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Jan Loeys
(1-212) 834-5874
jan.loeys@jpmorgan.com

Global Asset Allocation
The J.P. Morgan View
09 November 2012

J.P.Morgan

necessarily. Last summer, as equity markets rebounded in June and July,
Cyclical sectors actually underperformed. The thin grey line in the top chart
shows that Cyclical sectors have recaptured only a quarter of the
underperformance seen between March and August and thus provide a better
entry point. Position indicators suggest that investors are underweight
Cyclicals and overweight Defensives which is turn means that Defensive
sectors are more vulnerable to position unwinding.

• We introduced an underweight in US equities in mid October to position for
the US fiscal cliff risk. Obama’s win makes it more likely that this risk will
intensify into year-end. Across regions we favor EM Asia and Europe vs. the
US. While the US is facing fiscal cliff risks, Asian equities are benefiting
from concrete signs that economic activity is rebounding in China. European
equities are benefiting from greater improvement in financial conditions,
although they are more vulnerable to noise around the Greek and Spanish
issues.

Credit

• US credit spreads edged wider in response to the fall in equity markets
following the US elections. US HG widened 7bp to 160bp, undoing around
half of October’s peak-to-trough moves. Similar moves registered in other
USD credit markets. At 107bp, the CDX.IG is now back to early-August
levels, even as the CDS-Bond basis moved back into negative territory with
corporate bond spreads again moving above CDS.

• Credit spreads may be repricing the risk of a fiscal-cliff induced recession in
2013. For context, we expect the eventual outcome of the negotiations to lead
to about 2% of GDP in fiscal contraction, not enough to tip the economy back
into recession in itself, and considerably lower than the 4% drag under the full
enactment of all revenue raising measures and spending cuts currently set to
become law on Jan 1.

• From our point of view, the elections confirm the status quo both in
Washington and in market conditions – i.e. we should expect more of the
same and it has been a great year for credit. Therefore, we see the current
dip as an opportunity to add risk, and expect spreads to continue to tighten
into year end, albeit at a slower rate than in recent months. We stay down in
quality and outline in GMOS this week some relative value arguments for
Euro HY vs US HY. On that front, European credit shrugged off the election
outcome, tightening marginally in the HG space and widening very slightly in
the HY space.

Foreign Exchange

• The post-US election drama is unfolding as expected. Four more years with
the same cast is delivering a higher USD versus most currencies but JPY due
to deleveraging ahead of the fiscal cliff, and lower USD/CNY forwards due to
avoidance of US-China trade conflict (see An FX guide to America’s toss-up
election, FX Markets Weekly, Nov 2). The only surprise has been that FX
volatility remains so subdued (VXY unchanged at 7.4%) in a week when the
trade-weighted dollar and equity volatility have rallied. Chalk it up to
positioning, as most indicators suggest that institutions investors entered the
US polls with aggregate USD positions close to flat.

• Now, sausage-making season begins. US recession is guaranteed if the fiscal
cliff is enacted on schedule, and neither Congress nor the President welcomes

More details in ...
US Credit Markets Outlook and Strategy, Eric Beinstein
et al.
High Yield Credit Markets Weekly, Peter Acciavatti et al.
European Credit Outlook & Strategy, Steven Dulake et
al.
Emerging Markets Cross Product Strategy Weekly, Eric
Beinstein et al.

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