Morgan Stanley -Global Debates Playbook

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					May 17, 2013


                                                                                                                          Asset Class Views (6 months)                              MORGAN STANLEY RESEARCH
Global Debates Playbook                                                                                                 Asset Allocation
                                                                                                                          Equities                                                  Global Cross-Asset Strategy
A Sweet Spot… For Now                                                                                                     Credit
                                                                                                                          Government Bonds                                          Morgan Stanley & Co. LLC
                                                                                                                          Cash                                                      Jason Draho 
Risk assets are in a relative “sweet spot”; we would remain long equities                                                                                                           +1 212 761-7893
over credit over government bonds. The tailwind of ample central bank liquidity                                         Equities
                                                                                                                                                                                    Brennan Leong 
should continue at least near term, especially with inflation falling almost                                              US                                                        +1 212 761-9729
everywhere. Meanwhile, global growth data has turned more mixed after being                                               Europe                                                    Jerry Chen 
weak and disappointing for a few months, and still looks likely to accelerate in 2H.                                      Japan                                                     +1 212 761-8591
A tactical correction is a risk. Sentiment and positioning data are now clearly                                           EM
bullish, leaving markets vulnerable to a correction. The biggest risk to our view is                                    Credit                                                      Please see page 2 for full list of members
that the bulk of GME3 is now behind us. Hence the expected growth pickup in H2                                            US
may actually contribute to a bigger correction for risk.                                                                  Europe                                                    Global Cross-Asset Directory
Markets are pricing in better growth in DM, but not in EM. Cyclical stocks
have outperformed defensives, while the rise in Treasury yields signals higher                                                                                                      Subscribe to the Global Debates
growth expectations. In contrast, EM nominal local yields and inflation                                                                                                             Playbook
                                                                                                                        Government Bonds
expectations are falling, and commodities have drifted sideways, all of which
raises risks about EM growth.
Liquidity could continue to drive asset reflation, but pockets of credit                                                  JGBs
markets are getting frothy. There are parallels to the 2004-07 credit cycle, with                                         EM Local

easing lending standards and rising leverage. The current cycle is likely closer to                                     FX
the end than the beginning and is vulnerable to policy tightening.                                                        USD
Our asset allocation remains largely unchanged. Equities can benefit from                                                 JPY
asset reflation and better growth, while credit upside is constrained. Rates should                                       EM
stay in a range. EM assets are vulnerable if the macro doesn’t improve.                                                 Note: The rankings are relative within each asset class.

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objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment decision.

For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report.

+= Analysts employed by non-U.S. affiliates are not registered with FINRA, may not be associated persons of the member and may not be subject to NASD/NYSE restrictions on communications with a subject company, public appearances and
trading securities held by a research analyst account.
                                                                                                                                                                                                                               MORGAN STANLEY RESEARCH
                                                                                                                                                                                                                                                       Global Debates Playbook
                                                                                                                                                                                                                                                                 May 17, 2013

Table of Contents                                                                                                                                 Global Cross-Asset Strategy Group
Global Cross-Asset Strategy                                                                                                                        Economics
        Market Commentary                                                                                                3                                        Joachim Fels2                                                                   +44 (0)20 7425 6138
        Morgan Stanley Asset Class                                                                                      18                                        Vincent Reinhart1                                                               +1 212 761 3537
        Morgan Stanley Key Economic Forecasts                                                                           19                                        Elga Bartsch2                                                                   +44 (0)20 7425 5434
                                                                                                                                                                  Robert Feldman5                                                                 +81 3 5424 5285
Risk-Reward Views: Economics                                                                                                                                      Helen Qiao3                                                                     +852 2848 6511
        Global Economics                                                                                                20                                        Chetan Ahya3                                                                    +852 2239 7812
        US                                                                                                              21                                        Gray Newman1                                                                    +1 212 761 6510
        Europe                                                                                                          22                                        Tevfik Aksoy2                                                                   +44 (0)20 7677-6917
        Japan                                                                                                           23                                        Manoj Pradhan2                                                                  +44 (0)20 7425-3805
        China                                                                                                           24
        Asia ex-Japan                                                                                                   25                         Strategy
        India                                                                                                           26                                        Neil McLeish2+                                                                  +44 (0)20 7677 7481
        Russia                                                                                                          27                                        Jason Draho1                                                                    +1 212 761-7893
        Mexico                                                                                                          28                                        Laurence Mutkin2+                                                               +44 (0)20 7677 4029
                                                                                                                                                                  Matt Hornbach1                                                                  +1 212 761-1837
Risk-Reward Views: Strategy                                                                                                                                       Le Ngoc Nhan5                                                                   +81 3 5424-7698
        US Rates                                                                                                        29                                        Rashique Rahman1                                                                +1 212 761-6533
        Europe Rates                                                                                                    30                                        Hans Redeker2+                                                                  +44 (0)20 7425 2430
        Japan Rates                                                                                                     31                                        Gabriel de Kock1                                                                +1 212 761-5154
        UK Rates                                                                                                        32                                        Adam Parker1                                                                    +1 212 761-1755
        EM Fixed Income                                                                                                 33                                        Graham Secker2+                                                                 +44 (0)20 7425 6188
        G10 Currency                                                                                                    34                                        Jonathan Garner3+                                                               +852 2848 7288
        EM Currency                                                                                                     35                                        Adam Richmond1                                                                  +1 212 761-1485
        US Equities                                                                                                     36                                        Andrew Sheets2+                                                                 +44 (0)20 7677 2905
        Europe Equities                                                                                                 37                                        Viktor Hjort3+                                                                  +852 2848 7479
        Asia / GEMs Equities                                                                                            38                                        Vishy Tirupattur1                                                               +1 212 761 1043
        US Corporate Credit                                                                                             39                                        Sivan Mahadevan1                                                                +1 212 761 1349
        Europe Corporate Credit                                                                                         40
        Asia Corporate Credit                                                                                           41
        Securitized Credit                                                                                              42
        Global Credit Derivatives                                                                                       43
        Crude Oil                                                                                                       44
        Cross-Asset Volatility                                                                                          45

     1 Morgan Stanley & Co. LLC                 2 Morgan Stanley & Co. International plc      3 Morgan Stanley Asia Limited            4 Morgan Stanley Australia Ltd          5 Morgan Stanley MUFG Securities
     + Analysts employed by non-U.S. affiliates are not registered with FINRA, may not be associated persons of the member and may not be subject to NASD/NYSE restrictions on communications with a subject company, public appearances and trading securities
     held by a research analyst account.
                                                                                                                                             MORGAN STANLEY RESEARCH
                                                                                                                                                              Global Debates Playbook
                                                                                                                                                                        May 17, 2013

A Sweet Spot … For Now
Risk assets are in a relative “sweet spot” that’s likely to continue in the              Exhibit 1: Higher nominal and real UST yields, flat inflation expectations
near term. The tailwind of ample central bank liquidity should continue for a              2.8    (%)                                                                   (%)         -0.3
while, especially with inflation falling almost everywhere. Meanwhile, global
growth data has turned more mixed after being weak and disappointing for a                                                                                                          -0.4
couple months. That’s the good news, and why we continue to be long risk for               2.4
now. However, the risk of a correction remains. Sentiment and positioning data                                                                                                      -0.5
were still cautious earlier in the rally, but are now clearly bullish, conditions ripe                                                                                              -0.6
for a correction. The biggest risk has been that growth doesn’t accelerate in 2H
as consensus and we expect, especially if markets have already priced the                  1.8                                                                                      -0.7
recovery. With growth looking a little better, especially in the US, a growing risk        1.6
is that talk of Fed tapering asset purchases sooner rather than later heats up,                                                                                                     -0.8
                                                                                           1.4                                                         UST 10y Nominal
spooking markets. Globally, central banks have already done much of what                                                                               Breakeven                    -0.9
they can, and the benefit of more easing and liquidity could run out of steam.             1.2
                                                                                                                                                       Real Rate (right)
                                                                                           1.0                                                                                      -1.0
For now, markets are pricing in better growth in DM, but not in EM, which                   May-12             Aug-12              Nov-12            Feb-13            May-13
is a concern. In US equities, cyclical stocks have outperformed defensives in
May, after going in opposite directions the previous month. This may just be              Source: Bloomberg, Morgan Stanley Research

catch-up by underperforming sectors rather than a good indication of better
growth ahead. But the latter possibility is reinforced by the sharp rise in the 10-
                                                                                         Exhibit 2: Credit spreads have already reached MS YE forecasts
year Treasury, due entirely to higher real rates, signaling higher expectations
                                                                                                                          Current            MS                     MS
for real growth (Exhibit 1). In contrast, nominal yields in EM local markets have                                        5/15/2013          Base            Bull           Bear
                                                                                          Interest Rates
been falling, as have inflation expectations. In addition, even as EM equities                    UST 10y                   1.94            2.29            1.43            2.79
have moved higher with DM, commodity prices, especially base metals, have                         Bund 10y                  1.38            1.87            1.26            2.44
                                                                                                  Gilt 10y                  1.92            2.40            1.65            2.60
drifted sideways. All of this raises risks about EM growth accelerating in 2H, a                  Spain 5y                  3.07            3.96            4.12            5.16
negative for EM assets, but DM as well.                                                           Italy 5y                  2.93            3.66            3.67            4.26
                                                                                                  JGB 10y                   0.85            0.85            0.65            1.25
Even in a benign risk scenario, the upside looks more limited than last                           S&P 500                  1659             1600           1936            1264
                                                                                                  MSCI Europe              1282             1310           1560             825
month. Credit spreads in the US and Europe have already reached our                               Topix                    1253             1270           1700             880
strategists’ year-end base case targets, and the bull case for US high yield                      MSCI EM                  1046             1220           1575             715
                                                                                                  MSCI APxJ                 482              560           715              320
(Exhibit 2). There is still upside to our equity strategists’ base case targets,                  MSCI EM Latam            3715             4000           4500            2700
though mostly low single digits. Consequently, any significant upside from                Credit
                                                                                                  US IG Corp                129             160             105               230
current levels means reaching the bull case. Given the uncertainty about EM,                      US HY Corp                442             577             467               836
and especially China, achieving the faster growth that’s probably necessary for                   EU IG Corp                109             126             105               212
                                                                                                  Asia IG Corp              179             150             125               275
the bull case is looking increasingly doubtful. Moreover, with record low yields                  CDX IG                     72              77              64                97
and spreads past the base case targets, there would seem to be little upside              Source: Bloomberg, The Yield Book, Morgan Stanley Research estimates
left in credit.                                                                           Note: Cells shaded in pink indicate the current market price / spread has reached the MS target 3
                                                                                                                                                         MORGAN STANLEY RESEARCH
                                                                                                                                                                                  Global Debates Playbook
                                                                                                                                                                                            May 17, 2013

Liquidity Can Keep the Bull Market Going, But It’s Starting to Look Like the 2004 to 2007 Cycle
It’s possible that liquidity will continue to overwhelm fundamentals and              Exhibit 3: Banks are now providing more leverage to investors
valuations. We don’t underestimate this scenario, even if growth accelerates
only modestly. Central banks are likely to stay highly accommodative for an           450                                 Dealer Margin Debt ($k)
extended period to ensure rates don’t rise too rapidly. Falling inflation and         400
renewed talk of deflation reinforces the easing bias, though the underlying
trends suggest these fears are overblown. Either way, central bank policy
should perpetuate the search for yield, in equities as well as credit, and the        300
ongoing re-pricing of income-generating securities. But if this reduces the short-    250
term risk of a tactical correction, it also raises the risk of a credit bubble and    200
capital misallocation.
Credit market conditions already have uncomfortable parallels to the                  100
2004-2007 period. For starters, yields are well below the troughs of the pre-
crisis bubble period, although most spreads are still some ways from those
cycle tights. More worrying is that lending conditions are getting looser; over          0
50% of leveraged loan issuance in the US is covenant-lite. Leverage is also               2003              2005                 2007                 2009                 2011                  2013
increasing; e.g., margin lending from dealers in the US is up 30% over the past        Source: Bloomberg, Morgan Stanley Research
year (Exhibit 3). And investor demand for new credit issuance is almost
insatiable, though partly because the net supply is actually quite modest. All of
                                                                                      Exhibit 4: Credit issuance is mostly refinancing and maturity extension
this suggests frothiness, at least on the investor side of the credit markets,
reminiscent of 2006-07.                                                                                           High Yield Issuance: Use of Proceeds
For corporates, it’s closer to 2004… Our credit strategists argue that the
corporate side of credit markets are much less frothy. Leverage metrics have
started to increase in the US and Asia, less so in Europe, but balance sheets            60%
are still much stronger than they were in 2007. Also, 60% of the high yield
issuance YTD in the US has been for refinancing, compared to 38% in 2007
(Exhibit 4). Barring a recession, default rates should stay low for the time being,      20%
reducing the risk of the bubble bursting. However, if credit market conditions
remain favorable, leverage could keep grinding higher over the next year or                  0%
two, creating bigger bubble risks.

                                                                                             LBO          Refinance             Acquisition           Dividend/Buyback                     Other
                                                                                       Source: Yield Book, Morgan Stanley Research

                                                                                                                                          MORGAN STANLEY RESEARCH
                                                                                                                                                    Global Debates Playbook
                                                                                                                                                              May 17, 2013

2004 to 2007? Probably Neither, But We’re Closer to the End of the Credit Cycle Than the Beginning
…however, this cycle is unlikely to last another three years. Starting from            Exhibit 5: The current credit cycle is already as long as the 2003-07 cycle
their peak in November 2008, corporate credit spreads have been trending
                                                                                         210              US IG Corp Spread, Days From Start (bp)              700
lower for four and a half years (Exhibit 5). That’s the same length as the spread
tightening cycle that began in October 2002 and ended in May 2007. That                  190                                                                   600
doesn’t mean the current cycle can’t continue. But at this stage to have another                                         From 2003 (left)
three years of falling or flat spreads, when conditions are already getting frothy                                                                             500
and being distorted by central bank policy, is unlikely.                                 150                             From 2008 (right)
An unusual aspect of the 2003-2007 cycle was its resiliency to policy                                                                                          300
tightening. The Fed started raising rates in mid-2004, and did so 17 times               110
before stopping in mid-2006. It was around the end of that tightening that the                                                                                 200
yield curve inverted. Historically, the start of a tightening cycle and especially                                                                             100
the inversion of the yield curve have been followed by a turn in the credit cycle
6 to 12 months later. The fact that the cycle lasted 1-2 years longer than history        50                                                                   0
would dictate speaks to the unique aspects of that cycle. One was the belief at                1   121 241     361   481 601      721 841     961 1081 1201
the time in the Great Moderation thesis that the business cycle had been tamed.
Another was the belief that securitization was efficiently spreading risk, thus         Source: Bloomberg, Morgan Stanley Research

allowing spreads to fall to exceptionally low levels. It’s safe to say that few
investors hold those beliefs today.
                                                                                       Exhibit 6: The correlation between rates and HY spreads rose sharply
The current cycle is likely to turn once tightening starts, but that’s not a
                                                                                           0.8                    UST Yield, US HY Spread 3m Corr
near-term risk, in our view. This cycle is less likely to be immune to policy
tightening for two reasons. First, global growth is weaker this cycle – DM is
weighed down by deleveraging and much of EM is undergoing structural                       0.4

changes to growth models – and thus more vulnerable to shocks. Second, the                 0.2
current frothiness is a direct result of central bank policy; after all, the purpose       0.0
of QE is to push investors out on the risk curve and reduce spreads.                      -0.2
Consequently, the start of liquidity withdrawal could be painful for credit. An           -0.4
indication of this is that high yield spreads recently started moving higher with         -0.6
rates, resulting in a positive correlation (Exhibit 6). If the rise in rates was all      -0.8
about better growth, then spreads should have kept tightening. But if better              -1.0
growth also means the end of QE, then the fact that spreads didn’t tighten                -1.2
highlights the potential vulnerability of credit to policy withdrawal. However,             Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13
significant risk from Fed tightening is at least 6-12 months away, in our view,
                                                                                        Source: The Yield Book, Morgan Stanley Research
and this could lead to a turn in the cycle. In the near term, tactical risk stems
from increased talk of when the Fed will taper its asset purchases.                                                                                                      5
                                                                                                                                           MORGAN STANLEY RESEARCH
                                                                                                                                                           Global Debates Playbook
                                                                                                                                                                     May 17, 2013

The Growth and Credit Cycles Favor Equities Over Bonds, and Maybe DM Over EM
Equity and credit performance YTD has been a tale of two betas, and the                   Exhibit 7: Equities still look cheap relative to credit
outlook favors the former. Until this month, the equity rally was defensive in
                                                                                            12%                                  Equity Risk Premium
nature, while high-beta underperformed. In contrast, it was a full-on beta rally in
credit; CCC spreads in the US are now only 734bps. Credit investors have also               10%                                  Default Risk Premium
been extremely bullish for a while; equity investor sentiment only recently                   8%                                 Pure Equity Premium
caught up. All told, these price moves and the outlook reinforce our preference
for equities. Our preferred relative value measure, the pure equity risk premium,             6%
indicates that equity is still cheap to credit (Exhibit 7). If growth does improve,           4%
cyclicals and higher beta can lead equities even higher. But at this stage in the
credit cycle there’s little beta upside left; it’s largely a carry trade. If conditions
deteriorate, high beta credit is likely to lead on the way down; thus, credit has             0%
an asymmetric return profile. Nonetheless, investor demand remains very                      -2%
strong, and the consensus is that spreads can compress further. We’re not as
sanguine, despite these positive technicals, so we adhere to our strategists’                -4%
preference for an up-in-quality trade within credit.                                            1978       1983        1988       1993       1998        2003    2008     2013

The bond bull market may be over, but the bears will remain at bay for a                    Source: Bloomberg, The Yield Book, Morgan Stanley Research

while. More likely, rates will continue to trade in a range while the Fed keeps
purchasing assets and other central banks have an easing bias, with support
                                                                                          Exhibit 8: The CNY fixings have been moving lower quite rapidly
from roll-down and carry at the 10y point that’s attracting investors.
EM assets may be most at risk, on growth concerns and credit frothiness.
Falling local rates and inflation breakevens are raising red flags about EM                 6.32
growth. Policy easing should help, but the country that matters most, China, is
keeping domestic liquidity conditions relatively tight and USDCNY fixings are               6.29
heading steadily lower (Exhibit 8). China’s unwillingness thus far to ease, or
perhaps its diminishing effectiveness, is a big reason why commodity prices                 6.26
have continued to languish. That’s contributing to falling inflation and an easing
                                                                                            6.23                      USDCNY Mid Price fixing
bias that has led to recent sharp weakness in EM currencies. If these trends
continue, EM equities are likely to continue underperforming DM. EM credit has
been more resilient, but that’s likely due to strong technicals. The supply of EM
corporate credit was $45 in April, and total corporate and sovereign issuance               6.17
could reach $600bn this year from $430 billion last year. For now, demand is                   Aug-12          Oct-12         Dec-12        Feb-13         Apr-13
strong, but leverage is also rising to worrying levels. DM has no shortage of its
                                                                                            Source: Bloomberg, Morgan Stanley Research
own problems, but the outlook is at least trending positively compared to the
muddled outlook for EM.                                                                                                                                                          6
                                                                                                                                MORGAN STANLEY RESEARCH
                                                                                                                                                     Global Debates Playbook
                                                                                                                                                               May 17, 2013

Base Case Asset Allocation: Still Equities Over Credit and Sovereign Bonds

 Asset        • We maintain a preference for equities over bonds and keep them as an OW. Central              MS Asset Class Views (6 months)
 Allocation     banks are likely to remain highly accommodative, allowing asset reflation to continue,
                while the growth soft patch should be temporary. Equities have richened, but are still         Asset Allocation
                relatively cheap compared to bonds, while offering comparable yield. Credit conditions            Equities
                are getting frothy, but technicals should remain supportive near term, and the cycle is
                unlikely to turn this year.
                                                                                                                  Government Bonds
              • The risk of a correction remains. Sentiment and positioning are bullish. Markets are
                priced for better growth in 2H, and thus vulnerable to disappointment. If growth does
                improve, talk of liquidity withdrawal could spook the markets. Differentiation across          Equities
                markets and asset classes should continue, keeping the emphasis on alpha over beta.
 Equities     • Japan and AxJ remain our top regions. Tactically, Japan may pause after rallying 70%              Europe
                since November, as the risk-reward is now more balanced. But Japanese equities are                Japan
                still pricing in a high risk premium. As that declines, the Topix has significantly more
                upside. EM equities are trading at a significant discount to the US and Japan, but the
                uncertain macro environment and growth concerns could keep EM underperforming
                tactically. Across all regions, we continue to favor quality growth over cyclicals.            Credit

 Credit       • Favor structure over corporate credit. Structured credit remains attractive as yields             US
                are still relatively high, and in the case of RMBS is levered to fundamental improvements         Europe
                in the US housing market. Corporate credit conditions are getting frothy: record low              Asia
                yields, rising leverage, and easier lending conditions. Liquidity may keep spreads                EM
                grinding tighter, but the risk-return skew is to the downside. Across all regions, we favor
                up-in-quality trades.
                                                                                                               Government Bonds
 Government   • We’re neutral on G4 duration, as rates are getting back to the middle of their
 bonds          recent ranges. After rallying about 25bps, they’ve cheapened enough to make roll-down             Treasuries
                and carry in the 10-year range attractive. That should keep rates from selling off much           Bunds
                more, and the growth outlook and policy response comes into better focus. Euro                    JGBs
                periphery sovereigns are trading more on rate risk, less on systemic risk; Spanish and            EM Local
                Italian sovereigns remain attractive at current yields.
 FX           • Moving bullish on USD, and neutral on JPY. The JPY is close to our FX strategists’
                YE target of 105, and past the 2Q target of 100. Tactically, the JPY may retrace some of
                its weakness. JGB yields have increased, while foreign accounts have already pulled out           EUR
                extensively from Japanese money markets, removing a factor for the weakness.                      JPY
                Strategically, the USD is regaining its pro-cyclical status, which could accelerate with          EM
                signs that the soft patch won’t be deep or that long. EM weakness is likely to continue if
                deflationary pressures remain.                                                                Note: The rankings are relative within each asset class.
                                                                                                                                                              MORGAN STANLEY RESEARCH
                                                                                                                                                                         Global Debates Playbook
                                                                                                                                                                                   May 17, 2013

Rates and EM Equities Are Pricing in Better Growth, But Commodities Aren’t

The S&P and 10Y Treasury are moving together again                                   EM equities are now keeping pace with DM
                                                                                                                                                                 • The US rates and equity
1700                                                                          2.4%   140   Index Level (Jan 10 = 100)                               MSCI EM        markets were sending
                                 SPX (left)                                                                                                         MSCI World     different signals for the
1650                                                                          2.3%   130
                                 UST 10y (%, right)                                                                                                                outlook on the economy.
1600                                                                          2.2%   120
1550                                                                          2.1%
                                                                                                                                                                   The recent rise in yields
                                                                                     110                                                                           strengthens the growth
1500                                                                          2.0%
                                                                                     100                                                                           signals from the equity and
1450                                                                          1.9%
                                                                                                                                                                   credit markets.
1400                                                                          1.8%   90

1350                                                                          1.7%   80
                                                                                                                                                                 • In contrast, commodities
                                                                                                                                                                   markets have been
1300                                                                          1.6%   70
                                                                                                                                                                   sending a bearish signal
1250                                                                          1.5%
                                                                                     60                                                                            for EM growth, consistent
1200                                                                          1.4%    Jan-10     Jul-10    Jan-11       Jul-11   Jan-12   Jul-12   Jan-13          with falling EM local yields
   Jan-12      Apr-12      Jul-12         Oct-12       Jan-13      Apr-13
                                                                                                                                                                   and inflation breakevens.
 Source: Bloomberg, Morgan Stanley Research                                          Source: Bloomberg, Morgan Stanley Research                                    EM equity markets have
                                                                                                                                                                   moved higher but are still
                                                                                                                                                                   underperforming DM
But commodities, especially raw materials, still lag
                                                                                                                                                                   markets, raising risks
150    Index Level (Jan 10 = 100)                                                                                                                                  about EM growth
                                                                                                                                                                   accelerating in 2H.




                                                                CRB Raw Materials
                                                                S&P 500
  Jan-10     Jul-10     Jan-11       Jul-11   Jan-12      Jul-12     Jan-13

Source: Bloomberg, Morgan Stanley Research
                                                                                                                                                     MORGAN STANLEY RESEARCH
                                                                                                                                                                Global Debates Playbook
                                                                                                                                                                          May 17, 2013

Falling Inflation Is Raising Deflation Fears; The Risk Is Low in DM, But a Headache for EM

Inflation is low and falling in DM, but more mixed in EM                               Core G7 CPI has been resilient, the fall is in the headline
                                                                                                                                                        • Inflation has been falling in
 10                                DM             EM                                                                                                      most countries in DM and
                                                                                                                                                          EM, with some exceptions
  8                                                                                                                                                       to the latter. However,
                                                                                                                                                          concerns about deflation
                                                                                                                                                          risks are overdone, in our
  4                                                                                                                                                       view. Core CPI in the G10
                                                                                                                                                          has remained steady, with
  2                                                                                                                                                       most of the decline in
                                                                                                                                                          headline CPI the result of
  0                                                                                                                                                       falling energy and food
                                                                                                                                                          prices. In DM, breakeven
                                                                                                                                                          inflation expectations have
  Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13
                                                                                                                                                          fallen about 25bps, but
                                                                                                                                                          there is little indication the
 Source: IMF, national sources, Haver Analytics, Morgan Stanley Research               Source: Bloomberg, Morgan Stanley Research
                                                                                                                                                          markets are concerned
                                                                                                                                                          with deflation.
China has had negative PPI for over a year                                           Falling terms of trade is another result of lower commodities
                                                                                                                                                        • The challenges in EM vary
 10                                                                            80     110                                                                 depending on whether a
                                                                                                          Australia Terms of Trade                        country is a commodity
                                                                               70                                                                         importer or exporter.
                                                                                       90                                                                 Importers gain on lower
                                                                               60                                                                         prices, but that’s offset by
  0                                                                                    80                                                                 lower terms of trade for
                                                                               50                                                                         exporters, including
 -5                                                                                    70                                                                 countries like Brazil, South
                                                                               40                                                                         Africa, and Indonesia.
                             PPI (YoY %, left)
-10                                                                                                                                                     • Another problem is
                             PMI Input Prices (level, right)                           50                                                                 negative PPI, as in China,
-15                                                                             20                                                                        which hurts domestic
  Apr-09           Apr-10            Apr-11            Apr-12              Apr-13                                                                         producers’ profitability and
                                                                                        1995 1997 1999 2001 2003 2005 2007 2009 2011
                                                                                                                                                          debt servicing.
Source: Bloomberg, Morgan Stanley Research                                           Source: Bloomberg, Morgan Stanley Research
                                                                                                                                       MORGAN STANLEY RESEARCH
                                                                                                                                                  Global Debates Playbook
                                                                                                                                                            May 17, 2013

EM Fixed Income Markets Are Sending Troubling Signals About EM Growth

Nominal rates are falling, in contrast to DM rates                    The same applies to inflation expectations
                                                                                                                                          • Unlike in DM, local nominal
 5.5   EM 2y Nominal (%)                                              4.6   EM 2y Breakeven (%)                                             rates in some EM
                                                                                                                                            countries have continued
                                                                                                                                            to fall. This is happening
 4.5                                                                                                                                        on the expectation of more
                                                                                                                                            policy rate cuts as inflation
                                                                      3.8                                                                   and inflation expectations
 3.5                                                                                                                                        keep falling, all as a
                           Mexico                                                                                                           consequence of growth
                           Poland                                     3.4                                                                   uncertainty. Barring
 2.5                                                                                                                                        another wave of easing or
                                                                                                                                            disinflation, these
 2.0                                                                  3.0                                                                   prevailing yields will be
  Jan-12       Apr-12      Jul-12      Oct-12       Jan-13   Apr-13    Jan-12      Apr-12       Jul-12      Oct-12   Jan-13   Apr-13
                                                                                                                                            increasingly difficult to
                                                                                                                                            justify in most cases.
 Source: Bloomberg, Morgan Stanley Research                           Source: Bloomberg, Morgan Stanley Research
                                                                                                                                          • China is the country that
                                                                                                                                            matters most for
Inverting yield curve in China suggests tight liquidity conditions
                                                                                                                                            stimulating growth, and it is
 200                                                                                                                                        keeping domestic liquidity
                                                China 1s5s                                                                                  conditions relatively tight.
 150                                                                                                                                        The flattening of the yield
                                                                                                                                            curve has historically been
 100                                                                                                                                        a sign of slowing growth,
                                                                                                                                            domestically or globally.



   Jan-08      Jan-09      Jan-10     Jan-11       Jan-12    Jan-13
Source: Bloomberg, Morgan Stanley Research
                                                                                                                                                                  MORGAN STANLEY RESEARCH
                                                                                                                                                                               Global Debates Playbook
                                                                                                                                                                                         May 17, 2013

Unusual Caution Has Dissipated, With Sentiment Now Clearly Bullish

Put-call ratio has fallen with less tail hedging                                       Retail investors have now turned bullish
                                                                                                                                                                       • Through most of this rally,
                                                                  Put-Call Ratio        75   Net % of respondents bullish                                                futures traders have been
                                                                  10-day MA                                                                                              bullish, but retail investors
1.4                                                                                     50                                                                               have only participated in
                                                                                                                                                                         recent weeks.
                                                                                        25                                                                             • Investors have begun to
1.0                                                                                                                                                                      reduce tail hedges, while
                                                                                         0                                                                               positioning in the Nasdaq
0.8                                                                                                                                                                      has become more
                                                                                       -25                                                                               extended.
                                                                                                             AAII Bulls minus Bears Index      4-week MA               • The heightened level of
0.4                                                                                    -50                                                                               broader bullishness may
  Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13                         Jan-10     Jul-10      Jan-11   Jul-11     Jan-12    Jul-12   Jan-13            create the potential for a
                                                                                                                                                                         tradeable correction, but
 Source: Bloomberg, Morgan Stanley Research                                            Source: Bloomberg, Morgan Stanley Research
                                                                                                                                                                         sentiment alone does not
                                                                                                                                                                         signal an immediate move.
 Nasdaq position size has become more extended                                       Futures traders have been bullish through most of the rally

4.0    Z-score                                                                        % of traders bullish                                                 S&P
                                                                                       100                                                                 20-day MA
0.0                                                                                     60
-2.0                                                                                    40

-3.0                                                           Net Speculative
-4.0                                                           Position to Open
   Jan-00         Jan-03          Jan-06          Jan-09           Jan-12
                                                                                         Jan-12        Apr-12       Jul-12        Oct-12     Jan-13    Apr-13

 Source: Bloomberg, Morgan Stanley Research                                          Source: MBH Commodity Advisors, Morgan Stanley Research
 Note: Net speculative positioning defined as reportable non-commercial longs less
 shorts; total positioning based on basic contract plus 1/5 of mini contract                                                                                                                             11
                                                                                                                                                            MORGAN STANLEY RESEARCH
                                                                                                                                                                        Global Debates Playbook
                                                                                                                                                                                  May 17, 2013

Japanese Equities Can Continue to Rally, But Perhaps After a Tactical Pause

Forward looking valuations are nearing pre-crisis levels                           Equity risk premium still high in Japan
                                                                                                                                                                • While the risk / reward
 35    NTM P/E, x                                               Topix NTM P/E      9.0%   Implied ERP, %                                               Topix      balance has shifted in
                                                                                                                                                       US         Japan, valuations are not
                                                                                   8.0%                                                                Europe
 30                                                                                                                                                               yet extreme in the TOPIX.
                                                                                   7.0%                                                                         • The equity risk premium in
 25                                                                                                                                                               Japan is still above that of
                                                                                                                                                                  the US or Europe, and still
 20                                                                                                                                                               has room to fall further,
                                                                                                                                                                  suggesting more upside in
 15                                                                                4.0%                                                                           the equity market.

                                                                                                                                                                • The falling equity risk
 10                                                                                3.0%
                                                                                      Jan-04               Jan-07               Jan-10               Jan-13
                                                                                                                                                                  premium is predicated on
  May-07     May-08     May-09     May-10      May-11     May-12      May-13
                                                                                                                                                                  higher expected future
                                                                                                                                                                  growth in Japan, based on
 Source: Bloomberg, Morgan Stanley Research                                        Source: Federal Reserve, IMF, IBES, MSCI, Tokyo Stock Exchange, Bloomberg,
                                                                                   Datastream, Morgan Stanley Research                                            a weaker yen and loose
                                                                                                                                                                  monetary policy.
Rally in TOPIX has driven the ERP lower

7.5%                                                                        2000
7.0%                                                                        1800
5.5%                                                                        1400

5.0%                                                                        1200
3.5%                                                                        800

3.0%                                                                        600
   Jan-04               Jan-07                Jan-10               Jan-13

                      Topix ERP      Topix (Index Level, rhs)

Source: Federal Reserve, IMF, IBES, MSCI, Tokyo Stock Exchange, Bloomberg,
Datastream, Morgan Stanley Research
                                                                                                                                      MORGAN STANLEY RESEARCH
                                                                                                                                                  Global Debates Playbook
                                                                                                                                                            May 17, 2013

Higher Beta Stocks Rallied, and Remain Cheap Relative to Defensives, But Fundamentals Are Worse

US high-beta cyclicals outperformed defensives last month           Cyclicals are still cheap relative to Defensives
                                                                                                                                          • High-beta cyclicals have
125                                                    Defensives   1.55   Relative valuation                                    US         recently outperformed on a
      Index level
                                                       Cyclicals    1.45                                                         Europe     valuation catch up, but still
120                                                                 1.35                                                         EM         trade at a significant
                                                                    1.25                                                                    discount to Defensives.
115                                                                                                                                         Cheap valuations reflect
                                                                                                                                            poor fundamentals, but the
110                                                                 1.05
                                                                                                                                            wide dispersion of sector
                                                                                                                                            performance suggests that
105                                                                 0.85
                                                                                                                                            there exist opportunities to
                                                                    0.75                                                                    add alpha.
                                                                                                                                          • Defensive-oriented stocks
95                                                                  0.55
                                                                                                                                            have still outperformed
 Jan-13             Feb-13     Mar-13         Apr-13   May-13          Dec-10        Jun-11      Dec-11        Jun-12   Dec-12
                                                                                                                                            year to date. With better
 Source: Bloomberg, Morgan Stanley Research                         Source: MSCI, Datastream, Morgan Stanley Research                       fundamentals and support
                                                                                                                                            from low bond yields, we
                                                                                                                                            maintain our preference for
 Wide dispersion in performance of US cyclical sectors
                                                                                                                                            high-quality dividend
120    Index Level (Jan 13 = 100)                                                                                                           paying stocks over high-
118                                                                                                                                         beta cyclicals.
116          Cons. Disc.       Industirals
             IT                Energy
114          Materials
  Jan-13            Jan-13      Mar-13        Apr-13   May-13

 Source: MSCI, Datastream, Morgan Stanley Research
                                                                                                                     MORGAN STANLEY RESEARCH
                                                                                                                                 Global Debates Playbook
                                                                                                                                           May 17, 2013

With Corporate Credit Getting Rich and Market Conditions Frothy, Time to Trade Up in Quality

Spread-to-leverage near post-crisis lows in the US…           …in Europe, HY has richened more than IG
                                                                                                                         • Yields are at record lows,
450     Spread Per Leverage                                   450      Spread Per Leverage
                                                                                                                           but spreads are still only
                                                                                                                           around long-term averages
400                                                           400
                                                                                                                           and far from the tights pre-
350                                                           350                  Europe IG
                       US IG                                                                                               crisis. However, measured
300                                                           300                                                          as spread per leverage
                                                                                   Europe HY
250                    US HY                                                                                               (debt-to-EBITDA), credit is
200                                                           200                                                          looking rich. In Europe, this
                                                                                                                           is more true for HY than IG,
150                                                           150
                                                                                                                           which is one reason why
100                                                           100                                                          our strategists downgraded
 50                                                            50                                                          HY in Europe. In the US,
  0                                                              0                                                         beta has been a strong
      2003 2004 2005 2006 2007 2008 2009 2010 2011 2012              2003 2004 2005 2006 2007 2008 2009 2010 2011 2012     outperformer in YTD
                                                                                                                           returns, much more so
 Source: Yield Book, Morgan Stanley Research                  Source: Yield Book, Morgan Stanley Research
                                                                                                                           than in Europe. But with
                                                                                                                           little upside left, beta is
Beta has outperformed much more in the US than Europe                                                                      also at greater risk of
                                                                                                                           correcting if the cycle turns.
10     YTD Corp Credit Return (%)
                                                                                                                         • Given these valuations and
                                                                                                                           performance, our
                                                                                                                           strategists prefer to go up
 6                      US                                                                                                 in quality, even if the risk-
                        Europe                                                                                             rally continues. Not much
 4                                                                                                                         upside is lost by buying
                                                                                                                           higher quality, given
 2                                                                                                                         starting yields, while high
                                                                                                                           quality should significantly
                                                                                                                           outperform in a downturn.
        AAA       AA           A       BBB     BB   B   CCC

Source: Yield Book, Morgan Stanley Research
                                                                                                                                                            MORGAN STANLEY RESEARCH
                                                                                                                                                                        Global Debates Playbook
                                                                                                                                                                                  May 17, 2013

EMFX Has Weakened With a Strong USD, Which Is Turning Pro-Cyclical

The USD has strengthened rapidly in 2013                                            EMFX weakness has persisted for the past year
                                                                                                                                                                 • EM currency markets have
85                                                                     DXY Index    103                                                        .USDEM Index        corrected sharply in recent
                                                                                    102                                                                            weeks, on the back of a
                                                                                    101                                                                            broad USD move. We
83                                                                                  100                                                                            remain cautious in the face
                                                                                    99                                                                             of still-disappointing and
                                                                                    98                                                                             weak data out of EM, but
81                                                                                  97                                                                             maintain our thesis of
                                                                                                                                                                   differentiation on
                                                                                                                                                                   fundamental grounds.
                                                                                    95                                                    Rising index level =
79                                                                                  94                                                     EM depreciation       • Post-crisis, the USD has
78                                                                                  93                                                                             behaved like a safe-haven
 Jan-12      Apr-12        Jul-12          Oct-12        Jan-13     Apr-13           Jan-12      Apr-12     Jul-12     Oct-12    Jan-13      Apr-13                currency, strengthening in
                                                                                                                                                                   times of economic
 Source: Bloomberg, Morgan Stanley Research                                         Source: Bloomberg, Morgan Stanley Research                                     weakness. That
                                                                                                                                                                   relationship has reversed
                                                                                                                                                                   in 2013, but the recent
USD has been pro-cyclical in 2013, but has diverged recently
                                                                                                                                                                   divergence in USD and
90                      DXY Index (left)        CESIUSD (right)              150                                                                                   growth data may signal an
                                                                                                                                                                   end to this phase of the
                                                                             100                                                                                   pro-cyclical USD.

80                                                                           0


70                                                                           -150
 Jan-09        Jan-10           Jan-11              Jan-12        Jan-13

Source: Bloomberg, Morgan Stanley Research
                                                                                              MORGAN STANLEY RESEARCH
                                                                                                      Global Debates Playbook
                                                                                                                May 17, 2013

                                                                          Risk-Reward Views

Note: E = Morgan Stanley Research estimates, unless otherwise indicated
                                                                                                                                                             MORGAN STANLEY RESEARCH
                                                                                                                                                                           Global Debates Playbook
                                                                                                                                                                                     May 17, 2013

Global Economics Risk-Reward View
Investor Debates                                                   What’s in the price?
                                                                    Better payroll numbers and prospects of better 2H have
    Does Great Monetary Easing Part 3 have further to go?
                                                                     lifted US equity markets and real yields have risen too.
    Japan: What is the next step for Japan’s policy-makers?                                                                                                 June 6, 2013
                                                                    Commodity price weakness has to do with cyclical and
    QE: Tapering-off purchases– will they, won’t they?                                                                                                      ECB council meeting and press
                                                                     structural stories, but will help growth in the near term.
    China: Why has China’s growth faltered even as credit has      Sluggish recovery in China and EM reflected in market
                                                                                                                                                             June 19, 2013
                                                                                                                                                             US FOMC meeting
Base Case 2013 Global GDP: 3.2%                                     Bull Case                                      2013 Global GDP: 3.9%
The global economy is likely to move from twilight to daylight     In our bull scenario, more emphatic policy action in the major                            June 24, 2013
in the second half of the year. The soft-patch in global           countries than we assume in our base case propels a more                                  Nabiullina to take over as the new
growth seems to be ebbing very slowly in both the US and           rapid acceleration to almost 4% GDP growth already in                                     Governor of the CBR
EM. We forecast global GDP to grow by 3.2% in 2013 and             2013.
close to 4% in 2014.                                                                                                                                         July 2, 2013
The Great Monetary Easing Part 3: Almost every part of the          Bear Case                                      2013 Global GDP: 2.4%                    Australia RBA meeting
global central bank has participated in the third installment of   Without sustained policy action, the soft-patch could extend
the great monetary easing. While the bulk of the easing is         itself into greater downside to growth. Our bear scenario has                             July 4, 2013
done, it is too early to call an end to this process. QE           global GDP growth dropping to 2.4% in 2013, with                                          Mark Carney’s first MPC meeting as
remains in place in the US, the ECB has reiterated its             recessions in Europe and UK as well as some EM                                            Governor of the Bank of England
commitment to further easing as necessary and EM central           economies.
banks continue to ease. The weakness in commodity prices
pushes the risk of inflation further into the future and allows                                                                                              July 11, 2013
central banks more room to breathe.                                                                                                                          Japan upper house of the National
                                                                                                                                                             Diet elections
Key Indicators                                                     Growth has bottomed but the recovery is weak
                              2012        2013E      2014E                                                                                     S lo w in g   September 22, 2013
                                                                       G row th pe ak ing                                PER , TH L            fro m pe ak
                       Bear                2.4          2.9                                                                      CH L , ID N                 German parliamentary elections
     Global GDP        Base   3.1          3.2          3.9                                                                        N OR
                                                                                                                                     M AL
                       Bull                3.9          4.7                                                                             R US                 February 1, 2014
                                                                                                                                           CO L
                       Bear                0.1          0.9                                                                                                  Term begins for new chairman of the
       G10 GDP         Base   1.3          0.9          1.8                                              AUS
                                                                                                                                                             US Federal Reserve
                       Bull                1.6          2.6
                       Bear                4.6          4.7
                                                                                                                                                             March 1, 2014
                       Base   4.9          5.4          5.8
                                                                                                 C HN
                                                                                                                                                             ECB expected to assume supervisory
       EM GDP                                                                                TU R , K OR                                                     tasks within Single Supervisory
                       Bull                6.1          6.7               EA                U S , J P N , CA N , SW E
                                                                            ISR    IN D M EX , SAF , NG R                                                    Mechanism
                       Bear                3.1          3.1                        PO L U K
    Global Inflation   Base   3.3                       3.3         G r ow th      CZE
                                                                                                             R e-ac c e le ratin g fr om tr ou gh
                                           3.3                      b o ttom ing   HUN
         (CPI)                                                                     UKR
                       Bull                3.5          4.0
                                                                   Source: Morgan Stanley Research
Joachim Fels, Manoj Pradhan (44 207) 425-6138,
                                                                                                                                                                         MORGAN STANLEY RESEARCH
                                                                                                                                                                                       Global Debates Playbook
                                                                                                                                                                                                 May 17, 2013

US Economics Risk-Reward View
Investor Debates                                                          What’s in the price?                                                                           Signposts
 When will the Fed begin to taper asset purchases?                       • The initial run of softer than expected March data has increased
 To what extent will uncertainty from debt-limit and budget                                                                                                             May 30
                                                                            confidence that QE will not be tapered soon.
  showdowns be a drag on growth and sentiment?                                                                                                                           Q1 GDP Revision
                                                                          • The fed funds rate outlook also saw a significant dovish repricing
                                                                            as investors understood that a drop in the unemployment rate                                 June 7
                                                                            driven by a half a million people giving up trying to find work did
                                                                            not move the Fed closer to exit.                                                             May Employment Report
                                                                                                                                                                         June 18
 Base Case / Thesis                2013 GDP (Q4/Q4): 1.9%                  Bull Case                                         2013 GDP (Q4/Q4): 2.7%                     May CPI
 In our baseline forecast, the trajectory of economic activity marks an   The bull case focuses on the low-hanging fruit on the fiscal tree.
 inflection point midway through 2013. The expansion of Real GDP                                                                                                         June 19
                                                                          Means-testing of benefits, an occupationally sensitive stretching of
 steps up to around 2-3/4 percent in the second half of this year and     the retirement age, elimination of tax expenditures and                                        FOMC Meeting (SEP & Press Conf.)
                                                                          rationalization of the personal and corporate tax structure would be
                                                                          an enormous plus for economic efficiency.
 We are not optimistic that harmony will suddenly break out in the
 halls of power. Our forecast does not include any encompassing
 “Grand Bargain” on fiscal policy.                                         Bear Case                                         2013 GDP (Q4/Q4): 1.0%
                                                                          In our bear case, we assume that the political process breaks down.
 Housing is recovering, but the uptrend is likely to be shallow. While    Budgetary authority lapses and the ratings agencies join the
 mortgage terms and standards have eased, on net, from their peak         conversation by putting the credit rating of the US in play, and
 of stringency, credit is still hard to get.
                                                                          confidence is set back. This should be sufficient to trim 1
                                                                          percentage point from growth and set the warning bells for
 In the near term, inflation rises as the recent step-up in gasoline      recession full blare.
 prices passes through to headline inflation. Over time, with
 resource use remaining slack and inflation expectations well
 anchored, inflation should settle a touch above 1-1/2 percent.

Key Indicators                                                            Aggregate Weekly Payrolls Up Despite Weak Report
                               2011     2012    2013E    2013E                1.20
                                                                                     Aggregate Weekly Payrolls: Total Private Industries
                                                                                     % Change MoM
                  Bull                             2.7      3.2               1.00
GDP (Q4/Q4)       Base           2.0      1.7      1.9      2.7
                  Bear                             1.0      2.1
                                                   2.0      2.3               0.60

CPI                              3.1      2.1      1.8      1.5               0.40
                                                   1.5      1.2
                                                   7.6      7.0
Unemployment                     8.9      8.1      7.7      7.4               0.00

                                                   7.8      7.7
                                                  0.15     0.15
Policy Rates                                                                 -0.40
                               0.125     0.15     0.15     0.15
                                                  0.15     0.15              -0.60
                                                                                      Jul       Aug         Sep        Oct        Nov      Dec   Jan   Feb   Mar   Apr

Morgan Stanley Research                                                   Note: Aggregate Weekly Payrolls combines employment, hours and earnings.
                                                                          Source: Bureau of Labor Statistics                                                                                                18
Vince Reinhart, (212) 761-3575,
                                                                                                                                          MORGAN STANLEY RESEARCH
                                                                                                                                                        Global Debates Playbook
                                                                                                                                                                  May 17, 2013

Europe Economics Risk-Reward View
Investor Debates                                                                                                                         Signposts
                                                                  What’s in the price?
 Will the ECB cut again? And if so, will the deposit rate be          GDP contraction of -0.4% in 2013, recovery to 0.9% in 2014.
  cut too? What shape could support for the ABS market                                                                                   May 22
                                                                       HICP inflation to ease to 1.7% in 2013 and to 1.6% in 2014.       EU Council meeting
  take? When will the recession give way to recovery? Will             ECB watchers expect refi rate to stay at 0.50% till end 2013.
  less austerity spur on a rebound in the periphery? What
                                                                       Ten-year Bund yields to rise to 1.9% by end of 1Q 2014.          May 23
  impact will the German election have on the European
                                                                       EUR/USD at 1.29 in July 2013 and at 1.28 in April 2014            EMU PMI Flash estimates
                                                                                                                                          UK 1Q GDP (details)
Base Case                             2013 GDP: -0.7%              Bull Case                                     2013 GDP: 0.0%
                                                                                                                                         May 24
The current recession is set to be deeper and longer than         Our bull case assumes that political uncertainty recedes.               GER Ifo Business climate
the consensus expects as the weakness spreads to                  Europe responds by redoubling efforts on structural reforms.             FRA INSEE Business survey
domestic demand in France, Italy and the Netherlands.             The EC gives countries with a good reform record extra time to
Fresh political risks that have emerged in some countries,        reduce their deficits and the ECB cuts rates, in response to           May 29
notably Italy, could add to the downside risks to the baseline.   downward impact on inflation from the supply-side reforms.              EC to opine on SP and NRP
An economic stabilisation in 2H should pave the way to a
subpar recovery into 2014. Inflation should remain well            Bear Case                                    2013 GDP: -1.7%         May 31
below the ECB price stability norm over the forecast horizon.
                                                                  In our bear case, political uncertainty persists and the social         EMU HICP Flash climate
Against this backdrop and with some sentiment indicators
dipping again, the chances for another ECB rate cut are           impact of austerity leads to reform blockage. Uncertainty about
                                                                  economic policy weighs on aggregate demand, which pushes               June 6
rising, we think. Moreover, new unconventional measures to
                                                                  the economy into a deeper recession. The ECB remains                    ECB Council meeting (staff projections)
unclog the bank lending channel for SME’s are being
                                                                  inactive for long time in the absence of consensus within the           BoE MPC meeting (King’s last meeting)
considered in conjunction with the EIB and the EC.
                                                                  Governing Council about unconventional measures.
                                                                                                                                         June 20/21
Key Indicators                                                    Bull, Base and Bear Cases – ECB Refi Rate                               Eurogroup/Ecofin meeting
                            2012   2013E   2014E 2015–2019E
                                                                                                                                         June 27/28
               Bull                  0.0     1.8        2.2        4
                                                                                                                                          EU Council meeting
GDP            Base         -0.5    -0.7     0.9        1.5       3.5

               Bear                 -1.7     -0.2       0.8        3
                                                                                                     Base case                           July 4
                                     1.6     1.9        2.4
                                                                  2.5                                                                     ECB Council meeting & press conference
CPI                          2.5     1.5     1.6        1.9                                          Refi rate                            BoE MPC meeting (Carney’s first meeting)
                                     0.9     1.1        1.4
                                    11.8    11.5                  1.5
                            11.2    12.0    12.3                   1
Rate (%)
                                    12.5    12.9                                                                                 0.50%
                                    0.25    0.25                                                                                 0.25%
Policy Rates                                                       0
                            0.50    0.50    0.50
(EOP)                                                              2007       2008    2009    2010    2011       2012   2013   2014
                                    0.50    0.50
                                                                   Source: Morgan Stanley Research
Elga Bartsch, (+44) 207 425 5434,
                                                                                                                                      MORGAN STANLEY RESEARCH
                                                                                                                                                   Global Debates Playbook
                                                                                                                                                             May 17, 2013

 Japan Economics Risk-Reward View
 Investor Debates                                                    What’s in the price?                                             Signposts
  Will PM. Abe deliver on the third-arrow (micro-economic            Equity and FX markets responded to the BoJ’s surprise easing   • Growth Strategy Report by the
   reform) policies?                                                   under Gov. Kuroda in a textbook manner. Further impact on      Industrial Competitiveness Council
  Will Japan’s CPI to reach the 2% target within a 2-year             the macro outlook from policy must come largely from the       (June 2013)
   horizon as a result of Gov. Kuroda’s aggressive easing?             third-arrow (microeconomic reform) policies.
  How large will be a fiscal drag in 2014, especially negative       JGB yields have been volatile since the BoJ’s announcement,    • Mid-term Strategy Report by the
   effects from the scheduled VAT hike in April 2014?                  with yields edging up marginally higher.                       Council on Economic and Fiscal
                                                                                                                                      Policy (June 2013) and the
                                                                                                                                      government’s Mid-term Fiscal Plan
Base Case                              2013 GDP: +1.6%                 Bull Case                             2013 GDP: +2.4%         (Summer 2013 after the July
                                                                      For the bull case to materialize, we would need stronger        election)
We retain our bullish outlook for 2013 at +1.6%. Various              global growth for Japanese exports and production to
monthly economic data have been in line with our view that            recover at a faster pace. We would also need a ‘Kuroda          • Upper House Election (most likely
the economy bottomed out in November 2012 and has                     moment’ on micro-economic reforms and deregulation              on July 21, 2013)
entered an early expansion phase.                                     issues.
The BoJ’s aggressive easing in April raised the likelihood of                                                                         • Final decision on the consumption
Japan getting out of deflation. Although we currently do not           Bear Case                             2013 GDP: +1.0%
                                                                                                                                      tax hike scheduled in April 2014
expect the CPI to reach the 2% target in a 2-year horizon,                                                                            (October 2013)
                                                                      Near-term downside risks include (1) delays in executing
we see a good chance of the target being reached within
                                                                      public works, (2) economic reforms stalling, and (3) the
Gov. Kuroda’s five-year term.
                                                                      global economy being stuck in the ‘twilight’ zone longer than   PM Abe has established a solid
Still awaiting clarity regarding micro-economic reforms, we           we expect.                                                      framework of committees for third
have not incorporated significant progress on the third-arrow                                                                         arrow policies. The PM himself is a
front in our forecast.                                                                                                                regular and vocal attendee. However,
                                                                                                                                      the process remains complex and
Key Indicators                                                               Japan’s Real GDP Growth Scenarios                        vulnerable to interference by vested
                                2012      2013E      2014E      2015-19E                                                              interests. So far, the Third Arrow effort
                    Bull            2.0        2.4       2.3          2.0                                                Bull Case
                                                                                                                                      has done well in agriculture, energy,
 GDP                Base            2.0        1.6       1.3          1.0
                                                                                                                         Base Case    and employment. However,
                                                                             4                                           Bear Case
                    Bear            2.0        1.0       0.4         -0.5                                                             performance in medical care,
                    Bull           -0.1        0.5       3.1          2.4    3                                                        education, and government reform is
                                                                                                                  2.4           2.3
 CPI                                                                                                                                  inadequate. Electoral reform is one
                    Base           -0.1        0.2       1.8          1.8                             2.0
 (Ex. Fresh Food)
                    Bear           -0.1       -0.2       1.2          0.5
                                                                             2                                    1.6                 area in danger of a failing grade. We
                    Bull            4.4        3.9       3.6          3.4                                                             expect news flow on third arrow
 Unemployment                                                                                                                         policies will be erratic. Before official
                    Base            4.4        4.1       3.9          3.7                                         1.0
                    Bear           4.4         4.3       4.2          4.2    0                                                  0.4   reports due in June, many leaks -
                    Bull          0.05        0.05      0.05         1.00                                                             some by self-interested players - are
 Call Rate                                                                  -1                                                        likely.
                    Base          0.05        0.05      0.05         0.50
 (EOP)                                                                       2010        2011         2012       2013e        2014e
                    Bear          0.05        0.05      0.05         0.05
                                                                            Source: Morgan Stanley Research
 Robert Feldman (+81 3 5425-5385,, Takeshi Yamaguchi (
                                                                                                                                                                  MORGAN STANLEY RESEARCH
                                                                                                                                                                                Global Debates Playbook
                                                                                                                                                                                          May 17, 2013

China Economics Risk-Reward View
Investor Debates                                               What’s in the price?                                                                               Signposts
  Will the notable slowdown in 1Q change current policy         Market has priced in slowdown in growth, while investors
  setting?                                                       remain hopeful of anti-cyclical adjustments and details on                                       Announcement of any potential
  What policy measures will the new government release to        urbanization and potential structural reforms.                                                   policy stance change or
  help support urbanization efforts and stabilize growth?                                                                                                         economic reform plans

                                                                                                                                                                  July 2013
Base Case / Thesis                      2013 GDP: 8.2%         Bull Case                                     2013 GDP: 8.7%                                      Quarterly State Council Working
We see increasingly more downside risks to our GDP             The growth recovery is faster and more significant than we                                         Meeting
growth forecast of 8.2% YoY in 2013. Recent data release       forecast, due to 1) the start of a new political cycle usually
on GDP growth and activity indicators suggested the            helps boost investment, as there is a strong incentive to                                          October 2013
aggregate demand growth is easing, which challenged the        avoid a recession in the near term; 2) the diminishing                                             The third Plenary Session of 18th
stable growth recovery in our baseline scenario. A notable     political uncertainty could help eliminate the roadblocks for                                      Central Committee of CPC
growth slowdown calls for countercyclical policy adjustment.   economic policy implementation and induce structural
We expect policy makers to accelerate the urbanization         reforms.
promotion campaign to encourage more infrastructure and
property investments. With inflationary pressures to remain
                                                                Bear Case                                    2013 GDP: 7.6%
muted before growth momentum picks up, we expect the
monetary authority to leave financial conditions at an         Policy errors inadvertently nip the incipient recovery in the
accommodative level. However, the probability of the           bud: 1) premature tightening in banking and property sector;
government adopting an immediate policy boost such as a        2) new government’s anti-extravagance and cost cutting
rate cut or stimulus package is still low.                     campaign; 3) local government’s fiscal situation will likely
                                                               suffer setbacks due to diminishing land sales.

Key Indicators
                                                                    China: GDP growth decelerated in 1Q13
                           2011     2012    2013E     2014E         %                          GDP (%, YoY)                 GDP (%, QoQ, SAAR)
             Bull                             8.7       8.8

GDP          Base           9.2       7.8     8.2       7.9         20
             Bear                             7.6       7.2
             Bull                             3.7       4.5

CPI          Base           5.4       2.6     3.2       3.3         10

             Bear                             2.7       3.0
             Bull                             NA        NA
Trade Balance
              Base          2.1       2.9     2.4       2.3          0
(% of GDP)











             Bear                             NA        NA
                                                                                       Source: Morgan Stanley Research
Helen Qiao, (852) 2848-6511, ; Yuande Zhu, (852) 2239-7820,                                                                                                       21
                                                                                                                                                                                MORGAN STANLEY RESEARCH
                                                                                                                                                                                             Global Debates Playbook
                                                                                                                                                                                                       May 17, 2013

AxJ Economics Risk-Reward View
                                                              What’s in the price?                                                                                              Signposts
Investor Debates/Themes
                                                               The global soft patch will mean that support from external
     Will the weakness in 2Q external demand be extended       demand will be relatively weaker over the next 2-3 months.                                                      20 May
      into the second half of the year?                         However, in 2H13, our DM economics team believes that the                                                       Thailand Q1 2013 GDP
     Will policy makers enact structural reforms to boost      growth recovery will resume, as the effects of fiscal
      domestic demand on a sustainable basis?                   tightening taper off. As DM domestic demand recovers, this                                                      29 May
                                                                will help lift the region’s external demand back up.                                                            BOT Monetary Policy Meeting
                                                               We believe that policy reforms will hold the key towards
                                                                improvement in quality of growth. Although policy makers                                                        31 May
                                                                recognize the need to boost the productivity dynamic, the
                                                                                                                                                                                India Q1 2013 GDP
                                                                pace of reforms remains slow.
Base Case / Thesis                     2013 GDP: 6.7%          Bull Case                                                                   2013 GDP: 7.4%                      13 June
We expect growth in the region to recover only modestly to    We believe the key drivers that can influence our base case                                                       BOK Monetary Policy Meeting
6.7% in 2013 from 6.2% in 2012. We believe the region is      AXJ GDP growth forecasts positively would be an                                                                   BI Monetary Policy Meeting
                                                              improvement in the external environment and/or if policy
facing three key growth challenges: 1) weakening              makers accelerate the pace of structural reforms to boost
demographics, 2) relatively weaker support from external      domestic demand on a sustained basis.                                                                             17 June
demand, and 3) slowing productivity growth, which if left                                                                                                                       RBI Monetary Policy Meeting
unchecked will constrain the growth potential and place        Bear Case                                                                   2013 GDP: 6.0%
downward pressure on economic growth in the near team.        We believe there are two key downside risks to growth:                                                            20 June
We believe an acceleration in the pace of policy reforms to   (1) a weaker than expected domestic demand growth in DM
                                                              impacting the region’s exports and (2) if structural reforms                                                      CBC Monetary Policy Meeting
improve the productivity dynamic will help quicken the
adjustment for a sustained growth trajectory.                 fail to take off

Key Indicators                                                AXJ Real GDP Growth – Bull, Base Bear Case
                              2011A   2012A   2013E   2014E
                                                              Scenarios        AXJ GDP Growth (%)     10.8                                                    MSe
                      Bull                    7.4     7.8
                                                                                                    9.9                              9.6
GDP                   Base    7.6     6.2     6.7     6.9        9.8

                      Bear                    6.0     6.1
                      Bull                    4.7     4.9                              8.9
CPI                   Base    5.8     4.1     4.4     4.1        7.8      8.1                                           7.5
                                                                                                                                            7.6               7.4
                      Bear                    4.2     4.0                         Base                                                                           6.7 6.9
Policy Rates (EOP)            6.1     5.7     5.5     5.6                         Bear                                                                                  6.1
                                                                                                                                                     6.2        6.0
                              2.0     1.8     1.8     1.6        5.8
CAB (% of GDP)










Fiscal Balance                                                                                                                                                          2014E
(% of GDP)                    -2.9    -2.6    -2.9    -2.7
Chetan Ahya, +852 2239 7812,     Source: CEIC, Morgan Stanley Research.
                                                                                                                                                          MORGAN STANLEY RESEARCH
                                                                                                                                                                        Global Debates Playbook
                                                                                                                                                                                  May 17, 2013

Brazil / Latam Economics Risk-Reward View
Investor Debates                                                   What’s in the price?                                                                  Signposts
 Brazil’s economy continues to recover, but given structural       Slow growth is priced in, there seems to be an excessively
  supply side problems the growth continues to be muted              bearish tone towards growth.                                                        May 16
  for many investors. We continue to expect 2.8% GDP                Investors currently are pricing a 100 basis point of further                        Chile – Monetary Policy Meeting
  growth for 2013, many investors now are doubting that              interest rates hikes, but we believe this is more than the
  this is even possible.                                             central bank is willing to deliver given the political calendar.
                                                                                                                                                         May 20
 Inflation has surged and the central bank has started a                                                                                                Chile – GDP
  tighening cycle, although signaling just a fine tuning.
Base Case / Thesis                    2013 GDP: 2.8%                                                                                                     May 22
                                                                    Bull Case                                                        2013 GDP: 3.5%     Brazil – IPCA-15 (May)
We continue to expect a recovery in 2013 compared to last
year, but this will likely be a bumpy path especially due to       Brazil’s GDP could strengthen further thanks to better global
Brazils struggling industrial sector that continues to face        demand for its commodity-based exports due to more robust                             May 23
serious competitiveness issues. Brazil’s supply side               Chinese demand – especially on iron ore, this would require                           Peru – GDP
constraints continue to generate inflationary pressures            monetary policy to tighten at least 200 basis points. The
especially from wages due to historically low unemployment         administration’s new policy mix also starts to reduce                                 May 29
rate. We believe that the disconnect between robust                significantly the cost of doing business trough improving
                                                                                                                                                         Brazil – GDP
consumer demand and Brazil’s output performance will               infrastructure.
persist. Consumption has been strong, and we have little
doubt that it should be strong again in 2013, but our Growth        Bear Case                                                        2013 GDP: 2.0%     May 31
Mismatch thesis argues that strong consumption tells us little     Brazil suffers more as the globe takes a turn for the worse,                          Colombia – Monetary Policy Meeting
about how strong output will be. If there is a basis for hope in   even while avoiding a full-blown 2008-style crisis.
Brazil, it is the prospect that the authorities may begin to       Excessively active government policies lead to further                                June 7
reduce the cost of doing business by lowering taxes and            contraction in investments. The central bank reacts quickly
auctioning infrastructure projects.                                                                                                                      Brazil – IPCA (May)
                                                                   with 100 bp of rate cuts as inflation reverts closer to 5%.
                                                                                                                                                         June 14
Key Indicators                                                     Brazil: Real GDP Growth                                                               Brazil – GDP Proxy (IBC-br; May)
                            2011      2012   2013E      2014E      (% change y-o-y)
               Bull                            3.5         4.2
                                                                     10%                                                                                 June 21
                                                                                                                                                         Brazil – IPCA-15 (June)
GDP            Base           2.7      0.9     2.8         3.4

               Bear                            2.0         2.3       6%

               Bull                            6.5         6.7       4%

CPI            Base           6.6      5.4     6.2         5.7       2%

               Bear                            5.8         5.5

               Bull                           8.75       10.00                     Bear
                                                                     -2%           Base
Policy Rates                                                                       Bull
               Base         11.00     7.25    7.25        8.25
               Bear                           6.75        6.75             2004   2005    2006   2007   2008   2009   2010   2011   2012   2013   2014

                                                                    Source: Morgan Stanley Latam Economics                                                                                  23
Gray Newman, (212) 761-6510,
                                                                                                                                             MORGAN STANLEY RESEARCH
                                                                                                                                                           Global Debates Playbook
                                                                                                                                                                     May 17, 2013

  India Economics Risk-Reward View
   Investor Debates/Themes                                          What’s in the price?                                                     Signposts
                                                                     Since Sep-12 the government has taken steps to improve the
    Will macro stability indicators continue to improve?             growth mix, i.e., reduce government spending and improve               May 31
    What role will an external demand recovery play in this          investment sentiment. The government efforts on fiscal                 GDP for QE Mar-13
     cycle?                                                           consolidation are being delivered and it is likely to stay on          June 17
    Will the government continue to announce policy reforms          course in F2014. Fiscal consolidation is a positive for the
                                                                                                                                             RBI Monetary Policy Review
     to improve the growth mix?                                       economy as it will help to improve macro stability risks of CPI
                                                                      inflation and current account deficit. However, in the near            June 28
                                                                      term it will affect consumption growth and act as a drag on            Current Account Deficit for QE Mar-
                                                                      GDP. As such we believe that challenges in investment cycle            13
                                                                      and macro stability risks will lead to a gradual recovery.
   Base Case / Thesis                      2013 GDP: 5.9%                                                                                    Next 6 Months
                                                                     Bull Case                                  2013 GDP: 6.7%              (1) Tracking monthly CPI inflation and
   Given the ongoing fiscal consolidation, we believe that trend                                                                             trade deficit for signs on improvement
   in exports and government’s effort to revive investment will     We see a bull-case scenario growth for India at 6.7% in
                                                                    2013, assuming the government is able to implement                       of macro stability environment
   be the two anchors to growth sentiment. In our base case,
   we are building in a gradual recovery in export growth based     aggressive policy reforms in a way that begins to kick-start             (2) Tracking the progress on policy
   on DM growth trajectory which will also support                  large greenfield projects and external demand improves                   reforms to boost investment
   manufacturing, capex spending and assume that the                more than anticipated.                                                   especially progress from Cabinet
   government would continue to take policy measures to                                                                                      Committee on Investment
   revive investment spending, which will help to stabilize          Bear Case                                      2013 GDP: 5%            (3) Progress on effort to implement
   private corporate capex. We believe that the initial phase of    In the event that the government fails to continue                       tax reforms, particularly the new
   recovery will be driven by an improvement in productivity        implementing reforms and external environment deteriorates               Goods and Services tax (GST) Act
   growth rather than big rise in investment to GDP.                we could see GDP growth slipping to 5% in our bear case

   Key Indicators                                                   India’s Real GDP Growth – Bull-, Base- and Bear-case Scenarios
                             2010   2011    2012   2013e    2014e     11
                     Bull                           6.7      7.5      10
                     Base    9.8     7.3     5.1    5.9      6.8
                                                                       9    9.6    9.7
GDP                  Bear                           5.0      6.2
                                                                       8                                8.9                          7.5
                     Bull                           8.2      6.8                                                              6.7
                     Base    12.1    8.9     9.3    8.9      7.1       7                                      7.5                    6.8
CPI                  Bear                           9.7      7.8       6          Base           6.4                           5.9
Policy Rates (EOP)           6.25   8.50    8.00   7.25       7                                                                      6.2
                                                                       5          Bear                               5.1
CAB (% of GDP)               -3.2   -3.4    -5.1    -4.3     -3.3                                                             5.0
Fiscal Balance                                                         4
                                                                           2006   2007   2008   2009   2010   2011     2012 2013E 2014E
(% of GDP)                   -7.6   -8.2    -7.5    -7.0     -6.8
                                                                    E = Morgan Stanley Research estimates; Source: Morgan Stanley Research
  Chetan Ahya, +852 2239 7812,
                                                                                                                                             MORGAN STANLEY RESEARCH
                                                                                                                                                           Global Debates Playbook
                                                                                                                                                                     May 17, 2013

Russia Economics Risk-Reward View
Investor Debates                                                  What’s in the price?                                                       Signposts
 Will the new government deliver the promised pro-growth          The government has downgraded its 2013 growth forecast                   2013
  reforms?                                                          from 3.6% to 2.4%, while consensus sees GDP growth                       - CBR rate cut in 2013,
 How would Russia be affected by a fall in the oil price?          at 3.3%Y. We see growth slowing to 2.9%Y from 3.4%Y in                   - Rosneft integration of TNK-BP,
 Is a reversal of political liberalisation underway?               2012, in response to fiscal and monetary policy tightening.              - execution of privatisation deals;
                                                                                                                                             - progress on improving Russia's
                                                                                                                                             ranking on the World Bank's ease of
 Base Case / Thesis                    2013 GDP: 2.9%              Bull Case                                         2013 GDP: 4.0%         doing business index;
 In 2013 we see growth slowing to 2.9%Y from 3.4%Y in                                                                                        - pension reform
                                                                  Strong implementation of reform agenda, leading to pick up                 - anti-corruption campaign.
 2012, in response to policy tightening. We see consumption       in investment in line with target 25% of GDP by 2015, growth
 growth at 4.9%Y as the only growth engine in 2013                moving to 4%, and capital inflows driving RUB up.
 supported by the tight labour market and real wage growth.
 However, we do not expect a cut just yet. We expect the first
                                                                   Bear Case                                         2013 GDP: 4.0%
 rate cut in September when inflation returns to the target
 range. We now see 50bp of easing in total by the end of the      There have been calls from ministers for more policy
 year, up from 25bp previously, which would take the policy       stimulus – higher spending, easier rates – to support growth.
 rate (repo auction rate) to 5.00%. A July cut is also possible   We therefore see a risk of a policy-driven ‘go-stop’ cycle in
 as we expect inflation to start falling in June. Russia’s 2013   2013-14. Easy policy would support a pick-up in growth as
 Budget is based on the new fiscal rule, which, on our            high as 4%Y in 2013, but spark a rise in inflation, which we
 estimates, provides for a 0.5% of GDP fiscal consolidation.      think would then trigger a sharp tightening of policy in 2014
 However, the recent MinFin proposal to increase the base oil     to get inflation back under control, which would bring growth
 price undermines the credibility of the rule.                    down sharply to 1%Y.
Key Indicators                                                          Policy Tightening to Slow down Growth
                               2011      2012   2013     2014                   %Y
                                                                          30                                                   MS forecast
                  Bull                            4.0      4.5
    GDP           Base           4.3      3.4     2.9      3.4            10

                  Bear                            4.0      1.0             0
                  Bull                            7.0      6.0
    CPI           Base           8.5      5.1     6.7      5.4
                  Bear                            8.5      8.0           -40
                                                                            1Q-04    1Q-06        1Q-08      1Q-10    1Q-12    1Q-14
                  Bull                           5.50     6.75
                                                                               Real GDP                   HH consumption      Export
    Policy Rate   Base          5.25     5.50    5.00     4.50                 Fixed investment           Import
                  Bear                           4.00     7.00        Source: Rosstat, Morgan Stanley Research
Jacob Nell, (7495) 287 2134,; Alina Slyusarchuk, (44) 20 7677-6869,
                                                                                                                                                           MORGAN STANLEY RESEARCH
                                                                                                                                                                            Global Debates Playbook
                                                                                                                                                                                      May 17, 2013

Mexico Economics Risk-Reward View
Investor Debates                                                  What’s in the price?                                                                    Signposts
 Mexico’s reform momentum is likely to gain further ground.       The market appears confident that the new administration
  By pushing through changes in areas like fiscal and               will not backtrack on the prudent macro model in place –                              May 17
  energy – on top of recent moves on labor, education and           focused on trade opening and deregulation – but remains                               GDP (1Q)
  competition – Mexico could boost fiscal resources to              somewhat skeptical of any major breakthrough on the fiscal
  address shortcomings in infrastructure and human capital;         or oil and gas fronts, which could have important implications
                                                                                                                                                          May 24
  in turn, this could change Mexico’s narrative from that of a      for the country’s medium-term potential growth path.
                                                                                                                                                          Balance of Payments (1Q)
  country with stable policies into a reform leader
Base Case / Thesis                     2013 GDP: 3.2%                                                                                                     June 7
                                                                   Bull Case                                                            2013 GDP: 3.9%   Monetary Policy Meeting
Our outlook in Mexico, which has strong ties to the US
particularly on the manufacturing front, should remain heavily    The expected second half acceleration in US activity
dependent on the US industrial cycle; indeed, sluggishness        surprises to the upside, including the pickup in industry; this                         June 19
in the US in the first half of the year has led to a meaningful   boosts confidence and GDP growth, lifting Mexico’s export-                              GDP – Supply & Demand Detail (1Q)
slowdown in Mexico already. The new administration is likely      focused areas if the economy in the process and maintaining
to embark on an aggressive reform agenda on the energy            domestic demand on a moderate growth path.                                              June 21
and fiscal fronts, with initiatives that could be delivered to     Bear Case                                                            2013 GDP: 1.8%   Monetary Policy Minutes
congress as early as the second half of the year; indeed, the
Executive already signed into law a sweeping overhaul of the      Mexico suffers disproportionately as the US stalls in coming
education system and sent to congress a bill to boost             quarters. Even with the US sluggish, Mexico finds limited                               July 7
competition in the telecom sector. Reform progress won’t          room for fiscal stimulus – as was the case during the 2009                              Local elections
change out 2013 growth outlook, but it could mark a major         crisis – while sticky inflation and a weaker currency prevents
step in building a foundation for a more powerful long-term       the central bank from acting more aggressively (only                                    July 12
growth dynamic.                                                   delivering 50 basis points in additional cuts).                                         Monetary Policy Meeting

                                                                                                                                                          July 26
Key Indicators                                                    Mexico: Real GDP Growth                                                                 Monetary Policy Minutes
                            2011     2012    2013E     2014E      (% change y-o-y)

               Bull                            3.9        4.9

GDP            Base          3.9       3.9     3.2        4.2      4%

               Bear                            1.8        2.9      2%

               Bull                           4.00        4.5      0%

CPI            Base          3.4       4.1     3.7        3.8
               Bear                            3.6        3.5
               Bull                           4.00       4.00                    Base
                                                                  -8%            Bull
Policy Rates
               Base         4.50      4.50    4.00       4.00
(EOP)                                                             -10%
                                                                         2004   2005    2006   2007   2008   2009   2010   2011   2012    2013   2014
               Bear                            3.5        3.5
                                                                   Source: Morgan Stanley Latam Economics                                                                                       26
Gray Newman, (212) 761-6510,
                                                                                                                                              MORGAN STANLEY RESEARCH
                                                                                                                                                             Global Debates Playbook
                                                                                                                                                                       May 17, 2013

US Rates Risk-Reward View
 Investor Debates                                                        What’s in the price?                                                Trades
  Will the Federal Reserve begin to taper Treasury and                   According to our survey, 45% of market participants expect        • Treasuries: We expect roll down and
   agency MBS purchases later in 2013? Or beyond?                          the Fed to begin tapering in 2013, and 55% expect                   carry to dominate 2013. We like
  When the Fed begins to taper purchases, will they taper                 sometime beyond. Markets expect the Fed to maintain the             7s/30s and 10s/30s yield curve
                                                                           current monthly pace of $45bn Treasuries and $40bn MBS              steepeners.
   Treasury purchases before tapering agency MBS?
  Will the act or announcement of tapering help to steepen                until tapering begins, though remains split over whether          • Inflation: We prefer real yield curve
   the yield curve or flatten the yield curve?                             tapering will start with Treasuries alone, or also include MBS      steepeners between the 5-year and
                                                                                                                                               30-year maturities. We are neutral
Base Case / Thesis                                10y 2.29%               Bull Case                                UST 10y 1.43%              on the break-even inflation curve.
                                                                         The downside risks to global growth remain in Europe, but           • Spreads: We are tactically neutral,
We project the 10-year UST at 2.29% by end of 2013. Our                                                                                        but strategically believe long end
forecasts were developed by modifying expectations for                   we believe that downside would be less than experienced in
                                                                         2011 or 2012. This leaves us less bullish on Treasuries than          swap spreads should continue
Fed policy rates within our term structure framework. We                                                                                       widening. We like 30y wideners.
forecast 10-year yields to remain between 1.4% to 2.6%,                  we were in late 2012. The partial resolution to the fiscal cliff
the ‘fiscal cliff’ rate regime established since July 2011.              also softened our bull case, so we no longer see 10-year            • Volatility: We are neutral on implied
                                                                         Treasury yields approaching 1%, but 1.43% instead.                    volatility after having been bullish for
Our economists upgraded their forecasts for real growth                                                                                        the past six months. We like a 1-
and headline inflation slightly, although they remain more                Bear Case                                UST 10y 2.79%              year expiry 10s/30s notional-neutral
cautious than the Blue Chip consensus. Nevertheless, our                 Our bear case for Treasuries focuses on the upside risks to           bull steepener.
Treasury yield forecasts remain subdued relative to history.             US economic growth, but also assumes that risks in Europe           • Mortgages: We continue to expect
Two factors that explain our continued cautious stance                   alleviate. We also assume that the Fed begins to taper its            MBS spreads to compress as carry
against dramatically higher yields are (1) the outlook for               Treasury purchases in the latter half of the year, and that           drives returns. We remain down-in-
Europe, and (2) the outlook for the Fed.                                 allows term premiums to rise further. The yield curve bear-           coupon (3s~4.5s) and neutral on
                                                                         steepens and leaves 10-year Treasury yields near 2.79%.               15s/30s. Within spec pools, we like
                                                                                                                                               3.5% MHA 80-95 with lower fico
UST 10y Forecast                                                          Catalysts
4.40                                                     Base              What we're watching          Market Inflection Points
                                                         Bear              FOMC Meetings                FOMC meetings and the Minutes that detail the discussions continue to
3.40                                                                                                    shed light on the number of Committee members who favor tapering
                                                                                                        asset purchases earlier rather than later. As tapering gets closer in time,
2.90                                                                                                    we expect the yield curve to steepen more aggressively.
2.40                                                                       Unemployment                 The unemployment rate serves as a leading indicator for both economic
                                                                                                        growth as well as Fed policy. While the rate has fallen recently, the
                                                                                                        decline in the labor force – as opposed to an increase in employed
1.40                                                                                                    people – may pose a conundrum for the Fed.

0.90                                                                       Roll down and carry          As we expect 2013 to be dominated by roll and carry based trades,
   Jan-10   Oct-10   Jun-11   Feb-12   Oct-12   Jul-13          Mar-14                                  analyzing the best yielding curve sectors will provide valuable insight
                                                                                                        into the thought process and direction of markets.
Source: Morgan Stanley Research
Matthew Hornbach (212) 761-1837,
                                                                                                                                                    MORGAN STANLEY RESEARCH
                                                                                                                                                                   Global Debates Playbook
                                                                                                                                                                             May 17, 2013

             Europe Rates Risk-Reward View
             Investor Debates                                                  What’s in the price?                                                 Trades
              How much Japanese buying of euro-sovereigns; and how             EONIA prices Deposit Rate unchanged at 0.0% for 2 years            Rates: Neutral duration, with yield
               soon?                                                                                                                                curve steepening: 2s10s, 10s30s;
              Will the ECB take its Deposit Rate negative, and/or its Refi     CDS 5y cumulative default probability (40% recovery):              7-8 year maturities have best
               rate below 0.5%                                                   IE 15%(15) , PT 31%(35), SP 21%(23), IT 21%(22).                   roll+carry

             Base Case / Thesis: Bund yields remain low                         Bull Case                          10y Bund to 1%                  Long Italy+Germany vs France on
             but curve to steepen                                                                                                                   correlation-weighted butterfly
                                                                               If weak growth and falling inflation produce 25bp in official
             Bund 10-year yields are at our bull case for end-2013 in          rate cuts, and if risk aversion around euro-sovereigns rises,        France 10s30s flattener vs Germany
             anticipation of Japan buying of European bonds, but 2s do         10-year Bund yield could push even lower.                            Spain: 10s30s flattener vs Germany
             not price in a negative Deposit Rate, on which our bull case
             is predicated. We don’t think that 10s will be able to maintain                                                                        Italy: volatility-weighted 2s10s
                                                                                Bear Case                         10y Bund to 1.87%                flattener vs Germany
             present yield levels unless 2s begin to richen towards our
             bull case, hence we expect 2s10s to steepen in either a bull      If policy rates remain unchanged and sovereign spreads
             or bear environment. Plus we expect 10s30s to steepen for         remain well anchored, improving H2 GDP should see 10-
             structural reasons, so we also favour 2s30s steepening            year Bund yield return to our base case expectation of
                                                                               1.87% for end-2013
             The OMT’s mere existence has shifted market perception of
             euro-sovereigns from being credit- to duration-assets, which
             so far has been maintained despite tests from Italy elections,
             Cyprus etc. Hence Sharpe ratio becomes more important,
             making Spain & Italy increasingly good value vs France
               2s10s Bunds Has Plenty of Room to Steepen                         Catalysts

                                                                                 What we're watching           Why it matters
                                                                                 ECB policy rates              Refi at 0.50%, Depo at 0.0%. Next step, negative Depo; and negative
2s10s (bp)

                                                                                                               EONIA? Would add further momentum to peripherals’ rally

                                                                                 ECB preparing for QE?         ECB President Draghi revealed that there is an ECB/EIB task force
                                                                                                               looking into creating ABS from bank assets – a precursor to QE?

                                                                                 Japan flows                   To what extent will BoJ’s aggressive Quantitative Easing force
                                                                                                               Japanese investors into euro-denominated bonds

                                                                                 Source: Morgan Stanley Research
             Laurence Mutkin +44-207-677-4029,
                                                                                                                                                  MORGAN STANLEY RESEARCH
                                                                                                                                                                Global Debates Playbook
                                                                                                                                                                          May 17, 2013

 UK Rates Risk-Reward View
      Investor Debates                                                         What’s in the price?                                              Trades
       Will Q2 and Q3 be as strong as Q1 2-13?                                 35% of a 25bp Bank Rate cut priced in by YE                     Duration: Neutral
       Will the MPC cut the Bank Rate/ extend QE?                              First rate hike at end of 2015                                  Curve: UKT 2s5s flatteners, UKT
       What new unconventional monetary policy will Carney                     QE expectation: total spend of £400bn (i.e. another £25bn)      10s30s steepeners, Long UKT
        introduce                                                                                                                                10s20s30s
                                                                                                                                                 Asset Swaps: Long UKT 4y vs UKT

     Base Case Thesis – Growth Lower, CPI Lower,                                Bull Case – Europe sov debt crisis                              Cross Currency: Long 10y gilts vs
     More QE in February.                                                      deepens, UK economy goes deeper into
                                                                                                                                                 Vol: Rec GBP 2s5s10s via receivers
                                                                               recession, MPC accelerate asset purchases                         swaptions
     • Underlying economic growth is likely to remain weak before
     improving in 2H 2013, assuming an increase in confidence                  and possibly cuts Bank Rate
     on better euro area growth. We expect inflation to remain                 Front end yields break 10bp and 10y yield fall to 1.5%
     above target, reaching 2.5% by end 2013.
                                                                               Bear Case – EU tensions ease, UK growth
     We do not expect any more QE or Bank Rate cuts. Gilt                      strengthens and inflation rises
     yields will rise gradually as the economy stabilizes and gains
     traction. We believe a lot of the bad news regarding gilts                Market begins to anticipate rate rises in mid 2014, causing a
     (loss of safe-haven status, downgrade, fiscal slippage) is                sell-off led by the 5 year sector. 10y yield rises to 2.70%
     well known and hence we expect an outperformance vs

     FTSE vs GBP 15y15y – Another 30bp of Selloff                                Catalysts
                        GBP 15y15y
            4.10                                                                 What we're watching            Why it matters
                                                                                 May MPC Minutes and            What was the split in MPC vote for extending QE?
                                                                                 Inflation Report
Yield (%)



                                                                 5800            June – New Governor of
                                                                                 BoE                            Will Carney be more or less dovish than King? What other
            3.60                                                                                                unconventional policies will he introduce? Will he cut Bank Rate?

            3.35                                                 5200
               Feb-12   May-12       Aug-12    Nov-12   Feb-13

             Source: Morgan Stanley Research
 Anthony O’Brien +44-207-677-7748,
                                                                                                                                             MORGAN STANLEY RESEARCH
                                                                                                                                                            Global Debates Playbook
                                                                                                                                                                      May 17, 2013

Japan Rates Risk-Reward View
 Investor Debates                                                         What’s in the price?                                               Trades
  What is the impact of BoJ’s operations on the JGB curve?                The belly of the curve appears to have suffered from             • JGBs: We continue to like steepeners
  When will market participants start to see credible                      extreme volatility and resultant high risk premiums.               at this juncture. Unless the BoJ
   evidence of structural reforms and other growth-promoting                                                                                   assigns more weight to the super-
                                                                                                                                               long sector of the curve compared to
   policies? When will economic indicators show signs of a
                                                                                                                                               the current scheme, we believe sub-
   sustainable recovery?                                                                                                                       10y sector continues to be supported
                                                                                                                                               by the BoJ while the super-long
                                                                                                                                               sector would have to cope with rising
Base Case / Thesis                                        JGB 10y 0.85%    Bull Case                              JGB 10y 0.65%               inflation expectations without BoJ’s
We project the 10-year JGB at 0.85% by 2H2013.                            Market would question the effectiveness of BoJ’s policy              direct support.
                                                                          action if macroeconomic conditions fail to improve. Long-          • Spreads: We like buying 20y ASW
Yields have overshot compared to our initial forecast.                    term yields would fall significantly in this case as the             against 10y and 30y. We expect the
However, we attribute a large portion of increase in long                 likelihood of the BoJ staying on hold much longer than               relative cheapness of 20y ASW on
term yields to temporary positioning flows as evident in a                expected rises.                                                      the curve will correct and further
sharp sell-off in JGB futures. Poorer liquidity due to BoJ’s                                                                                   richening of the sector should yen
sizable bond purchase program tends to undermine risk                      Bear Case                              JGB 10y 1.25%               weakens further
taking ability of dealers and amplify volatility. We believe              PM Abe’s growth strategy, beginning with the so-called
the BoJ will act to stabilize the market and 7-10y sector will                                                                               • Volatility: Over time, we expect the
                                                                          “third arrow” policies, progresses better than expected.             belly of the curve to stabilize while
outperform on the curve. We therefore keep our forecast                   Structural reform and deregulation are key to long-term
unchanged for 10y JGB yield at 0.85% by the end of 2013.                                                                                       the super-long part of the curve
                                                                          growth. If successful, the bond market would see a                   remains volatile. Selling straddles at
                                                                          significant sell-off in the 10y sector of the curve.                 the belly vs. super-long is preferred.

JGB 10y Forecast                                                           Catalysts
 1.40    %
 1.30                                                                       What we're watching        Market Inflection Points
 1.10                                                                       BoJ’s operations           The BoJ might restructure the purchase program to deal with heightened
 1.00                                                                                                  market volatility. It might disclose more details on the schedule of bond
                                                                                                       purchase program to improve its transparency. The belly of the curve
                                                                                                       should outperform in that case.
                                                                            Inflation                  We particularly keep a watchful eye on inflation data. A strong positive
 0.60                                                                                                  surprise would imply a higher likelihood that the BoJ’s reflation strategy
 0.50                                                                                                  will work and would send yields much higher and vice versa.
    Jan-11   Jul-11    Jan-12      Jul-12   Jan-13   Jul-13

        new forecast            bull case        bear case

Source: Morgan Stanley Research
Le Ngoc Nhan 81 0(3) 5424-7698,
                                                                                                                                       MORGAN STANLEY RESEARCH
                                                                                                                                                       Global Debates Playbook
                                                                                                                                                                 May 17, 2013

EM Fixed Income Risk-Reward View
 Investor Debates                                                  What’s in the price?                                              Trades
  Will the recent reversal of Q1 losses be sustained or have       Overall we remain at tight levels, particularly following the   Credit
   we moved too far too quickly?                                     pullback of spreads seen since the start of April.              Buy SOAF 2022 vs. SOAF 2041
  Have we seen a structural shift of inflows now favouring         Fundamentals have not yet picked up in most countries with      Buy Peru 2019 vs. Brazil Jan-2019
   local currency debt vs. hard currency debt?                       growth in particularly sluggish, indicating that many of the
                                                                     countries continue to trade rich.                               Buy VIP '18
  Will a potential rise in US Treasury yields limit returns on
   all but the highest carry credits in 2013?                       Limited supply can however keep spreads low.                    Buy SBERRU'21
                                                                                                                                     Buy BCOCPE’20
 Base Case / Thesis                    Bond Index: 287 bp           Bull Case                  USD Bond Index: 255 bp
                                                                                                                                     Buy KZOKZ’23
 After ending the first quarter down 2.3%, EM credit has           Upward momentum in global growth continues, but pressure
 returned 2.66% in the second quarter, or 0.3% on the year.        on UST remains limited, keeping EM yields and spreads at
 This rally has been on the back of the announcements out of       low levels. Gains are however limited given the already
                                                                   extremely tight spread levels.
 Japan adding to the global monetary easing which is in turn
 expected to see inflows continue into EM. Additionally, the
 expected soft patch of data out of the US in Q2 is likely to       Bear Case                  USD Bond Index: 351 bp               Morgan Stanley & Co. Limited (“Morgan
                                                                                                                                     Stanley”) is acting as financial advisor to
 keep investor expectations of early tapering of QE contained      Global growth disappoints again on the downside, triggering       Yandex N.V. ("Yandex"), in relation to
 and hence see US Treasuries remain lower for longer.              another bout of volatility in the credit market. Fundamental      the proposed formation of a JV between
 Looking ahead, we expect a low return for the asset class as      problems remain in the DM world, with the very high level of      Yandex.Money and Sberbank of Russia,
 a whole, although some improvement should materialise in          indebtedness combined with slow economic growth.                  as announced on 19th Dec 2012.
 the second half of the year. We base this on a broader risk                                                                         Yandex has agreed to pay fees to
 environment that should remain benign, abundant global                                                                              Morgan Stanley for its financial services.
 liquidity and low funding stress                                                                                                    Please refer to the notes at the end of
                                                                                                                                     the report.
EM USD Sovereign Bond Index Spread (bp)                              Catalysts
EM bond spreads expected to remain fairly flat
                                                                     What we're watching       Why it matters

                                                                     US Economy                The rebound of the US economy is still to be confirmed, particularly
                                                                                               given the expected soft patch in 2Q13. Yet, a sudden rise in UST yields
400                                                                                            remains the most significant risk for the EM credit market at this stage,
                                                                                               the ratio between downside and upside being largely asymmetric, in our
                                                                     Fundamentals              Further signs of global economic recovery will support a continued
250                                    287                                                     allocation to riskier assets.
200                                                                  Capital flows             We have seen periods of outflows from retail funds since the start of the
                                                                                               year which needs to be watched as it could trigger a more pronounced
  Apr-11   Oct-11    Apr-12   Oct-12    Apr-13   Oct-13   Apr-14                               pullback. However, we believe the nature of flows overall is more
                                                                                               structural than in previous years, and therefore much stickier than
 Source: Morgan Stanley Research, Bloomberg                                                    cyclical retail flows.
Rashique Rahman, (212) 761-6533,
                                                                                                                                         MORGAN STANLEY RESEARCH
                                                                                                                                                       Global Debates Playbook
                                                                                                                                                                 May 17, 2013

 G10 Currency Risk-Reward View
  Investor Debates                                                   What’s in the price?                                               Trades
                                                                      USD/JPY 4Q13 forecast: 105, forward 101.55                       1)     Sell USD/JPY
   Will Japanese meet market expectations and increase
    overseas allocations?                                             EUR/USD 4Q13 forecast: 1.26, forward 1.2966                      2)     Sell AUD/CAD
                                                                      AUD/USD 4Q13 forecast: 1.01, forward 1.0001
   Will the Fed continue the current pace of its asset                                                                                 3)     Sell GBP/SEK
    purchasing program?
   What is the likelihood of the ECB cutting the deposit rate
    below zero?
 Sell USD/JPY                                       Target: 92.00  Bull Case
 We believe USDJPY has room to correct lower. The JPY                Our bull case is an economic collapse in the US triggered by
 weakening trend appears to have overshot many of the flow           fiscal restraint while Japanese investors remain reluctant to
 indicators, suggesting there is now an increasing risk of a         reallocate overseas. Weak US economic data would likely
 correction. Indeed, our analysis of portfolio flow data             weigh on USD, as the market anticipates more QE. In that
 highlights that Japanese investors have not increased               scenario, we expect the Fed to keep policy accommodative
 overseas allocation so far, but have in fact repatriated funds
 from abroad, which risks triggering a JPY corrective                in the near term. Also, we believe Japanese repatriation
 rebound.                                                            inflows have kept JGB yields suppressed, consistent with
                                                                     both BoJ monetary policy and JPY strengthening.
 While we reaffirm our longer-term JPY bearish view, we
 recommend a near-term tactical short USD/JPY position to             Bear Case
 participate in the anticipated corrective setback, targeting the
 94.00/92.00 area. Furthermore, we expect fiscal restraint           Risks to our view are (1) if Japanese life insurance and
 will likely suspend the debate on tapering QE for the time          pension funds dramatically reduce their hedge ratios, (2) if
 being, weighing on USD in the near term.                            Japanese reallocate abroad more rapidly, and (3) if BoJ
                                                                     Governor Kuroda initiates further, unexpected measures.
 Money Market Inflows No Longer USD/JPY                                Catalysts
 Supportive                                                         What we're
                                                                    watching               Why it matters
                                                                    Japanese Investor      Where and when will Japanese investors reallocate their portfolios will likely play
                                                                    Flows                  a big role in extending JPY weakness. In the long term, we expect more outflows
                                                                                           into higher-yielding foreign assets from JPY-denominated securities.
                                                                    Fed QE Tapering        On the one hand, we believe tapering QE sooner than expected could initially
                                                                    Debate                 pose a threat to global risk appetite, as strong liquidity conditions seem to have
                                                                                           been supportive since the beginning of the year. On the other, constructive
                                                                                           liquidity from the Fed should continue to support equity markets and risk appetite.
                                                                    Global Growth          According to the Global Economics team (please see the Spring Global Macro
                                                                                           Outlook, March 12, 2013), the US appears to be entering ‘daylight’, the recovery
                                                                                           phase of its economic cycle. In the long term, we believe sustainable US
  Source: Reuters Ecowin, Morgan Stanley Research                                          strength should drive USD higher, especially as US rate expectations begin to
Hans Redeker +44 207 425 2430,                              rise.                                                                           32
                                                                                                                                              MORGAN STANLEY RESEARCH
                                                                                                                                                            Global Debates Playbook
                                                                                                                                                                      May 17, 2013

EM Currency Risk-Reward View
Investor Debates                                                            What’s in the price?                                             Trades
 Will EM growth show signs of improvement in 2H13?                          EM currencies have more decisively priced in local and         Sell SGD/INR
 How will JPY depreciation impact EM currencies?                             idiosyncratic factors over the past few months, with           Buy 3m USD/MXN 1x2 Put Spread
 How aggressive (where applicable) will EM central banks                     differentiation across EM becoming the most dominant
                                                                                                                                             Buy 1y USD/CNY Put Spread
  be in preventing ‘excessive’ currency appreciation?                         theme.
 Will USD/CNY continue to head lower?                                                                                                       Sell THB/JPY
                                                                                                                                             Sell RUB vs. Basket

Base Case / Thesis                            1.5% depreciation              Bull Case                             3% appreciation
We maintain an ‘on-hold’ stance for EM currencies as we expect              Any signs of a more robust global recovery would lead to a
performance to be limited over the medium term by broad USD                 quicker closing of EM output gaps, stable commodities, and
strength and the possibility of increased intervention by EM central        may cause a bias towards tightening measures. In addition,
banks, who are faced with a still weak global environment and capital       such an environment would make currency appreciation
inflow related to G3 central bank liquidity. The Bank of Israel is the      more tolerable for central banks as exports recover. This
latest to join the growing number of ‘interveners.’ Indeed, evidence        would allow for more aggressive currency appreciation.
that global growth is still weak – in particular we watch China – and
the related decline in commodity prices makes it difficult for us to take
on a constructive view on most currencies. This is particularly the          Bear Case                             6% depreciation
case when carry is also declining, which reduces the attractiveness of      Given the heavy inflow into EM debt markets, EM currencies
EMFX and also makes it easier to hold short positions. We believe           are vulnerable to any rise in systemic risk, that may be
the correct strategy is rotating out of commodity currencies and into       related to the Euro area or to a withdrawal of liquidity from
currencies that benefit from declines in raw materials. Indeed, our         the major central banks. Also, a prolonged decline in
open trade recommendations reflect this view, as we recommend               commodities that is rooted in anaemic growth would impact
being short RUB vs the EUR, USD basket and long INR versus SGD.             the asset class.

EM FX Carry Keeps on Falling                                                  Catalysts
3m FX Forward Implied Yields (annualised)
                                                                              What we're watching       Why it matters
4.8                                                                 15
4.6                                                                 14        G3 Central Bank Policy    Helping provide a bid for EM currencies is the continuation of easy
4.4                                                                                                     policy from the world’s major central banks. Any signs of a withdrawal
                                                                                                        in liquidity provisions – such as a tapering of US QE – would have
                                                                    12                                  negative repercussions on EM currencies, and cause weakness versus
4.0                                                                                                     the USD.
3.4                                                                 9         Commodities               As commodities have come under pressure over the last few months
3.2                                                                 8                                   with weaker global macro data, we have seen underperformance in
                                                                                                        commodity-linked currencies such as BRL, RUB and ZAR. We watch
3.0                                                                 7
                                                                                                        commodities as another crucial determinant of differentiated EM
 Jan-12     Apr-12     Jul-12     Oct-12     Jan-13      Apr-13
                                                                                                        currency performance.
      Avg 3m Carry on FX Fwds (LHS)        Avg Implied 3m vol (%, RHS)
Source: Morgan Stanley Research, Bloomberg
Rashique Rahman, (212) 761-6533,
                                                                                                                                                                                                                                                                          MORGAN STANLEY RESEARCH
                                                                                                                                                                                                                                                                                       Global Debates Playbook
                                                                                                                                                                                                                                                                                                 May 17, 2013

 US Equities Risk-Reward View
 Investor Debates                                                                                                                                                                                  What’s in the price?                                                 Trades
  The Economy and the Fed – Will economic growth                The S&P 500 is trading at roughly 14.7x 2013 consensus                                                                                                                                                Themes:
   accelerate in the second half of 2013, and how long will the   earnings of $111.17. The consensus expects earnings to                                                                                                                                                1.    China Exposure – China-
   Fed continue unconventional policy?                            grow 8% in 2013 and 11% in 2014 — above the long-term                                                                                                                                                       centric US equities have lagged
  Corporate Profitability – How much more can Corporate          average of 7% growth.                                                                                                                                                                                       and are cheap vs. US-centric
   America expand margins, and what is the path of earnings                                                                                                                                                                                                                   equities.
   through 2013 and into 2014?                                                                                                                                                                                                                                          2.    Dividend Yield/Growth – the
                                                                                                                                                                                                                                                                              cohort has low payout ratios,
 Base Case / Thesis                                                                                                                          S&P 500: 1600                                          Bull Case                                   S&P 500: 1936                attractive yields vs. bonds, and
                                                                                                                                                                                                   In our bull case, sustainable economic growth driven by non-               record cash balances.
 Our earnings estimate for 2013 calls for no growth versus
 2012, followed by 7% growth in 2014. Our base case 2013                                                                                                                                           government forces takes hold, and companies begin to                 3.    Mega Caps – are attractively
 year-end price target reflects a 14.5x multiple on $110.21 of                                                                                                                                     aggressively allocate capital. We apply a roughly 15.0x                    valued and higher quality with
 2014 earnings derived from our proprietary earnings model,                                                                                                                                        multiple to $129.50 of 2014 earnings.                                      better estimate achievability vs.
 SWEEP. We assign a 60% probability to our base case.                                                                                                                                                                                                                         the broader market.
                                                                                                                                                                                                    Bear Case                                   S&P 500: 1264
                                                                                                                                                                                                                                                                        Sector weights:
                                                                                                                                                                                                   In our bear case, we apply 13.9x to our 2014 estimate of
                                                                                                                                                                                                   $90.93 to reach 1264. Our bear case represents a significant         1.    Overweight – Health Care,
                                                                                                                                                                                                   economic slowdown. We assign a 20% probability to our                      Industrials, Technology,
                                                                                                                                                                                                   bear and bull cases.                                                 2.    Market Weight – Financials,
 Our probability weighted 2013 year-end price target is                                                                                                                                                                                                                       Materials, Telecoms, Utilities,
 1600.                                                                                                                                                                                                                                                                        Energy
                                                                                                                                                                                                                                                                        3.    Underweight – Discretionary,
Our Sector Weights                                                                                                                                                                                   Catalysts
 4%                                                 Morgan Stanley Sector Recommendations                                                                                                            What we're watching             Why it matters
                                                                As of May 2013
 2%                                                                                                                                                                                                  Company Results                 Our 2013 year-end target calls for low single-digit downside predicated
 1%                                                                                                                                                                                                                                  on our view that 2014 corporate earnings are likely to modestly recover
 0%                                                                                                                                                                                                                                  from our 2013 forecasted level.
                                                                                                                                                                                                     Stock Ideas                     We recommend mega cap quality stocks, and stocks with high,
                                                                                                                                                                                                                                     sustainable and growing dividends in some combination. We are no
       Overweights - Health Care, Industrials, Technology                                                                                                                                                                            longer making a strong growth / value bet given that revenue results
(4%)   Market-Weights - Financials, Materials, Telecoms, Utilities, Energy
(5%)   Underweights - Staples, Discretionary                                                                                                                                                                                         have been muted of late.
                                                                                                                                                          D is c r e ti o n a r y
                                                       T e c h n o lo g y
         H e a l th C a r e

                                                                                                             T elec o m s
                              In d u s tr i a l s

                                                                                               M at erials
                                                                            F in a n c ia ls

                                                                                                                                                                                    S t a p le s

                                                                                                                                                                                                     Dividends                       The payout ratio of dividend-paying stocks is near historical lows, and
                                                                                                                                               E ne rgy
                                                                                                                            U t il iti e s

                                                                                                                                                                                                                                     managements have been paying themselves more in RSUs than options
                                                                                                                                                                                                                                     at a steady pace, making dividend increases increasingly likely.

                                                                                                                                                                                                     Source: Morgan Stanley Research estimates                                                                  34
 Adam Parker, (212) 761-1755,
                                                                                                                                                                                                                                 MORGAN STANLEY RESEARCH
                                                                                                                                                                                                                                                 Global Debates Playbook
                                                                                                                                                                                                                                                           May 17, 2013

                                               European Equities Risk-Reward View
                                                Investor Debates                                                                                      What’s in the price?                                                       Trades
                                                 What is the right PE for European equities?                                                          MSCI Europe is on a consensus 12m forward P/E of 12.4.                   Sectors:
                                                 Will liquidity drive stocks higher despite continued EPS                                              In our base case we assume that this ratio can rise to                   O/W – Banks, Consumer
                                                  weakness                                                                                              12.5, however an overshoot to 13.5 is possible in the bull               Discretionary, Diversified Financials
                                                 Should investors sell Quality and rotate into some of the                                             case. Our MTI indicator is in constructive territory at -0.38.           and Pharmaceuticals.
                                                  laggards?                                                                                                                                                                      U/W – Consumer Staples, Industrials,
                                                                                                                                                                                                                                 Insurance and Telecoms.
                                               Base Case / Thesis                    MSCI Europe: 1335                                                 Bull Case                            MSCI Europe: 1672
                                               Modest growth, aggressive policy’ (5% upside). We assume                                               Liquidity gains economic traction’ (31% upside). More                      Themes:
                                               the global growth environment remains relatively subdued in                                            decisive and aggressive policy action gains traction and
                                                                                                                                                      drives a re-acceleration in global GDP growth. European                    1) Tactically, we now prefer Value
                                               1H13, but accelerates thereafter. Monetary policy remains                                                                                                                         over Growth.
                                               aggressive across all regions and provides support to stocks.                                          EPS grows 14% in 2013 and 15% in 2014. Europe’s 12m PE
                                               Weak European economic growth will continue to weigh on                                                rises to 13.5 which is consistent with the peak multiple seen
                                                                                                                                                      since 2003.                                                                2) OW European financials.
                                               EPS and we forecast 5% growth in 2013 (3% ex financials).
                                               We forecast 9% EPS growth in 2014. The consensus 12m                                                    Bear Case                             MSCI Europe: 865                   3) Underweight defensives.
                                               PE for MSCI Europe rises to 12.5.
                                                                                                                                                      European recession and renewed crisis’ (32% downside).                     4) Neutral cyclicals.
                                               We probability weight our scenarios as: Bull case =20%;                                                European economic activity fails to recover and recession
                                               Base case = 60%; Bear case = 20%. Our probability                                                      lingers. European EPS falls a further 10% in 2013 and is flat
                                               weighted index target for MSCI Europe is 1310 (3% upside).                                             in 2014. Sovereign concerns resurface and drives Europe’s
                                                                                                                                                      12m PE back to 10.5.

              Europe’s earnings revisions are troughing                                                                                              Catalysts
                                               20                                                          200
                                                                                                                                                     What we're watching    Why it matters
MSCI Europe FY1 Earnings Revisions Ratio (%)

                                               15                                                          150

                                               10                                                          100                                       Growth indicators      Although the economic consensus is that the global economy will rebound in 2H13 investors
                                                                                                                  Eurozone Economic Surprise Index

                                                                                                                                                                            are a little nervous. Hence, evidence of improving economic activity would likely be positive for
                                                5                                                          50
                                                                                                                                                                            markets and cyclicals, while a further deterioration would undermine the outlook for corporate
                                                0                                                          0                                                                profits and may increase the risks of an inflation scare.
                                                -5                                                         -50
                                                                                                                                                     Monetary policy        Central bank monetary policy remains a key driver of equity prices in the short-term. Further
                                               -10                                                         -100                                                             easing from the ECB and or Bank of England would likely be a modest positive for stocks,
                                               -15                                                         -150
                                                                                                                                                                            however any signs that the Fed is getting closer to tapering off its own QE purchases would
                                                                                                                                                                            likely create headwinds for stocks.
                                               -20                                                         -200

                                                                           Earnings Revisions Ratio
                                                                                                           -250                                      EPS trends             Equities have rallied this year despite European earnings revisions falling to their lowest level
                                                                           Economic Surprise Index (RHS)
                                               -30                                                         -300
                                                                                                                                                                            since May-09. If EPS trends remain this weak, or deteriorate further, it will start to put more
                                                     09    10         11            12                13                                                                    significant pressure on equity market valuations and could cause a correction.
                         Source: MSCI, IBES, Citigroup, Morgan Stanley Research

                                               Graham Secker, +44-207-425-6188,                                                                                                                                                          35
                                                                                                                                             MORGAN STANLEY RESEARCH
                                                                                                                                                           Global Debates Playbook
                                                                                                                                                                     May 17, 2013

 Asia / GEMs Equities Risk-Reward View
Investor Debates                                                           What’s In The Price?                                      Key Trades:
 Will earnings growth resume after a lengthy plateau of  MSCI EM trailing PE of 12.1x is the close to the 5-year average             Regional Trade Ideas: We expect Asia ex
  almost two years                                            of 12.5x. We expect EM EPS to pick up and reach US$ 100 by
                                                              2013-end versus consensus expectation of US$97. Within EM,                Japan and EM Asia to outperform EM again
 Can EM Banks continue to outperform & can cyclicals         defensives trade at 74% P/E premium to cyclicals with only 4%             in 2013. We have also turned tactically
  reverse their underperformance versus defensives            ROE premium.                                                              cautious on Japan as the risk-reward has
 MSCI EM scenario-weighted target price for end- Bull Case (20% prob.): 1575 for end-2013(+50%)
 2013 is 1220 (+16%)                                          In our bull case for 2013, structural reforms in Europe &                Our key thematic ideas are : 1) Continue to
                                                              upside momentum in US and China’s economic recovery will                  Prefer Dividend Yield 2) Quality (Best
 Base Case (60% prob.): 1270 for end-2013 (+21%)                                                                                        Business Models approach) 3) Our Top pick
                                                              help in delivering a sustained upside in commodity prices. In
 Our Base case price target for 2013 is derived using MS                                                                                industry is Banks 4) Prefer Cyclicals to
                                                              our bull case , we assume global growth of 3.9% with EM                   Defensives on recovery in economic activity
 economics team’s base case forecast of 3.2% for global
                                                              GDP growth at 6.1%. This would translate into a 25%                       in 2H13– but more selectively than in 2009
 GDP growth in 2013 with EM growth of 5.4% (4.9% in
                                                              increase in EM EPS to US$ 110 and ROE of 14.7%. We also
 2012). In this scenario, we expect 14% USD EPS growth                                                                                 Our Key OW countries are: Russia, China,
 derived from a four-factor regression model which implies assume trailing P/E multiple to reach to 14.4x by end-2013.                  Poland , Hong Kong, Peru & Australia. Key
 a US$ EPS of 100 vs. consensus forecast of $97. We           Bear Case (20% prob.): 715 for end- 2013 (-32%)                           UW countries: Mexico, South Africa,
 forecast an exit trailing P/E of 12.7x for end 2013 which is In our bear case for 2012, we assume MSCI EM US$ EPS                      Taiwan, Brazil, Hungary and Philippines.
 derived using an average of the year-ahead prediction        would decline by 17% to US$73, due to a combination of                   Key OW industries are: Banks, Consumer
 from four quant models. Our base case ROE is 14.0%.          weaker commodity prices, DM GDP growth and FX losses in                   Services, Energy, Semiconductors, Pharma
                                                              a more recessionary / risk-ff environment. In our bear case               and Software and Key UW industries:
                                                              we assume global growth of 2.4% with EM GDP growth at                     Food Beverages, Retailing, Health Care
                                                              4.6%. In this scenario, we assume a trailing P/E multiple of              Equip., Tech Hardware, Consumer Durables
                                                              9.8x for 2013 with ROE at 11.5%.                                          and Telecom
         Morgan Stanley Target Price History for MSCI EM                                Key Indicators to Watch
1,500    MSCI EM USD                                                                    What We're
1,350   December 11th, 2006                                                             Watching              Why It Matters
         MS GEMs Strategy

             Initiation                                                                 China & Asia Macro    China’s growth indicators in April posted mixed results. IP growth
                                                                                        Data                  picked up but was lower than expectations (+9.3Y vs. +8.9%Y in Mar),
1,050                                                                                                         FAI growth moderated to +20.6% YTD YoY% (vs +20.9%Y in Mar)
                                                                                                              while Retail sales growth and power production growth strengthened
 900                                                                                                          to +12.8%YoY (vs. +12.6%Y in Mar) and 6.2%Y ( vs. +2.1%Y in Mar)
                                                                                                              respectively. Going forward, we need to see a sustained pickup in
                                                                                                              economic activity in China and Asia, to achieve our target prices for
                                                                                                              APxJ and EM.
            MSCI EM   Benchmark                                                         Corporate earnings    In the ongoing 1Q13 earnings season, both APxJ and EM earnings
 450        MSCI EM
            MSCI EM
                      Index Price Target
                      Index Bear Case
                                                                                                              have beaten consensus estimates by 3% and 2% respectively. For
            MSCI EM   Index Extreme Bear case*                                                                APxJ, this is the highest earnings surprise since the time we began
                                                                                                              tracking quarterly earnings from 3Q2011. We believe earnings growth




















                                                                                                              will be more important than further P/E expansion in driving the target
                                                                                                              price upside from here for APxJ and EM equities
 Source: MSCI, Factset, Morgan Stanley Research. Data as of May 13, 2013                                                                                                         36
                                                                                                        Jonathan Garner, +852 2848 7288,
                                                                                                                                                                  MORGAN STANLEY RESEARCH
                                                                                                                                                                                     Global Debates Playbook
                                                                                                                                                                                               May 17, 2013

Crude Oil Risk-Reward View
Investor Debates                                                                                            What’s in the price?
Will refinery run cuts actually occur given the poor margin environment in the                              Oil prices continue to hover between $100-105/bbl amid lingering macro concerns and
EU and Asia? A poor margin environment owing to weak demand has sparked fears                               poor economic data. Weak end-user demand, from the EU primarily, has also caused
of refinery run cuts in the EU and possibly even Asia. We view this as a relatively low                     concern resulting in poor refining margins, and sparking fears of potential run cuts.
probability event as firmer physical markets indicate balances are somewhat tighter                         However, impending maintenance with the Ekofisk stream (one of 4 crude streams that sets
                                                                                                            the price for Dated Brent) in June and lower than expected Nigerian exports for May and
than future markets and recently poor economic data suggest. In addition, though
                                                                                                            June, have provided support in light of weaker crude demand scenarios East of the Atlantic.
stocks are in better shape than 2012, inventories are still at relatively low levels; run                   In the US, margins remain relatively robust given stabilizing domestic demand and
cuts will likely eat into any surplus of product inventories over the past year,                            continued exports to Latin American markets; crude runs are inline with 2012 levels despite
provoking another margin rally, similar to 3Q12.                                                            new refinery capacity as planned maintenance (such as BP Whiting) is ongoing.
Base Case / Thesis                                                                                                   2013 =$110/bbl (Brent)                Bull Case                     2013: $116/bbl
Near-term risks remain, but we would be buyers as Brent hovers near $100/bbl. Although near-term downside risk remains, the                               Renewed geopolitical risks reignite fears of supply
2Q13 sell-off in Brent is unlikely to match that of 2Q12. In fact, the global oil balance looks much tighter this summer with prices likely to            disruption. In particular, if Iranian threats to close the
trade back up to $110-115/bbl in 2H13. As a result, we believe the risk-reward for 2H13 becomes quite attractive as front-month prices                    Strait of Hormuz are realized, prices would rise sharply
approach $100/bbl with potential to capture upside from both spot prices and backwardation.                                                               owing to the lack of alternate routes available to
                                                                                                                                                          transport the 15-17 mmb/d of crude flowing through
Prices could face additional pressure near term. Brent’s risk-reward is now more balanced, but we still have reservations that keep                       the strait. Moreover, if non-OPEC supply disappoints
us on the sidelines for now. Our concerns center around two key areas, with a particular focus on Europe and Brent. Crude demand is                       again on elevated shut-ins and/or project delays, it
likely to be weak over the next month or two, particularly in Europe and the Atlantic Basin. Elevated refinery maintenance and a
                                                                                                                                                          would force OPEC to bring more barrels to the market
disappointing macro remain as headwinds, while poor European refining margins likely limit near-term crude demand recovery.
                                                                                                                                                          and in turn, thin already limited spare capacity.
2Q13 weakness unlikely to match 2Q12 levels. Following high prices, ongoing elevated OPEC production and significant fear-
induced stockpiling in 1Q12, 2Q12 was setup for a large correction. The ensuing correction was exacerbated by concerns of a euro                           Bear Case                     2013: $102/bbl
break-up coming to a head. The 2Q13 setup is much less bearish. Macro tail risks have faded, OPEC proactively cut production at year-                     Greater economic woes. DM policy errors, primarily
end, and the oil market is not facing the same inventory overhang. In addition, supply concerns, stemming from North Sea maintenance                      from the US fiscal cliff, and debt contagion from
and lower than expected WAF exports have and continue to support Brent structure.                                                                         Europe spread globally may damage an already weak
The Brent market should firm this summer with prices likely trading back up to $110-115/bbl. Any 2Q12 weakness will likely be                             economy. While not a repeat of 2008, we believe
short-lived. If we look past peak maintenance, global crude balances look much tighter despite prolific supply gains from the US and                      global oil demand growth could fall well below 2012
Canada. The IEA expects global crude throughput to increase by over 2.1 mmb/d from March to June vs. a seasonal norm of 1.7                               levels, with sluggish growth from the emerging market.
mmb/d. We estimate OPEC will need to lift production by over 850 kb/d from 1Q13 to 3Q13 to keep inventories from drawing beyond                           If OPEC is slow to respond, large inventory builds
seasonal norms. The greater demand pull and reduced spare capacity should create upside for price and structure this summer.                              could be realized.
2Q Downside Risk to Feed into Summer Strength                                           Catalysts
(MS average Brent price forecast, $/bbl)
 135                                                                                     What we're watching          Why it matters
 125                                                                                     US/Euroil/China/Japan        Provides timely confirmation of demand developments in the OECD – weekly
                                                                                         Fundamental Data             for the US and Japan, monthly for Europe and China. In addition, inventory
 115                                                                                                                  level updates help us evaluate our forecasts for supply and demand.
                                                                                         Physical Markets             The structure of the forward curve, as well as crude and product prices in the
  95                                                                                                                  cash markets, provides color on what the fundamentals are saying – there is
                                                                                                                      little influence from speculators in the cash markets.
   Jan-11      Jul-11       Jan-12         Jul-12           Jan-13     Jul-13
                                                                                         The Middle East: OPEC        OPEC must continue to produce at elevated levels to keep markets balanced.
             Price                     2013 Bear                     2013 MS Base
                                                                                         and Geopolitical Tensions    Iran and Syria could quickly reignite supply fears if tensions escalate further.
             2013 Bull                 2011 Average Price            2012 MS Forecast

Source: Bloomberg, Morgan Stanley Commodity Research estimates                          Adam Longson, (212) 761-4061,                                                             37
                                                                                                                                                 MORGAN STANLEY RESEARCH
                                                                                                                                                                Global Debates Playbook
                                                                                                                                                                          May 17, 2013

 US Corporate Credit Risk-Reward View
  Investor Debates                                                         What’s in the price?                                                  Trades
                                                                                                                                                 Modest Overweight IG, Equal-
   Can the bull market for fixed income corporate credit                   Fundamental improvement has stalled, and valuations are
                                                                             less attractive in US IG and HY. Weak growth is starting to         weight in HY– We remain modestly
    continue given historically low yields?
                                                                             filter through and defaults have ticked higher in HY.               overweight investment grade overall,
   Will 2013 be another “beta” year or will credit picking                                                                                      but recommend looking at pockets of
    matter?                                                                 Corporates remain cash rich in sub-par growth world.
                                                                            In IG, yields are at all-time lows, whereas market duration         value, but don’t think risk reward is
   Can Financials continue to outperform Industrials?                                                                                           too attractive in HY. Within IG, we are
                                                                             and dollar prices are at all-time highs.
   How does rising M&A activity impact the credit market?                                                                                       overweight Financials and the TMT
  Base Case                 Modest OW for IG, EW for HY                     Bull Case                     Robust Growth Returns                 sector.
                                                                           IG 104bp, HY 467bp. US economic growth and corporate
  IG 157bp, HY 577bp. 2013 will be a lower total return year                                                                                     Prefer the front-end in IG cash
                                                                           earnings surprise to the upside. The new issue market is
  for credit, a simple reality dictated by tighter spreads and                                                                                   bonds– We think roll-down will be a
                                                                           robust for most credits. Liquidity improves meaningfully as
  lower yields, in our view what you buy will be more important                                                                                  key driver of performance in 2013
  than if you buy.                                                         dealers and investors re-risk. Easier financial conditions,
                                                                           rising inflation expectations, and higher risk-free yields            and like the 5-7Y sector in US IG.
  We maintain an overweight on US IG, given the strong                     provide a better entry point into high quality credit, while low
  technical backdrop from Fed policy. We forecast cash IG                  defaults drive investors into HY.                                     Leveraged Loans Over HY Bonds –
  spreads at 157bp and CDX IG at 66bp. We think risk/reward
  is not overly attractive for US HY and forecast a total return            Bear Case                           Mild US Recession               For investors looking to stay
  of 3.1% for HY bonds and 5.0% for loans.                                                                                                       defensive, we recommend
                                                                           IG 218bp, HY 836bp. European sovereign stresses escalate              purchasing loans over HY bonds.
  In IG, we are overweight Financials, given the improving                 and Financials deteriorate, pushing the US into a mild
  fundamental trend relative to non-financials. We expect more             recession. Spreads widen materially (at or above 2002                 Prefer CDS Longs to Cash Bonds –
  dispersion in performance in 2013 and the case for credit                wides) as investors demand more compensation for volatility           Given cash versus CDS valuations
  picking should get stronger as a low growth environment                  and deteriorating fundamentals. HY defaults rise to 5.9%, but         and excessive premium prices in
  should differentiate winners from losers.                                remain below prior recessions due to strong fundamentals.             cash, we prefer CDS longs.
Modest Overweight in IG in 2013                                               Catalysts
(bp)                 IG Spreads - Historical and Projected
300                                                                           What we're watching         Why it matters
                                                                              Rates, dollar prices        Falling yields have been a support for corporate credit as a fixed
                                                                  218 (10%)                               income asset class. A spike in yields could curb the strong trend in
200                                                                                                       inflows into credit. High dollar prices increase potential downside if we
                                                                                                          see a potential credit negative environment.
150                                                               157 (50%)
                                                                              Corporate Credit            Even as flows and issuance remain strong and a key driver of credit
100                                                  130          104 (40%)   Fundamentals                spreads today, we expect fundamentals to matter more going forward.
                                                                                                          In spite of generally healthy fundamentals, we have seen some
 50                                                                                                       deterioration across IG and HY as well as a pick up in defaults.
  Jan-10           Jan-11        Jan-12        Jan-13
                                                                              US Fiscal Cliff,            While our US Economists expect slow but steady 2% economic growth
         Historical Spreads       Current Spread        Spread Base Case      Eurozone Contagion          for the next few years, the possible fiscal cliff at the end of 2012 could
       Source: Morgan Stanley estimates, Yieldbook
                                                                                                          be a major impediment to growth if not resolved.
 Sivan Mahadevan (212) 761-1349, . Adam Richmond (212) 761-1485,
                                                                                                                                     MORGAN STANLEY RESEARCH
                                                                                                                                                   Global Debates Playbook
                                                                                                                                                             May 17, 2013

European Corporate Credit Risk-Reward View
Investor Debates                                                  What’s in the price?                                               Trades
                                                                                                                                     Buy short-dated credit volatility –
 How severe of a recession in the price? What can                 Spreads still imply above-average default rates, but the risk    Trading cheap versus recent
  investors do in low yield, low growth world?                      premium now looks broadly ‘average’, either outright or          realized, credit volatility offers an
 How powerful are the “technicals”. Our work suggests              adjusted for leverage. Financials valuation advantage has        inexpensive, convex hedge against
  European insurers are incentivised to add significantly           diminished. GBP market priced with more risk premium.            seasonal summer weakness
  more credit. But the ‘technicals’ have weakened before.           Credit volatility is rich, pricing below realized volatility.
                                                                                                                                     Buy GBP Credit – the cheapest
                                                                                                                                     corporate credit market globally.
                                                                   Bull Case                                Japan(ification)        Valuations, investor positioning, and
Base Case                                 Muddle Through                                                                             lower net supply are all advantages
                                                                  Decisive policy action across regions reduces systemic risk        for £ credit
Europe looks increasingly Japan-like, with poor growth, weak      premiums. ECB cuts rates and with the OMT, pushes
credit demand and slow deleveraging. In contrast to other         peripheral yields aggressively lower and reduces financial         Curves are too steep, we think 3s/5s
regions, the incentives for bondholders and issuers remain        fragmentation. Overall growth remains subdued Peripherals          flatteners, which benefit from positive
broadly aligned, especially in the periphery.                     and financials LT2 debt benefit the most.                          carry and are long default exposure,
                                                                                                                                     are most attractive
However, tighter spreads increasingly reflect this backdrop,
and growth remains extremely weak. We recommend                                                                                      Long core, high quality LT2s. Bank
                                                                   Bear Case             Resurgence in Systemic Risk                deleveraging ongoing, core LT2s
investors use market strength to move up in quality, and
increase differentiation in credit portfolios. We have recently   Markets are too confident that the OMT (which remains              have lagged senior rally.
downgraded High Yield to E/W                                      untested) is operational, and that the ECB and other
                                                                  policymakers are willing to relax their austerity demands.         Prefer European IG over HY. Within
We worry less about a rise in yields or asset reallocation.       Weaker growth leads to another round of peripheral ratings         HY, move up in quality. In a change
Our greatest fears are elevated investor sentiment, and           downgrades, and puts more pressure                                 of view, we now prefer BBs of
overestimating the commitment of the ECB to keep systemic                                                                            Single-Bs
risk contained                                                                                                                       In core IG, sell bonds and sell CDS
                                                                                                                                     to take advantage of positive basis,
Credit Valuations looking ‘Average’                                  Catalysts                                                       reduce rate duration, and reduce
EUR IG Non-Financial Asset Swap Spreads (bp)                                                                                         potential loss in a default

                                                                     What we're watching         Why it matters
                                                                     Depth of recession          Our economists expect Eurozone to contract by 0.2% in 2013. The risk
                                                                                                 is that growth stalls more than expected, and corporates face more
                                                                                                 severe stress to earnings and cashflow.
                                                                      Signs financial            ECB actively targeting fragmentation aids funding picture for peripheral
                                                                      fragmentation is abating   corporates and sovereigns, reducing systemic risks; credit availability
                                                                                                 becomes more about balance sheet strength than domicile
                                                                      Speed of deleveraging      Deleveraging drives continued negative net issuance out of European
                                                                                                 banks and low net issuance in corporates.

 Source: Morgan Stanley Research, iBoxx
 Andrew Sheets, +44 20 7677 2905,
                                                                                                                                                             MORGAN STANLEY RESEARCH
                                                                                                                                                                               Asia Credit Strategy
                                                                                                                                                                                      January 2012

Asia Corporate Credit Risk-Reward View
Investor Debates                                                                    What’s in the Price?                                                     Key Themes
 When will policy tightening in China begin?                                        Asian credit spreads still compensate well for volatility. The          Spreads: expect moderately tighter
                                                                                      Current IG spread per loss-adjusted volatility (SPV), at 76              spreads.
 Are credit valuations too rich at current levels?
                                                                                      bp/%, is much higher than the long term median of 36bp/%.               Key stance: We are constructive on
                                                                                                                                                               high-quality Asian credit. We see
                                                                                                                                                               good reward/risk in Asia IG,
                                                                                                                                                               favouring financials.
Base Case                                (150bp, 60% prob, +3.4% ER)                 Bull Case                    (125bp, 20% prob, +4.7% ER)                Supply: expect over US$100 billion
                                                                                                                                                               of gross corporate supply, similar to
Global recovery: Sluggish but recovering global growth                              Strong growth: policy gains traction and vigorous private                  last year.
(global GDP +3.2%) but no global monetary policy unwind                             sector demand allows government stimulus to step back. Global
                                                                                                                                                              Key risk: Policy unwind looms as the
yet. Macro favours both equity and credit markets. Stronger                         GDP: +3.9%. Credit spreads reach a post-2008 tight consistent
                                                                                    with very low volatility but fails to regain all-time tights as policy     bigger risk on the investment horizon
growth drives an increase in corporate spending and
moderate deterioration in balance sheet quality. China begins                       unwind risks loom and corporate animal spirits trigger more                with China first among the major
to tighten and moves policy to a neutral stance, leading to                         rapid deterioration in balance sheets.                                     economies.
deteriorating credit conditions, an increase in idiosyncratic                                                                                                Key Trades
risks and volatility for lower-rated credit. Spreads tighten to                      Bear Case                    (275bp, 20% prob, -3.1% ER)
                                                                                                                                                              Sovereigns: Tactically constructive
long-term averages consistent with moderately higher                                                                                                           on HY sovereigns.
volatility.                                                                         Downturn: Global downturn most likely triggered by policy
                                                                                    tightening – consciously or not. Triggers: EU/US policy mistake           IG: Constructive, prefer Financials
                                                                                    – AXJ growth is now more dependent on external demand – or                 over non-Financial corporates, bank
                                                                                    aggressive policy tightening in China. Global growth: 2.4%.                capital and bond-like hybrids.
                                                                                    However, more responsive central bank prevents systemic risks             HY: Neutral China HY, marginal
                                                                                    similar to 2011. Asian credit spreads widen but hold inside                preference for property over
                                                                                    3Q11 levels.                                                               industrials.
                                                                                                                                                              Curve: We prefer the 6-10y part of
Asia IG: Marginally Tighter Spreads through 2013 Catalysts                                                                                                     the IG curve.

               350                                                                     What We're Watching           Why it Matters
                                                                                       Credit Conditions in          Asia high yield credit is highly sensitive to credit conditions in China:
Spread (bps)

                                                                            275bp      China                         when credit growth accelerates China HY outperforms markets and vice
               250                                                                                                   versa. Slowing credit growth in China remains an important headwind for
                                                            180                                                      Asia HY.
                                                                            170bp      Rates                         Falling yields have been a support for corporate credit as a fixed income
               150                                                          150bp                                    asset class. A big spike in yields could curb the strong trend in inflows
                                                                            125bp                                    into credit.
                                                                                       Eurozone Contagion            Our Global Economics team expects only a mild European recession, but
                 Jan-10        Jan-11      Jan-12      Dec-12      Dec-13
                                                                                                                     Eurozone sovereign stresses remain on investors’ minds.
                Historical Performance      Current Spread      Spread Fair Value
   Source: FactSet, Morgan Stanley Research estimates                                                                                                                                             40
   Viktor Hjort, +852 2848 7479,
                                                                                                                                                  MORGAN STANLEY RESEARCH
                                                                                                                                                                    Asia Credit Strategy
                                                                                                                                                                           January 2012

Securitized Credit Risk-Reward View
Investor Debates                                                             What’s in the price?                                                 Trades
 Magnitude and timing of losses in mortgage pools, both                      The sustained rally in securitized products has yet to expunge     RMBS: Long originally AAA tranches
  residential and commercial.                                                  investor interest. While the run-up in non-agency RMBS can be      of Alt-A Collateral
 Uncertainties of cash flows due to loan modifications and                    attributed to conviction in a US housing bottom, with scenarios
                                                                                                                                                  RMBS: Long Last Cash Flow
  resolution of foreclosures between judicial and non-judicial states          adjusted accordingly, we still believe prices reflect worse
                                                                               economic outcomes than alternatives, and offer attractive value
                                                                                                                                                  tranches off aggressively modified
 Resolution of put back related litigation.                                                                                                      Subprime Pools
 Re-pricing in leveraged loans, changes to FDIC assessments                   in today’s low yield environment.
  and the effect of BoJ actions                                                                                                                   CLO: Long US and European AAA’s,
                                                                                                                                                  both legacy and new issue
 Base Case / Thesis                                                           Bull Case                                                          CLO: Long 2.0 Mezz
 In non-agency RMBS, the broader low yield environment has fostered
 strong investor appetite in the relatively higher yields of this asset      Rising home prices combined with easing mortgage credit
                                                                             standards unlock credit for non-agency borrowers who have not        European CMBS: Long senior and
 class. Further, the apparent sustainability of the housing recovery                                                                              selective mezz tranches
 promises to boost all aspects of the market, with investors already         been able to refinance, sending prepayments higher. In CLOs, the
 adjusting bond pricing scenarios to reflect lower defaults and losses.      AAA mispricing corrects (tightening to below 100 bps) and re-        UK Non-Conforming RMBS: Mezz
 Finally, the rapidly shrinking legacy market provides a positive supply     prices the capital structure.                                        tranches with pro-rata optionality
 technical going forward.
                                                                              Bear Case
 In CLOs, BBB and above tranches have attractive returns that are            Any macro event that causes a selloff in risk assets broadly would
 invariant to a broad range of default and recovery outcomes. Single-A       be a negative for the securitized credit space. For non-agency in
 tranches are a “sweet spot”. The AAA tranches, both in legacy and           particular, blanket principal forgiveness modifications for
 new issue, both in US and European markets are among the highest            performing borrowers would add duration while removing potential
 spread pick up opportunities in the class of risk remote, ratings stable    positive convexity of prepay increases. Loan re-pricings in
 investments.                                                                leveraged loans reducing excess spread in recent vintage new
                                                                             issue transactions and the effect of the new FDIC rules on
                                                                             assessments reducing the potential sponsorship of CLO AAAs by
                                                                             US domestic banks are key risks for CLOs

New Issue Curve Flattening: CLOs
                                                                            What we're watching          Why it matters

                                                                            Potential for policy         Mortgage credit conditions remain tight. Any policy action to expand or
                                                                            intervention                 further constrain the credit box would be very meaningful for
                                                                                                         securitized products in general.
                                                                            BoJ Actions                  Securitized assets are among the yieldier USD/EUR denominated
                                                                                                         assets that are potentially of interest to Japanese banks and insurers.

     Source: Morgan Stanley Research                                                                                                                                                   41
Vishwanath Tirupattur, (212) 761-1043,
                                                                                                                                              MORGAN STANLEY RESEARCH
                                                                                                                                                            Global Debates Playbook
                                                                                                                                                                      May 17, 2013

                                                                                                    In the United States, portions of this report regarding non-US options are
 Global Credit Derivatives Risk-Reward View                                                         intended for Morgan Stanley’s Institutional Clients only.
  Investor Debates                                                   What’s in the price?                                                    Trade Ideas
   Are we in a low-vol world? What does a low-vol world look         Implied credit volatility is close to post crisis lows, but remains   OPTIONS:
    like and what is the optimal investment playbook?                  high relative to pre-crisis realized vol levels.                      Sell Straddles to Lock-in Ranges,:
   Can CDS continue to outperform cash bonds?                        Credit curves have steepened recently, and forward spreads            We think the implied-realized premium
   Could credit curves steepen further? What could be the             trade at multiples of worst case losses.                              is large enough to motivate investors to
    catalyst of curve flattening today?                               CDS has significantly outperformed cash this year, given the          consider short straddles to own ranges
                                                                       headwind from higher rates and dollar prices.                         in CDX IG.

  Base Case / Thesis                                                  Bull Case            Tighter spreads, lower volatility                Sell Slightly OTM Payers: Relative to
                                                                     CDX IG 61bp, Growth surprises to the upside and contained               realized distribution, we think the
  CDX IG 66bp, Credit spreads have rallied on the back of                                                                                    options market overestimates modest
  central bank policy and technical support for fixed income         sovereign volatility in faster progress on fiscal consolidation in
  assets in general. Our models predict CDX IG modestly              Europe complements stronger US growth as the fiscal cliff is            downside and like selling OTM payers
  tighter from current levels in 2013.                               largely resolved and a ‘grand bargain’ is reached. Policy               to monetize excessive hedging.
                                                                     certainty lifts business and consumer confidence, allowing
  Even-though volatility is at post-crisis low, we highlight that    business inventories to climb.
  the investment playbook for sustained periods of low                                                                                       INDICES:
  volatility is different from other points in the cycle.             Bear Case Recession, wider credit                                     Front-end Flatteners, Long 10Y
  Credit curves are too steep given the spread regime and we         spreads, and higher volatility                                          CDS/CDS: Given steep curves and roll-
  think the best opportunity for flatteners is in the front-end of   CDX IG 83bp, Risks skewed to the bear case as the US                    down, we think the best opportunity is in
  CDX indices.                                                       faces substantial fiscal tightening and business spending               the front-end of the IG and HY market.
                                                                     moves downwards, leading to a slower growth regime or mild              The long end of the CDS market is a
  We like junior mezzanine tranches in legacy indices for the                                                                                good strategic long in the US
  spread and senior mezzanine tranches in new indices to             recession. Producer inflation inches higher due to
  cushion against dispersion and to lever carry and roll-down.       international unrest, inventories stagnate and EU sovereign             TRANCHES:
                                                                     woes trigger funding stresses. 42                                       Long Mezzanine Risk: We like owning
                                                                                                                                             mezzanine risk in IG indices to lever
  CDX IG: Range-bound in 2013                                          Catalysts                                                             carry and roll-down in a low-vol world.
                                                                        What we're watching         Why it matters
                                                                        Credit Volatility           The investment playbook for a sustained period of low volatility is
                                                                                                    different from other parts of the cycle.

                                                                        Cash / CDS Basis            The cash CDS basis, while driven by more sector-specific factors
                                                                                                    today, could be more sensitive to funding risks in an extreme outcome.
100                                                                                                 On the other hand, single name hedging could drive the basis more
                                                                                                    positive in certain sectors in a more idiosyncratic environment.
                                                                        Index and Tranche           Credit curves can move around a lot in times of stress, and the curve
                                                                        Curves                      shape will be an important indicator for deciding the optimal maturity at
 Nov-03     Nov-05      Nov-07      Nov-09     Nov-11     Nov-13                                    which to implement directional (i.e., long/short) trades.
  Source: Morgan Stanley Research
 Sivan Mahadevan, (212) 761-1349,                                                                                                               42
                                                                                                                                                MORGAN STANLEY RESEARCH
                                                                                                                                                              Global Debates Playbook
                                                                                                                                                                        May 17, 2013

Cross-Asset Volatility
  Volatility and Skew Remain Low as Markets Rally

   Equity vol low, skew                       Near-term equity volatility remains low and skew is at historical norms.
   Credit vol similar to equities             While market consensus on tail risks seems to be relatively sanguine for the moment, there are several catalysts looming
                                              in the next several months. Various market sentiment and pricing indicators suggest investors have become very
                                              comfortable with tail scenario risks. Volatility has fallen across assets from October 2011 highs.
   US rates                                   Vols fell led by gamma over the past week, causing the vol surface to steepen. Lower realized volatility and term premiums
                                              have pressured implieds to fairer levels, and we do expect implieds to stay within this range.

   FX                                         Vols continued to fall in both USD and EUR crosses across the board. Meanwhile, AXJ and CEEMEA vols appear to be
                                              flat to slightly higher.

                                                                                                                                                              Change in
                                                                                      Change in             3m imp           Change in                       spread/price
                                                    Current          2006-07         3m vol since          vol 3y %-         skew since       3m skew        since Jun 1,
 Asset Class        Asset                             vol            average          Jun 1, 2012              ile           Jun 1, 2012      3y %-ile           2012
 Equities           SPX                                12%              13%               -12%                 1%                  7%           0%                 24%
                    SX5E                               18%              15%               -14%                 13%                 8%           30%                27%
                    HSI                                16%              17%               -10%                 9%                  2%           2%                 19%
                    EEM                               16%              28%                -17%                 4%                  7%           16%                14%
 Credit             CDX IG                            36%               NA                -23%                 0%                  0%           70%              -45 bps
                    iTraxx                            42%               NA                -30%                 1%                  1%           55%              -66 bps
 Rates              1y US Rates                      19 bps           61 bps             -20 bps               4%                -8 bps         31%              -27 bps
                    10y US Rates                     63 bps           67 bps             -32 bps               0%               -12 bps         72%               24 bps
 FX                 EURUSD                             8%              7%                  -5%                 8%                 -2%           19%                 5%
                    USDJPY                            13%              7%                   3%                 96%                -1%           9%                 26%
 Commodities        Oil                               20%              29%                -18%                 3%                 -2%           39%                 7%
                    Gold                              16%              19%                 -7%                 29%                 1%           99%                -8%
Note: Rate volatility is in normalized basis points, credit volatility is volatility of spreads, and all others are price return volatility
* Pre-Crisis Average is the average level from 7/1/06 through 6/30/07
Source: Morgan Stanley Research, Morgan Stanley Quantitative and Derivative Strategies, Bloomberg
Portions of this report regarding non-US options are not intended for US clients, other than Institutional Clients. Investing in options is not suitable for all investors.
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Please direct all market-specific questions to the coverage analyst and all options-specific questions to Sivan Mahadevan, Derivative Research Strategist.
Sivan Mahadevan (212) 761-1349,
                                                                                                                                                     MORGAN STANLEY RESEARCH
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Disclosure Section (Cont.)
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 Stock Rating Category                                                  Count                  % of Total                    Count              % of Total IBC       % of Rating Category

Overweight/Buy                                                          1034                        36%                        399                       39%                       39%
Equal-weight/Hold                                                       1250                        44%                        479                       47%                       38%
Not-Rated/Hold                                                            105                        4%                        27                         3%                       26%
Underweight/Sell                                                          473                       17%                       123                        12%                       26%
Total                                                                   2,862                                                1028
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                                                                                                                                                         MORGAN STANLEY RESEARCH
                                                                                                                                                                         Global Debates Playbook
                                                                                                                                                                                   May 17, 2013

Disclosure Section (Cont.)
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                                                                                                                                                                         Global Debates Playbook
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                                                                                                                                                                   Global Debates Playbook
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                                                                                                                Global Debates Playbook
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