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North America Equity Research

19 August 2010

Circle of Life
Equities tailwinds are relative value and the Fed; 19 ideas

The continued choppiness in equity markets has exhausted equity investors, worsened by the fact we are in August. We have been US Equity Strategy
disappointed by mixed messages in recent economic data, with weekly claims hitting 500k in the latest week particularly troubling. In AC
Thomas J Lee, CFA
other words, fundamentals are the focus while valuations, particularly relative value, have been secondary. Increasingly, we are also
(1-212) 622-6505
hearing investors note the challenge of making money in equities, with a surprising number shifting into corporate credit. Based on thomas.lee@jpmorgan.com
our Circle of Life analysis, equities have modestly improved overall, aided by improving price momentum in some industries.
Bhupinder Singh
• DECADE OUTPERFORMANCE OF TREASURIES OVER EQUITIES LARGEST IN DOW HISTORY. Treasuries (1-212) 622-6406
outperformed equities in past decade by 8,800bp, the worst underperformance of equities in the history of the Dow. It obviously bhupinder.b.singh@jpmorgan.com
explains the chorus of disenchantment with equities. Ironically, the underperformance of stocks bodes well for equities. Stocks Daniel M McElligott
delivered strong gains in subsequent 10-year period in every instance (since 1900) after stocks lost to bonds. The avg. cumulative (1-212) 622-5598
gain was 258%, with a CAGR of 13.6%. Thus, those leaving equities seem to be making the change at exactly the wrong time. daniel.m.mcelligott@jpmchase.com

• CAN WE DOUBLE DIP GIVEN KEY AREAS OF ECONOMY STILL AT TROUGH? Historically, recessions have driven J.P. Morgan Securities Inc.
downturns in four areas: (i) housing; (ii) auto sales; (iii) capex; and (iv) inventory. Currently, these four areas are at trough levels
(see Figure 11) seen in past recessions, and therefore are less likely to be major drivers of downside. For instance, housing is Circle of Life: Credit
Bottoming… Recovering…
currently at 2.4% of GDP, well below the 4.2% of GDP seen in prior recession troughs. If housing were to rise back to 4.2% (avg. HY/Lev Loans
trough in prior recessions), this would add $325b or 2.2% growth to GDP. HG Corporates
TIPS
• FED LOW FOR LONG/QE BOOST CORPORATE CREDIT/MORTGAGE REFI AND RISKY ASSET PRICES. Relative ABX, ABS, CDOs
value continues to be one of the reasons we still like equities. The low 10-year in our view increasingly reflects more monetary CMBS, MBS, RMBS
policy and risk aversion, a byproduct of the Fed’s current low for long and QE. As we noted last week, this should boost risky assets Peaking… Breaking Down…
(including stocks), corp refi, and mortgage refi. One could say even M&A should be supported by lower hurdle rates. Convertibles
Munis
• MARKET STRATEGY: CYCLICALS STILL OUTPERFORMING. Cyclicals YTD have outperformed the broader market by Treasuries
230bp, but Defensives have outperformed since April. Our analysis of relative strength shows about 1/3 of Cyclicals still show solid
relative strength. 77% of S&P 500 has an earnings yield greater than bond yield and 78% has FCF yield above bond yield. Circle of Life: Equity Sectors
Bottoming… Recovering…
• TRADE IDEA: 19 IDEAS. We identified 19 stocks using the following criteria: (i) 24 industry groups strong on relative strength; Telecom Financials
(ii) correlated to recovery in residential construction or inventory builds; (iii) FCF and EY > BY by 100bp; and (iv) rated OW. The Utilities Materials
Healthcare Discretionary
tickers are GS, BK, DD, MS, ETR, FCX, MHP, ITW, DE, CMS, DISH, OMC, IR, DHR, TWC, ASH, CBS, NEM, and CAT. Industrials
How to use this report: The “Circle of Life” premise is assets follow cycles of: (i) Peaking; (ii) Breaking Down; (iii) Bottoming; and (iv) Recovery. Peaking… Breaking Down…
i. Circle of Life. “Circle of Life” graphically situates where macro, credit instruments, and sectors are moving within their respective cycles. Technology Staples
Energy
ii. Sector Comparative. We analyzed each sector in 11 areas: (1) Relative price charts; (2) Price momentum; (3) Monthly sales revision per FC
mean; (4) Sales momentum; (5) EPS revisions; (6) Earnings momentum; (7) Credit spreads; (8) FC mean rating trends; (9) Trends in short
interest; (10) Fund Flows; and (11) Valuation. Rather than force rank on the latest data point, we subjectively labeled each sector as Good,
Neutral, or Unattractive on these metrics. We then compiled these into an overall score.

See page 54 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 19 August 2010
thomas.lee@jpmorgan.com

Table of Contents
#1: BIG PICTURE: In past decade, bonds beat stocks by largest margin ever....not a good
omen for bonds ............................................................................................................................. 4
Every 10-year period of Stock underperformance was followed by strong 10-year Equity
returns, with average CAGR of 13.6% ......................................................................................... 5
Will this be 20 years of positive equity performance?........................................................................................................................ 6
#2: Several positives of Fed bolstering QE (plus low for long) ................................................. 7
First, the Fed drives return-seekers into duration or risk .................................................................................................................... 8
Second, corporate borrowing costs have dropped so much, equity is now the most expensive for issuers… .................................... 9
…and record-low corporate borrowing costs skew debt issuance .................................................................................................... 10
…looking like an “Era of De-Equitization”….................................................................................................................................. 11
…de-equitization enables S&P 500 companies to generate EPS growth > GDP growth… ............................................................. 12
Third, room for home prices to inflate, which now stand at 158% of GDP, the lowest levels since the 1970s…............................ 13
Closing the gap versus the long-term average represents 17% of GDP, or $2 trillion….................................................................. 13
#3: Can we “double dip” if most US economic metrics at trough levels? ............................. 14
Housing, Autos, Capex, and Inventories are at Troughs…thus, can we double dip? ....................................................................... 15
What is notable is how low Housing and Business investment are as % of GDP............................................................................. 16
From trough to long-term average implies $882b or 6% of GDP..................................................................................................... 17
MARKET STRATEGY: Leverage to economic activity increases ............................................ 18
Cyclicals still managing to outperform YTD.................................................................................................................................... 18
Relative strength: Many groups showing positive relative strength…. ............................................................................................ 19
Examples of Cyclicals with continued relative outperformance....................................................................................................... 20
Valuations: 78% of S&P 500 companies’ Earnings Yield and FCF Yield > Bond Yield................................................................. 21
TRADE IDEA: Stocks and industries leveraged to a recovery in Residential Construction
or Inventory.................................................................................................................................. 22

2
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Cyclicals continue to outrank Defensives on Circle of Life metrics ....................................... 26


Update on Clobbered Stocks with FCF Yield > Bond Yield Trade .................................................................................................. 28
Update on Employment Demographics Stocks Trade Idea............................................................................................................... 30
Update on Target Price Stocks Trade Idea........................................................................................................................................ 31
Update on Financials Stocks Trade Idea........................................................................................................................................... 32
Update on Pro-Cyclical Stocks Trade Idea ....................................................................................................................................... 33
Sector Comparative..................................................................................................................... 37
Trailing 1-Month Relative Price Performance – Sectors .................................................................................................................. 39
Price vs. 50-Day Moving Avg – Sectors (best is low and rising) ..................................................................................................... 40
Monthly Sales Revision – Sectors .................................................................................................................................................... 41
Relative Sales Growth (vs. S&P 500) – Sectors (best if tail is rising) .............................................................................................. 42
Monthly Earnings Revision – Sectors............................................................................................................................................... 43
Relative Earnings Momentum – Sectors (best if tail is rising).......................................................................................................... 44
JULI Spreads (Relative to All Industries’ Averages) – Sectors (best is high and narrowing) .......................................................... 45
First Call Mean Rating (Relative to S&P 500) – Sectors (best is low and rising) ............................................................................ 46
Short Interest (Relative to S&P 500) – Sectors (best is high and falling)......................................................................................... 47
ETF Fund Flows – Sectors................................................................................................................................................................ 48
Price/10-Yr EPS (Relative to S&P 500) – Sectors (best if low and rising)....................................................................................... 49
Circle of Life Metrics Monthly Changes .......................................................................................................................................... 50
Quarterly Price Performance............................................................................................................................................................. 51
US Equity Strategy Recent Publications........................................................................................................................................... 52

3
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

#1: BIG PICTURE: In past decade, bonds beat stocks by largest


margin ever....not a good omen for bonds
As shown in Figure 1, over the past 10 years, Treasuries outperformed equities by 96% through 01/10 and 88% (8,800bp) as of
today. This is an even greater outperformance than during the Great Depression (when bonds beat by 7,400bp).

• Below we have shown the corresponding forward 10-year returns of equities. And as shown below, stocks have seen positive
10-year forward returns after every period of major underperformance (vs. bonds).

Figure 1: S&P 500 Relative Total Return (Trailing 10 Years) vs. S&P 500 Forward 10-Year Return
Monthly Data since 1900

600% S&P 500 10 Year less 10 Yr Treasuries total return (rolling)


Bonds Outperform % Stocks Outperform

500%
400%
300%
200%
100%
0%
Current
-100% 6/32, 8/39, 12/78, -88%
-48% 1/10,
-200% -55% -74%
-96%
S&P 500 10Yr Forward

550%

350%
Return

150%

-50%
1910 1917 1924 1931 1938 1945 1952 1959 1966 1973 1980 1987 1994 2001 2008 2015
S&P 500 Forward 10Yr Total Return

Source: J.P. Morgan and Shiller. S&P 500 total return includes dividend and the return for US Treasuries assumes bonds will be held until maturity. Note: Past performance is not indicative of future results.

4
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Every 10-year period of Stock underperformance was followed by


strong 10-year Equity returns, with average CAGR of 13.6%
We plotted on a scatter chart below the relative 10-year performance of Stocks (vs. bonds) and the subsequent total return of
stocks over the following decade. Not surprisingly, this data suggests an inverse relationship: the worse stocks did over a 10-year
period (vs. bonds), the better the future performance of stocks.

• Moreover, as shown below, whenever the return was NEGATIVE (below ZERO), the subsequent 10-year return of stocks was
positive with a range of 97%-450% (or CAGR of 7%-19%).
• The average gain was 258%, or 13.6% per year, meaningfully above the 2.6% yield offered by Treasuries.

Figure 2: Trailing 10-Year Relative Return vs. Forward S&P 500 10-Year Return
Monthly Data since 1900

600%
Following NEGATIVE
ZERO line
equity vs. bond returns
S&P 500 Forward 10Yr Total Return

500%
(10-yr), equities have
seen strong 10-yr 400%

forward total return: 300%

Cumulative: 258% 200%


CAGR: 13.6%/year
100%

0%

-100%
-150% -50% 50% 150% 250% 350% 450% 550%

S&P 500 Total Return less Treasuries Total Return (Trailing 10 Year)

Source: J.P. Morgan and Shiller. S&P 500 total return includes dividend and the return for US Treasuries assumes monthly. Note: Past performance is not indicative of future results.

5
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Will this be 20 years of positive equity performance?


In Figure 3 below, we looked at the rolling 10-year performance of stocks vs. bonds. This chart shows that we have gone full
circle in terms of investor preference for bonds over equities, as the historical outperformance of stocks over bonds disappeared in
the past decade.

• The average negative performance of stocks lasted 10-16 years, and the average up-cycle lasted 20-25 years. The one question
we wonder about is whether the forces of excess leverage are sufficient to lead to worse forward performance for equities.

Figure 3: 10-Year Rolling Total Return – S&P 500 vs. 10-Year US Treasuries
Monthly Data since 1900

700% S&P 500 (10 Yr Rolling Total Return) Treasuries Total Return (Held until Maturity)
600% 7/59, 569%
9/29, 500% 16-yrs 9/00, 484%
500%
Cumulative 10 Yr Return

10-yrs 10-yrs
400%

300% 20-
yrs?
200%
20-yrs
100%
76%
0% -11%
1/75, 17% 3/09, -30%
9/39, -29% 25-yrs
-100%
1910 1917 1924 1931 1938 1945 1952 1959 1966 1973 1980 1987 1994 2001 2008

Source: J.P. Morgan and Shiller. S&P 500 total return includes dividend and the return for US Treasuries assumes bonds will be held until maturity. Note: Past performance is not indicative of future results.

6
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

#2: Several positives of Fed bolstering QE (plus low for long)


Investors increasingly are accepting that the current low yields on Treasuries do not solely reflect economic conditions. Rather,
the level reflects a combination of: (a) economic conditions; (b) monetary policy; and (c) risk appetite. Arguably, the latter two
are the primary drivers, in our view, of movements in Treasury markets currently.

While we would rather the market smell reflation (via Treasury rates rising), the Fed’s “low for long” plus QE (buying Treasuries)
should ultimately benefit equity markets in three ways:

1. Fed policy is driving investors to seek returns by moving into duration or risky assets, which should ultimately boost stocks;
2. Extremely low corporate bond rates are skewing corporates to prefer debt issuance (in lieu of equity, hence, accretive) and
even bolstering M&A activity;
3. Low policy rates, we believe, should ultimately boost home prices, increasing affordability and lowering carrying costs for
existing homeowners.

Figure 4: How Fed Low for Long/QE Impact Equities

Fed Low for Long/QE

Forces investors into risky assets Lowers corporate borrowing costs Lowers mortgage costs
lowering yields on credit record-low yields on IG and near HY lows saving as much as $40b/year on refi

Drives eventual rise in Equities Accretive to EPS Eventually boosts home prices
based on widening relative value via (1) lower borrowing costs; As transactions increase plus increased
(2) reduced equity financing (less dilution); disposable income boosts economy
(3) M&A hurdle costs lowered

Source: J.P. Morgan.

7
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

First, the Fed drives return-seekers into duration or risk


As one client noted, a zero interest rate coupled with economic stability makes it painful to be in risk-free assets. In other words,
eventually, the Fed will drive return-seeking investors into duration or risky assets. As shown below in Figure 5, we are seeing a
progressive move for investors out of risk-free assets into:

• Longer-duration treasuries (pushing down 10-year);


• Investment grade corporate bonds (pushing down bond yields);
• And eventually equities (further on the spectrum of risky assets).

Figure 5: Zero Fed Funds Rate Is Driving Investors into Duration or Risky Assets….
Low for long (1Q12)… …pushed down 10-year to 1950 levels… …driving record-low corporate bond yields… …and eventually should make its way into equities

6.00% Fed Funds Target Rate 10yr Treasury Yield 9.00% HG Bond Yield S&P 500
5.25%
8.50% 1,200
5.00%
4.75% 8.00%

4.00% 4.25% 7.50% 1,150


7.00%
3.75%
3.00% 6.50%
1,100
3.25% 6.00%
2.00%
5.50%
2.75%
5.00% 1,050
1.00%
2.25% 4.50%
0.00% 1.75% 4.00% 1,000
1/07 1/08 1/09 1/10 1/11 1/12 1/07 7/07 1/08 7/08 1/09 7/09 1/10 7/10 10/08 2/09 6/09 10/09 2/10 6/10 1/10 3/10 5/10 7/10 9/10

Source: J.P. Morgan and Bloomberg.

In other words, we think the 10-year yield in many ways reflects monetary policy as much as it reflects the economic outlook.

8
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Second, corporate borrowing costs have dropped so much, equity is now the most
expensive for issuers…
As shown in Figure 6, high-grade bonds now yield a record-low 4.4%, which is implicitly a 22.7x P/E ratio (see right).

• Even more startling is that for the first time in history, the yield of high-yield bonds is about to dip below the earnings yield on
the S&P 500—think about that, it means that equity funding costs are perceived as higher than high yield.

Does that make sense?

Figure 6: Comparative Cost of Funding; Equities, High Grade, and High Yield
Since 12/99; Equities Is Earnings Yield (inverse is P/E)
Record-low yields in High-Grade and High-Yield… Implied P/E of High-Grade, High-Yield very high and now both trade above Par...

25% S&P 500 Earnings Yield HY Yield HG Yield S&P 500 PE (NTM) HY PE (1/Yield) HG PE (1/Yield)
29x

20%
24x
HG, 22.7x

15%
19x
Yield

PE
10% 14x S&P 500, 12.3x
HY, 8.3%
S&P 500, 8.1% HY, 12.0x
5% HG, 4.4% 9x

0% 4x
12/99 4/01 8/02 12/03 4/05 8/06 12/07 4/09 8/10 12/11 12/99 4/01 8/02 12/03 4/05 8/06 12/07 4/09 8/10 12/11

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

9
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

…and record-low corporate borrowing costs skew debt issuance


The main pushback on our “relative value” argument has been, “How is it resolved?”

We argue it is resolved by companies shifting their funding mix. As shown below, this indeed has been the case. The top portion
of Figure 7 shows the differential in funding costs of Equity (EY) vs. Debt (IG debt).

• In the mid- to late 1990s, the cost of equity was much lower than debt and, as a result, the funding mix was over 50% equity
(as % of gross capital issuance).
• The exact opposite situation exists today, where the cost of equity funding is higher vs. debt and, as a result, the mix is now
15-20% equities, a level not seen in the past 20 years.

Figure 7: Equity Issuance as % of Total Issuance (Equity + Debt) – Ex-Financials


Since 1994, LTM

4.5%
EY minus BY

1. Equity cost of funding, more expensive than debt..


2.5%
0.5%
-1.5%
3. Equity cost of funding much lower
-3.5%
Equity Issuance % of Total Avg % Equity Issuance
Corporates resolve the 55%
differential in funding 50% 2. Thus, dramatic shift in
costs of equity vs. debt, 45%
funding mix AWAY from
% of Gross Issuance

by shifting funding 40%


equities.
mix… 35%
30%
Higher debt mix 25% 4. Thus, heavier funding
ultimately should be 20%
mix of equities.
PER SHARE ACCRETIVE 15%
to equities… 12/93 12/94 12/95 12/96 12/97 12/98 12/99 12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/10

Source: J.P. Morgan, Standard & Poor's, Shiller, and Dealogic.

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

…looking like an “Era of De-Equitization”…


Ultimately, this implies lower equity dilution, particularly compared to the 1950s and 1970s when equity issuance diluted EPS
returns (Figure 8). During the 1950s and 1970s, corporates raised approximately 1% of their market cap per year in new equity
issuance. However, the current era seems more like the 1980s, when the markets refrained from issuing new equity and the
markets actually rose 14.8% compounded annually from 1984 to 1989. We think the situation bodes well for EPS growth and
positive technicals with shrinking supply.

Figure 8: Net Equity Issued as % of Market Value of Equities – Nonfarm, Nonfinancial Corporate Business
Since 1952

Net Equity issued as % of Market Value of Equities Av g lev el

Avg level 0.9% Avg level 1.2%


Net Equity issued as % of Market Value of Equities

2%

-1%

-3%

-5%

-7%
Avg level -3.0%

Avg level -4.6%


-9%
3/52 3/56 3/60 3/64 3/68 3/72 3/76 3/80 3/84 3/88 3/92 3/96 3/00 3/04 3/08

Source: J.P. Morgan, FactSet, Standard & Poor's, and Federal Reserve Flow of Funds.

11
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

…de-equitization enables S&P 500 companies to generate EPS growth > GDP growth…
One investor concern as we head towards 2011 is how the S&P 500 can be expected to grow earnings by 15% when nominal GDP
is only projected to grow by 3-4%, particularly given that margins may have already peaked for many companies. Part of this
strong EPS growth is likely to be driven by a contraction in the equity base as net equity issuance remains negative.

• As shown in Figure 9, there has been a strong inverse correlation between the level of corporate equity issuance (as % of
market cap) and the magnitude by which corporate profits growth outpaced GDP growth. As net equity issuance (as % of
market cap) contracted, similar to today, S&P 500 EPS growth tended to outpace nominal GDP growth by a larger margin.
• Given that the cost of equity funding is currently higher relative to bonds (due to the valuation gap between stocks and bonds),
the funding mix is likely to remain more skewed towards bonds than equities, preventing the equity base from expanding and
diluting EPS.

Figure 9: S&P 500 EPS Growth Stronger than GDP Growth as Equity Base Contracted
Since 1952
S&P 500 EPS growth minus Nominal GDP growth

28.0%
We are here…
A contracting equity 23.0%
base provides
18.0%
support for strong
EPS growth. 13.0%

8.0%

3.0%

-2.0%

-7.0% y = -2.5643x - 0.0382


R 2 = 0.5933
-12.0%
-8.5% -6.5% -4.5% -2.5% -0.5% 1.5%

Net Equity Issued as % of Market Value of Equities

Source: J.P. Morgan, FactSet, and Federal Reserve Flow of Funds.

12
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Third, room for home prices to inflate, which now stand at 158% of GDP, the lowest levels
since the 1970s…
As shown below in Figure 10, homes’ aggregate value (calculated as total units per the U.S. Census Bureau multiplied by median
price for an existing single-family home per National Association of Realtors) is 158% of GDP (on a 12-month moving average).
This is well off the 217% level seen at the peak in 2006 and comfortably below the 175% long-term average. In fact, this level of
home value is the lowest since the 1970s.

Figure 10: US Total Home Value (All Units * Median Price) as % of GDP – 12-Month Average
Since 1965

225%
Average 12Month Moving Average 5/06, 217%
215%
Housing Value as % of GDP

205%

195%

185% Average, 175%


175% Closing the
gap (175% vs
165% 158%) would
158% represent 17%
155% lowest levels since the early 70s of GDP, or $2T
145%

135%
3/66 3/69 3/72 3/75 3/78 3/81 3/84 3/87 3/90 3/93 3/96 3/99 3/02 3/05 3/08 3/11

Source: J.P. Morgan and Bloomberg. Total unit data as per the Census Bureau and the median home price as per the National Association of Realtors.

Closing the gap versus the long-term average represents 17% of GDP, or $2 trillion…
In other words, if the Fed, by maintaining low interest rates, is seeking to ultimately support higher home prices, this is not
necessarily creating a bubble in home prices. In fact, if home prices were to recover back to long-term average of 175% of GDP,
this would add $2 trillion to homeowners’ net worth.

• This is equivalent to a 10% rise in home prices from current levels.

13
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

#3: Can we “double dip” if most US economic metrics at trough


levels?
Jobless claims have been stubbornly high and rising, which is no doubt a negative signal for the US recovery. What is unclear at
this time, however, is whether the layoffs of the 500k-plus temporary Census hires are affecting weekly claims. That is, 500k
layoffs over 12 weeks imply 42k increase in weekly claims during that time. But the more troubling concern is the potential that
the US is seeing itself slip back into recession—a double dip. We still see the recent weakness as a growth scare, however.

According to our economists, a recession is triggered, historically, by one of three factors:

1. Inflation spikes, Fed responds. The recessions of the late 1960s, 1970s, 1980s, and early 1990s were mainly a story of high
inflation leading to Fed tightening which pulled the economy down into recession. Often, inflation was associated with strong
US and global growth that pushed up oil prices. Fed tightening and higher interest rates were usually toughest on the credit-
sensitive sectors, housing and autos, although weakness quickly spread to the rest of the economy.
2. Asset price bubble bursts. The recessions of 2001 and 2008-2009 were associated with sectoral booms getting exaggerated
and then crashing. In the late 1990s the tech boom and associated NASDAQ bubble pushed up spending, especially business
spending. When the NASDAQ bubble burst, business found itself over-extended and quickly cut spending and hiring which
led to recession. The more recent story was housing rather than tech, but when housing and house prices crashed, with major
shocks to the financial system, the whole economy went into recession.
3. Run on the currency. A common source of recessions in smaller, more open economies has come from imprudent political or
economic policies that led to a run on the currency. The weaker currency led to much higher local interest rates and a cut-off
of foreign investment inflows that led to recession.

And there are really 4 areas of the US economy that typically bear the brunt of a retrenchment and, hence, where the recession is
evident:

1. Residential construction—Housing, basically;


2. Automobile sales;
3. Capital spending; and
4. Inventories.

We decided to look at the level of each of these four areas in the following section.

14
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Housing, Autos, Capex, and Inventories are at Troughs…thus, can we double dip?
We compared the current levels of (i) Housing, (ii) Autos, (iii) Capex, and (iv) Inventories compared to previous recession
troughs (since 1940) in Figure 11 below. And we also highlighted the average “trough” level with a dashed line.

• What stands out to us is that the current level of economic activity for each of these areas of durables spending is already
BELOW troughs seen in past recessions. Thus, if these levels are already at the bottom, we wonder if they could in fact
decline further. For instance, Housing is at 2.4% of GDP, well below the 4.2% trough seen in other recessions.

Figure 11: Recession Trough Levels vs. Current Level


% of Nominal GDP
Residential Construction Auto & Parts Sales Business Fixed Investment Inventory
Trough Lev el (% of GDP) Av g Trough Lev el (% of GDP) Av g Trough Lev el (% of GDP) Av g Trough Lev el (% of GDP) Av g

Av g, 4.2% Av g, 3.3% Av g, 10.5% Av g, 17.5%


Current 2.4% Current 2.3% Current 9.6% Current 10.3%

12/07 to 7/09 2.4% 12/07 to 7/09 2.2% 12/07 to 7/09 9.7% 12/07 to 7/09 11.1%

3/01 to 11/01 4.5% 3/01 to 11/01 4.1% 3/01 to 11/01 11.3% 3/01 to 11/01 12.3%

7/90 to 3/91 3.2% 7/90 to 3/91 3.1% 7/90 to 3/91 10.3% 7/90 to 3/91 15.0%

7/81 to 11/82 3.3% 7/81 to 11/82 3.2% 7/81 to 11/82 12.4% 7/81 to 11/82 18.2%
1/80 to 7/80 4.0% 1/80 to 7/80 2.7% 1/80 to 7/80 12.9% 1/80 to 7/80 19.6%

11/73 to 3/75 3.6% 11/73 to 3/75 3.0% 11/73 to 3/75 10.9% 11/73 to 3/75 20.6%

12/69 to 11/70 4.2% 12/69 to 11/70 2.9% 12/69 to 11/70 10.2% 12/69 to 11/70 18.2%

4/60 to 2/61 4.7% 4/60 to 2/61 3.1% 4/60 to 2/61 9.0% 4/60 to 2/61 17.5%

8/57 to 4/58 4.5% 8/57 to 4/58 3.3% 8/57 to 4/58 9.6% 8/57 to 4/58 18.3%

7/53 to 5/54 5.0% 7/53 to 5/54 3.3% 7/53 to 5/54 9.2% 7/53 to 5/54 18.0%

11/48 to 10/49 5.3% 11/48 to 10/49 4.1% 11/48 to 10/49 9.0% 11/48 to 10/49

1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 1.0% 2.0% 3.0% 4.0% 5.0% 7.0% 9.0% 11.0% 13.0% 8.0% 13.0% 18.0% 23.0%

% of GDP % of GDP % of GDP % of GDP

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

15
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

What is notable is how low Housing and Business investment are as % of GDP....
We have plotted the ratio of Housing and Capital spending (as % of GDP) since the 1940s. The recessions are shaded.

• ALL-TIME LOW IN HOUSING… While known, it is still worth highlighting again. Housing at 2.4% of GDP is at the
absolute lowest ever, and well below the 4.6% long-term average. The fact that it has declined is ultimately not a surprise
given the overbuilding that took place during the 2003-2006 timeframe. But today, the exact opposite has occurred. It is now
at extremely depressed levels.
• BUSINESS CAPEX LOWEST SINCE 1960s... Similarly, the depressed level of capex is shown in Figure 13 below, which
shows that business fixed investment is currently only 9.6% of GDP, below the long-term average of 10.7%.

Figure 12: Residential Construction as % of GDP Figure 13: Business Fixed Investment as % of GDP
Since 1952 Since 1952

Recession Residential Construction % of GDP LT Avg Recession Business Fixed Investment % of GDP LT Avg

7.0% 14.0%

13.0%
6.0%
12.0%

% of GDP
% of GDP

5.0% LT Avg
4.6% 11.0% LT Avg
4.0% 10.7%
10.0%
9.6%
3.0% OFF THE
CHARTS! 9.0%
Lowest since ‘60s
2.4%
2.0% 8.0%
3/47 3/52 3/57 3/62 3/67 3/72 3/77 3/82 3/87 3/92 3/97 3/02 3/07 3/47 3/52 3/57 3/62 3/67 3/72 3/77 3/82 3/87 3/92 3/97 3/02 3/07

Source: J.P. Morgan and BEA. Source: J.P. Morgan and BEA.

16
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

From trough to long-term average implies $882b or 6% of GDP


The impact on US GDP would be significant if the four factors mentioned earlier were able to recover to their long-term average
percentage of nominal GDP. As shown in Figure 14 below, these four factors would contribute $882 billion to nominal GDP if
they returned to their long-term average (using the current level of nominal GDP of $14.6 trillion). For Inventory, we used the %
of GDP from 3Q07 (prior to the start of the recent recession) rather than the long-term average since Inventory as a % of GDP has
been on a generally downward trend since the early 1980s.

• Where there is incremental GDP, there are also incremental jobs…One could actually argue that it is also these areas that
reflect where future jobs growth should come from. That is, when housing activity recovers, and capital spending revives, and
car purchasing normalizes, we should see significant recovery in labor markets associated with these areas.

Figure 14: What Would Be GDP Effect in $ Terms if Four Areas Normalize? Figure 15: …and as % of GDP
$ impact if each factor returns to long-term avg. % of GDP % impact if each factor returns to long-term avg. % of GDP

$1,000 $882 7.0%


6.0%
$900
6.0%
$800
$700 5.0%
$ in billions

$600 4.0%
$500

%
$400 $325 3.0% 2.2%
$300 $225 2.0% 1.5%
$154 $178 1.1% 1.2%
$200
1.0%
$100
$0 0.0%
Business Fix ed Auto & Parts Inv entory Residential Total Business Fix ed Auto & Parts Inv entory Residential Total
Inv estment Sales Construction Inv estment Sales Construction

Source: J.P. Morgan, Bloomberg, and Federal Reserve Flow of Funds. Note: We used the % of GDP from 3Q07 rather than the long- Source: J.P. Morgan, Bloomberg, and Federal Reserve Flow of Funds. Note: We used the % of GDP from 3Q07 rather than the long-
term average for Inventory since Inventory as a % of GDP has been on a generally downward trend since the early 1980s. term average for Inventory since Inventory as a % of GDP has been on a generally downward trend since the early 1980s.

In other words, rather than the potential downside of a “double dip,” we see potential upside associated with activity levels
normalizing.

17
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

MARKET STRATEGY: Leverage to economic activity increases


Cyclicals still managing to outperform YTD
Believe it or not, Cyclicals are still managing to outperform the S&P 500 YTD by 230bp (see Figure 16) despite the drag from
Technology (which is down 8.3%). That is not to say Defensives have not outperformed recently—Defensives have moved from
underperforming by 900bp in April to currently flat with the market overall.

• The natural question looking into year-end is whether we still believe Cyclicals can outperform. The answer is yes with the
arguments outlined in a recent report (please see “US Equity Strategy FLASH: 8 Reasons why this is likely to be a longer
cycle for Cyclicals” dated 8/5/2010).
Figure 16: Cyclicals Still Modestly Outperforming YTD....
2009 and YTD
2009…Cyclicals beat big… 2010…Cyclicals still modestly ahead of Defensives…
Energy Financials
Energy Financials Cy clicals Defensiv es
12 Cy clicals Defensiv es
20
Cy clicals, 17
15 9

Relative Performance since 12/31/2009


Relative Performance since 12/31/2008

10
6
5
3 Cy clicals, 2.3
0
Defensiv es, 0.5
(5) 0
Financials, 0.1
Financials, (9)
(10) (3)
Energy , (12)
(15) Energy , (4.5)
Defensiv es, (14)
(6)
(20)
(9)
(25)

(30) (12)
12/08 2/09 4/09 6/09 8/09 10/09 12/09 2/10 12/09 1/10 2/10 3/10 4/10 5/10 6/10 7/10 8/10 9/10

Source: J.P. Morgan and FactSet.

18
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Relative strength: Many groups showing positive relative strength….


We decided to look at the recent equity performance of the 65 industry groups in the S&P 500 by comparing their relative strength
to that of the S&P 500 overall. We then grouped them into “poor,” “recovering,” or “attractive,” with attractive meaning these
groups have had meaningful and sustained price appreciation against the broader market.

• Defensives not the only outperformers. By our estimate, about 33% of Cyclical groups, 44% of Defensive groups, and even
50% of Financials are showing attractive relative strength….
Figure 17: Recent Equity Price Trends of S&P 500 Industries
Relative Strength of Industries (% of Groups)

Poor Recovering Attractive "Unattactive" on Relative Strength Groups "Attractive" on Relative Strength

Cyclicals 31% 36% 33%

Basic Materials 20% 20% 60% Construction Materials — Chemicals Containers & Packaging
— — Metals & Mining —

Industrials 36% 18% 45% Aerospace & Defense Construction & Engineering Electrical Equipment Machinery
Industrial Conglomerates Commercial Svcs & Supplies Trading Cos & Distributors Air Freight & Logistics
— — Road & Rail —

Consumer Discretionary 25% 42% 33% Household Durables Diversified Consumer Svcs Hotels Restaurants & Leisure Media
Specialty Retail — Distributors Internet & Catalog Retail

Technology 38% 63% 0% Computers & Peripherals Electronic Equipment — —


Semiconductors — — —

Defensives 11% 44% 44%

Staples 33% 33% 33% Food & Staples Retailing Household Products Beverages Tobacco

Health Care 0% 67% 33% — — Health Care Technology Pharmaceuticals

Telecom Services 0% 0% 100% — — Diversified Telecom Svcs Wireless Telecom Svcs

Utilities 0% 50% 50% — — Electric Utilities Multi-Utilities

Other
Financials 38% 13% 50% Commercial Banks Thrifts & Mortgage Finance Consumer Finance Capital Markets
Diversified Financial Services — Real Estate Investment Trusts Real Estate Mgmnt & Dvlpmnt

Energy 0% 100% 0% — — — —
Source: J.P. Morgan and FactSet.

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

Examples of Cyclicals with continued relative outperformance


Below we illustrate two examples of Cyclicals with strong relative performance.

• Containers and Packaging has been outperforming for most of 2010, supported by solid fundamentals of rising volumes and
pricing.
• Machinery continues to outperform the S&P 500 broadly, even with the group already close to its 2010 highs set in April.
Machinery and engine sales remain strong, which again point to fundamentals supporting the equity performance in this
industry group.

Figure 18: Relative Strength of Containers & Packaging and Machinery


Daily price since 2005
Containers and Packaging recently renewed RSI… Machinery has been strong for some time and continued during correction…
S&P 500 / Containers & Packaging -IND (SPN77) S&P 500 / Machinery -IND (SP177)
18-Aug-2005 to 19-Aug-2010 (Daily) High: 159.09 Low: 59.31 Last: 122.63 18-Aug-2005 to 19-Aug-2010 (Daily) High: 537.71 Low : 187.13 Last: 427.86
160 550
500
140 450
120 400
100 350
300
80
250

60 200

Relative Strength Index (RSI) 75 Relative Strength Index (RSI) 75


50 50
25 25
0.13
Relative Price to S&P 500 0.12 Relative Price to S&P 500 0.40
0.11 0.36
0.10
0.32
0.09
Recently invigorated 0.08 0.28
0.07 Continued
'06 '07 '08 '09 '10 '06 '07 '08
strength
'09
since '10
©FactSet Research Systems ©Fa ct Set Res ea rch S ys tems

Source: FactSet.

20
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Valuations: 78% of S&P 500 companies’ Earnings Yield and FCF Yield > Bond Yield
Valuations are also attractive for equities at this time, in our view. Building on our theme of relative value, the relative value
chasm between equities and bonds is further shown in Figure 19 below. We calculated what % of companies have an earnings
yield above their respective bond yield and a FCF yield above their bond yield.

• 77% of S&P 500 companies have a higher earnings yield than their respective bond yield (Figure 19). Most companies fall
into the 3.0-6.0% bucket, indicating that most S&P 500 companies’ earnings yield exceeds their respective bond yield by 300-
600bp.
• 78% of companies have a higher free cash flow yield than their respective bond yield. In fact, almost a quarter of companies
have a free cash flow yield that exceeds their respective bond yield by 900bp or more.

Figure 19: Distribution of S&P 500 Companies Based on Earnings Yield minus Bond Yield
% of S&P 500 companies
77% of companies have a Earning Yield > Bond Yield 78% of companies have a Earning Yield > Bond Yield
45% 30% 27%
40%
40%
25% 23%
% of S&P 500 companies

35%

% of S&P 500 companies


30% 20%
16%
25% 20%
20% 15% 12%
11% 11%
15% 11% 12% 12%
10%
10% 5%
5% 5%
0%
0%
< -3.0% -3.0% to 0.0% to 3.0% to 6.0% to > 9.0%
0.0% 3.0% 6.0% 9.0% < -3.0% -3.0% to 0.0% to 3.0% to 6.0% to > 9.0%
0.0% 3.0% 6.0% 9.0%
Ranges of EY minus BY
Ranges of FCF Yield minus BY

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

21
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

TRADE IDEA: Stocks and industries leveraged to a recovery in


Residential Construction or Inventory
Given that we remain confident that the US economy is unlikely to enter a “double-dip” scenario, we believe it is more
appropriate to focus on the areas that are likely to benefit as activity levels normalize. In Figure 20 below, we have highlighted the
24 industries that have positive relative strength, and we have identified which of these groups have been correlated with a
recovery in Residential Construction (as % of GDP) or Inventory (as % of GDP). We identified the industries with these
correlations by looking at the price of each of these industries (as a % of the S&P 500 price) since 1973 and compared that against
both Residential Construction (as % of GDP) and Inventory (as % of GDP).

• The industries that have been correlated with Residential Construction and also have positive relative strength are: Metals &
Mining, Consumer Finance, Capital Markets, and Wireless Telecom Services.
• The industries that are correlated with Inventory are: Chemicals, Metals & Mining, Machinery, Media, Distributors,
Diversified Telecom Services, Electric Utilities, and Multi-Utilities.

22
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Figure 20: Industries with Positive Relative Strength and Strong Correlation with Residential Construction or Inventory
Industries correlated with… Stocks on screen
Industries with Positive Relative Stocks with EY 100bp > BY and FCF
Strength Residential Construction Inventory yield 100bp > BY
1 Chemicals Chemicals ASH, DD
2 Containers & Packaging
3 Metals & Mining Metals & Mining Metals & Mining FCX, NEM
4 Electrical Equipment
5 Machinery Machinery CAT, DE, DHR, IR, ITW
6 Trading Cos & Distributors
7 Air Freight & Logistics
8 Road & Rail
9 Hotels Restaurants & Leisure
10 Media Media CBS, DISH, MHP, OMC, TWC
11 Distributors Distributors
12 Internet & Catalog Retail
13 Beverages
14 Tobacco
15 Health Care Technology
16 Pharmaceuticals
17 Consumer Finance Consumer Finance
18 Capital Markets Capital Markets BK, GS, MS
19 Real Estate Investment Trusts
20 Real Estate Mgmnt & Dvlpmnt
21 Diversified Telecom Svcs Diversified Telecom Svcs
22 Wireless Telecom Svcs Wireless Telecom Svcs
23 Electric Utilities Electric Utilities ETR
24 Multi-Utilities Multi-Utilities CMS
Source: J.P. Morgan, Datastream, and FactSet. Note: Past performance is not indicative of future results.

23
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Within the industries highlighted above that have both positive relative strength and a correlation with Residential Construction or
Inventory, we screened for stocks that are attractive on both Earnings Yield and Free Cash Flow Yield (relative to Bond Yield).
Specifically, we identified 19 stocks using the following criteria:

• Industry has positive relative strength;


• Industry has historically had a strong correlation with either Residential Construction (as % of GDP) or Inventory (as % of
GDP);
• Earnings Yield at least 100bp greater than Bond Yield;
• Free Cash Flow Yield at least 100bp greater than Bond Yield; and
• Rated Overweight by J.P. Morgan.

The resulting 19 stocks are shown below in Figure 21.

24
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Figure 21: 19 Stocks in Industries with Positive Relative Strength, Strong Correlation with Residential Construction or Inventory, and Both EY 100bp > BY and FCF Yield 100bp > BY
Priced as of 8/18/2010
JPM Coverage EPS Estimates Bond Yield vs. EY and FCF Yield
YTD % off EY
Current High YTD Market JPM Target Implied Bond EY FCF minus FCF Yield
Name Industry Ticker Price Price High Cap Rating JPM Analyst Price Upside 2010 2011 Yield (LTM) Yield BY minus BY

1 Goldman Sachs Group Inc. Capital Markets GS $149.20 $186.41 -20% $76,911 OW Abouhossein Kia $175.00 17% $4.86 $5.73 3.9% 13.3% 44.1% 942 bp 4027 bp

2 Bank of New York Mellon Cor Capital Markets BK $25.11 $32.65 -23% $30,485 OW Juneja Vivek $33.00 31% $0.60 $0.70 2.0% 8.9% 10.2% 685 bp 818 bp

3 E.I. DuPont de Nemours & CoChemicals DD $41.42 $42.66 -3% $37,547 OW Zekauskas Jeffre $50.00 21% $0.29 $0.35 2.4% 8.0% 8.5% 559 bp 610 bp

4 Morgan Stanley Capital Markets MS $26.26 $33.27 -21% $36,685 OW Abouhossein Kia $33.00 26% $0.65 $0.87 4.0% 9.5% 64.0% 548 bp 5992 bp

5 Entergy Corp. Electric Utilities ETR $79.38 $84.33 -6% $14,883 OW Smith Andrew $96.00 21% $1.37 $1.33 4.1% 9.1% 6.2% 500 bp 219 bp

6 Freeport-McMoRan Copper & Metals & Mining FCX $73.22 $90.55 -19% $34,413 OW Gambardella Mic $88.00 20% $2.18 $2.15 5.7% 10.6% 15.0% 487 bp 928 bp

7 McGraw-Hill Cos. Media MHP $29.24 $36.94 -21% $9,038 OW Meltz Michael $39.00 33% $0.54 $0.59 4.1% 8.6% 14.6% 451 bp 1047 bp

8 Illinois Tool Works Inc. Machinery ITW $42.62 $52.72 -19% $21,460 OW Duignan Ann $55.00 29% $0.79 $0.93 2.1% 6.3% 6.7% 426 bp 466 bp

9 Deere & Co. Machinery DE $65.98 $69.48 -5% $28,031 OW Duignan Ann $72.00 9% $0.88 $0.99 2.0% 5.8% 4.9% 383 bp 294 bp

10 CMS Energy Corp. Multi-Utilities CMS $17.14 $17.61 -3% $3,913 OW Smith Andrew $19.00 11% $0.29 $0.28 4.0% 7.8% 6.7% 378 bp 268 bp

11 DISH Network Corp. (Cl A) Media DISH $18.12 $24.16 -25% $8,120 OW Jain Manish $25.00 38% $0.46 $0.49 5.7% 9.2% 11.8% 349 bp 605 bp

12 Omnicom Group Inc. Media OMC $36.94 $44.08 -16% $11,132 OW Quadrani Alexia $50.00 35% $0.83 $0.90 3.5% 7.0% 11.9% 341 bp 832 bp

13 Ingersoll-Rand Plc Machinery IR $36.13 $40.65 -11% $11,663 OW Tusa, Jr Stephen $46.00 27% $0.63 $0.81 2.8% 5.8% 8.2% 301 bp 535 bp

14 Danaher Corp. Machinery DHR $37.35 $43.77 -15% $24,375 OW Tusa, Jr Stephen $48.00 29% $0.63 $0.73 3.0% 5.5% 7.1% 246 bp 409 bp

15 Time Warner Cable Inc. Media TWC $56.12 $59.47 -6% $19,939 OW Jain Manish $63.00 12% $0.99 $1.10 3.8% 5.7% 10.7% 194 bp 686 bp

16 Ashland Inc. Chemicals ASH $50.21 $63.73 -21% $3,942 OW Zekauskas Jeffre $65.00 29% $1.19 $1.40 6.6% 8.1% 12.9% 157 bp 632 bp

17 CBS Corp (Cl B) Media CBS $14.20 $16.98 -16% $9,646 OW Meltz Michael $18.00 27% $0.44 $0.47 4.2% 5.6% 16.3% 142 bp 1209 bp

18 Newmont Mining Corp. Metals & Mining NEM $59.49 $63.38 -6% $29,292 OW Bridges John $74.00 24% $1.06 $1.11 4.8% 5.9% 6.9% 113 bp 214 bp

19 Caterpillar Inc. Machinery CAT $69.75 $72.83 -4% $43,975 OW Duignan Ann $85.00 22% $1.13 $1.46 2.6% 3.6% 6.8% 100 bp 422 bp
Average -16% 26% 3.9% 7.8% 10.2% 378 bp 610 bp

Source: J.P. Morgan and FactSet.

25
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Figure 22: % Change since 6/3 Cyclicals continue to outrank Defensives on Circle of Life metrics
Telecom 8.5%
Utilities 5.8%
Our subjective ranking of the ten economic sectors based on fundamentals, credit profile, valuation, investor flow, and analyst
Materials 3.8% ratings is shown in Figure 23. The net change column on the right of Figure 23 shows the accumulated delta compared to the last
Staples 0.7% Circle of Life publication for each of the ten sectors, and the net change row at the bottom of Figure 23 shows the accumulated
Energy 0.2% delta for each of the 11 metrics.
Health Care -0.3%
• Cyclicals still more attractive, but Defensives showing more momentum recently. The Cyclicals overall continue to rank
Industrials -1.4%
S&P 500 -1.7%
the highest on our Circle of Life metrics, as the overall average composite score for Cyclicals is Good, while the Defensives
Financials -4.3%
are still only Neutral. However, since our last update of Circle of Life, the Cyclicals have seen a net worsening on the Circle of
Discretionary -5.0% Life metrics by -2 (right column of Figure 23), while the Defensives have seen a net improvement of +5.
Technology -5.3%
Figure 23: Overall Subjective Ranking of 10 Economic Sectors
-10 -5% 0% 5% 10% Fundamental, Technical, and Sentiment Metrics (Relative to S&P 500)
% Strategy Price Price/50d Sales Sales Earnings Earnings JULI FC Mean Short ETF Fund P/10Yr Composite Net
Source: FactSet. Sectors Rating Perf mavg Revision Momentum Revision Momentum Spreads Rating Interest Flows EPS Score Change
Discretionary OW G G from N G N G G N G G G G G +1

Industrials OW G N from G G U G G N from G G G G from N G G -1


Reading the Table
Energy N N from U G G G N G N N G from N N G G from N +2
The overall rankings, as shown Health Care N N from U G G G G G G U N N G G from N +1
earlier, should be viewed as a Technology OW N from G G from N G G G G N N N U from N N N -1
“conviction” measure, separate but Materials OW N N G G N G N from G G G N U N -1
generally consistent with our
Financials OW N from G N from U G N N from G G N from G G N U from N G N from G -3
"Strategy ratings."
Telecom N G from U N N N N N N N N G from U G N +2

Staples UW N from U G G N N from G N G U N G from N U N +1

Utilities UW G from N U from G U U N N N U N G from U U N +1


Cyclicals still rank
higher overall, but the 10 Sectors N N G N N from G G N from G N N N N N

Defensives have seen 10 Sectors +3 +1 -2 -3 +1 +2 +2

more improvement
Cyclicals G G from N G N G G N from G G G N N G
recently.
Cyclicals -1 +1 -2 -2

Defensives G from U N from G N N N from G N G U N G from U N N

Defensives +4 -1 -1 +3 +5

Other N G from N G G N from G G N from G G G from N U from N G N

Other +1 -1 -1 +1 -1 -1

Source: J.P. Morgan and FactSet. G: Good; N: Neutral; U: Unattractive.

26
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

The Circle of Life: Figure 24: Circle of Life


Subjective based on JPM Strategy views
Macro
The jobs data has been poor lately Peaking
with Initial jobless claims crossing
over 500,000. This is the highest PBM Biotech
level of claims since the week
ending November 14, 2009. Health Care Brewers
Home
Services
Improvement
Early-stage
Industrial production has been
Later-stage Pharma
Retailers
more encouraging, increasing 1.0% REITs Technology Underweight
in July. Manufacturing production Overweight HC
Food Retail
was strong (increasing 1.1%) due Technology
to an increase in production of Homebuilders Materials Munis
Agency MBS
Autos and Parts.
Casinos High Grade
Total industry capacity utilization Convertibles Treasuries
increased from 74.1% to 74.8% in Auto Parts/ HY/
TIPS
Tires Financials Lev loans
July, while manufacturing capacity
ISM Energy
utilization increased from 71.4% to Wireless
Industrials
CMBS
72.2%. EM GDP
RMBS
Systems Auto sales Breaking
Credit
Recovery Software
Airlines
Retail sales
Macro
Down
Steels
HG bond spreads are now 163bp Discretionary ABX, ABS,Oil
US GDP
compared to 172bp one month CDOS Dollar Ed. Svcs
ago. HG Yields are now 4.34% Euro GDP
Housing
Cable & SateliteTelecom
Jobs
HY is now trading above par at
Multiline
101.6%. One month ago, it was InsuranceHealth Care
100.4%. Utilities Thrift/
Towers Staples
Mortgage
Paper Products
Equity
Cyclicals outperformed over the
last month with Materials and Early-stage Chemicals Later-stage
Industrials up 7.9% and 6.5%, Forest
E&P Soft Drinks/
respectively. Overweight
Products
Aluminum
Refiners
Beverages
Integrated Oil
Underweight
Oil &
EMS
Technology was the worst Drilling Ag/
Storage/Transp.
performer over the past month, Fertilizer
down -0.2%.
Bottoming
Source: J.P. Morgan.

27
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Update on Clobbered Stocks with FCF Yield > Bond Yield Trade
We are keeping our Clobbered Stocks trade open, which we opened in June. As a reminder, for this trade we identified 25 stocks
that had been “clobbered,” using the following criteria: 1) FCF Yield > Bond Yield; 2) Overweight rated by J.P. Morgan; and
3) Declined by >17% from 3-month high.

28
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Figure 25: Clobbered Stocks Trade Performance


Initiated on 6/3/10
6/3/2010 — 8/19/2010 (Open Trade): 25 Clobbered Stocks with FCF Yield > Bond Yield
JPM Rating Trade Initiated As of 8/19/2010 Profit (Loss)
25 Clobbered Stocks with FCF Stock Current as of Date Price $ Value Date Price $ Value $ Chg % Chg
Yield > Bond Yield Ticker 6/3/10
1 ArcelorMittal SA (NY Reg Sh) MT OW OW 6/03/10 $29.13 $400 8/19/10 $30.41 $418 $18 4.4%
2 Interpublic Group Of Cos. IPG OW OW 6/03/10 $8.31 $400 8/19/10 $8.53 $411 $11 2.6%
3 KB Home KBH OW OW 6/03/10 $13.86 $400 8/19/10 $10.36 $299 ($101) -25.3%
4 Avis Budget Group Inc. CAR OW 6/03/10 $11.90 $400 8/19/10 $9.65 $324 ($76) -18.9%
5 Metals USA Holdings Corp. MUSA OW OW 6/03/10 $15.24 $400 8/19/10 $11.86 $311 ($89) -22.2%
6 Sonic Automotive Inc. (Cl A) SAH OW OW 6/03/10 $9.77 $400 8/19/10 $8.85 $362 ($38) -9.4%
7 Lennar Corp. (Cl A) LEN OW OW 6/03/10 $16.28 $400 8/19/10 $12.89 $317 ($83) -20.8%
8 Lamar Advertising Co. (Cl A) LAMR OW OW 6/03/10 $28.99 $400 8/19/10 $28.43 $392 ($8) -1.9%
9 Freeport-McMoRan Copper & Gold I FCX OW OW 6/03/10 $66.17 $400 8/19/10 $72.09 $436 $36 8.9%
10 Nalco Holding Co. NLC N OW 6/03/10 $22.15 $400 8/19/10 $23.11 $417 $17 4.3%
11 McGraw-Hill Cos. MHP OW OW 6/03/10 $28.01 $400 8/19/10 $28.77 $411 $11 2.7%
12 Gaylord Entertainment Co. GET OW OW 6/03/10 $26.39 $400 8/19/10 $26.96 $409 $9 2.2%
13 Regal Entertainment Group RGC OW OW 6/03/10 $14.23 $400 8/19/10 $12.82 $360 ($40) -9.9%
14 Domtar Corp. UFS OW OW 6/03/10 $60.95 $400 8/19/10 $61.56 $404 $4 1.0%
15 Penn Virginia Corp. PVA OW OW 6/03/10 $22.71 $400 8/19/10 $14.90 $262 ($138) -34.4%
16 Goodyear Tire & Rubber Co. GT OW OW 6/03/10 $12.06 $400 8/19/10 $9.99 $331 ($69) -17.2%
17 Mylan Inc. MYL OW OW 6/03/10 $18.85 $400 8/19/10 $17.60 $373 ($27) -6.6%
18 Owens-Illinois Inc. OI OW OW 6/03/10 $30.39 $400 8/19/10 $26.67 $351 ($49) -12.2%
19 Rockwood Holdings Inc. ROC OW OW 6/03/10 $25.13 $400 8/19/10 $27.71 $441 $41 10.3%
20 Mohawk Industries Inc. MHK OW OW 6/03/10 $54.40 $400 8/19/10 $44.72 $329 ($71) -17.8%
21 WellPoint Inc. WLP OW OW 6/03/10 $54.45 $400 8/19/10 $50.12 $368 ($32) -8.0%
22 Ashland Inc. ASH OW OW 6/03/10 $52.48 $400 8/19/10 $48.79 $372 ($28) -7.0%
23 Western Union Co. WU OW OW 6/03/10 $16.15 $400 8/19/10 $16.06 $398 ($2) -0.6%
24 SPX Corp. SPW OW OW 6/03/10 $59.87 $400 8/19/10 $59.11 $395 ($5) -1.3%
25 Omnicare Inc. OCR OW OW 6/03/10 $25.40 $400 8/19/10 $20.09 $316 ($84) -20.9%
Sub-Total ($792) -7.9%

S&P 500 SP50 6/03/10 1,103 $10,000 8/19/10 1,076 $9,753 ($247) -2.5%
Long: 25 Employment Demographics Stocks 6/03/10 $10,000 8/19/10 $9,208 ($792) -7.9%
Trade vs. S&P 500 ($545) -5.4%
Source: J.P. Morgan and FactSet. Note: The table above shows the performance of a hypothetical trade assuming an investor bought and sold all the stocks shown on the dates shown.

29
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Update on Employment Demographics Stocks Trade Idea


We are keeping our Employment Demographics Stocks trade open, which we opened in April. As a reminder, for this trade, we
identified 25 late-cycle stocks that our analysts believed were levered to an upturn in employment for some of the demographics
hardest hit in the downturn.
Figure 26: Employment Demographics Stocks Trade Performance
Initiated on 4/23/10
4/22/2010 — 8/19/2010 (Open Trade): 25 Stocks levered to an upturn in employment for demographics hit hard in downturn
JPM Rating Trade Initiated As of 8/19/2010 Profit (Loss)
25 Stocks levered to an upturn in Stock Current as of Date Price $ Value Date Price $ Value $ Chg % Chg
employment for groups hit hard Ticker 4/22/10
1 Sprint Nextel Corp. S N N 4/22/10 $4.19 $400 8/19/10 $4.25 $406 $6 1.4%
2 Leap Wireless International Inc. LEAP UW UW 4/22/10 $18.08 $400 8/19/10 $10.76 $238 ($162) -40.5%
3 MetroPCS Communications Inc. PCS N N 4/22/10 $7.73 $400 8/19/10 $8.88 $460 $60 14.9%
4 KB Home KBH OW OW 4/22/10 $18.87 $400 8/19/10 $10.36 $220 ($180) -45.1%
5 Wendy's/Arby's Group Inc. WEN N N 4/22/10 $5.51 $400 8/19/10 $4.19 $304 ($96) -24.0%
6 D.R. Horton Inc. DHI N N 4/22/10 $13.69 $400 8/19/10 $10.43 $305 ($95) -23.8%
7 Sonic Corp. SONC N 4/22/10 $13.00 $400 8/19/10 $8.21 $253 ($147) -36.8%
8 Jack in the Box Inc. JACK N 4/22/10 $25.25 $400 8/19/10 $19.99 $317 ($83) -20.8%
9 Citi Trends Inc. CTRN OW OW 4/22/10 $36.37 $400 8/19/10 $23.16 $255 ($145) -36.3%
10 Burger King Holdings Inc. BKC N N 4/22/10 $21.89 $400 8/19/10 $16.72 $306 ($94) -23.6%
11 Safeway Inc. SWY N N 4/22/10 $26.94 $400 8/19/10 $20.03 $297 ($103) -25.6%
12 Kroger Co. KR OW OW 4/22/10 $23.68 $400 8/19/10 $21.09 $356 ($44) -10.9%
13 Family Dollar Stores Inc. FDO OW N 4/22/10 $39.82 $400 8/19/10 $43.17 $434 $34 8.4%
14 Ross Stores Inc. ROST N N 4/22/10 $58.40 $400 8/19/10 $50.28 $344 ($56) -13.9%
15 Dollar Tree Inc. DLTR UW N 4/22/10 $40.93 $400 8/19/10 $43.86 $429 $29 7.2%
16 TJX Cos. TJX N N 4/22/10 $47.69 $400 8/19/10 $41.93 $352 ($48) -12.1%

17 Coldwater Creek Inc. CWTR N N 4/22/10 $8.62 $400 8/19/10 $3.63 $168 ($232) -57.9%
18 Chico's FAS Inc. CHS N N 4/22/10 $16.05 $400 8/19/10 $8.94 $223 ($177) -44.3%
19 Talbots Inc. TLB N N 4/22/10 $16.29 $400 8/19/10 $10.18 $250 ($150) -37.5%
20 Harley-Davidson Inc. HOG N N 4/22/10 $35.22 $400 8/19/10 $25.41 $289 ($111) -27.9%
21 P.F. Chang's China Bistro Inc. PFCB N N 4/22/10 $47.13 $400 8/19/10 $41.52 $352 ($48) -11.9%
22 California Pizza Kitchen Inc. CPKI N 4/22/10 $21.30 $400 8/19/10 $15.59 $293 ($107) -26.8%
23 T. Rowe Price Group Inc. TROW OW OW 4/22/10 $58.98 $400 8/19/10 $45.65 $310 ($90) -22.6%
24 Darden Restaurants Inc. DRI OW OW 4/22/10 $48.66 $400 8/19/10 $41.06 $338 ($62) -15.6%
25 Panera Bread Co. (Cl A) PNRA N 4/22/10 $87.77 $400 8/19/10 $78.65 $358 ($42) -10.4%
Sub-Total ($2,146) -21.5%

S&P 500 SP50 4/22/10 1,209 $10,000 8/19/10 1,076 $8,899 ($1,101) -11.0%
Long: 25 Employment Demographics Stocks 4/22/10 $10,000 8/19/10 $7,854 ($2,146) -21.5%
Trade vs. S&P 500 ($1,045) -10.5%
Source: J.P. Morgan and FactSet. Note: The table above shows the performance of a hypothetical trade assuming an investor bought and sold all the stocks shown on the dates shown.

30
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Update on Target Price Stocks Trade Idea


We are keeping our Target Price Stocks trade open, which we opened in March. As a reminder, for this trade, we identified 23
stocks that we believed were non-consensus ideas for which J.P. Morgan Analysts had significantly raised targets. Specifically,
this non-consensus group of 23 stocks was derived based on the following criteria: (1) JPM target price at least 15% greater than
the consensus target; (2) Implied upside >15%; and (3) JPM target price increased by more than 20% over the last six months.
Figure 27: Target Price Stocks Trade Performance
Initiated on 3/25/10
3/25/2010 — 8/19/2010 (Open Trade): 23 Stocks with Price Target Upgrades
JPM Rating Trade Initiated As of 8/19/2010 Profit (Loss)
23 Price Target Upgrade Stocks Stock Current as of Date Price $ Value Date Price $ Value $ Chg % Chg
Ticker 3/25/10
1 Mariner Energy Inc. ME OW 3/25/10 $14.56 $435 8/19/10 $23.19 $692 $258 59.3%
2 Assured Guaranty Ltd. AGO OW OW 3/25/10 $21.44 $435 8/19/10 $17.10 $347 ($88) -20.2%
3 Cadence Design Systems Inc. CDNS OW OW 3/25/10 $6.64 $435 8/19/10 $6.80 $445 $10 2.4%
4 El Paso Corp. EP OW OW 3/25/10 $10.73 $435 8/19/10 $11.50 $466 $31 7.2%
5 AMR Corp. AMR OW OW 3/25/10 $9.09 $435 8/19/10 $6.67 $319 ($116) -26.6%
6 Range Resources Corp. RRC OW OW 3/25/10 $45.73 $435 8/19/10 $34.57 $329 ($106) -24.4%
7 KB Home KBH OW OW 3/25/10 $16.78 $435 8/19/10 $10.36 $268 ($166) -38.3%
8 Lennar Corp. (Cl A) LEN OW OW 3/25/10 $18.05 $435 8/19/10 $12.89 $310 ($124) -28.6%
9 Pioneer Natural Resources Co. PXD OW OW 3/25/10 $53.36 $435 8/19/10 $58.00 $473 $38 8.7%
10 Toll Brothers Inc. TOL OW OW 3/25/10 $20.71 $435 8/19/10 $16.60 $348 ($86) -19.8%
11 Amazon.com Inc. AMZN OW OW 3/25/10 $134.73 $435 8/19/10 $127.57 $412 ($23) -5.3%
12 Franklin Resources Inc. BEN OW OW 3/25/10 $112.23 $435 8/19/10 $98.42 $381 ($54) -12.3%
13 Monster Worldwide Inc. MWW OW OW 3/25/10 $16.96 $435 8/19/10 $11.00 $282 ($153) -35.1%
14 tw telecom inc. (Cl A) TWTC OW OW 3/25/10 $17.59 $435 8/19/10 $17.52 $433 ($2) -0.4%
15 CB Richard Ellis Group Inc. (Cl A) CBG OW OW 3/25/10 $14.45 $435 8/19/10 $16.42 $494 $59 13.6%
16 BorgWarner Inc. BWA OW OW 3/25/10 $37.39 $435 8/19/10 $45.26 $526 $92 21.0%
17 ev3 Inc. EVVV OW 3/25/10 $15.95 $435 8/19/10 $22.56 $615 $180 41.4%
18 Saks Inc. SKS OW OW 3/25/10 $8.89 $435 8/19/10 $7.70 $377 ($58) -13.4%
19 Smithfield Foods Inc. SFD OW OW 3/25/10 $20.15 $435 8/19/10 $15.13 $326 ($108) -24.9%
20 Rockwell Collins Inc. COL OW OW 3/25/10 $62.67 $435 8/19/10 $55.36 $384 ($51) -11.7%
21 Comerica Inc. CMA OW OW 3/25/10 $38.22 $435 8/19/10 $35.52 $404 ($31) -7.1%
22 Essex Property Trust Inc. ESS OW OW 3/25/10 $91.12 $435 8/19/10 $102.42 $489 $54 12.4%
23 Cliffs Natural Resources Inc. CLF OW OW 3/25/10 $69.03 $435 8/19/10 $61.50 $387 ($47) -10.9%
Sub-Total ($491) -4.9%

S&P 500 SP50 3/25/10 1,166 $10,000 8/19/10 1,076 $9,227 ($773) -7.7%
Long: 23 Price Target Upgrade Stocks 3/25/10 $10,000 8/19/10 $9,509 ($491) -4.9%
Trade vs. S&P 500 $282 2.8%
Source: J.P. Morgan and FactSet. Note: The table above shows the performance of a hypothetical trade assuming an investor bought and sold all the stocks shown on the dates shown.

31
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Update on Financials Stocks Trade Idea


We are keeping our Financials trade open again this month. As a reminder, for this trade, we recommended Financials stocks that
met the combination of potential for positive variance (JPM analysts rated Overweight) and also were attractive on valuation
(Price/Tangible Book). Specifically, we identified 19 stocks that met the following criteria: 1) In Financials sector; 2) Rated
Overweight by J.P. Morgan; 3) Market Cap > $500mm; and 4) Price/Tangible Book < 1.25x.

Figure 28: Financials Trade Performance


Initiated on 1/14/10
1/14/2010 — 8/19/2010 (Open Trade): 19 Financials Stocks
JPM Rating Trade Initiated As of 8/19/2010 Profit (Loss)
19 Financials Stocks Stock Current as of Date Price $ Value Date Price $ Value $ Chg % Chg
Ticker 1/14/10
1 MF Global Ltd. MF OW OW 1/14/10 $6.86 $526 8/19/10 $6.90 $529 $3 0.6%
2 Hartford Financial Services Group In HIG OW OW 1/14/10 $27.26 $526 8/19/10 $20.36 $393 ($133) -25.3%
3 Citigroup Inc. C OW OW 1/14/10 $3.51 $526 8/19/10 $3.79 $568 $42 8.0%
4 Brandywine Realty Trust BDN OW OW 1/14/10 $11.48 $526 8/19/10 $10.78 $494 ($32) -6.1%
5 Endurance Specialty Holdings Ltd. ENH OW OW 1/14/10 $36.95 $526 8/19/10 $36.74 $523 ($3) -0.6%
6 Umpqua Holdings Corp. UMPQ OW OW 1/14/10 $13.55 $526 8/19/10 $11.10 $431 ($95) -18.1%
7 Everest Re Group Ltd. RE N OW 1/14/10 $86.03 $526 8/19/10 $79.77 $488 ($38) -7.3%
8 PartnerRe Ltd. PRE OW OW 1/14/10 $74.04 $526 8/19/10 $73.71 $524 ($2) -0.4%
9 ACE Ltd. ACE OW OW 1/14/10 $48.73 $526 8/19/10 $53.32 $576 $50 9.4%
10 MFA Financial Inc. MFA OW OW 1/14/10 $7.28 $526 8/19/10 $7.23 $523 ($4) -0.7%
11 Reinsurance Group of America Inc. RGA OW OW 1/14/10 $50.36 $526 8/19/10 $46.42 $485 ($41) -7.8%
12 Assurant Inc. AIZ N OW 1/14/10 $31.26 $526 8/19/10 $36.72 $618 $92 17.5%
13 Douglas Emmett Inc. DEI OW OW 1/14/10 $14.55 $526 8/19/10 $15.65 $566 $40 7.6%
14 Entertainment Properties Trust EPR OW OW 1/14/10 $35.68 $526 8/19/10 $41.55 $613 $87 16.5%
15 Prudential Financial Inc. PRU OW OW 1/14/10 $54.08 $526 8/19/10 $52.87 $515 ($12) -2.2%
16 Comerica Inc. CMA OW OW 1/14/10 $34.13 $526 8/19/10 $35.52 $548 $21 4.1%
17 Annaly Capital Management Inc. NLY N OW 1/14/10 $17.30 $526 8/19/10 $17.52 $533 $7 1.3%
18 MetLife Inc. MET OW OW 1/14/10 $38.28 $526 8/19/10 $37.95 $522 ($5) -0.9%
19 Assured Guaranty Ltd. AGO OW OW 1/14/10 $23.58 $526 8/19/10 $17.10 $382 ($145) -27.5%
Sub-Total ($169) -1.7%

S&P 500 SP50 1/14/10 1,148 $10,000 8/19/10 1,076 $9,366 ($634) -6.3%
Long: 19 Financials Stocks 1/14/10 $10,000 8/19/10 $9,831 ($169) -1.7%
Trade vs. S&P 500 $465 4.7%
Source: J.P. Morgan and FactSet. Note: The table above shows the performance of a hypothetical trade assuming an investor bought and sold all the stocks shown on the dates shown.

32
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Update on Pro-Cyclical Stocks Trade Idea


We are keeping our Pro-Cyclicals trade from November open, in which we compiled a list of 25 Pro-Cyclical stock ideas, since
we continue to favor Cyclicals in the near term. The list identified stocks with a “pro-Cyclical” tilt, and where our analysts had a
forecast above Street consensus. More specifically, we used the following criteria: 1) In the Energy, Materials, Industrials,
Discretionary, Technology, or Telecom sectors, since we saw the most upside in these sectors into year-end; 2) J.P. Morgan EPS
estimate for 2010 at least 10% above Street consensus estimate for 2010; 3) Rated Neutral or Overweight by J.P. Morgan to
ensure there was a strong fundamental story; and 4) Market Cap > $4 billion.

33
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Figure 29: Pro-Cyclical Stocks Trade Performance


Initiated on 11/19/09
11/19/2009 — 8/19/2010 (Open Trade): 25 Pro-Cyclical Stocks
JPM Rating Trade Initiated As of 8/19/2010 Profit (Loss)
25 "Pro-Cyclical" Stocks Stock Current as of Date Price $ Value Date Price $ Value $ Chg % Chg
Ticker 11/19/09
1 United States Steel Corp. X OW OW 11/19/09 $41.28 $400 8/19/10 $47.78 $463 $63 15.7%
2 Alcoa Inc. AA N OW 11/19/09 $13.22 $400 8/19/10 $10.66 $323 ($77) -19.4%
3 Crown Castle International Corp. CCI N N 11/19/09 $36.99 $400 8/19/10 $40.61 $439 $39 9.8%
4 Kinder Morgan Energy Partners L.P. KMP OW OW 11/19/09 $56.22 $400 8/19/10 $67.71 $482 $82 20.4%
5 Delta Air Lines Inc. DAL OW OW 11/19/09 $7.59 $400 8/19/10 $10.78 $568 $168 42.0%
6 Ford Motor Co. F N N 11/19/09 $8.73 $400 8/19/10 $11.89 $545 $145 36.2%
7 Magna International Inc. (Cl A) MGA OW OW 11/19/09 $49.93 $400 8/19/10 $80.56 $645 $245 61.3%
8 Cabot Oil & Gas Corp. COG N OW 11/19/09 $38.80 $400 8/19/10 $29.59 $305 ($95) -23.7%
9 Southwestern Energy Co. SWN OW OW 11/19/09 $41.49 $400 8/19/10 $34.32 $331 ($69) -17.3%
10 Hertz Global Holdings Inc. HTZ N 11/19/09 $9.89 $400 8/19/10 $9.21 $372 ($28) -6.9%
11 Vulcan Materials Co. VMC OW 11/19/09 $49.50 $400 8/19/10 $38.47 $311 ($89) -22.3%
12 Pioneer Natural Resources Co. PXD OW OW 11/19/09 $41.31 $400 8/19/10 $58.00 $562 $162 40.4%
13 Las Vegas Sands Corp. LVS OW OW 11/19/09 $16.95 $400 8/19/10 $29.64 $699 $299 74.9%
14 XTO Energy Inc XTO OW 11/19/09 $41.63 $400 ** $41.81 $402 $2 0.4%
15 Petrohawk Energy Corp. HK OW OW 11/19/09 $21.18 $400 8/19/10 $15.86 $300 ($100) -25.1%
16 MeadWestvaco Corp. MWV OW OW 11/19/09 $26.37 $400 8/19/10 $21.48 $326 ($74) -18.5%
17 Cree Inc. CREE OW OW 11/19/09 $46.72 $400 8/19/10 $58.23 $499 $99 24.6%
18 Wynn Resorts Ltd. WYNN N N 11/19/09 $64.14 $400 8/19/10 $86.53 $540 $140 34.9%
19 International Paper Co. IP N N 11/19/09 $24.96 $400 8/19/10 $21.28 $341 ($59) -14.7%
20 ArcelorMittal SA (NY Reg Sh) MT OW OW 11/19/09 $38.00 $400 8/19/10 $30.41 $320 ($80) -20.0%
21 Paccar Inc. PCAR OW OW 11/19/09 $38.87 $400 8/19/10 $42.34 $436 $36 8.9%
22 Liberty Media Holding Corp. Interact LINTA OW OW 11/19/09 $10.74 $400 8/19/10 $10.64 $396 ($4) -0.9%
23 J.C. Penney Co. Inc. JCP N OW 11/19/09 $29.39 $400 8/19/10 $20.60 $280 ($120) -29.9%
24 Williams Cos. WMB OW OW 11/19/09 $19.82 $400 8/19/10 $18.90 $381 ($19) -4.6%
25 Chesapeake Energy Corp. CHK OW OW 11/19/09 $23.38 $400 8/19/10 $20.81 $356 ($44) -11.0%
Sub-Total $621 6.2%

S&P 500 SP50 11/19/09 1,095 $10,000 8/19/10 1,076 $9,824 ($176) -1.8%
Long: 25 Pro-Cyclical Stocks 11/19/09 $10,000 8/19/10 $10,621 $621 6.2%
Trade vs. S&P 500 $797 8.0%
Source: J.P. Morgan and FactSet. Note: The table above shows the performance of a hypothetical trade assuming an investor bought and sold all the stocks on the dates shown. Note: XTO acquired by
XOM on 6/28/10.

34
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Figure 30: Circle of Life Trades since Launch of Publication


Performance of trades
Publication Dates Pair Trade Re-Cap Long/Short Performance Sector rating changes

Long REL Perf

Perf vs S&P
vs S&P 500
Short REL
Upgrade/

500
Trade Open Trade Close Long Short Sector Perf + or - % chg Downgrade Sector

6/3/2010 - Open Long 25 Clobbered Stocks with FCF Yld > BY -7.9% x +100.0% -7.9% -5.4% Downgrade Energy OW ---> N

4/22/2010 - Open Long 25 Employment Demographics Stocks -21.5% x +100.0% -21.5% -10.5%

3/25/2010 - Open Long 23 Price Target Upgrade Stocks -4.9% x +100.0% -4.9% 2.8%

2/11/2010 - 3/25/2010 Long 24 Correction Stocks 11.4% x +100.0% 11.4% 3.3%

1/14/2010 - Open Long 19 Financials Stocks -1.7% x +100.0% -1.7% 4.7%

11/19/2009 - Open Long 25 Pro-Cyclical Stocks 6.2% x +100.0% 6.2% 8.0%

12/11/2009 Upgrade Health Care UW ---> N

10/22/2009 - 11/19/2009 Long 25 High Debt Stocks -2.0% x +100.0% -2.0% -2.2%

9/18/2009 - 10/22/2009 Long 26 Cyclical Stocks for the Next Leg of the Recovery -2.5% x +100.0% -2.5% -4.8%

8/5/2009 - 1/14/2010 Long Top 15 Energy Stks (Composite Score) 19.2% x +100.0% 19.2% 4.7% Upgrade Energy N ---> OW
Downgrade Health Care N ---> UW
7/1/2009 - 8/5/2009 Long 15 Top Smoke Stackey Industries 14.7% x +100.0% 14.7% 6.1%

6/25/2009 Upgrade Industrials N ---> OW


Upgrade Materials N ---> OW
Source: J.P. Morgan and FactSet. Note: The table above shows the performance of hypothetical trades assuming an investor bought and sold on the dates shown above, according to the trade parameters highlighted in each of our past Circle of Life reports.

35
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Figure 31: Circle of Life Trades since Launch of Publication (continued)


Performance of trades
Publication Dates Pair Trade Re-Cap Long/Short Performance Sector rating changes

Long REL Perf

Perf vs S&P
vs S&P 500
Short REL
Upgrade/

500
Trade Open Trade Close Long Short Sector Perf + or - % chg Downgrade Sector

6/4/2009 - 7/1/2009 Long 6 Sub-Industries -1.9% x +100.0% -1.9% 0.1%


Short 5 Sub-Industries -6.6% x -100.0% 6.6% 4.6%

4/29/2009 - 6/4/2009 Long Consumer Ideas -0.3% x +100.0% -0.3% -8.2%


Short Consumer Ideas -1.2% x -100.0% 1.2% 9.1%

4/29/2009 - 6/4/2009 Long Discretionary 4.5% x +100.0% 4.5% -3.4% Upgrade Energy UW ---> N
Short Staples 8.0% x -100.0% -8.0% -0.1%

3/30/2009 - 4/29/2009 Long Materials 12.6% x +100.0% 12.6% 1.7% Upgrade Industrials UW ---> N
Long Industrials 18.2% x +100.0% 18.2% 7.3% Downgrade Health Care OW ---> N
Short Utilities 2.4% x -100.0% -2.4% 8.6%

2/19/2009 - 3/30/2009 Long Materials 8.0% x +100.0% 8.0% 6.9% Upgrade Materials UW ---> N
Short Telecom Svcs 8.4% x -100.0% -8.4% -7.3% Downgrade Telecom OW ---> N

1/16/2009 - 2/19/2009 Long Health Care 0.0% x +100.0% 0.0% 8.3% Upgrade Health Care N ---> OW
Short Energy -7.3% x -100.0% 7.3% -1.1% Downgrade Energy N ---> UW
Source: J.P. Morgan and FactSet. Note: The table above shows the performance of hypothetical trades assuming an investor bought and sold on the dates shown above, according to the trade parameters highlighted in each of our past Circle of Life reports.

36
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Sector Comparative
Relative Price Performance
Price vs. 50-Day Moving Avg
Monthly Relative Sales Revision
Relative Sales Growth (vs. S&P 500)
Monthly Relative Earnings Revision
Relative Earnings Momentum
JULI Spreads (Relative to All Industries’ Average)
First Call Mean Rating (Relative to S&P 500)
Short Interest (Relative to S&P 500)
ETF Fund Flows
Price/10-Yr EPS (Relative to S&P 500)

Circle of Life Metrics Monthly Changes


Quarterly Price Performance

Sector Comparative
37
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

38
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Trailing 1-Month Relative Price Performance – Sectors


Figure 32: Resources: Energy Figure 33: Resources: Materials Figure 34: Exports: Industrials Figure 35: Exports: Technology
Recession Trailing 1-mos Relative Perf. MAVG past 12mos N:
Recession Underperformance
Trailing 1-mos Relative Perf. MAVG past 12mos Recession Trailing 1-mos Relative Perf. MAVG past 12mos Recession Trailing 1-mos Relative Perf. MAVG past 12mos
20% recently G: Has underperformed
10% 10% 8%
15% in latest month 6%
10% 5% 5% 4%
5% 2%
0% C 0% 0% 0%
-2%
-5% N from U: Several months -5% -5% -4% N from G: Global recovery
-10% of underperformance -6% providing support
-15% -10% -10% -8%
12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/03 12/04 12/05 12/06 12/07 12/08 12/09

Figure 36: Defensives: Staples Figure 37: Defensives: Health Care Figure 38: Defensives: Telecom Figure 39: Defensives: Utilities
Recession Trailing 1-mos Relative Perf. MAVG past 12mos Recession Trailing 1-mos Relative Perf. MAVG past 12mos Recession Trailing 1-mos Relative Perf. MAVG past 12mos Recession Trailing 1-mos Relative Perf. MAVG past 12mos

10%
N from U: Defensives 10% 15% G from U: 15%
8%
outperformed recently 5% 10%
Outperformance recently 10%
6%
4%
2% 0% 5% 5%
0% -5% 0% 0%
-2%
-4%
N from U: Outperformed in G from N: Outperforming
-10% -5% -5%
-6% latest month in past two months
-8% -15% -10% -10%
12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/03 12/04 12/05 12/06 12/07 12/08 12/09

Figure 40: Discretionary Figure 41: Financials


Relative Price Performance: Recession Trailing 1-mos Relative Perf. MAVG past 12mos Recession Trailing 1-mos Relative Perf. MAVG past 12mos
G: Outperformed N from G: Mostly
10% 15%
Trailing 1-Mo Price Performance of for several months outperforming recently
10%
Sector Minus Trailing 1-Mo Price 5%
5%
Performance of S&P 500 0%
0%
-5%
-5% -10%
-15%
-10% -20%
12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/03 12/04 12/05 12/06 12/07 12/08 12/09

Source: J.P. Morgan and Datastream.

39
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Price vs. 50-Day Moving Avg – Sectors (best is low and rising)
Figure 42: Resources: Energy G Figure 43: Resources: Materials N Figure 44: Exports: Industrials N from G Figure 45: Exports: Technology G from N
% of stocks above mavg % of stocks above mavg % of stocks above mavg % of stocks above mavg
100% Caution
Caution 100% 100% Caution 100% Caution
% of stocks above 50day mavg

90% Zone

% of stocks above 50day mavg

% of stocks above 50day mavg

% of stocks above 50day mavg


Zone 90% 90% Zone 90% Zone
80% 80% 80% 80%
70% 70% 70% 70%
60% 60% 59% 60% 60%
54%
50% 50% 50% 50%
40% 45%
40% 40% 40%
30% 30% 30% 30%
20% 25%
Buy 20% Buy 20% Buy 20% Buy
10% Zone 10% 10% 10%
Zone Zone Zone
0% 0% 0% 0%
12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09

Figure 46: Defensives: Staples Figure 47: Defensives: Health Care Figure 48: Defensives: Telecom N Figure 49: Defensives: Utilities U from G
G G
% of stocks above mavg % of stocks above mavg % of stocks above mavg % of stocks above mavg
100% Caution 100% 100% 100%
Caution Caution Caution
% of stocks above 50day mavg

% of stocks above 50day mavg

% of stocks above 50day mavg

% of stocks above 50day mavg


Zone
90% 90% Zone 90% Zone 90% Zone
85%
80% 80% 80% 80%
70% 70% 70% 67% 70%
60% 60% 60% 60%
50% 49% 50% 51% 50% 50%
40% 40% 40% 40%
30% 30% 30% 30%
20% Buy 20% Buy 20% Buy 20% Buy
10% Zone 10% Zone 10% Zone 10% Zone
0% 0% 0% 0%
12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09

Figure 50: Discretionary Figure 51: Financials N from U


G from N
Price Momentum: % of stocks above mavg % of stocks above mavg
100% Caution 100% Caution
% of stocks above 50day mavg

% of stocks above 50day mavg


90% Zone 90% Zone
% of stocks in sector above 50-day 80% 80%
70% 70%
moving average.
60% 60%
50% 50%
40% 37% 40% 41%
30% 30%
20% Buy 20% Buy
10% Zone 10% Zone
0% 0%
12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09

Source: J.P. Morgan and FactSet.

40
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Monthly Sales Revision – Sectors


Figure 52: Resources: Energy Figure 53: Resources: Materials Figure 54: Exports: Industrials Figure 55: Exports: Technology
G: Revisions
40.0% 8.0% 4.0% 8.0%
consistently flat or up 6.0%
NTM Sales Revision

NTM Sales Revision


NTM Sales Revision

NTM Sales Revision


4.0% 2.0%
20.0% 4.0%
0.0% 0.0% 2.0%
0.0% 0.0%
-4.0% -2.0%
-2.0%
-20.0%
-8.0% G: Consistently -4.0% G: Positive for -4.0% G: Upward revisions
-6.0% continue
-40.0% positive -6.0% several months
-12.0% -8.0%
1/05 1/06 1/07 1/08 1/09 1/10 1/05 1/06 1/07 1/08 1/09 1/10
1/05 1/06 1/07 1/08 1/09 1/10 1/05 1/06 1/07 1/08 1/09 1/10

Figure 56: Defensives: Staples Figure 57: Defensives: Health Care Figure 58: Defensives: Telecom Figure 59: Defensives: Utilities
3.0% G: Consistently positive 6.0%
G: Revisions have been 6.0%
N: Minor revisions 4.5%
5.0%
consistently positive
2.5%
NTM Sales Revision

NTM Sales Revision


NTM Sales Revision

NTM Sales Revision


2.0%
4.0%
4.0% 0.5%
1.0%
3.0% 2.0% -1.5%
0.0% 2.0%
1.0% 0.0% -3.5% U: Revisions skewed to
-1.0% the downside
0.0% -5.5%
-2.0% -1.0% -2.0% -7.5%
1/05 1/06 1/07 1/08 1/09 1/10 1/05 1/06 1/07 1/08 1/09 1/10
1/05 1/06 1/07 1/08 1/09 1/10 1/05 1/06 1/07 1/08 1/09 1/10

Sales Revisions: Figure 60: Discretionary Figure 61: Financials G: Positive


6.0% 3.0% revisions recently
Change in Sales NTM (Current vs.
4.0% 2.0%
NTM Sales Revision
NTM Sales Revision

1 month ago) divided by Sector


2.0% 1.0%
Sales (1 month ago).
0.0% 0.0%
Based on bottom-up consensus -2.0% -1.0%
Sales of current S&P 500 -4.0% G: Small but -2.0%
constituents. -6.0%
consistently positive -3.0%
1/05 1/06 1/07 1/08 1/09 1/10 1/05 1/06 1/07 1/08 1/09 1/10

Source: J.P. Morgan and Datastream. Change in Sales (NTM) as compared to one month ago divided by total sales of the sector.

41
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Relative Sales Growth (vs. S&P 500) – Sectors (best if tail is rising)
Figure 62: Resources: Energy Figure 63: Resources: Materials Figure 64: Exports: Industrials Figure 65: Exports: Technology
40% 8% 8% 8%
G: Momentum G: V-shaped

Rel Sales Growth Momentum

Rel Sales Growth Momentum


Rel Sales Growth Momentum

Rel Sales Growth Momentum


30% 4% 3.7% 6%
5.1%
20% improving 19.0% 0%
recovery in sales… 4% 4%
10% 2%
-4% 0% 0.0%
0% 0%
-8%
-10% -2%
-4%
-12%
-20% U: Waiting for trend -4% G: Improving growth
-16% -6%
-30% -8% to turn positive
12/05 11/06 10/07 9/08 8/09 7/10 6/11 12/05 11/06 10/07 9/08 8/09 7/10 6/11 12/05 11/06 10/07 9/08 8/09 7/10 6/11 12/05 11/06 10/07 9/08 8/09 7/10 6/11

Figure 66: Defensives: Staples Figure 67: Defensives: Health Care Figure 68: Defensives: Telecom Figure 69: Defensives: Utilities
12% 16% 30% 8%
Rel Sales Growth Momentum

Rel Sales Growth Momentum


Rel Sales Growth Momentum

Rel Sales Growth Momentum


8% 12% G: Less momentum 20% 4%

8%
recently 0% 0.0%
4% 10%

0% 4% 0% -4%
-1.4%
-5.9%
-4% 0% -10% -8%
-1.2%
-8% -4% -20%
N: Momentum turning -12%
12/05 11/06 N: Momentum
10/07 9/08 turning
8/09 7/10 6/11 12/05 11/06 10/07 9/08 8/09 7/10 6/11 12/05 negative
11/06 10/07 9/08 8/09 7/10 6/11 12/05 U:
11/06Weak momentum
10/07 9/08 8/09 7/10 6/11
negative

Figure 70: Discretionary Figure 71: Financials


Relative Sales Growth NTM:
4% 30%
N: Outlook for N: Tougher comps

Rel Sales Growth Momentum


Rel Sales Growth Momentum

Sales growth NTM of Sector less 2% 20%


0%
consumer unclear in 2010
Sales growth NTM of S&P 500. 10%
-2% -2.3%
0%
Based on bottom-up results of -4%
-10%
-6%
current S&P 500 constituents. -14.9%
-8% -20%

Historical data reflects actual -10% -30%


12/05 11/06 10/07 9/08 8/09 7/10 6/11 12/05 11/06 10/07 9/08 8/09 7/10 6/11
growth.
Source: J.P. Morgan and Datastream.
Dashed line reflects First Call
bottom-up consensus.

Up or Down trend of line is most


important indicator for determining
sector momentum.

42
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Monthly Earnings Revision – Sectors


Figure 72: Resources: Energy Figure 73: Resources: Materials Figure 74: Exports: Industrials Figure 75: Exports: Technology
4.0% 2.0% 0.8% 0.8%
NTM Earnings Revisions

NTM Earnings Revisions

NTM Earnings Revisions

NTM Earnings Revisions


0.4%
2.0% 1.0% 0.4%
0.0%
0.0% 0.0% -0.4% 0.0%

-2.0% -1.0% -0.8% -0.4%


N: Minor
-1.2%
-4.0% N: Flat revisions -2.0% revisions G: Positive -0.8%
-1.6%
recently revisions recently G: Positive
-6.0% -3.0% -2.0% -1.2%
revisions
1/05 1/06 1/07 1/08 1/09 1/10 1/05 1/06 1/07 1/08 1/09 1/10 1/05 1/06 1/07 1/08 1/09 1/10 1/05 1/06 1/07 1/08 1/09 1/10

Figure 76: Defensives: Staples Figure 77: Defensives: Health Care Figure 78: Defensives: Telecom Figure 79: Defensives: Utilities
0.3% 0.5% 1.2% 0.8%
N: Mixed
G: Strong positive revisions recently
NTM Earnings Revisions

NTM Earnings Revisions

NTM Earnings Revisions

NTM Earnings Revisions


0.2% 0.4% 0.8% 0.6%
0.1% 0.3%
revisions 0.4% 0.4%
0.0% 0.2%
0.0% 0.2%
-0.4% 0.0%
-0.1% 0.1%
-0.8% -0.2%
-0.2% 0.0% -1.2% -0.4%
N from G: N: No clear upward
-0.3% -0.1% -1.6% -0.6%
Revisions positive trend just yet
-0.4% -0.2% -2.0% -0.8%
1/05 1/06 1/07 1/08 1/09 1/10 1/05 1/06 1/07 1/08 1/09 1/10 1/05 1/06 1/07 1/08 1/09 1/10 1/05 1/06 1/07 1/08 1/09 1/10

Earnings Revisions: Figure 80: Discretionary Figure 81: Financials


1.0% G: Strong positive 2.0%
N from G: Revisions
Change in net income NTM revisions recently positive recently
NTM Earnings Revisions

NTM Earnings Revisions


(current vs. 1 month ago) divided 0.5% 1.0%
by sector market cap. 0.0% 0.0%

Based on bottom-up consensus net -0.5% -1.0%


income of current S&P 500 -1.0% -2.0%
constituents. -1.5% -3.0%
1/05 1/06 1/07 1/08 1/09 1/10 1/05 1/06 1/07 1/08 1/09 1/10

Source: J.P. Morgan and Datastream. Change in Net Income (NTM) as compared to one month ago divided by market cap.

43
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Relative Earnings Momentum – Sectors (best if tail is rising)


Figure 82: Resources: Energy Figure 83: Resources: Materials Figure 84: Exports: Industrials Figure 85: Exports: Technology

6% G: Turned positive as global 6%


G: Back in positive
6% 8%
Relative Earnings Momentum

Relative Earnings Momentum


Relative Earnings Momentum

Relative Earnings Momentum


4% economy recovers territory
4% 4% 6%
2% 2.5%
2% 4%
0% 2% 2.9%
-2% 0.5% 0.7% 2%
0% 0%
-4% G: Positive 0%
-2% -2%
-6% growth projected -2% G: Trending
-8% -4% -4%
-4% upwards
-10% -6% -6% -6%
12/05 11/06 10/07 9/08 8/09 7/10 6/11 12/05 11/06 10/07 9/08 8/09 7/10 6/11
12/05 11/06 10/07 9/08 8/09 7/10 6/11 12/05 11/06 10/07 9/08 8/09 7/10 6/11

Figure 86: Defensives: Staples Figure 87: Defensives: Health Care Figure 88: Defensives: Telecom Figure 89: Defensives: Utilities

6% 6% 6% 6%
Relative Earnings Momentum

Relative Earnings Momentum


Relative Earnings Momentum

Relative Earnings Momentum


4% 4% 4% 4%
2% 2% 2% 2%
0.4% 0.9% 0.1%
0% 0% 0% 0% -0.4%
-2% -2% -2% -2%
N: Flat earnings N: Flat earnings
-4% G: Improving earnings -4% N: Flat earnings
momentum -4% -4% momentum
-6%
momentum -6%
momentum
-6% -6%
12/05 11/06 10/07 9/08 8/09 7/10 6/11 12/05 11/06 10/07 9/08 8/09 7/10 6/11
12/05 11/06 10/07 9/08 8/09 7/10 6/11 12/05 11/06 10/07 9/08 8/09 7/10 6/11

Relative Earnings Momentum: Figure 90: Discretionary Figure 91: Financials


G: Positive growth
Contribution of Growth by Sector to G: Recovered to contributor
6% 15%
Relative Earnings Momentum
Relative Earnings Momentum

S&P 500 EPS. Change in net positive growth 10%


4% 7.0%
income (NTM vs. year ago) divided 5%
2% 0%
by S&P 500 net income. 1.3%
0% -5%
Based on bottom-up results of -2% -10%
current S&P 500 constituents. -15%
-4% -20%
Historical data reflect actual -6% -25%
growth. 12/05 11/06 10/07 9/08 8/09 7/10 6/11 12/05 11/06 10/07 9/08 8/09 7/10 6/11

Dashed line reflects First Call Source: J.P. Morgan and Datastream. Area portion of the chart is actual relative earnings and the line is based on consensus NTM.
bottom-up consensus.

44
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

JULI Spreads (Relative to All Industries’ Averages) – Sectors (best is high and narrowing)
Figure 92: Resources: Energy Figure 93: Resources: Materials Figure 94: Exports: Industrials Figure 95: Exports: Technology
N from G: Spreads flatWidening Widening
Widening
N: Widening recently Widening N from G: Tightening N: Stable recently
JULI Spread rel to all Industry avg (bp)

175 175 recently 175 175

JULI Spread Rel to Ind Avg (bp)

JULI Spread Rel to Ind Avg (bp)

JULI Spread Rel to Ind Avg (bp)


50 50 50 50
(75) (75) (75) (75)
(200) (200) Narrowing (200) Narrowing (200) Narrowing
Narrowing
(325) (325) (325) (325)
'01 '03 '05 '07 '09 '01 '03 '05 '07 '09 '01 '03 '05 '07 '09 '01 '03 '05 '07 '09
Energy Z Spread (Libor) Avg 1 STD Materials Z Spread (Libor) Avg 1 STD Industrials Z Spread (Libor) Avg 1 STD Technology Z Spread (Libor) Avg 1 STD

Figure 96: Defensives: Staples Figure 97: Defensives: Health Care Figure 98: Defensives: Telecom Figure 99: Defensives: Utilities
Widening N: Spreads
G from N: TighteningWidening Widening Widening
175 G: Spreads tightening 175 175 stabilizing
JULI Spread Rel to Ind Avg (bp)

JULI Spread Rel to Ind Avg (bp)

JULI Spread Rel to Ind Avg (bp)


recently 175
JULI Spread Rel to Ind Avg (bp)

50 50 50
50
(75) (75) (75)
(75)
(200) (200) N: Spreads stabilizing (200)
Narrowing Narrowing
Narrowing (200) recently
(325) Narrowing (325) (325)
'01 '03 '05 '07 '09 (325) '01 '03 '05 '07 '09 '01 '03 '05 '07 '09
Staples Z Spread (Libor) Avg 1 STD '01 '03 '05 '07 '09 Telecoms Z Spread (Libor) Avg 1 STD Utilities Z Spread (Libor) Avg 1 STD

Healthcare Z Spread (Libor) Avg 1 STD

Figure 100: Discretionary Figure 101: Financials


Relative JULI Spreads:
Widening Widening
Calculated as Spread of Sector
175 175
JULI Spread Rel to Ind Avg (bp)

JULI Spread Rel to Ind Avg (bp)


less Avg Spread of 10 Sectors.
50 50
A figure above zero means sector
has higher yields (relative). (75) (75)
(200) (200)
When line is falling, it means N: Spreads stable at
Narrowing
Narrowing N from G: Some
spreads are tightening on a relative (325) historical avg (325) widening recently
basis. '01 '03 '05 '07 '09 '01 '03 '05 '07 '09
Discreationary Z Spread (Libor) Avg 1 STD Financials Z Spread (Libor) Avg 1 STD

Source: J.P. Morgan and Datastream.

45
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

First Call Mean Rating (Relative to S&P 500) – Sectors (best is low and rising)
Figure 102: Resources: Energy Figure 103: Resources: Materials Figure 104: Exports: Industrials Figure 105: Exports: Technology
Recession Avg Relative FC Mean Rating Average Recession Avg Relative FC Mean Rating Average Recession Avg Relative FC Mean Rating Average Recession Avg Relative FC Mean Rating Average
(0.55) More (0.55) G: Upgrades (0.55) (0.55)

(0.35) Liked
(0.35) continuing More (0.35) More (0.35)
Liked More
Liked Liked
(0.15) (0.15) (0.15) (0.15)

0.05 0.05 0.05 0.05


0.25 0.25 Less Less
0.25 Less Less 0.25
N:
LikedStreet
rating nearing 0.45 Liked
0.45
Liked
G: Upgrades recently Liked N: Upgrades leveling off
0.45 0.45
parity with overall S&P 500
11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09 11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09 11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09 11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09

Figure 106: Defensives: Staples Figure 107: Defensives: Health Care Figure 108: Defensives: Telecom Figure 109: Defensives: Utilities
Recession Avg Relative FC Mean Rating Average Recession Avg Relative FC Mean Rating Average Recession Avg Relative FC Mean Rating Average Recession Avg Relative FC Mean Rating Average
(0.55) (0.55) (0.55) (0.55)
U: Downgrades may be More U: Sharp relative
(0.35) (0.35) (0.35) More (0.35)
starting More Liked Liked downgrades
More
(0.15) Liked (0.15) (0.15) (0.15) Liked
0.05 0.05 0.05 0.05
0.25 0.25 U: Downgrades
Less
0.25 Less 0.25
Less
Liked continue
Liked Like Less
0.45 0.45 0.45 0.45
N: Downgrades slowing Liked

11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09 11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09 11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09 11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09

Relative FC Mean Rating: Figure 110: Discretionary Figure 111: Financials


Recession Avg Relative FC Mean Rating Average Recession Avg Relative FC Mean Rating Average
Bottom-up FC Mean Rating of
(0.55) (0.55)
Street for Sector less S&P 500 G: Stable recently
(0.35) More (0.35)
overall. Liked More
(0.15) (0.15) Liked
Negative "relative" value means 0.05 0.05
Street has more Buys on Sector vs. 0.25 Less Less
0.25
S&P 500. Liked Liked
0.45 0.45
G: Upgrades continue
When line is rising, it means Street
11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09 11/95 11/97 11/99 11/01 11/03 11/05 11/07 11/09
is upgrading….
Source: J.P. Morgan and FactSet.

46
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Short Interest (Relative to S&P 500) – Sectors (best is high and falling)
Figure 112: Resources: Energy Figure 113: Resources: Materials Figure 114: Exports: Industrials Figure 115: Exports: Technology

1.0%
0.5% 1.0%
-0.4% 0.5%
0.0%
-0.5% 0.0% -0.9%
G from N: High G: Peaking G: Declining -0.5%
and declining recently N: Stable recently
-1.5% -1.0% -1.4% -1.0%
9/99 9/01 9/03 9/05 9/07 9/09 9/99 9/01 9/03 9/05 9/07 9/09 9/99 9/01 9/03 9/05 9/07 9/09 9/99 9/01 9/03 9/05 9/07 9/09

Figure 116: Defensives: Staples Figure 117: Defensives: Health Care Figure 118: Defensives: Telecom Figure 119: Defensives: Utilities
0.0% 1.1% 1.5%
-0.4%
-0.5% 0.1% 0.5%
-0.9%
N: Stable recently after -1.0% N: Volatile recently -0.9% -0.5%
-1.4% N: In line with
rising rapidly N: May be peaking S&P 500
-1.9% -1.5% -1.9% -1.5%
9/99 9/01 9/03 9/05 9/07 9/09 9/99 9/01 9/03 9/05 9/07 9/09 9/99 9/01 9/03 9/05 9/07 9/09 9/99 9/01 9/03 9/05 9/07 9/09

Figure 120: Discretionary Figure 121: Financials


Relative Short Interest:
G: Still elevated
Calculated as sector short interest 3.0% N: Has declined
3.3%
(as % shares outstanding) less significantly
average for S&P 500. 2.0% 2.3%
Calculated bi-weekly. 1.3%
1.0%
0.3%
At extremes, we see short interest
0.0% -0.8%
as a useful potential contrarian
indicator, i.e., if relative short 9/99 9/01 9/03 9/05 9/07 9/09 9/99 9/01 9/03 9/05 9/07 9/09
interest is high, we see the sector
as vulnerable to any Source: J.P. Morgan and FactSet. Note: Calculated as shares sold short as % of shares outstanding in each sector minus shares sold short as % of shares outstanding for S&P 500.
disappointments…

47
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

ETF Fund Flows – Sectors


Figure 122: Resources: Energy Figure 123: Resources: Materials Figure 124: Exports: Industrials Figure 125: Exports: Technology
$5,000 N: Energy
Flat flows recently $800 Materials $800 Industrials $1,200 U from N: Technology
$1,000
$4,000 $600 $600
$800
Outflows
Monthly Flows ($mm)

Monthly Flows ($mm)

Monthly Flows ($mm)

Monthly Flows ($mm)


$3,000 $400 $400
$600
$200 $200 $400
$2,000
$0 $0 $200
$1,000 $0
-$200 -$200
$0 -$200
-$400 -$400
-$1,000
N: Mixed flows -$400
-$600 -$600
-$2,000
G from N: Outflows recently -$600
-$800
-$800 -$800
5/07 9/07 1/08 5/08 9/08 1/09 5/09 9/09 1/10 5/10 5/07 9/07 1/08 5/08 9/08 1/09 5/09 9/09 1/10 5/10 5/07 9/07 1/08 5/08 9/08 1/09 5/09 9/09 1/10 5/10 5/07 9/07 1/08 5/08 9/08 1/09 5/09 9/09 1/10 5/10

Figure 126: Defensives: Staples Figure 127: Defensives: HealthCare Figure 128: Defensives: Telecom Figure 129: Defensives: Utilities
$600 Staples $800 HealthCare $200 Telecom $1,500 Utilities
$500 $600 $150 G from U: Several
$400 $1,000
$100 months of outflows
Monthly Flows ($mm)

Monthly Flows ($mm)


Monthly Flows ($mm)

Monthly Flows ($mm)


$400
$300 $50
$200 $200 $500
$0
$100 $0
-$50
$0 -$200 $0
-$100 -$100
-$200 G from N: Mixed -$400
N: Mixed flows -$150 G from U: Outflows -$500
-$600
-$300 flows recently recently -$200
for several months
-$400 -$800 -$250 -$1,000
5/07 9/07 1/08 5/08 9/08 1/09 5/09 9/09 1/10 5/10 5/07 9/07 1/08 5/08 9/08 1/09 5/09 9/09 1/10 5/10 5/07 9/07 1/08 5/08 9/08 1/09 5/09 9/09 1/10 5/10 5/07 9/07 1/08 5/08 9/08 1/09 5/09 9/09 1/10 5/10

ETF Fund Flows: Figure 130: Discretionary Figure 131: Financials


$1,000 Discretionary $7,000 Financials
Monthly fund flows for five largest $800 $6,000
U from N: Mostly
ETFs (based on AUM) in each $600 $5,000 flat flows recently
Monthly Flows ($mm)

Monthly Flows ($mm)


$400 $4,000
sector. $200 $3,000
$0 $2,000
$1,000
-$200
$0
-$400
-$1,000
-$600 G: Outflows -$2,000
-$800 recently -$3,000
5/07 9/07 1/08 5/08 9/08 1/09 5/09 9/09 1/10 5/10 5/07 9/07 1/08 5/08 9/08 1/09 5/09 9/09 1/10 5/10

Source: J.P. Morgan and EPFR Global.

48
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Price/10-Yr EPS (Relative to S&P 500) – Sectors (best if low and rising)
Figure 132: Resources: Energy Figure 133: Resources: Materials Figure 134: Exports: Industrials Figure 135: Exports: Technology
1.6x 1.6x 1.4x G: Attractive level
G: Attractive level U: Elevated N: At long-term
Relative P/E to S&P 500

Relative P/E to S&P 500

Relative P/E to S&P 500

Relative P/E to S&P 500


3.0x
avg…
1.2x 1.2x 1.2x 2.4x
1.8x
0.8x 0.8x 1.0x
1.2x
0.4x 0.4x 0.8x 0.6x
'84 '88 '92 '96 '00 '04 '08 '84 '88 '92 '96 '00 '04 '08 '84 '88 '92 '96 '00 '04 '08 '84 '88 '92 '96 '00 '04 '08
Recessions Rel to SP500 STD +1 Recessions Rel to SP500 STD +1 Recessions Rel to SP500 STD +1 Recessions Rel to SP500 STD +1
STD -1 Avg STD -1 Avg STD -1 Avg STD -1 Avg

Figure 136: Defensives: Staples Figure 137: Defensives: Health Care Figure 138: Defensives: Telecom Figure 139: Defensives: Utilities
1.0x G: Below long- 1.2x
U: Very rich… term avg 1.1x U: Coming off
1.8x
Relative P/E to S&P 500

Relative P/E to S&P 500

Relative P/E to S&P 500

Relative P/E to S&P 500


0.8x 1.0x extreme levels…
1.5x 0.8x
0.6x 0.8x
1.2x
0.4x 0.6x 0.5x
0.9x
G: Attractive level
0.2x 0.6x 0.4x 0.2x
'84 '88 '92 '96 '00 '04 '08 '84 '88 '92 '96 '00 '04 '08 '84 '88 '92 '96 '00 '04 '08 '84 '88 '92 '96 '00 '04 '08
Recessions Rel to SP500 STD +1 Recessions Rel to SP500 STD +1 Recessions Rel to SP500 STD +1 Recessions Rel to SP500 STD +1
STD -1 Avg STD -1 Avg STD -1 Avg STD -1 Avg

Relative P/10-Yr EPS: Figure 140: Discretionary Figure 141: Financials


1.6x G: Attractive level
Calculated as Sector P/10-Yr EPS 1.2x
G: Extreme low
Relative P/E to S&P 500

Relative P/E to S&P 500

divided by S&P 500 P/10-Yr EPS. 1.4x


1.0x
The lower the line, the greater the 1.2x
0.8x
relative discount.
1.0x 0.6x
0.8x 0.4x
'84 '88 '92 '96 '00 '04 '08 '84 '88 '92 '96 '00 '04 '08
Recessions Rel to SP500 STD +1 Recessions Rel to SP500 STD +1
STD -1 Avg STD -1 Avg

Source: J.P. Morgan and Datastream.

49
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Circle of Life Metrics Monthly Changes


Figure 142: Circle of Life Metrics Monthly Changes
Energy Materials Industrials Technology Staples
2/10 3/10 4/10 6/10 8/10 2/10 3/10 4/10 6/10 8/10 2/10 3/10 4/10 6/10 8/10 2/10 3/10 4/10 6/10 8/10 2/10 3/10 4/10 6/10 8/10
Price Performance
Price/50d mavg
Sales Revision
Sales Momentum
Earnings Revision
Earnings Momentum
JULI Spreads
FC Mean Rating
Short Interest
ETF Fund Flows
P/10Yr EPS

Total Delta -1 -1 1 0 2 2 0 -1 -2 -1 1 -1 -1 2 -1 1 -2 0 -2 -1 2 -1 1 2 1
Composite Score 0.4 0.3 0.4 0.4 0.5 0.8 0.7 0.6 0.5 0.4 0.5 0.5 0.5 0.7 0.6 0.8 0.6 0.6 0.5 0.4 (0.1) (0.2) (0.1) 0.1 0.2

Health Care Telecom Utilities Financials Discretionary


2/10 3/10 4/10 6/10 8/10 2/10 3/10 4/10 6/10 8/10 2/10 3/10 4/10 6/10 8/10 2/10 3/10 4/10 6/10 8/10 2/10 3/10 4/10 6/10 8/10
Price Performance
Price/50d mavg
Sales Revision
Sales Momentum
Earnings Revision
Earnings Momentum
JULI Spreads
FC Mean Rating
Short Interest
ETF Fund Flows
P/10Yr EPS

Total Delta 3 -2 0 2 1 1 -1 0 1 2 0 0 1 1 1 0 0 -1 2 -3 0 -1 0 0 1
Composite Score 0.3 0.2 0.2 0.5 0.5 (0.1) (0.2) (0.2) (0.1) 0.3 (0.5) (0.5) (0.5) (0.4) (0.3) 0.5 0.5 0.4 0.5 0.3 0.8 0.7 0.7 0.7 0.8

Source: J.P. Morgan.

50
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

Quarterly Price Performance


Figure 143: Sector Quarterly Price Performance
Shaded box highlights performance of sector, Bold/Italics highlights S&P 500 performance
Energy Materials Industrials Technology Staples
3Q09 4Q09 1Q10 2Q10 QTD 3Q09 4Q09 1Q10 2Q10 QTD 3Q09 4Q09 1Q10 2Q10 QTD 3Q09 4Q09 1Q10 2Q10 QTD 3Q09 4Q09 1Q10 2Q10 QTD
25% 10% 12% -5% 11% 25% 10% 12% -5% 11% 25% 10% 12% -5% 11% 25% 10% 12% -5% 11% 25% 10% 12% -5% 11%
21% 9% 11% -6% 10% 21% 9% 11% -6% 10% 21% 9% 11% -6% 10% 21% 9% 11% -6% 10% 21% 9% 11% -6% 10%
21% 9% 10% -9% 8% 21% 9% 10% -9% 8% 21% 9% 10% -9% 8% 21% 9% 10% -9% 8% 21% 9% 10% -9% 8%
19% 7% 5% -11% 7% 19% 7% 5% -11% 7% 19% 7% 5% -11% 7% 19% 7% 5% -11% 7% 19% 7% 5% -11% 7%
17% 6% 5% -12% 7% 17% 6% 5% -12% 7% 17% 6% 5% -12% 7% 17% 6% 5% -12% 7% 17% 6% 5% -12% 7%
15% 6% 3% -12% 7% 15% 6% 3% -12% 7% 15% 6% 3% -12% 7% 15% 6% 3% -12% 7% 15% 6% 3% -12% 7%
11% 5% 2% -12% 5% 11% 5% 2% -12% 5% 11% 5% 2% -12% 5% 11% 5% 2% -12% 5% 11% 5% 2% -12% 5%
9% 5% 2% -13% 5% 9% 5% 2% -13% 5% 9% 5% 2% -13% 5% 9% 5% 2% -13% 5% 9% 5% 2% -13% 5%
9% 5% 0% -13% 3% 9% 5% 0% -13% 3% 9% 5% 0% -13% 3% 9% 5% 0% -13% 3% 9% 5% 0% -13% 3%
5% 4% -5% -14% 3% 5% 4% -5% -14% 3% 5% 4% -5% -14% 3% 5% 4% -5% -14% 3% 5% 4% -5% -14% 3%
4% -4% -6% -16% 2% 4% -4% -6% -16% 2% 4% -4% -6% -16% 2% 4% -4% -6% -16% 2% 4% -4% -6% -16% 2%

HealthCare Telecom Utilities Financials Discretionary


3Q09 4Q09 1Q10 2Q10 QTD 3Q09 4Q09 1Q10 2Q10 QTD 3Q09 4Q09 1Q10 2Q10 QTD 3Q09 4Q09 1Q10 2Q10 QTD 3Q09 4Q09 1Q10 2Q10 QTD
25% 10% 12% -5% 11% 25% 10% 12% -5% 11% 25% 10% 12% -5% 11% 25% 10% 12% -5% 11% 25% 10% 12% -5% 11%
21% 9% 11% -6% 10% 21% 9% 11% -6% 10% 21% 9% 11% -6% 10% 21% 9% 11% -6% 10% 21% 9% 11% -6% 10%
21% 9% 10% -9% 8% 21% 9% 10% -9% 8% 21% 9% 10% -9% 8% 21% 9% 10% -9% 8% 21% 9% 10% -9% 8%
19% 7% 5% -11% 7% 19% 7% 5% -11% 7% 19% 7% 5% -11% 7% 19% 7% 5% -11% 7% 19% 7% 5% -11% 7%
17% 6% 5% -12% 7% 17% 6% 5% -12% 7% 17% 6% 5% -12% 7% 17% 6% 5% -12% 7% 17% 6% 5% -12% 7%
15% 6% 3% -12% 7% 15% 6% 3% -12% 7% 15% 6% 3% -12% 7% 15% 6% 3% -12% 7% 15% 6% 3% -12% 7%
11% 5% 2% -12% 5% 11% 5% 2% -12% 5% 11% 5% 2% -12% 5% 11% 5% 2% -12% 5% 11% 5% 2% -12% 5%
9% 5% 2% -13% 5% 9% 5% 2% -13% 5% 9% 5% 2% -13% 5% 9% 5% 2% -13% 5% 9% 5% 2% -13% 5%
9% 5% 0% -13% 3% 9% 5% 0% -13% 3% 9% 5% 0% -13% 3% 9% 5% 0% -13% 3% 9% 5% 0% -13% 3%
5% 4% -5% -14% 3% 5% 4% -5% -14% 3% 5% 4% -5% -14% 3% 5% 4% -5% -14% 3% 5% 4% -5% -14% 3%
4% -4% -6% -16% 2% 4% -4% -6% -16% 2% 4% -4% -6% -16% 2% 4% -4% -6% -16% 2% 4% -4% -6% -16% 2%

Source: J.P. Morgan and FactSet.

51
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

US Equity Strategy Recent Publications


US Strategy Special Reports
Low 10-yr forces further rally in IG, HY, and potential $900b mortgage refi. 24 high-FCF ideas – Second Half 2010 Outlook : J. P. Morgan’s Roadmap for Equity Investors – 7/26/10
8/12/10
US Equity Strategy Slide Deck: July 2010 : 10 Reasons to remain long equities: S&P 500 YE
8 Reasons why this is likely to be a longer cycle for Cyclicals – 8/5/10 Target of 1300 – 7/15/10

Raising FY ’10E to $84 from $81, maintain FY ’11E $90 (but upside likely). Smelling reflation key Quantifying Euro Exposure – 5/12/10
– 7/29/10
Positive on Housing Food Chain: Homebuilders most attractive, but also Mortgage Insurers,
Improving visibility suggests bias to risk-on. Cyclicals outperform during risk-on – 7/22/10 Suppliers, Timber. 12 Ideas – 4/9/10

2Q10 Preview: Beat and Meet : Good enough for now as biz is stable and consumer health 2010 Outlook: Back to Business: Visibility in 1H. YE Target Is 1300. – 12/10/09
improves – 7/15/10
7 Reasons We Are Early in Cycle for Cyclicals – 6/25/09
This week provided a reality check – 7/8/10
Guide to Stock Bottoms: Part II – Shift to Offense. Top 3 Tech, Disc & Financials – 5/12/09
Now the Negative Feedback Loop on Economy; Friday Labor, 2Q Are Reality Checks – 7/1/10
S&P 500 Model Book, Reducing ’09/’10 EPS to $57/$76 from $65/$80 – 3/24/09
Clarity on issues should improve in coming weeks. Opportunities in 1 std-dev laggards – 6/24/10
2009 US Equity Outlook: Range-bound 1H. Constructive 2H. – 12/17/08
Hope is the thing with feathers. Lessons from prior growth scares – 6/17/10
Guide to Stock Bottoms: Part I, Bottoms best called on a “rear”-ward basis – 11/21/08
The case for equities based on relative value: Another reason to remain slow buyers – 6/10/10
The Franchise 16: Stocks to Own Beyond the Market Turmoil – 10/17/08
Circle of Life: Plunge in May Brings Lunge in June; Downgrade Energy to N from OW – 6/3/10
The Recession Guidebook, Analysis of Index and 10 Sectors during recessions – 3/12/08
Time to be a slow buyer as capitulation is evident. 26 FCF ideas – 5/28/10

“Fish & Chips” (battered & fried). ST caution warranted, but 21 stocks Equity FCF > BY – 5/20/10
US SMid Cap Perspective
Confidence remains fragile, but labor recovery looks like ’75/’82. 19 ideas – 5/13/10
3 Reasons Small-caps are still attractive. We like late-cycle Consumer Cyclicals – 4/29/10
When “possibles” are treated as “probable”: Tail events assigned higher-than-likely probabilities –
Chapter After Ch 11: A Strategic Guide to Reorgs – 3/5/10
5/6/10
Stealth revenue recovery…adding ASH, GPI, and MWV to the JPM SMid Money List – 2/4/10
Life at 60: 70% of the time, ISM sustained above 60 6 mos or longer; 23 stock ideas – 5/5/10
Small-Caps a decade later – stronger, larger & cheaper – 12/30/09
Circle of Life: Revert back to “Stay Constructive, Buy the Dips” – Focus on Late-Cycle Consumer
Stocks: 25 Ideas – 4/23/10 2010 SMid Outlook: Stock-picking to outperform again – 11/30/09

2009 SMid Conf Must-See Presentations – 11/30/09

52
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

53
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

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54
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 19 August 2010
thomas.lee@jpmorgan.com

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Stock Exchange of Hong Kong Limited. An updated list can be found on HKEx website: http://www.hkex.com.hk/prod/dw/Lp.htm. Japan: There is a risk that a loss may occur due to a change in

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

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