FBR SJ COM SJ 1TM SJ IPL SJ BVT SJ Price 119.8 55.9 209.9 78.2 93.9 282.9 17.4 15.9 20.0 2.2 0.8 82.1 121.7 JPM Rec. OW Neutral Neutral NR NR OW OW Neutral NR NR NR NR NR Analyst Jean-Charles Lemardeley Jean-Charles Lemardeley Mike J. Gibbs Ziyad Joosub Mervin Naidoo Vikhyat Sharma -

Source: J.P. Morgan estimates. Note: JPMorgan does not have coverage of certain of the stocks in the leisure, air transport and industrial sectors as shown above. City Lodge, Sun International, Famous Brands, Comair, 1 Time, Imperial and Bidvest have been included in our list of top picks purely to reflect our positive stance on Soccer World Cup-related stocks. J.P. Morgan has no fundamental opinion on these companies.

Energy

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Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

None of these events reflect an official J.P. Morgan view; they are intended to stimulate discussion

Surprises for 2010The US dollar strengthens. This is driven by the better-than-expected US growth. Initially, emerging equity markets and commodities decline as traders assume that the casual inverse relationship between EM equities and the DXY will dominate. The new dollar funded carry trade unwinds, adding to the sell-off. Eventually, as investors recognize that healthy US growth is good for equities, markets recover. And of course, the old yen funded carry trade is reinstated. The renminbi appreciates by more than 10%. Our base case is a very modest appreciation from Rmb/US$6.82 to 6.5 by end-10. A recovery in exports plus the move to positive inflation encourages Beijing to allow faster appreciation. Other Asian currencies rally more than the Rmb. This move combined with the increased use of Rmb in trade settlement is the start of the Asian renminbi block. MSCI announces that it will include China A-shares in standard indices. Initially, a limited investibility factor is applied. Assuming a 35% free-float in the Ashare market, China moves from 18% to 37% of MSCI EM. This event is destabilizing. Investors have the Hobson choice of needing to be ahead of large capital inflows but recognizing they are buying expensive stocks. Run on the Japanese yen and Japanese Government Bonds. International investors would require a risk premium to fund a country where public sector debt to GDP is 190% in 2009 (J.P. Morgan estimate) but for now, Japans excess savings are sufficient. In JGB challenge: exploding public debt amid falling domestic savings, Kanno et al, 21 October 2009, we estimate that assuming no major fiscal initiatives, demographic demands should push this ratio to 300% by 2019. Current demographic trend could push the savings rate to zero in five years. This, plus the strong yen hollowing out Japanese manufacturing, could require foreign savings to fill the gap. Todays 10-year JGB yield of 1.34% is too low to attract foreign capital. Too many speculators drink at the commoditys kool-aid fountain; commodity and energy prices rise choking off a fragile recovery. In contrast to above, commodity investors become frustrated with low financial returns due to the cost of roll (upward sloping future curves). This results in 2009 record inflows into energy and commodity funds reversing. Although the sharp fall in commodity and energy prices is unnerving, the resulting stimulus underpins the recovery. Developed economies property markets, after a relief rally, stagnate in real terms as better economic data drive up mortgage costs. EM FX bubble builds despite unconventional policies used to lean against the trend.

DXY strengthnew carry trade unwinds

Rmb stronger than 6.5/US$

China 37% of EM

Run on JPY and JGB

Momentum of flows in commodity funds pushes up prices and chokes growth

Run on commodity funds

Dont be too keen to return to property

EM FX momentum unstoppable

26

Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

Emerging Market Rates OutlookEmerging Markets pass a stress testInvesting in EM assets has been a one-way bet over the past year. Across all asset classes (e.g., equities, sovereign credit, corporate credit and local markets), EM strongly outperformed (chart 1). Going into 2010, EM fundamental and financial markets outlook remain robust. EM is shedding its image as the most volatile asset class. The outperformance of EM fixed income in the midst of market turbulence in 2008 and the subsequent outperformance over the past year as the market recovered have resulted in a re-rating of EM risk. Even frontier EM countries have outperformed. With EM growth and yields well above developed markets, EM will continue to move into the mainstream as an asset class in 2010. We expect a first quarter rally as both EMBIG cashflows and strategic inflows from nontraditional investors are high. External demand for EM assets remains strong and we expect inflows into EM fixed income to reach $30-35bn in 2010 compared to only $18bn this year. Worldwide pension funds are starting from a position of close to zero allocation to Emerging Markets, and yet assets are more than $17bn. New and growing sources of inflows include high grade crossover investors, US pension and endowment allocations, sovereign wealth funds and Japanese retail allocations.Figure 35: Asset class performance

Joyce ChangAC(1-212) 834-4203 [email protected] J.P. Morgan Securities Inc., New York

surpassing that of the US. Indeed, over the past four years, EM contributed more to global GDP growth than the whole of developed markets. In 2010, EM growth will recover to 5.8%oya, with risks to the upside, while G-3 growth will remain below par at only 2.7%. We recommend overweight positions in EM credit (both sovereign and corporate) versus developed fixed income markets. We also expect EM local markets, as tracked in J.P. Morgans GBI-EM index, to generate double-digit returns next year. 2009 will be remembered as the year that EM carried the global economy, with EM consumption well surpassing that of the US. Indeed, over the past four years, EM contributed more to global GDP growth than the whole of developed markets. In 2010, EM growth will recover to 5.8%oya, with risks to the upside, while G-3 growth will remain below par at only 2.7%. We recommend overweight positions in EM credit (both sovereign and corporate) versus developed fixed income markets. We also expect EM local markets, as tracked in J.P. Morgans GBI-EM index, to generate double-digit returns next year.

EM valuations more compelling than US High Grade marketsYields for the EMBIG have fallen to 6.49% (close to the record low of 6.34% reached in April 2007), but remain much higher than US investment grade yields (5.2%) and yields for the Barclays Global Aggregate index (3%). Other US fixed income asset classes will deliver near flat or negative returns for the full year 2010, assuming our preliminary spread and yield forecasts for 2010 are accurate. We expect EMBIG returns in 2010 to reach a maximum of 6.5% compared to 4.5% for US investment grade. We have been overweight the EMBIG for the past seven months and upgraded several smaller weighted EM countries in the benchmark index last week. In addition to our overweight recommendations in Dominican Republic, Indonesia, Mexico, and Russia, we upgraded Poland, Hungary, Jamaica, and Belize to Overweight. We downgraded high beta Venezuela to Marketweight from Overweight and maintained the overweight in Argentina but switch assets for relative value considerations.

Source: J.P. Morgan, 1-J.P. Morgan commodity total return index, 2-Barclays capital global aggregate

2009 will be remembered as the year that EM carried the global economy, with EM consumption well

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Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

EM sovereigns have already prefinanced one-third of the total $66bn EM sovereign financing needs. EM sovereign issuance for the year reached $71 billion last week. Note that five countries Argentina, Poland, Russia, Turkey and Venezuela account for nearly 50% of total EM sovereign issuance needs. Technicals for the EMBIG remain favorable as coupons and amortizations are also the highest in 1Q10, with cashflow of $21.5 billion to be put to work (chart 2). EM sovereign cash flows will total $56.4bn in 2010 versus $66.5bn in sovereign financing requirements.Figure 36: EMBIG coupons and amortizations highest in 1Q10

Figure 37: EM local yields remain attractive

Source: J.P. Morgan.

Source: J.P. Morgan.

Shift the focus to local markets: GBI-EM returns to reach 12% in 2010After a brief dip during the credit crisis, international demand for EM bond markets is growing again, particularly for high carry markets. The weak USD trend will persist next year and J.P. Morgan forecasts EUR/USD bottoming at 1.62 in mid-2010 before recovering to end the year at 1.50. The Fed is proving more comfortable with a zero rate environment than almost every other G-10 or EM central bank and the most recent balance of payments data indicate that the US is also suffering from a re-emergence of net FDI/M&A outflows and weaker equity inflows than other countries, highlighting that USD weakness is more than a simple carry trade.

We favor the higher carry currencies going into 2010 and recommend TRY, RUB, PLN and HUF in particular, as all are likely to deliver returns in excess of 15%. While FX intervention is likely to intensify in Asia and Latin America, CEEMEA countries are more focused on FX reserve accumulation. Brazil was the outperformer in 2009 (+25%), but the most attractive opportunities for 2010 are concentrated in the CEEMEA region. Appetite for local rates remains subdued due to the growing uncertainty about the timing and pace of monetary policy normalization. EM local markets debt returns (USD unhedged) break down roughly into half local rates returns and half FX returns. Our bottoms-up return forecast for the GBI-EM Global Diversified index, which is the leading EM local markets benchmark, is 12% in 2010.

EM Corporates likely to outperform EM sovereigns and US High GradeThe resilience shown by EM Corporates throughout the credit crisis has improved their profile amongst investors, with the asset class likely to garner a greater following as valuations in developed credit markets look increasingly expensive. Although the pace of the markets recovery has brought us back to precrisis levels, we believe that there is still room for spreads to tighten and set a year-end 2010 target for the CEMBI Broad at 300bp versus 388bp at present. . There were notable casualties in 2009, with combined defaults and debt exchanges rising to 10.8% of the EM corporate high yield bond stock (compared with a par-weighted default rate of 10.96% and 16.24% including distressed exchanges in the US high yield market), many of the concerns that shaped expectations for a more serious

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Adrian Mowat (852) 2800-8599 [email protected]

Emerging Markets Equity Research 02 December 2009

collapse and prolonged period of market weakness at the end of 2008such as rising capital flight and mounting external refinancing risks in Russia, unhedged corporate derivative exposures in Brazil and Mexico, the downturn in and overheated real estate markets in China and Dubai respectively, and short-term FX funding needs in Koreahave come to pass without prompting broader systemic failures. At the aggregate level, we move EM Corporates as an asset class (CEMBI Broad) to Overweight relative to EM sovereigns (EMBIG) and US credit (JULI). At the regional level, we expect credits from Asia and Europe to contribute the lions share of the spread tightening followed by Latin America, while at the country level we still expect some of the more significant spread opportunities in higher beta countries such as Indonesia, India, Kazakhstan and Argentina, although note that these account for less than 6% of the corporate index. We believe