JPM-US-Equity-Outlook-2011

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					                                                                                                              North America Equity Research
                                                                                                              10 December 2010




2011 Outlook
YE 2011 Target 1425; Raise '11E EPS to $94 from
$91; Introduce '12E EPS of $102

We see the S&P 500 delivering at least a 15% gain 2011, driven more by valuation                              US Equity Strategy
expansion (risk premium falling) than EPS beats. Our YE2011 S&P 500 target is                                                                  AC
                                                                                                              Thomas J Lee, CFA
1425, based on 14x 2012E EPS of $102. History (see below) suggests an even stronger
                                                                                                              (1-212) 622-6505
20%-plus gain, and history also suggests there should be more rapid industry rotation                         thomas.lee@jpmorgan.com
in 2011 (year 3) than any prior year. Thus, for the portfolio manager, 2011 represents
                                                                                                              Daniel M McElligott
some daunting challenges—a 15-20% “bogey” to beat along with even greater group
                                                                                                              (1-212) 622-5598
rotation than in 2010. Thus far, this market has been “textbook” in staging                                   daniel.m.mcelligott@jpmorgan.com
leadership, and we introduce some tools in this report to target alpha generation.
                                                                                                              J.P. Morgan Securities LLC
• US GDP growth is forecast to accelerate to 3.5% (4Q/4Q) from 2.6% in 2010 (see
  Figure 9) aided by expansionary behavior by business and consumer, rehabilitation
  of consumer balance sheets, and accommodative fiscal and monetary policy. We see                            Year-End 2011 S&P 500 Price Target: 1425
  labor picking up, adding 175k/month. Inflation remains muted due to resource slack.
                                                                                                              S&P EPS Estimates
• History strongly argues for an even stronger year in equities. This is the 3rd year
                                                                                                                                  JPM                  Bottom-Up
  of a business expansion AND the 3rd year of a presidential term. There were only 5
                                                                                                                              Strategy                      Street
  periods (see Figure 10) in the 111 years of Dow history when both occurred and
                                                                                                              2010E            $85.50                     $84.67
  markets rose in each instance posting an average gain of 21%. The risks of a bear                           2011E            $94.45           +10%      $95.88
  market in 2011 appear low given (i) low recession risk; (ii) low inflation;                                 2012E           $102.00            +8%     $108.97
  (iii) positive real rates; and (iv) higher EY vs. BAA BY. These 4 items were key
                                                                                                              Sector Weightings
  determinants (of 20 we examined) of longer (vs. shorter) bull markets (Figure 14).
                                                                                                              Overweight:          Financials
• Finally, relative value should strongly support stocks in 2011. Equity risk premium                                              Industrials
  remains at 50-year high at 6.2% (see Figure 15) (our 14x assumes premium drops to                                                Energy
  5.7%, well above 10-yr avg. of 3.56%). Moreover, forecast returns in 2011 for fixed                                              Materials
                                                                                                                                   Technology
  income markets are meaningfully weaker—with treasuries negative (see Figure 17),                                                 Discretionary
  high grade +2%—against double-digit increases seen for commodities and equities.
                                                                                                              Neutral:             Healthcare
• Sector correlations historically have fallen to cycle lows during the 3rd year of a bull                                         Telecom
  market suggesting a drop in correlation from 90% (see Figure 21).                                           Underweight:         Staples
                                                                                                                                   Utilities
• MARKET STRATEGY: GROUP LEADERSHIP LIKELY ROTATES MORE
  RAPIDLY IN 2011, ARGUING FOR STAGING MARKETS. We compared the                                               Strategy View
  price performance of 30 industries at each point in the bull market cycle (thus,                            • Third year of expansion and third year of
                                                                                                              presidential cycle
  staging) and found top-quartile leadership shifted rapidly in Year 3 compared to
                                                                                                              • Credit eases in 2011 and labor grows
  Years 1 and 2 (see Figure 26). This seems logical to us as a fall in correlation leads                      175k/month
  to divergences and business cycle dynamics dominate. This bull market, as we                                • Sector rotation greatest in third year of bull
  noted, has been a “textbook” example thus far. The top 8 groups which history                               market; best window is 4-mo intervals
  indicated should outperform in 2010 indeed outperformed by 1,000bp while the                                • Favor Cyclicals early in ’11 and Defensives
  expected worst 8 (based on history) underperformed by 400bp. For 2011, staging                              later in year
  analysis suggests best groups in the first 4 months of 2011 should be: Asset                                • Domestic Cyclicals over Int’l
  Managers, Insurance, Construction Materials, Restaurants, Retail, Gaming,
  and oddly Telecom Services, and Utilities (see Figure 25).
• 18 IDEAS. We identified 18 names expected to outperform in early 2011, using the
  following criteria: (i) top quartile of staging (above); (ii) top style factor of high-beta
  which is attractive on institutional ownership and relative P/E (vs. LT avg.); and
  (iii) rated OW. The tickers are: ODP, OZM, IVZ, ALL, NIHD, OMX, OC, LVS,
  LTD, MW, AFL, GPI, BEN, PNK, HIG, M, MET, and AXP.


See page 70 for analyst certification and important disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may
have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their
investment decision.
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




                          Table of Contents
                          #1: Solid GDP Growth Expected in 2011 ................................3
                          #2: History Argues for 20%-Plus Year ....................................9
                          #3: Relative Return of Equities Should Outperform Risky
                          Assets......................................................................................13
                          Setting Target of 1425 ............................................................17
                          Market Strategy: Staging as Correlation Falls .....................19
                          Staging in 2011: The Year in 3 Phases…..............................25
                          STOCKS: 18 Names for 1st Third of 2011 ............................29
                          Special: Still See Housing Bottom in 2011...........................31
                          Risk: P/E Volatility ..................................................................35
                          Risk: Sovereign Concerns Real ............................................37
                          Risk: Municipal Debt—Budget Deficits Helped by Recovery
                          in Revenue ..............................................................................39
                          2011 Sector Outlook...............................................................43
                          Basic Materials: Overweight..................................................45
                          Industrials: Overweight..........................................................47
                          Consumer Discretionary: Overweight ..................................49
                          Technology: Overweight........................................................51
                          Energy: Overweight................................................................53
                          Financials: Overweight ..........................................................55
                          Healthcare: Neutral.................................................................57
                          Telecom: Neutral ....................................................................59
                          Consumer Staples: Underweight ..........................................61
                          Utilities: Underweight.............................................................63
                          Appendix: Bull Market Metrics in Months 22-34 After Start
                          of Bull Market..........................................................................65




2
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




                          #1: Solid GDP Growth Expected in 2011
                          J.P. Morgan Economic Outlook Above Consensus
                          J.P. Morgan economists see a fragile recovery but with enough cyclical lift to
                          overcome fiscal drags (see Figure 9) resulting in growth above Street consensus. This
                          above-consensus outlook is evident in Figure 1 and Figure 2.

                          What is notable is that J.P. Morgan’s US GDP forecasts are above Street consensus
                          in 1H (and below consensus in 4Q), while our Euro-area forecast calls for upside to
                          Consensus later in the year (2H).

                          The US forecast assumes passage of the compromise tax package offered by the
                          White House and Congress. What is notable in the compromise plan is the reduction
                          in Social Security withholding taxes. Previously, Kasman and team had expected
                          withholding taxes to be a drag on income growth in 2011, but now they stand to
                          support income growth. Thus, our economics team sees GDP growth of 3.5-4.0% in
                          1H11, which is 110-130bp above that seen by Consensus.

                          Figure 1: JPM US GDP vs. Consensus                      Figure 2: JPM Euro GDP vs. Consensus
                          %q/q saar                                               %oya saar
                                        3.50       4.00      3.50                     2.10      2.00
                                                                          3.00
                              2.50                                                                                                1.60




                                                                                                                                             #1: Solid GDP Growth Expected in 2011
                                                                                                           1.40      1.40

                                                                                               JPM
                                      JPM              Consensus
                                        1.10       1.30       0.55                             Consensus
                              0.30                                                                        More upside seen in 2H
                                                                                                                     0.30         0.30
                                                                                                           0.20
                                                                                      0.10      0.10
                                                                          -0.20
                                        Upside seen in 1H
                              4Q10      1Q11       2Q11      3Q11         4Q11
                                                                                     4Q10       1Q11      2Q11       3Q11         4Q11
                          Source: JPM Economics Research and Bloomberg.           Source: JPM Economics Research and Bloomberg.


                          Washington Moving to the Center…Boosting Small Biz
                          The White House is moving to the center, which should provide a boost for business
                          confidence and, in our view, a particular boost to small/medium biz confidence. We
                          think small and medium business confidence has been hampered by bleak
                          fundamentals and tight credit, but also concerns about taxes, regulatory creep, and
                          the general anti-business sentiment from Washington.

                          Thus, we believe small and medium business confidence should improve in 2011,
                          which should engender hiring. Granted, this is circular (as hiring in the past has been
                          driven by better business conditions). But the point of this is that an improving
                          outlook from Washington, particularly towards the center, should at least help sustain
                          some of the improvements we are seeing in small and medium business conditions.
                          Consider the two charts below:




                                                                                                                                         3
Thomas J Lee, CFA                        North America Equity Research
(1-212) 622-6505                         10 December 2010
thomas.lee@jpmorgan.com




                                         • The NFIB small business optimism index (see Figure 3) has nearly recovered to
                                           cycle highs as of October and, again, we see reasons for the rise to be sustained.
                                           After all, this survey was completed before the mid-term elections and before the
                                           recent strengthening in labor market conditions.
                                         • In addition, NFIB hiring plans have similarly improved as shown in Figure 4 with
                                           the employment index continuing its move above the zero line. Granted, we are
                                           still a long way from reaching the 8.5 long-term level, but, by the same token,
                                           this survey was taken as of October, before recent incremental improvements.

Figure 3: NFIB Small Business Optimism Improving                    Figure 4: NFIB Small Business Employment Plans Are Turning Positive
Business conditions                                                 Hiring plans




                                                                                         ZERO line




Source: Bloomberg.                                                  Source: Bloomberg.


                                         Consumer Balance Sheets—Credit Better than Mortgages…
                                         Household balance sheet repair progressed substantially in the past few years. We
                                         realize that debt reduction has been driven both by “charge-offs” as well as a higher
                                         savings rate. Still, one needs to remember that a 5% savings rate equates to about
                                         $550 billion annually in debt reduction.

                                         • Balance sheet repair can be seen most clearly in credit card balances, which have
                                           fallen 14% from a peak of $866 billion in 4Q08. Figure 5 shows that this credit
                                           card reduction may have potentially “overshot” equilibrium, as the balance of
                                           6.6% is below the 7.3% level seen at the start of the decade. An increase of 0.7%
                                           (to get to 2000 levels) would represent $79.0 billion of incremental credit card
                                           balances, or potential upside to spending in 2011.

                                         • On the other hand, mortgage debt likely has further to fall. At $8.7 trillion, it
                                           stands at 76.7% of Disposable Income (see Figure 6). While this is down from
                                           85.5% at the peak in March 2008, it is well above the 50.1% at the start of the
                                           decade and would need to fall a further $3.0 trillion to reach 50%. We actually do
                                           not expect it to fall to 50% of disposable income, as low interest rates mitigate the
                                           debt burden. But we do anticipate further declines in this balance.




4
Thomas J Lee, CFA                                   North America Equity Research
(1-212) 622-6505                                    10 December 2010
thomas.lee@jpmorgan.com




Figure 5: FIXED HERE…Consumer Credit as % Disposable Income                                Figure 6: IN PROCESS…Mortgage Debt as % Disposable Income
% of Nominal Disposable Income                                                             % of Nominal Disposable Income




Source: Federal Reserve.                                                                   Source: Federal Reserve.


                                                    KEY TO REMEMBER, Excess Leverage in Housing Is
                                                    Concentrated in 8% of Households
                                                    But, wait, isn’t there too much mortgage debt? Aren’t many Americans underwater
                                                    in their mortgages? We think it is important to remember that only a fraction of US
                                                    households today have negative equity. Take a look at Figure 7 below. We have
                                                    stratified the homeowner market into: (i) Positive Equity; (ii) Borderline (Loan-to-
                                                    Value (LTV) between 100% and 130%); and (iii) Seriously Negative (LTV>130%).
                                                    The data was provided by our ABS team.
                                                    • As shown below, 80mm households today have positive equity, including 32mm
                                                      with no mortgage. There are also another 38mm or so renters with no mortgage.
                                                      There are 3.9mm households that are seriously delinquent, representing
                                                      $1.0 trillion in mortgages (negative equity is $372 billion).
Figure 7: Distribution of Mortgages Based on Loan-to-Value
                                                                                                                          POSITIVE EQUITY
Households in thousands, $ billions; from Matt Jozoff/John Sim, MBS Strategist                                            79mm Households
                                                               # of Households                                                                     31,859
                      SERIOUS NEG EQ (LTV > 130%)
                           3.9mm Households                                                 BORDERLINE
                                                                                                                                          16,117
                                                                                         6.0mm Homeowners             11,022
                                                                                                            8,037                7,699
                                                                                          2,419   4,382
   303      148      242    420     400     486    589      1,348     1,840      1,728


   >200   190-200 180-190 170-180 160-170 150-160 140-150 130-140 120-130 110-120 100-110 90-100            80-90      70-80     60-70     <60     HH w ith
                                                                                                                                                     NO
                                                                                           BORDERLINE                          POSITIVE EQUITY mortgage
                                                                                            $1.4 Trillion                        $7.3 Trillion
            SERIOUS NEG EQ (LTV > 130%)            Mortgage balance outstanding ($ billions)                          $1,965
          $1.0 Trillion, $372 billion NEG EQUITY                                                            $1,620                        $1,693

                                                                                                   $995                          $1,070
                                                                                          $578
                                                                      $401       $417
   $85                     $119     $119   $163    $199     $226
            $43      $69                                                                                                                              0


   >200   190-200 180-190 170-180 160-170 150-160 140-150 130-140 120-130 110-120 100-110 90-100            80-90     70-80      60-70     <60     HH w ith
                                                                                                                                                     NO
                                                                                                                                                   mortgage

Source: J.P. Morgan ABS/MBS Research.


                                                                                                                                                              5
Thomas J Lee, CFA                                                                             North America Equity Research
(1-212) 622-6505                                                                              10 December 2010
thomas.lee@jpmorgan.com




                                                                                              Labor Tracking Like “Jobless Recoveries” of ’91/’01…
                                                                                              Suggesting 150-200k Jobs in ’11
                                                                                              Kasman and team forecast payrolls to grow by 175k/month in 2011.

                                                                                              This would be consistent with the trajectory of labor markets during the jobless
                                                                                              recoveries of ’91 and ’01. As shown in Figure 8 below, the recovery in labor markets
                                                                                              looks a lot like the jobless recoveries of ’91 and ’01. In those precedent periods,
                                                                                              stronger hiring did not take place until 18 months after the labor market began to
                                                                                              grow—think of it as a rolling start.

                                                                                              • And similar dynamics are at work currently even if the drivers differ—businesses
                                                                                                have chosen to defer hiring, meeting rising demand with increased hours worked,
                                                                                                temporary hires, and eventually full-time hiring. What is different this cycle is
                                                                                                regulatory and tax uncertainty coupled with tight credit inhibiting hiring. But
                                                                                                eventually businesses should need to hire as shown in Figure 8 below.

Figure 8: 2011 Payrolls Should Grow 150-200k per Month, Similar to Past “Jobless Recoveries” of 1991/2001
Six-month average of monthly payroll gains (Private Payrolls)
                                                                                                                                ’91/’03 Jobs grew 150k-200k/ month
                                                                                                                                                                     1991
                                                                  11/90     2/91     5/91     8/91     11/91    2/92     5/92   8/92     11/92    2/93     5/93
                                                                  2/03     5/03     8/03      11/03    2/04     5/04     8/04   11/04    2/05     5/05     8/05      2003

                                                                                                                                                              2003
          Monthly ∆ in private payroll (trailing 6m avg)




                                                           200      Date labor                                                                                1991
                                                                    growth turned
                                                           100      positive.
                                                                                       9/03
                                                             0

                                                                                                                                          2011
                                                           -100                        1/10

                                                                                       6/91
                                                           -200


                                                           -300
                                                                  6/09     9/09     12/09     3/10     6/10     9/10    12/10   3/11     6/11     9/11    12/11      2010

Source: J.P. Morgan and Bloomberg.




6
Thomas J Lee, CFA                           North America Equity Research
(1-212) 622-6505                            10 December 2010
thomas.lee@jpmorgan.com




Figure 9: J.P. Morgan Economic Forecast Summary
Saar
                                                              %q/q, saar                                  %q4/q4                   %y/y
                                           2Q10 3Q10      4Q10 1Q11 2Q11 3Q11 4Q11                 2010    2011    2012   2010     2011     2012
Gross domestic product
Real GDP                                     1.7  2.5       2.5     3.5      4.0     3.5     3.0    2.6      3.5    3.0     2.8      3.1      3.0
 Final sales                                 0.9  1.2       4.1     3.8      3.9     3.8     2.9    1.8      3.6    3.0     1.3      3.3      2.9
   Domestic                                  4.3  2.9       2.7     3.3      3.7     4.1     3.3    2.8      3.6    3.0     1.9      3.4      3.1
    Consumer spending                        2.2  2.8       2.5     3.5      3.5     4.0     3.0    2.3      3.5    2.6     1.7      3.2      2.7
    Business investment                    17.2 10.3        7.0     7.8    10.6    11.5    10.1    10.5     10.0    8.9     5.7      9.6      9.7
     Equipment                             24.8 16.8      10.0    10.0     12.0    12.0    10.0    17.9     11.0    8.5    15.6     12.3      9.6
     Structures                             -0.5 -5.8      -3.0     0.0      5.0     9.0   10.0    -7.0      5.9   10.0   -14.5      1.3      9.6
    Residential investment                 25.6 -27.5       5.0   10.0     20.0    15.0    10.0    -4.3     13.7   13.7    -2.9      6.7     13.1
    Government                               3.9  4.0       1.1    -0.6     -1.0    -1.0    -0.1    1.8     -0.7   -0.5     1.2      0.5     -0.5
Net exports ($bn, chained $2005)           -449 -507      -467    -454     -453    -468    -487       -        -      -       -        -        -
Exports (goods and services)                 9.1  6.3       7.0     7.0      8.0     9.0     8.0    8.4      8.0    8.0    11.6      7.5      8.1
Imports (goods and services)               33.5 16.8       -2.0     3.0      6.0   10.0    10.0    14.2      7.2    6.7    13.5      7.2      8.2
Inventories (ch $bn, chained $2005)        68.8 111.5     61.2    51.6     55.3    47.2    52.4       -        -      -       -        -        -
Contribution to real GDP growth (% pts):
Domestic final sales                         4.4    3.0     2.7    3.3      3.7     4.1     3.3     2.8      3.6    3.0     1.9      3.4      3.1
  Housing                                    0.6   -0.8     0.1    0.2      0.4     0.3     0.2    -0.1      0.3    0.3    -0.1      0.1      0.3
  Consumer Spending                          1.5    2.0     1.8    2.5      2.5     2.8     2.1     1.6      2.4    1.8     1.2      2.2      1.9
Net exports                                 -3.5   -1.8     1.3    0.5      0.2    -0.3    -0.5    -1.0      0.0    0.0    -0.6     -0.1     -0.2
Inventories                                  0.8    1.3    -1.6   -0.3      0.1    -0.3     0.1     0.8     -0.1    0.0     1.4     -0.2      0.0
Income and profits (NIPA basis)
Adjusted corp profits                       12.7   11.5    8.0     8.0     10.0     8.0     7.0    19.2      8.2    5.5    29.8      9.0      5.9
Real disposable personal income              5.6    0.9    1.0     4.5      3.5     3.0     3.0     2.2      3.5    2.4     1.3      3.0      2.3
            1
Saving rate                                  6.2    5.8    5.4     5.7      5.7     5.4     5.4       -        -      -     5.7      5.6      5.2
Prices and labor cost
Consumer price index                        -0.7    1.5     2.3    1.8      1.0     1.1     1.1     1.1      1.2    1.3     1.6      1.4      1.2
                Core                         0.9    1.2     0.4    0.6      0.6     0.7     0.8     0.6      0.7    1.1     1.0      0.7      0.9
Producer price index                        -0.5    0.9     4.0    1.0      0.7     0.8     1.3     3.2      0.9    1.4     4.1      1.4      1.3
                Core                         1.7    2.2     1.0    0.6      0.5     0.5     1.0     1.8      0.6    1.1     1.3      0.9      1.0
GDP chain-type price index                   1.9    2.3     1.3    1.0      1.0     1.0     1.1     1.6      1.0    1.2     1.0      1.3      1.2
Core PCE deflator                            1.0    0.8     0.5    0.6      0.6     0.7     0.8     0.9      0.7    1.0     1.4      0.7      0.9
S&P/C-S house price index (%oya)             3.6   -1.2    -2.1   -2.5     -1.0     1.0     2.0    -2.1      2.0    2.0     0.6     -0.1      2.0
Productivity                                -1.8    1.9     1.0    2.0      2.5     2.0     2.0     1.2      2.1    1.6     3.4      1.7      1.7
Other indicators
                                 1
Housing starts (mn units, saar)            0.602 0.584    0.550 0.600 0.650 0.675 0.700               -        -      -   0.588    0.656    0.781
Industrial production, mfg.                   9.3   3.7      4.0   4.5   5.0   4.5   3.5            5.8      4.4    3.5      6.0      4.6      3.7
                               1
Capacity utilization, mfg. (%)              71.6 72.3      73.0 73.7 74.4 75.0 75.5                   -        -      -    71.7     74.6     76.2
                                    1
Light vehicle sales (mn units, saar)        11.3 11.6      12.2 12.4 12.6 12.8 12.9                   -        -      -    11.5     12.7     13.2
                      1
Unemployment rate                             9.7   9.6      9.7   9.6   9.4   9.2   9.0              -        -      -      9.7      9.3      8.7
Nominal GDP                                   3.7   4.8      3.8   4.5   5.0   4.5   4.1            4.3      4.6    4.3      3.9      4.5      4.2
Source: J.P. Morgan Economic Research.




                                                                                                                                               7
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




8
Thomas J Lee, CFA                                                North America Equity Research
(1-212) 622-6505                                                 10 December 2010
thomas.lee@jpmorgan.com




                                                                 #2: History Argues for 20%-Plus Year
                                                                 Markets Gained Each Time in the 3rd Year of Expansion
                                                                 AND 3rd Year of Presidential Term
                                                                 We have found substantial relevance in using historical analysis and cycle analysis as
                                                                 key elements of framing our forecast. (Of course, the challenge is to explore the
                                                                 differences in the current context.) We believe this provides us with a baseline
                                                                 context to examine how market reaction is likely to evolve. Moreover, basic
                                                                 decision-making instincts by investors are assumed to be similar over periods.

                                                                 Based on 111 years of Dow history, 2011 looks to be an extremely favorable
                                                                 combination of (i) 3rd year of an expansion and (ii) 3rd year of a presidential term:
                                                                 • This combination has only occurred 5 times since 1900 and the average return
                                                                   has been 20.6% with the market rising in each instance (see Figure 11).
                                                                 • On a standalone basis, performance of the Dow in the 3rd year of a Presidential
                                                                   term has been superior to that in other years (13.3% vs. 7.2% for all years). And,
                                                                   of course, in such periods Senators are aiming for re-election as well. The
                                                                   prevailing theory is that re-election dynamics drive fiscal spending. But it could
                                                                   also be due to a President ultimately shifting toward the center.
                                                                 • And, on a standalone basis, performance in the 3rd year of an expansion has
                                                                   typically been decent, with gains of 7.2% vs. declines of 6.7% seen during
                                                                   recessions.
Figure 10: Annual Performance of S&P 500 During Expansion/Contraction and Presidential Cycles                                                                                                           Figure 11: Years that Were Both




                                                                                                                                                                                                                                                           #2: History Argues for 20%-Plus Year
Annual % change                                                                                                                                                                                         3rd Year of Presidential Term
                                                % Annual Gain                                       Number of Instances                            % times Instances >=0%                               and 3rd Year of Expansion
                                                                                                                                                                                                        Annual % change
                                                   Contraction




                                                                                                          Contraction




                                                                                                                                                               Contraction
                                                                              3rd Year of




                                                                                                                                    3rd Year of




                                                                                                                                                                                          3rd Year of
                                                                  Expansion




                                                                                                                        Expansion




                                                                                                                                                                             Expansion
                                                                              Expansion




                                                                                                                                    Expansion




                                                                                                                                                                                          Expansion
                                    All Years




                                                                                            All Years




                                                                                                                                                  All Years




                                                                                                                                                                                                           1935                         41.4%

All Years                          7.2%          -6.7%           11.4%         7.2%         111          26              85            14         66%         42% 72%                       71%                                 26.4%
                                                                                                                                                                                                           2003

Presidential Election Years        8.2%          1.2%            11.1%         0.1%          28          8               20             5         71%         50% 80%                       60%            1963            18.9%

Non-Presidential Election Years    6.8%         -10.2% 11.5%                  11.1%          83          18              65             9         63%         39% 69%                       78%
                                                                                                                                                                                                           1951            16.3%
                                                                                                                                                                                                                                during 2-y r of bear
3rd Year of Presidential Term      13.3%        -13.9% 21.0%                  20.6%          27          6               21             5         81%         33% 95% 100%
                                                                                                                                                                                                           1947    0.0%         market w hich
Source: J.P. Morgan and FactSet.                                                                                                                                                                                                started in 05/46
                                                                              Wow…                                                                                                       Wow…
                                                                                                                                                                                                                  0%      20%      40%      60%


                                                                                                                                                                                                        Source: J.P. Morgan and FactSet.


                                                                 Should it be any different in 2011? We don’t think so…
                                                                 The naysayers will no doubt argue that it is different this time. Take the White
                                                                 House—because of large deficits and midterm turmoil, skeptics are likely to argue
                                                                 that there is little the White House can do in this 3rd year in terms of policy action.
                                                                 • But consider that split chambers of Congress and/or split Congress/White House
                                                                   have been the norm in history, yet, 81% of the time the market has recorded
                                                                   positive performance in the 3rd year of a Presidential term.

                                                                                                                                                                                                                                                       9
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




                          But Haven’t Half of All Bull Markets Ended by Year 3? Yes…
                          There is another wrinkle in the historical analysis.

                          Of the 19 Bull markets that lasted at least 22 months (which is the current age of the
                          2009 bull market), 9 turned into bear markets before the 34th month (equivalent to
                          December 2011). In fact, 7 of the 9 would indicate an end to this bull market by
                          June 2011 (see below in Figure 12).

                          Figure 12: Duration of Bull Markets (Lasting at Least 22 Months)
                          Since 1900
                                        Lifespan beyond month 22


                                                                                                                                                                                      92
                                                                                                                                                                                 75
                                                                                     9 of 19 bull markets
                                                                                    did not last thru month
                                                                                               34                                                             34    38     39
                                                                                                                                             24    27    28
                                                                                                                                 21    22
                                                                                                                   10      11
                                                                     1     1    2       2      2     4       5


                                                                    1919 1916 1979 1976 1909 1968 1905 1972 1989 1951 1964 1955 1944 1959 1934 2004 1984 1923 1992

                                                                                                         Lifespan of bull bey ond month 22

                          Source: J.P. Morgan and Bloomberg.


                          But even in those years the market gained 3% to 30% before peaking...
                          Interestingly, as shown below in Figure 13, even in those 9 years in which a bear
                          market ensued (between months 22 and 34), intra-year gains ranged from 3% to 30%
                          (in 1909 and 1979, respectively).

                          Figure 13: Maximum % Gain from Month 22 to Month 34 (Best Intra-Year Gain)...
                          Since 1900, sorted by duration of bull market (see chart above)

                                                                                           9 of 19 bull markets did
                            % Gain Mo 22 to Peak in Mo 22-34




                                                                   40%                      not last thru month 34
                                                                                     30%                     29%
                                                                   30%
                                                                                                                                                                         23%
                                                                                                                                                   19%
                                                                   20%                                                           14%         15%
                                                                                                                     11%                                           13%
                                                                                                       11%                             10%
                                                                               9%                                           7%                                                  7% 7%
                                                                   10%   5%                 4% 3%                                                        2%
                                                                                                                                                              0%
                                                                   0%
                                                                         1919 1916 1979 1976 1909 1968 1905 1972 1989 1951 1964 1955 1944 1959 1934 2004 1984 1923 1992

                          Source: J.P. Morgan and Bloomberg.




10
Thomas J Lee, CFA                               North America Equity Research
(1-212) 622-6505                                10 December 2010
thomas.lee@jpmorgan.com




                                                Analysis of Long vs. Short Bull Points to “Longer” Variety…
                                                We looked at 20 discrete metrics to understand what distinguishes a “short” vs.
                                                “long” bull market (see Appendix and Figure 91 to Figure 94). Of these 20 metrics,
                                                we found 4 that had strong intuitive and explanatory powers for what distinguishes a
                                                long vs. short bull market. Those are summarized in Figure 14:

Figure 14: Factors that Differentiate Longer vs. Shorter Bull Markets
As indicated
     Time to next recession…                          Inflation…                     Real 10-year rates…               S&P 500 EY vs. BAA Yields
             40                                                      7.8%             1.7%        today                                 today
                                                                                                                            1.6%        1.7%
                                                                                                  1.4%



                               16                3.1%
                                                             today
                                                             1.1%


                                                                                                                                                -0.6%
         Longer bull     Short bulls (end      Longer bull    Short bulls (end by                         -1.1%           Longer bull     Short bulls (end
           markets       by 34th month)         markets          34th month)
                                                                                    Longer bull     Short bulls (end       markets        by 34th month)
                                                                                     markets        by 34th month)

Source: J.P. Morgan, Bloomberg, and FactSet.

                                                #1: Time to next recession
                                                Foremost, it was the proximity to the next recession. Shorter bull markets saw a
                                                recession start within 16 months. (In the current context, that would mean a recession
                                                starting in 2012). On the other hand, longer bull markets saw a recession start only
                                                within 40 months. This makes sense. Recessions bring bear markets.
                                                • Bruce Kasman and team do not see a recession in 2012.

                                                #2: Inflation was a big differentiator
                                                Inflation at Month 22 was a key differentiator as well. Shorter bull markets suffered
                                                from higher inflation of around 8%, compared to longer bull markets with 3%
                                                inflation. In our past work, we showed that inflation rates above 6% have driven P/E
                                                compression, so this again is logical.
                                                • Inflation is running at about 1% today, again indicating a longer bull market.

                                                #3: Real 10-year rates
                                                Real 10-year rates (10-year less inflation) were POSITIVE during longer bull
                                                markets whereas in Month 22 of shorter bull markets rates were negative. This is
                                                somewhat less intuitive, but we think it speaks to rate-of-return opportunities for
                                                businesses. Higher real rates imply positive expected returns for risky assets and
                                                therefore capital investment.
                                                • Today, real rates, at positive 140bp, again clearly indicate a longer bull market.

                                                #4: Equity relative value vs. BAA bond yields
                                                Finally, relative value was positive in longer bull markets with EY (1/P/E) higher
                                                than bond yields (lowest investment grade). This again is intuitive—stocks were
                                                cheaper and therefore did well.
                                                • Today, EY is 170bp above the BAA bond yield.

                                                                                                                                                             11
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




12
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




                          #3: Relative Return of Equities Should
                          Outperform Risky Assets
                          #1: 50-Year High in Equity Risk Premia...
                          Our global asset allocation team recently produced a 50-year time series of equity
                          risk premia shown below in Figure 15. They calculated these by comparing the
                          earnings yield of equities against the “real” yield on the 10-year, which is basically




                                                                                                                                   #3: Relative Return of Equities Should Outperform Risky Assets
                          the 10-year bond yield less inflation.

                          • As shown below, the current equity risk premium of 620bp is the highest ever,
                            higher even than that during the 1974 bear market trough and definitely well
                            above the level at which it settled at the 2002 bear market low.

                          • This high risk premium obviously raises a few questions. Foremost is that
                            investors are showing little trust in equities, which may not be entirely surprising
                            given the awful performance of stocks over the past decade.

                          • But it also may reflect a general fear of capital investment, both physical and
                            financial. After all, many investors and companies still question the durability of
                            this recovery and thus have been reluctant to invest in longer-duration assets.
                            Equities, after all, are infinite-duration assets.

                          Figure 15: Equity Risk Premia
                          Calculated as Earnings Yield less Real 10Y Yield (10Y Less Inflation)

                                                                                                                           9/10
                             7.0                                          12/74
                                                                                                            12/02          6.21
                             6.0                                          5.56
                                                                                                             4.12
                             5.0
                             4.0
                             3.0
                             2.0
                             1.0
                                                                                                              10-y ear av erage
                             -
                                                                                                                    3.56
                            (1.0)
                                               Equity Risk Premia                 10-y ear av erage
                            (2.0)
                                    '57 '59 '62 '64 '67 '69 '72 '74 '77 '79 '82 '84 '87 '89 '92 '94 '97 '99 '02 '04 '07 '09

                          Source: J.P. Morgan Global Asset Allocation Strategy.


                          The implication though is risk/reward for equities is attractive
                          The key takeaway, in our view, is that risk/reward appears favorable for stocks—that
                          is, the margin for error is lower for equities when the equity risk premium is high.

                          • Even if one were to argue that the equity risk premium has been rising, which has
                            been the case over the past decade, it is well above the 10-year average.




                                                                                                                              13
Thomas J Lee, CFA                               North America Equity Research
(1-212) 622-6505                                10 December 2010
thomas.lee@jpmorgan.com




                                                #2: Equities Offer Attractive Return Potential vs. Other
                                                Risky Assets
                                                Equities did not outperform other risky assets in 2010 as shown in Figure 16 below.
                                                In fact, most fixed income markets and commodities saw gains of 11-25%. Most of
                                                these were above the 11.5% gain of the S&P 500 YTD (2.0% from dividends).

                                                But 2011 forecast returns point to better relative performance for equities
                                                We have compared our 2011 Target of 1425 for the S&P 500 to J.P. Morgan’s
                                                projected returns for other risky assets. These are shown below in Figure 17.

                                                • The forecast return for Equities of 18.5% matches the expected return for
                                                  commodities (oil up 26% and commodities broadly up 19%) and is higher than
                                                  that for fixed income assets. Of this, the majority consists of capital gains (EPS
                                                  growth and P/E expansion) rather than dividend yield.

                                                • Our fixed income teams expect the rally in fixed income to end, with Treasuries
                                                  projected to be flat (down 0.9%), high-grade returns a mere 2%, and high-yield
                                                  delivering an 8% total return. This is quite a contrast to 2010 when CMBS
                                                  returned 25% and high-yield 13%.

Figure 16: 2010 Comparative Returns for Risky Assets                              Figure 17: 2011 FORECASTED Comparative Returns of Risky Assets
% change, YTD as of 12/02/10                                                      % change


                  Gold (S&P GSCI)                                       25.8                Oil (S&P GSCI Brent)                                  26.0

                         CMBS (AAA)                                    25.0              Commodities (JPMCCI)                              19.0

                            High Yield                13.2                                      Equities (S&P500)                         18.5

         Emerging Markets Bonds                      12.8                                        Gold (S&P GSCI)                         17.0

                       Treasury (10y )               12.1                                                High Yield                8.0

                 Equities (S&P500)               11.5                                                CMBS (AAA)                6.5
                                                             Fixed income
     Inv estment Grade Corporates               10           forecasted returns        Emerging Markets Bonds                4.5
                                                             are substantially
           Commodities (JPMCCI)           7.1                more modest than      Inv estment Grade Corporates        2.0
                                                             those for equities
              Oil (S&P GSCI Brent)        7.1                or commodities…                                   MBS    1.0

                                 MBS     5.7                                                       Treasury (10y )    -0.9

Source: J.P. Morgan.                                                              Source: J.P. Morgan estimates.




14
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




                          #3: JPM Client Survey Indicates Allocation into Equities…
                          In J.P. Morgan’s Fixed Income Survey, investors were asked about expected changes
                          in portfolio allocation over the next six months (see “US Fixed Income Markets 2011
                          Outlook” dated 11/24/10 by Srini Ramaswamy). The survey is broad-based, but this
                          particular question has only been asked this year. The survey was based on a client’s
                          intended changes in asset allocation. If a respondent had a desire to add exposure,
                          they were asked to indicate +1, with -1 representing a desire to reduce exposure.

                          • As shown below in Figure 18, respondents expressed the strongest desire to add
                            exposure for Equities, followed by TIPS and Emerging Markets.

                          • On the other end of the spectrum, respondents expressed modest preferences to
                            reduce exposure to Non-Agency MBS and High-Yield.

                          Broadly, our interpretation is that macro funds and institutional managers are
                          likely to add to equity exposure in 2011…
                          Our takeaway is that institutional investors are likely to add to equity exposure in
                          2011. The nagging question remains whether retail investors will add to exposure.

                          • What we do know is that retail investors tend to follow outperformance. Thus, if
                            the outperformance of equities continues into 2011, we believe investors will
                            make a pronounced allocation into equities.

                          Figure 18: Client Survey Indicates Planned Move into Equities
                          Scale: +1 desire to add; -1 desire to reduce

                            1.0
                                                                                                               0.4      0.5
                            0.5                                                                    0.3   0.3
                                                                                             0.1
                                                                                     0.0
                            0.0

                                     -0.2                  -0.1        -0.1   -0.1
                           -0.5                 -0.2

                                     Non-       High      CMBS         Agy    Agy    Dur'n   ABS   IG    EM    TIPS   Equities
                                      Agy       Yield                  debt   MBS    risk
                                     MBS

                          Source: J.P. Morgan Fixed Income Strategy.




                                                                                                                              15
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




16
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




                          Setting Target of 1425
                          S&P 500 to Reach 1425 in 2011—Debate Will Be on P/E
                          We believe the S&P 500 can reach 1425 in 2011 (see Figure 19). Consensus is
                          centered about 100 points lower with a top-down Strategist consensus (NI WGT
                          <<GO>>) of 1337. Michael Krauss, J.P. Morgan Technical Strategist, sees 1300-
                          1350. So, for reasons discussed in prior sections, we are more bullish than consensus
                          for 2011.

                          2011 should be more about valuation expansion rather than EPS upside...
                          The composition of market return in 2010 was more about EPS upside, as top-down
                          forecasts rose about 7% in 2010 (2010E EPS started the year at $74 and is now $83).
                          For 2011, we see less potential for upward revisions to estimates, but rather see the
                          shift in market performance toward a decline in the risk premium—resulting in P/E
                          expansion. Specifically, our target is based on the following:

                          Figure 19: Comparative S&P 500 Price Levels Based on EPS and P/E Ratios
                          Index level
                                                                          Range of 2012 EPS….
                                           Implied '12 GDP gth              2.25%      2.50%     2.75%     3.00%     3.25%
                                                           EPS             $98.00     $100.00   $102.00   $104.00   $106.00
                            Applied       Implied Equity Risk EY vs BAA
                              P/E            Premia YE '11      Yield
                                           (EY less {10Y less
                                               inflation})
                              12.5x              6.57%          2.02%       1,222     1,247      1,272     1,297     1,322
                              13.0x              6.26%         1.71%        1,271     1,297      1,323     1,349     1,375
                              13.5x              5.97%         1.42%        1,320     1,347      1,374     1,401     1,428
                              14.0x              5.71%         1.16%        1,369     1,397      1,425     1,453     1,481
                              14.5x              5.46%         0.91%        1,418     1,447      1,476     1,505     1,534
                              15.0x              5.23%         0.68%        1,467     1,497      1,527     1,557     1,587
                              15.5x              5.01%         0.46%        1,516     1,547      1,578     1,609     1,640
                          Source: J.P. Morgan estimates.


                          #1: Raise 2011E to $94 from $91 and New 2012E EPS of $102


                                                                                                                                  Setting Target of 1425
                          The global cyclical recovery should enable S&P 500 companies to generate at least
                          high-single-digit EPS growth in 2011/2012. Our estimates are basically built around
                          2.5-3.0% GDP growth (in line with Kasman’s US GDP view), but we see upside to
                          our 2011 estimates in the context of an accelerating cyclical outlook which is
                          possible if Europe’s sovereign issues do not damage the economy.

                          • We are raising our 2011 EPS estimate to $94 from $91 (see details in Figure 20),
                            principally reflecting higher anticipated EPS contributions from Financials and
                            Industrials.

                          • Our 2012 EPS estimate of $102 anticipates that the prior EPS peak (in 2Q07 at
                            $92) will be surpassed. This is consistent with prior earnings cycles.




                                                                                                                             17
Thomas J Lee, CFA                                         North America Equity Research
(1-212) 622-6505                                          10 December 2010
thomas.lee@jpmorgan.com




                                                          #2: Forward P/E Ratio Should Creep to 14.0x 2012E
                                                          While there are considerable countervailing forces acting on asset values (hence
                                                          P/E), we believe the primary drivers of P/E expansion will be:
                                                          1. Contracting relative value relationship of equities vs. corporate credit, in which
                                                             risk premium for stocks narrows from record-high to normalized levels. As
                                                             shown in Figure 19, our target risk premium is 5.43%, down from 6.21%
                                                             currently (see Figure 15) but still well above 10-year average of 3.56%; and
                                                          2. Positive impact on asset prices from LSAP (Fed’s large-scale asset purchases, or
                                                             QE2).

                                                          EPS Driven by Cyclicals
                                                          The drivers of earnings growth in 2011 and 2012 should basically be the
                                                          economically sensitive stocks—Cyclicals and near-Cyclicals account for $8 of the $9
                                                          in incremental EPS we forecast for 2011. We highlight forecasts by Sector in Figure
                                                          20 below.
                                                          • We are revising our 2011 EPS estimate up slightly to $94 (from $91) to reflect
                                                            the expected re-acceleration of the economic recovery in 2011. Our estimate of
                                                            $94 does implicitly assume meaningful GDP growth as the 4Q10E EPS run-rate
                                                            is $88 ($22 x 4 = $88).
                                                          • We forecast that Financials will be the largest contributor of incremental EPS
                                                            year-over-year ($3.13) and report the fastest growth on a % basis.
Figure 20: S&P 500 EPS Forecast
$ per share
                                                            JPM Strategy Estimates
                                                            2011E EPS                                                           2012E EPS
                   JPM
                 Strategy                            FY                                         FY                  Bottom-Up                              Bottom-Up
                  Rating     FY 2008 FY 2009      2010E     1Q11E 2Q11E 3Q11E 4Q11E          2011E $ chg      % chg Consensus   FY 2012E    $ chg    % chg Consensus

Cyclicals
Materials          OW          $2.57      $1.31   $2.40      $0.71   $0.78   $0.70   $0.65   $2.85 $0.45       19%      $2.88     $2.93     $0.08      3%      $3.13
Industrials        OW              9.41    6.41    7.68       1.98    2.29    2.35    2.38    9.00   1.32      17%       9.23      9.62      0.62      7%      10.28
Discretionary      OW              3.07    5.02    8.28       2.04    2.25    2.32    2.54    9.15   0.87      11%       9.33     10.45      1.30     14%      11.17
Technology         OW          11.62      11.83   16.45       4.03    4.20    4.46    5.06   17.75   1.30       8%      18.56     19.43      1.68      9%      20.76

Near-Cyclicals
Energy             OW         $16.11      $6.81 $10.07       $2.63   $2.76   $2.88   $2.97 $11.25 $1.18        12%     $11.07    $13.26     $2.01     18%     $14.17
Financials         OW          (6.84)      4.91   13.37       3.59    4.13    4.21    4.58   16.50   3.13      23%      16.63     19.55      3.05     19%      20.89

Defensives
Staples            UW          $8.97      $9.20   $9.61      $2.33   $2.55   $2.62   $2.75 $10.25 $0.64         7%     $10.41    $10.04 ($0.21)       -2%     $10.72
HealthCare          N          11.10      11.17   11.77       3.06    3.08    3.06    2.99   12.20   0.43       4%      12.28     11.61     (0.59)    -5%      12.40
Telecom             N              2.91    2.25    2.18       0.58    0.61    0.61    0.60    2.40   0.22      10%       2.41      2.26     (0.14)    -6%       2.41
Utilities          UW              2.93    3.12    3.71       0.78    0.67    0.95    0.70    3.10   (0.61)   -16%       3.08      2.85     (0.25)    -8%       3.04

S&P 500                       $61.85 $62.02 $85.52          $21.74 $23.33 $24.16 $25.22 $94.45 $8.93           10%     $95.88   $102.00     $7.55      8%    $108.97
S&P ex-Fin                     68.69      57.11   72.15      18.15   19.20   19.95   20.65   77.95   5.80       8%      79.25     82.45      4.50      6%      88.08

Cyclicals                     $26.67 $24.56 $34.81           $8.77   $9.52   $9.82 $10.64 $38.75 $3.94         11%     $40.00    $42.43     $3.68     10%     $45.34

Defensives                    $25.91 $25.73 $27.27           $6.75   $6.91   $7.25   $7.04 $27.95 $0.68         2%     $28.18    $26.75 ($1.20)       -4%     $28.58
Source: J.P. Morgan and FactSet.


18
Thomas J Lee, CFA                            North America Equity Research
(1-212) 622-6505                             10 December 2010
thomas.lee@jpmorgan.com




                                             Market Strategy: Staging as Correlation
                                             Falls
                                             Correlation Typically Falls in Year 3 of a Bull Market…
We define Sector correlation                 One of the complaints of this bull market has been the extremely high sector
based on 1-month performance                 correlation. While this bull market certainly has seen higher-than-normal sector
vs. S&P 500 1-month
performance.
                                             correlation (see Figure 21), sector correlations have typically declined to cycle lows
                                             during the third year of a bull market (the 2009 bull market reaches Month 22 in
                                             January).

                                             • As shown in Figure 21, typically correlations have been high early in a bull
                                               market before drifting lower, were stable in Year 2, and then made a pronounced
                                               move lower in the 3rd year.
                                             • The path of this current market has varied in Year 2. Instead of remaining stable
                                               in Year 2, correlations SURGED to cycle highs at 90%. The drivers seemed to
                                               be the macro uncertainty that dominated markets in 2010.
                                             • Thus, to the extent clarity improves in 2011, we believe correlations should




                                                                                                                                                                                          Market Strategy: Staging as Correlation Falls
                                               decline sharply from the current 90% toward the 65% typically seen in bull
                                               markets.

                                             Figure 21: Sector Correlations Typically Have Declined in Months 22-34 of Bull Market
                                             Correlation (over trailing 20 weeks) of Sectors’ 1-month performance vs. S&P 500 1-month performance

                                                                                   Months 22-34 after start of Bull Mkt        2009 Bull market         All bull markets since '73

                                                                    95%                                                                                        Correlations
                                                                                                                                                             declined sharply
                  Correlations surged in                            90%                                                                                        in Year 3…
                                                                                                                                       Year 3
                  2010 to cycle highs, a
                  contrast with prior bull                          85%
                                               Sector Correlation




                         markets
                                                                    80%

                                                                    75%

                                                                    70%

                                                                    65%

                                                                    60%
                                                                          0   13      26     39     52     65     78      91   104   117    130   143     156    169    182    195

                                                                                                             Weeks after Start of Bull Market

                                             Source: J.P. Morgan and Datastream.


                                             Our takeaway? Sector and style strategy will gain in value in 2011
                                             This should be good news for active managers.

                                             The implication—this market should not feel like a “one-way” trade with all things
                                             moving together. Rather, we would expect to see substantially greater performance
                                             differential among industry groups.

                                                                                                                                                                                     19
Thomas J Lee, CFA               North America Equity Research
(1-212) 622-6505                10 December 2010
thomas.lee@jpmorgan.com




                                STAGING: Using Prior Bull Markets to Pick Groups Today
                                We have derived substantial insight with staging markets which is the basis for our
                                “Circle of Life” analysis, and we decided to further enhance this analysis by staging
                                prior bull markets across time. We also did similar work in our “Guide to Stock
                                Bottoms” Part I and Part II.

                                The idea here is that industry groups generally gain favor over time as a bull market
                                progresses, reflecting the combination of fundamental developments (earnings
                                power, employment, etc.) against changes in market behavior (valuation sensitivity
                                or M&A, etc.).

                                One can visually see such prior shifting of leadership in Figure 22 below indicating
                                the shifts in the composition of the top quartile of groups as bull markets aged:

                                • Note, for instance, that in the Year -1 period (prior to market bottom), the leaders
                                  were mostly Defensives (personal products, food, etc.).

                                • But moving through Year 2 (now), leadership in the past has shifted more heavily
                                  to Cyclicals.

                                • Certainly this is the case today and we have compiled some analysis in the
                                  following section discussing this.

                                Figure 22: Top Quartile Industry Groups as Bull Markets Aged
                                All bull markets since '74. Top quartile identified in DARK GREEN based on 6-month relative performance
                                Average '74 to '02                                    YEAR -1                              YEAR 1                        YEAR 2                           YEAR 3                         YEAR 4


                                Date
                                Months into Bull market             -11   -9    -7      -5      -3   -1   1     3     5      7      9    11 13 15        17    19   21 23 25 27           29   31    33 35 37 39         41   43    45 47 49



             1. Prior to        S&P 500 % chg next 6-months (ro (1)       3     (9) (16) (12) 5           19 17 11           7      7    9     8    6    1     3    3     6     5    2    1    (1)   3    7    8    7    8    7     4    4     7
             market
                                       Personal products
             bottom,
                                                                     6    10     9       7      3    5     0    -2    -5     -4     1     2    5    0     2    1     1    -1    -1   0    -2    3    3    6    1    3    3     3    3     2    -1

                                       Health Care Eq & Svcs         7     6     5       8      5    10   -1    -1    -4     -4     0    -4    -4   -7   -2    1    -4    -3    -2   5    5     7    6    10   1    4    2     7    0    -2    -4

                                       Food & Beverages
             Defensives
                                                                     6     9     8       8      2    4    -4     0    -3     0      3     3    3    1     3    3    -1    -1    -1   3    3     6    3    2    -1   5    5     9    2     0    -4

                                       Homebuilders                  6    10     9       7      3    5     0    -2    -5     -4     1     2    5    0     2    1     1    -1    -1   0    -2    3    3    6    1    3    3     3    3     2    -1



             led…                      Biotech                      18    0     8        7      18   32   28    31    18     15     -2   -10   -5   -8   -3    3     1    -12   0    6    25   23    32   44   20   33   24   19    -4   -18   -10

                                       Pharma                        4     6     5       6      5    6    -2    -4    -6     -3     -1   -2    -4   -6   -1    -3   -9    -12   -4   2    4     2    1    3    0    7    9    12    4     0    -5

                                       Software                      9     4    -3      -3      -1   8    16     7    5      3      7     2    -5   -9   -5    -1    4    -2    1    -5   -2    2    11   14   6    4    9    11    13    6     7

                                       PC                            5     3     0      -2      0    10    2     1    -6     3      1    1     -5   -6   -9    -8   -4     2    2    -3   -7    0    8    12   0    -7   -6   -2    4     3     6

                                       Semis                        12     8    -4      -9      -8   7    35    19    7      2      7    16    0    -4   -13   -3    7     9    4    -4   -2   -1    4    14   6    0    -7   -6    1     3    16

                                       Telco Eq                      3     4     0      -5      -8   -1   14     9    4      2      8    12    7    6    -2    3     5     9    11   4    2     0    -1   9    7    10   2     2    6     2     5

                                       Chemicals                     3     6     2       1      -1   -3    2     3    7      -2     4     2    4    -3   -5    -4   -3    -2    -1   -4   -5   -4    1    2    6    4    4    -2    1     3     8

                                       Metals, Paper and Gold        3    -1    -1      -3      -1   -1    6     3    6      -1     2     3    6    1    -6    -4   -3    -1    -1   -3   -7   -5    1    3    7    2    5    -4    3     2    11

                                       Asset Mgrs, Cons. Fin, etc   -12   -15   -8      -10     10   41   62    42    21     14     3     6    -3   4    -13   0     2     6    0    -4   1     0    4    15   16   13   9     4    5     0     1


             2. But as bull            Banks
                                       Construction Materials       2
                                                                     0    -4

                                                                           5
                                                                                -4

                                                                                -2
                                                                                        -6

                                                                                        -5
                                                                                                1

                                                                                                -6
                                                                                                     4

                                                                                                     4
                                                                                                           7

                                                                                                          13
                                                                                                                 6

                                                                                                                14
                                                                                                                      4

                                                                                                                      5
                                                                                                                             2

                                                                                                                             1
                                                                                                                                    -4

                                                                                                                                    -1
                                                                                                                                          0

                                                                                                                                          2
                                                                                                                                               3

                                                                                                                                               5
                                                                                                                                                    4

                                                                                                                                                    1
                                                                                                                                                          0

                                                                                                                                                          0
                                                                                                                                                               -4

                                                                                                                                                               -3
                                                                                                                                                                     0

                                                                                                                                                                     6
                                                                                                                                                                           3

                                                                                                                                                                           6
                                                                                                                                                                                3

                                                                                                                                                                                5
                                                                                                                                                                                     1

                                                                                                                                                                                     0
                                                                                                                                                                                          -2

                                                                                                                                                                                          -2
                                                                                                                                                                                               -2

                                                                                                                                                                                                0
                                                                                                                                                                                                     0

                                                                                                                                                                                                     1
                                                                                                                                                                                                          4

                                                                                                                                                                                                          6
                                                                                                                                                                                                               9

                                                                                                                                                                                                               5
                                                                                                                                                                                                                    10

                                                                                                                                                                                                                    3
                                                                                                                                                                                                                         7

                                                                                                                                                                                                                         0
                                                                                                                                                                                                                               1

                                                                                                                                                                                                                              -8
                                                                                                                                                                                                                                    -3

                                                                                                                                                                                                                                    -5
                                                                                                                                                                                                                                         -4

                                                                                                                                                                                                                                         -4
                                                                                                                                                                                                                                               -3

                                                                                                                                                                                                                                                7


             market aged,              Auto & Auto Parts
                                       Hotels
                                                                     2

                                                                    -5
                                                                           7

                                                                          -10
                                                                                 0

                                                                                -11
                                                                                        -4

                                                                                        -13
                                                                                                -8

                                                                                                -7
                                                                                                     -4

                                                                                                     11
                                                                                                          0

                                                                                                          24
                                                                                                                 3

                                                                                                                24
                                                                                                                      3

                                                                                                                      11
                                                                                                                             3

                                                                                                                             14
                                                                                                                                    7

                                                                                                                                    8
                                                                                                                                          4

                                                                                                                                         10
                                                                                                                                               7

                                                                                                                                               12
                                                                                                                                                    1

                                                                                                                                                    19
                                                                                                                                                         -3

                                                                                                                                                          8
                                                                                                                                                               -6

                                                                                                                                                               1
                                                                                                                                                                    -1

                                                                                                                                                                     5
                                                                                                                                                                           2

                                                                                                                                                                           3
                                                                                                                                                                                1

                                                                                                                                                                                10
                                                                                                                                                                                     -3

                                                                                                                                                                                     7
                                                                                                                                                                                          -5

                                                                                                                                                                                          2
                                                                                                                                                                                               -4

                                                                                                                                                                                               -1
                                                                                                                                                                                                     -5

                                                                                                                                                                                                     6
                                                                                                                                                                                                          -5

                                                                                                                                                                                                          17
                                                                                                                                                                                                               2

                                                                                                                                                                                                               10
                                                                                                                                                                                                                    -2

                                                                                                                                                                                                                    6
                                                                                                                                                                                                                         -3

                                                                                                                                                                                                                         15
                                                                                                                                                                                                                              -10

                                                                                                                                                                                                                               9
                                                                                                                                                                                                                                    -4

                                                                                                                                                                                                                                    6
                                                                                                                                                                                                                                          0

                                                                                                                                                                                                                                          5
                                                                                                                                                                                                                                                9

                                                                                                                                                                                                                                               16


             leadership                Gaming
                                       Insurance
                                                                    23

                                                                    -4
                                                                          31

                                                                          -4
                                                                                20

                                                                                -3
                                                                                         1

                                                                                        -3
                                                                                                -1

                                                                                                1
                                                                                                     6

                                                                                                     3
                                                                                                          15

                                                                                                           2
                                                                                                                25

                                                                                                                -2
                                                                                                                      37

                                                                                                                      0
                                                                                                                             23

                                                                                                                             -1
                                                                                                                                    9

                                                                                                                                    -2
                                                                                                                                          2

                                                                                                                                          2
                                                                                                                                               6

                                                                                                                                               2
                                                                                                                                                    3

                                                                                                                                                    1
                                                                                                                                                          1

                                                                                                                                                          2
                                                                                                                                                               7

                                                                                                                                                               6
                                                                                                                                                                    17

                                                                                                                                                                     6
                                                                                                                                                                          17

                                                                                                                                                                           4
                                                                                                                                                                                18

                                                                                                                                                                                3
                                                                                                                                                                                     15

                                                                                                                                                                                     4
                                                                                                                                                                                          12

                                                                                                                                                                                          5
                                                                                                                                                                                                2

                                                                                                                                                                                                5
                                                                                                                                                                                                     9

                                                                                                                                                                                                     4
                                                                                                                                                                                                          18

                                                                                                                                                                                                          4
                                                                                                                                                                                                               29

                                                                                                                                                                                                               2
                                                                                                                                                                                                                    32

                                                                                                                                                                                                                    2
                                                                                                                                                                                                                         56

                                                                                                                                                                                                                         0
                                                                                                                                                                                                                              29

                                                                                                                                                                                                                               0
                                                                                                                                                                                                                                    9

                                                                                                                                                                                                                                    0
                                                                                                                                                                                                                                          2

                                                                                                                                                                                                                                          0
                                                                                                                                                                                                                                               13

                                                                                                                                                                                                                                               -1


             shifted to other          REITs
                                       Restaurants
                                                                    -5

                                                                     4
                                                                           2

                                                                          11
                                                                                -2

                                                                                 1
                                                                                        -11

                                                                                        -1
                                                                                                -9

                                                                                                -7
                                                                                                     1

                                                                                                     -1
                                                                                                          17

                                                                                                          4
                                                                                                                16

                                                                                                                 6
                                                                                                                      0

                                                                                                                      5
                                                                                                                             1

                                                                                                                             3
                                                                                                                                    8

                                                                                                                                    6
                                                                                                                                          8

                                                                                                                                         13
                                                                                                                                               1

                                                                                                                                               10
                                                                                                                                                    -5

                                                                                                                                                    1
                                                                                                                                                         -3

                                                                                                                                                         -2
                                                                                                                                                               3

                                                                                                                                                               5
                                                                                                                                                                     5

                                                                                                                                                                     8
                                                                                                                                                                          -1

                                                                                                                                                                           5
                                                                                                                                                                                -5

                                                                                                                                                                                -2
                                                                                                                                                                                     0

                                                                                                                                                                                     -3
                                                                                                                                                                                          1

                                                                                                                                                                                          5
                                                                                                                                                                                                4

                                                                                                                                                                                                6
                                                                                                                                                                                                     1

                                                                                                                                                                                                     8
                                                                                                                                                                                                          17

                                                                                                                                                                                                          8
                                                                                                                                                                                                               15

                                                                                                                                                                                                               6
                                                                                                                                                                                                                    14

                                                                                                                                                                                                                    8
                                                                                                                                                                                                                         6

                                                                                                                                                                                                                         2
                                                                                                                                                                                                                               1

                                                                                                                                                                                                                               2
                                                                                                                                                                                                                                    -2

                                                                                                                                                                                                                                    0
                                                                                                                                                                                                                                         -3

                                                                                                                                                                                                                                          0
                                                                                                                                                                                                                                                1

                                                                                                                                                                                                                                               -2

             groups in a               Telecom
                                       Oil & Gas
                                                                    -7

                                                                     1
                                                                          -8

                                                                          -1
                                                                                -3

                                                                                 4
                                                                                         6

                                                                                         2
                                                                                                8

                                                                                                4
                                                                                                     4

                                                                                                     -7
                                                                                                          -11

                                                                                                          -5
                                                                                                                -12

                                                                                                                -6
                                                                                                                      -8

                                                                                                                      -3
                                                                                                                             -4

                                                                                                                             1
                                                                                                                                    -2

                                                                                                                                    -6
                                                                                                                                         -1

                                                                                                                                         -6
                                                                                                                                               3

                                                                                                                                               -3
                                                                                                                                                    1

                                                                                                                                                    5
                                                                                                                                                          7

                                                                                                                                                          8
                                                                                                                                                               7

                                                                                                                                                               6
                                                                                                                                                                     8

                                                                                                                                                                     3
                                                                                                                                                                           3

                                                                                                                                                                           3
                                                                                                                                                                                0

                                                                                                                                                                                3
                                                                                                                                                                                     1

                                                                                                                                                                                     7
                                                                                                                                                                                          4

                                                                                                                                                                                          7
                                                                                                                                                                                                0

                                                                                                                                                                                                3
                                                                                                                                                                                                     -4

                                                                                                                                                                                                     -3
                                                                                                                                                                                                          -6

                                                                                                                                                                                                          -8
                                                                                                                                                                                                               -3

                                                                                                                                                                                                               -6
                                                                                                                                                                                                                    -1

                                                                                                                                                                                                                    -7
                                                                                                                                                                                                                         -3

                                                                                                                                                                                                                         -2
                                                                                                                                                                                                                               1

                                                                                                                                                                                                                              -3
                                                                                                                                                                                                                                    1

                                                                                                                                                                                                                                    2
                                                                                                                                                                                                                                          2

                                                                                                                                                                                                                                          0
                                                                                                                                                                                                                                               -5

                                                                                                                                                                                                                                                6

             consistent                E&P                           3    -2     2      -6      -1   -8    0    -9    -4     -2     -6   -7    -7   4     8    11    3    -1    2    8    9     1    -4   -9   -7   -3   -2   -4    -7   -4     6

                                       Utes
             manner…
                                                                    -7    -8    -1       3      6    -2   -10   -7    -4     1      -2   -2    -4   -2    2    4     7     5    3    5    7     4    -3   -9   -8   -4   -5    2    0     1    -3

                                       Retail                        8    13     2      -2      -6   6    16    19    13     7      1    -3    -4   -5   -2    1     5     3    -1   -4   -3    1    2    9    4    4    0     0    -4   -4    -5

                                       Transports                    3    -1    -3      -4      -1   -1    2    -2    -1     -1     4     3    0    -1    0    1     2     3    7    1    2     1    6    5    7    2    1    -5    -2    0     2

                                       Airlines                      1     6    -3      -7      -9   3     9     6    3      -5     0     3    1    6    -2    -5   -10   -5    7    2    -3   -1    8    6    4    0    0    -3    2     0     0

                                       Industrials                  0      0    -1      -3      -3   -1    3     3    2      -1     0     1    2    2     0    0     1     1    5    2    0    -2    0    2    5    3    2    -3    -2   0      2

                                       Media                        0     -2    -1      -1      -3   2     3     6    -2     -7     -2   -2    1    -6   -5    -5   -3    -4    -3   -6   -2   -2    -1   -5   -3   3    6     3    1     1     2



                                Source: J.P. Morgan and Datastream.




20
Thomas J Lee, CFA                           North America Equity Research
(1-212) 622-6505                            10 December 2010
thomas.lee@jpmorgan.com




                                            In 2010, Top-Quartile Groups Based on Staging Materially
                                            Outperformed...
                                            So would staging have identified top groups in 2010?

                                            We have compiled the data in Figure 23 below. We took the 30 largest industry
                                            groups in the S&P 500 (weights of at least 2%) and stratified them by quartile based
                                            on their historical outperformance in Year 2 of a bull market (roughly 2010).

                                            • The implied returns are those with the dashed lines around the columns. For
                                              instance, the top quartile (8 groups) would be expected to outperform by 650bp
                                              (see Figure 24) based on their behavior during bull markets since ’74.

                                            • The blue column shows the actual outperformance for each of these quartiles. As
                                              noted, the top quartile outperformed the S&P 500 by 1,030bp this year.

                                            • By contrast, the worst quartile underperformed by 400bp.

                                            Overall, in 2010, each group performed roughly in line with expected performance
                                            suggested by historical bull markets. In other words, interestingly, the market this
                                            year has acted in very “textbook” manner.

                                            Figure 23: Suggested Top Quartile (Based on Staging) Outperformed in 2010
                                            % change relative to S&P 500                                                       The bottom 8 groups
                                                                                                                               underperformed by
                                                                                              Predicted 2010   Actual 2010     400bp
                   The top 8 groups expected to                                        10.3
                   perform well based on results
                                                     Relative perf. vs S&P 500




                   in past bull markets did in                                   6.5
                   fact outperform by 1,030bp in                                                    3.9                 3.8
                   2010                                                                       2.7
                                                                                                                 0.2



                                                                                                                                 -2.2
                                                                                                                                        -4.0

                                                                                 Quartile 1   Quartile 2          Quartile 3      Quartile 4

                                            Source: J.P. Morgan and Datastream.


                                            To give some context on those groups, we have detailed these in Figure 24 below.
                                            For instance, historical staging suggests that Consumer Cyclicals (Auto Parts,
                                            Restaurants, Hotels, Gaming) should have led in 2010 and, as the “actual” shows—
                                            these sectors indeed outperformed.




                                                                                                                                               21
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




                          Figure 24: 2010 Comparative Performance: What History Would Suggest vs. What Happened
                          % change (next 6 months)
                                                                                               Good =Top quartile
                          2010 stylized                           Actual 2010
                          (based on all bull markets since '73)   1H performance               Bad   = Bottom quartile

                          1H10                                    1H10                               Comment


                          Asset Mgrs, Cons. Fin, etc              Asset Mgrs, Cons. Fin, etc         Financials did not stand out in 1H as
                          Banks                                   Banks                              expected. Although history said REITs
                          Insurance                               Insurance                          should have been top quartile
                          REITs                                   REITs

                          Chemicals                               Chemicals
                          Metals, Paper and Gold                  Metals, Paper and Gold             Chemicals as expect but Metals better
                          Oil & Gas                               Oil & Gas                          Energy did badly in 1H10 as expected
                          E&P                                     E&P

                          Semis                                   Semis
                          Telco Eq                                Telco Eq
                          Construction Materials                  Construction Materials             Corporate-capex plays were as expected
                          Transports                              Transports                         but Airlines rather than Transports outperform
                          Airlines                                Airlines                           in 1H10
                          Industrials                             Industrials
                          Software                                Software
                          PC                                      PC

                          Auto & Auto Parts                       Auto & Auto Parts
                          Homebuilders                            Homebuilders
                          Restaurants                             Restaurants                        Consumer Cyclicals performed like
                          Retail                                  Retail                             clockwork….
                          Hotels                                  Hotels
                          Gaming                                  Gaming
                          Media                                   Media

                          Health Care Eq & Svcs                   Health Care Eq & Svcs
                          Biotech                                 Biotech
                          Pharma                                  Pharma                             Defensives did poorly as history suggested
                          Food & Beverages                        Food & Beverages                   framework in a near text-book format
                          Personal products                       Personal products
                          Telecom                                 Telecom
                          Utes                                    Utes
                          Source: J.P. Morgan and Datastream.




22
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




                          Analysis: How Do We Stage?
                          To do our staging analysis, we took multiple steps:

                          1. First, we examined the five bull markets since 1974 and looked at rolling six-
                             month performance each month from Year -1 to Year +4, or six months in total.

                          2. Second, we identified the 30 largest industry groups (with at least a 2%
                             weighting) and looked at the relative performance of each of these groups (vs.
                             S&P 500).

                          3. Third, we aggregated the performance of each of these groups to establish a
                             composite performance ranking at each point in the bull market.

                          4. Using quartiles identified, we now can determine at each month in the life cycle
                             of a bull market what groups outperformed and underperformed.

                          We then stylized this information by indicating when a particular industry group
                          started outperforming (labeled “Buy”) and underperforming (labeled “Sell”) (see
                          Figure 26 and Figure 27).




                                                                                                                23
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




24
Thomas J Lee, CFA                    North America Equity Research
(1-212) 622-6505                     10 December 2010
thomas.lee@jpmorgan.com




                                     Staging in 2011: The Year in 3 Phases…
                                     Historical analysis suggests that we should see substantial shifts in industry
                                     leadership in 2011. Based on all bull markets since 1974 (5 in total), the groups
                                     expected to outperform (top quartile) are shaded in Green below in Figure 25 and the
                                     groups expected to underperform are italicized (bottom quartile).
                                     • Basically, in the first third of 2011, Consumer Cyclicals along with Insurance and
                                       Asset Managers are expected to lead.
                                     • As we move into the second third, enterprise/infrastructure Cyclicals should lead.
                                     • And by the final third of the year, there is likely to be a more pronounced shift
                                       into Defensives (Biotech, etc.)
                                     • Utilities, Insurance, and Gaming are expected to outperform consistently during
                                       each phase of 2011. We will monitor this in our “Circle of Life” reports.

                                     Figure 25: Groups Expected to Outperform in 2011 Based on Historical Staging
                                     Top quartile is shaded green; Bottom quartile in italics and red
                                                                2011 stylized (based on all bull markets since '73)

                                                                1st third (~month 22)                2nd third (~month 26)        3rd third (~month 30)


      1. Consumer Cyclicals          Credit Sensitive           Asset Mgrs, Cons. Fin, etc           Asset Mgrs, Cons. Fin, etc   Asset Mgrs, Cons. Fin, etc
      expected to outperform in                                 Banks                                Banks                        Banks
      early 2011, along with




                                                                                                                                                                    Staging in 2011: The Year in 3 Phases…
                                                                Insurance                            Insurance                    Insurance
      Financials                                                REITs                                REITs                        REITs

                                     Resource &                 Chemicals                            Chemicals                    Chemicals
                                     Commodity                  Metals, Paper and Gold               Metals, Paper and Gold       Metals, Paper and Gold
                                     Producers                  Oil & Gas                            Oil & Gas                    Oil & Gas
      2. Leadership is                                          E&P                                  E&P                          E&P
      expected to shift toward
      Enterprise/Capex Sensitives.   Corporate                  Semis                                Semis                        Semis
      It makes sense that domestic   Capex &                    Telco Eq                             Telco Eq                     Telco Eq
      cyclicals would be expected    Infrastructure             Construction Materials               Construction Materials       Construction Materials
      to gain…                       Plays                      Transports                           Transports                   Transports
                                                                Airlines                             Airlines                     Airlines
                                                                Industrials                          Industrials                  Industrials
                                                                Software                             Software                     Software
                                                                PC                                   PC                           PC

                                                                Auto & Auto Parts                    Auto & Auto Parts            Auto & Auto Parts
                                     Consumer                   Homebuilders                         Homebuilders                 Homebuilders
                                     Cyclicals                  Restaurants                          Restaurants                  Restaurants
                                                                Retail                               Retail                       Retail
                                                                Hotels                               Hotels                       Hotels
                                                                Gaming                               Gaming                       Gaming
                                                                Media                                Media                        Media

                                     Defensives                 Health Care Eq & Svcs                Health Care Eq & Svcs        Health Care Eq & Svcs
      3. Defensives expected to
                                                                Biotech                              Biotech                      Biotech
      gain in the final third
      of 2011…                                                  Pharma                               Pharma                       Pharma
                                                                Food & Beverages                     Food & Beverages             Food & Beverages
                                                                Personal products                    Personal products            Personal products
                                                                Telecom                              Telecom                      Telecom
                                                                Utes                                 Utes                         Utes
                                     Source: J.P. Morgan and Datastream.


                                                                                                                                                               25
Thomas J Lee, CFA                                               North America Equity Research
(1-212) 622-6505                                                10 December 2010
thomas.lee@jpmorgan.com




                                                                Stylized Sorting of Group Outperformance
                                                                We present the above analysis in a different format below, in which we show a
                                                                sequential ordering of groups based on their historical relative outperformance at
                                                                each point in a bull market cycle.

Figure 26: Historical Staging – Stylized Timing of Group Outperformance (“Buy” Indicates Start of Outperformance)***
Based on Top Quartile performance at each month of bull market

Average '74 to '02                                       YEAR -1                           YEAR 1                   YEAR 2                           YEAR 3                          YEAR 4

Date
Months into Bull market                   -11 -9    -7     -5      -3   -1    1    3   5     7      9   11 13 15    17    19    21 23 25 27          29   31    33 35 37 39          41    43   45 47 49

                                                                                                                                              2011
S&P 500 % chg next 6-months (rolling) (1)      3    (9) (16) (12)       5    19 17 11        7      7   9   8   6   1     3     3    6    5    2     1    (1)   3    7    8    7     8     7    4   4   7

      Auto & Auto Parts                                                                     BUY —►—►—► █
      Telecom                                             BUY —► █                                          BUY —► —► —► —► █
      Oil & Gas                                    BUY —►          █                                            BUY —► —► —►—►—►—► —►                      █                                    BUY —►—►
      E&P                                                                                                       BUY —► —► —►—►—►—► —►                      █                                            BUY
      Utes                                                                                                          BUY —► —►—►—►—► —►                     █
      Gaming                             BUY —►—► —► —► —►—►—►—►—►—►—►—►—► —► —► —►—►—►—► —►                                                               █                              BUY —►—►—►
      Hotels                                                            BUY —►—►—►—►—►—►—►—► —► —► —►—►—►—► █                                                                                   BUY —►—►
      Insurance                                                                                                 BUY —► —► —►—►—►—► —► —► —► █
      Asset Mgrs, Cons. Fin, etc                                        BUY —►—►—►—►—►—► █                                     BUY —►—► █                                BUY —► —►         █
      Banks                                                                       BUY —► █                                          BUY —► █                             BUY —► —►         █
      Construction Materials                                                 BUY —► █                                          BUY —►—► █
      Transports                                                                                 BUY —► █                                BUY —► —► —► —► █
      Health Care Eq & Svcs              BUY —►—► —► —► —► █                                                                                  BUY —► —► —►—►—►—► —►                        █
      Food & Beverages                        BUY —► —► —► █                                                        BUY —► █                  BUY —► —► █                     BUY —► —► █
      Restaurants                                                                      BUY —►—►—►—►—► —► —► —► █                                   BUY —► —►—►—►—► █
      Biotech                                                    BUY —►—►—►—►—► █                                                                  BUY —► —►—►—►—► —► —► █
      REITs                                                                                      BUY —► █                                                 BUY —►—►—►—► █
      Retail                             BUY —► █                                 BUY —►—► █                                   BUY —► █                   BUY —► █
      Software                                                          BUY —►—►—►—►—► █                                                                  BUY —►—►—►—► —► —► —►—► █
      Airlines                                                          BUY —►—► █                                                       BUY █                  BUY —► █
      Industrials                                                                                BUY —►—► █                              BUY —► █                        BUY —► █
      PC                                                                BUY —►—► █                                                                              BUY —► █                        BUY —►—►
      Personal products                  BUY —►—► —► —► █                                               BUY —►—► —►       █                                         BUY —►—► —► —► —►—► █
      Homebuilders                       BUY —►—► —► —► █                                               BUY —►—► —►       █                                         BUY —►—► —► —► —►—► █
      Semis                              BUY █                               BUY —►—►—►—►—► █                                                                       BUY █                           BUY —►
      Telco Eq                                                               BUY —► █            BUY —►—► █                         BUY —► █                        BUY —►—► █
      Chemicals                                    BUY —►          █                   BUY —►—►—►—► █                                                                    BUY —► —► —► —►—►—►
      Metals, Paper and Gold                                                 BUY —►—►—►—►—► █                                                                            BUY —► —► —► —►—►—►
      Pharma                                              BUY —► —► █                                                                                                         BUY —► —► —► █
      Media                                        BUY —► —► █                                                                                                                            BUY —►—► █

Source: J.P. Morgan and Datastream.
*** “Buy” only indicates period in which specific group started to outperform in past bull markets, and does not indicate a J.P. Morgan Strategy sector rating or recommendation. For J.P. Morgan
Strategy sector ratings and analysis, please see 2011 Sector Outlook starting on page 43 of this report.




26
Thomas J Lee, CFA                                                North America Equity Research
(1-212) 622-6505                                                 10 December 2010
thomas.lee@jpmorgan.com




                                                                 Stylized Sorting of Group Underperformance
                                                                 We present the above analysis in a different format below. We show a sequential
                                                                 ordering of groups based on their historical relative UNDERperformance at each
                                                                 point in the bull market cycle.

Figure 27: Historical Staging – Stylized Timing of Group Underperformance (“Sell” Indicates Start of Underperformance)***
Based on Bottom Quartile performance at each month of bull market

Average '74 to '02                                        YEAR -1                            YEAR 1                       YEAR 2                        YEAR 3                        YEAR 4

Date
Months into Bull market                   -11 -9     -7     -5      -3   -1    1    3    5     7      9    11 13 15      17    19   21 23 25 27         29   31    33 35 37 39       41    43    45 47 49

                                                                                                                                                 2011
S&P 500 % chg next 6-months (rolling) (1)       3   (9) (16) (12)        5    19 17 11         7      7    9    8    6    1    3    3   6    5    2     1    (1)   3    7   8    7    8    7     4        4    7

      Pharma                                                                       SELL ▼ ▼ ▼ ▼ ▼ ▼                      ▼    ▼     ▼ ▼      ▀                                                                SELL
      Health Care Eq & Svcs                                                             SELL ▼ ▼ ▼ ▼ ▼                   ▼    ▼     ▼ ▼      ▀                                                         SELL ▼
      Media                              SELL ▀                                              SELL ▼ ▼ ▼ ▼                ▼    ▼     ▼ ▼ ▼ ▼             ▼    ▼     ▼ ▼      ▀
      Biotech                                 SELL ▼        ▀                                             SELL ▼ ▼       ▼    ▼     ▼   ▀                                                              SELL ▼
      PC                                                                                                  SELL ▼ ▼       ▼    ▼     ▼   ▀                                       SELL ▼     ▀
      Software                                                                                                 SELL ▼    ▼    ▼     ▼ ▼ ▼ ▼             ▀
      Semis                                         SELL ▼          ▼    ▀                                          SELL ▼    ▼     ▀                                           SELL ▼     ▀
      Chemicals                                                                                                          SELL ▼     ▼ ▼ ▼ ▼             ▼    ▼     ▀
      Metals, Paper and Gold                                                                                             SELL ▼     ▼ ▼ ▼ ▼             ▼    ▼     ▀
      Auto & Auto Parts                                    SELL ▼        ▼ ▼        ▀                                         SELL ▼ ▼ ▼ ▼              ▼    ▼     ▼ ▼ ▼ ▼           ▼     ▼     ▼ ▼ ▼
      Hotels                                  SELL ▼        ▼       ▀                                                                                        SELL ▼ ▼ ▼ ▼             ▀
      Telecom                            SELL ▼      ▀                        SELL ▼ ▼ ▼ ▼                 ▀                                                       SELL ▼ ▼ ▼         ▀
      Oil & Gas                                                          SELL ▼ ▼ ▼ ▼ ▼ ▼                       ▀                                                  SELL ▼ ▼ ▼        ▼     ▀
      E&P                                                  SELL ▼        ▼ ▼ ▼ ▼ ▼ ▼ ▼                          ▀                                                  SELL ▼ ▼ ▼        ▼     ▼     ▼        ▀
      Utes                               SELL ▀                          SELL ▼ ▼ ▼ ▼ ▼ ▼                       ▀                                                  SELL ▼ ▼ ▼        ▼     ▼     ▀
      Insurance                          SELL ▼ ▼           ▼       ▼    ▼ ▼        ▀                                                                                           SELL ▼     ▼     ▼ ▼ ▼
      Airlines                                      SELL ▼          ▀                                                         SELL ▼    ▀             SELL ▀                    SELL ▼     ▼     ▼ ▼           ▀
      Construction Materials                                                                       SELL ▀                                                                            SELL ▼      ▼ ▼ ▼
      Transports                                    SELL ▀                                                                                                                           SELL ▼      ▼        ▀
      Banks                                   SELL ▼        ▼       ▼    ▼     ▀                   SELL ▼       ▀             SELL ▀                  SELL ▼       ▀                            SELL ▼ ▼
      REITs                              SELL ▼ ▼           ▼       ▀                                                                                                                           SELL ▼ ▼
      Retail                                                                                              SELL ▼     ▀                                                                          SELL ▼ ▼
      Gaming
      Asset Mgrs, Cons. Fin, etc         SELL ▼ ▼           ▼       ▀                                               SELL ▼     ▀
      Food & Beverages                                                        SELL ▼ ▼         ▀                                                                       SELL ▀                                 SELL
      Restaurants                                                 SELL ▼ ▼          ▀                                                       SELL ▀
      Industrials                                                 SELL ▼       ▀                                                                             SELL ▼     ▀
      Personal products                                                            SELL ▼ ▼           ▀
      Homebuilders                                                                 SELL ▼ ▼           ▀
      Telco Eq                                                    SELL ▀

Source: J.P. Morgan and Datastream.
*** “Sell” only indicates period in which specific group started to underperform in past bull markets, and does not indicate a J.P. Morgan Strategy sector rating or recommendation. For J.P. Morgan
Strategy sector ratings and analysis, please see 2011 Sector Outlook starting on page 43 of this report.




                                                                                                                                                                                                     27
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




28
Thomas J Lee, CFA                                          North America Equity Research
(1-212) 622-6505                                           10 December 2010
thomas.lee@jpmorgan.com




                                                           STOCKS: 18 Names for 1st Third of 2011
                                                           We decided to compile a list of ideas for the first third of 2011, based on our staging
                                                           concept—that is, identify a group of stocks that is expected to outperform in the first
                                                           few months of 2011. Again, one of the changes in our thinking about 2011 is that we
                                                           believe there could be greater sector rotation than in past years. The criteria we used
                                                           are as follows:

                                                           • In top quartile of industries for 2011, namely: Asset Managers, Consumer
                                                             Finance, Insurance, Construction Materials, Restaurants, Retail, Gaming,
                                                             Telecom, and Utilities;
                                                           • Style factor of High-Beta, as this style looks attractive on institutional ownership
                                                             and relatively cheaper vs. long-term valuations;
                                                           • Upside implied by J.P. Morgan target price is at least 10%; and
                                                           • Rated Overweight by J.P. Morgan.

                                                           The list of 18 stocks is shown in Figure 28 below. These stocks have an average P/E
                                                           (2011E) of only 13.4x and average implied upside of 21% to J.P. Morgan target
                                                           prices.

Figure 28: 18 Ideas Expected to Outperform in Early 2011




                                                                                                                                                                                                    STOCKS: 18 Names for 1st Third of 2011
$ millions
                                                                                                          JPM Coverage                            Sentiment               EPS and Valuation
                                                                                                                                                   FC Mean
                                                                                                                                                     Rating       Short
                                                                             Current     Market           JPM                    Target Implied     (1=buy,    Int % of    2011E      P/E
     Name                           Sub-Industry                      Ticker   Price        Cap    Beta   Rtg   JPM Analyst       Price Upside       5=sell)      Float      EPS   ('11E)     P/B
1    Office Depot Inc.              Specialty Stores                  ODP     $5.03     $1,394    3.30    OW    Horvers Christo $8.00     59%          2.90       6.7%     $0.07   68.9x    1.72x
2    Och-Ziff Capital Management Asset Management & Custody Bank OZM         $14.12     $1,281    2.00    OW    Worthington Ke $19.00     35%          1.90       5.7%     $1.39   10.1x
3    INVESCO Ltd.                   Asset Management & Custody Bank IVZ      $23.08    $10,664    1.75    OW    Worthington Ke $30.50     32%          2.20       2.3%     $1.71   13.5x    1.31x
4    Allstate Corp.                 Property & Casualty Insurance     ALL    $30.48    $16,404    1.49    OW    Heimermann M $40.00       31%          2.20       1.3%     $3.88     7.9x   0.85x
5    NII Holdings Inc.              Wireless Telecommunication ServiceNIHD $41.34       $6,998    2.03    OW    Baggio Andre $51.00       23%          1.90       3.1%     $2.64   15.7x    2.21x
6    OfficeMax Inc.                 Specialty Stores                  OMX    $18.07     $1,536    2.83    OW    Horvers Christo $22.00    22%          2.20     10.2%      $1.07   16.9x    2.85x
7    Owens Corning                  Building Products                 OC     $28.77     $3,586    8.50    OW    Rehaut Michae $34.50      20%          1.90       8.9%     $2.16   13.3x    0.94x
8    Las Vegas Sands Corp.          Casinos & Gaming                  LVS    $46.04    $31,525    4.09    OW    Greff Joseph    $55.00    19%          2.00     10.5%      $1.69   27.2x    5.18x
9    Limited Brands Inc.            Apparel Retail                    LTD    $31.10    $10,031    1.69    OW    Tunick Brian    $37.00    19%          2.40       3.0%     $2.20   14.1x    4.89x
10   Men's Wearhouse Inc.           Apparel Retail                    MW     $23.65     $1,246    1.74    OW    Tunick Brian    $28.00    18%          2.20       9.5%     $1.64   14.4x    1.26x
11   AFLAC Inc.                     Life & Health Insurance           AFL    $54.92    $25,882    1.75    OW    Bhullar Jimmy $65.00      18%          2.10       1.2%     $6.18     8.9x   2.32x
12   Group 1 Automotive Inc.        Automotive Retail                 GPI    $39.76       $943    1.76    OW    Patel Himanshu $46.00     16%          2.10     22.7%      $3.22   12.3x    1.22x
13   Franklin Resources Inc.        Asset Management & Custody Bank BEN $118.92        $26,637    1.50    OW    Worthington Ke $136.00    14%          2.20       1.8%     $7.81   15.2x    3.45x
14   Pinnacle Entertainment Inc. Casinos & Gaming                     PNK    $14.00       $860    1.94    OW    Greff Joseph    $16.00    14%          2.00     10.7%      $0.17   83.3x    1.67x
15   Hartford Financial Services Gr Multi-line Insurance              HIG    $25.00    $11,114    3.03    OW    Bhullar Jimmy $28.00      12%          2.60       4.7%     $3.68     6.8x   0.55x
16   Macy's Inc.                    Department Stores                 M      $25.49    $10,794    1.82    OW    Grom Charles $28.00       10%          2.00       4.3%     $2.24   11.4x    2.20x
17   MetLife Inc.                   Life & Health Insurance           MET    $42.79    $42,159    1.80    OW    Bhullar Jimmy $47.00      10%          1.80       2.2%     $5.04     8.5x   0.84x
18   American Express Co.           Consumer Finance                  AXP    $45.63    $54,928    1.99    OW    Shane Richard $50.00      10%          2.00       1.3%     $3.75   12.2x    3.45x
     Average                                                                                      2.50                                    21%         2.14       6.1%              13.4x 1.72x
Source: J.P. Morgan and FactSet.




                                                                                                                                                                                              29
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




30
Thomas J Lee, CFA                                        North America Equity Research
(1-212) 622-6505                                         10 December 2010
thomas.lee@jpmorgan.com




                                                         Special: Still See Housing Bottom in 2011
                                                         We still believe US housing markets are likely to see a bottom in mid-2011 (see
                                                         “Positive on housing food chain” dated 4/9/2010) sustained by household formation,
                                                         recovery in employment, tightening markets for housing (vacancy rates), and
                                                         gradually easing credit conditions.

                                                         • A sustained recovery in housing provides upside to the GDP outlook. Each
                                                           increment of 500k home starts (from the current 519k) adds 1.5% to GDP growth
                                                           and about 2mm jobs.

                                                         • Thus, if US housing indeed starts to see a recovery in starts, this would add
                                                           substantially to the upside potential for GDP forecasts.

                                                         Of course, there is an “animal spirits” element to the recovery in housing. After all,
                                                         purchasing a home requires the buyer to accept a large liability and, thus,
                                                         expectations of future home prices are key. If one expects rising home prices, one
                                                         consequently has an incentive to acquire the liability.

                                                         Demand Forecast to Improve in 2011 Leading to Gradual
                                                         Rise in Prices…
                                                         Foremost, demand for housing is forecast to recover. Economists broadly see home




                                                                                                                                                                                   Special: Still See Housing Bottom in 2011
                                                         sales rising in 2011 (see Figure 29) with some variance between a 2% and 18% rise
                                                         in demand for existing homes (EHS). The drivers for this are noted above.

                                                         • The gradual improvement in demand (existing homes, not new homes) should
                                                           stabilize home prices. The J.P. Morgan Securitized Products Group HPA (home
                                                           price) forecasts are shown below in Figure 30. The relevant one is the “Base”
                                                           case and they see flat home prices in 2011 followed by gradual rises going
                                                           forward.

Figure 29: Economists Predict a Recovery in Housing Demand                                   Figure 30: J.P. Morgan SPG Sees Home Prices Flat in 2011…
From 2011 Global Housing Outlook by John Sim                                                 From 2011 Global Housing Outlook by John Sim




Source: J.P. Morgan. From ”Home Price Monitor: 2011 Outlook” by John Sim dated 11/24/2010.



                                                                                             Source: J.P. Morgan. From “Home Price Monitor: 2011 Outlook” by John Sim dated
                                                                                             11/24/2010.




                                                                                                                                                                              31
Thomas J Lee, CFA                                                                                     North America Equity Research
(1-212) 622-6505                                                                                      10 December 2010
thomas.lee@jpmorgan.com




                                                                                                      Improvement in Employment Should Boost Household
                                                                                                      Formation…1.5mm in 2011 and 1.6mm in 2012
                                                                                                      Equally important is a recovery in the labor markets. J.P. Morgan economists see the
                                                                                                      US adding 175k per month in payrolls, a major step up from the 100k seen in 2010.
                                                                                                      Historically, this bodes well for household formation. One can see below in Figure
                                                                                                      31 that household formation varies with labor market conditions. Specifically, it has
                                                                                                      plunged during recessions before recovering.

                                                                                                      • The pace of that recovery is illustrated in Figure 32 on the right. As one can see,
                                                                                                        Housing formed per net adult change meaningful accelerates as labor market
                                                                                                        conditions improve. The result is that by Year +2 and +3 (which equates to 2011
                                                                                                        and 2012), this ratio would be expect to rise from a low of 0.19 to 0.7 and this
                                                                                                        implies a meaningful step up in demand.
                                                                                                      • For 2011 and 2012, moving to the average ratio of 0.7 times 2.6mm net new
                                                                                                        adults implies 1.9mm-plus formed.

Figure 31: Household Formation vs. Employment Growth                                                                                                                                                       Figure 32: Following Labor Trough, HH Formation
Jobs and Households formed per net adult chg                                                                                                                                                               Accelerates
                                                                                                                                                                                                           Jobs and Households formed per net adult chg
                                                                  Recession       Increase in Nonfarm Payrolls     HH Formation per Net Adult chg                                                                                   From trough HH Formed/ Net Adult chg
                                                   1.30                                                                                        4,000                                                             Year of Trough
 H H fo r m a ti o n p e r N e t A d u l t C h g




                                                                                                                                                        I n c r e a s e i n N o n fa r m P a y r o l l s



                                                                                                                                                                                                                 in Ratio                  0        1        2       3       4       5
                                                   1.10                                                                                       2,000                                                              1962                  0.27     0.69     0.92    1.24    0.54    0.71
                                                                                                                                                                                                                 1966                  0.54     0.71     0.82    0.53    0.54    0.55
                                                   0.90                                                                                                                                                          1974                  0.47     0.60     0.47    0.65    0.43    1.14
                                                                                                                                              0
                                                                                                                                                                                                                 1982                  0.16     0.50     0.70    0.69    0.48    0.87
                                                   0.70
                                                                                                                                                                                                                 1989                  0.22     0.44     0.63    0.36    0.41    1.23
                                                                                                                                              (2,000)
                                                   0.50                                                                                                                                                          1995                  0.42     0.67     0.84    0.67    0.55    0.67
                                                                         0.54
                                                                                                                 0.42                                                                                      b     Avg All Years         0.35     0.60     0.73    0.69    0.49    0.86
                                                                                0.47                                                          (4,000)
                                                   0.30           0.27                                                                                                                                           2009 (today)          0.19     0.38        —       —       —       —
                                                                                                          0.22
                                                                                               0.16                                   0.16
                                                   0.10                                                                                       (6,000)                                                          Implied HHs formed                        2011e 2012e 2013e 2014e
                                                          1/59 1/63 1/67 1/71 1/75 1/79 1/83 1/87 1/91 1/95 1/99 1/03 1/07 1/11 1/15                                                                       a   Incr. Adults                             2.6mm 2.6mm 2.6mm 2.6mm
                                                                                                                                                                                                           b   HH/adult (see above)                       0.73  0.69  0.49  0.86
Source: J.P. Morgan and Bloomberg.
                                                                                                                                                                                                           a*b Implied HHs Formed                       1.9mm 1.8mm 1.3mm 2.2mm
                                                                                                                                                                                                           Source: J.P. Morgan and Bloomberg.




                                                                                                      Shadow Inventory Is Peaking…
                                                                                                      The J.P. Morgan Securitized Product Research (or SPG) team sees shadow inventory
                                                                                                      of homes (homes delinquent, plus foreclosure plus REO) as peaking and gradually
                                                                                                      dipping going forward (see Figure 33). But as has been apparent in the past few
                                                                                                      years, the pace at which these homes are liquidated plays a big role in home price
                                                                                                      movements.

                                                                                                      • Their base case is for foreclosure liquidations to rise to 2.5mm in 2011 assuming
                                                                                                        a foreclosure rate of 10% and foreclosures becoming REO (real estate owned,
                                                                                                        homes owned by banks) staying at roughly 3.5-4.0%.
                                                                                                      • In our view, a decline in shadow inventory sets the stage for home prices to
                                                                                                        gradually bottom and that is the forecast of our SPG team which expects home
                                                                                                        prices to bottom in 2011 before gradually rising.

32
Thomas J Lee, CFA                                        North America Equity Research
(1-212) 622-6505                                         10 December 2010
thomas.lee@jpmorgan.com




Figure 33: Shadow Inventory Is Peaking…                                                  Figure 34: Liquidations of Foreclosures Are Peaking…
Shadow is all delinquent, foreclosure, and REO loans (millions)                          Millions




                                                                                         Source: J.P. Morgan. From “2011 Securitized Product Outlook” by Ed Reardon, John Sim,
Source: J.P. Morgan. Loan Performance, MBA, and the “2011 Securitized Product            and team.
Outlook” by Ed Reardon, John Sim, and team.


                                                         Vacancy Rates of Housing Are Falling, While Apartment
                                                         Rents Are Rising
                                                         Vacancy rates for both housing and rental use in the meantime are falling
                                                         meaningfully. In fact, we believe rental vacancy rates at 10.3% are essentially back
                                                         to equilibrium levels seen in the 2003-2004 period (see Figure 36).

                                                         • But vacancy rates for US housing are still somewhat elevated at 2.5%. A tighter
                                                           market would see vacancy rates below 2%. The key for reducing vacancy rates
                                                           for US housing is the need for household formation (see above). Again, we see
                                                           that accelerating in 2011.
                                                         • The pushback is that one might say more households may become renters. This is
                                                           possible, but the issue, in our view, is the limited rental stock available.

Figure 35: Housing Vacancy Rates Are Declining                                           Figure 36: Housing Vacancy Rates Are Declining
%                                                                                        %




                                                                                                                                Equilibrium


                                       Still high




Source: Bloomberg.                                                                       Source: Bloomberg.




                                                                                                                                                                           33
Thomas J Lee, CFA                                        North America Equity Research
(1-212) 622-6505                                         10 December 2010
thomas.lee@jpmorgan.com




                                                         Record Affordability, But Credit Needs to Ease
                                                         In the meantime, affordability of housing has improved greatly according to our SPG
                                                         team. As shown in Figure 37 below, given the combination of falling home price and
                                                         lower interest rates, payments on a 30-year fixed-rate mortgage today are lower than
                                                         those using non-traditional lending products to purchase a home in 2006 and 2008. In
                                                         fact, compared to 2008, mortgage payments are 50% lower.

                                                         • The movement in mortgage payments is illustrated in Figure 38 below which
                                                           shows that conforming mortgages (30-year fixed) have a lower payment now
                                                           than would ARMs originated in 2004 and prior. In other words, affordability is
                                                           very strong.

Figure 37: Affordability Is Better Today than During Any                   Figure 38: Conforming Loans Cheaper Than Option-ARMs of 5 Years Ago
Boom Time...                                                               Payment on a given mortgage product
Forecasted payments




                                                                           Source: J.P. Morgan. Loan Performance, MBA, and the “2011 Securitized Product Outlook” by Ed Reardon,
                                                                           John Sim, and team. Assumes a $500K home in June ’06, with Case-Shiller home price increases/declines
Source: J.P. Morgan. Loan Performance, MBA, and the “2011 Securitized      before and after. LTV ramps up from 70% to 80% during the boom and then back to 70%. Option ARM
Product Outlook” by Ed Reardon, John Sim, and team.                        assumes a minimum 1.5% teaser payment.




34
Thomas J Lee, CFA                                                                                          North America Equity Research
(1-212) 622-6505                                                                                           10 December 2010
thomas.lee@jpmorgan.com




                                                                                                           Risk: P/E Volatility
                                                                                                           Expect Higher Interest Rate and Dollar Volatility…
                                                                                                           Higher volatility in interest rates and the dollar should be all but certain in 2011, with
                                                                                                           the resulting implication being higher P/E volatility (see Figure 39 and Figure 40).
                                                                                                           The drivers of this are the combination of Fed monetary easing cycle (QE) against
                                                                                                           the backdrop of rising sovereign debt sustainability (EU mostly) and diverging
                                                                                                           cyclical momentum:
                                                                                                           • It should be no surprise that QE coupled with mounting sovereign debt
                                                                                                             sustainability questions are raising the volatility of interest rates. Similarly, given
                                                                                                             the diverging global economic momentum (EM vs. developed), the Fed’s latest
                                                                                                             easing cycle is driving debate about dollar intervention and competitive
                                                                                                             devaluation.
Figure 39: Interest Volatility High...                                                                                                                   Figure 40: Dollar Volatility High...
Delivered volatility since 2005                                                                                                                          Delivered volatility since 2005
                                                                                     5y r Av g +/- 1std dev                                                                                                             5y r Av g +/- 1std dev                              DXY Deliv ered Volatility (20D av g)
                                                                                     10y r Treasury Deliv ered Volatility (20D av g)                                                                                    Trailing 5y r Av g
                                            4.0%                                     Trailing 5y r Av g

                                            3.5%                                                                                                                                                     1.0%

                                            3.0%
                                                                                                                                                                                                     0.8%
                                                                                                                                                          Delivered Volatility
 Delivered Volatility




                                            2.5%
                                                                                                                                                                                                     0.6%
                                            2.0%

                                            1.5%                                                                                                                                                     0.4%

                                            1.0%
                                                                                                                                                                                                     0.2%
                                            0.5%

                                            0.0%                                                                                                                                                     0.0%
                                                   1/05     7/05   1/06   7/06     1/07   7/07    1/08    7/08     1/09   7/09      1/10   7/10                                                             1/05     7/05    1/06     7/06    1/07     7/07   1/08   7/08    1/09    7/09   1/10    7/10


Source: J.P. Morgan and Bloomberg.                                                                                                                       Source: J.P. Morgan and Bloomberg.


                                                                                                           Higher interest rate and dollar volatility naturally produce higher P/E vol…
                                                                                                           Naturally, with higher interest rate and dollar volatility, we should expect higher P/E
                                                                                                           volatility. Historical analysis indicates this has been the case (with 90% correlation).

Figure 41: High Rate Volatility Indicates Higher P/E Volatility…                                                                                         Figure 42: Higher FX Volatility Indicates Higher P/E Volatility…
Delivered volatility since 1967                                                                                                                          Delivered volatility since 1976
                                                  1.40                                                                                                                                                      1.00
                                                                                                                                                                                                                                                                                                                   Risk: P/E Volatility
 P/E (NTM) Volatility # std dev from 5yr




                                                                                                                                                          P/E (NTM) Volatility # std dev from 5yr




                                                                                                                 y = 0.3596x + 0.1101
                                                  1.20                                                                                                                                                      0.80
                                                                                                                     R 2 = 0.9181                                                                                                   y = 0.3058x + 0.0765
                                                  1.00
                                                                                                                                                                                                            0.60                        R 2 = 0.9616
                                                  0.80
                                                  0.60                                                                                                                                                      0.40
                                                  0.40                                                                                                                                                      0.20
                                           avg




                                                                                                                                                                                                    avg




                                                  0.20                                                                                                                                                      0.00
                                                  0.00
                                                                                                                                                                                                          (0.20)
                                                 (0.20)
                                                 (0.40)                                                                                                                                                   (0.40)
                                                 (0.60)                                                                                                                                                   (0.60)
                                                          (2.00)          (1.00)           0.00               1.00               2.00             3.00                                                             (1.60)    (1.10)      (0.60)      (0.10)   0.40     0.90         1.40     1.90      2.40

                                                                          10yr Treasury Yield Volatility # std dev from 5yr avg                                                                                                               DXY Volatility # std dev from 5yr avg


Source: J.P. Morgan and Bloomberg.                                                                                                                       Source: J.P. Morgan and Bloomberg.


                                                                                                                                                                                                                                                                                                           35
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




36
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




                          Risk: Sovereign Concerns Real
                          There are risks that the Euro-zone crisis could shift from “periodic flares” toward a
                          larger and potentially more systematic crisis. But our economists and euro-area
                          strategists place that probability toward that of a “tail” mainly because of the
                          liquidity available through various mechanisms. Moreover, to the extent global
                          cyclical recovery gains momentum, this further diminishes risk.

                          The Euro zone has been distressed by its sovereign debt crisis which started in May
                          after Greece lost access to the primary bond markets, and emerged again in late 2010
                          when Ireland requested an EU/IMF bailout. The worries that plague most investors
                          today regarding Euro risk are (i) contagion risks across other countries, including
                          Portugal, Italy, and Spain, and (ii) the ability of the EFSF to cover the gross funding
                          needs of these sovereigns. Again, there is a consensus among J.P. Morgan
                          economists and Fixed Income teams that while Ireland’s request for a bailout will not
                          be the last, Peripheral European risk is manageable.

                          Contagion Risk Likely Limited to Portugal…
                          While we expect to see Portugal requesting an EFSF bailout in 2011, we believe
                          Spain and Italy will be spared. Pavan Wadhwa, J.P. Morgan’s European Rates
                          Strategist, notes that Portuguese spreads have followed a similar trajectory to those
                          of Ireland and Greece, and CDS spreads currently imply 20-35% default probabilities
                          for these three countries. In contrast, CDS spreads only imply a 15% marginal
                          probability of default for Spain, and around 11% for Italy.

                          Figure 43: CDS Spreads and Implied Default Probabilities for Distressed Peripherals




                                                                                                                               Risk: Sovereign Concerns Real
                          Source: J.P. Morgan European Rates Strategy.
                                                                         Implied default probability of Spain and Italy
                                                                         roughly half of Greece, Ireland, Portugal

                          Spain and Italy distinguish themselves from the pack for the following reasons:
                          (i) better overall fiscal health, (ii) more disciplined policymaking, (iii) better-
                          capitalized banking sectors with the biggest names especially still able to fund in
                          private markets. Wadhwa notes that Spain also has a relatively low net debt position
                          (63% of GDP) and is expected to be able to cut its deficit before debt overhang
                          becomes too large. Italy does not have significant primary budget deficits and
                          therefore should find it relatively easier to achieve debt sustainability despite its large
                          overhang.




                                                                                                                          37
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




                          Sufficient Funds to Meet Funding Requirements of Ireland
                          and Portugal, and Spain, if Needed, Until 2013
                          Cumulatively, funds from the EFSF (European Financial Stability Fund), the IMF,
                          and EU balance of payments facility can provide €565bn of loans to Euro area
                          sovereigns. From Figure 44, which our European Rates Strategy team put together,
                          we can see that the cumulative estimated funding requirements of Ireland, Portugal,
                          and Spain are roughly €140bn below the funding capacity. Although we do
                          acknowledge concerns that there have only been opaque signs of these liquidity
                          arrangements being extended beyond 2013, we believe that the existing supports will
                          be sufficient to allow fiscal consolidation to proceed in the peripheral economies,
                          even if it only means creating a buffer away from harsher and more difficult
                          decisions of fiscal transfers, debt restructuring, and fiscal reform.

                          Figure 44: Ireland, Portugal, and Spain Require €23bn of Funding Until End 2013
                          Estimated funding requirements* until 2013 for Ireland, Portugal, and Spain




                                                                                                                                           €140bn “buffer”…




                          Source: J.P. Morgan European Rates Strategy.
                          * Excludes T-bills and bank recapitalization from funding requirements. The number for Ireland includes €3bn/yr of promissory notes.
                          **BoP is the €60bn Extended Balance of Payments facility agreed upon by the EU. The €565bn loans consists of €250bn from the IMF,
                          €255bn from the EFSF, and €60bn from the Balance of Payments facility.




38
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




                          Risk: Municipal Debt—Budget Deficits
                          Helped by Recovery in Revenue




                                                                                                                                                          Risk: Municipal Debt—Budget Deficits Helped by Recovery in Revenue
                          US public indebtedness has come under elevated scrutiny in the recent months. If
                          municipalities begin to make widespread cuts to balance budgets, there would be
                          impacts on labor and capital spending. The city/state issue is arguably less about debt
                          given the relatively smaller debt burdens (see below).

                          Ultimately, though, this is a question of timing. If this does not become an issue in
                          2011, the US cyclical recovery should boost tax revenues making the overall impact
                          in future years smaller.

                          State Budget Deficits Largest Yet...But Revenue Growth
                          Expected to Help Bridge Gap
                          From our discussions with our Municipal Finance team, we believe that fears of the
                          so-called “muni crisis” are exaggerated and that states and, to a lesser extent, local
                          governments are able to, and committed to, meet their debt obligations. Although we
                          expect to see state budget gaps increasing, our Municipal Finance team does not view
                          this as a catalyst for an increase in muni default/liquidity risk although headline risks
                          likely will still persist.

                          In our earlier reports (see “Post-Midterm Equity Strategy Call…” dated 11/3/10), we
                          discussed how the new Republican-controlled US House of Representatives likely
                          will herald in a new wave of fiscally conservative measures, which we believe will
                          reduce the likelihood of ARRA funding renewal. Consequently, FY2012 budget
                          deficits are expected to be larger than in previous years (ARRA contribution to
                          closing the gap expected to decrease from $59bn to $6bn).

                          Figure 45: Next Year’s Budget Gaps Should Be the Largest Yet
                          Total states' budget shortfalls, $ billion




                                                                                                                                $33bn increase in
                                                                                                                                state responsibility




                          Source: J.P. Morgan Municipal Finance Credit Research. Center on Budget and Policy Priorities analysis using data from US
                          Department of Health and Human Services, US Department of Education, Congressional Budget Office, and state budget documents.




                                                                                                                                                     39
Thomas J Lee, CFA                                       North America Equity Research
(1-212) 622-6505                                        10 December 2010
thomas.lee@jpmorgan.com




                                                        There are several reasons why our Muni team remains constructive on the space:

                                                        • States are constitutionally obligated to meet their debt obligations, which
                                                          simply means that bondholders can sue state governments in the event of a
                                                          default. That, coupled with the risk of losing access to the public markets, should
                                                          be sufficient deterrent against default. Moreover, states are also constitutionally
                                                          obliged to balance their budgets.

                                                        • State revenue growth has been rebounding, and is expected to continue
                                                          recovering into 2011. The best high-frequency gauge would be the weekly initial
                                                          jobless claims which J.P. Morgan Economists predict will grind down toward
                                                          400k, from which we would expect to see an acceleration in tax receipts six
                                                          months later.

Figure 46: State Taxes Are Rebounding                                             Figure 47: And Should Continue to Recover Alongside Initial Jobless Claims
YoY change in real estate and local tax revenue, %                                Quarterly state tax receipt growth (%); Weekly initial jobless claims (000s)

     6%                                State          Local                                                     5%                                  State tax receipts       200
     4%                                                                                                                                             Initial jobless claims
     2%                                                                                                                                                                      300
                                                                                    State tax receipt growth




                                                                                                                                                                                   Initial jobless claims
     0%                                                                                                         0%
                                                                                                                                                                             400
     -2%
     -4%                                                                                                                                                                     500
                                                                                                               -5%       Expected improvements in the
     -6%                                                                                                                 labor markets are a leading
                                                                                                                         indicator of acceleration in                        600
     -8%
                                                                                                                         state tax receipts (6mo delay)
 -10%                                                                                                          -10%                                                          700
           2006             2007               2008           2009         2010                                       2006     2007      2008      2009         2010

Source: US Census Bureau, J.P. Morgan Municipal Finance Credit Research.          Source: US Census Bureau, US Bureau of Labor Statistics, J.P. Morgan Municipal Finance Credit
                                                                                  Research.




40
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




                          States Have Relatively Small Debt Levels and Are Distinctly
                          Different from Other Sovereigns...
                          Roever and team expect debt issuance to decline as debt becomes more “taboo” with
                          the Republican influence seen to dampen the marginal propensity to borrow. But
                          how much of this is actually relevant to the already much less indebted states and
                          local governments?

                          • For starters, munis are distinct from other sovereigns in that they have limited
                            rollover risk—the debt is long-term, at a fixed rate, and is amortizing.

                          • Moreover, there is much less of it around! States and local governments only owe
                            10% of the total US public bonded debt (Figure 48). Pension and Healthcare
                            obligations remain daunting but even at current levels, they are estimated to be,
                            on average, solvent for the next 10 years and do not pose a 2011 risk.

                          • Interest payments for debt obligations also only make up 5-6% of state budgets.

                          • With significant resources, especially in the light of continuous revenue growth,
                            the willingness of states to repay is also bolstered by their continued need for
                            capital.

                          Figure 48: Magnitude of State and Local Debt Is Small Relative to Federal Debt
                          $ in billions
                                                         Bonded Debt               % of Total Debt
                          Federal                               8,627.7                     89.2%

                          State                                    373.3                     3.9%

                          County                                   111.3                     1.1%    States and local
                                                                                                     governments hold only
                          School district                          326.4                     3.4%    10% of the total bonded
                                                                                                     debt
                          City                                     238.0                     2.5%

                          Total                                 9,676.6                    100.0%

                          Source: J.P. Morgan Municipal Finance Credit Research.




                                                                                                                               41
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




42
Thomas J Lee, CFA                                         North America Equity Research
(1-212) 622-6505                                          10 December 2010
thomas.lee@jpmorgan.com




                                                          2011 Sector Outlook
                                                          Our Strategy Sector Overweights and Underweights are explored on the following
                                                          pages, as well as some discussion of the views of each of J.P. Morgan’s fundamental
                                                          equity analysts. Figure 49 below summarizes the views of our analysts on the
                                                          likelihood of his/her industry outperforming the market in 2011.

                                                          For our Strategy Sector ratings, in summary, our sector ratings are as follows:

                                                          • Overweight: Materials, Industrials, Discretionary, Technology, Energy, and
                                                            Financials
                                                          • Neutral: Telecom and HealthCare
                                                          • Underweight: Staples and Utilities

Figure 49: J.P. Morgan Fundamental Analyst Conviction Levels on Likelihood of Industry Outperforming Market in 2011
HC = High Conviction, N = Neutral, LC = Low Conviction
CYCLICALS
Materials — OW                                Industrials — OW                                Discretionary — OW                             Technology — OW
Gold / Bridges                           HC   Airlines / Baker                           HC   Gaming / Greff                            HC   Communications Equipment / Hall         HC
Platinum/Palladium / Bridges             HC   Business Services / Steinerman             HC   Lodging / Greff                           HC   LED (Alt Energy) / Blansett             HC
Metals & Mining / Gambardella            HC   Airfreight/Surface Transport / Wadewitz    HC   Global QSR (Restaurants) / Ivankoe        HC   IT Hardware / Moskowitz                 HC
Chemicals / Zekauskas                    HC   Machinery / Duignan                        N    Homebuilders / Rehaut                     HC   Electronic Mfg Services / O’Brien       HC
Coal / Bridges                           N    Engineering & Construction / Levine        N    Broadlines & Department Stores / Grom     HC   Software Technology / Auty              HC
                                              Environmental Services / Levine            N    Food / Grom                               HC   Applied and Emerging Tech / Coster      HC
                                              Aerospace & Defense / Nadol                N    Hardlines / Horvers                       HC   Computer Svcs & IT Consulting / Huang   HC
                                              Electrical Equip & Multi-Industry / Tusa   N    Media / Khan                              HC   SMid Semiconductors / Sur               HC
                                              Oil Tankers / Chappell                     LC   Autos, Auto Parts & Tires / Patel         HC   Software / DiFucci                      N
                                              Dry Bulk / Chappell                        LC   Advertising & Marketing Svcs / Quadrani   HC   Enterprise Voice Equipment / O’Brien    N
                                                                                              Casual Dining (Restaurants) / Ivankoe     N    Solar Alt Energy) / Blansett            LC
                                                                                              Building Products / Rehaut                N    Semiconductors / Danely                 LC
                                                                                              Specialty Retail / Tunick                 N    Electronic Components / O’Brien         LC
                                                                                              Info Svcs/Radio/TV Broadcasting / Meltz   N
                                                                                              Education Services / Steinerman           N
                                                                                              Internet / Khan                           LC

NEAR-CYCLICALS
Energy — OW                                   Financials — OW
Oil Services & Equipment / Anderson      HC   Life Insurance / Bhullar                   HC
Integrated Oil & Gas / Minyard           HC   Asset Managers / Worthington               HC
Oil & Gas E&P / Allman                   N    Large Cap Banks / Juneja                   HC
Energy MLPs / Liu                        N    REITs / Michael Mueller / Paolone          HC




                                                                                                                                                                                          2011 Sector Outlook
                                              Credit card / Shane                        N
                                              Exchanges / Worthington                    N
                                              Small/Mid Cap Banks / Alexopoulos          N
                                              Non-Life Insurance / Heimermann            LC

DEFENSIVES
HealthCare — N                                Telecom — N                                     Staples — UW                                   Utilities — UW
Healthcare Tech & Distribution / Gill    HC                                                   Tobacco / Maile                           HC   Unregulated Utilities / Smith           HC
SMid Biotechnology / Kasimov             HC                                                   HH & Personal Care Products / Faucher     N    Regulated Utilities / Smith             N
SMid Med/Life Sciences Tech / Peterson   HC                                                   Packaged Food / Bivens                    LC
Managed Care / Rex                       HC                                                   Beverages / Faucher                       LC
Healthcare Facilities / Rex              HC
Pharmaceuticals / Schott                 HC
Healthcare Information Tech / Rahim      HC
Biotechnology / Meacham                  N
Medical Tech & Devices / Weinstein       LC
Source: J.P. Morgan.




                                                                                                                                                                                     43
Thomas J Lee, CFA                                     North America Equity Research
(1-212) 622-6505                                      10 December 2010
thomas.lee@jpmorgan.com




Figure 50: Sector Earnings Outlook and Valuation
                             Earnings growth… (2011)                                                          Valuation…. (2012 P/E)
                   JPM        JPM Est Consensus                                                                          P/E (2012)
                 Strategy         EPS     Est EPS    JPM vs.                                                         P/E Relative to
                  Rating        Growth     Growth Consensus                       Comment                         (2012)   S&P 500                       Comment
Cyclicals
Materials          OW              18.8%     20.2%    -144 bp   Domestic materials like Paper, Construction       15.2x        3.2x    Valuatons less attractive
                                                                materials and Steels
Industrials        OW              17.2%     20.1%    -295 bp   Domestic cyclicals still more attractive          13.6x        1.6x    Upside to P/E

Discretionary      OW              10.5%     12.7%    -222 bp                                                     12.7x        0.7x    Upside to P/E

Technology         OW               7.9%     12.8%    -491 bp   See some risk to EPS growth due to Europe         12.2x        0.2x    Upside to P/E

Near-Cyclicals
Energy             OW              11.7%      9.9%    177 bp    Above consensus due to higher Oil forecast        10.7x       -1.3x    See upside here

Financials         OW              23.4%     24.4%     -98 bp   Fastest EPS growth in 2011 and largest             9.6x       -2.4x    Some P/E expansion possible
                                                                contributor to EPS gains
Defensives
HealthCare          N               3.7%      4.3%     -66 bp   Weak EPS growth…                                  11.4x       -0.6x    Upside to P/E as market trades higher

Telecom             N              10.1%     10.5%     -41 bp                                                     16.2x        4.2x    Expensive

Staples            UW               6.7%      8.3%    -165 bp   Slower EPS                                        14.0x        2.0x    …and rel. higher valuatio

Utilities          UW              -16.4%    -16.9%     51 bp                                                     14.2x        2.2x    P/E bit high


S&P 500                            10.4%     12.1%    -167 bp                                                     12.0x                Forecast P/E to reach 14x
S&P ex-Fin                          8.0%      9.8%    -180 bp                                                     12.6x

Cyclicals                          11.3%     14.9%    -360 bp   EPS gains driven by Cyclicals                     12.8x        0.8x    P/E should be 15x-16x
Defensives                          2.5%      3.3%     -83 bp                                                     13.1x        1.1x
Cylicals vs. Defensives            883 bp   1159 bp   -277 bp                                                     -0.3x       -0.3x
Source: J.P. Morgan and FactSet.




44
Thomas J Lee, CFA                                        North America Equity Research
(1-212) 622-6505                                         10 December 2010
thomas.lee@jpmorgan.com




                                                         Basic Materials: Overweight
Headline Drivers for the Sector:                         The Bottom Line…
Global Economic Recovery
                                                         Shift from global commodities to domestic materials
Fiscal Stimulus
Commodity Prices
                                                         The global synchronized expansion has fueled a recovery in demand for many global
Weak Dollar                                              commodities—a reason Basic Materials has been a top-quartile group for most of the
                                                         last two years. The Fed’s QE is essentially another easing cycle with a resulting
                                                         weakening of the USD (being a byproduct) and, thus, boosting the outlook for these
                                                         commodity producers.
                                                         • The change for 2011, in our view, is we see strengthening momentum in the
                                                           US economy and, thus, favor a shift towards domestic plays such as steel,
J.P. Morgan Analyst Coverage                               lumber, etc.
                                 Analyst
Sector            Analyst      Conviction
                                                         J.P. Morgan Analysts Generally Constructive
Metals            Gambardella            HC              Beyond dollar play, the recovering global economy is also propelling commodity
Coal              Bridges                 N              demand. Our Chemicals analyst, Jeffrey Zekauskas, sees high prices for corn, soy,
Gold              Bridges                HC              cotton, wheat, and rice which should position fertilizer companies well.
Platinum          Bridges                HC              John Bridges, who covers Coal, Gold, and Silver, is also constructive on his
Palladium         Bridges                HC
                                                         coverage universe. For Coal, Bridges sees strong supply/demand fundamentals,
Chemicals         Zekauskas              HC
                                                         especially from steelmakers. For Gold, Bridges highlights that it is currently trading
HC: High Conviction; N: Neutral;                         more as a currency than as a commodity, and is bolstered by the support of investors
LC: Low Conviction.
                                                         who see it as a hedge for both inflationary and deflationary times. Our Metals &
Analyst conviction based on our takeaways
from discussions with analysts about likelihood
                                                         Mining analyst, Michael Gambardella, is positive on the 2011 outlook for the steel
of outperformance by their sectors vs. overall           sector due to the combination of stronger 2H11 economic activity, domestic steel raw
market in 2011.                                          material cost advantage, and supply discipline.

                                                         Sector Performance and Valuation
                                                         The current P/10-yr EPS of the Materials sector is 26% above the long-term average




                                                                                                                                                                                  Basic Materials: Overweight
                                                         and is also more than one standard deviation above the long-term average. This
                                                         suggests that there is limited support for valuation expansion unless investors make a
                                                         case that the sector valuation can expand back to previous peak levels.

Figure 51: Quarterly Price Performance – Basic Materials                           Figure 52: Basic Materials – P/10-Yr EPS
Shaded box highlights performance of sector, Bold/Italics box highlights           10-Yr EPS
S&P 500 performance
 1Q09      2Q09       3Q09    4Q09      1Q10      2Q10   3Q10   QTD                                           1.6x
                                                                                    Relative P/E to S&P 500




  4%       35%        25%      10%       12%      -5%    19%    16%
  -3%      19%        21%       9%       11%      -6%    17%    12%                                           1.2x
  -8%      18%        21%       9%       10%      -9%    15%    11%                                                                                                   Expensive
  -9%      18%        19%       7%       5%       -11%   14%    9%
                                                                                                              0.8x
  -9%      16%        17%       6%       5%       -12%   12%    8%
 -11%      15%        15%       6%       3%       -12%   11%    7%
 -12%                          5%        2%
                                                                                                              0.4x
           10%        11%                         -12%   11%    6%
 -12%       9%        9%        5%       2%       -13%   11%    3%                                                   '85    '89   '93      '97     '01   '05    '09
 -12%       9%        9%        5%       0%       -13%   10%    1%                                                   Recessions         Rel to SP500       STD +1
                                                                                                                     STD -1             Avg
 -22%       8%        5%        4%       -5%      -14%   8%     1%
                                                                                   Source: J.P. Morgan and Datastream.
 -29%       2%        4%       -4%       -6%      -16%   4%     -2%
Source: J.P. Morgan and FactSet.



                                                                                                                                                                        45
Thomas J Lee, CFA                                                North America Equity Research
(1-212) 622-6505                                                 10 December 2010
thomas.lee@jpmorgan.com




                                                                 Earnings Outlook and Performance
                                                                 Materials sales and earnings have recovered sharply over the past year, as the
                                                                 collapse in global commodities demand and pricing hurt earnings in 2009, followed
                                                                 by a sharp rebound in 2010.

                                                                 Looking ahead to next year, the recovery is projected to continue at a strong pace,
                                                                 with sales growth in the Materials sector outpacing the sales growth of the S&P 500
                                                                 by 290bp over the next 12 months (Figure 53). The Materials sector is a relatively
                                                                 small contributor to the overall S&P 500, however, so the sector’s contribution to
                                                                 S&P 500 projected earnings growth (Figure 54) is relatively small.

Figure 53: Relative Sales Growth – Materials                                                Figure 54: Relative Earnings Momentum – Materials
Sales growth NTM of sector less sales growth NTM of S&P 500                                 Sector chg in net income (NTM vs. year ago) divided by S&P 500 net income

                              12%
  Rel Sales Growth Momentum




                               8%                                                                                                6%


                                                                                                    Relative Earnings Momentum
                               4%                                                    2.9%                                        4%
                               0%
                                                                                                                                 2%
                              -4%
                                                                                                                                 0%                                        0.3%
                              -8%
                              -12%                                                                                               -2%
                              -16%                                                                                               -4%
                                     4/06   3/07   2/08   1/09   12/09    11/10   10/11                                          -6%
Source: J.P. Morgan and FactSet.                                                                                                       4/06 3/07 2/08 1/09 12/09 11/10 10/11
                                                                                            Source: J.P. Morgan and FactSet.




46
Thomas J Lee, CFA                                        North America Equity Research
(1-212) 622-6505                                         10 December 2010
thomas.lee@jpmorgan.com




                                                         Industrials: Overweight
Headline Drivers for the Sector:                         The Bottom Line: Valuations Attractive...
ISM and Industrial Production                            Industrials prove attractive during most of a bull market cycle but we believe
Global Recovery
Business Confidence
                                                         valuation sensitivity or, at a minimum, GARP traits, will matter in 2011. So we still
Credit Availability                                      recommend exposure but realize a lot more good news has been priced in. These
Dollar/Exports                                           stocks obviously have seen a big recovery in earnings and valuation expansion.

                                                         J.P. Morgan Analyst Views Mostly Constructive
                                                         Joseph Nadol, J.P. Morgan’s Aerospace & Defense analyst, sees solid returns for
                                                         2011 on the back of attractive fundamentals and a challenging defense outlook.
                                                         Similarly, Thomas Wadewitz, J.P. Morgan’s Airfreight & Surface Transportation
J.P. Morgan Analyst Coverage                             analyst, believes that his coverage universe is poised to realize pricing
                                                         improvements, while Scott Levine, J.P. Morgan’s Engineering & Construction
                                 Analyst
Sector            Analyst      Conviction                analyst, expects the recovering global economy to support more broad-based growth
                                                         in E&C order books. Ann Duignan, J.P. Morgan’s Machinery analyst, sees the
Aerospace         Nadol                   N
                                                         recovery in housing as boding well for her coverage universe and views this as the
Airfreight        Wadewitz               HC
Multi-Ind.        Tusa                    N              beginning of a long, but possibly more moderate, up-cycle.
E&C               Levine                  N
Waste             Levine                  N              Sector Performance and Valuation
Machinery         Duignan                 N
Oil Tankers       Chappell               LC              Industrials price performance stayed relatively strong throughout most of 2010, as
Dry Bulk          Chappell               LC              Cyclicals continued to outperform Defensives overall. The only quarter in which the
Airlines          Baker                  HC              sector sharply underperformed was 2Q10, when the market overall sold off sharply
Bus. Svcs         Steinerman             HC
                                                         due to concerns about sovereign debt issues and weakening economic data.
HC: High Conviction; N: Neutral;
LC: Low Conviction.                                      Industrials valuation remains cheap on a P/10-yr EPS basis, despite the sector’s
Analyst conviction based on our takeaways
                                                         strong performance over the past year. The P/10-yr EPS of Industrials is currently
from discussions with analysts about likelihood
of outperformance by their sectors vs. overall
                                                         one standard deviation below the long-term average, suggesting significant room for
market in 2011.                                          multiple expansion.




                                                                                                                                                                              Industrials: Overweight
Figure 55: Quarterly Price Performance – Industrials                               Figure 56: Industrials – P/10-Yr EPS
Shaded box highlights performance of sector, Bold/Italics box highlights           10-Yr EPS
S&P 500 performance
 1Q09      2Q09       3Q09    4Q09      1Q10      2Q10   3Q10   QTD                                           1.4x
                                                                                    Relative P/E to S&P 500




  4%       35%        25%      10%       12%      -5%    19%    16%
  -3%      19%        21%       9%       11%      -6%    17%    12%                                           1.2x
  -8%      18%        21%       9%       10%      -9%    15%    11%
  -9%      18%        19%       7%       5%       -11%   14%    9%
                                                                                                              1.0x
  -9%      16%        17%       6%       5%       -12%   12%    8%                                                                                                    Cheap
 -11%      15%        15%       6%       3%       -12%   11%    7%
 -12%      10%        11%      5%        2%       -12%   11%    6%
                                                                                                              0.8x
 -12%       9%        9%        5%       2%       -13%   11%    3%                                                   '85    '89   '93      '97     '01   '05    '09
 -12%       9%        9%        5%       0%       -13%   10%    1%                                                   Recessions         Rel to SP500       STD +1
                                                                                                                     STD -1             Avg
 -22%       8%        5%        4%       -5%      -14%   8%     1%
                                                                                   Source: J.P. Morgan and Datastream.
 -29%       2%        4%       -4%       -6%      -16%   4%     -2%
Source: J.P. Morgan and FactSet.




                                                                                                                                                                       47
Thomas J Lee, CFA                                               North America Equity Research
(1-212) 622-6505                                                10 December 2010
thomas.lee@jpmorgan.com




                                                                Earnings Outlook and Performance
                                                                Industrials earnings deteriorated along with the overall economy in 2008 and early
                                                                2009, as industrial production sharply declined, but then sharply rebounded in 2010,
                                                                as industrial production quickly returned to a more normalized level.

                                                                Looking ahead to next year, top-line growth in the Industrials sector is projected to
                                                                outpace S&P 500 revenue growth by 210bp over the next 12 months. Earnings
                                                                growth should also continue to stay relatively strong, with the Industrials sector
                                                                contributing 1.2% of the 9.9% earnings growth for the S&P 500 over the next 12
                                                                months. Therefore, both top- and bottom-line momentum should continue to provide
                                                                support for the sector early on next year.

Figure 57: Relative Sales Growth – Industrials                                             Figure 58: Relative Earnings Momentum – Industrials
Sales growth NTM of sector less sales growth NTM of S&P 500                                Sector chg in net income (NTM vs. year ago) divided by S&P 500 net income

                              8%
  Rel Sales Growth Momentum




                                                                                                                                6%
                                                                                                   Relative Earnings Momentum
                              4%
                                                                                    2.1%                                        4%
                              0%                                                                                                2%
                                                                                                                                                                                1.2%
                                                                                                                                0%
                              -4%
                                                                                                                                -2%
                              -8%                                                                                               -4%
                                    4/06   3/07   2/08   1/09   12/09   11/10    10/11                                          -6%
Source: J.P. Morgan and FactSet.                                                                                                      4/06   3/07   2/08   1/09 12/09 11/10 10/11
                                                                                           Source: J.P. Morgan and FactSet.




48
Thomas J Lee, CFA                                 North America Equity Research
(1-212) 622-6505                                  10 December 2010
thomas.lee@jpmorgan.com




                                                  Consumer Discretionary: Overweight
Headline Drivers for the Sector:                  Bottom Line: Own Them as Consumer Strengthens
Consumer Confidence                               Consumer Discretionary has been a top-quartile performer since the start of this bull
Job Recovery
Credit Availability
                                                  market. This is entirely consistent with past bull market cycles. And history suggests
US Housing Market Bottom                          that in early 2011, investors should still want to own consumer cyclicals, particularly
Auto Market Recovery                              Restaurants, Retail, and Gaming. And given our expectation of a strengthened
                                                  consumer, coupled with rising employment and repaired balance sheets, there could
                                                  be upside to estimates as well.

                                                  J.P. Morgan Analysts Still Constructive
J.P. Morgan Analyst Coverage
                                                  Consumer Discretionary is a catch-all group, apparent by looking at the number of
                                 Analyst
                                                  analysts on the left.
Sector            Analyst      Conviction

Autos       Patel                        HC       An improved pace of jobs growth in 2011, as we expect based on historical trends of
Advertising Quadrani                     HC
                                                  job growth in the second year of a jobs recovery (see Figure 8), would be a major
Broadlines Grom                          HC
Food        Grom                         HC       catalyst for many groups in Discretionary. For example, John Ivankoe,
Homebuilders Rehaut                      HC       J.P. Morgan’s Restaurants analyst, suggests that even with accelerating GDP growth
Bld Products Rehaut                       N       projected for next year, better-than-expected gains in employment would be the key
Gaming      Greff                        HC       catalyst to provide additional upside for his group.
Lodging     Greff                        HC
Internet    Khan                         LC
Media       Khan                         HC       Himanshu Patel, J.P. Morgan’s Autos & Auto Parts analyst, expects that auto sales




                                                                                                                                            Consumer Discretionary: Overweight
Global QSR Ivankoe                       HC       should continue to recover but earnings growth should moderate for auto parts
Casual Dining Ivankoe                     N       suppliers since margins are already in line with medium-term potential.
Hardlines Horvers                        HC       Brian Tunick, J.P. Morgan’s Specialty Retail analyst, sees a similar issue, as he
Specialty   Tunick                        N
                                                  expects margin pressure across retail in 2011 due to growing inventories and higher
TV          Meltz                         N
Education Steinerman                      N       raw material costs. John Ivankoe also sees a similar issue, as rising food and energy
                                                  prices are likely to hurt margins for the restaurants.
HC: High Conviction; N: Neutral;
LC: Low Conviction.
Analyst conviction based on our takeaways         Sector Performance and Valuation
from discussions with analysts about likelihood
                                                  Consumer Discretionary has outperformed the S&P 500 in every quarter since the
of outperformance by their sectors vs. overall
market in 2011.
                                                  start of 2009, and it has been one of the top three sectors in 4 out of the past 5
                                                  quarters. Discretionary valuations have been relatively range-bound over the past few
                                                  years, as multiples were not elevated at the start of this recession and didn’t
                                                  necessarily have as far to fall. However, the current multiple is still below the long-
                                                  term average and has been rising recently, suggesting there may be upside potential
                                                  for multiples.




                                                                                                                                       49
Thomas J Lee, CFA                                                           North America Equity Research
(1-212) 622-6505                                                            10 December 2010
thomas.lee@jpmorgan.com




Figure 59: Quarterly Price Performance – Consumer Discretionary                                        Figure 60: Consumer Discretionary – P/10-Yr EPS
Shaded box highlights performance of sector, Bold/Italics box highlights                               10-Yr EPS
S&P 500 performance
 1Q09                           2Q09        3Q09     4Q09     1Q10   2Q10   3Q10    QTD                                           1.6x




                                                                                                        Relative P/E to S&P 500
   4%                            35%        25%      10%       12%    -5%   19%     16%
                                                                                                                                  1.4x
  -3%                            19%        21%      9%        11%    -6%   17%     12%
  -8%                            18%        21%      9%        10%    -9%   15%     11%                                           1.2x                                                                                  Cheap
  -9%                            18%        19%      7%        5%    -11%   14%     9%
  -9%                            16%        17%      6%        5%    -12%   12%     8%                                            1.0x
 -11%                           15%         15%      6%        3%    -12%   11%     7%
 -12%                            10%        11%      5%        2%    -12%   11%     6%
                                                                                                                                  0.8x
 -12%                            9%         9%       5%        2%    -13%   11%     3%                                                                       '85         '89    '93      '97         '01   '05   '09
 -12%                            9%         9%       5%        0%    -13%   10%     1%                                                               Recessions                       Rel to SP500          STD +1
                                                                                                                                                     STD -1                           Avg
 -22%                            8%         5%       4%        -5%   -14%   8%      1%
                                                                                                       Source: J.P. Morgan and Datastream.
 -29%                            2%         4%       -4%       -6%   -16%   4%      -2%
Source: J.P. Morgan and FactSet.




                                                                            Earnings Outlook and Performance
                                                                            Discretionary earnings peaked back in late 2006, well before most other sectors’, as
                                                                            the impact of the decline in housing and lower consumer spending hit this sector the
                                                                            earliest. However, earnings in Discretionary also troughed slightly earlier, in 1Q09,
                                                                            and rebounded strongly in 2010.

                                                                            Looking ahead to 2011, however, the contribution to top-line growth should be less
                                                                            significant, with revenue growth for the Discretionary sector projected to lag behind
                                                                            S&P 500 revenue growth by 30bp over the next 12 months. Discretionary’s
                                                                            contribution to earnings growth is also projected to be less significant next year, with
                                                                            the sector only contributing 1.0% of the S&P 500’s 9.9% earnings growth over the
                                                                            next 12 months.

Figure 61: Relative Sales Growth – Discretionary                                                       Figure 62: Relative Earnings Momentum – Discretionary
Sales growth NTM of sector less sales growth NTM of S&P 500                                            Sector chg in net income (NTM vs. year ago) divided by S&P 500 net income

                               4%
  Rel Sales Growth Momentum




                               2%                                                                                                                                6%
                                                                                                                                    Relative Earnings Momentum




                               0%                                                              -0.3%                                                             4%
                              -2%
                                                                                                                                                                 2%
                              -4%                                                                                                                                                                                1.0%
                              -6%
                                                                                                                                                                 0%
                              -8%                                                                                                                                -2%
                              -10%                                                                                                                               -4%
                                     4/06     3/07          2/08     1/09   12/09    11/10   10/11                                                               -6%
Source: J.P. Morgan and FactSet.                                                                                                                                       4/06 3/07 2/08 1/09 12/09 11/10 10/11
                                                                                                       Source: J.P. Morgan and FactSet.




50
Thomas J Lee, CFA                                 North America Equity Research
(1-212) 622-6505                                  10 December 2010
thomas.lee@jpmorgan.com




                                                  Technology: Overweight
Headline Drivers for the Sector:                  Bottom Line: Euro-Area Risk
Hardware Replacement Cycle                        We are not overly excited about Technology in 2011 and would tilt to “visible”
International Exposure                            growth stories in Technology. The group is not expensive but we see risks in Europe
CEO Confidence                                    as fiscal austerity leads to budget cuts (DiFucci believes 30-40% of tech spend in
Utilization
                                                  Europe is government) and similar risk from US states and towns. In addition, the
                                                  group historically has not been a strong “Year 3” group.

                                                  But the reason we stay Overweight is the strong balance sheets (M&A, dividends,
                                                  etc.) coupled with potential upside in US visibility as the US economic accelerates.
                                                  Thus, we stay Overweight going into 2011.
J.P. Morgan Analyst Coverage
                                                  • We believe Technology could face some challenges in 2011 (see Figure 27)
                                 Analyst
                                                    based on our staging analysis.
Sector            Analyst      Conviction

Com. Equip Hall                          HC
Elec Man Svcs O’Brien                    HC
                                                  J.P. Morgan Fundamental Analysts Mixed
Elec Compon O’Brien                      LC       Sterling Auty, J.P. Morgan’s Software Technology analyst, believes that Software
Enterprise Voice O’Brien                  N       Technology, which saw a very strong 2010, will continue to see outperformance in
IT Hardware Moskowitz                    HC
IT Services Huang                        HC
                                                  2011 as an improving employment picture shifts focus back to software application
Semis       Danely                       LC       names. Steven O’Brien, J.P. Morgan’s Communications Infrastructure Technology
SMid Semi Sur                            HC       analyst, mirrors this view—he sees employment levels as the primary catalysts for
Software     DiFucci                      N       system upgrades.
AppliedTech Coster                       HC
Software Tech Auty                       HC
LED        Blansett                      HC
                                                  However, on the flip side, Euro concerns mire the outlook of John DiFucci,
Solar      Blansett                      LC       J.P. Morgan’s Software analyst, for his coverage universe as he believes that Euro
                                                  sovereign budget cuts will dampen European demand, which accounts for a third of
                                                  worldwide Software spending. Chris Danely, J.P. Morgan’s Semiconductors analyst,
HC: High Conviction; N: Neutral;
LC: Low Conviction.
                                                  is also relatively cautious as he sees the industry currently in the middle of a
Analyst conviction based on our takeaways         semiconductor inventory correction. However, Danely also believes that the best




                                                                                                                                              Technology: Overweight
from discussions with analysts about likelihood   time to buy semiconductors would be after the second stage of the correction which
of outperformance by their sectors vs. overall    is expected to happen some time during 2011.
market in 2011.


                                                  Sector Performance and Valuation
                                                  The relative price performance of the Technology sector improved throughout 2010,
                                                  as the sector trailed the overall S&P 500 in the first half of the year before
                                                  outperforming in the second half of the year.

                                                  The sector has not been as strong of a leader as it was throughout 2009, when the
                                                  sector was one of the top two sectors in three out of four quarters, reflecting the
                                                  early-cycle nature of the sector in 2009. However, given that the Technology sector
                                                  has significant exposure to international markets and is thus leveraged to a recovery
                                                  in the global economy, we believe its recent leadership should continue into 2011.

                                                  Technology valuations are in line with the long-term average, suggesting the sector is
                                                  neither particularly cheap nor expensive. If multiples do continue to expand, we
                                                  could see as much as 28% upside for the sector before the valuation gets
                                                  overstretched and exceeds one standard deviation above the long-term average. Thus,

                                                                                                                                         51
Thomas J Lee, CFA                                                               North America Equity Research
(1-212) 622-6505                                                                10 December 2010
thomas.lee@jpmorgan.com




                                                                                while valuations for Technology should not necessarily be a driver for upside in
                                                                                2010, they shouldn’t be a drag either since there still could be room for further
                                                                                expansion.

Figure 63: Quarterly Price Performance – Technology                                                        Figure 64: Technology – P/10-Yr EPS
Shaded box highlights performance of sector, Bold/Italics box highlights                                   10-Yr EPS
S&P 500 performance
 1Q09                           2Q09       3Q09     4Q09      1Q10       2Q10   3Q10    QTD




                                                                                                            Relative P/E to S&P 500
  4%                            35%        25%      10%       12%        -5%    19%     16%                                           3.0x
  -3%                           19%        21%      9%        11%        -6%    17%     12%
                                                                                                                                      2.4x
  -8%                           18%        21%      9%        10%        -9%    15%     11%
  -9%                           18%        19%      7%            5%     -11%   14%     9%                                            1.8x                                                                              In-line
  -9%                           16%        17%      6%            5%     -12%   12%     8%                                            1.2x                                                                              with LT
 -11%                           15%        15%      6%            3%     -12%   11%     7%                                                                                                                              avg
 -12%                           10%        11%      5%            2%     -12%   11%     6%
                                                                                                                                      0.6x
 -12%                               9%     9%       5%            2%     -13%   11%     3%                                                                      '85          '89    '93      '97     '01   '05   '09
 -12%                               9%     9%       5%            0%     -13%   10%     1%                                                                     Recessions                 Rel to SP500      STD +1
                                                                                                                                                               STD -1                     Avg
 -22%                               8%     5%       4%            -5%    -14%   8%      1%
                                                                                                           Source: J.P. Morgan and Datastream.
 -29%                               2%     4%       -4%           -6%    -16%   4%      -2%
Source: J.P. Morgan and FactSet.




                                                                                Earnings Outlook and Performance
                                                                                Earnings in the Technology sector recovered sharply in 2010, as global demand has
                                                                                quickly recovered along with the global economy.

                                                                                Technology revenue and earnings are expected to continue to grow at a strong pace
                                                                                next year, with top-line growth outpacing S&P 500 revenue growth by 480bp over
                                                                                the next 12 months. Technology’s contribution to earnings growth should also be
                                                                                relatively significant over the next 12 months at 1.6% (out of 9.9%), although this
                                                                                contribution is projected to gradually decline over the next 12 months.

Figure 65: Relative Sales Growth – Technology                                                              Figure 66: Relative Earnings Momentum – Technology
Sales growth NTM of sector less sales growth NTM of S&P 500                                                Sector chg in net income (NTM vs. year ago) divided by S&P 500 net income

                              10%
  Rel Sales Growth Momentum




                               8%                                                                                                                                    8%
                                                                                                                                        Relative Earnings Momentum




                               6%
                                                                                                    4.8%                                                             6%
                               4%
                                                                                                                                                                     4%
                               2%
                               0%                                                                                                                                     2%                                         1.6%
                              -2%                                                                                                                                     0%
                              -4%                                                                                                                                    -2%
                              -6%                                                                                                                                    -4%
                                    4/06     3/07          2/08         1/09    12/09    11/10   10/11                                                               -6%
Source: J.P. Morgan and FactSet.                                                                                                                                           4/06 3/07 2/08 1/09 12/09 11/10 10/11
                                                                                                           Source: J.P. Morgan and FactSet.




52
Thomas J Lee, CFA                                 North America Equity Research
(1-212) 622-6505                                  10 December 2010
thomas.lee@jpmorgan.com




                                                  Energy: Overweight
Headline Drivers for the Sector:                  Bottom Line: Still One of Our Favorite Sectors
OPEC and Crude                                    Long term, Energy is a secular story of favorable supply/demand dynamics:
Downstream Demand
Global Growth
                                                  production is increasingly expensive (or, for the alarmists, in decline) while demand
Dollar and QE2                                    tracks overall global economic growth, which means demand rises long term. In the
Regulatory Outlook                                shorter term, the group is very sensitive to the price of oil and other commodities and
                                                  to the perception about the durability of the global economic expansion.

                                                  In the short term, we see strong fundamental trends and a positive outlook driving
                                                  outperformance for the sector, justifying our recent upgrade of the sector to OW.

                                                  J.P. Morgan Oil Strategist and Equity Analysts Constructive
J.P. Morgan Analyst Coverage
                                                  Lawrence Eagles, J.P. Morgan Oil Strategist, recently raised his price deck for oil to
                                 Analyst
Sector            Analyst      Conviction         a 2011 average WTI price of $89.75 which is $4.75 above consensus, with the
                                                  drivers being better demand as well as a weaker dollar and QE2. Earnings estimates
E&P               Allman                  N
                                                  for the Energy sector reflect more modest economic growth and have not yet
MLPs              Liu                     N
Integrateds       Minyard                HC       adjusted to the higher price deck forecast by Lawrence Eagles, suggesting upside for
Oil Svcs          Anderson               HC       estimates and stock prices.
Oil price         Eagles                 HC
                                                  J.P. Morgan’s fundamental analysts also see upside to estimates on their names,
                                                  particularly if US economic momentum is indeed sustained. According to David
HC: High Conviction; N: Neutral;
                                                  Anderson, J.P. Morgan’s Oilfield Services analyst, national oil companies have been
LC: Low Conviction.
Analyst conviction based on our takeaways
                                                  hesitant to spend too much given current spare oil capacity, but as demand outpaces
from discussions with analysts about likelihood   supply sometime in 2011 and oil prices trend higher, spending levels should increase.
of outperformance by their sectors vs. overall
market in 2011.                                   In the Exploration and Production space, Joseph Allman, J.P. Morgan’s Oil & Gas
                                                  E&P analyst, continues to see more upside potential in the “oily” E&Ps than in the
                                                  “gassy” E&Ps due to the continued oversupply of natural gas.

                                                  Centrist Washington reduces regulatory risk
                                                  Shift toward centrist Washington also reduces risk of regulatory creep and other
                                                  actions punitive to Energy companies. The current issue relates to using the EPA to



                                                                                                                                               Energy: Overweight
                                                  regulate carbon emissions after climate-change legislation failed to pass. Currently,
                                                  states like Texas are challenging these rules but we believe changes in Washington
                                                  recently favor a moderation of these risks. Other issues include recent easing of
                                                  offshore drilling.

                                                  Energy also tends to be a good coincident economic sector—thus, to the extent GDP
                                                  growth sustains an upward bias as J.P. Morgan Economists expect, we see upside to
                                                  Energy relative performance.

                                                  Sector Performance and Valuation
                                                  As a typically later-cycle sector, Energy was not a leading sector throughout 2009
                                                  and early 2010, but it has begun to exert leadership over the past two quarters. So far
                                                  in 4Q10, Energy is the top-performing sector, rising by 16% QTD. As we enter the
                                                  later stages of this economic recovery, the Energy sector is also poised to outperform
                                                  as global energy demand recovers.

                                                                                                                                          53
Thomas J Lee, CFA                                                               North America Equity Research
(1-212) 622-6505                                                                10 December 2010
thomas.lee@jpmorgan.com




                                                                                Energy valuations are only slightly below the long-term average, suggesting the
                                                                                sector is neither particularly cheap nor expensive at the moment. However, the P/10-
                                                                                yr EPS has been expanding recently, suggesting we could see multiple expansion in
                                                                                2011.

                                                                                • In mid-2008, the relative P/10-yr EPS of the Energy sector peaked at 1.3x, which
                                                                                  is 74% higher than the current level of 0.8x. A more conservative upside level for
                                                                                  valuations would be one standard deviation above the long-term average, which
                                                                                  would be 1.0x, which is 26% above the current level. Either of these suggests
                                                                                  substantial room for upside if valuations do expand.

Figure 67: Quarterly Price Performance – Energy                                                           Figure 68: Energy – P/10-Yr EPS
Shaded box highlights performance of sector, Bold/Italics box highlights                                  10-Yr EPS
S&P 500 performance
 1Q09                           2Q09        3Q09     4Q09      1Q10      2Q10   3Q10    QTD                                          1.6x

                                                                                                           Relative P/E to S&P 500
   4%                            35%        25%      10%       12%        -5%   19%     16%
  -3%                            19%        21%      9%        11%        -6%   17%     12%                                          1.2x
  -8%                            18%        21%      9%        10%        -9%   15%     11%
  -9%                            18%        19%      7%            5%    -11%   14%     9%
                                                                                                                                                                                                                                 In-line
                                                                                                                                     0.8x                                                                                        with LT
  -9%                            16%        17%      6%        5%        -12%   12%     8%
                                                                                                                                                                                                                                 avg
 -11%                           15%         15%      6%            3%    -12%   11%     7%
 -12%                            10%                 5%
                                                                                                                                     0.4x
                                            11%                    2%    -12%   11%     6%
 -12%                            9%         9%       5%            2%    -13%   11%     3%                                                                        '85      '89      '93        '97       '01   '05      '09
 -12%                            9%         9%       5%            0%    -13%   10%     1%                                                                        Recessions              Rel to SP500         STD +1
                                                                                                                                                                  STD -1                  Avg
 -22%                            8%         5%       4%        -5%       -14%    8%     1%
                                                                                                          Source: J.P. Morgan and Datastream.
 -29%                            2%         4%       -4%       -6%       -16%    4%     -2%
Source: J.P. Morgan and FactSet.


                                                                                Earnings Outlook and Performance
                                                                                Top-line growth in the Energy sector is projected to recover sharply next year, with
                                                                                revenue in the Energy sector outpacing S&P 500 revenue growth by 1,420bp over the
                                                                                next 12 months. At the bottom line, Energy has swung back to a positive contributor
                                                                                to S&P 500 earnings growth, projected to add 1.1% to S&P 500 earnings growth.

Figure 69: Relative Sales Growth – Energy                                                                 Figure 70: Relative Earnings Momentum – Energy
Sales growth NTM of sector less sales growth NTM of S&P 500                                               Sector chg in net income (NTM vs. year ago) divided by S&P 500 net income

                              40%
  Rel Sales Growth Momentum




                              30%                                                                                                                                   6%
                                                                                                                                     Relative Earnings Momentum




                              20%                                                                                                                                   4%
                                                                                                  14.2%                                                             2%
                              10%                                                                                                                                                                                             1.1%
                                                                                                                                                                    0%
                               0%
                                                                                                                                                                   -2%
                              -10%
                                                                                                                                                                   -4%
                              -20%
                                                                                                                                                                   -6%
                              -30%                                                                                                                                 -8%
                                     4/06     3/07          2/08        1/09    12/09   11/10    10/11                                                            -10%
Source: J.P. Morgan and FactSet.                                                                                                                                         4/06    3/07   2/08     1/09 12/09 11/10 10/11
                                                                                                          Source: J.P. Morgan and FactSet




54
Thomas J Lee, CFA                                 North America Equity Research
(1-212) 622-6505                                  10 December 2010
thomas.lee@jpmorgan.com




                                                  Financials: Overweight
Headline Drivers for the Sector:                  Bottom Line: Steeper Curve, Washington Backs Off, and
Foreclosures and Putbacks
                                                  Dividends
Job Growth (Lower Delinquencies)                  There is a trifecta of reasons to like this group in 2011. Moreover, historical staging
Home and Commercial Real Estate
                                                  favors banks and insurance in 2011 (see Figure 25 and Figure 26). In addition, this
Prices Bottoming
Capital Requirements/Regulatory                   group is the largest contributor to expected EPS growth and should be the fastest
Reform                                            grower in 2011 (see Figure 20)
M&A Activity Recovering
                                                  J.P. Morgan Analysts Constructive
                                                  J.P. Morgan’s Financials analysts are constructive on the sector and expect to see
                                                  healthy positive returns in 2011. In fact, Steven Alexopoulos, J.P. Morgan’s SMid-
                                                  Cap Banks analyst, anticipates double-digit return potential through YE11 for his
                                                  coverage universe. The expectation that there will an extended period of low rates
J.P. Morgan Analyst Coverage                      should also propel investors to migrate back into equities, which would be an added
                                                  boost to asset managers with equity exposure. Jimmy Bhullar, J.P. Morgan’s
                                 Analyst
Sector            Analyst      Conviction         Insurance – Life analyst, bolsters the bullish view by seeing healthier balance sheets,
                                                  improving returns, and accelerating sales in his coverage universe.
Banks             Juneja         HC
SMid Banks        Alexopoulos     N
Asset Mgr         Worthington    HC               While the overhang of regulatory and political pressure will continue to weigh on
Exchanges         Worthington     N               Financials in the coming months, the impact from the Dodd-Frank Act should be less
Insurance         Bhullar        HC               severe than originally anticipated due to the center-shift in political power in
Non-Life          Heimermann     LC               Congress. Credit losses and costs should also decrease further in ’11 on the back of
REITs             Paolone/MuellerHC
                                                  improvements in the housing market and the general economy.
Cons Fin          Shane           N

HC: High Conviction; N: Neutral;
                                                  Sector Performance and Valuation
LC: Low Conviction.
Analyst conviction based on our takeaways         The performance of the Financials sector lagged behind most sectors’ throughout
from discussions with analysts about likelihood   most of 2010, as the impact of financial regulatory reform, as well as tougher comps
of outperformance by their sectors vs. overall
                                                  in 2010, became relative drags on the sector. Going forward into 2011, the impact of
market in 2011.
                                                  regulatory reform will likely continue to be important for the performance of the




                                                                                                                                                 Financials: Overweight
                                                  Financials sector, as Congress works through how to implement the new regulations.

                                                  The relative valuation of the Financials sector based on relative Price/10-yr EPS
                                                  continues to remain near an all-time low, suggesting there is still significant upside
                                                  for multiple expansion on this metric. If the relative P/10-yr EPS were able to
                                                  recover to the long-term average, it would suggest 74% upside for the sector. Even if
                                                  valuations are only able to recover to one standard deviation below the long-term
                                                  average, that would imply 44% upside for the sector, suggesting the sector has strong
                                                  upside potential even with a more conservative view of multiple reflation.




                                                                                                                                            55
Thomas J Lee, CFA                                                                North America Equity Research
(1-212) 622-6505                                                                 10 December 2010
thomas.lee@jpmorgan.com




Figure 71: Quarterly Price Performance – Financials                                                         Figure 72: Financials – P/10-Yr EPS
Shaded box highlights performance of sector, Bold/Italics box highlights                                    10-Yr EPS
S&P 500 performance
 1Q09                           2Q09        3Q09     4Q09      1Q10       2Q10   3Q10    QTD
                                                                                                                                       1.2x




                                                                                                             Relative P/E to S&P 500
   4%                            35%        25%      10%       12%         -5%   19%     16%
  -3%                            19%        21%      9%        11%         -6%   17%     12%                                           1.0x
  -8%                            18%        21%      9%        10%         -9%   15%     11%
  -9%                            18%        19%      7%            5%     -11%   14%     9%
                                                                                                                                       0.8x
  -9%                            16%        17%      6%            5%     -12%   12%     8%                                            0.6x                                                                                  Cheap
 -11%                            15%        15%      6%            3%     -12%   11%     7%
 -12%                            10%        11%      5%            2%     -12%   11%     6%                                            0.4x
 -12%                            9%         9%       5%            2%     -13%   11%     3%                                                                    '85           '89    '93      '97     '01   '05    '09
 -12%                            9%         9%       5%            0%     -13%   10%     1%                                                                    Recessions                 Rel to SP500       STD +1
                                                                                                                                                               STD -1                     Avg
 -22%                            8%         5%       4%            -5%    -14%    8%     1%
                                                                                                            Source: J.P. Morgan and Datastream.
 -29%                            2%         4%       -4%           -6%    -16%    4%     -2%
Source: J.P. Morgan and FactSet.


                                                                                 Earnings Outlook and Performance
                                                                                 Earnings in Financials have been volatile the past few years. Earnings for this sector
                                                                                 were a significant drag on overall S&P 500 earnings in 2008, as asset write-downs
                                                                                 and credit charges were severe at the height of the credit crisis, while earnings
                                                                                 rebounded sharply in 2009 as financial markets stabilized.

                                                                                 However, in 2010, comps became more difficult, as there was less room for further
                                                                                 top-line recovery after the strong rebound in 2009. Looking ahead to 2011, top-line
                                                                                 growth should again be difficult with top-line growth in Financials expected to lag
                                                                                 the S&P 500’s by 1,490bp over the next 12 months.

                                                                                 At the earnings level, however, Financials should be a major contributor to growth,
                                                                                 with the sector contributing 4.9% of the S&P 500’s 9.9% projected earnings growth
                                                                                 over the next 12 months, as a continued improvement in credit and lower
                                                                                 provisioning and charge-offs provide a boost to earnings.

Figure 73: Relative Sales Growth – Financials                                                               Figure 74: Relative Earnings Momentum – Financials
Sales growth NTM of sector less sales growth NTM of S&P 500                                                 Sector chg in net income (NTM vs. year ago) divided by S&P 500 net income

                              30%
  Rel Sales Growth Momentum




                              20%                                                                                                                                      15%
                                                                                                                                         Relative Earnings Momentum




                              10%
                                                                                                                                                                       10%
                                                                                                                                                                        5%                                            4.9%
                               0%                                                                                                                                       0%
                              -10%                                                                                                                                     -5%
                                                                                                   -14.9%                                                             -10%
                              -20%
                                                                                                                                                                      -15%
                              -30%                                                                                                                                    -20%
                                     4/06     3/07          2/08         1/09    12/09   11/10    10/11                                                               -25%
Source: J.P. Morgan and FactSet.                                                                                                                                             4/06 3/07    2/08 1/09 12/09 11/10 10/11
                                                                                                            Source: J.P. Morgan and FactSet.




56
Thomas J Lee, CFA                                 North America Equity Research
(1-212) 622-6505                                  10 December 2010
thomas.lee@jpmorgan.com




                                                  Healthcare: Neutral
Headline Drivers for the Sector:                  Bottom Line: Healthcare Is Not Getting Sicker...
Healthcare Reform Implementation                  The group could look more attractive later in 2011, once we get closer to seeing the
Unemployment                                      full impact of healthcare reform and move toward the other side of the “valley” for
                                                  several segments.

                                                  • History suggests Healthcare should do poorly in 1H11, despite valuations that are
                                                    attractive. But fundamental clarity is needed before getting more constructive.

J.P. Morgan Analyst Coverage                      J.P. Morgan Fundamental Analysts More Constructive
                             Analyst              First, the outcome of healthcare regulatory reform was in line with our analysts’
Sector             Analyst Conviction             expectations, for the most part, and not as burdensome as some on the Street had
Biotech      Meacham                      N       feared. Republicans’ victories in the recent elections should also limit further
Mgd Care     Rex                         HC       regulatory initiatives on healthcare, providing more visibility for the future and
Facilities   Rex                         HC       reducing the risk of negative headlines.
Distribution Gill                        HC
MedDevice Weinstein                      LC
Pharma       Schott                      HC       From a fundamental perspective, 2010 was actually a relatively good year for many
SMid Biotech Kasimov                     HC       groups within Healthcare, despite all of the headline risk. For example, John Rex,
SMid MedTech Peterson                    HC       J.P. Morgan’s Managed Care analyst, has noted that many of his companies saw
HealthCare IT Rahim                      HC       significant earnings upside throughout the year.

HC: High Conviction; N: Neutral;                  Improvement in employment trends in 2011 should also provide additional support
LC: Low Conviction.                               for Healthcare stocks in 2011 due to the consumer spending aspect of many
Analyst conviction based on our takeaways
                                                  industries within this sector. For example, Atif Rahim, J.P. Morgan’s Healthcare IT
from discussions with analysts about likelihood
of outperformance by their sectors vs. overall
                                                  analyst, has highlighted that healthcare providers’ capital spending budgets have
market in 2011.                                   been restricted due to reduced doctor and hospital visits, as consumers look to cut
                                                  costs. Lisa Gill, J.P. Morgan’s Healthcare Technology & Distribution analyst, has
                                                  also highlighted that prescription growth has slowed due to the weak economy, but
                                                  an acceleration in hiring could provide upside potential for companies.

                                                  There are also several positive trends within each industry in HealthCare.
                                                  Geoffrey Meacham, J.P. Morgan’s Biotech analyst, believes strong earnings



                                                                                                                                              Healthcare: Neutral
                                                  momentum, new product cycles, and M&A activity create some attractive
                                                  opportunities in his space. Lisa Gill also believes favorable demographic trends,
                                                  such as Baby Boomers reaching retirement age in 2011, provide upside for continued
                                                  earnings growth. M&A and share buybacks may also provide support for stocks in
                                                  2011. For example, Tycho Peterson, J.P Morgan’s SMid Medical & Life Sciences
                                                  Technology analyst, believes his companies’ overcapitalized balance sheets will lead
                                                  to increased capital deployment next year.

                                                  Sector Performance and Valuation
                                                  Healthcare has not been a leading sector in terms of price performance in the past
                                                  two years. In mid-2009 when the market rallied off of the bear market bottom, the
                                                  sector lagged along with other Defensive sectors.

                                                  The sector briefly outperformed the market in 4Q09, when healthcare reform seemed
                                                  less likely, but this outperformance didn’t last long as the sector again

                                                                                                                                         57
Thomas J Lee, CFA                                                               North America Equity Research
(1-212) 622-6505                                                                10 December 2010
thomas.lee@jpmorgan.com




                                                                                underperformed in 1Q10-2Q10. The magnitude of underperformance of the sector
                                                                                has grown in recent quarters, as investors have rotated back toward favoring
                                                                                Cyclicals sectors, leaving Defensives sectors such as Healthcare lagging behind.

                                                                                Valuations in Healthcare are currently well below the long-term average, suggesting
                                                                                there is substantial room for upside from multiple expansion. If multiples are able to
                                                                                recover back to the long-term average, this would represent 31% upside for the
                                                                                sector. As a result, Healthcare could still have potential for outperformance if
                                                                                multiples are able to expand next year, despite the relatively mild outlook for
                                                                                earnings growth.

Figure 75: Quarterly Price Performance – Healthcare                                                        Figure 76: Healthcare – P/10-Yr EPS
Shaded box highlights performance of sector, Bold/Italics box highlights                                   10-Yr EPS
S&P 500 performance
 1Q09                           2Q09       3Q09     4Q09      1Q10       2Q10   3Q10    QTD
                                                                                                                                      1.8x
                                                                                                            Relative P/E to S&P 500
   4%                           35%        25%      10%       12%        -5%    19%     16%
  -3%                           19%        21%      9%        11%        -6%    17%     12%                                           1.5x
  -8%                           18%        21%      9%        10%        -9%    15%     11%
  -9%                           18%        19%      7%            5%     -11%   14%     9%                                            1.2x                                                                                  Cheap
  -9%                           16%        17%      6%            5%     -12%   12%     8%                                            0.9x
 -11%                           15%        15%      6%            3%     -12%   11%     7%
 -12%                           10%        11%      5%            2%     -12%   11%     6%
                                                                                                                                      0.6x
 -12%                               9%     9%       5%            2%     -13%   11%     3%                                                                    '85           '89    '93      '97         '01   '05    '09
 -12%                               9%     9%       5%            0%     -13%   10%     1%                                                              Recessions                       Rel to SP500           STD +1
                                                                                                                                                        STD -1                           Avg
 -22%                               8%     5%       4%            -5%    -14%   8%      1%
                                                                                                           Source: J.P. Morgan and Datastream.
 -29%                               2%     4%       -4%           -6%    -16%   4%      -2%
Source: J.P. Morgan and FactSet.


                                                                                Earnings Outlook and Performance
                                                                                Looking ahead, top-line growth in HealthCare is projected to lag behind the
                                                                                S&P 500’s by 460bp over the next 12 months, as Cyclicals in general should
                                                                                continue to be the main top-line growth drivers. The contribution to earnings growth
                                                                                should also be small at only 0.5% of the S&P 500’s total projected earnings growth
                                                                                of 9.9%.

Figure 77: Relative Sales Growth – Healthcare                                                              Figure 78: Relative Earnings Momentum – Healthcare
Sales growth NTM of sector less sales growth NTM of S&P 500                                                Sector chg in net income (NTM vs. year ago) divided by S&P 500 net income

                              16%
  Rel Sales Growth Momentum




                              12%                                                                                                                                    6%
                                                                                                                                        Relative Earnings Momentum




                              8%                                                                                                                                     4%
                              4%                                                                                                                                     2%
                              0%                                                                                                                                     0%                                              0.5%

                              -4%                                                                  -4.6%                                                             -2%
                              -8%                                                                                                                                    -4%
                                    4/06     3/07          2/08         1/09    12/09    11/10   10/11
                                                                                                                                                                     -6%
Source: J.P. Morgan and FactSet.                                                                                                                                           4/06 3/07 2/08 1/09 12/09 11/10 10/11
                                                                                                           Source: J.P. Morgan and FactSet.




58
Thomas J Lee, CFA                                 North America Equity Research
(1-212) 622-6505                                  10 December 2010
thomas.lee@jpmorgan.com




                                                  Telecom: Neutral
Headline Drivers for the Sector:                  Bottom Line: Dividends and Towers
Price Competition                                 The telecom services industry potentially is “overcapitalized” as the number of scale
Unemployment                                      players suggests pricing pressure while intermodal threats challenge volumes and
M&A                                               share.
Interest Rates
4G Rollout
                                                  • At the same time, one of the best business models globally is in the telecom
                                                    services sector—Towers. Towers have significant barriers to entry, require little
                                                    capital to generate growth, and generate high ROEs.

                                                  In 2011, the Telecom sector is expected to grow top line at an anemic 1.6% rate
                                                  (based on consensus), although earnings are projected to grow by 14.9%, suggesting
                                                  consensus is projecting margins to expand next year.

                                                  Sector Performance and Valuation
                                                  The group has only outperformed when the market has fallen in the past two years.
                                                  The price performance of the Telecom sector has been extremely varied over the past
                                                  two years, with the sector ranging from the top-performing sector to the worst-
                                                  performing sector over the past 8 quarters.

                                                  The P/10-yr EPS of the Telecom sector is currently close to the long-term average,
                                                  suggesting the sector is neither particularly cheap nor expensive. The valuation is
                                                  slightly below the long-term average and has been mostly trending upward since
                                                  April of this year, suggesting valuations could continue to expand further from here
                                                  before becoming stretched.

Figure 79: Quarterly Price Performance – Telecom                            Figure 80: Telecom – P/10-Yr EPS
Shaded box highlights performance of sector, Bold/Italics box highlights    10-Yr EPS
S&P 500 performance
 1Q09     2Q09      3Q09     4Q09   1Q10   2Q10   3Q10    QTD                                          1.2x
                                                                             Relative P/E to S&P 500




  4%       35%      25%       10%   12%    -5%    19%     16%
                                                                                                       1.0x
  -3%      19%      21%       9%    11%    -6%    17%     12%
                                                                                                                                                               In-line
  -8%      18%      21%       9%    10%    -9%    15%     11%                                          0.8x                                                    with LT
  -9%      18%      19%       7%    5%     -11%   14%      9%
                                                                                                                                                               avg
                                                                                                                                                                         Telecom: Neutral
  -9%      16%      17%       6%    5%     -12%   12%      8%                                          0.6x
 -11%      15%      15%       6%    3%     -12%   11%     7%
 -12%      10%      11%       5%    2%     -12%   11%      6%
                                                                                                       0.4x
 -12%       9%       9%       5%    2%     -13%   11%      3%                                                 '85     '89   '93      '97     '01   '05   '09
 -12%       9%       9%       5%    0%     -13%   10%      1%                                                 Recessions          Rel to SP500      STD +1
                                                                                                              STD -1              Avg
 -22%       8%       5%       4%    -5%    -14%    8%      1%
                                                                            Source: J.P. Morgan and Datastream.
 -29%       2%       4%       -4%   -6%    -16%    4%     -2%
Source: J.P. Morgan and FactSet.




                                                                                                                                                                   59
Thomas J Lee, CFA                                                North America Equity Research
(1-212) 622-6505                                                 10 December 2010
thomas.lee@jpmorgan.com




                                                                 Earnings Outlook and Performance
                                                                 The outlook for top-line growth in the Telecom sector shows the lack of momentum
                                                                 in this category. Top-line growth is projected to lag behind the S&P 500’s revenue
                                                                 growth by 350bp over the next 12 months.

                                                                 Telecom’s contribution to earnings growth should also be negligible next year, with
                                                                 the sector projected to only contribute 0.2% of the S&P 500’s total 9.9% earnings
                                                                 growth over the next 12 months. However, this small contribution to earnings growth
                                                                 by Telecom is partially due to the sector’s small representation in the overall
                                                                 S&P 500 index.

Figure 81: Relative Sales Growth – Telecom                                                  Figure 82: Relative Earnings Momentum – Telecom
Sales growth NTM of sector less sales growth NTM of S&P 500                                 Sector chg in net income (NTM vs. year ago) divided by S&P 500 net income

                              30%
  Rel Sales Growth Momentum




                                                                                                                                 6%


                                                                                                    Relative Earnings Momentum
                              20%
                                                                                                                                 4%
                              10%                                                                                                2%
                                                                                                                                 0%                                             0.2%
                               0%
                                                                                    -3.5%                                        -2%
                              -10%                                                                                               -4%
                                     4/06   3/07   2/08   1/09   12/09   11/10    10/11                                          -6%
Source: J.P. Morgan and FactSet.                                                                                                       4/06   3/07   2/08   1/09 12/09 11/10 10/11
                                                                                            Source: J.P. Morgan and FactSet.




60
Thomas J Lee, CFA                                        North America Equity Research
(1-212) 622-6505                                         10 December 2010
thomas.lee@jpmorgan.com




                                                         Consumer Staples: Underweight
Headline Drivers for the Sector:                         Fundamental Outlook
Commodity Prices                                         The fundamental outlook for the Staples sector is mixed, but generally positive, with
Consumer/Unemployment                                    offsetting effects from slowly rising demand but also rising cost pressures.
International Growth                                     J.P. Morgan’s Consumer Staples analysts generally expect demand to continue to
Dollar Effects
                                                         recover in 2011 along with the overall economic recovery. However, consumers
M&A
                                                         continue to remain valued-oriented, given the stubbornly high unemployment levels,
                                                         so demand growth is likely to be relatively mild. Given the relatively muted outlook
                                                         for demand growth, John Faucher, J.P. Morgan’s Beverages and Household
                                                         Products analyst, believes investors should focus on areas with exposure to
                                                         international markets, particularly emerging markets, where growth prospects are
                                                         more robust.
J.P. Morgan Analyst Coverage
                                                         Margin pressure in 2011 slowing earnings growth
                                 Analyst
Sector            Analyst      Conviction                On the negative side, however, J.P. Morgan’s analysts expect downward pressure on
                                                         margins, as input costs continue to rise. Charles Grom, J.P. Morgan’s
Beverages         Faucher                LC
                                                         Broadlines/Department Stores and Food Retail analyst, expects that higher raw
HH Prod           Faucher                 N
Foods             Bivens                 LC              material costs and increased labor/shipping costs will put pressure on margins.
Tobacco           Maile                  HC
                                                         Sector Performance and Valuation
HC: High Conviction; N: Neutral;                         Staples only briefly outperformed the overall S&P 500 early this year, when the
LC: Low Conviction.
                                                         market began its steep correction and Defensives in general held up better.
Analyst conviction based on our takeaways
from discussions with analysts about likelihood
                                                         Valuations in the Staples sector, based on Price/10-yr EPS, have remained elevated




                                                                                                                                                                                       Consumer Staples: Underweight
of outperformance by their sectors vs. overall
market in 2011.                                          throughout the downturn and recovery. The current valuation is more than one
                                                         standard deviation above the long-term average, suggesting Staples is still
                                                         particularly expensive based on long-term earnings.

Figure 83: Quarterly Price Performance – Consumer Staples                          Figure 84: Consumer Staples – P/10-Yr EPS
Shaded box highlights performance of sector, Bold/Italics box highlights           10-Yr EPS
S&P 500 performance
 1Q09      2Q09       3Q09    4Q09      1Q10      2Q10   3Q10   QTD                                           1.0x
                                                                                    Relative P/E to S&P 500




  4%       35%        25%      10%       12%      -5%    19%    16%
                                                                                                              0.8x
  -3%      19%        21%       9%       11%      -6%    17%    12%                                                                                                        Expensive
  -8%      18%        21%       9%       10%      -9%    15%    11%                                           0.6x
  -9%      18%        19%       7%       5%       -11%   14%    9%
  -9%      16%        17%       6%       5%       -12%   12%    8%                                            0.4x
 -11%      15%        15%       6%       3%       -12%   11%    7%
 -12%      10%        11%      5%        2%       -12%   11%    6%                                            0.2x
 -12%       9%        9%        5%       2%       -13%   11%    3%                                                   '85     '89   '93      '97         '01   '05    '09
 -12%       9%        9%        5%       0%       -13%   10%    1%                                                   Recessions          Rel to SP500           STD +1
                                                                                                                     STD -1              Avg
 -22%       8%        5%        4%       -5%      -14%   8%     1%
                                                                                   Source: J.P. Morgan and Datastream.
 -29%       2%        4%       -4%       -6%      -16%   4%     -2%
Source: J.P. Morgan and FactSet.




                                                                                                                                                                             61
Thomas J Lee, CFA                                               North America Equity Research
(1-212) 622-6505                                                10 December 2010
thomas.lee@jpmorgan.com




                                                                Earnings Outlook and Performance
                                                                Top-line growth in the Staples sector held up well during the downturn due to the
                                                                defensiveness of the sector. In 2010, however, top-line growth lagged behind that of
                                                                the overall S&P 500.

                                                                Looking ahead to next year, however, top-line growth in the Staples sector is actually
                                                                projected to outpace the S&P 500’s revenue growth by 140bp over the next 12
                                                                months. Staples’ contribution to earnings growth, however, should be relatively
                                                                small at only 0.6% (out of the S&P 500’s total 9.9% projected earnings growth).

Figure 85: Relative Sales Growth – Staples                                                 Figure 86: Relative Earnings Momentum – Staples
Sales growth NTM of sector less sales growth NTM of S&P 500                                Sector chg in net income (NTM vs. year ago) divided by S&P 500 net income

                              12%
  Rel Sales Growth Momentum




                                                                                                                                6%



                                                                                                   Relative Earnings Momentum
                              8%
                                                                                                                                4%
                              4%
                                                                                    1.4%                                        2%
                              0%                                                                                                                                                0.6%
                                                                                                                                0%
                              -4%                                                                                               -2%
                              -8%                                                                                               -4%
                                    4/06   3/07   2/08   1/09   12/09   11/10    10/11                                          -6%
Source: J.P. Morgan and FactSet.                                                                                                      4/06   3/07   2/08   1/09 12/09 11/10 10/11
                                                                                           Source: J.P. Morgan and FactSet




62
Thomas J Lee, CFA                                North America Equity Research
(1-212) 622-6505                                 10 December 2010
thomas.lee@jpmorgan.com




                                                 Utilities: Underweight
Headline Drivers for the Sector:                 Bottom Line: History Suggests Good Performance, But
Household and Corporate Health
                                                 Rising Rates Say Wait
Interest Rates                                   We remain Underweight, and see little reason to put fresh money to work in the
Energy Prices
                                                 sector given the slower EPS growth. However, as the bull market matures, valuations
M&A
Regulatory Outlook                               should become more attractive at some point.
Industrial Activity
                                                 • Historical staging (see prior sections) argues for owning Utilities. Utilities have
                                                   typically been a top-quartile group in Year 3 (see Figure 25).
                                                 • Another positive case to be made is the positive leverage to a domestic cyclical
                                                   acceleration. And later in the year, it is possible that “Dividends at a reasonable
                                                   price” could become a more relevant strategy.
J.P. Morgan Analyst Coverage

                                 Analyst
                                                 J.P. Morgan Analysts Constructive
Sector            Analyst      Conviction        Strong fundamental outlook supported by continued economic recovery
Reg Utilities   Smith                     N      The fundamental outlook for the Utilities companies looks optimistic in 2011, as
Unreg Utilities Smith                    HC      continued improvement in economic conditions benefits utility companies.
                                                 According to Andrew Smith, J.P. Morgan’s Electric Utilities analyst, demand for
HC: High Conviction; N: Neutral;
                                                 electricity has been improving for the past several quarters and is up almost 4% YTD
LC: Low Conviction.                              versus 2009 through mid-November. Industrial demand for electricity has recovered
Analyst conviction based on our takeaways        along with the overall economy, but still has significant upside to re-attain its prior
from discussions with analyst about likelihood   peak. Residential demand for electricity has also recovered sharply this year,
of outperformance by his sector vs. overall
                                                 alleviating concerns that conservation efforts were structurally cutting residential
market in 2011.
                                                 demand for electricity.

                                                 Utility rate regulation important, but likely not main focus of regulators in 2011
                                                 The regulatory outlook is a key driver for this sector as many companies are
                                                 regulated, but Andrew Smith expects regulators to be less focused on rising utility
                                                 rates next year as long as the economy continues to recover.




                                                                                                                                              Utilities: Underweight
                                                 Relatively attractive risk/return potential in 2011
                                                 Andrew Smith remains particularly bullish on Utilities stocks, and expects a total
                                                 return potential of 10-12% next year, with about half of the return from dividends.
                                                 Given the lower-beta nature of stocks in this sector and more defensive nature of
                                                 earnings, Smith believes the group offers an attractive low-risk, high-reward
                                                 opportunity for equity investors.

                                                 Sector Performance and Valuation
                                                 Utilities has been one of the biggest underperformers for most of the past two years,
                                                 as it has little leverage to the global economic recovery. The sector briefly
                                                 outperformed in 2Q10, as it held up better during the market’s correction. However,
                                                 the sector has now been the worst-performing sector in the latest quarter, as Cyclicals
                                                 regained traction, leaving Defensives lagging behind.




                                                                                                                                         63
Thomas J Lee, CFA                                                            North America Equity Research
(1-212) 622-6505                                                             10 December 2010
thomas.lee@jpmorgan.com




                                                                             Relative valuations in the Utilities sector have contracted sharply over the past two
                                                                             years, but the valuation is still elevated based on the relative Price/10-yr EPS,
                                                                             suggesting relative multiples could contract further next year.

                                                                             • Although relative valuations have improved since peaking back in late 2008, the
                                                                               current valuation is still one standard deviation above the long-term average,
                                                                               suggesting it is still elevated.

Figure 87: Quarterly Price Performance – Utilities                                                      Figure 88: Utilities – P/10-Yr EPS
Shaded box highlights performance of sector, Bold/Italics box highlights                                10-Yr EPS
S&P 500 performance
 1Q09                           2Q09        3Q09     4Q09     1Q10   2Q10    3Q10    QTD
                                                                                                                                   1.1x




                                                                                                         Relative P/E to S&P 500
   4%                            35%        25%      10%       12%    -5%    19%     16%
  -3%                            19%        21%      9%        11%    -6%    17%     12%
                                                                                                                                   0.8x
  -8%                            18%        21%      9%        10%    -9%    15%     11%
                                                                                                                                                                                                                           Expensive
  -9%                            18%        19%      7%        5%     -11%   14%     9%
  -9%                            16%        17%      6%        5%    -12%    12%     8%
                                                                                                                                   0.5x
 -11%                            15%        15%      6%        3%     -12%   11%     7%
 -12%                            10%        11%      5%        2%     -12%   11%     6%
                                                                                                                                   0.2x
 -12%                            9%         9%       5%        2%     -13%   11%     3%                                                                           '85      '89    '93      '97         '01   '05   '09
 -12%                            9%         9%       5%        0%     -13%   10%     1%                                                              Recessions                         Rel to SP500          STD +1
                                                                                                                                                     STD -1                             Avg
 -22%                            8%         5%       4%        -5%    -14%   8%      1%
                                                                                                        Source: J.P. Morgan and Datastream.
 -29%                            2%         4%       -4%       -6%    -16%   4%      -2%
Source: J.P. Morgan and FactSet.



                                                                             Earnings Outlook and Performance
                                                                             Top-line growth in the Utilities sector lagged well behind S&P 500 top-line growth
                                                                             this past year. Looking ahead to next year, revenue growth should continue to lag
                                                                             that of the overall index, trailing by an estimated 80bp over the next 12 months.

                                                                             Earnings growth in the Utilities sector is also projected to trail that of the overall
                                                                             index, with Utilities actually contributing negative growth of -0.4% over the next 12
                                                                             months (out of the S&P 500’s total +9.9% earnings growth).

Figure 89: Relative Sales Growth – Utilities                                                            Figure 90: Relative Earnings Momentum – Utilities
Sales growth NTM of sector less sales growth NTM of S&P 500                                             Sector chg in net income (NTM vs. year ago) divided by S&P 500 net income

                               8%
  Rel Sales Growth Momentum




                               4%                                                                                                                                  6%
                                                                                                                                     Relative Earnings Momentum




                               0%                                                               -0.8%                                                              4%
                              -4%                                                                                                                                  2%
                              -8%                                                                                                                                  0%                                              -0.4%
                              -12%                                                                                                                                 -2%
                              -16%                                                                                                                                 -4%
                                     4/06     3/07          2/08     1/09    12/09    11/10   10/11                                                                -6%
Source: J.P. Morgan and FactSet.                                                                                                                                         4/06 3/07 2/08 1/09 12/09 11/10 10/11
                                                                                                        Source: J.P. Morgan and FactSet.




64
Thomas J Lee, CFA                                                     North America Equity Research
(1-212) 622-6505                                                      10 December 2010
thomas.lee@jpmorgan.com




Appendix: Bull Market Metrics in Months 22-34 After Start of Bull Market
Figure 91: Bull Market Metrics in Months 22-34 After Start of Bull Market
      Bull Markets surviving through 34 months                                                 1                         2                          3                              4                             5                           6                                      7
                                                                                     Metrics in Months 22-34
                                                                                     Dates                     Price Performance         EPS Growth (LTM)               EPS Growth (NTM)               Real GDP Growth           Unemployment Rate             Payrolls (private)
                                               Months                     Months
                                                  after    Month of   after Month
                                             Month 22          Next        22 that                                                                                                                                                                                                                  Avg
          Bull Mkt Bull Mkt End Length        that Bull   Recession    Recession                                Month Month                Month   Month                  Month   Month                 Month Month               Month Month                                                    Monthly
        Start Date         Date (months)         ends         Start         starts      Month 22    Month 34        22    34 % chg            22      34        Delta        22      34        Delta        22   34   Delta           22    34 Delta  Avg      Month 22   Month 34       Delta     Delta
  1     8/24/1921      9/3/1929     96             75       5/1923             (1)     6/17/1923   6/16/1924       95    94   -1%           96%     27%     -6863 bp       27%      4%     -2249 bp         —    —      —             —     —    —      —            —          —           —        —
  2      7/8/1932 3/10/1937         56             34       5/1937            37        5/1/1934    5/1/1935       10     9  -12%            8%     61%      5294 bp       61%      8%     -5311 bp         —    —      —         16.6% 17.6% 91 bp 19.1%            —          —           —        —
  3     4/28/1942 5/29/1946         49             27       2/1945            12       2/19/1944   2/18/1945       12    14   19%           -9%     -1%       767 bp       -1%      3%       429 bp         —    —      —          1.4% 1.1% -30 bp 1.2%             —          —           —        —
  4     6/13/1949      1/5/1953     43             21       7/1953            28        4/6/1951    4/5/1952       22    24   11%           19%    -15%     -3460 bp      -15%      1%      1644 bp     10.4% 4.9% -548 bp         3.4% 2.9% -50 bp 3.2%        41,461     41,842         381       32
  5     9/14/1953 7/12/1957         46             24       8/1957            26        7/8/1955    7/7/1956       43    48   13%           23%     12%     -1110 bp       12%     -5%     -1680 bp      7.9% 2.3% -565 bp         4.2% 4.3% 10 bp 4.1%         43,770     45,216       1,446      121
  6    10/22/1957 12/13/1961        50             28       4/1960              8      8/15/1959   8/14/1960       59    57   -4%           16%     -4%     -2016 bp       -4%     -7%      -294 bp      9.6% 2.1% -746 bp         5.1% 5.5% 40 bp 5.3%         45,630     45,861         231       19
  7     6/26/1962      2/9/1966     44             22      12/1969            69       4/18/1964   4/18/1965       81    88    9%           13%     12%       -71 bp       12%     14%       214 bp      6.3% 5.4% -92 bp          5.4% 4.7% -70 bp 5.0%        48,287     49,993       1,706      142
  8     8/12/1982 8/25/1987         60             39       7/1990            74        6/4/1984    6/4/1985      154   190   23%           23%      7%     -1546 bp        7%    -11%     -1881 bp      8.5% 4.5% -395 bp         7.4% 7.2% -20 bp 7.3%        77,979     80,818       2,839      237
  9    10/11/1990 3/24/2000        114             92       3/2001           104        8/3/1992    8/3/1993      425   449    6%            4%     19%      1493 bp       19%     21%       228 bp      3.0% 2.9%   -7 bp         7.7% 6.9% -80 bp 7.2%        89,894     91,898       2,004      167
 10     10/9/2002 10/9/2007         60             38      12/2007            40        8/1/2004    8/1/2005    1,102 1,235   12%           23%     15%      -846 bp       15%     15%       -19 bp      4.1% 3.1% -100 bp         5.5% 5.0% -50 bp 5.3%       109,883    112,122       2,239      187
      Mean — Longer Bull              62           40                        40                                                     8%      22%     13%     -836 bp        13%      4%     -892 bp      7.1%    3.6% -350 bp       6.3%   6.1% -18 bp   6.4%                            1,549      129
      Median — Longer Bull            53           31                        32                                                    10%      18%     12%     -978 bp        12%      4%     -156 bp      7.9%    3.1% -395 bp       5.4%   5.0% -30 bp   5.3%                            1,706      142
      % times > 0 — Longer Bull                                             90%                                                    70%      90%     70%        30%         70%     70%        40%       100%    100%     0%                      33%                                    100%

      Bull Markets ending in months 22-34                                                      1                         2                          3                              4                             5                           6                                      7
                                                                                     Metrics in Months 22-34
                                                                                     Dates                     Price Performance         EPS Growth (LTM)               EPS Growth (NTM)               Real GDP Growth           Unemployment Rate             Payrolls (private)
                                               Months                     Months
                                                  after    Month of   after Month
                                             Month 22          Next        22 that                                                                                                                                                                                                                  Avg
          Bull Mkt   Bull Mkt End Length      that Bull   Recession    Recession                                Month Month                Month   Month                  Month   Month                 Month Month               Month Month                                                    Monthly
        Start Date           Date (months)       ends         Start         starts     Month 22 Month 34           22    34 % chg             22      34    Delta            22      34        Delta       22    34   Delta          22    34 Delta      Avg   Month 22   Month 34       Delta     Delta
  1     11/9/1903      1/19/1906      26             5      5/1907            21       9/1/1905   9/1/1906        80    94   18%            14%     23% 955 bp             23%     -1%     -2398 bp        —     —      —            —     —    —          —         —          —           —         —
  2    11/15/1907     11/19/1909      24             2      1/1910              5      9/7/1909   9/7/1910        97    78  -19%             8%     11% 313 bp             11%    -11%     -2260 bp        —     —      —            —     —    —          —         —          —           —         —
  3    12/24/1914     11/21/1916      23             1      8/1918            22     10/16/1916 10/16/1917       101    77  -24%            73%     -2% -7499 bp           -2%    -21%     -1902 bp        —     —      —            —     —    —          —         —          —           —         —
  4    12/19/1917      11/3/1919      23             1      1/1920              4    10/12/1919 10/11/1920       114    84  -27%           -11%    -12%   -80 bp          -12%    -50%     -3795 bp        —     —      —            —     —    —          —         —          —           —         —
  5     10/7/1966     11/29/1968      26             4     12/1969            17      7/30/1968 7/30/1969         98    90   -8%             5%      5%    34 bp            5%     -5%     -1033 bp     5.4% 3.0% -241 bp         3.7% 3.5% -20 bp      3.4%    55,917     58,277       2,360      197
  6     5/26/1970        1/5/1973     31           10      11/1973            20      3/18/1972 3/18/1973        108   114    5%            11%     13% 152 bp             13%     27%      1447 bp     4.5% 7.0% 242 bp          5.7% 5.0% -70 bp      5.5%    59,354     62,306       2,952      246
  7     10/3/1974      9/21/1976      24             2      1/1980            42      7/26/1976 7/26/1977        104   100   -4%            16%     13% -356 bp            13%      8%      -488 bp     6.2% 4.5% -172 bp         7.6% 7.2% -40 bp      7.5%    64,413     67,281       2,868      239
  8      3/6/1978      2/13/1980      23             2      1/1980              1    12/28/1979 12/27/1980       108   137   27%            26%      0% -2638 bp            0%      4%       423 bp     2.3% -1.6% -391 bp        5.9% 7.5% 160 bp      7.1%    74,401     74,350         (51)       (4)
  9    10/19/1987      7/16/1990      33           11       7/1990            12      8/11/1989 8/11/1990        345   336   -3%            16%    -16% -3208 bp          -16%     -8%       756 bp     3.6% 2.5% -111 bp         5.2% 5.5% 30 bp       5.3%    90,125     91,215       1,090       91
      Mean — Shorter Bull             26            4                        16                                                    -4%      18%      4% -1370 bp            4%     -6% -1028 bp          4.4%   3.1% -135 bp       5.6%   5.7% 12 bp    5.8%                            1,844      154
      Median — Shorter Bull           24            2                        17                                                    -4%      14%      5%   -80 bp            5%     -5% -1033 bp         4.5%    3.0% -172 bp       5.7%   5.5% -20 bp   5.5%                            2,360      197
      % times > 0 — Shorter Bull                                           100%                                                    33%      89%     67%     44%            67%     33%     33%          100%     80%    20%                      40%                                      80%

      Mean — All Bulls                45           23                        29                                                     2%      20%      9% -1089 bp            9%     -1%     -956 bp      6.0%    3.4% -260 bp       6.1%   6.0% -7 bp    6.2%                            1,672      139
      Median — All Bulls              43           21                        21                                                     5%      16%     11% -356 bp            11%      1%     -488 bp      5.8%    3.0% -206 bp       5.5%   5.3% -25 bp   5.3%                            1,855      155
      % times > 0 — All Bulls                                               95%                                                    53%      89%     68%     37%            68%     53%        37%       100%     92%     8%                      36%                                      92%

         3/9/2009                                                                    12/31/2010 12/31/2011      1,200    ???       ???      37%     13% -2353 bp           13%                           2.6%   3.5%     88 bp     9.7%   9.0% -70 bp   9.3%

Source: J.P. Morgan, Bloomberg, FactSet, and Datastream. Note: Uses Dow Jones Industrial Avg for 1900-1927 and S&P 500 for 1928-present.




                                                                                                                                                                                                                                                                                                  65
Thomas J Lee, CFA                                                       North America Equity Research
(1-212) 622-6505                                                        10 December 2010
thomas.lee@jpmorgan.com




Figure 92: Bull Market Metrics in Months 22-34 After Start of Bull Market (Continued)
      Bull Markets surviving through 34 months                                                  1                         2                                 8                                 9                                10                                  11                                   12
                                                                                      Metrics in Months 22-34                                                                                                     PEG (NTM P/E divided by NTM                                            Real Treasury Bond Yield (10yr
                                                                                      Dates                     Price Performance         Inflation (CPI yoy % chg)           P/E (NTM)                           growth)                            Treasury Bond Yield (10yr)          Treas. minus Inflation)
                                               Months                      Months
                                                  after    Month of    after Month
                                             Month 22          Next         22 that
       Bull Mkt Bull Mkt End Length           that Bull   Recession     Recession                                Month Month               Month Month                         Month Month                         Month   Month                      Month Month                         Month    Month
     Start Date         Date (months)            ends          Start         starts      Month 22    Month 34        22    34 % chg            22   34 Delta            Avg       22    34        Delta     Avg       22      34     Delta     Avg        22   34 Delta    Avg                22       34      Delta     Avg
  1 8/24/1921       9/3/1929     96                75       5/1923              (1)     6/17/1923   6/16/1924       95    94   -1%          1.2% 0.6% -60 bp           2.4%     9.0x  8.4x        -0.6x    8.8x     0.3x    1.9x      1.6x    1.6x     4.3% 4.0% -27 bp 4.1%               3.1%     3.4%      33 bp     1.8%
  2   7/8/1932 3/10/1937         56                34       5/1937             37        5/1/1934    5/1/1935       10     9  -12%          5.6% 3.8% -180 bp          3.1%    14.3x 11.7x        -2.6x   12.0x     0.2x    1.4x      1.2x    0.3x     3.0% 2.8% -28 bp 2.9%              -2.6%    -1.0%     152 bp    -0.2%
  3 4/28/1942 5/29/1946          49                27       2/1945             12       2/19/1944   2/18/1945       12    14   19%          3.0% 2.3% -70 bp           1.6%    12.7x 14.6x         2.0x   13.0x     neg     4.5x        —     2.6x     2.5% 2.4% -11 bp 2.4%              -0.5%     0.1%      59 bp     0.8%
  4 6/13/1949       1/5/1953     43                21       7/1953             28        4/6/1951    4/5/1952       22    24   11%          9.3% 1.9% -740 bp          6.4%     9.1x  9.9x         0.8x    9.7x     neg     7.9x        —     8.0x     2.6% 2.7% 12 bp 2.6%               -6.7%     0.8%     752 bp    -3.7%
  5 9/14/1953 7/12/1957          46                24       8/1957             26        7/8/1955    7/7/1956       43    48   13%         -0.7% 1.9% 260 bp           0.5%    11.8x 14.0x         2.2x   13.0x     1.0x    neg         —    11.8x     2.8% 3.0% 22 bp 3.0%                3.5%     1.1%    -238 bp     2.5%
  6 10/22/1957 12/13/1961        50                28       4/1960               8      8/15/1959   8/14/1960       59    57   -4%          0.8% 1.4% 56 bp            1.4%    18.2x 18.7x         0.5x   17.8x     neg     neg         —       —      4.4% 3.9% -50 bp 4.4%               3.6%     2.5%    -106 bp     3.0%
  7 6/26/1962       2/9/1966     44                22      12/1969             69       4/18/1964   4/18/1965       81    88    9%          1.4% 1.2% -24 bp           1.2%    17.2x 16.5x        -0.7x   17.0x     1.4x    1.2x     -0.3x    1.4x     4.2% 4.2%   -4 bp 4.2%              2.8%     3.0%      20 bp     3.0%
  8 8/12/1982 8/25/1987          60                39       7/1990             74        6/4/1984    6/4/1985      154   190   23%          4.2% 3.7% -50 bp           3.9%     9.4x 13.1x         3.7x   11.2x     1.3x    neg         —     1.3x    13.3% 9.9% -339 bp 12.0%             9.1%     6.2%    -289 bp     8.0%
  9 10/11/1990 3/24/2000        114                92       3/2001            104        8/3/1992    8/3/1993      425   449    6%          3.1% 2.8% -33 bp           3.1%    17.7x 15.5x        -2.2x   16.3x     1.0x    0.7x     -0.2x    0.7x     6.7% 5.8% -91 bp 6.3%               3.6%     3.0%     -57 bp     3.2%
 10 10/9/2002 10/9/2007          60                38      12/2007             40        8/1/2004    8/1/2005    1,102 1,235   12%          3.0% 3.1% 11 bp            3.0%    16.2x 16.3x         0.1x   16.4x     1.1x    1.1x      0.0x    1.1x     4.5% 4.3% -16 bp 4.2%               1.2%     1.2%      -5 bp     1.2%
      Mean — Longer Bull              62           40                         40                                                     8%     3.1%     2.3% -83 bp       2.7%    13.6x      13.9x   0.3x    13.5x     0.9x     2.7x    0.5x    3.2x      4.8%    4.3% -53 bp        4.6%     1.7%    2.0%      32 bp     1.9%
      Median — Longer Bull            53           31                         32                                                    10%     3.0%    2.1% -41 bp        2.7%    13.5x      14.3x   0.3x    13.0x     1.0x     1.4x    0.0x    1.4x      4.3%    3.9% -22 bp        4.1%     2.9%    1.9%       7 bp     2.1%
      % times > 0 — Longer Bull                                              90%                                                    70%      90%    100%    30%        100%                       60%                                60%                              20%                   70%     90%       50%       80%

      Bull Markets ending in months 22-34                                                       1                         2                                 8                                 9                                10                                  11                                   12
                                                                                      Metrics in Months 22-34                                                                                                     PEG (NTM P/E divided by NTM                                            Real Treasury Bond Yield (10yr
                                                                                      Dates                     Price Performance         Inflation (CPI yoy % chg)           P/E (NTM)                           growth)                            Treasury Bond Yield (10yr)          Treas. minus Inflation)
                                               Months                      Months
                                                  after    Month of    after Month
                                             Month 22          Next         22 that
          Bull Mkt   Bull Mkt End Length      that Bull   Recession     Recession                                Month Month               Month    Month                      Month Month                         Month   Month                      Month Month                         Month Month
        Start Date           Date (months)       ends          Start         starts     Month 22 Month 34           22    34 % chg             22       34      Delta  Avg        22    34        Delta     Avg       22      34 Delta         Avg        22    34 Delta   Avg                22     34 Delta     Avg
  1     11/9/1903      1/19/1906      26             5      5/1907             21       9/1/1905   9/1/1906        80    94   18%              —        —         —      —     12.9x 13.7x         0.8x   12.8x     0.6x    neg       —       1.2x     3.5% 3.6% 12 bp 3.5%                   —      —      —       —
  2    11/15/1907     11/19/1909      24             2      1/1910               5      9/7/1909   9/7/1910        97    78  -19%              —        —         —      —     13.7x 13.4x        -0.3x   13.8x     1.2x    neg       —       4.4x     3.8% 4.0% 10 bp 3.9%                   —      —      —       —
  3    12/24/1914     11/21/1916      23             1      8/1918             22     10/16/1916 10/16/1917       101    77  -24%           9.9%    19.8%     990 bp 16.2%      7.2x  7.6x         0.4x    7.6x     neg     neg       —         —      4.2% 4.5% 29 bp 4.3%               -5.7% -15.3% -961 bp -11.8%
  4    12/19/1917      11/3/1919      23             1      1/1920               4    10/12/1919 10/11/1920       114    84  -27%          13.4%    12.4%    -100 bp 17.7%     10.8x 18.9x         8.0x   12.9x     neg     neg       —         —      4.8% 5.1% 24 bp 5.0%               -8.6% -7.4% 124 bp -12.7%
  5     10/7/1966     11/29/1968      26             4     12/1969             17      7/30/1968 7/30/1969         98    90   -8%           4.3%     5.5%     117 bp 4.8%      16.7x 16.3x        -0.4x   17.6x     3.5x    neg       —      23.0x     5.4% 6.7% 131 bp 6.0%               1.1%   1.2% 14 bp     1.2%
  6     5/26/1970        1/5/1973     31           10      11/1973             20      3/18/1972 3/18/1973        108   114    5%           3.7%     3.9%      19 bp 3.3%      16.8x 13.9x        -2.9x   15.1x     1.3x    0.5x   -0.8x      0.7x     6.1% 6.8% 69 bp 6.3%                2.4%   2.9% 50 bp     3.0%
  7     10/3/1974      9/21/1976      24             2      1/1980             42      7/26/1976 7/26/1977        104   100   -4%           5.9%     6.9%      96 bp 5.8%      10.0x  8.9x        -1.1x    9.4x     0.8x    1.1x    0.4x      0.9x     7.9% 7.3% -59 bp 7.4%               2.0%   0.4% -155 bp   1.6%
  8      3/6/1978      2/13/1980      23             2      1/1980               1    12/28/1979 12/27/1980       108   137   27%          12.6%    12.6%      -1 bp 13.6%      7.4x  8.9x         1.6x    7.9x   107.8x    2.1x -105.7x     10.7x    10.4% 12.3% 184 bp 11.4%            -2.2% -0.4% 185 bp -2.2%
  9    10/19/1987      7/16/1990      33           11       7/1990             12      8/11/1989 8/11/1990        345   336   -3%           5.0%     4.8%     -19 bp 4.7%      16.2x 17.2x         1.0x   16.2x     neg     neg       —         —      8.1% 8.7% 58 bp 8.3%                3.1%   3.8% 76 bp     3.6%
      Mean — Shorter Bull             26            4                         16                                                    -4%    7.8%      9.4% 158 bp       9.5%    12.4x      13.2x   0.8x    12.6x    19.2x     1.2x   -35.4x   6.8x      6.0%    6.5%     51 bp     6.2%    -1.1%    -2.1% -95 bp        -2.5%
      Median — Shorter Bull           24            2                         17                                                    -4%    5.9%      6.9% 19 bp        5.8%    12.9x      13.7x   0.4x    12.9x     1.3x     1.1x    -0.8x   2.8x      5.4%    6.7%     29 bp     6.0%     1.1%     0.4% 50 bp          1.2%
      % times > 0 — Shorter Bull                                            100%                                                    33%    100%     100%    57%        100%                       56%                                 33%                                89%               57%       57%   71%           57%

      Mean — All Bulls                45           23                         29                                                     2%     5.1%     5.2% 16 bp        5.5%    13.0x      13.6x   0.5x    13.1x     9.3x     2.3x   -13.0x   4.6x      5.4%    5.4%     -4 bp     5.4%     0.5%    0.3% -20 bp         0.1%
      Median — All Bulls              43           21                         21                                                     5%     4.2%     3.7% -19 bp       3.3%    12.9x      13.9x   0.4x    13.0x     1.1x     1.3x    -0.1x   1.4x      4.4%    4.3%     10 bp     4.3%     2.0%    1.2% 20 bp          1.6%
      % times > 0 — All Bulls                                                95%                                                    53%      94%    100%    41%        100%                       58%                                 50%                                53%               65%      76%   59%           71%

         3/9/2009                                                                     12/31/2010 12/31/2011      1,200    ???       ???     1.1%     1.2%       7 bp   1.4%    12.9x                                0.8x                               2.5%    3.5%     95 bp     3.1%     1.4%    2.0%      60 bp     1.7%

Source: J.P. Morgan, Bloomberg, FactSet, and Datastream. Note: Uses Dow Jones Industrial Avg for 1900-1927 and S&P 500 for 1928-present.




66
Thomas J Lee, CFA                                                      North America Equity Research
(1-212) 622-6505                                                       10 December 2010
thomas.lee@jpmorgan.com




Figure 93: Bull Market Metrics in Months 22-34 After Start of Bull Market (Continued)
      Bull Markets surviving through 34 months                                                  1                         2                             13                                14                               15                                 16                                    17
                                                                                      Metrics in Months 22-34                                                                Corporate Bond Yield (Moody's    Corp Bond Spread (Moody's        EY (S&P 500 NTM) minus BY             Equity Risk Premium (EY minus
                                                                                      Dates                     Price Performance         Yield Curve (10yr minus 3yr)       BAA)                             BAA minus 10yr Treas)            (Moody's Corp BAA)                    real 10yr Treas yield)
                                               Months                      Months
                                                  after    Month of    after Month
                                             Month 22          Next         22 that
          Bull Mkt Bull Mkt End Length        that Bull   Recession     Recession                                Month Month               Month Month                        Month Month                      Month    Month                   Month Month                           Month Month
        Start Date         Date (months)         ends          Start         starts      Month 22    Month 34        22    34 % chg           22     34 Delta     Avg             22    34 Delta    Avg           22       34 Delta     Avg         22    34  Delta   Avg                 22   34 Delta    Avg
  1     8/24/1921      9/3/1929     96             75       5/1923              (1)     6/17/1923   6/16/1924       95    94   -1%            —      —      —      —           7.2% 7.0% -20 bp 7.3%          291 bp   298 bp   7 bp 315 bp      4.0% 5.0% 97 bp 4.2%                  8.1% 8.5% 43 bp 9.7%
  2      7/8/1932 3/10/1937         56             34       5/1937             37        5/1/1934    5/1/1935       10     9  -12%            —      —      —      —           6.0% 6.1% 12 bp 6.2%           297 bp   338 bp 40 bp 335 bp       1.0% 2.4% 146 bp 2.2%                 9.5% 9.6%    6 bp 8.7%
  3     4/28/1942 5/29/1946         49             27       2/1945             12       2/19/1944   2/18/1945       12    14   19%            —      —      —      —           3.8% 3.5% -30 bp 3.6%          128 bp   109 bp -19 bp 117 bp      4.1% 3.4% -76 bp 4.1%                 8.4% 6.8% -165 bp 6.9%
  4     6/13/1949      1/5/1953     43             21       7/1953             28        4/6/1951    4/5/1952       22    24   11%            —      —      —      —           3.2% 3.5% 28 bp 3.5%            64 bp    81 bp 16 bp 85 bp        7.8% 6.6% -121 bp 6.9%               17.8% 9.3% -845 bp 14.6%
  5     9/14/1953 7/12/1957         46             24       8/1957             26        7/8/1955    7/7/1956       43    48   13%         39 bp   5 bp -34 bp 15 bp           3.5% 3.8% 25 bp 3.6%            73 bp    76 bp   3 bp 66 bp       4.9% 3.4% -157 bp 4.1%                5.0% 6.0% 106 bp 5.1%
  6    10/22/1957 12/13/1961        50             28       4/1960               8      8/15/1959   8/14/1960       59    57   -4%        -20 bp 27 bp 47 bp -14 bp            5.1% 5.2% 14 bp 5.2%            68 bp   132 bp 64 bp 83 bp        0.4% 0.1% -29 bp 0.4%                 1.9% 2.8% 91 bp 2.6%
  7     6/26/1962      2/9/1966     44             22      12/1969             69       4/18/1964   4/18/1965       81    88    9%          8 bp   9 bp   1 bp 16 bp           4.8% 4.8%    -5 bp 4.8%         60 bp    58 bp  -2 bp 62 bp       1.0% 1.3% 30 bp 1.1%                  3.0% 3.0%    5 bp 2.9%
  8     8/12/1982 8/25/1987         60             39       7/1990             74        6/4/1984    6/4/1985      154   190   23%         53 bp 110 bp 58 bp 68 bp           14.7% 13.2% -159 bp 13.9%        94 bp   289 bp 195 bp 198 bp     -4.1% -5.5% -139 bp -5.0%              1.5% 1.4% -9 bp 1.0%
  9    10/11/1990 3/24/2000        114             92        3/2001           104        8/3/1992    8/3/1993      425   449    6%        188 bp 137 bp -52 bp 172 bp          8.7% 7.8% -87 bp 8.4%          199 bp   202 bp   3 bp 215 bp     -3.0% -1.4% 168 bp -2.3%               2.1% 3.5% 139 bp 2.9%
 10     10/9/2002 10/9/2007         60             38      12/2007             40        8/1/2004    8/1/2005    1,102 1,235   12%        147 bp 24 bp -123 bp 82 bp           6.6% 6.0% -61 bp 6.1%          213 bp   168 bp -45 bp 190 bp     -0.4% 0.1% 57 bp 0.0%                  4.9% 4.9%    1 bp 4.9%
      Mean — Longer Bull              62           40                         40                                                     8%    69 bp    52 bp -17 bp     56 bp     6.4%   6.1% -28 bp      6.3%   149 bp 175 bp     26 bp 167 bp     1.6%    1.5%       -2 bp    1.6%     6.2%     5.6% -63 bp      5.9%
      Median — Longer Bull            53           31                         32                                                    10%    46 bp    25 bp -17 bp     42 bp     5.5%   5.6% -13 bp      5.7%   111 bp 150 bp      5 bp 153 bp     1.0%    1.9%        0 bp    1.6%     4.9%     5.5%   6 bp      5.0%
      % times > 0 — Longer Bull                                              90%                                                    70%     83%     100%    50%       83%                    40%                                 70%              70%     80%        50%      80%     100%     100%   70%       100%

      Bull Markets ending in months 22-34                                                       1                         2                             13                                14                               15                                 16                                    17
                                                                                      Metrics in Months 22-34                                                                Corporate Bond Yield (Moody's    Corp Bond Spread (Moody's        EY (S&P 500 NTM) minus BY             Equity Risk Premium (EY minus
                                                                                      Dates                     Price Performance         Yield Curve (10yr minus 3yr)       BAA)                             BAA minus 10yr Treas)            (Moody's Corp BAA)                    real 10yr Treas yield)
                                               Months                      Months
                                                  after    Month of    after Month
                                             Month 22          Next         22 that
          Bull Mkt   Bull Mkt End Length      that Bull   Recession     Recession                                Month Month               Month     Month                    Month Month                      Month    Month                   Month    Month                        Month    Month
        Start Date           Date (months)       ends          Start         starts     Month 22 Month 34           22    34 % chg             22       34 Delta     Avg          22    34 Delta   Avg            22       34 Delta     Avg         22       34      Delta     Avg        22       34      Delta  Avg
  1     11/9/1903      1/19/1906      26             5      5/1907             21       9/1/1905   9/1/1906        80    94   18%              —        —      —      —           —     —     —      —            —        —      —      —          —        —         —         —        —        —         —      —
  2    11/15/1907     11/19/1909      24             2      1/1910               5      9/7/1909   9/7/1910        97    78  -19%              —        —      —      —           —     —     —      —            —        —      —      —          —        —         —         —        —        —         —      —
  3    12/24/1914     11/21/1916      23             1      8/1918             22     10/16/1916 10/16/1917       101    77  -24%              —        —      —      —           —     —     —      —            —        —      —      —          —        —         —         —    19.6%    28.4%     883 bp 25.1%
  4    12/19/1917      11/3/1919      23             1      1/1920               4    10/12/1919 10/11/1920       114    84  -27%              —        —      —      —        7.3% 8.1% 87 bp 8.0%           246 bp   309 bp 63 bp 305 bp       2.0%    -2.8%    -480 bp     0.0%    17.8%    12.7%    -517 bp 20.7%
  5     10/7/1966     11/29/1968      26             4     12/1969             17      7/30/1968 7/30/1969         98    90   -8%           -9 bp   -66 bp -57 bp -11 bp       7.1% 7.7% 63 bp 7.2%           143 bp    97 bp -46 bp 120 bp     -1.1%    -1.6%     -47 bp    -1.6%     4.9%     4.9%       2 bp 4.4%
  6     5/26/1970        1/5/1973     31           10      11/1973             20      3/18/1972 3/18/1973        108   114    5%           30 bp   -25 bp -55 bp 34 bp        8.2% 8.0% -26 bp 8.1%          219 bp   133 bp -86 bp 179 bp     -2.3%    -0.8%     150 bp    -1.5%     3.6%     4.3%      74 bp 3.6%
  7     10/3/1974      9/21/1976      24             2      1/1980             42      7/26/1976 7/26/1977        104   100   -4%           73 bp    76 bp   3 bp 101 bp       9.9% 8.9% -98 bp 9.2%          203 bp   171 bp -32 bp 182 bp      0.1%     2.3%     217 bp     1.4%     8.1%    10.8%     274 bp 9.0%
  8      3/6/1978      2/13/1980      23             2      1/1980               1    12/28/1979 12/27/1980       108   137   27%          -28 bp   -56 bp -28 bp -7 bp       12.0% 14.6% 265 bp 13.4%        161 bp   192 bp 31 bp 197 bp       1.6%    -3.5%    -504 bp    -0.7%    15.8%    11.5%    -424 bp 14.9%
  9    10/19/1987      7/16/1990      33           11       7/1990             12      8/11/1989 8/11/1990        345   336   -3%            1 bp    56 bp 55 bp    7 bp       9.8% 10.3% 51 bp 10.1%         175 bp   168 bp  -7 bp 174 bp     -3.7%    -4.5%     -86 bp    -3.9%     3.1%     2.0%    -111 bp 2.6%
      Mean — Shorter Bull             26            4                         16                                                    -4%    14 bp -3 bp -16 bp        25 bp     9.0%   9.6%     57 bp   9.3%   191 bp 178 bp -13 bp 193 bp       -0.6%    -1.8% -125 bp       -1.0%    10.4% 10.7%        26 bp 11.5%
      Median — Shorter Bull           24            2                         17                                                    -4%     1 bp -25 bp -28 bp        7 bp     9.0%   8.5%     57 bp   8.7%   189 bp 170 bp -19 bp 180 bp       -0.5%    -2.2% -66 bp        -1.1%     8.1% 10.8%         2 bp 9.0%
      % times > 0 — Shorter Bull                                            100%                                                    33%     60%    40%    40%         60%                       67%                           33%                 50%      17%    33%          17%     100% 100%          57% 100%

      Mean — All Bulls                45           23                         29                                                     2%    44 bp    27 bp -17 bp     42 bp     7.4%   7.4%      4 bp   7.4%   165 bp 176 bp     12 bp 176 bp     0.8%    0.3%      -48 bp    0.6%      7.9%     7.7% -26 bp      8.2%
      Median — All Bulls              43           21                         21                                                     5%    30 bp    24 bp -28 bp     16 bp     7.1%   7.3%      4 bp   7.2%   168 bp 168 bp      3 bp 180 bp     0.7%    0.1%      -38 bp    0.2%     5.0%     6.0%    5 bp     5.1%
      % times > 0 — All Bulls                                                95%                                                    53%     73%      73%    45%       73%                       50%                              56%             63%      56%        44%      56%     100%     100%    65%      100%

         3/9/2009                                                                     12/31/2010 12/31/2011      1,200    ???       ???   209 bp 202 bp      -8 bp             6.0%                           321 bp                             1.7%                                  6.1%

Source: J.P. Morgan, Bloomberg, FactSet, and Datastream. Note: Uses Dow Jones Industrial Avg for 1900-1927 and S&P 500 for 1928-present.




                                                                                                                                                                                                                                                                                                   67
Thomas J Lee, CFA                                                  North America Equity Research
(1-212) 622-6505                                                   10 December 2010
thomas.lee@jpmorgan.com




Figure 94: Bull Market Metrics in Months 22-34 After Start of Bull Market (Continued)
      Bull Markets surviving through 34 months                                                 1                         2                                18                                              19                                     20                    21
                                                                                     Metrics in Months 22-34                                                                                                                              Price as % of         % Retracement of
                                                                                     Dates                     Price Performance         Peak Price (within months 22-34)         Performance of Bull Market                              Prior Peak            Bear Mkt Decline
                                               Months                   Months                                                                                          Months
                                                  after    Month of after Month                                                                               % chg       from    Start of Bull             Start of Bull Start of Bull
                                             Month 22           Next     22 that                                                                              Month Month 22        Mkt to 12                 Mkt to 22 Mkt to 34
          Bull Mkt Bull Mkt End Length        that Bull   Recession Recession                                   Month Month                  Date of Price at 22 to to Peak           months Months 12-         months        months
        Start Date         Date (months)         ends          Start      starts        Month 22    Month 34        22    34 % chg        Peak Price Peak Peak            Point           later 22 Bull Mkt         later         later   Month 22 Month 34     Month 22 Month 34
  1     8/24/1921      9/3/1929     96             75       5/1923           (1)       6/17/1923   6/16/1924       95    94   -1%          2/6/1924     101      7%          8           56%           -5%         48%           47%         79%      78%          56%      54%
  2      7/8/1932 3/10/1937         56             34       5/1937          37          5/1/1934    5/1/1935       10     9  -12%          5/1/1934      10      0%          0          171%         -13%         137%          109%         33%      29%          22%      18%
  3     4/28/1942 5/29/1946         49             27       2/1945          12         2/19/1944   2/18/1945       12    14   19%         2/15/1945      14    19%         12            54%            3%         58%           88%         85%     102%          68%     104%
  4     6/13/1949      1/5/1953     43             21       7/1953          28          4/6/1951    4/5/1952       22    24   11%         1/22/1952      25    14%         10            42%          13%          60%           77%        113%     125%         143%     184%
  5     9/14/1953 7/12/1957         46             24       8/1957          26          7/8/1955    7/7/1956       43    48   13%         3/20/1956      49    15%           8           38%          36%          88%          112%        160%     180%         505%     641%
  6    10/22/1957 12/13/1961        50             28        4/1960           8        8/15/1959   8/14/1960       59    57   -4%          1/5/1960      60      2%          5           31%          16%          52%           45%        121%     115%         201%     175%
  7     6/26/1962      2/9/1966     44             22      12/1969          69         4/18/1964   4/18/1965       81    88    9%         4/14/1965      88    10%         12            33%          16%          54%           68%        111%     122%         140%     177%
  8     8/12/1982 8/25/1987         60             39       7/1990          74          6/4/1984    6/4/1985      154   190   23%          6/4/1985     190    23%         12            58%           -5%         51%           86%        110%     135%         136%     230%
  9    10/11/1990 3/24/2000        114             92       3/2001         104          8/3/1992    8/3/1993      425   449    6%         3/10/1993     456      7%          7           29%          11%          44%           52%        115%     122%         176%     209%
 10     10/9/2002 10/9/2007         60             38      12/2007          40          8/1/2004    8/1/2005    1,102 1,235   12%         7/28/2005 1,244      13%         12            34%            6%         42%           59%         72%      81%          43%      61%
      Mean — Longer Bull              62           40                        40                                                     8%                          11%         9            55%           8%          63%           74%         100%     109%        149%      185%
      Median — Longer Bull            53           31                        32                                                    10%                          11%         9            40%           9%          53%           73%         110%     118%        138%      176%
      % times > 0 — Longer Bull                                             90%                                                    70%                                                  100%          70%         100%          100%

      Bull Markets ending in months 22-34                                                      1                         2                                18                                              19                                     20                    21
                                                                                     Metrics in Months 22-34                                                                                                                              Price as % of         % Retracement of
                                                                                     Dates                     Price Performance         Peak Price (within months 22-34)         Performance of Bull Market                              Prior Peak            Bear Mkt Decline
                                               Months                     Months                                                                                        Months
                                                  after    Month of   after Month                                                                              % chg      from    Start of Bull             Start of Bull Start of Bull
                                             Month 22          Next        22 that                                                                             Month Month 22       Mkt to 12                 Mkt to 22 Mkt to 34
          Bull Mkt   Bull Mkt End Length      that Bull   Recession    Recession                                Month Month                   Date of Price at 22 to to Peak          months Months 12-         months        months
        Start Date           Date (months)       ends         Start         starts     Month 22 Month 34           22    34 % chg         Peak Price Peak Peak            Point           later 22 Bull Mkt         later         later   Month 22 Month 34     Month 22 Month 34
  1     11/9/1903      1/19/1906      26             5      5/1907            21       9/1/1905   9/1/1906        80    94   18%           1/19/1906     103    29%          5           59%          19%          89%          123%        102%     120%         104%     144%
  2    11/15/1907     11/19/1909      24             2      1/1910              5      9/7/1909   9/7/1910        97    78  -19%          11/19/1909     101     3%          2           67%          10%          84%           48%         95%      76%          89%      51%
  3    12/24/1914     11/21/1916      23             1      8/1918            22     10/16/1916 10/16/1917       101    77  -24%          11/21/1916     110     9%          1           85%            3%         91%           45%        101%      77%         102%      50%
  4    12/19/1917      11/3/1919      23             1      1/1920              4    10/12/1919 10/11/1920       114    84  -27%           11/3/1919     120     5%          1           25%          39%          73%           27%        104%      76%         110%      41%
  5     10/7/1966     11/29/1968      26             4     12/1969            17      7/30/1968 7/30/1969         98    90   -8%          11/29/1968     108    11%          4           33%            0%         34%           23%        104%      96%         118%      80%
  6     5/26/1970        1/5/1973     31           10      11/1973            20      3/18/1972 3/18/1973        108   114    5%           1/11/1973     120    11%        10            44%            8%         56%           64%        100%     105%          99%     113%
  7     10/3/1974      9/21/1976      24             2      1/1980            42      7/26/1976 7/26/1977        104   100   -4%           9/21/1976     108     4%          2           38%          21%          67%           61%         87%      84%          73%      66%
  8      3/6/1978      2/13/1980      23             2      1/1980              1    12/28/1979 12/27/1980       108   137   27%          11/28/1980     141    30%        11            13%          10%          24%           57%        100%     127%         100%     237%
  9    10/19/1987      7/16/1990      33           11       7/1990            12      8/11/1989 8/11/1990        345   336   -3%           7/16/1990     369     7%        11            23%          24%          53%           49%        102%     100%         107%      99%
      Mean — Shorter Bull             26            4                        16                                                    -4%                          12%         5            43%          15%          63%           55%          99%         96%     100%      98%
      Median — Shorter Bull           24            2                        17                                                    -4%                           9%         4            38%          10%          67%           49%         101%         96%     102%      80%
      % times > 0 — Shorter Bull                                           100%                                                    33%                                                  100%         100%         100%          100%

      Mean — All Bulls                45           23                        29                                                     2%                          11%         7            49%          11%          63%           65%         100%     103%        126%      144%
      Median — All Bulls              43           21                        21                                                     5%                          10%         8            38%          10%          56%           59%         102%     102%        104%      104%
      % times > 0 — All Bulls                                               95%                                                    53%                                                  100%          84%         100%          100%

         3/9/2009                                                                    12/31/2010 12/31/2011      1,200    ???       ???                                                   69%            5%          77%                       77%                   59%

Source: J.P. Morgan, Bloomberg, FactSet, and Datastream. Note: Uses Dow Jones Industrial Avg for 1900-1927 and S&P 500 for 1928-present.




68
Thomas J Lee, CFA         North America Equity Research
(1-212) 622-6505          10 December 2010
thomas.lee@jpmorgan.com




                                                          69
Thomas J Lee, CFA                                North America Equity Research
(1-212) 622-6505                                 10 December 2010
thomas.lee@jpmorgan.com




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J.P. Morgan Equity Research Ratings Distribution, as of September 30, 2010
                                                    Overweight      Neutral    Underweight
                                                    (buy)           (hold)     (sell)
J.P. Morgan Global Equity Research Coverage         46%             43%        12%
   IB clients*                                      49%             45%        33%
JPMS Equity Research Coverage                       43%             48%        8%
   IB clients*                                      69%             60%        50%
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70
Thomas J Lee, CFA                              North America Equity Research
(1-212) 622-6505                               10 December 2010
thomas.lee@jpmorgan.com




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                                                                                                                                                     71
Thomas J Lee, CFA                              North America Equity Research
(1-212) 622-6505                               10 December 2010
thomas.lee@jpmorgan.com




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