JP Morgan 2010 Outlook Back To Business

North America Equity Research
10 December 2009
2010 Outlook: Back to Business

Visibility in 1H. YE Target Is 1300
US Equity Strategy
“The error of optimism dies in the crisis, but in dying it gives birth to an error of
AC
pessimism. This new error is born, not an infant, but a giant . . . .” Thomas J Lee, CFA
A.C. Pigou, as quoted by W. Mitchell “Business Cycles: The Problem . . .” (1927) (1-212) 622-6505
thomas.lee@jpmorgan.com
The outlook for U.S. equities in 2010 is positive, in our view, reflecting both a Bhupinder Singh
broadening of the U.S. economic recovery as well as the Fed on hold for a sustained (1-212) 622-6406
period. This is close to the “Goldilocks” scenario for equities, as expressed by many bhupinder.b.singh@jpmorgan.com
PMs - a slow U-shaped jobless GDP recovery that should keep the Fed Daniel M McElligott
accommodative for a prolonged length of time. Thus, equities are likely to gain in (1-212) 622-5598
attractiveness relative to credit, given their inherent greater leverage to GDP growth. daniel.m.mcelligott@jpmchase.com
• It is too early to gauge whether the equity recovery since March ’09 is the start of J.P. Morgan Securities Inc.
a secular, multiyear bull market or one of a shorter (cyclical) variety with a
median duration of 18 months. The difference being whether sufficient conditions
exist to create an above-average GDP recovery: (i) pent-up demand; (ii) strong
Year end 2010 S&P 500 price target: 1300
payrolls recovery; (iii) easing household and small-biz credit availability.
• This bull market is entering its 9th month, making this the 20th bull market of S&P EPS Estimates
such duration since 1900. Of the preceding 19 periods, the S&P 500 rose 95% of JPM Bottom-Up
the time between month-10 to month-22 (Jan-Dec ’10) with an avg gain of 16%. Strategy Street
MARKET STRATEGY: 2010 YE Target 1300. We believe the S&P 500 can reach 2009E $63.00 $61.33
1300 by YE10, based on a 14.5X P/E on our 2011E EPS of $90. Visibility likely strong 2010E $80.00 +27% $77.68
in 1H given positive payrolls, home price trough, 2010 profit outlooks. We remain OW 2011E $90.00 +13% $94.00
Cyclicals. We are also upgrading Healthcare to Neutral from Underweight, as Sector Weightings
risk/reward is favorable given greater visibility on Healthcare reform. Overweight: Financials
Industrials
Energy
WHERE DO WE DIFFER FROM CONSENSUS? Investors remain too pessimistic Materials
regarding the durability and trajectory of 2010 US growth as well as valuation upside. Technology
Specifically, there are 6 areas where we differ from consensus: Discretionary
1. The risk for the US economic recovery is to the upside, with unemployment Neutral: Healthcare
falling in ’10E potentially faster than the 50bp projected by J.P. Morgan; Telecom
2. The 2.6mm-per-annum increase in the adult population (>age 19) creates 13.1mm Underweight: Staples
new consumers thru ’14E (Figure 15) - not enough homes nor autos today; Utilities
3. US home prices bottom in 1Q10 (per JPM ABS research) and Commercial Real Strategy View
Estate prices in 2010 (per JPM CMBS), which lead to improved credit availability; • Housing bottoms in 1Q
4. Top-line y/y gains in 1Q10. S&P 500 cos defend margins in as volumes despite • Credit eases in 2010
lack of pricing power - only 22% of cost savings were achieved by employment • Possible full job recovery
cuts, thus, rehiring does not nullify margin expansion. We see S&P 500 • Early in cycle for Cyclicals
’10E/’11E profits of $80/$90; • Favor “Bad Balance Sheets”
5. Valuations reasonable, as S&P 500 LTM EPS as % peak is 68%, in line with
Index at 70% of its peak value;
6. Supply and demand analysis by Srini Ramaswamy, JPM Fixed Income strategist,
shows sufficient demand for Treasuries in 2010, mitigating risk of rising rates.
See page 141 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
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www.morganmarkets.com or can call 1-800-477-0406 toll free to request a copy of this research.
Thomas J Lee, CFA North America Equity Research
(1-212) 622-6505 10 December 2009
Table of Contents
2010 Outlook: Visibility in 1H ..................................................3
Preceding Bulls 1900-2009 ....................................................11
RISKS: Upside and Downside to Outlook ............................15
The Base Case: 3.6% GDP growth in ’10E ...........................17
Reality check: 3 Ingredients for Upside ...............................21
Ingredient 1: Pent-up Demand? Yes .....................................23
Ingredient 2: Possible Job-FUL recovery.............................33
Ingredient 3: Credit conditions ease.....................................37
Our ’10E/’11E is above Consensus.......................................45
Valuations reasonable on ’10E/’11E EPS .............................55
Sufficient demand for Treasuries in 2010, mitigating risk of
rising rates ..............................................................................61
2010 Sector Outlooks.............................................................67
Financials: Overweight ..........................................................73
Industrials: Overweight..........................................................79
Technology: Overweight........................................................85
Basic Materials: Overweight..................................................91
Energy: Overweight................................................................97
Consumer Discretionary: Overweight ................................103
Telecom: Neutral ..................................................................109
Healthcare: Neutral from Underweight ...............................115
Consumer Staples: Underweight ........................................121
Utilities: Underweight...........................................................127
All prices in the text of this report are as of the close on December 9, 2010.
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(1-212) 622-6505 10 December 2009
2010 Outlook: Visibility in 1H

The outlook for U.S. equities in 2010 is positive, in our view, reflecting both a
broadening of the U.S. economic recovery as well as the Fed on hold for a sustained
period. This is close to the “Goldilocks” scenario for equities, as expressed by many
PMs - a slow U-shaped jobless GDP recovery that should keep the Fed
accommodative for a prolonged length of time. Thus, equities are likely to gain in
attractiveness relative to credit, given their inherent greater leverage to GDP growth.
The difference as to whether this It is too early to gauge whether the equity recovery since March ’09 is the start of a
is a secular or cyclical bull secular, multiyear bull market or a shorter (cyclical) recovery with a median duration
depends upon: (i) pent-up
demand; (ii) strong payrolls
of 18 months. It all depends on whether sufficient conditions exist to create an
recovery; (iii) easing credit above-average GDP recovery: (i) pent-up demand; (ii) strong payrolls recovery; (iii)
availability easing household and small-biz credit availability.
What we do know is pessimism is pervasive; as A.C. Pigou notes, “the error of

optimism dies in crisis, but in dying gives birth to the error of pessimism. This new
error is born, not an infant, but a giant . . . .” It is reflected in bank financial forecasts
that see unemployment unchanged in 2010; in companies hoarding cash with little
appetite for borrowing; in the insatiable appetite for gold and hard assets; and, more
recently, in the constant query of where is the pent-up demand?
6 areas where we differ from consensus . . .

1. The risk for the US economic recovery is to the upside, with possibility of
unemployment falling faster than the 50bp projected by J.P. Morgan, which is
already above consensus;
2. Pent-up demand is building as the 2.6mm-per-annum increase in the adult
population (> age 19) will create 13.1mm incremental consumers over the next 5
years (see Figure 15) and, coupled with restricted housing starts, auto production,
2010 Outlook: Visibility in 1H

retail sales and capex, suggests an eventual surge in demand;
3. US home prices bottom in 1Q10 (per J.P. Morgan ABS research) and
Commercial Real Estate prices in 2010 (per J.P. Morgan CMBS), which, coupled
with improving labor and pent-up demand, leads to improved credit availability
to households and small business. That itself reinforces a positive cycle;
4. Top-line y/y gains in 1Q10E. S&P 500 companies will likely defend margins, as
only 22% of cost savings were achieved by employment cuts, thus enabling
businesses to hire and expand margins. We see S&P 500 profits reaching at least
$90 by 2011;
5. We believe valuations solely reflect the earnings recovery to date as S&P 500
LTM EPS as % peak is 68%, in line with Index at 70% of its peak value. At
12.2X P/2011E EPS, the 8% earnings yield is 290bp above the 5.1% yield of
JPM JULI HG Index;
6. Supply and demand analysis by Srini Ramaswamy, J.P. Morgan Fixed Income
strategist, shows sufficient demand for Treasuries issuance in 2010, mitigating
risk of rising rates.
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(1-212) 622-6505 10 December 2009
We believe the S&P 500 can 2010 YE Target of 1300 based on ’10E/’11E EPS of $80/$90
reach 1300 by YE10, based on a We are constructive on equities in 2010, regardless of whether this is a secular or
14.5X P/E on our 2011E EPS of
$90.
cyclical bull. As we move through 2010, we see S&P 500 profits surpassing Street
expectations (3.5% GDP growth would result in $84 in EPS) and meaningful
catalysts to support lower risk premiums, and hence P/E expansion. We believe the
S&P 500 can reach 1300 by YE10, based on a 14.5X P/E on our 2011E EPS of $90.
Headwinds and Tailwinds: Less visibility in 2H

Tailwinds visible in 1H
We outline the broad headwinds and tailwinds to equities in 2010 in Figure 1 below.
In a nutshell, tailwinds (positive catalysts) are stronger in 1H, and the most
prominent are:
• Payrolls turn positive consistently, likely in 1Q10;

• US home prices bottom in 1Q10;
• Credit availability begins to improve for consumers and small-business;
• Pent-up demand strengthens demand for housing (via starts), automobile sales.
In other words, as 2010 progresses, the US gets back to business.
Less visibility in 2H, but not necessarily bearish

Headwinds, in our view, build progressively in 2010. The good news is the
headwinds are obvious to investors and thus unlikely to blindside markets. The bulk
of the headwinds relate to government policy from Healthcare reform; federal, state
and municipal budget deficits; and a focus on higher household and corporate tax
rates. Moreover, despite a “Fed on hold thru 2011,” capital markets will likely begin
to weigh the Fed’s and other central banks’ eventual shift to policy normalization
(reduced liquidity at the least).
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Figure 1: Headwinds vs. Tailwinds: Bullish 1H, Neutral 2H10

Visibility in 1H . . . Less clear in 2H . . .
Equity outlook Bullish Neutral Bearish
2009 2010 2011

9 Tailwinds… 4Q 1Q 2Q 3Q 4Q 1Q 2Q
$787b US fiscal stimulus 1H10E has
Auto sales rebound ex-Cash for Clunkers greater tailwinds,
Payrolls sustain 3-months of improvements as pent-up
US home prices bottom per Case-Shiller demand and
US housing starts increase YoY pricing stability
VIX sustains below 20 boosting equity inflows boost overall
Consumer credit begins thawing results . . . .
Commercial RE prices trough
M&A increases as biz expand
9 Headwinds…
Tight credit hurts Consumer & small-biz
Deficit,
Rising commodity prices
Health care reform
monetary
Municipal gov't budget face challenges policy
EM central banks move to normalize weigh on
Budget deficit concerns 2H10
Markets begin to price policy normalization
Housing tax credit fades
Higher Household & Corporate income taxes
S&P 500 Earnings trend
Source: J.P. Morgan estimates.
The effect from headwinds is likely pushed out, not pulled ahead . . . .
Hence, the surprise to markets is Timing when equity markets focus on headwinds is “sloppy” science, and the
either earlier (1H10E) or later consensus view is this will be 2H10. Hence, the surprise to markets is either earlier
(2011E). We believe probabilities
favor headwinds pushed to later
(1H10E) or later (2011E). We believe probabilities favor the effects of headwinds
in 2010/2011 . . . . pushed to later:
• If the GDP growth outlook remains tepid, the risks of overheating diminish;
hence, the timeline for policy normalization is pushed out.
• If a boom economic scenario evolves (see below), resulting in stronger GDP, the
focus on headwinds shifts further out – as rising incomes boost gov’t coffers and
even the notion of policy normalization could be pushed out as the Fed focuses
on potential output.
Base Case: 3.6% GDP growth, but upside possible
Bruce Kasman, J.P. Morgan’s Chief Economist, sees 2010 as the year US firms shift
from retrenchment to expansion, driving a forecast 3.6% GDP growth (4Q/4Q). This
is a weak recovery relative to the magnitude of the decline (0.9X vs. 1.9-2.4X seen in
past deep recessions) and reflects drag from tight credit markets (to households and
small-biz), household deleveraging and drags from state and local gov’t. Under this
scenario, the US economy is projected to produce 0.9-1.8mm jobs, improving
unemployment to 9.7% by YE (from a projected peak of 10.2% in 1Q10).
Upside to this scenario, in our view, exists to the extent three conditions are met in
2010: (i) pent-up demand exists and is secular given the continued US population
expansion of about 2.6mm (>age 19) yearly; (ii) we see upside to the jobs recovery
with one matching 1973-75 and 1982-83, which implies unemployment improving
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(1-212) 622-6505 10 December 2009
by 160bp and 250bp in the first 12 months, resulting in an implied 3mm jobs or so;
(iii) credit availability eases at a faster pace for households and small-biz driven by a
bottom in home prices in 1Q, CRE stabilization in 2010 and employment recovery.
This scenario would result in higher GDP growth and obvious upside to our EPS
forecasts as well. Moreover, stronger US growth would improve the fiscal outlook
for federal, state and local governments.
YE Target of 1300 based on ’10E/’11E EPS of $80/$90

Under the base case for GDP growth, we believe 2010 S&P 500 earnings will be
comfortably at $80 with Financials, Energy and Technology driving two-thirds of
that increase (see Figure 43).
• Top line is expected to show positive comparisons in 4Q09 and rise 7% in 2010
and to be conservative relative to the GDP base case of 3.5% growth.
• Margins, we believe, are defensible, as employee cuts were only 22% of the cost
savings (see Figure 47), with the rest driven by lower commodity costs, cost
avoidance and eliminations.
We are introducing a 2011 EPS forecast of $90, which is essentially the S&P 500
recovering to prior peak earnings of $92.11. Already 25% (as of 3Q09) of S&P 500
companies have exceeded their prior peak earnings and another 25% are within 10%
of peak earnings. The 2011E EPS represents 12% growth.
Establishing 2010 YE Target for the S&P 500 of 1300

We are establishing a YE target of 1300, based on applying a 14.5X P/E to our ’11E
EPS of $90 (see Figure 2). Without a doubt, we see upside to P/E multiples as the
S&P 500 is currently at 12.3X P/our 2011E. Moreover, only 6% of S&P 500
companies have seen a stock price recovery (price as % peak) greater than their EPS
recovery (2010E as % peak). In fact, at our target, only two Sectors would have a P/E
above their long-term average (Materials and Financials, both of which likely will
not see normalized earnings until 2012).
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Figure 2: S&P 500 Year-End 2010 Target of 1300

Target P/E ratios YE10 Target Level
Target P/E Long-Term Implied
as % of LT Current Avg P/E 2011E EPS Target S&P 500 % chg vs
Sector Target P/E Avg P/E Implied P/E (since '73) Contribution Value Point chg current
Cyclicals
Materials 18.3x 113% 15.5x 16.3x $2.50 46 7 18%
Industrials 16.0x 97% 13.3x 16.5x $8.50 136 23 20%
Discretionary 16.5x 80% 14.0x 20.5x $7.50 124 19 18%
Technology 16.5x 69% 13.2x 24.1x $16.00 264 52 25%
Defensives
Staples 14.2x 100% 13.2x 14.1x $10.50 149 11 8%
HealthCare 11.8x 59% 11.1x 19.9x $12.50 148 8 6%
Telecom 15.0x 91% 13.4x 16.4x $2.50 38 4 12%
Utilities 12.0x 99% 11.2x 12.2x $3.50 42 3 7%
Other
Energy 13.1x 89% 10.4x 14.7x $12.50 164 34 26%
Financials 14.2x 111% 11.5x 12.8x $14.00 199 38 24%
S&P 500 14.5x 77% 12.3x 18.8x $90.00 1,308 199 18%
Source: J.P. Morgan and FactSet.
Based on 19 prior Bull markets, 95% possibility 2010 is

“Up” year
This bull market is now entering its 9th month, which makes this the 20th bull
market lasting at least 9 months. We looked at the prior 19 bull markets to better
understand the potential path of equities in 2010 (equivalent of month-10 to month-
22). So what did we learn? History favors a positive return for equities in 2010. A
few things surprised us:
• 95% likelihood of an “Up” year: Of the 19 preceding bull markets, only 1

finished with a negative 12-month return (month 10-month 22), a 6% decline
(1982) (see Figure 5). Think about that: a 95% likelihood of an up year. The
overall average gain was 16%, and 7 of 19 years gained 20% or more.
• Implied 2010 Range is 1081 to 1319: We looked at the 20 best and 20 worst
days of each preceding bull market – we used 20 days to smooth out spikes, and
this implies the market lingered for one full month at that level. Across all
preceding bulls, this implies an upside range of 1319 (see Figure 6) and a
downside range of 1081 (see Figure 7).
• Possibility of a 10% correction, based on the past, is 32%. In 2009, there was
not a single 10% correction, frustrating many investors looking for an entry point.
We looked at these preceding bull markets to determine how many had a 10%
correction in month 10-month 22 (which implies 2010 for us). Of these, there
were 6 corrections of 10% or more. It typically occurred in month 17 (implies
July ’10) and lasted 3 months (until October ’10). We would not advise
WAITING FOR A CORRECTION, however.
For a stylized composite roadmap of 2010 (using the 19 preceding bull markets), see
Figure 3 below. Basically, we see the likelihood of achieving 1300 by midyear,
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(1-212) 622-6505 10 December 2009
which fits with our own thoughts that visibility on markets is greater in 1H10. Thus,
there is a possibility of 2011 EPS being discounted by midyear, which implies the
S&P 500 reaching 1300 then. And a 10% correction from the 1300 level would push
the market to 1170, which is higher than current levels. In other words, we think it is
a mistake to wait for a correction.
Figure 3: Stylistic roadmap for 2010E based on 19 Preceding Bull Markets

Based on 19 preceding bull markets
1,500
Implied Upside based on... Top quartile: 1,513
1616
1560
Year-End based on...

1473
1460
1,400
1452
1389
1903
1336
1559
1311
1309
1300
1267
Average '00-09: 1,319

1242
1953 1490
1223
1222
1200
1191
1176
1171
1156
1,300 1987 1469
1957 1425
1917 1402
1903
1932
1953
1987
1957
1917
1907
1974
1949
2002
1962
1921
1942
1978
1990
1970
1914
1966
1982
1,200
1932 1401
Average '00-09: 1,081 1907 1334
1,100 1949 1315
Bottom quartile: 1,019 1974 1308
1962 1264
1,000 1914 1205
2002 1204
1990 1196
900 Implied downside based on...
1197
1970 1189
1127
1121
1116
1113
1108
1103
1103
1978 1187
1091
1089
1083
1079
1058
1052
1041
800 1942 1162
1028
1023
1005
1966 1124
997
1921 1111
700 1982 1034
1932
2002
1957
1987
1903
1953
1942
1921
1962
1978
1907
1990
1949
1974
1982
1966
1970
1914
1917
600
12/08 1/09 2/09 3/09 4/09 5/09 6/09 7/09 8/09 9/09 10/09 11/09 12/09 1/10 2/10 3/10 4/10 5/10 6/10 7/10 8/10 9/10 10/10 11/10 12/10
Source: J.P. Morgan estimates and Dow Jones.
Market Strategy: OW Cyclicals. Healthcare to N from UW

As for market strategy, we continue to favor Cyclicals, given their greater leverage to
GDP upside, business sensitivity to easing credit (for consumers and small-biz), EPS
revisions, analyst upgrade potential, valuation expansion and M&A (see Figure 4).
Moreover, as we noted in several previous reports (see, for example, “7 Reasons We
Are Early in Cycle for Cyclicals,” dated 6/25/09), the shortest cycle of Cyclical
outperformance is 14 months (average is 37).
Best groups: Financials and Industrials

We believe the risk to GDP growth is to the upside, and hence we favor sectors in
which the combination of positive earnings revisions and valuation revisions is
highest. In our view, this applies to Financials (Insurance, Consumer Finance more
than Banks) and Industrials.
• For Financials, a stronger economic recovery shortens the credit cycle, creating
potential upside to earnings, and there is top-line leverage as well.
• As for Industrials, they tend to be later cycle, and we see room for upside to
conservative EPS forecasts as well as potential for valuation expansion from a
13.3X 2011E P/E ratio.
Upgrading Healthcare to Neutral from Underweight
We are also moving Healthcare to Neutral from Underweight. The risk/reward for
Healthcare is attractive, as investors have enough visibility to model the “base case”
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(1-212) 622-6505 10 December 2009
of Healthcare reform in valuations, while improvements to the program are likely to

be to the upside, in our view. Moreover, the group’s valuation of 11.1X P/’11E is at
the low end of historical multiples. There is also potential for strategic and cost-
driven M&A. While we see little room for EPS upgrade, nor leverage to GDP, this
warrants a Neutral stance, we believe, versus our previous UW.
Figure 4: 2010 Sector Ratings

%
S&P 500 JPM Strategy EPS First Call
Weight Top-down Forecast P/E Multiples Consensus Equity Drivers in 2010…
ity
JPM
ion
gr ck
ing
itiv
it E to
Va des
Up Sto
vis
as
ns
ion
Cr g e
Index % 2010E JPM vs.
ex tion
Strategy
a
Re
se
st
ns
r
lua
ve
aly
P
ed
pa
A
Rating Points weight 2009E 2010E 2011E 2010E 2011E EPS Street
S
GD
M&
Le
EP
An
Resources Energy OW 130 12% $6.62 $10.66 $12.50 12.2x 10.4x $10.21 675bp 5 5 5 7 7 8
Materials OW 39 3% $1.25 $2.17 $2.50 17.8x 15.5x $1.94 1833bp 5 5 5 6 8 7
Exports Industrials OW 113 10% $6.32 $7.50 $8.50 15.1x 13.3x $7.00 798bp 5 5 5 7 5 6
Technology OW 212 19% $11.17 $13.74 $16.00 15.4x 13.2x $13.74 -1bp 5 5 6 7 7 6
Defensives Staples UW 138 12% $9.28 $9.85 $10.50 14.1x 13.2x $9.82 31bp 1 1 8 1 1 6
Healthcare N from UW 139 13% $11.01 $11.87 $12.50 11.7x 11.1x $11.48 349bp 8 1 1 1 6 7
Telecom N 34 3% $2.35 $2.31 $2.50 14.5x 13.4x $2.31 12bp 7 1 8 1 6 5
Utilities UW 39 4% $3.09 $3.24 $3.50 12.1x 11.2x $3.11 422bp 7 1 1 8 1 8
Total S&P 500 (ex-Disc/ex-Fin) 843 76% $51.09 $61.34 $68.50 13.7x 12.3x $59.61 338bp
Consumer Discretionary OW 105 9% $4.70 $6.80 $7.50 15.4x 14.0x $6.83 -67bp 5 5 7 6 6 7
Financials OW 161 14% $6.98 $11.87 $14.00 13.5x 11.5x $10.96 1291bp 5 5 5 5 5 5
Total S&P 500 1,109 100% $62.78 $80.00 $90.00 13.9x 12.3x $77.41 414bp
Source: J.P. Morgan estimates. 5 = best. 1 = least.
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Preceding Bulls 1900-2009

Possibilities now: 95% of up year; 32% of 10% correction
History favors a positive return This bull market is now entering its 9th month, which makes this the 20th bull
for equities in 2010 market lasting at least 9 months. We looked at the prior 19 bull markets to better
understand the potential path of equities in 2010.
So what did we learn?
History favors a positive return for equities in 2010. A few things surprised us:
• 95% likelihood, based on past, of an “Up” year: Of the 19 preceding bull

markets, only 1 finished with a negative 12-month return (month 10-month 22), a
6% decline (1982) (see Figure 5). Think about that: a 95% possibility of an up
year. The overall average gain was 16%, and 7 of 19 years gained 20% or more.
• Implied 2010 Range is 1081 to 1319: We looked at the 20 best and 20 worst
days of each precedent bull market – we used 20 days to smooth out spikes, and
this implies the market lingered for one full month at that level. Across all
preceding bulls, this implies an upside range of 1319 (see Figure 6) and downside
range of 1081 (see Figure 7).
• Possibility of a 10% correction is 32%. In 2009, there was not a single 10%
correction, frustrating many investors looking for an entry point. We looked at
these preceding bull markets to determine how many had a 10% correction in
month 10-month 22 (which implies 2010 for us). Of these, there were 6
corrections of 10% or more. It typically occurred in month 17 (implies July ’10)
and lasted 3 months (until October ’10).
Figure 5: 19 Preceding Bulls: Implied 2010 Gain (Month 10-22)
Based on 19 preceding bull markets. Return from month 10 to month 22
Preceding Bulls 1900-2009

Quartile Distribution…
Bull market start Month 10-22 Implied level of Low Middle Top
date % gain S&P 500 Quartile Quartiles Quartile
11/9/1903 41% 1,559 •
11/15/1907 21% 1,334 •
12/24/1914 9% 1,205 •
12/19/1917 27% 1,402 •
8/24/1921 1% 1,111 •
7/8/1932 27% 1,401 •
4/28/1942 5% 1,162 •
6/13/1949 19% 1,315 •
9/14/1953 35% 1,490 •
10/22/1957 29% 1,425 •
6/26/1962 14% 1,264 •
10/7/1966 2% 1,124 •
5/26/1970 8% 1,189 •
10/3/1974 18% 1,308 •
3/6/1978 7% 1,187 •
8/12/1982 -6% 1,034 •
10/19/1987 33% 1,469 •
10/11/1990 8% 1,196 •
10/9/2002 9% 1,204 •
Top Quartile 33% 1,469

Average 19 bulls 16% 1,283
Bottom Quartile 2% 1,124
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Intrayear gain of at least 19% possible and top quartile 37%

The bottom line, in our view, is We looked at the 20 best and 20 worst days of each preceding bull market, and their
that we see a strong likelihood performance between month 10 and month 22 (which equates to January 2010 to
that the S&P 500 closes well
above 1300 during part of 2010
December 2010). We used 20-days to smooth out spikes, and this implies the market
lingered for one full month at that level. In other words, this looks at the upper end of
how the markets traded. The analysis is in Figure 6 below:
• As shown, the average intrayear gain is 19%, which implies 1319. Recall this is
20 days at 1319 - which means the market could spend an entire month at that
level.
• The top quartile of returns is a 37% intrayear gain, which implies there is a 25%
possibility the S&P 500 could linger at 1,513 for one month. These years
occurred when the US was exiting either a severe recession (1953, ’57 or 2003)
or a sharp decline in equities (1932 or ’57).
• And looking at the lowest quartile, this implies 1,179, or 7% upside.
Figure 6: 19 Preceding Bulls: Best 20 days for each Bull market
Based on 19 preceding bull markets. 20 best days in each bull market month 10 to month 22.
Bull market start Implied level of Low Middle Top

date Best 20-days S&P 500 Quartile Quartiles Quartile
11/9/1903 46% 1,616 •
11/15/1907 21% 1,336 •
12/24/1914 6% 1,176 •
12/19/1917 26% 1,389 •
8/24/1921 12% 1,242 •
7/8/1932 41% 1,560 •
4/28/1942 11% 1,223 •
6/13/1949 18% 1,309 •
9/14/1953 33% 1,473 •
10/22/1957 31% 1,452 •
6/26/1962 15% 1,267 •
10/7/1966 6% 1,171 •
5/26/1970 8% 1,191 •
10/3/1974 19% 1,311 •
3/6/1978 11% 1,222 •
8/12/1982 5% 1,156 •
10/19/1987 32% 1,460 •
10/11/1990 9% 1,200 •
10/9/2002 18% 1,300 •

Average 19 bulls 19% 1,319
Bottom Quartile 7% 1,179
The bottom line, in our view, is that we see a strong likelihood that the S&P 500
closes well above 1300 during part of 2010. In fact, while this is not our base case,
there is a 25% possibility we approach 1500 during 2010 — clearly something we
don’t currently expect.
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Intrayear drop to 1081 is typical of 19 prior bulls

Bottom line, we believe the S&P We looked at the 20 worst days of each of the 19 preceding bull markets, and their
500 is likely to spend most of performance between month 10 and month 22 (which equates to January 2010 to
2010 above 1,000
December 2010). We used 20 days to smooth out spikes, and this implies the market
lingered for one full month at that level. In other words, this looks at the lower end of
how the markets traded. The analysis is in Figure 7 below:
• As shown, the average intrayear decline (from start of 2010) is 2%, which implies
1081. Recall this is 20 days at 1081 — which means the market could spend an
entire month at that level.
• The worst quartile of decline is an 8% intrayear fall, which implies there is a 25%
possibility the S&P 500 could linger at 1,019 for one month. These years
occurred when the US was exiting wartime periods (1914, ’17) or short
recessions (1966 and ’70), and the only similar recession was 1982 (down 6%).
Figure 7: 19 Preceding Bulls: Worst 20 days for each Bull market
Based on 19 preceding bull markets. 20 worst days in each bull market from month 10 to month 22
Bull market start Worst 20- Implied level of Low Middle Top
date days S&P 500 Quartile Quartiles Quartile
11/9/1903 1% 1,113 •
11/15/1907 -2% 1,083 •
12/24/1914 -9% 1,005 •
12/19/1917 -10% 997 •
8/24/1921 0% 1,103 •
7/8/1932 8% 1,197 •
4/28/1942 0% 1,103 •
6/13/1949 -4% 1,058 •
9/14/1953 0% 1,108 •
10/22/1957 1% 1,121 •
6/26/1962 -1% 1,091 •
10/7/1966 -7% 1,028 •
5/26/1970 -7% 1,023 •
10/3/1974 -5% 1,052 •
3/6/1978 -1% 1,089 •
8/12/1982 -6% 1,041 •
10/19/1987 1% 1,116 •
10/11/1990 -2% 1,079 •
10/9/2002 2% 1,127 •

Average 19 bulls -2% 1,081
Bottom Quartile -8% 1,019
Bottom line, we believe the S&P 500 is likely to spend most of 2010 above 1,000 but
acknowledge that short-term spikes could push markets down below 1,000.
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32% possibility of a 10% correction, based on past, implied

around July-Sept
In other words, as we close on The S&P500 avoided a 10% correction in 2009, something which initially frustrated
July, there is a 32% possibility of us (as we thought one could occur in early 2009). Now that we are approaching
at least a 10% correction lasting
3 months
month 10 of this bull market, we were interested in the possibility of a 10%
correction in 2010 (during month 10-month 22). We compiled the data below in
Figure 8:
• Of those 19 preceding markets, 6 saw at least a 10% correction. Thus, a

frequency of 32%. The magnitude of the decline is 13%.
• The typical correction occurred during the 17th month (equivalent to July 2010),
but two of the instances happened in month 14 (April 2010). The average
duration is 3 months. In other words, as we close on July 2010, there is a 32%
possibility of at least a 10% correction lasting 3 months.
From what level is key . . . . and we advise against WAITING for correction
We think investors should not WAIT for a correction, but rather, prepare themselves
in terms of market strategy. After all, if this correction takes place around July and
lasts 3 months, that is a lot of waiting.
• Frankly, this fits with our own thoughts that visibility on markets is greater in
1H10. Thus, there is a possibility of 2011 EPS being discounted by midyear,
which implies the S&P 500 reaching 1300 then.
A 10% correction from there would push the market to 1170, which is higher than
current levels. In other words, we think it is a mistake to wait for a correction.
Figure 8: Possibility of a Correction Is 32%

%
Correction Analysis (>10% decline)
Month 10 to
Start Date Start of Duration of
of Correction End Date of Correction
Correction (mos) Correction (mos) % Decline
4/14/1905 7 5/22/1905 1 -15%
3/20/1923 9 6/20/1923 3 -14%
2/5/1934 9 5/7/1934 3 -14%
7/14/1943 4 11/29/1943 5 -11%
10/5/1979 9 11/7/1979 1 -10%
10/10/1983 4 5/29/1984 8 -13%
7 3 -13%
8 3 -13%
Source: Dow Jones and J.P. Morgan estimates.
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RISKS: Upside and Downside to Outlook

Downside Risks
There are substantial downside risks to our 2010 outlook. The risks basically fall into
two categories: (i) government policy/Fed errors; and/or (ii) risk appetite failures:
Slower jobs due to Healthcare • Healthcare reform concerns keep companies from hiring. The likelihood that
uncertainty Healthcare reform passes is high, and our Healthcare analysts are using the
Senate base case in their models. Our concern is that until a final version
emerges, uncertainty keeps businesses from expanding given lack of visibility on
their obligations.
Deficits push down dollar and • Government deficits lead to currency crisis or fears of higher taxation. The
higher rates US budget deficit is forecast to be 9% in 2010, surpassed only by the UK funding
requirements. There are concerns that sufficient demand for Treasuries does not
exist, but as the supply/demand analysis by our Fixed Income teams shows (see
Figure 68 and Figure 69), demand and supply should be in balance in 2010. As
for concerns about a dollar crisis, historically, one needs to see asset price
collapse to presage a currency crisis.
Caution leads to double dip • Excess caution choking a recovery, creating a double dip. There are fears that
only policy efforts have created growth and that excess caution by households
RISKS: Upside and Downside to Outlook

and businesses could choke off a recovery, leading to a double dip. As we note in
Figure 12, there are broad signs of demand recovery that, coupled with our
virtuous loop (pent-up demand, credit easing, business expansion/jobs recovery),
likely lead to a sustained expansion in 2010.
Interest rates rise in anticipation • Policy normalization causes interest rates rise, causing multiple contraction
of Fed tightening worsened by dollar strengthening. The Fed is on hold, but if investors begin
selling risk-free assets such as Treasuries, rates could rise in anticipation of
tightening. Moreover, if banks begin lending, they could divest some of their
securities holdings, pushing up rates. This would lead to P/E contraction for
equities. But as we noted above, we believe supply and demand are in balance.
Asset bubbles in EM burst or • Asset bubbles in EM drives up commodity prices and lead to an eventual
commodity prices choke correction in risk assets. There are some concerns that the continued recovery in
recovery
EM economies, easy monetary policy, and the weak dollar not only drive higher
asset prices but also lead to another unsustained surge in commodity prices. This
in turn chokes off a US recovery. We definitely need to be mindful of this risk.
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Upside Risks
The upside risks to our 2010E $80 S&P 500 EPS and YE Price Target of 1300 is that
we see an economic recovery more in line with 1973-75 and 1982, thus pushing a
much higher EPS forecast and P/E target: Our P/E target is 14.5X 2011E EPS, but
lower risk premiums could easily push this 1X-2X higher.
Consumers’ old normal is new • Consumers return to their old normal. Consumers and businesses have both
normal, leading to GDP upside become extremely cautious during this recession, and our 2010 forecast shows
only a most conservative recovery in consumer spending. However, we believe
there is risk of pent-up demand for housing and autos, which could produce a
much more vigorous bounce in spending. Moreover, if housing indeed bottoms in
2010, this results in preserving much more household net worth. Each 1% change
in home price is $180 billion in household net worth. Thus, if home prices fall
only 5% further from here, that is nearly $1 trillion of wealth effect.
M&A accelerates, leading to • M&A activity accelerates, leading to higher target P/E. Businesses have not
higher P/Es set in motion expansion plans in 2010, which is reflected in low capex levels. The
likelihood of M&A accelerating in 2010 is high, as CEOs realize that generating
sufficient EPS growth requires acquisitions and not just organic growth (slow
GDP is in most of their forecasts, plus little expansion). Moreover, additional cost
cutting via labor cuts is limited, so future cost savings via mergers is attractive.
This likely pushes P/E multiples higher in 2010.
Accelerated inflows into equities • Investor inflows accelerate into equities pushing up multiples. 2009 saw
pushes up P/E via lower risk muted equity inflows coming in at a pace that is 50% below 2003 at $51 billion
premiums
after 30 weeks. We believe higher relative volatility of equities is behind this (see
Figure 60) and thus, see possibility of accelerated equity inflows in 2010. This
likely reduces risk premiums and thus higher P/E multiples.
Each 1% upside to GDP growth • US Economy expands at a faster pace, EPS estimates increase. Our 2010 EPS
is $4 in S&P 500 EPS. Our $80 forecast is reflecting 2010 US GDP growth of 2.5%. Each additional 1% of GDP
figure reflects 2.5% GDP growth
growth is worth about $4 in S&P 500 EPS (see “Circle of Life” dated November
20, 2009). If GDP growth reaches 3.5%, as forecast by Bruce Kasman, we
believe S&P 500 EPS could come in at $85 or higher.
Equity markets would be • We see a much stronger payrolls recovery with 3mm jobs. The improvement
surprised by a strong recovery in jobless claims, which is down 20% from its peak, is tracking more similarly to
in labor markets, above the 0.9-
1.8mm forecast by our
1973-75 and 1982-83, and coupled with the surge in US unemployment above the
Economists. This would drive up rest of the world, suggests US labor markets could surprise in 2010. This could
EPS estimates but also reduce represent upside to our GDP forecast as well as accelerate reductions in risk
risk premiums, thus pushing up premiums, pushing up P/E multiples.
P/Es
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The Base Case: 3.6% GDP growth in ’10E

Following the deepest recession in the post-WWII U.S., the U.S. economy finally
began expanding in mid-2009, reflecting the successful policy actions of U.S. and
global gov’ts and central banks. J.P. Morgan economists forecast roughly 3.6% GDP
growth in 2010 (4Q/4Q), with 2010 reflecting changes in corporates and households
toward expansion (see Figure 9).
The profile of growth in 2010 is a contrast with 2009

Basically, the story of 3.5% GDP growth in 4Q09E was really that of inventory
drawdowns, but as that pace slowed, it became additive to GDP by 90-180bp. In
2H09, net trade was actually a drag, and equipment investment (capex) was only
modestly bouncing off a low.
2010 growth is driven by capex, housing, export and inventory builds in 2H

The details of Bruce Kasman’s GDP forecast are shown in Figure 9 below. We
achieve 3%-4% growth consistently in 2010, driven by expansionary behavior of
businesses, households and the global economy. As we mark in Figure 9 below,
capital spending is forecast to grow 6%-8% (seasonally adjusted annual rate, or
SAAR). Housing construction grows 15%-20% SAAR. Exports should see strong
The Base Case: 3.6% GDP growth in ’10E

double-digit gains, leading to a positive net trade contribution. And, as a result,
domestic final sales are consistently in the 2.7-3.1% SAAR range.
Figure 9: Base Case of US Economic Outlook for 2010

Percentage change over previous period; seasonally adjusted annual rate
1. Capex
2. Housing
3. Exports
4. Final sales
Source: J.P. Morgan estimates. From "US Weekly Prospects," dated November 27, 2009, by Bruce Kasman.
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2010E GDP growth of 3.6% 4Q/4Q is weak relative to prior deep recessions . . . .
The projected 3.6% growth is a roughly 0.9 ratio to the magnitude of the GDP
decline since 2008 (see Figure 10). We have boxed in the four prior severe recessions
(greater than a 2.5% peak-to-trough decline) and, as shown below, the first-year
expansion is typically 1.9x-2.7x the contraction. In other words, the bigger the
decline the greater the recovery.
As discussed by Bruce Kasman, J.P. Morgan Chief Economist, in the 2010

Economic Outlook, while 3.6% GDP growth is certainly one of the strongest growth
rates since 2007, the recovery is forecast to be hampered by levered household
balance sheets, fragile financial system stability, and extreme caution by corporates.
In other words, the severity of the financial crisis seems to be inhibiting the more
robust rebound seen in prior downturns.
Figure 10: 2010 Recovery is ANEMIC vs. past DEEP DOWNTURNS . . . .

US Contractions and Recoveries since WWII. % change cumulative.
Deep downturn
Deep downturn
Deep downturn
Deep downturn
Source: J.P. Morgan. From “2010 Economic Outlook,” dated November 27, 2009, by Bruce Kasman.
This GDP outlook produces closer to a “jobless” recovery . . . .

3.6% GDP growth is likely to Using this base case, unemployment in the U.S. is expected to modestly improve
produce 0.9-1.8mm jobs in 2010, from the current 10.2% to 9.8% by the end of 2010. According to Michael Feroli,
or 75,000 to 150,000 per month
J.P. Morgan Economist, 3.6% GDP growth is likely to produce 0.9-1.8mm jobs in
2010, or 75,000 to 150,000 per month.
• Hardly a barnburner, and really only a dent in the cumulative 8mm jobs lost
during the downturn.
Households and small-biz face headwinds of tight credit, deleveraging
Relative tight credit conditions will likely weigh on both households and small-
businesses, both of which rely heavily on consumer credit (the vast majority of
small-biz is funded by credit cards and loans < $100k). Until banks see a pronounced
reversal in business trends (i.e., unemployment improving) and as long as households
remain cautious, the amplification provided by credit is largely absent. Moreover, it
is still unknown whether there is a “new” normal or whether the “old” normal returns
in terms of household behavior.
Little risk of inflation, but oil and dollar are potential risks
Core inflation typically slows even during the first few years of an expansion,
according to Bruce Kasman, J.P. Morgan Chief Economist, as high rental vacancies
(which goes into “owners’ equivalent rent”), high unemployment and low capacity
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utilization rates imply little inflation risk. There are some potential risks to inflation,
however:
• Surges in commodity prices affect inflation, albeit with a delay, and the
possibility exists given the global synchronized recovery and anticipated resource
usage. Surging commodities are more likely to create another recession (growth
risk) rather than inflation.
• Further weakening of the dollar (see below) is a risk as well. There has been a
strong linkage between dollar/renminbi (yuan), and as China’s currency devalues,
we see competitive devaluation among other EM currencies. Consequently, there
has been little inflationary pressure “imported” to the US via a weaker dollar.
Fed remains on hold
Our forecast, for a Fed hike sometime in 2011 (by 1H), is consistent with the GDP
growth scenario forecast in the base case (little inflationary pressures and high
resource slack). Market expectations have also been pushing out toward 2011.
Dollar expected to remain weak for most of 2010

A major story in 2009 has been the weakness of the dollar, which is on track to
decline 12% for the decade, its worst performance since the 1970s. The combination
of Fed policy rates, negative foreign direct investment (FDI) flows, and international
M&A has produced the weakness. John Normand, J.P. Morgan’s FX strategist,
believes the 2010 outlook for the dollar is challenging for a number of reasons: (i)
the US recovery is mostly discounted; (ii) the dollar is already cheap.
• His forecasts for the USD against other currencies are summarized below (in
Figure 11), and his target is for the Dollar Index (DXY Index <<GO>>) to fall to
69.3 from 75.1 currently.
• This would represent a new low for the dollar. In fact, he sees the risk of an
“undershoot” given the extreme rate environment we are in.
Figure 11: 2010 Dollar forecast: Strengthening late-2010 . . .
Exchange rate vs. Dollar
Source: Global FX Strategy 2010 by John Normand, dated November 24, 2009.
Barring a full-blown dollar crisis, the above forecast is arguably positive for S&P
500 profits (generated outside US) and hence helpful for equity valuations. But of
course, forecasting currency movements is notoriously difficult.
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Reality check: 3 Ingredients for Upside

A broadening US recovery
Broadly, the US economy is strengthening. In Figure 12 below, we have highlighted
the current state of nine indicators of economic activity (and three macro series)
relative to their business-cycle peak and trough. We have sorted these by their move
from the trough to illustrate the robustness of their recovery.
• Topping the list is the recovery in the Architectural Billings Index, which is up
39% from its low and has now recovered 46% of its decline from peak (right
column). This index fell 46% from peak to trough and at the current level stands
at 75% of its prior peak.
• Containerboard has also improved and recovered 41% of its decline. As Claudia
Shank-Hueston, J.P. Morgan Paper and Packaging Analyst, notes, containerboard
is a real-time ticker tape of the US economy, as corrugated boxes are rarely kept
in inventory. Containerboard fell 27% from its peak and now stands at 83% of its
prior peak.
Figure 12: Economy has shown signs of life in ’09
Various
Peak to % Rise
Peak Trough Current Trough % Trough as from Current as % % of Decline
Reality check: 3 Ingredients for Upside

Units Level Level Level Decline % of Peak Trough of Peak Recovered
Micro-Economic Indicators
Architectural Billings Index index 61.2 33.3 46.1 -46% 54% 39% 75% 46%
New Home Sales Homes (000s) 1,389 329 430 -76% 24% 31% 31% 10%
Airfreight Freight Revenue Ton Miles (000s) 1,130,013 775,530 910,799 -31% 69% 17% 81% 38%
Airline Passengers Passenger Enplanements (000s) 45,682 32,346 37,689 -29% 71% 17% 83% 40%
Container Board Shipments Billions of square feet 35.4 26.0 29.9 -27% 73% 15% 84% 41%
Auto Sales New car sales units (mm) 20.6 9.1 10.5 -56% 44% 15% 51% 12%
Lumber Volume Shipments 373.6 166.5 191.0 -55% 45% 15% 51% 12%
Rail Volumes Actual Carloads 697,055 525,733 584,955 -25% 75% 11% 84% 35%
Remittances to Mexico Volume (mm) 2,637 1,572 1,692 -40% 60% 8% 64% 11%
Broad Indicators
Exports $b 1,913 1,494 1,622 -22% 78% 9% 85% 31%
Industrial Production index 112 96 100 -15% 85% 5% 89% 28%
Retail Sales $b 272.9 242.5 250.1 -11% 89% 3% 92% 25%
Source: J.P. Morgan, Bloomberg, and Datastream.
Still, broad-based measures of activity have risen double digits from lows . . . .
Taken as a whole, these measures of broad economic activity, from ABI, to
containerboard, to rail volumes, have all risen double digits from their lows. In fact,
Tom Wadewitz, J.P. Morgan Rails and Trucking Analyst, notes that both October
and November have seen a meaningful improvement in international airfreight
volumes to the US, which he sees as an early harbinger of the sustained recovery.
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How to get this economy strengthening beyond a bounce?

But a bounce off the bottom neither is a sustained recovery nor tells us the magnitude
of the subsequent recovery. In our view, a stronger US recovery stems from the
positive reinforcement of three elements, as shown in Figure 13 below:
Figure 13: Virtuous Circle of Demand, Liquidity, and Expansion

The self-reinforcing interaction of the ingredients
Pent-up
Demand
Strong Easing
Jobs gains Credit
Source: J.P. Morgan.
1. Pent-up demand. Of course, innovation or a new secular theme could be the

next driver of demand. But for our analysis, the question we ask ourselves is
whether there is any “pent-up” demand created during this recession. We believe
there is evidence of pent-up demand in housing, autos, capex, and retail sales.
2. Easing credit availability. As many are aware, credit standards and availability
remain tight, a result of the crisis, weakness in housing and commercial real
estate, and uncertainty about the durability of the recovery. Moreover, demand
from credit is low as few businesses have expansionary mindsets. As pent-up
demand emerges, corporate confidence should improve, boosting demand, while
trends reinforce easing credit.
3. Expansionary behavior via jobs gains. As businesses begin to respond to
improving demand, they begin expansionary behavior, which in turn entails
hiring. For a variety of reasons, we believe an above-trend economic recovery
could set the stage for a strong rebound in jobs greater than the 900k-1.8mm
gains forecast by our Economists.
This virtuous and sustained recovery requires all three elements to trend positively.
In the following Sections, we discuss our outlook for each of these three factors.
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Ingredient 1: Pent-up Demand? Yes

Probably one of the more frequent questions we get asked is whether there is any
pent-up demand in the economy. Even with unemployment at double-digit levels and
total employment down 7% from its peak, we believe several areas of the economy
have seen depressed spending, which after several years of below-trend levels, likely
creates pent-up demand. We have selected four areas, and others likely exist, to
illustrate the potential pent-up demand. The analysis is summarized in Figure 14
below.
• For instance, on housing, historically, the US built 10.7 homes for every 1,000
people greater than age 19. We use age 19 as the threshold to consider it as a
measure of the addressable market (people who could have jobs). Since 1999, this
ratio has been lower, at 7.4 per 1,000 eligible people. Currently, this ratio is 2.4,
or well below average since 1999. In total unit terms, this is 529k (current rate of
annual new home starts) vs. 1.7 million implied by historical trend.
We discuss these areas more fully in the following pages.
Figure 14: Four areas of potential pent-up demand . . .

Various
Implied pent-up demand… % upside
Current Low Mid High Mid vs
Ratio Long-term avg Latest ratio run-rate Units -1 std dev LT avg +1 std dev current
Ingredient 1: Pent-up Demand? Yes

Housing starts Housing starts/ 1,000 7.4 since '90 2.4 529k homes/ year 1.3mm 1.6mm 1.9mm 216%
people (>age 19) 10.7 since '47
Automobile sales Auto sales/ 1,000 people 81 since '76 49 10.9mm SAAR 16.1mm 18.0mm 19.9mm 65%
(>age 19)
CapEx Fixed investment / GDP 7.1% since '47 6.3% $898 billion $/ year $900 billion $1.1 trillion $1.22 trillion 18%
aka CapEx as % Sales
Retail sales % of disposable income 29.6% since '92 27.3% $3.0 trillion $/ year $3.3 trillion $3.4 trillion $3.5 trillion 13%
ex-Autos
Source: J.P. Morgan estimates, Census Bureau, BEA, NAR.
We are not saying the whole US economy is a coiled spring . . . .

No doubt, there is a lot of slack in the US economy, and areas of excess capacity,
such as mall space and housing in remote areas, may not fully recover in the next
five years. But at the same time, we need to be mindful that pent-up demand exists at
the end of every recession.
Addressable Population (>age 19) expanding thru 2014 . . . .

Currently, the total US population is 308 million (growing about 3mm per year). Of
this total, 223 million are over the age of 19, which one could assert is the
addressable population for housing (can have a full-time job) and automobile
purchases (16 could be the threshold, but 19 is more conservative).
23
(1-212) 622-6505 10 December 2009
In our view, it is helpful to consider the outlook for the growth of this population
pool. Using data from the Census Bureau, we have detailed the Census Bureau
forecast for this population thru 2014. Projecting populations over the next 5 years is
fairly reliable as this figure simply reflects the vintaging of various age groups
adjusted for death and immigration.
• As shown in Figure 15 below, this pool is projected to be 13.1mm higher by

2014, or to increase by 6%, which means the addressable market for products
such as housing, automobiles, etc., is organically higher by 6%.
• This is the highest 5-year increase since 1984, a 30-year high. The rate of growth
of this population pool is increasing at a faster pace. As shown in Figure 15, this
pool has been seeing 5-year increases of 11.8mm recently, but this 5-year
absolute increase is accelerating and projected to reach 13.1mm by 2014.
This is above the 12.6mm increase seen in 2002, and at that time, auto sales were
18mm, and housing starts were well over 1.5mm. In other words, this rising
population pool should further advance the notion that pent-up demand exists.
Figure 15: US Eligible Population (>age 19) is set to expand thru 2014 . . . .
13.1mm increase
Pops in millions
250 223.3 236.4 16.0
5-y r chg (>age 19)— right scale
15.0
230
Population (age >19) in millions
210 15.0
5Year Change in Pop (age >19)

Population (age >19) — left scale
190 Rising…
13.6
14.0
170 A 30-year high in terms of 5-yr increase
13.1
12.6
12.5
150 13.0
12.4
12.3
12.1
130
11.8
110 12.0
90 11.0
70
10.1
50 10.0
1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014
Forecast
Source: Census Bureau and J.P. Morgan
Housing Starts: 529k below LT trend of 1,675k

After five years of the major correction in the US housing market, one is tempted
wonder if the US will ever build homes again. Of course, that is a bit of an
exaggeration as US housing starts have been running at around 529k per year. But
that is well off the 2mm plus level of starts seen as recently as 5 years ago.
All of those excess homes built are being absorbed as vacancy rates down . . . .
Fortunately, the vacancy rate of US homes is coming down. After peaking at 2.9% in
March ’08, this ratio has been improving and currently stands at 2.6%. It needs to fall
an additional 80bp to reach the 1.8% levels seen in most of the last 50 years, or about
another 800k-1.0mm fewer homes need to be absorbed. Each year, we estimate that
household formation is about 1.5-1.7mm (see Figure 18); thus, this implies about
another 6 months of household formation should help reduce this level of excess
vacancy.
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Figure 16: US Homeowner Vacancy rate have been falling since March 2008 . . . .
% of US homes, updated on a quarterly basis. Since 1956
Peak Mar ’08 @ 2.9%

Current @ 2.6%
Source: Census Bureau. Bloomberg.com HVRAHOME Index GP <<GO>>
US housing starts could be 7.4 per 1,000 people (>age 19)

For our purposes of housing demand, we chose to look at housing starts, as this is the
metric that most benefits the US economy via construction activity. As for our own
ratio, we decided to look at eligible population, or those in the US age 19 or higher
(can have a full-time job). This is our addressable population, and according to the
Census Bureau, there are 223 million in the US over age 19.
• As shown in Figure 17 below, the long-term ratio of housing starts to US

population (>age 19) is 12.3, but since 1999 it has been lower at 7.4 per 1,000
eligible Pops.
• Recently, this ratio has plunged to 2.4, meaning we are only building 2.4 homes
for every 1,000 potential buyers, while the trend ratio is 7.4.
Figure 17: Pent-up demand: Housing Starts per 1,000 capita should be 7.4 vs. 2.4 currently
Housing starts SAAR, Addressable population = Age > 19
25
Housing Starts ABOVE Avg.
Babyboom homeownership...
Housing Starts/1000 Pop (age >19)
20
Housing Starts rise due to an

increase in 2nd home purchases...
15
Av g: 12.3
Av g: 10.7
10
Av g: 7.4
Housing Starts per 1000 Pop (age >19)
5 Av g since '90
2.4
Av g '47-'90
Av g since (1947)
0
1/47 1/51 1/55 1/59 1/63 1/67 1/71 1/75 1/79 1/83 1/87 1/91 1/95 1/99 1/03 1/07 1/11
Source: Census Bureau and J.P. Morgan.
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Housing starts have plunged for a number of logical reasons. There was a boom in
homebuilding that ended in 2006, but as the surge in vacancy rates in Figure 16
above shows, there were more homes than buyers. The steep rise in home prices
made affordability unattractive for many Americans while financing essentially
disappeared as the securitization and traditional lending markets dried up.
As US Population expands, normalized starts is 1.670mm

But demand for households, or rather, household formation, continues, a function of
the ever-expanding US population. That is the virtue for the US. By our estimate, the
eligible population is also growing each year, by about 2.6 million.
• Thus, applying this long-term ratio of 7.4 (we used the more conservative ratio
since ’99) suggests that the US should be building 1.670mm homes annually. In
fact, 1 standard deviation is 303k.
• In other words, housing starts could rise 200%+ from the 529k recently to meet
the trend level of 1,670mm.
Figure 18: Housing starts. 2010 Normalized (using ratio since ’90) is 1.670k . . .
Long-term housing starts per 1,000 capita (>Age 19) x US eligible population (>Age 19) +/- 1 std deviation
3,500
+/- 1 std dev of trendline since '90
3,000 Housing Starts (actual)
Housing Starts (trend since '47)
2,500
+1Std:
Housing Starts (in '000)
1,975k
2,000
Trend '10:
1,670k
1,500
-1Std:
1,000 1,370k
10/09,
500
529
0
1/47 1/52 1/57 1/62 1/67 1/72 1/77 1/82 1/87 1/92 1/97 1/02 1/07 1/12 1/17
Source: Census bureau and J.P. Morgan.
Autos: Trend demand is 18.0 million saar

Auto sales plunged in late-07 when availability of financing contracted as
securitization markets froze. In the meantime, the plunge in US auto sales caused
inventories to surge and put severe stress on US automakers, ultimately leading to
the bankruptcy of both GM and Chrysler. Outside the US, auto sales have since
rebounded strongly and recently surpassed prior peaks.
However, in the US, auto sales are still well off levels seen in the past 5 years (16-
18mm SAAR) and most recently were at 10.9mm. While this figure is higher than
any figure seen in 2009 (besides the two months of 11.2mm (July) and 14.1mm
(August) when “Cash for Clunkers” was in effect), a 10-11mm SAAR has not been
seen since the 1980s (see Figure 20).
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Figure 19: Pent-up demand: 47 Auto sales per 1,000 capita is way below trend
Addressable population = Age > 19
New Auto Sales per 1000 Population (age >19) Av g since (1976)
130 Cars Sold ABOVE Avg...
New Auto Sales/1000 Pop (age >19)

110
90
81
70
50 49
Cars Sold BELOW Avg...
30
1/76 1/79 1/82 1/85 1/88 1/91 1/94 1/97 1/00 1/03 1/06 1/09 1/12
The long-term trend for auto purchases per 1,000 eligible people (>age 19) has been
81 cars. The recent ratio has been 49, which is about half the pace relative to trend. In
fact, as shown in Figure 19 above, a rate of 49 cars bought per 1,000 people (>age
19) was not even seen during the 1980s. In fact, at that time, auto sales per 1,000
people were in the 50s-70s.
Applying the 81 ratio (long-term trend) to the population of 226mm (>age 19)
implies normalized auto sales in the US would be 18.0mm during 2010 (see Figure
20). Getting there requires the virtuous loop we described in Figure 13, which is
demand supported by credit availability and expansionary behavior. And auto
financing availability is linked to overall consumer credit. Financing costs are less of
an issue as rates are low for most installment products.
Figure 20: US Auto SAAR: 2010 normalized is 18.0 million saar vs. 10.9 currently . . .
Based on long-term Auto sales per 1,000 capita (>Age 19) x US eligible population (>Age 19)
+/- 1 std dev of trendline since '76 Auto Sales (actual) Auto Sales (trend since '76)
22.0
Above Avg # of Cars +1Std: 19.9
20.0 P h d
Trend '10:
18.0
Auto Saar (in millions)
18.0
16.0
-1Std: 16.1
14.0
12.0
10.9
10.0
Below Avg # of Cars
8.0
1/76 1/79 1/82 1/85 1/88 1/91 1/94 1/97 1/00 1/03 1/06 1/09 1/12 1/15
Source: Census Bureau and J.P. Morgan estimates.
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Capital spending: business holding back . . .

Businesses have been exceptionally cautious in this downturn, despite relatively
strong balance sheets. As we wrote throughout 2009, business cuts employment
aggressively and, by several measures, likely cut too many jobs (see Figure 26).
Similarly, capital spending has plunged. There are several ways to measure the
adequacy of capital spending and by multiple measures, US companies are
underspending. For instance, capex to depreciation is below 1.0 for the first time
since WWII. Moreover, capex as % of sales recently reached a 35-year low at 6.3% –
one has to go back to 1971 to find comparable levels of capex as % of sales (see
Figure 21). For our analysis, our capex proxy is Private Fixed Investment (per BEA)
and sales is US GDP.
• The long-term average of capex as % of sales is 7.1%, and we were comfortably

above that level for most of the past 35 years.
Figure 21: Pent-up demand: CapEx to Sales at lowest level since 1971
Private Fixed Investment (equipment & software) as % of GDP
Priv ate Fix ed Inv estment (equipment & softw are) as % of GDP Av g since (1947)
10%
Private Fixed Investment ABOVE Avg... 9.6%
Private Fixed Investment as % of GDP
9%
8%
7% 7.1%
6.3%
6%
5%
Private Fixed Investment BELOW Avg...
4%
3/47 3/51 3/55 3/59 3/63 3/67 3/71 3/75 3/79 3/83 3/87 3/91 3/95 3/99 3/03 3/07 3/11
Source: BEA and J.P. Morgan.
Applying this ratio to current nominal GDP implies capital spending should be $1.06
trillion, well above the current annualized level of $898 billion. In other words,
business spending should be about 18% higher than current levels.
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(1-212) 622-6505 10 December 2009
Figure 22: CapEx: 2010 normalized is $1,060 billion (saar) vs. $898 billion current
Based on long term capital spending ratio x GDP
$1,400 +/- 1 std dev of trendline since '47 +1Std:
Private Fixed Investment ($'s in billions, saar)

$1,220b
$1,200 Priv ate Fix ed Inv estment (equipment and softw are) — actual
Trend:
Priv ate Fix ed Inv estment (equipment and softw are) — since '47 $1,060b
$1,000
-1Std:
$800 $900b
$898
$600
$400
$200
$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 3/12 3/17
Source: BEA and J.P. Morgan.
Retail sales: About 13% below trend

Lastly, one might be wondering about US retail sales, excluding automobile
purchases. Consumer spending plunged in recent years, reflecting the lack of credit
availability, weakening labor markets and, of course, very weak consumer
confidence. And this rippled through many consumer sectors as demand fell.
• These factors have resulted in retail spending running at about 27% of disposable
income (see Figure 24). This has modestly improved in recent months from a low
of 26.8% in April ’09 but is still well off the long-term average of 29.6%.
To avoid double counting, this calculation is retail sales ex-autos and auto parts. The
next question, naturally, is what would be the normalized level of spending if US
households went back to their “old” normal.
Figure 23: Pent-up demand: Retail spending by households is below trend

Retail sales (ex-Autos) as % of disposable income since 1992
Retail Sales ex Autos/Parts % of Disposable Income Av g since (1992)
32%
Monthly Retail Sales as % of Disposable Income
Retail Sales as % of disposable income ABOVE Avg...
31%
30%
29.6%
29%
28%
Retail Sales as % of disposable income Below Avg... 27.3%

27%
26%
1/92 1/94 1/96 1/98 1/00 1/02 1/04 1/06 1/08 1/10 1/12
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As shown in Figure 24 below, consumer spending, after rising steadily throughout

the past two decades, plunged during the 2008 recession. And as noted in Figure 23
above, the US household ratio of spending to disposable income is well below long-
term averages.
Figure 24: Retail Sales (ex-Autos): 2010 normalized retail spending is $3,390 billion annually
Based on long term retail spending (since ’92) x disposable income +/- 1 std deviation
4,000
Retail Sales ex Autos/Parts, annualized ($'s in billions)
+/- 1 std dev of trendline since '92 +1Std: $3,475b

Trend:
3,500 Retail Sales ex Autos/Parts (actual)
$3,390b
Retail Sales ex Autos/Parts (trend since '92)
3,000 -1Std: $3,305b
$2,999
2,500
2,000
1,500
1,000
1/92 1/94 1/96 1/98 1/00 1/02 1/04 1/06 1/08 1/10 1/12
• Applying 29.6% implies that normalized retail sales should be $3.39 trillion, or
13% higher than the current level of $3.00 trillion. Fortunately, this level is up
meaningfully from a low of $2.91 trillion in early 2009.
What categories in US retail are below trend?
The next question is, Where has the US household underspent? We compiled those
statistics from the Census Bureau’s retail sales data. For this analysis, we looked at
the long-term spend in this category as % of disposable income. We compared this
long-term ratio to the current level and calculated the delta, or the difference between
the two (see Figure 25).
• For these top five categories, current spending is anywhere from 16% to 27%
below long-term levels. Flipping that around suggests the potential for double-
digit growth in those categories.
• Not surprisingly, retail spending on home products and materials is the most
below trend (2.5% vs. 3.1% LT trend) and is a function of the weak US housing
market. This again supports the common sense notion that the revival of the US
economy is dependent on pent-up demand, rising credit availability and
expansionary behavior.
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Figure 25: What category has potential pent-up demand?

Based on long term retail spending (since ’92) compared to current ratio
Retail Sales as % of Disp. Income Monthly Retail Sales ($'s in million)
Avg Avg Avg Implied
since Last Delta Delta/ Last (Long-Term
Retail Categories 1/1992 3Mos (bp) LT Avg 3Mos Trend) Delta % Chg
Building mat. and garden equip. and supplies dealers 3.1% 2.5% (57) -18% $23,348 $28,537 ($5,189) -18%
Clothing and clothing access. stores 2.3% 1.9% (36) -16% $17,417 $20,679 ($3,263) -16%
Furniture and home furnishings stores 1.2% 0.8% (31) -27% $7,747 $10,549 ($2,802) -27%
Sporting goods, hobby, book, and music stores 1.0% 0.8% (19) -19% $7,252 $8,998 ($1,747) -19%
Electronics and appliance stores 1.1% 0.9% (17) -16% $8,317 $9,872 ($1,555) -16%
General merchandise stores 5.5% 5.4% (13) -2% $49,313 $50,467 ($1,154) -2%
Food services and drinking places 4.2% 4.1% (8) -2% $37,965 $38,718 ($753) -2%
Health and personal care stores 2.1% 2.3% 20 10% $21,162 $19,286 $1,876 10%
Electronic shopping and mail order houses 1.4% 1.9% 51 37% $17,540 $12,844 $4,695 37%
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Ingredient 2: Possible Job-FUL recovery

Three reasons to consider the upside risk scenario of a
“job-ful” recovery . . .
Forecasting a complex $14 trillion economy like the U.S. is difficult, entailing both
upside and downside risk scenarios. Given the natural caution borne out the past 18
months, most investors, in our view, have more readily embraced and explored the
downside risks: CRE, linger housing problems, risks from policy normalizations, etc.
But we wonder if one scenario that might be considered is the “upside” risk of a job-
ful recovery. That is, the possibility that the GDP expansion is similarly robust to
those seen during the four prior downturns, thus producing a surge in hiring demand
by companies. We see three reasons this could be a possibility:
1. The US unemployment rate exceeded the rise in UE rates in other economies

despite the severity of the US downturn matching the rest of the world (see
Figure 26).
2. The back-to-back surge in US productivity (2Q 6.9%, 3Q 9.5%) has pushed
productivity (see Figure 27) well above trend. Sustaining this surge would
suggest US businesses permanently engineered reduced need for labor; or,
Ingredient 2: Possible Job-FUL recovery

alternatively, this surge suggests businesses have been squeezing workers and
will soon have to start hiring rapidly.
3. The rapid improvement in US initial jobless claims since the end of this recession
is tracking more similarly to the “strong jobs recoveries” of 1973-75 and 1981-82
than to the “jobless” recoveries of 1990-91 and 2001-2002 (see Figure 28).
US unemployment soared past that of Developed and Emerging markets
The global severity of this recession is well understood. Euro-area GDP fell 3.9% in
2009, worse than the 2.5% drop in the US, and many Asian/Emerging countries saw
4%-5% GDP declines. Despite the greater severity of downturns outside the US, US
labor markets absorbed larger losses.
This is apparent in Figure 26 below. Since 2003, US unemployment rates had been
much lower than those in other developed markets and in emerging markets. But
starting in mid-2008, US employment rates surged past other regions’.
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Figure 26: U.S. Unemployment rate soars: Did companies CUT TOO MANY JOBS?
Percent, SA
Unemployment rate
Percent, sa
Did US firms
cut too many US
11 jobs?
Developed excluding US
10
9
Global
8
7
6
Emerging
5
4
2004 2005 2006 2007 2008 2009
Source: J.P. Morgan. From “Daily Economic Briefing,” dated August 28, 2009, by David Hensley.
This raises the question whether US companies shed workers too aggressively in
response to the downturn. If so, they may need to rehire workers as the expansion
continues.
Productivity has shot way above trend . . . .

Within the framework of GDP concepts, companies meet output by either labor or
productivity. And of course, the known paradox is that, long term, higher labor
incomes are dependent on productivity growth (which means it steadily creeps up),
but in the short term surges in productivity come at the expense of labor.
David Hensley, J.P. Morgan Global Economist, recently wrote that on the back of the
huge 6.9%/9.5% 2Q/3Q productivity gains, “the level of productivity has made an
unusual leap higher that is hard to justify on fundamental grounds; instead, it appears
that this reflects unusual business caution, or continued problems obtaining needed
financing to expand operations in the small business sector, in the face of a rapidly
improving demand picture” (see Figure 27).
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Figure 27: US nonfarm productivity: Moving back to trend means HIRING ABOVE TREND
Index, SA
US nonfarm business productivity

Index , sa Extrapolating 2Q/3Q
growth rate
160
JPM fcst
Going back to
150 this line implies
RAPID hiring
140
130 Assumes average 2003-07 productivity gains

through 2008-10
120
110
99 01 03 05 07 09
Source: J.P. Morgan. Bars represent recessions. From “Daily Economic Briefing,” dated November 5, 2009, by David Hensley.
Hensley posits that there are some possible implications from this recent surge. One
is that this is a new paradigm and that the new line is a steeper productivity curve –
likely implausible given few companies actually permanently re-engineered their
businesses.
The base case J.P. Morgan Economic forecast assumes that from this higher plateau,
productivity resumes its more single-digit improvements. This base case produces
the improvement in labor as noted previously.
Alternately, the 2Q/3Q surge was indeed transitory and in response to tight credit
conditions. Thus, as the expansion continues, productivity returns to its prior long-
term trend. This scenario would result in a rapid hiring as companies meet production
by rehiring workers. In other words, a job-ful recovery.
Improvement in jobless claims is more similar to the “job-ful” 73-75 & 81-82
Finally, Bruce Kasman recently noted that the improvement in weekly jobless claims
(see Figure 28, 100 = 3 months before recession end) is tracking more similarly to
the 1973-75 and 1981-82 periods, which were strong GDP and jobs recoveries. This
is a sharp contrast to the more temperate recoveries seen in 1990-91 and 2001-03.
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Figure 28: Initial jobless claims improvement matches that of 73-75, 81-82 “Job-FUL” recoveries
Index, three months prior to end of recession = 100
110
100
90 Mild recovery
80
Current
70
Strong recovery
60
-3 0 3 6 9 12
Months (0 = end of recession)
Source: J.P. Morgan. From "2010 Economic Outlook," dated November 27, 2009, by Bruce Kasman. Mild recovery average
performance at the end of 2001 and 1990-1991 recessions. Strong recovery average performance at end of 1973-1975 and 1981-1982
recessions.
Incidentally, the 1973-75 and 1981-82 recoveries produced 2.8mm and 3.5mm jobs
in the first year of expansion. These figures are 1-2mm higher compared to the
forecast 0.9-1.8mm jobs projected to be created in 2010.
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Ingredient 3: Credit conditions ease

Credit availability saw nearly unprecedented tightening during this recession, a
function of the excess optimism during the 2004-2007 boom, contraction of the
securitization market, adverse global contraction and soaring unemployment. Thus, it
is logical that availability of credit is restricted, amplifying the business cycle
dynamics. And while credit availability has improved for larger corporations, it is
still very tight for small businesses and households.
We have spent some time with loan officers and those in charge of commercial
lending to better understand the roadmap to eventually ease credit availability.
• On the business side, banks are engaged in three businesses: C&I (commercial
and industrial); CRE (essentially real estate venture lending plus mortgages) and
leveraged financing.
• On the consumer side, residential (but agencies/GSE more involved) and
consumer credit (credit cards plus the majority of small biz funded by consumer
credit).
Banks are extremely risk-averse currently, mirror imaging their optimism during the
prior expansion. Demand for credit is lower, but the reality is standards for lending
are even tighter. For credit availability to broadly improve, three changes are needed:
1. Banks need to see a pronounced and persistent improvement in their credit
Ingredient 3: Credit conditions ease

portfolio. This is improvements in early warning indicators of problems, such as
0- to 60-day delinquencies. For consumer credit, as we discuss below, this has
been stabilizing and potentially improving.
2. Banks also need to see pronounced improvements in national trends
(unemployment, housing prices and consumer confidence). Historically, credit
quality has turned coincident with those broader indicators. Unemployment rates
are forecast to peak early in 2010. And our ABS team believes both residential
and commercial real estate likely bottom in 2010, thus setting the stage for
national trends to improve.
3. Their customers have to become expansionary. Businesses are exceptionally
cautious and likely “fighting” any inclination for expansion, worried about a
double dip and lingering concerns about the crisis. But as national employment
improves and consumer confidence strengthens, businesses are likely to consider
expansion and hence improve demand for credit.
We believe all three conditions are likely to see pronounced improvements in trends
in 2010, thus setting the stage for credit availability to improve during the course of
2010.
Credit tight . . . but trends showing some stabilization

J.P. Morgan ABS Strategists expect the worst of the credit cycle (ABS consumer
credit) to hit in the first months of 2010, coinciding with the peak in unemployment
rates and the trough in home prices. Consumers are paying down debt (lower
demand) and tighter standards (from lenders) are dynamics that drag on overall
consumer spending. Trends in consumer credit, as we approach the peak in losses,
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(1-212) 622-6505 10 December 2009
are showing some signs of stabilization. For instance, as highlighted in Figure 29,
credit card losses (per data provided by Andrew Wessel, JPM Specialty and
Consumer Finance Analyst) are down from levels seen earlier this year, suggesting it
may be realistic to say credit losses should peak in early 2010 (as the trend already
seems better).
Figure 29: Credit Card losses peaking by early 2010E Figure 30: Early stage Credit Card delinquencies plateauing . . .
Net charge-off rate of top 6 credit cards 60-89 day delinquency rate
Source: J.P. Morgan. "Credit Card Monthly" by Andrew Wessel dated November 17, 2009. Source: J.P. Morgan. "Credit Card Monthly" by Andrew Wessel dated November 17, 2009.
Fed Reserve Snr Loan Officer Survey shows pace of credit tightness slowing
The Federal Reserve’s Senior Loan Officer Survey shows that banks are still
tightening standards but at a slowing pace. Credit will lag an overall expansion, and
this recession is definitely following that pattern, but the fact that credit conditions
are so tight does imply there is less room to tighten (the vise).
• For the 2001 recession, it took one to two years after the end of the recession for
standards to loosen, and easing credit standards was more coincident with
improving payrolls. And the current high and rising unemployment rate (we
expect it to peak at 10.2%) should make banks cautious about lending to
households, and that is apparent in the loan officer survey.
• Still, it is possible for credit standards to ease more quickly (around the turn in
payrolls, that is). In the DEEP recessions of 1973-75 and 1982-83, consumer
credit eased quickly after payrolls improved, and the percentage of those
“tightening” vs. “easing” shifted to a net “easing” very soon.
Going back to our virtuous scenario, this suggests that a positive turn in labor
markets, coupled with pent-up demand, should improve credit flow and standards
quickly.
Demand for Residential Prime Loans is rising, though . . . .

Credit demand is weak for C&I (commercial loans) and consumer credit, but it is
rising for Prime residential loans. This is not surprising given the surge in existing
and new home sales. Still, banks are tightening lending standards in this area: a net
24.1% of banks tightened standards on prime mortgages in the October survey,
compared to 21.6% in the July survey and 49.0% in the April survey.
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Figure 31: Domestic Banks tightening standards for Consumer Loans Figure 32: Domestic Banks’ willingness to make Consumer Installment
Net percentage loans
Net percentage
Source: J.P. Morgan. "US: Loan Officer Survey," dated November 9, 2009, by Abiel Reinhart.
Source: J.P. Morgan. "US: Loan Officer Survey," dated November 9, 2009, by Abiel Reinhart.
As noted in the Loan Officer survey, CRE challenging . . .

Credit tightening remains the most severe in CRE (commercial real estate), and CRE
historically lags the US residential cycle. The Fed recently inserted a special question
in this survey about how banks were dealing with maturing CRE loans. So far, based
on responses, banks are generally leaning toward extending CRE loans instead of
refinancing them or foreclosing. The notion being tighter financial conditions and a
drop in valuations make it harder to refinance, and foreclosing on the property would
entail selling it into a depressed market. Plus, extending a loan allows banks to sit on
loans for which the borrower can still cover the debt service, in the hope that an
eventual thawing in financial conditions or increase in valuations will lead to a more
favorable outcome.
C&I Lending still tight, but bank tightening to small biz no worse than large biz
The lending trend in commercial and industrial loans for both large and small
businesses is still tightening but at a slower pace than earlier in the year. Banks, in
general, are not tightening more for small firms vs. large firms, contrary to popular
opinion. The net percentage of domestic banks that tightened standards on C&I loans
to small and medium businesses was 14.0% compared to 31.5% in the July survey,
and the net percentage of banks that tightened standards on small businesses was
16.1%, down from 34.0%.
• But as we note throughout this report, small business funding is also via financing
entities such as CIT and GE Capital, and in the case of small business, via credit
cards and consumer credit. Thus, the tightness in consumer credit impacts
disproportionately small business.
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Figure 33: Domestic Banks tightening C&I loan standards Figure 34: Domestic Banks reporting stronger demand for loans
Net percentage Net percentage
Source: J.P. Morgan. "US: Loan Officer Survey," dated November 9, 2009, by Abiel Reinhart. Source: J.P. Morgan. "US: Loan Officer Survey," dated November 9, 2009, by Abiel Reinhart.
Bottom in US housing market bottom in 2010 expected . . .

Hard as it may be to believe, the US housing market is likely nearing a bottom (in
terms of price) after falling 33% from its 2006 high to April 2009, based on the Case-
Shiller 20-city index. As shown in Figure 35 below, since the April ’09 low, home
prices are up 5% (to $146.5k), but our ABS Strategists believe this is a seasonal
reprieve further supported by a moratorium on foreclosures.
• John Sim, JPM ABS Strategist, forecasts home prices to fall a further 8% from
current levels, establishing a bottom in 1Q10 (see Figure 35) and resulting in a
cumulative 35% peak-to-trough decline.
Sim still sees a substantial wave of residential foreclosures ahead, and he estimates
this “shadow” inventory may be up to 7mm homes. Despite this looming foreclosure
wave, he sees home prices bottoming in 1Q10. We discuss this in a later section.
Figure 35: Home prices set to bottom in 2010E . . .

Case-Shiller Composite-20 city home price
Jul ’06 @ $206.5
Sep ’09 @ $146.5
8% drop
1Q’10 @ $135.5
Source: Bloomberg. SPCS20 Index <<GO>>
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(1-212) 622-6505 10 December 2009
The dynamics in the US housing market have improved sharply in 2009 compared to
2007 and 2008. The pace of existing and new homes sales has improved (demand
side) while the inventory of existing homes for sale is down 1mm to 3.574mm from
4.575mm (mid-’08) and the months’ supply has fallen to 7.0 months from 11.3
months in April ’08 and nearing the crucial equilibrium 5.5 months level. The drivers
for this improvement are multiple: (i) record-low mortgage rates; (ii) 33%-plus
decline in home prices; (iii) realistic sellers, particularly banks and lenders, with
foreclosures and distress accounting for 50% of sales.
Foreclosures still loom

According to Moody’s Economy.com, an estimated 15mm homeowners have
negative equity, or 11-12% of all homes in the USA. This figure is much higher in 6
states, running at 30%-60% for CA, AZ, NV, FL, MI, OH and GA based on data by
Thomas Eggleston, Benham REO Group.
• Foreclosure filings run at about 340k per month, or about 3.5-4.0mm annually at
the current pace. The vast majority of foreclosures are for loans originated in
2005-2007, representing 91% of foreclosure sales in California alone
(Foreclosure Radar). REO (real estate owned) sales are running at a slower pace,
about 51k per month, or 600k annually. For the past year, according to
Foreclosure Radar, it has taken a bank about 7.33 months to dispose of a
California home.
Buyer interest is still high for foreclosures, and in CA, there are an average of 15-30
bids per foreclosure, supporting the notion that home prices have reached a healthy
clearing level. Foreclosures still represent a substantial share of all real estate sales.
JPM Securitized Research believes there are 7mm homes in shadow inventory
J.P. Morgan’s Securitized Product Research team sees a substantial backlog of
shadow inventory. By its estimate (see “MBS and ABS Dec Conference Call,” dated
December 4, 2009), it believes there are 7mm homes in “shadow” inventory, defined
as:
• Existing foreclosures 2.5mm;

• Expected defaults through 2012 2.1mm;
• Expected redefaults on loan modifications thru 2012 2.4mm.
Despite this rather sizable figure, JPM SPG believes homes prices can bottom in
1Q10. The reason is these foreclosures take time to transition from foreclosure to
REO (real estate owned) and ultimate sales, thus do not flood the market. For its
forecast for foreclosures, see Figure 36; for REO, see Figure 37.
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(1-212) 622-6505 10 December 2009
Figure 36: Projected Foreclosure Inventory Figure 37: REO (Real Estate Owned) Inventory
Projected (mm) Projected (mm)
Lower by 2012 despite 7mm
“shadow” inventory….
Mods slow pace REO builds…
Source: J.P. Morgan ABS Research (“MBS and ABS Monthly Call" dated Dec 4, 2009) and Loan
Performance. Source: J.P. Morgan ABS Research (“MBS and ABS Monthly Call" dated Dec 4, 2009) and Loan
Performance.
Foreclosure inventories falling thru 2012, even as “shadow” looms

By 2012, foreclosure inventory is As shown in the above (see Figure 36), provided by John Sim, because of the
expected to contract to 1.5mm relatively measured pace of foreclosures, the actually inventory level is expected to
from the current 2.5mm or so
steadily decline, under both scenarios of either continued modifications or no-mods.
By 2012, this inventory is expected to contract to 1.5mm from the current 2.5mm or
so.
Banks’ REO Inventory is projected to swell during this time, rising from 500k
currently to 1.5-3.0mm by 2012. The sizable variance, as noted in Figure 37 above,
reflects the benefit from modifications (HAMP, etc.). Sim and the ABS team
estimate that there will be 4mm modifications over the next three years (3.25mm
HAMP, 0.75mm non-HAMP), and they expect about 60% to fail. Modifications
which fail occur at a later date, which slows the pace of inventory build of REO.
Our takeaway from this analysis is that, despite the heavy foreclosure wave ahead
and the shadow inventory, home prices are still likely to bottom in 1Q10.
CRE potentially stabilizes in 2010

Fundamentals in commercial real estate (CRE) should deteriorate in 2010, with a
growing number of maturing loans (which have refi difficulty) adding a layer of
stress to the market compared to 2009 (which was mostly about rents under
pressure). CRE historically lags the residential housing cycle and the economy with a
15-month lag.
While fundamentals likely deteriorate, even for as much as six additional quarters,
Alan Todd, JPM CMBS Analyst, believes CRE prices are nearing a bottom with
another 5-10% further decline before a slow recovery occurs (see “2010 CMBS
Outlook,” dated November 27, 2009). The reasoning being he sees the elements for a
bottom forming:
• Private market buyers have been returning to the market, and these typically have
the most detailed knowledge of the properties and local economy. In 2009,
private market buyers were up to 50% of all transaction volumes vs. 37% in
2007-2008.
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• Transaction volumes have been increasing, rising 2% in 2Q09 and 24% in 3Q09.
Recently, offered transaction volume has been running at $20b/quarter. While an
improvement, it is still well off the $120-140b per quarter in 2007 or the $40-50b
per-quarter levels of 2004-2005.
• The last piece is prices have to reach a sufficiently low level that not only is the
fundamental value attractive (NOI) but an “illiquidity” discount exists. This is
estimated to be based on a 40%-50% drop from peak prices. Currently, CRE has
fallen 43% from its peak.
Michael Gilberto, JPM Asset Mgmt Real Estate Portfolio Manager, similarly sees
CRE in the stages of recovery and, in fact, believes that private market pricing
reverts to equilibrium (read better prices) by 2011-2012 (see Figure 38).
Figure 38: Per J.P. Morgan Asset Management: 3 Stages of CRE Recovery
From "Commercial Real Estate Update" dated October 2009
Source: “Commercial Real Estate Update,” dated October 2, 2009, with data from Michael Giliberto, J.P. Morgan Asset Management.
Gilberto believes CRE created less excess capacity in the past decade. An example is
shown in Figure 39, which shows office construction in the past decade was much
lower than the pace seen in the ’70s, ’80s or even early ’90s. This is borne out in
office vacancy rates, which are still well off their 20-year highs. For instance,
downtown LA vacancy rates were recently 13% (up from 9%) but still well off their
20-year high of 22%.
Figure 39: Per J.P. Morgan Asset Management: Office construction modest in past decade
From "Commercial Real Estate Update" dated October 2009
Source: CoStar, TortoWheaton, “Commercial Real Estate Update,” dated October 2, 2009, with data from Michael Giliberto, J.P.
Morgan Asset Management.
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Commercial real estate prices underwent a severe price adjustment in the past two
years, steeper than in past cycles. For instance, beginning in 2008, prices took only 4
quarters to fall 35% compared to the 24 quarters it took in the period beginning in
1989 (see Figure 40). Similarly, yoy declines have been 37%, resulting in CRE’s
peak to trough already matching that seen in US housing (per Case-Shiller) as shown
on Figure 41.
Figure 40: CRE Price Adjustment Rapid this cycle Figure 41: CRE Price declines caught up to US housing
From "Commercial Real Estate Update" dated October 2009 From “2010 CMBS Outlook” dated November 27, 2009.
Source: J.P. Morgan, S&P, Case-Shiller, Moody’s.
Source: NCREIF, “Commercial Real Estate Update,” dated October 2, 2009, with data from Michael
Giliberto, J.P. Morgan Asset Management.
Lack of liquidity drove collapse in CRE prices, buyer liquidity reviving market
Fundamentals have been playing out better than expectations, which suggests that the
collapse in prices anticipated much greater negative outcomes. Alan Todd estimates
that property-level NOI should decline a cumulative 15% from peak in 2007 to 2010.
This decline is not as steep as the decline seen in CRE prices. Liquidity in debt
markets, particularly CMBS, was helped by TALP, PPIP, and by the broader
liquidity initiatives seen in the past 18 months.
• If CRE prices indeed bottom in 2010, this would be a positive outcome relative to
market expectations and likely improve credit availability and also represent a net
positive to bank balance sheets.
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Our ’10E/’11E is above Consensus

Street is too conservative
Historically, the Street has tended to underestimate earnings recovery - an intuitive
response and consistent with tempered expectations that typically develop at the
trough in the business cycle. We are seeing the same pattern in the outlook for 2010
earnings.
• The average top-down Strategy estimate for S&P 500 EPS in 2010 is currently
$72.33 (Bloomberg NI WGT <<GO>>). This is an improvement from the $65
Street top-down estimate back in June, but we believe $72 is still too conservative
an estimate.
• Based on our analysis of the relationship between GDP growth and S&P 500
earnings growth, the 3.5% GDP growth forecast by JPM Economics for 2010
suggests that S&P 500 EPS should be $84 in 2010 (see “Circle of Life: Raising
YE09 Target to 1160; Raising ’10E EPS to $80; Pro-Cyclical Bias into YE” from
11/20/09).
Figure 42: 2010E S&P 500 EPS: JPM vs. Consensus
$ per share
10 S&P 500 EPS Forecast Firm
$80.00 - $82.49 JPM

77.75 - 79.99
Our ’10E/’11E is above Consensus

75.50 - 77.74 CS GS
73.25 - 75.49
71.00 - 73.24 BoM C BAC RBC
68.75 - 70.99 MS
66.50 - 68.74 DB
64.25 - 66.49
62.00 - 64.24
59.75 - 61.99 Barclays
Source: Bloomberg NI WGT <<GO>>/
Details of our 2010E/2011E EPS of $80/$90

Financials major driver of profit improvement
The 2009 story on Corporate profits was one of extreme cost-cutting measures (read
as record payroll contractions), which, coupled with changes in currency and interest
rates, enabled S&P 500 companies to generate an impressive level of EPS at the
business-cycle trough. In fact, as we noted in prior reports, about 25% of companies
in 3Q09 generated record 3Q profits.
• From this higher baseline of earnings, which for 3Q09 annualized is $67.12
($16.78 x 4), we believe companies can not only defend this higher level of EPS
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(1-212) 622-6505 10 December 2009
but also generate historical incremental net income margins on the increase in
GDP (which boosts revenues).
• The bulk of the 2010E EPS increase is in our forecasts for Financials ($11.87),
Energy ($10.66), and Industrials ($7.50). In many ways, we believe this estimate
is arguably conservative, as it is below the EPS implied by the historical
relationship between S&P 500 EPS and GDP growth of $84.
• Not surprisingly, “pro-Cyclical” Sectors are forecast to show the strongest EPS
growth – Cyclicals with 19%-73% projected growth (2010 vs. 2009), Energy (up
61%), and Financials (up 70%). By comparison, the projected EPS growth from
Defensives is relatively pedestrian, ranging from flattish to +8%.
We are introducing a 2011 EPS forecast of $90, which is a 12% increase over
2010E EPS. This remains below the $92.15 peak EPS seen in 2007 (LTM thru
2Q07) and is driven again primarily by Cyclicals posting teens EPS growth.
Figure 43: JPM 2010/2011 S&P 500 EPS Forecast

$ per share
JPM Top-Down Estimates
Delta '10E/ '09E Delta '11E/ '10E
JPM
Strategy FY FY FY FY $ % FY $ %
Rating 2007 2008 1Q09 2Q09 3Q09 4Q09E 2009E 1Q10E 2Q10E 3Q10E 4Q10E 2010E chg chg 2011E chg chg
Cyclicals
Materials OW $2.87 $2.57 $0.20 $0.32 $0.41 $0.33 $1.25 $0.57 $0.62 $0.50 $0.47 $2.17 $0.92 73% $2.50 $0.33 15%
Industrials OW 9.57 9.41 1.48 1.68 1.45 1.70 6.32 1.48 1.71 2.06 2.24 7.50 1.18 19% 8.50 1.00 13%
Discretionary OW 6.62 3.07 0.11 1.31 1.66 1.62 4.70 1.41 1.67 1.79 1.93 6.80 2.10 45% 7.50 0.70 10%
Technology OW 11.48 11.62 2.23 2.37 3.03 3.54 11.17 3.06 3.24 3.46 3.99 13.74 2.57 23% 16.00 2.26 16%
Defensives
Staples UW $8.33 $8.97 $2.01 $2.30 $2.45 $2.52 $9.28 $2.18 $2.49 $2.60 $2.59 $9.85 $0.57 6% $10.50 $0.65 7%
HealthCare N from UW 10.28 11.10 2.94 2.84 2.68 2.55 11.01 2.81 2.97 3.04 3.04 11.87 0.85 8% 12.50 0.63 5%
Telecom N 3.20 2.91 0.64 0.62 0.55 0.53 2.35 0.56 0.57 0.58 0.59 2.31 (0.04) -2% 2.50 0.19 8%
Utilities UW 2.97 2.93 0.83 0.68 0.97 0.61 3.09 0.80 0.68 1.04 0.73 3.24 0.15 5% 3.50 0.26 8%
Other
Energy OW $13.35 $16.11 $1.53 $1.50 $1.66 $1.93 $6.62 $2.21 $2.49 $2.90 $3.05 $10.66 $4.04 61% $12.50 $1.84 17%
Financials OW 15.90 (6.84) 0.85 2.42 1.91 1.81 6.98 2.24 2.67 3.24 3.72 11.87 4.88 70% 14.00 2.13 18%
S&P 500 $84.56 $61.85 $12.83 $16.03 $16.77 $17.14 $62.78 $17.32 $19.11 $21.22 $22.35 $80.00 $17.23 27% $90.00 $10.00 12%
S&P ex-Fin 68.66 68.69 11.98 13.61 14.87 15.34 55.79 15.08 16.44 17.98 18.63 68.14 12.35 22% 76.00 7.86 12%
Source: J.P. Morgan, FactSet, and Thomson Director's Report.
SANITY CHECK: S&P 500 Has Typically Reattained Peak

Profits within 12 Months Post Trough
For some reason, investors seem to view 2007 earnings as a “high water” mark that
likely will not be achieved again for years. Granted, we understand that the US is
emerging from its most severe recession since WWII, but the fact is that earnings are
already staging a strong recovery.
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As shown in Figure 44, following a trough in the business cycle, it has been the norm
for the S&P 500 to reach its prior peak within 12 months. This context would suggest
that S&P 500 profits could reattain the 2007 peak sometime in the middle of 2010.
• Our revised 2010 EPS estimate implies that S&P 500 profits will not achieve the
prior peak until 2011, or 18 months after the business cycle trough. This is more
similar to the corporate profit recovery of 2002 (which took 24 months) and, in
our view, suggests that even our $80 estimate could be conservative.
Figure 44: In Past Recoveries S&P 500 Has Reattained Peak EPS in Less than 12 Months . . . .
Net Income for all sectors ($ billions)
18Mos
$1,000,000 24Mos 4/11
Net Income all Sectors (in 000's)
2/04 9/09
12Mos 2/02
12Mos 1/93
$100,000 12/86 1/92
6Mos 12/85 U-shaped GDP… thus took
longer for EPS to recov er
3/76
9/75 V-shaped GDP…
thus, steep EPS
$10,000
1/73 1/76 1/79 1/82 1/85 1/88 1/91 1/94 1/97 1/00 1/03 1/06 1/09 1/12
Source: Bloomberg, FactSet, and J.P. Morgan.
TOP LINE: Turns the corner in 4Q09, quelling criticism of

earnings . . .
S&P 500 top-line revenues have been progressively recovering. As shown below,
S&P 500 revenues should generate positive YoY revenue growth in 4Q09.
• Ex-Financials, this is modestly positive in 4Q09E but is expected to surge to 8%-

9% throughout 1H10. This suggests that many analysts and investors will begin
to view earnings results more constructively as the growth will be driven by year-
over-year gains in revenues.
• In other words, it will quell those investors dismissing results because revenues
have not been growing. That in itself was a misconception, as Q/Q revenue
growth has been improving steadily since 1Q09 . . . .
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(1-212) 622-6505 10 December 2009
Figure 45: S&P 500 Revenue Forecasts Figure 46: S&P 500 ex-Financials Revenue Forecasts
Based on First Call Bottom-up Consensus. $ billions and % change Based on First Call Bottom-up Consensus. $ billions and % change
Sequential growth in revs… Sequential growth in revs…
$2,349 $2,303
$2,261
$2,183 $2,157 $2,110 $2,166 $2,215
$2,071 $2,104 $2,105
$2,024 $2,016 $1,984
$1,945 $1,963
$1,884 $1,892 $1,892 $1,941
$1,804 $1,841
$1,739
$1,681
1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09E 1Q10E 2Q10E 3Q10E 4Q10E 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09E 1Q10E 2Q10E 3Q10E 4Q10E
9.3% 12.0% 8.9% 6.6% 8.5% 7.5% 6.9% 4.8% 12.8% 14.8% 12.9% 9.5% 8.8% 7.6% 4.9%
0.4%
-9.2% -6.7%
-10.9% -10.1%
-14.2% -14.3% -14.3%
Y/Y growth in revs… -17.4%
Y/Y growth in revs…
1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09E 1Q10E 2Q10E 3Q10E 4Q10E 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09E 1Q10E 2Q10E 3Q10E 4Q10E
Source: J.P. Morgan and FactSet Source: J.P. Morgan and FactSet
MARGINS: Employee cuts were 22% of cost savings . . . .

It is a common assertion to say companies achieved the majority of their profit
growth by cutting jobs. Our analysis suggests this notion is in fact wrong.
• As shown below in Figure 47, we estimate S&P 500 companies cut about 1.9
million workers from their payrolls since the peak in 2007. This is about 25% of
the total 7.5mm job cuts in the U.S. private payrolls (ex-Govt).
• Based on $60,000 annual salary/benefits per employee, this results in about $112
billion in pretax savings ($73 billion after-tax). Or $8.00 per S&P 500 share
benefit (from cost cutting).
Total S&P 500 cash expenses are down $508 billion since the employment peak in
4Q07. Thus, the $112 billion in employee costs reduced is only 22% of the total cost
savings. The remainder is lower volumes (thus lower COGS), lower commodity
prices (Energy is a big savings) and cost initiatives by companies.
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Figure 47: Employee cuts were 22% of cost savings for S&P 500 companies . . . .
employees in millions, $ billions except per share
Peak Now Change vs Peak
Dec '07 Oct '09 Units % chg
US private payrolls (ex-Govt, ex-Education) 112.8 105.3 (7.5) -7%
x % est employed in S&P 500 companies 25% 25%
Implied payrolls in S&P 500 companies 28.2 26.3 (1.9) -7%
Benefit to S&P 500 EPS from Job cuts

Decline in S&P 500 payrolls since 2007 (1.9)
x Est. avg annual salary + benefits $60,000
= Implied savings pre-tax from job cuts ($112)
x (1-tax rate) 65%
= Net income cost savings ($73)
/ S&P 500 Divisor * -1 9.1
= S&P 500 EPS impact $8.01
What % of cost savings were Job cuts?

Implied savings pre-tax from job cuts ($112)
/ S&P 500 cash expense (Revs less EBITDA) $7,096 $6,588 ($508) -7%
= Employee cuts as % S&P 500 expense savings 22%
Memo: S&P 500 Sales $9,068 $8,016 ($1,052) -12%

Source: J.P. Morgan estimates.
. . . thus, we believe current margins are defendable

The takeaway, in our view, is that companies have not simply wielded an axe to
achieve profit improvements. A lot of other costs were taken out of the business as
well. For instance, we highlight the income statements for two companies, TJX
Companies (TJX) and MeadWestvaco (MWV). These companies are from two
different Sectors and the reason we selected these companies is their most recent 3Q
CY09 results were record profits (see Figure 48), and compared 3Q09 to their prior
record quarter.
• Revenues were lower in 3Q CY09 for TJX and MWV compared to their prior
peak (see Figure 48) by $147mm for TJX and $51mm for MWV, or about 3%
below their peak.
• Despite that, net income for both were considerably higher at $47mm for TJX
and $13mm for MWV, or 15.6% and 11.3% respectively.
The takeaway, in our view, is that as the top line is anticipated to improve in 2010
(see our prior discussion), we similarly see many S&P 500 companies in a position to
defend their margins.
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Figure 48: Two examples of companies back at peak profits . . .

$ millions, except per share
The TJX Companies MeadWestvaco Corp
(a) (b) (a) - (b) (a) (b) (a) - (b)
FQ3 2010 FQ4 2008 Delta FQ3 2009 FQ3 2007 Delta
Revenue $5,245 $5,392 ($147) Revenue $1,627 $1,678 ($51)

Cost of Revs 3,802 4,073 (271) Cost of Revs 1,297 1,349 (52)
Gross Profit 1,443 1,319 124 Gross Profit 330 329 1
Gross Margin 27.5 24.5 Gross Margin 8.7 6.4
EBITDA 703 583 120 EBITDA 255 235 20
Net Income $348 $301 $47 Net Income $128 $115 $13
Diluted EPS Cont. $0.81 $0.65 Diluted EPS Cont. $0.50 $0.43
Source: J.P. Morgan and Bloomberg.
SANITY CHECK: Top Quartile of Stocks Already Back to

Peak Earnings
It is also helpful to look at the S&P 500 companies based on their respective profit
cycle staging (Quartiles of where their profits stand vs. the peak). The charts below
show indexed LTM earnings (100 = peak LTM earnings in 2007-2008) for four
quartiles (125 stocks each) within the S&P 500. The four quartiles are broken up
based on each stock’s 3Q09 EPS (annualized) as a percentage of the peak LTM EPS
in 2007-2008 (see Figure 49 to Figure 52).
• The top quartile of stocks has already reattained the prior peak earnings level as
we head into 4Q09 (see Figure 49). In fact, as shown, by 2010 this group of
companies is projected to see EPS 10% above the prior peak.
• We believe the Street is likely underestimating the profit recovery potential in the
Quartile 4 stocks. Even by 2011, the Street is forecasting earnings for these
stocks to still be 50% below the prior peak.
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Figure 49: Top Quartile Figure 50: 2nd Quartile

130 130
Indexed Earnings (100=peak in '07-'08)

110 6/08 110 6/08
90 97 90 90
6/09, 91 6/09, 88
70 70
50 50
30 30
10 Actual Estimate 10
Actual Estima
t
(10) (10)
3/07 3/08 3/09 3/10 3/11 3/07 3/08 3/09 3/10 3/11
Source: J.P. Morgan and FactSet. Source: J.P. Morgan and FactSet.
Figure 51: 3rd Quartile Figure 52: Bottom Quartile

130 130
Actual Estimate

110 6/08 110 3/07
90 90
70 70
69
50 50
30 30
10 10
Actual Estimate
-5
(10) (10)
3/07 3/08 3/09 3/10 3/11 3/07 3/08 3/09 3/10 3/11
Source: J.P. Morgan and FactSet. Source: J.P. Morgan and FactSet.
ROE at 10.8%, still well below the peak

The Return on Equity for the S&P 500 is recovering sharply to 10.9% and 13.3%
(ex-financials) by 4Q09E. As shown in Figure 53, this is a large improvement in
ROE compared to the trough level seen during the year of 1.6% for the S&P 500 (the
trough level was 550bp lower during this downturn as compared to the previous
trough in 2001).
• Despite the recent recovery in ROE, the current levels are well below the peak
levels seen during mid-2007 (10.9% for the S&P 500 vs. 17.4% at peak).
Figure 53: ROE recovering sharply
1995 through 3Q09 LTM actual, 4Q09 based on consensus estimate
20.0%
18.1% 17.4%
Return on Equity (LTM)
16.0%
13.3%
12.0%
10.9%
7.1%
8.0%
8.0%
4.0% S&P 500
5.4%
S&P 500 ex Financials 1.6%
0.0%
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
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EPS CONCENTRATION: 50 cos account for 64% of ’10E

profit increase . . . .
We wanted to better understand which companies would be responsible for driving
the earnings improvements in each of the 10 major economic sectors. Using
consensus estimates, we looked at the top five contributors to the net income
improvement for each Sector. We were comfortable using Consensus, as total
bottom-up Consensus is below our $80 forecast ($77 Consensus), implying upside to
the individual estimates for each company.
• In total, therefore, we compiled the earnings impact from 50 companies (5 cos x

10 sectors), and these data are summarized in Figure 54 below. Our insights are
as follows:
• In total, these 50 companies are forecast to represent $89b of incremental net
income, or $9.65 per S&P 500 share. This is 64% of our anticipated increase in
earnings.
At the Sector level, each set of five companies represents between 46% and 110% of
the incremental profits for the Sectors.
In other words, if one wanted to better test the reasonableness of any S&P 500
forecast, simply focus on these 50 stocks.
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Figure 54: S&P 500 EPS: Contribution by Top 5 stocks in each Sector
$ billions except per share
Cyclicals Defensives
EPS Delta '10E/'09 S&P 500 EPS Impact EPS Delta '10E/'09 S&P 500 EPS Impact
% of % of
S&P 500 Sector S&P 500 Sector
Company Name Ticker 2009E 2010E $/share $ gross per share EPS chg Company Name Ticker 2009E 2010E $/share $ gross per share EPS chg
Materials Staples
United States Steel Corp. X ($10.35) $0.98 $11.34 $1,567 $0.17 21% Wal-Mart Stores Inc. WMT $3.61 $3.96 $0.35 $1,087 $0.12 19%
Nucor Corp. NUE ($0.86) $2.80 $3.65 $1,174 $0.13 15% Philip Morris International Inc. PM $3.27 $3.82 $0.56 $749 $0.08 13%
Alcoa Inc. AA ($0.66) $0.55 $1.21 $1,150 $0.13 15% Coca-Cola Co. KO $3.07 $3.42 $0.36 $748 $0.08 13%
Freeport-McMoRan Copper & GFCX $5.17 $7.09 $1.92 $924 $0.10 12% PepsiCo Inc. PEP $3.76 $4.22 $0.46 $664 $0.07 12%
Dow Chemical Co. DOW $0.46 $1.32 $0.86 $921 $0.10 12% Walgreen Co. WAG $2.36 — $333 $0.04 6%
Sub-total — Materials Top 5 $5,736 $0.63 76% Sub-total — Staples Top 5 $3,581 $0.39 63%
Industrials HealthCare
Boeing Co. BA $1.44 $4.34 $2.89 $2,040 $0.22 38% Pfizer Inc. PFE $2.03 $2.26 $0.23 $3,709 $0.41 31%
United Parcel Service Inc. (Cl BUPS $2.18 $2.68 $0.51 $489 $0.05 9% Merck & Co Inc MRK $3.28 $3.46 $0.18 $3,627 $0.40 31%
Illinois Tool Works Inc. ITW $1.81 $2.67 $0.86 $428 $0.05 8% Johnson & Johnson JNJ $4.58 $4.93 $0.36 $899 $0.10 8%
Caterpillar Inc. CAT $2.01 $2.68 $0.67 $404 $0.04 8% Abbott Laboratories ABT $3.71 $4.15 $0.44 $652 $0.07 6%
United Technologies Corp. UTX $4.11 $4.53 $0.42 $361 $0.04 7% Genzyme Corp. GENZ $2.27 $3.71 $1.45 $404 $0.04 3%
Sub-total — Industrials Top 5 $3,722 $0.41 70% Sub-total — HealthCare Top 5 $9,291 $1.02 78%
Discretionary Telecom
Ford Motor Co. F ($0.50) $0.48 $0.98 $2,921 $0.32 23% AT&T Inc. T $2.12 $2.25 $0.13 $732 $0.08 66%
Pulte Homes Inc. PHM ($4.02) ($0.48) $3.54 $1,132 $0.12 9% Sprint Nextel Corp. S ($0.69) ($0.57) $0.12 $252 $0.03 23%
Johnson Controls Inc. JCI $1.49 — $697 $0.08 5% Verizon Communications Inc. VZ $2.46 $2.50 $0.04 $124 $0.01 11%
DIRECTV DTV $1.38 $2.19 $0.81 $658 $0.07 5% American Tower Corp. AMT $0.61 $0.84 $0.23 $81 $0.01 7%
Goodyear Tire & Rubber Co. GT ($1.12) $0.78 $1.90 $494 $0.05 4% Frontier Communications Corp. FTR $0.53 $0.59 $0.07 $28 $0.00 3%
Sub-total — Discretionary Top 5 $5,901 $0.65 47% Sub-total — Telecom Top 5 $1,217 $0.13 109%
Technology Utilities
Intel Corp. INTC $0.72 $1.46 $0.74 $4,190 $0.46 19% PPL Corp. PPL $1.79 $3.28 $1.50 $633 $0.07 32%
Micron Technology Inc. MU $0.26 — $1,973 $0.22 9% FPL Group Inc FPL $4.15 $4.57 $0.42 $198 $0.02 10%
Apple Inc. AAPL $7.79 — $1,456 $0.16 7% Sempra Energy SRE $4.58 $5.19 $0.61 $168 $0.02 9%
Google Inc. (Cl A) GOOG $22.79 $26.36 $3.57 $1,251 $0.14 6% Duke Energy Corp. DUK $1.20 $1.29 $0.09 $156 $0.02 8%
Hewlett-Packard Co. HPQ $4.34 — $1,078 $0.12 5% Southern Co. SO $2.32 $2.43 $0.12 $147 $0.02 7%
Sub-total — Technology Top 5 $9,949 $1.09 46% Sub-total — Utilities Top 5 $1,301 $0.14 66%
Financials and Energy Total S&P 500

EPS Delta '10E/'09 S&P 500 EPS Impact EPS Delta '10E/'09 S&P 500 EPS Impact
% of % of
S&P 500 Sector S&P 500 Sector
Company Name Ticker 2009E 2010E $/share $ gross per share EPS chg Company Name Ticker 2009E 2010E $/share $ gross per share EPS chg
Energy Total S&P 500

Exxon Mobil Corp. XOM $3.91 $5.85 $1.94 $8,947 $0.98 32% Total $87,982 $9.65 64%
Chevron Corp. CVX $5.04 $7.75 $2.71 $5,672 $0.62 20%
ConocoPhillips COP $3.73 $6.06 $2.33 $3,977 $0.44 14%
Occidental Petroleum Corp. OXY $3.74 $5.88 $2.14 $1,619 $0.18 6%
Apache Corp. APA $5.48 $9.48 $4.00 $1,558 $0.17 6%
Sub-total — Energy Top 5 $21,773 $2.39 77%
Financials
Bank of America Corp. BAC $0.37 $0.72 $0.35 $5,307 $0.58 13%
Morgan Stanley MS ($0.53) $3.33 $3.85 $5,155 $0.57 12%
JPMorgan Chase & Co. JPM $2.16 $3.23 $1.07 $5,145 $0.56 12%
Citigroup Inc. C ($0.26) $0.07 $0.32 $4,956 $0.54 12%
American International Group InAIG ($10.78) $5.86 $16.63 $4,948 $0.54 12%
Sub-total — Financials Top 5 $25,511 $2.80 61%
Source: J.P. Morgan. EPS estimates Bloomberg consensus.
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Valuations reasonable on ’10E/’11E EPS

S&P 500 EPS and Index are both at 70% of prior peak . . . .
The performance of corporate profits in 2009 has surprised investors, as we
discussed in the previous section. In our view, it is this steeper earnings recovery that
has supported and justified the improvement in equity prices. Moreover, we believe
there remains a misconception that the rally in equities since March is purely driven
by unrealistic expectations of an earnings recovery. A simple illustration provides
some perspective:
• S&P 500 LTM EPS (thru 4Q09E) is $62.89 using First Call EPS (see Figure 55).
These EPS are 68% of S&P 500 peak EPS of $92.15 achieved in 2007.
• The S&P 500 Index at 1100 is 70% of its prior peak of 1565.
In other words, the S&P 500 Index levels (relative to prior peak) are aligned with the
relevant earnings levels on an LTM basis.
Figure 55: STOCKS ARE NOT EXPENSIVE . . . . EPS and Index level are 70% of the prior peak . . . .
Various.
Peak to
Valuations reasonable on ’10E/’11E EPS

Trough Trough % Trough as Current as %
Units Peak Level Level Current Level Decline % of Peak of Peak
GDP (nominal) $ billions 14,547 14,151 14,422 -3% 97% 99%
S&P 500 Index Index level 1,565 677 1,096 -57% 43% 70%
S&P 500 EPS (LTM) $ per share $92.15 $51.25 $62.89 -44% 56% 68%
On ’10E EPS, 9% have stock recoveries > EPS recoveries

With earnings still recovering, we believe it is important to compare current stock
levels with ’10E EPS. We decided to do a similar analysis for each of the S&P 500
companies, comparing each stock’s ’10E EPS (relative to its 2007 peak) and the
comparative stock prices (current vs. 2007 peak).
We then plotted each of these companies on a scatter chart, with the X-axis
representing the ’10E EPS (as % of peak) and the Y-axis the stock price (as % of
peak). We also drew a 45-degree line. To the extent a company followed this line, the
more “reasonable” one could argue valuation. To the extent a plot is above that line,
one could say a stock’s current price discounts more than ’10E EPS recovery.
• On this basis, only 44 companies (9% of S&P 500) sit more than 20% above that
line as shown in Figure 56. In other words, these companies, one could say, are
either discounting more than ’10E EPS or their cyclical valuations are higher
compared to 2007.
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Figure 56: 9% of stocks are expensive on ’10E EPS based on comparative EPS vs. Stock recovery
X-axis: Current EPS as % Peak; Y-axis: Current stock price as % Peak
9% PRICEY on ’10E EPS

44 companies w/
Stock price (as % peak)
EXCEEDS
‘10E EPS (as % peak)
42% of stocks have '10E EPS recovery > stock recovery

We can also look at stocks that sit below this 45-degree line. A company plotting
below this line is one for which the ’10E EPS recovery is greater than the recovery in
the stock price (both as % of peak). Again, because we cannot assume stocks can
form fit the 45-degree line and we are not interested in finding only minor
aberrations, we looked at companies whose earnings recovery percentage is 20%
more than their stock price recovery – that is, sitting 20% away from the line.
Figure 57: 42% of stocks are Cheap on ’10E EPS based on comparative EPS vs. Stock recovery
X-axis: Current EPS as % Peak; Y-axis: Current stock price as % Peak
CHEAP on ’10E EPS

210 companies w/
Stock price (as % peak)
WELL BELOW
‘10E EPS (as % peak)
• A substantially greater number of companies sit below this line. As shown in

Figure 57, 210 companies fall below this line, or 42% of the companies in the
S&P 500.
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(1-212) 622-6505 10 December 2009
166 companies in 2010 should have all-time highs in EPS

What really jumps out at us is the large number of companies whose earnings are
100% or greater above their 2007 peak. In fact, a total of 166 companies are expected
to have 2010 EPS at all-time highs.
CHEAP STOCKS are seen in most Sectors

Naturally, one is likely to wonder which Sectors encompass these “Inexpensive”
stocks - those sitting well below the 45-degree line and vice-versa. This analysis is
summarized in Figure 58 below.
• The “Cheap” stocks are represented in most Sectors. Perhaps the exception is
Energy, where only 15% of the stocks in this Sector have an EPS recovery >
stock recovery.
• The groups with the greatest composition are Healthcare and Utilities, for which
67%-71% of the stocks have an EPS recovery greater than their stock recovery.
Figure 58: Where are the Cheap and Expensive stocks? . . . Unless Earnings forecasts too low . . .
% based on '10E EPS
% stocks in Sector EXPENSIVE % stocks in Sector CHEAP
20% Financials 34%

17% Materials 37%
13% Energy 15%
11% Telecom 56%
10% Industrials 34%
10% Discretionary 30%
3% Utilities 71%
2% Health Care 67%
1% Technology 50%
0% Staples 46%
Weak ’09 Equity inflows likely due to volatility . . .

We have heard many investors wonder if the equity culture is dead in the US. That is,
investors, having seen two fierce bear markets with a decline of 40% or more, are
likely to orient away from equities.
Without a doubt, investor inflows into equities have been disappointing. Based on
AMG data, inflows into US equities since March ’09 have been $52 billion, or $1.7
billion per week. This is running well below the $2.2 billion average weekly inflow
since 1992 into equity funds.
2009 inflows are at half the levels seen in 2003 . . . .

Moreover, equity inflows since March are running at less than half those seen in
2003. By the 29th week (from positive flows in ’03), cumulative inflows reached
$112 billion.
• In fact, by this time in ’03, equity inflows were running consistently at $5-6
billion per week. It is this continued inflow that supports further increases in
stock prices. After all, once a manager is fully invested (and we know cash as %
of positions is near lows), the incremental inflow represents the incremental
buyer. Short interest has been declining, so one cannot say there is a lot of room
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(1-212) 622-6505 10 December 2009
for short covering to add buying pressure. M&A does reduce supply of stocks, so
it is a tailwind in 2009 and 2010 to the extent we envisage greater M&A activity.
Figure 59: Comparative money flows 2009 vs. 2003. Running on fumes today . . .
$ millions per week
2003 Start of Inflow s 2009 Start of Inflow s $237,572
Cumulative Level of Flows Peak to

$200,000
Trough ($mm)
$150,000
$112,282
$100,000
$50,000 $52,046
Flat since week 16

$0
-40 -36 -32 -28 -24 -20 -16 -12 -8 -4 0 4 8 12 16 20 24 28 32 36 40 44 48 52
Time 0 is Peak of Outflows
Source: J.P. Morgan and AMG.
Weak equity inflows probably due to lower volatility in credit YTD

We believe the weak inflows this year can partly be explained by the relative
outperformance of credit vs. equities. More specifically, we believe it is the relative
low volatility of credit in 2009 (vs. equities) that has made those assets relatively
more attractive. We used delivered volatility for S&P 500 and the JPM Global HY
Index for this analysis. As we highlight in Figure 60 below, when this ratio of
relative volatility is rising, equity inflows have been poor. Similarly, when relative
volatility is falling, equity inflows have been strong. This pattern also was seen in
early 2009.
• However, note that relative volatility for equities recently increased, and we
believe this explains the slowing of equity inflows.
Figure 60: Relative Volatility of Equities vs. Bonds and Forward Flows into Equity Funds
Forw ard 12w k Av g Equity Fund Flow s Relativ e Del Vol (S&P 500 / JULI) (3mos av g)
1/00 1/01 1/02 1/03 1/04 1/05 1/06 1/07 1/08 1/09 1/10
$10,000
10
$8,000
9
Avg Weekly Equity Fund Flows ($mm)
$6,000 8
Flows…
Relative Delivered Volatility
$4,000 7
6
$2,000
5
$0
4
($2,000)
3
($4,000) 2
Rel volatility Rising recently…
($6,000) 1
1/00 1/01 1/02 1/03 1/04 1/05 1/06 1/07 1/08 1/09 1/10
Source: J.P. Morgan and FactSet. Note: Relative volatility calculated as volatility of S&P 500 divided by volatility of JULI index.
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This recent rise in relative equity volatility in ’09 contrasts with ’03
As we noted in Figure 59 above, equity inflows in ’09 began to flatten contrasting
with a steepening of the pace of inflows in ’03 at week 16. As shown below in Figure
61, the pattern of relative volatility is a similar contrast.
• In 2003, relative volatility of equities vs. credit continued to improve, falling 50%
after the 16th week (or 80 days as seen in this chart).
• By contrast, since the 16th week in ’09, relative equity volatility has been rising.
Figure 61: Comparative Equity vs. Credit Volatility: 2003 vs. 2009
Relative Volatility of Equity vs. Credit. 100=Start date of equity inflows
2003 2009
Stocks relative
160
Relative Volatility of Equities vs. Bonds
volatility HIGHER
140
120
100
80
60
40
Stocks relative
20 volatility LOWER This surge contrasts with ’03, when
relative volatility kept falling . . . .
0
-40 -36 -32 -28 -24 -20 -16 -12 -8 -4 0 4 8 12 16 20 24 28 32 36 40 44 48 52
Weeks around Peak in Outflows
Source: J.P. Morgan and AMG.
We believe improving incoming economic data, more attractive valuations and

consensus estimate increases serve to lower equity volatility
We expect relative volatility of equities to actually improve in 2010. Credit returns
are likely to be more variable, as more spread tightening is likely driven by Treasury
volatility than absolute yield falling. And as economic data are more convincing,
payrolls strengthen and investors being valuing stocks on 2010 EPS, we believe
equity volatility should fall further.
• In other words, we see the VIX index (a measure of equity volatility) falling in
2010 to below 20 (see Figure 62).
Figure 62: VIX index
85 VIX Index
75
65
55
45
35
25
15
5
1/90 1/92 1/94 1/96 1/98 1/00 1/02 1/04 1/06 1/08 1/10
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Sufficient demand for Treasuries in 2010,

mitigating risk of rising rates
Sufficient demand for Treasuries in 2010, mitigating risk of rising rates

Even as the Fed is expected to remain on hold in 2010, investors are properly
concerned long-term rates could widen from: (i) imbalance of supply and demand
from heavy issuance; (ii) unwinding of risk trades in anticipation of policy
normalization (as other Fed facilities and programs expire).
Sufficient demand exists to absorb heavy Treasury issuance . . . .

J.P. Morgan’s Fixed Income Strategist, Srini Ramaswamy, has done a 2010 Cross-
market supply and demand analysis, and his analysis is detailed later (see Figure 68
and Figure 69). In a nutshell, he believes that supply will equal about $1.3 trillion in
2010 and demand is about $1.3 trillion - in other words, there is less concern about
demand to absorb heavy issuance.
Widening as risk trades unwind is a risk, but depends on timing of Fed action
As for risk trades unwinding, this is something about which investors would need to
be vigilant. As shown in Figure 63 below, many fixed income markets have already
retraced much of their widening following Lehman’s bankruptcy and, in fact, many
are now approaching spreads last seen pre-crisis (June 2007).
Figure 63: Spreads have retraced much of their widening post-LEH

Level as of 11/20/09, 6/29/07, worst level* over 9/12/08-current, % retracement to pre-Lehman level, %
retracement to pre-crisis level; bp unless otherwise indicated
Source: J.P. Morgan Fixed Income, “2010 Outlook,” dated 11/27/09, by Srini Ramaswamy. * Worst level is the minimum value over
the period for 30Y swap spreads, CMBX.1.AAA, ABX.07-1.AAA, the CDX-cash basis and the cross-currency basis swaps; for all others
it is the maximum value.
The recovery in many of these markets was due to the massive intervention in
markets. Naturally, rates should widen as the Fed tightens and arguably will widen
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ahead of Fed action. Countering this, Vivek Juneja, J.P. Morgan Banks analyst, notes
that because of the liquidity of many of these instruments, participants in these
markets are not likely to unwind positions until we are in close proximity to Fed
action (say 2-3 months). However, one still wonders if markets anticipate these
changes sooner.
J.P. Morgan Fixed Income strategists see higher Treasury rates in 2010 (see Figure
64), with the 10-year forecast to rise to 4.5% from 3.32% currently, or a sharp 120bp
widening. Credit markets are expected to further tighten however, but much of this
reflects widening from Treasuries (Yields on credit stand still for High Yield, for
instance).
Figure 64: 2010 Forecasts Cross-markets

%
Source: J.P. Morgan. From "2010 US Fixed Income Outlook" dated November 27, 2009.
Growing deficits in 2010 . . .

J.P. Morgan Economists estimate that fiscal stimulus spending will amount to nearly
2% of global GDP in 2009, and there is additional stimulus spending in 2010, with
US and China expenditures in 2010 projected to exceed 2009’s. Naturally,
government deficits increased globally and in the US. Even the current forecast of
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US GDP growth of 3.6% will not significantly reduce budget deficits over the next
several years. According to David Hensley, J.P. Morgan Economist, changes in the
fiscal deficit have been closely correlated with changes in the output gap and thus,
global economies need to achieve extended periods of above-potential GDP growth
in order to really affect deficits (see Figure 65-Figure 66).
Figure 65: OECD Output Gap and budget deficits Figure 66: Read GDP growth and fiscal deficits, developed economies
Source: J.P. Morgan. From “Daily Economic Briefing” dated December 2, 2009, by David
Hensley.
Budget forecasts still show sizable deficits globally in 2010, according to J.P.
Morgan Economic forecasts, with some reductions seen in emerging markets (EM),
which have seen a more robust GDP recovery. The EM aggregate budget balance is
forecast to rise from -4.1% of GDP to - 3.2%. Meanwhile, in developed countries,
budget deficits are projected to be nearly unchanged in 2010 at about 8% of GDP.
The bottom line is that the US will run a sizable deficit, one of many global
economies to see such surge in borrowings.
Figure 67: 2009-2010 Gov’t Budget Balances – only slight improvement in 2010 . . .
Percentage, SA
Source: J.P. Morgan. From “Daily Economic Briefing” dated December 2, 2009, by David Hensley.
SUPPLY: J.P. Morgan Fixed Income forecasts $1.292

Trillion of net issuance
In the 2010 US Fixed Income Markets Outlook, Srini Ramaswamy forecasts about
$1.292 Trillion of net issuance across fixed income markets (see Figure 68) with
Treasuries representing the bulk of issuance at $1.386 Trillion (see deficit discussion
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above) followed by $235 billion of MBS and smaller figures for High Grade, Munis,
High Yield.
Securitized products will have negative net issuance (ABS, CMBS) as maturities
outpace new issuance. And these estimates by Ramaswamy do not make an implicit
assumption about M&A, which could further increase supply.
The $1.292 Trillion supply is lower than the $2.2 trillion issued in 2009, and
Treasury supply is also lower than the $1.566 Trillion issued. As many know, the
limited supply of risky assets drove spread compression. According to Ramaswamy,
for investors with high credit rating requirements, the negative issuance in
Securitized markets (ABS/CMBS) means “sourcing” risk is challenging as many
banks’ debts were downgraded to below AA. He sees this as a particular challenge
for pension funds.
Figure 68: NET SUPPLY: $1.29 Trillion +$1.58T long term; $-290bn short term
2008 actual net issuance, 2009 expected net issuance, 2010 expected net issuance by quarter and total;
long-term (>1Y) supply only; $bn
Sector 2008 2009 1Q10 2Q10 3Q10 4Q10 2010 total
Non Agency MBS -194 -208 -34 -34 -34 -34 -136
Agency debt -39 -20 0 0 -55 -55 -110
ABS -60 -20 -18 -18 -18 -18 -70
CMBS -31 -33 -9 -8 -7 -7 -30
HG Corporates (gteed) 114 293 -13 0 0 0 -13
High yield -24 85 20 20 20 20 80
Municipals 29 60 20 26 22 26 94
HG Corporates (ex gteed) 105 64 37 37 37 37 146
MBS 493 458 63 50 62 60 235
Treasuries 342 1,566 411 333 317 324 1,386
Total 735 2,246 477 406 344 354 1,582
plus: Short-term net issuance (T-bills, Agency discos) -290
Net Issuance (LT + ST) $1,292bn

Source: J.P. Morgan Fixed Income “2010 Outlook,” dated 11/27/09, by Srini Ramaswamy.
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DEMAND: $1.28 Trillion

Fortunately, Ramaswamy forecasts about $1.2 Trillion of demand across markets,
allaying concerns about who will absorb this supply. Basically, Srini modeled
demand from six major classes of investors:
• mutual funds,
• non-US nationals,
• life insurance companies,
• commercial banks,
• pension and retirement funds, and
• the Federal Reserve.
A summary of his forecast is in Figure 69 below. Ramaswamy used models to
estimate demand for Mutual Funds (based on Fed fund and curve), Non-US nationals
(based on Trade flows), Life Insurance (based on Yield curve). He estimated pension
funds would maintain their average buying pace over 2004-08 and that remaining
Federal Reserve purchases in 2010 will total $220bn.
The fact that Government debt will constitute the bulk of supply across fixed income
markets next year could challenge pension funds from the asset/liability perspective,
in Ramaswamy’s forecast, Since changes in defined benefit pension fund liabilities
are highly correlated with long-dated AA corporate yields (actuarial estimates of
future payouts are discounted at corporate bond yields to estimate present value).
Thus, a 1bp increase in the JULI yield translates into a $1.3bn decline in liabilities.
With next year’s supply coming predominantly in government debt, pension fund
asset managers will find it challenging to source assets that they should ideally seek
out.
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Figure 69: DEMAND: $1.21 Trillion, mostly from non-US nationals, life insurance and Fed
Statistics for regression models for quarterly changes in fixed income holdings for various investor classes
(1-year avg), estimated purchases based on forecast for variables, and expected purchases in 2010; $bn.
MUTUAL FUNDS
Period 2Q94 -2Q09
R-sq 58%
Factor Beta T-stat Forecast
3M lag Fed funds curve* (1Y avg; %) -16.01 -7.4 0.68
3M lag 1Y S&P returns (1Y avg; %) -0.50 -5.2 16.0
Intercept 38.55 18.3
Estimated 2010 purchases ($bn) 79
FOREIGNERS
Period 1Q92-2Q09
R-sq 76%
Quarterly trade balance** (1Y avg; $bn) -0.95 -14.6 -109.5
Intercept 10.18 1.5
LIFE INSURANCE COMPANIES
Period 3Q89-2Q09
R-sq 37%
10s/30s Tsy curve (1Y avg; %) 29.75 6.8 0.68
Intercept 10.71 5.3
COMMERCIAL BANKS
Expected 2010 purchases ($bn) 200
PENSION AND RETIREMENT FUNDS
FEDERAL RESERVE
TOTAL EXPECTED PURCHASES ($bn) 1208
Source: J.P. Morgan Fixed Income “2010 Outlook,” dated 11/27/09, by Srini Ramaswamy; Federal Reserve Flow of Funds. * Expected
Fed funds rate eight meetings forward minus current target rate. ** Positive numbers indicate surplus; negative numbers indicate
deficit. Note: Pension and retirement funds include private pension funds, as well as state, local, and federal government retirement
funds.
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2010 Sector Outlooks

Our Sector Overweights and Underweights reflects our pro-Cyclical tilt (positive
revisions) coupled with recognition that valuations are broadly attractive. Of these
factors, we believe EPS revisions are likely to play a bigger role as we believe the
Street is modeling overly conservative assumptions of GDP growth and operating
leverage in their earnings models. Guidance by companies is likely to be similarly
muted, as we doubt any company is talking to investors about a 5% GDP outlook.
EPS: Our ’10E EPS 414bp ahead of bottom-up . . . . revisions still important.
Our 2010E EPS of $80 are $2.60 ahead of Street bottom-up consensus and our EPS
growth rate is 414bp higher. As we noted in the prior section, our 2010E EPS of $80
only model 2.5% GDP growth; thus, 3.5% GDP growth is $84. Thus, in 2010,
positive earnings revision continues to be a positive theme, but in our view, this is
concentrated in the economically sensitive groups. Consider the case of Caterpillar
(CAT): according to Machinery analyst Ann Duigman, each 5% change in housing
starts is $0.50 in EPS, or 7% in EPS delta.
VALUATIONS: Broadly attractive. Most groups at 12-13X ’11E EPS

We provide Sector and S&P 500 P/E valuations in Figure 70 below. Overall, the
S&P 500 is trading at 13.9X/12.3X our ’10E/’11E EPS forecasts, a discount to the
16.7X average seen in the past 36 years. Most groups also have seen an earnings
recovery (’10E EPS as % peak) ahead of their stock price recovery (price as % peak).
CONTRARIAN: Street ratings still less constructive on Cyclicals

Based on FC Mean ratings, Analysts still favor Defensive groups (see Figure 76)
with only a few seeing the current FC Mean (relative to S&P 500) below LT average
(rel to S&P 500). The opposite is true for Cyclicals, where most Analysts have fewer
Buys. Thus, we see upside for Cyclicals as EPS momentum leads ratings upgrades.
Figure 70: Comparative Sector Valuation Summary

S&P 500 JPM Strategy EPS First Call
Weight Top-down Forecast P/E Multiples EPS Growth Consensus
JPM 2010E 2011E % chg

Strategy Index % LT Avg vs. vs. 2010E '10 vs. JPM vs.
2010 Sector Outlook

Rating Points weight 2009E 2010E 2011E 2010E 2011E P/E 2009E 2010E EPS '09 Street
Resources Energy OW 130 12% $6.62 $10.66 $12.50 12.2x 10.4x 14.7x 61% 17% $10.21 54% 675bp
Materials OW 39 3% $1.25 $2.17 $2.50 17.8x 15.5x 16.3x 73% 15% $1.94 55% 1833bp
Exports Industrials OW 113 10% $6.32 $7.50 $8.50 15.1x 13.3x 16.5x 19% 13% $7.00 11% 798bp
Technology OW 212 19% $11.17 $13.74 $16.00 15.4x 13.2x 24.1x 23% 16% $13.74 23% -1bp
Defensives Staples UW 138 12% $9.28 $9.85 $10.50 14.1x 13.2x 14.1x 6% 7% $9.82 6% 31bp
Healthcare N from UW 139 13% $11.01 $11.87 $12.50 11.7x 11.1x 19.9x 8% 5% $11.48 4% 349bp
Telecom N 34 3% $2.35 $2.31 $2.50 14.5x 13.4x 16.4x -2% 8% $2.31 -2% 12bp
Utilities UW 39 4% $3.09 $3.24 $3.50 12.1x 11.2x 12.2x 5% 8% $3.11 1% 422bp
Total S&P 500 (ex-Disc/ex-Fin) 843 76% $51.09 $61.34 $68.50 13.7x 12.3x 16.8x 20% 12% $59.61 17% 338bp
Consumer Discretionary OW 105 9% $4.70 $6.80 $7.50 15.4x 14.0x 20.5x 45% 10% $6.83 45% -67bp
Financials OW 161 14% $6.98 $11.87 $14.00 13.5x 11.5x 12.8x 70% 18% $10.96 57% 1291bp
Total S&P 500 1,109 100% $62.78 $80.00 $90.00 13.9x 12.3x 16.7x 27% 12% $77.41 23% 414bp
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Source: J.P. Morgan and FactSet
Best overall groups . . .

We applied this same analysis to the S&P 500 Industry Groups (Level 3 GICS) and
highlighted those in Figure 71 and Figure 72 below. We highlighted the Quartile of
the Industry relative to other groups. The darker the moon, the better the outlook for
that metric.
Figure 71: 2010 Summary Outlook for Cyclical Industries: (GICS Level 3) Outlook
Industry Metrics
tile g
ad k
ar Av
yro y to
gr toc
Av of
oc vs
Industry
Qu hted
es
LT s %
up st s
Pa itivit
re ngs
St ngs
W ery
lls
ion
g
al y
k
v
a
i
ei g
ns
Industry Name GICS
rn
vis
rn
Rank
co
S
Se
An
Ea
Ea
P/
re
Resources Energy Energy Equp. & Services 101010 5 5 3 4 3 5
Oil Gas & Consumable Fuels 101020 5 3 5 2 3 4
Materials Containers & Packaging 151030 4 3 4 3 5 5

Chemicals 151010 4 4 4 3 3 4
Construction Materials 151020 3 5 5 3 2 4
Metals & Mining 151040 3 5 5 2 2 3
Paper & Forest Products 151050 3 3 5 3 2 2
Exporters Industrials Aerospace & Defense 201010 5 3 4 3 4 5

Electrical Equp. 201040 4 5 5 3 3 5
Construction & Engineering 201030 4 3 3 4 5 4
Industrial Conglomerates 201050 4 5 2 5 3 4
Road & Rail 203040 5 3 5 2 3 4
Professional Services 202020 5 4 3 4 2 3
Commercial Services & Supplies 202010 3 3 3 4 4 3
Air Freight & Logistics 203010 3 3 5 3 3 3
Building Products 201020 3 5 2 5 2 2
Airlines 203020 2 5 2 5 2 2
Machinery 201060 3 2 5 3 2 2
Technology Software 451030 5 3 3 4 5 5

Communications Equp. 452010 5 4 2 5 4 5
Semis & Semi Equp. 453010 5 3 4 4 4 5
IT Services 451020 4 2 3 5 5 4
Computers & Peripherals 452020 3 4 4 3 4 4
Electronic Equp. Instruments & Comp 452030 4 3 5 2 4 4
Internet Software & Services 451010 4 2 2 5 5 3
Discretionary Discretionary Auto Components 251010 5 5 5 3 3 5

Hotels Restaurants & Leisure 253010 5 4 4 4 3 5
Diversified Consumer Services 253020 5 5 3 4 5 5
Media 254010 4 5 2 5 4 5
Specialty Retail 255040 5 4 3 4 3 4
Automobiles 251020 3 3 3 5 5 4
Household Durables 252010 4 5 5 2 2 4
Leisure Equp. & Products 252020 2 5 4 3 3 3
Textiles Apparel & Luxury Goods 252030 2 4 5 2 4 3
Internet & Catalog Retail 255020 3 2 5 2 5 3
Multiline Retail 255030 2 4 3 4 3 2
Financials Financials Diversified Financial Services 402010 3 5 3 4 5 5

Consumer Finance 402020 5 5 3 5 3 5
Insurance 403010 4 4 3 5 4 5
Capital Markets 402030 5 3 4 3 4 5
Real Estate Investment Trusts (REITs 404020 4 5 4 3 2 4
Commercial Banks 401010 3 4 2 5 2 2
Thrifts & Mortgage Finance 401020 2 4 5 2 5 4
Source: J.P. Morgan. 5 = best. 1 = least. We consolidated some industry groups.
68
(1-212) 622-6505 10 December 2009
Figure 72: 2010 Summary Outlook for Defensive Industries: (GICS Level 3) Outlook
tile g
ad k
ar A v
yro y to
gr toc
Av of
oc vs
Industry
Qu hted
es
LT s %
up st s
Pa itivit
re n g s
St ngs
W ery
lls
ion
g
aly
k
a
v
i
i
ns
eig
Industry Name GICS
rn
rn
vis
Rank
co
S
Se
An
Ea
Ea
P/
re
Defensives Staples Food & Staples Retailing 301010 3 3 4 4 5 4
Beverages 302010 2 4 5 2 4 3
Food Products 302020 4 2 4 3 4 3
Tobacco 302030 3 2 5 2 3 2
Household Products 303010 2 2 4 4 3 2
Personal Products 303020 2 3 4 4 3 2
Health Care Health Care Equp. & Supplies 351010 4 4 4 4 5 5

Health Care Technology 351030 5 5 2 5 4 5
Life Sciences Tools & Services 352030 4 4 4 3 4 5
Health Care Providers & Services 351020 5 3 3 4 4 4
Biotechnology 352010 2 4 2 5 5 3
Pharmaceuticals 352020 2 2 3 5 5 2
Telecom Services Wireless Telecom Services 501020 4 4 2 5 4 4

Diversified Telecom Services 501010 3 2 3 5 5 3
Utilities Electric Utilities 551010 3 2 4 3 5 3
Source: J.P. Morgan. 5 = best. 1 = least. We consolidated some industry groups.
Cyclicals have seen Earnings recover ahead of stock prices

....
Below, in Figure 73, we looked at how much EPS has recovered (’10E as % of peak
EPS) compared to stock recovery (current price as % peak) by subtracting the stock
ratio from the EPS ratio. Thus, a figure above zero means earnings have recovered
more than the stock. As shown below, about 75% of Cyclical groups have earnings
outpacing the stock price recovery.
• There are some groups where this ratio is negative, which means the rise in the
stocks is higher than the recovery in EPS. Among these are Financials such
Commercial Banks and REITs and others. This suggests that investors are
either valuing these groups using “normalized EPS” or see upside to estimates. In
any case, the risk/reward in these stocks is arguably less attractive.
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(1-212) 622-6505 10 December 2009
Figure 73: Cyclicals: Vast majority have stocks that do not reflect the earning recovery
2010E Earnings as % of Peak minus Price as % of Peak
Internet Software & Services

Construction & Engineering
Electronic Equp. Instruments &
Diversified Financial Services

Diversified Consumer Services
Commercial Services & Supplies
Textiles Apparel & Luxury Goods
200%
2010 Earnings as % of Peak
Thrifts & Mortgage Finance

Hotels Restaurants & Leisure
Internet & Catalog Retai

Oil Gas & Consumable Fuels
minus Price as % of Peak
Containers & Packaging

Computers & Peripherals
Communications Equp.
Industrial Conglomerates
Energy Equp. & Services
Components
Leisure Equp. & Products
Aerospace & Defense

150%
Semis & Semi Equp.

Air Freight & Logistics
Professional Services
Consumer Finance
Capital Markets
Auto Components
Electrical Equp.
Specialty Retail
IT Services
Multiline Retail
100%
Metals & Mining
Software
Insurance
Chemicals
Road & Rail
Media
50%
0%
Machinery
Household Durables
Real Estate Investment Trusts
Airlines
Construction Materials
Building Products
Paper & Forest Products
Commercial Banks
-50%
DISCOUNTING EPS UPSIDE or NORMALIZED EPS:

(REITs)
-100%
These groups have seen their stock prices recover
faster than their EPS has recovered….
-150%
-200%
Source: J.P. Morgan; First Call.
Defensive stocks do not reflect an earnings recovery

The Defensives, in particular, are attractive on this analysis, as none of the Defensive
industries is currently pricing in an earnings recovery. As shown in Figure 74 below,
the earnings for all of the Defensive industries have recovered much more than the
stock prices have recovered (all industries are above 0%), suggesting that the market
is not currently pricing in an earnings recovery in 2010 for these industries. For
example, Food & Staples Retailing and Pharmaceuticals industries have seen the
highest earnings recovery while stock performance has lagged.
Figure 74: Defensives: All groups have stocks that do not reflect an earnings recovery . . . .
2010E Earnings as % of Peak minus Price as % of Peak
100%
2010 Earnings as % of Peak minus Price as % of Peak
90%
Health Care Providers & Services
80%
Health Care Equp. & Supplies
Diversified Telecom Services
Life Sciences Tools & Services
Food & Staples Retailing
70%
Wireless Telecom Services
Health Care Technology
60%
Pharmaceuticals
Electric Utilities
Food Products
50%
Household Products
Personal Products
Beverages
40%
Tobacco
30%
20%
10%
0%
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Cyclicals still mostly out of favor with the Street . . .

The Cyclicals are also attractive, as they are still mostly out of favor with the Street
based on FC mean rating. In Figure 75 below, we looked at the delta between the
current FC mean rating (relative to the S&P 500) and the long-term average FC mean
rating (relative to the S&P 500). As shown on the left side of Figure 75 below, most
of the Cyclical industries are still less liked than the historical average, suggesting
these industries should have upside catalysts as Street analysts begin upgrading these
stocks. As mentioned earlier, the Street continues to have the least conviction for the
Building Products followed by Leisure, Airline, and REIT industries.
Figure 75: Cyclicals: Still mostly out of favor with the Street . . .
Current FC Mean rating (relative to S&P 500) compared to long-term average FC Mean Rating
-2.00
Commercial Services & Supplies

FC Mean Rating vs. LT Avg
Internet & Catalog Retai

Internet Software & Services
Groups in Favor:
Oil Gas & Consumable Fuels

(negative implies in-favor)
Construction & Engineering

Paper & Forest Products
Current relativ e FC Mean ABOVE
Containers & Packaging

-1.50
Aerospace & Defense

Air Freight & Logistics
Groups out of Favor: Long-term av erage
Semis & Semi Equp.

Current relativ e FC Mean BELOW
Capital Markets
-1.00
Long-term av erage
Automobiles
IT Services
Road & Rail
Machinery
Software
-0.50
0.00
Electronic Equp. Instruments &
Hotels Restaurants & Leisure
Communications Equp.
Multiline Retail
Thrifts & Mortgage Finance
Insurance
Textiles Apparel & Luxury Goods
Chemicals
Computers & Peripherals
Life Sciences Tools & Services
Specialty Retail
Commercial Banks
Professional Services
Diversified Consumer Services
Diversified Financial Services
Media
Auto Components
Metals & Mining
Household Durables
Industrial Conglomerates
Real Estate Investment Trusts
Electrical Equp.
Consumer Finance
Energy Equp. & Services

Airlines
Leisure Equp. & Products
0.50
Building Products
Components
1.00
(REITs)
1.50
2.00
Defensives still mostly in favor with the Street . . .

In contrast to the Cyclicals, the Defensives are still mostly in favor with the Street.
As shown in Figure 76 below, the relative FC mean rating of most of the Defensives
shows that these industries are more liked by the Street now than the historical
average. This suggests that analyst upgrades are less likely to be a catalyst for the
Defensives, especially for Electric Utilities, Food Products, and Tobacco.
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Figure 76: Defensives: Still mostly in favor with the Street . . .

Current FC Mean rating (relative to S&P 500) compared to long-term average FC Mean Rating
FC Mean Rating v s. LT Av g (negativ e implies in-fav or)

-2.00
Health Care Providers & Services
Diversified Telecom Services

-1.50 Groups in Favor:
Food & Staples Retailing

Current relativ e FC Mean ABOVE
Electric Utilities
Household Products
Long-term av erage
Personal Products
Pharmaceuticals
Food Products
-1.00
Tobacco
-0.50
0.00
Beverages
Health Care Equp. & Supplies
Biotechnology
Wireless Telecom Services
0.50
Health Care Technology
Groups out of Favor:

Current relativ e FC Mean BELOW
1.00
Long-term av erage
1.50
2.00
Source: J.P. Morgan;.First Call.
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Financials: Overweight
Headline Drivers for the Sector: Fundamental Outlook
Trending interest rates Earnings upside and valuation potential
Job Growth (declining The Financial system recovery is still fragile in many ways, but much progress has
delinquencies) been made. The repayment of TARP by several major institutions demonstrates the
Home and Commercial Real Estate private sector is again providing capital to Financials, setting the stage for an
prices bottom
Capital requirements/Regulation
eventual exit by the public sector. In fact, the pivot point for most of the Financials in
2009 was the emergence of the private sector, whether for REITs, Banks, or
Insurance. The key to Financials performance in 2010, in our view, is improving
visibility on credit trends, economic recovery and home and other asset prices.
On the one hand, the credit cycle, which moves in slow motion, in contrast to equity
markets, is still running its course and, depending on one’s forecast for housing,
J.P. Morgan Analyst Coverage commercial real estate, labor markets and the economy, we are somewhere in the
Analyst
middle to latter stages. Vivek Juneja, JPM Large-Cap Banks analyst, forecasts loan-
Sector Analyst Conviction loss provisions to peak in early ’10 with some potential release in provisioning
during 2H10 (contingent upon regulatory changes). But in most scenarios, we see a
Banks Juneja HC
SMid Banks Alexopoulos N
recovery in Financial profits in 2010.
Asset Mgr Worthington N
Exchanges Worthington HC As we noted in our report, we expect home prices to bottom in 1Q10 (5-10% further
Insurance Bhullar HC downside), commercial real estate in 2010 and employment to stay somewhere
Non-Life Heimermann LC between a solid to robust labor recovery. All these point to upside in trends in loan
REITs Paolone/MuellerLC
Cons Fin Wessel LC
portfolios, while improved economic visibility boosts demand.
HC: High Conviction; N: Neutral; LC: Low

But still unclear is the ultimate direction of capital requirements, regulatory oversight
Conviction. Analyst conviction based on our
takeaways from discussions with analysts
and regulation, which naturally creates uncertainty. Nevertheless, purely cyclical
about likelihood of outperformance by their dynamics make this group attractive in 2010. This has not been lost on equity
sectors vs. overall market in 2010. investors as S&P 500 Financials have risen 131% since March 9, 2009 (a 63% rise in
the S&P 500), with four of the top 10 performing industry groups being Financials,
Real Estate Management (up 350%), Consumer Finance (269%), Diversified
Financial Services (up 179%), and Commercial Banks (up 140%).
Financials: Overweight
M&A is likely in the Sector as well, a function of the market’s differentiation of
winners and losers, which in turn alters cost of capital. Within regional and midsize
banks, an attractive opportunity is under way, with bank failures creating very
attractive ROIC opportunities for the acquiring banks. The reason for this is the high
level of failures (552 problem banks and as many as 200 failures in 2010)
overwhelms the ability of the FDIC to process the failures.
Investors are likely to focus on normalized earnings and, on that basis, Financials are
attractive. For instance, Life Insurance trade at P/B of 0.9X vs. a normalized 1.1-
1.3X, pointing to valuation upside as well as book value growth. Bank stocks trade at
sub-10X P/normalized EPS; for instance, Bank of America (BAC-OW/$15.39)
trades at 5.5X normalized EPS, based on Vivek Juneja’s estimates. Lastly, the group
is still out of favor, which suggests that these stocks will also benefit from a “stock
ratings” upgrade cycle.
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Sector Price Performance

The performance of the Financials sector has been volatile over the past two years,
with the sector sharply underperforming early on, particularly in 4Q08 and 1Q09
following the bankruptcy of Lehman, before sharply outperforming in 2Q09-3Q09.
• This sharp volatility in performance reflects that the Financial companies were at
the heart of the credit crisis which began back in mid-2007, while the sharp
rebound in this sector in 2009 reflects the rapidly improving fundamental outlook
for these companies as credit markets improve and the global economy recovers.
Figure 77: Quarterly Price Performance — Financials
Shaded box highlights performance of sector, Bold/Italics box highlights S&P 500 performance
1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 QTD
-3% 17% 4% -3% 4% 35% 25% 9%
The sector -4% 7% 0% -12% -3% 19% 21% 8%
performance has
been very volatile, -4% 4% 0% -13% -8% 18% 21% 7%
seeing double-digit
losses/gains for -6% 2% -1% -14% -9% 18% 19% 7%
almost all quarters -8% -2% -9% -21% -9% 16% 17% 7%
since 1Q08 . . . .
-10% -3% -9% -23% -11% 15% 15% 7%
-11% -5% -12% -23% -12% 10% 11% 6%
-12% -6% -16% -25% -12% 9% 9% 5%
-15% -8% -19% -26% -12% 9% 9% 5%
-15% -11% -23% -31% -22% 8% 5% 4%
-15% -19% -25% -38% -29% 2% 4% -2%
Circle of Life: Trending Composite Score

In the figure below, we looked at the trend of the composite score for the Financials
sector, which is calculated based on our ranking of ten metrics in our monthly Circle
of Life report (see “Circle of Life: Raising YE09 Target to 1160: Raising ’10E EPS
to $80: Pro-Cyclical Bias into YE” from 11/20/09 for a full explanation of the ten
metrics”).
• The composite score for the Financials sector saw a sharp improvement early on
this year, as the credit markets recovered and several government programs began
to take effect (TARP, TALF, etc.). JULI spreads for this sector declined sharply
from their extremely elevated levels, and the sales and earnings outlook for the
sector improved, resulting in an improved composite score.
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Figure 78: Circle of Life Metrics Monthly Changes — Financials Figure 79: Circle of Life Trending Composite Score — Financials
Jan Feb Mar Apr Jun Jul Aug Sep Oct Nov
Composite score is avg ranking of metrics calculated in Circle of Life
Price Performance
Sales Revision 1.0 Financials
Sales Momentum
0.5
Composite Score
Earnings Revision
Earnings Momentum
0.0
JULI Spreads
FC Mean Rating (0.5)

Short Interest
ETF Fund Flows (1.0)

P/10Yr EPS Jan Mar Jun Aug Oct
Total Delta 0 1 2 0 0 1 0 0 -1
Composite Score 0.4 0.4 0.6 0.8 0.7 0.7 0.8 0.8 0.8 0.7
Earnings Outlook and Performance

Earnings in Financials have been volatile, similar to the price performance of the
sector over the past two years. Earnings for this sector were a significant drag on
overall S&P 500 earnings in 2008, as asset write-downs and credit charges were
severe at the height of the credit crisis.
However, now that credit markets have stabilized and the economic outlook
continues to improve, the Financials sector is expected to generate 55% earnings
growth in 2010 based on consensus and is likely to be the largest driver for S&P 500
earnings.
Figure 80: Financials: Sector Earnings and % chg yoy

$ per share
y oy % chg in LTM EPS LTM EPS
$30.00 JPM estimate --> 100%
$25.00 50%
Contribution to S&P 500 EPS (LTM)
neg to
Financials should
$20.00 pos EPS
provide a strong positive 0%
boost to S&P 500 $15.00
earnings in 2010 -50%
yoy % chg
$10.00
-100%
$5.00
-150%
$0.00
($5.00) -200%
($10.00) -250%
12/02 6/03 12/03 6/04 12/04 6/05 12/05 6/06 12/06 6/07 12/07 6/08 12/08 6/09 12/09 6/10 12/10
Figure 81 below further highlights the strong recovery in Financials both at the top-
line sales and bottom-line earnings levels, according to the Street consensus outlook.
While sales are only projected to grow 2% in 2010, as a result of the strong recovery
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(1-212) 622-6505 10 December 2009
in sales that we have already seen this past year, earnings are projected to grow by
55% in 2010. This strong earnings growth reflects the impact of lower credit charges
and provisioning as the global economy continues to recover. If we look longer term
to 2011 as credit continues to normalize, provisions are likely to decline even further,
allowing Financials to make an outsize contribution to earnings growth again in
’11E.
Figure 81: Consensus Outlook for Financials: Quarterly Sales and Earnings (1Q08 — 4Q10E)
$ in mm
1Q08 2Q08 3Q08 4Q08 2008 1Q09 2Q09 3Q09 4Q09E 2009E 1Q10E 2Q10E 3Q10E 4Q10E 2010E
Financials
Sales $220,053 $244,734 $198,116 $140,082 $802,986 $263,844 $276,775 $267,550 $265,494 $1,073,663 $269,759 $274,167 $273,836 $276,949 $1,094,712
• $ chg yoy -$38,400 -$21,283 -$51,921 -$70,620 -$182,224 $43,791 $32,041 $69,434 $125,411 $270,677 $5,916 -$2,608 $6,286 $11,455 $21,049
% chg yoy -14.9% -8.0% -20.8% -33.5% -18.5% 19.9% 13.1% 35.0% 89.5% 33.7% 2.2% -0.9% 2.3% 4.3% 2.0%
• $ chg qoq $9,350 $24,681 -$46,618 -$58,034 $123,761 $12,931 -$9,224 -$2,057 $4,266 $4,408 -$331 $3,112
% chg qoq 4.4% 11.2% -19.0% -29.3% 88.3% 4.9% -3.3% -0.8% 1.6% 1.6% -0.1% 1.1%
Net Income $18,254 $22,860 $3,743 -$73,882 -$29,025 $7,746 $23,411 $17,795 $16,287 $65,238 $20,303 $24,242 $26,116 $30,554 $101,215
• $ chg yoy -$30,029 -$26,727 -$36,392 -$79,679 -$172,827 -$10,508 $551 $14,052 $90,169 $94,263 $12,557 $831 $8,321 $14,268 $35,977
% chg yoy -62.2% -53.9% -90.7% -1374.4% -120.2% -57.6% 2.4% 375.4% — — 162.1% 3.6% 46.8% 87.6% 55.1%
• $ chg qoq $12,456 $4,606 -$19,116 -$77,625 $81,627 $15,665 -$5,616 -$1,508 $4,016 $3,939 $1,874 $4,438
% chg qoq 214.9% 25.2% -83.6% -2073.6% -110.5% 202.2% -24.0% -8.5% 24.7% 19.4% 7.7% 17.0%
Sector Valuation
Despite the sharp rally in the market since March, and in Financials in particular, the
relative P/10yr EPS of the Financials sector remains near an all-time low, suggesting
there is still significant upside for multiple expansion on this metric.
• If the relative P/10yr EPS were able to recover to the long-term avg, it would
suggest 70% upside for the sector. Even if valuations are only able to recover to
one standard deviation below the long-term avg, that would imply 44% upside for
the sector, suggesting the sector has strong upside potential even with a more
conservative view of multiple reflation.
Figure 82: Financials: P/10-yr EPS
10-yr EPS
1.2x
Relative P/E to S&P 500
Financials valuations 1.0x

remain near an all-time
low despite the rally
since March. If the
relative P/10yr EPS
0.8x
were to recover to the
LT avg, it suggests
70% upside 0.6x
0.4x
'84 '88 '92 '96 '00 '04 '08
Recessions Rel to SP500 STD +1 STD -1 Avg
Source: J.P. Morgan and Datastream.
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Best and Worst Industries within Financials

Within the Financials sector, the different industries vary broadly on the current
valuation and Street analyst sentiment. The chart below looks at how the current
relative valuation (P/S) of each industry compares to the historical avg relative
valuation (X-axis) and how the current relative FC Mean rating compares to the
historical avg rating (Y-axis).
Most of the Financials industries are still out of favor with Street analysts and
cheaper than the long-term avg relative P/S, suggesting there are still opportunities
for cheap, contrarian ideas within the sector.
• REITs and Consumer Finance, in particular, currently trade at 0.4-0.6 turns

cheaper on a relative basis than they have historically, based on P/S, and they are
also less liked than usual relative to the S&P 500, suggesting both industries are
still relatively cheap and may contain contrarian ideas. The REITs were hit
especially hard during the downturn due to concerns surrounding whether or not
companies would be able to rollover debt. However, due to a sharp recovery in
the credit market along with several rounds of successful TALF CMBS
subscriptions during the year, REITs are likely to continue to recover.
Figure 83: Financials: Comparative Valuation and Sentiment Matrix
X-axis: Current relative P/S vs. Long-term avg. Y-axis: Current relative FC Mean Rating vs. Long-term avg
(0.10)
Most industries are still Capital Markets Expensive &
out of favor with Street In-Favor
analysts and cheaper -
than the long-term avg Insurance Thrifts & Mortgage
relative P/S, suggesting Finance
Current FC Mean vs. LT Avg FC Mean
there are still 0.10

Commercial Banks Div ersified Financial
opportunities for cheap,
contrarian ideas in the Serv ices
sector 0.20
0.30 Consumer Real Estate

Finance
Inv estment Trusts
0.40 (REITs)
Cheap & Out Real Estate

0.50 Management &
of Favor
Dev elopment
0.60
-1.2x -1.0x -0.8x -0.6x -0.4x -0.2x 0.0x 0.2x 0.4x 0.6x 0.8x 1.0x
Current P/S vs. LT Avg P/S
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Industrials: Overweight
ISM and Industrial Production
Pro-cyclical trade to continue at least during 1H10 as the economy recovers . . .
Inventory Rebuild
Global Recovery
In 2009, an investor could not make a call on Industrials based on fundamentals,
Business Confidence which were still deteriorating, but rather on business cycle considerations (buy
Credit Availability Industrials based on ISM, etc.) and the fact that credit markets saw fit to tighten
Dollar/Exports Industrial credit spreads. In fact, in 2009 Industrials were the second best
performing sector since the March ’09 bottom (up 85%), outperforming the S&P 500
by 2,150bp.
A recurring theme for many Sectors is that visibility is key or at least expectations of
improving visibility. At this stage, most companies have little evidence of
“expansionary” activity - at this point, all surviving businesses have “stabilization”
J.P. Morgan Analyst Coverage
and some even see gradual expansion. In most conversations, the difference between
Analyst a constructive and negative view on Industrial simply hinges on the perspective about
Sector Analyst Conviction the strength of the US recovery. Those less constructive argue that there is little
Aerospace Nadol N evidence of an expansion, at least one supporting the 2.8% GDP growth we saw in
Airfreight Wadewitz HC 3Q09, and further their caution into 2010.
Multi-Ind. Tusa LC
E&C Levine N
Waste Levine N
We disagree with that view, however. A 2.8% GDP Q/Q SAAR, is $98 billion of
Machinery Duignan HC additional activity on a $14 trillion economy. Think about that - it would be a 0.7%
Shipping Chappell LC increase sequentially, and likely concentrated in a handful of industries. Few
Airlines Baker HC companies would feel that at this point. Give us 2-3 quarters of that, and we are
Bus. Svcs Steinerman HC talking $200-$300 billion of greater activity, and the companies will certainly feel it.
HC: High Conviction; N: Neutral; LC: Low In other words, we think it is premature for most companies to have improved
Conviction. Analyst conviction based on our visibility after only 1 quarter of GDP growth.
about likelihood of outperformance by their
sectors vs. overall market in 2010.
That said, some companies are seeing improvements. This is certainly the case for
Transports. Thomas Wadewitz, J.P. Morgan Airfreight & Surface Transportation
analyst, has noted that international airfreight has increased solidly in both October
and November and is increasingly supported by rail volumes and other activity
Industrials: Overweight
measures. Andrew Steinerman, J.P. Morgan Business Services analyst, notes that
hiring trends have improved nicely in the past few months and are further
corroborated by the improved hours worked in recent payroll reports.
The earnings leverage to order growth is substantial. Ann Duignan, J.P. Morgan
Machinery analyst, noted that each 5% increase in housing starts is 7% upside to her
Caterpillar (CAT-OW/$56.18) estimate. Still, we get the sense that businesses, in
general, are fighting the recovery; or, perhaps more accurately, are unwilling to
embrace a recovery until they see the whites of the expansion. Moreover, one has to
wonder what kind of pricing power exists given the low US capacity utilization. That
said, the fact that capital spending has been depressed, suggests that few new
competitors for markets are emerging.
Bottom line: A constructive case on Industrials is based on a robust GDP view

The bottom line is Industrials have significant leverage to upside in US economic
growth and significant positive exposure to easing credit conditions (for their
customers). After all, if the Economy begins adding 150k-300k jobs per month and
orders expand, this is going to accrue to the smokestack companies in America.
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(1-212) 622-6505 10 December 2009

Industrials price performance gradually deteriorated relative to the S&P 500 as the
economy worsened in 2008 and early 2009, but it has recovered strongly in the past
few quarters as signs of the economic recovery continue to emerge.
Although the sector has not been a leader so far in 4Q09, we expect that Industrials
will continue to outperform early on in 2010 as the global economy recovers and
industrial production recovers toward normalized levels.
Figure 84: Quarterly Price Performance — Industrials

Industrials price
performance 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 QTD
gradually
deteriorated relative -3% 17% 4% -3% 4% 35% 25% 9%
to the S&P 500 as the -4% 7% 0% -12% -3% 19% 21% 8%
economy worsened
in 2008 and early -4% 4% 0% -13% -8% 18% 21% 7%
2009, but it has
recovered strongly in
-6% 2% -1% -14% -9% 18% 19% 7%
the past few quarters -8% -2% -9% -21% -9% 16% 17% 7%
as signs of the
economic recovery -10% -3% -9% -23% -11% 15% 15% 7%
continue to emerge
-11% -5% -12% -23% -12% 10% 11% 6%
-12% -6% -16% -25% -12% 9% 9% 5%
-15% -8% -19% -26% -12% 9% 9% 5%
-15% -11% -23% -31% -22% 8% 5% 4%
-15% -19% -25% -38% -29% 2% 4% -2%

The composite score of the Industrials sector reflects the sharp improvement in the
global economy in 2009, as this sector has moved from being one of the lowest-
ranked sectors on our metrics bank in January to one of the top-ranked sectors
currently.
• The improvement in the composite score reflects the impact of tighter credit
spreads and upward sales and earnings revisions. Along with the improvement in
these fundamental metrics, sentiment for the sector has also greatly improved, as
short interest has declined and the FC mean rating has improved as Street
analysts have upgraded stocks in the sector.
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Figure 85: Circle of Life Metrics Monthly Changes — Industrials Figure 86: Circle of Life Trending Composite Score — Industrials
Price Performance
Sales Revision 1.0 Industrials

Sales Momentum
0.5
Composite Score
Earnings Revision
Earnings Momentum
0.0
JULI Spreads

Short Interest

Total Delta 2 2 0 0 0 2 1 3 0
Composite Score (0.8) (0.6) (0.3) (0.3) (0.3) (0.3) (0.1) 0.0 0.3 0.3

Industrials earnings deteriorated along with overall economy in 2008 and early 2009
as industrial production sharply declined in the past year. However, earnings growth
appears to have troughed on a yoy basis in 3Q09 and is poised for a strong recovery
in 2010.
• Although yoy earnings growth is not projected to turn positive again until 3Q10,
earnings should continue to improve sequentially and yoy earnings growth should
be 10-20% for full-year 2010.
• During 2010, five companies in the industrials sector will contribute 70% of the
EPS growth, with Boeing contributing nearly 40% of the total sector growth
based on consensus estimates (see Figure 54).
Figure 87: Industrials: Sector Earnings and % chg yoy
$ per share
$11.00 JPM estimate --> 30%
Industrials earnings
deteriorated along $10.00 20%
with the overall

economy in 2008 and $9.00 10%
early 2009 but appear
to have troughed on $8.00 0%
yoy % chg
a yoy basis in 3Q09

and are poised for a $7.00 -10%
strong recovery in
2010E $6.00 -20%
$5.00 -30%
$4.00 -40%
12/02 6/03 12/03 6/04 12/04 6/05 12/05 6/06 12/06 6/07 12/07 6/08 12/08 6/09 12/09 6/10 12/10
Source: J.P. Morgan estimates, FactSet, and Thomson Director's Report.
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The strong recovery in 2010 for Industrials is likely to be driven by two factors: 1) a
return to positive top-line growth and 2) continued improvement in margins. First,
the return to positive top-line growth in 2010E is a sharp swing from the -12%
decline in sales in 2009E and reflects the impact of a recovery in global industrial
production. Second, margins are likely to continue expanding in 2010 from their
recent trough in 2009E as these companies benefit from cost-cutting initiatives
implemented in 2009 and their upside leverage to global economic growth.
Figure 88: Consensus Outlook for Industrials: Quarterly Sales and Earnings (1Q08 — 4Q10)
$ in mm
Industrials
Sales $256,066 $278,088 $272,698 $257,634 $1,064,486 $230,639 $233,205 $232,939 $241,652 $938,435 $231,331 $240,033 $244,188 $252,558 $968,110
• $ chg yoy $23,141 $28,865 $21,974 -$8,163 $65,818 -$25,427 -$44,883 -$39,759 -$15,982 -$126,050 $691 $6,828 $11,249 $10,906 $29,675
% chg yoy 9.9% 11.6% 8.8% -3.1% 6.6% -9.9% -16.1% -14.6% -6.2% -11.8% 0.3% 2.9% 4.8% 4.5% 3.2%
• $ chg qoq -$9,731 $22,022 -$5,390 -$15,064 -$26,995 $2,565 -$265 $8,713 -$10,321 $8,702 $4,155 $8,369
% chg qoq -3.7% 8.6% -1.9% -5.5% -10.5% 1.1% -0.1% 3.7% -4.3% 3.8% 1.7% 3.4%
Net Income $20,557 $23,557 $22,105 $17,944 $84,163 $13,246 $15,373 $13,359 $15,523 $57,500 $13,551 $15,641 $16,653 $18,048 $63,892
• $ chg yoy $1,569 $1,521 -$175 -$5,969 -$3,054 -$7,311 -$8,185 -$8,746 -$2,421 -$26,663 $305 $268 $3,294 $2,525 $6,392
% chg yoy 8.3% 6.9% -0.8% -25.0% -3.5% -35.6% -34.7% -39.6% -13.5% -31.7% 2.3% 1.7% 24.7% 16.3% 11.1%
• $ chg qoq -$3,356 $3,000 -$1,452 -$4,161 -$4,698 $2,127 -$2,014 $2,164 -$1,972 $2,090 $1,013 $1,395
% chg qoq -14.0% 14.6% -6.2% -18.8% -26.2% 16.1% -13.1% 16.2% -12.7% 15.4% 6.5% 8.4%
Sector Valuation
Industrials valuations remain cheap on a P/10yr EPS basis as valuations do not yet
reflect the upswing in earnings that should occur as we move back through the
earnings cycle. Valuations still likely reflect the near-term view of earnings and do
not account for the full-cycle earnings potential of this sector once industrial
production returns to normalized levels.
• If valuations recover to the long-term avg, it would imply 15% upside for the
sector. Even if valuations only recover to one standard deviation below the long-
term avg (a more conservative target for valuations), it would still suggest 5.5%
upside for the sector.
Figure 89: Industrials: P/10-yr EPS
10-yr EPS
1.4x
Industrials valuations
remain attractive, and

if valuations were to 1.2x
recover to the long-
term avg, it would
imply 15% upside for
the sector
1.0x
0.8x
'84 '88 '92 '96 '00 '04 '08
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Best and Worst Industries within Industrials

The range of valuations and sentiment is mixed for the Industrials sector as several
industries are expensive compared to their long-term relative valuation and also more
liked than usual while several industries remain cheap and are still out of favor with
analysts.
• Building Products, for example, could be poised for strong performance as

relative multiples expand toward the long-term avg and Street analysts upgrade
stocks in the sector. Road & Rail, on the other hand, is currently more expensive
than usual and is slightly more liked than usual, suggesting it may have less
upside potential.
Figure 90: Industrials: Comparative Valuation and Sentiment Matrix
(0.40)
Several Industrials Trading Companies
Expensive &
industries remain (0.30) & Distributors
cheap and are still out In-Favor
of favor with analysts. (0.20)
Building Products, for Aerospace &&

(0.10) Construction
Machinery
Air Freight &
example, could be Commercial Defense
Engineering Road & Rail
poised for strong Logistics
- Serv ices & Supplies
performance as relative
multiples expand
0.10 Professional
toward the long-term
avg and Street analysts Serv ices
0.20
upgrade stocks in the
Industrial
sector 0.30 Electrical Equip
Conglomerates
Airlines
0.40
Cheap & Out Building Prdcts
0.50
of Favor
0.60
-1.0x -0.5x 0.0x 0.5x 1.0x 1.5x
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Technology: Overweight
Windows 7 Upgrade Cycle Technology was a defensive group for investors in late 2008, given the pristine
(Software & Hardware) balance sheets, cash generative business models and exposure to emerging markets.
Hardware replacement Cycle Then, as the ISM bottomed and the economy troughed, Technology became a
International Exposure
Cyclical group benefiting from order growth, EPS revisions and M&A as well.
CEO Confidence
Utilization Technology stocks rose 54% in 2009 (vs. S&P 500 22.1%).
The Technology groups leading growth in the past decades are maturing and, given
the law of large numbers, simply are not likely to post the V-shaped growth of the
1990s. That said, overall Technology spending is highly linked to overall Capex (a
rising share) and consumer spending - both of which have improved outlook and thus
bode well for top lines.
Analyst Mark Moskowitz, J.P. Morgan IT Hardware analyst, sees mid-single-digit growth in
Sector Analyst Conviction most segements of storage, servers, PCs and printers – but growth in these areas in
2009 surprised to the upside and could again given pent-up demand. Enterprise
Com. Equip Hall LC
Infras. Tech O’Brien HC spending on IT has natural beta to GDP growth, employment trends and CEO
IT Hardware Moskowitz N confidence, which again, we believe, will improve in 2010 (see Figure 79).
IT Services Huang N
Semis Danely N Pricing power is always a question in this group and gross margins in particular. On
Software DiFucci N
the one hand, given the cyclical nature of this group coupled with less durable
AppliedTech Coster HC
Software Tech Auty N pricing power, one certainly could argue that margins are close to a peak.
Alt Energy Blansett —
But counter-arguments are valid. Competitive dynamics have improved in
Technology given mergers and limited competition from new businesses. There are
Conviction. Analyst conviction based on our multiple instances of strong competitive advantages of US companies, such as Apple
takeaways from discussions with analysts (AAPL-OW/$197.80) and Google (GOOG-OW/$589.02), among others. Moreover,
about likelihood of outperformance by their the group’s exposure to fast-growing Emerging markets, dollar arbitrage and a
weaker dollar, downward pressure on wages support better top lines, relatively more
stable pricing and hence upside to margins.
Technology: Overweight
Bottom line: Not paying a lot for earnings growth
The group is still attractive on a risk/reward basis. Based on our estimates,
Technology trades at 15X/13X P/10E/11E EPS, a discount to the forecast earnings
growth of 23%/16% YoY in ’10E/’11E. Lastly, the strong balance sheets position the
industry for M&A.
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Figure 91: YoY Change in IT Spending Figure 92: IT Equipment & Software Investment as % of GDP
since 1947 Since 1947
50% 6.0%
40% YoY Change in IT Spending 4.9%
5.0% IT Spending as % of GDP
IT Spending as % GDP
30%
20% 4.0%
YoY Chg
10% 3.0% 3.6%
0%
2.0%
-10%
1.0%
-20% -15%-16% -14% -11%
-30% -21% 0.0%
2/47 2/55 2/63 2/71 2/79 2/87 2/95 2/03 2/47 2/55 2/63 2/71 2/79 2/87 2/95 2/03
Source: BEA & J.P. Morgan. Source: BEA & J.P. Morgan.

The Technology sector underperformed in late 2008, declining sharply in 3Q08 and
4Q08, but it became an early leader in the recovery in 2009 and has been one of the
top-performing sectors in every quarter in 2009.
• This early recovery in performance of the Technology sector reflects its early-
cycle nature. The strong performance is also likely to continue early in 2010: the
Technology sector has significant exposure to international markets and thus is
leveraged to a recovery in the global economy.
Figure 93: Quarterly Price Performance — Technology
1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 QTD
Technology -3% 17% 4% -3% 4% 35% 25% 9%

underperformed in -4% 7% 0% -12% -3% 19% 21% 8%
2008, but it became an
early leader in the -4% 4% 0% -13% -8% 18% 21% 7%
recovery in 2009 and
has been one of the top -6% 2% -1% -14% -9% 18% 19% 7%
performing sectors in -8% -2% -9% -21% -9% 16% 17% 7%
every quarter in 2009
-10% -3% -9% -23% -11% 15% 15% 7%
-11% -5% -12% -23% -12% 10% 11% 6%
-12% -6% -16% -25% -12% 9% 9% 5%
-15% -8% -19% -26% -12% 9% 9% 5%
-15% -11% -23% -31% -22% 8% 5% 4%
-15% -19% -25% -38% -29% 2% 4% -2%
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The consistent improvement in the composite score for the Technology sector in
2009 reflects the impact of the improvement in the global economy in 2009 as well
as the stabilization in credit markets.
• In early 2009, Technology was one of the lowest-ranked sectors on our metrics,
similar to the Cyclicals in general at that time. However, the sector has seen
consistent improvement in sales and earnings revisions and momentum, tighter
credit spreads, and improved sentiment, and it is now one of the top-ranked
sectors on our metrics.
Figure 94: Circle of Life Metrics Monthly Changes — Technology Figure 95: Circle of Life Trending Composite Score —
Technology
Price Performance
1.0 Technology
Sales Revision
0.5
Composite Score
Sales Momentum
Earnings Revision
0.0
Earnings Momentum
JULI Spreads (0.5)

FC Mean Rating
Short Interest (1.0)

ETF Fund Flows Jan Mar Jun Aug Oct
P/10Yr EPS
Total Delta 0 1 2 1 2 1 1 0 1
Composite Score (0.3) (0.3) (0.2) 0.0 0.2 0.4 0.5 0.6 0.6 0.7

Earnings in the Technology sector saw a sharp decline from 3Q08 to 2Q09 as the
sector was hit hard by the impact of the credit crisis and sharp contraction in the
global economy.
• Technology earnings, however, appear to have troughed in 3Q09 and are

projected to rebound strongly to 20-30% yoy earnings growth in 2010. This
strong growth in 2010E is achievable partly due to the significant exposure to
international markets in this sector, which makes it leveraged to a recovery in the
global economy.
• At the company level, the top five EPS contributors within the S&P 500 are
expected to deliver 46% of the sector’s EPS growth. Based on consensus
estimates, Intel is expected to contribute 19% of the tech sector’s EPS growth.
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Figure 96: Technology: Sector Earnings and % chg yoy

$ per share
$16.00 JPM estimate --> 100%
$14.00 80%

Technology earnings
saw sharp yoy $12.00 60%
declines in early 2009
but appear to have $10.00 40%
yoy % chg
troughed in 3Q09 and
are projected to $8.00 20%
rebound strongly to
20-30% yoy earnings $6.00 0%
growth in 2010
$4.00 -20%
$2.00 -40%
12/02 6/03 12/03 6/04 12/04 6/05 12/05 6/06 12/06 6/07 12/07 6/08 12/08 6/09 12/09 6/10 12/10
Source: J.P. Morgan, FactSet, and Thomson Director’s Report.
Similar to the outlook for Industrials, the recovery in earnings for the Technology
sector is driven by both a return to top-line growth and an expansion of margins.
• Consensus estimates currently project 8.6% yoy revenue growth in 2010, with
particularly strong 10% revenue growth in 1Q10 and 2Q10. As mentioned earlier,
this strong top-line sales growth reflects the Technology sector’s exposure to
international markets, leveraging it to a continued recovery in the global
economy. The Technology sector also has exposure to the consumer, both in the
US and abroad, so an improvement in payrolls in 2010 could provide upside to
sales estimates that consensus is not currently projecting.
• At the bottom line, consensus is projecting yoy net income growth of 24% in
2010, well above the projected 8.6% sales growth, implying that consensus
expects continued expansion in margins in 2010.
Figure 97: Consensus Outlook for Technology: Quarterly Sales and Earnings (1Q08 — 4Q10)
$ in mm
Technoloy
Sales $200,937 $207,428 $208,626 $199,614 $816,605 $175,114 $180,924 $190,341 $207,615 $753,994 $193,524 $199,035 $205,835 $220,451 $818,845
• $ chg yoy $18,528 $21,074 $13,668 -$15,144 $38,125 -$25,823 -$26,503 -$18,285 $8,001 -$62,611 $18,410 $18,111 $15,494 $12,836 $64,851
% chg yoy 10.2% 11.3% 7.0% -7.1% 4.9% -12.9% -12.8% -8.8% 4.0% -7.7% 10.5% 10.0% 8.1% 6.2% 8.6%
• $ chg qoq -$13,821 $6,491 $1,198 -$9,012 -$24,500 $5,811 $9,416 $17,274 -$14,091 $5,511 $6,800 $14,616
% chg qoq -6.4% 3.2% 0.6% -4.3% -12.3% 3.3% 5.2% 9.1% -6.8% 2.8% 3.4% 7.1%
Net Income $27,347 $27,617 $28,555 $24,699 $108,219 $19,800 $21,692 $27,736 $32,281 $101,509 $27,990 $29,621 $31,699 $36,585 $125,894
• $ chg yoy $2,516 $3,302 $1,694 -$7,374 $138 -$7,547 -$5,926 -$819 $7,582 -$6,710 $8,190 $7,929 $3,963 $4,303 $24,385
% chg yoy 10.1% 13.6% 6.3% -23.0% 0.1% -27.6% -21.5% -2.9% 30.7% -6.2% 41.4% 36.6% 14.3% 13.3% 24.0%
• $ chg qoq -$4,726 $270 $938 -$3,856 -$4,899 $1,892 $6,044 $4,545 -$4,291 $1,631 $2,078 $4,886
% chg qoq -14.7% 1.0% 3.4% -13.5% -19.8% 9.6% 27.9% 16.4% -13.3% 5.8% 7.0% 15.4%
Sector Valuation
Technology valuations are in line with the long-term avg, suggesting the sector is
neither particularly cheap nor expensive. However, the P/10yr EPS appears to be
expanding, so we could still see additional multiple expansion in 2010.
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• If multiples do continue to expand, we could see as much as 29% upside for the
sector before the valuation gets overstretched and exceeds one standard deviation
above the long-term average. Thus, while valuations for Technology are not
necessarily a driver for upside in 2010, they are not a drag either since there still
could be room for further expansion.
Figure 98: Technology: P/10-yr EPS
10-yr EPS
Technology 3.0x
valuations are in line

with the long-term
avg . . . . 2.4x
1.8x
1.2x
0.6x
'84 '88 '92 '96 '00 '04 '08
Best and Worst Industries within Technology

Most industries in Technology are currently near the long-term relative valuation and
near the long-term relative FC mean rating, suggesting there are fewer contrarian
ideas in this space.
• Computers & Peripherals is one of the few contrarian ideas in the space at the
moment as it is in line with historical valuations\ but currently out of favor with
analysts, suggesting it could see upside as analysts upgrade stocks in the industry.
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Figure 99: Technology: Comparative Valuation and Sentiment Matrix

(0.30)
Expensive &
In-Favor
(0.25)
Computers & Peripherals Office Electronics
is one of the few
contrarian ideas in the (0.20)

space
(0.15)
Internet Softw are &

(0.10)
Serv ices IT Serv ices
(0.05) Semiconductors &

Electronic
Semiconductor
Communications Equipment
Softw are Equip
- Instruments &
Equipment
Components
0.05 Cheap & Out
Computers &
of Favor
Peripherals
0.10
-8.0x -7.0x -6.0x -5.0x -4.0x -3.0x -2.0x -1.0x 0.0x 1.0x 2.0x
90
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Basic Materials: Overweight

Global Economic Recovery
More than a dollar play . . .
Fiscal Stimulus
Commodity Prices
Basic Materials is viewed by some investors as a weak-dollar play. Buy commodities
Weak dollar producers when the dollar weakens, especially as commodities are gobbled up by
Emerging markets. That premise actually worked well for the past 5 years. And
Basic Materials is a late-cycle play, which is why it worked until 2008 and, in fact, in
the 2009 time frame, Basic Materials is late-cycle for EM regions, which recovered
in October 2008.

The thesis for this group is evolving to one of significant leverage to early-cycle
economic activity, thus, strong earnings upside. Anything produced by a smokestack
Analyst uses a basic material, thus this group is the epicenter of economic leverage to a GDP
Sector Analyst Conviction
recovery. This cycle, some other things are also working in the group’s favor:
Metals Gambardella HC
Coal Bridges N
• A weak dollar is limiting imports of competitive products as US companies are
Gold Bridges HC
Chemicals Zekauskas HC positioned to be low-cost producers. That is already the case for steels.
Paper Hueston HC
• Growing demand from emerging markets coupled with a weak dollar strengthens
HC: High Conviction; N: Neutral; LC: Low the export story and with lower transportation costs (lower fuel), orders can travel
Conviction Analyst conviction based on our longer distances.
about likelihood of outperformance by their • Supply discipline seems greater in the space as well and fits into the broader story
sectors vs. overall market in 2010. that these companies have better financial positions than they did in past cycles.
In fact, this prevented greater price declines in industries such as Paper and
Packaging, covered by Claudia Shenk-Hueston.
But mostly it comes down to the volumes upside as the economy recovers. Because
of the large fixed cost nature of most these scale businesses, incremental margins are
high. For instance, in Chemicals, this is over 50%. Michael Gambardella’s 2010
Basic Materials: Overweight

EPS estimate for US Steel (X-OW/$46.74) is 300% above Street consensus.
The valuation is still attractive for Materials, trading at 15.5 2011E EPS, arguably
reasonable considering the 73%/15% EPS growth forecast for ’10E/’11E. Within the
Materials sector, the top five EPS contributors are expected to deliver 76% of the
sector’s EPS growth (see Figure 54). Based on consensus estimates, US Steel is
expected to generate 21% of the sector’s EPS growth.

Similar to the other Cyclicals, Materials outperformed over the past few quarters of
2009, bouncing back after a sharp decline in late 2008. The outperformance in 2009
has reflected the recovery in the global economy, which has caused a rebound in the
demand for commodities and other materials globally. This outperformance is also
likely to continue in the first half of 2010, as the global economy, industrial
production, and the U.S. housing market recover and drive up the demand for
materials products.
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Figure 100: Quarterly Price Performance — Basic Materials

1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 QTD
-3% 17% 4% -3% 4% 35% 25% 9%
-4% 7% 0% -12% -3% 19% 21% 8%
Materials has been a
steady performer -4% 4% 0% -13% -8% 18% 21% 7%
over the past several
quarters after a sharp -6% 2% -1% -14% -9% 18% 19% 7%
decline in late 2008 -8% -2% -9% -21% -9% 16% 17% 7%
-10% -3% -9% -23% -11% 15% 15% 7%
-11% -5% -12% -23% -12% 10% 11% 6%
-12% -6% -16% -25% -12% 9% 9% 5%
-15% -8% -19% -26% -12% 9% 9% 5%
-15% -11% -23% -31% -22% 8% 5% 4%
-15% -19% -25% -38% -29% 2% 4% -2%

The Circle of Life composite score for Materials improved significantly early in 2009
as the sector rebounded from being the lowest-ranked sector back in January to one
of the higher-ranked sectors in more recent months.
• This recovery in the composite score reflected fundamental improvements from

upward earnings and sales revisions as well as improved sentiment from analyst
upgrades and lower short interest.
• The composite score has faltered in recent months, however, as earnings
revisions have leveled off more recently and valuations in the sector have become
stretched.
Figure 101: Circle of Life Metrics Monthly Changes — Materials Figure 102: Circle of Life Trending Composite Score — Materials
Price Performance
Sales Revision 1.0 Materials

Sales Momentum
0.5
Composite Score
Earnings Revision
Earnings Momentum
0.0
JULI Spreads

Short Interest

P/10Yr EPS Jan Feb Mar Apr Jun Jul Aug Sep Oct Nov
Total Delta 3 2 2 1 1 1 2 -1 -1
Composite Score (0.9) (0.4) (0.2) 0.0 0.2 0.3 0.4 0.6 0.5 0.4
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Materials earnings have been extremely volatile over the past year, as the collapse in
global commodities demand and pricing hurt earnings in 2009, but the sector is
poised for strong 60+% earnings growth in 2010.
• The drop in earnings in the Materials sector was particularly steep, as LTM
earnings declined by 66% from the peak in 3Q08 to the recent trough in 3Q09.
• The recovery in earnings, however, is projected to be extremely steep as well,
with 70+% growth projected in 2010 vs. 2009. The Materials sector is a relatively
small contributor to the overall S&P 500, so this sharp swing in earnings won’t
have as significant an impact to the overall index’s earnings as other sectors’,
such as Financials’. However, the sharp earnings recovery should help provide a
catalyst for outperformance for the sector early in 2010.
Figure 103: Basic Materials: Sector Earnings and % chg yoy
$ per share
100%
The sector is
$3.00
poised for a strong 80%
earnings growth 60%
during 2010E and $2.50
40%
2011E
yoy % chg
$2.00 20%
0%
$1.50
-20%
-40%
$1.00
-60%
$0.50 -80%
12/02 6/03 12/03 6/04 12/04 6/05 12/05 6/06 12/06 6/07 12/07 6/08 12/08 6/09 12/09 6/10 12/10
The consensus outlook for earnings and sales in 2010 is similar to that for the other
Cyclicals, with a sharp swing from negative growth in 2009 to positive growth in
2010 as well as further expansion of margins.
• Sales are projected to grow by 11.2% in 2010, a sharp recovery from the 24.4%
decline in sales in 2009. However, Materials revenue in 2010 will still be 16%
below the peak level in 2008.
• Earnings are similarly projected to show a strong recovery in 2010, with
consensus projecting 68% earnings growth in 2010. However, the $19.9b in
earnings projected for 2010 is still 18% below the $24.1b in earnings from 2008,
suggesting the estimate for 2010 is not unreasonable.
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Figure 104: Consensus Outlook for Materials: Quarterly Sales and Earnings (1Q08 — 4Q10)
$ in mm
Materials
Sales $89,640 $98,731 $92,881 $71,882 $353,134 $63,036 $66,745 $68,722 $68,369 $266,872 $72,973 $75,640 $74,373 $73,717 $296,703
• $ chg yoy $13,074 $13,501 $11,404 -$10,511 $27,467 -$26,604 -$31,986 -$24,160 -$3,512 -$86,262 $9,937 $8,894 $5,651 $5,348 $29,830
% chg yoy 17.1% 15.8% 14.0% -12.8% 8.4% -29.7% -32.4% -26.0% -4.9% -24.4% 15.8% 13.3% 8.2% 7.8% 11.2%
• $ chg qoq $7,247 $9,091 -$5,850 -$21,000 -$8,846 $3,709 $1,976 -$352 $4,604 $2,667 -$1,267 -$656
% chg qoq 8.8% 10.1% -5.9% -22.6% -12.3% 5.9% 3.0% -0.5% 6.7% 3.7% -1.7% -0.9%
Net Income $7,867 $8,655 $6,499 $1,122 $24,143 $2,020 $3,057 $3,707 $3,031 $11,815 $5,186 $5,752 $4,660 $4,255 $19,852
• $ chg yoy $1,105 $429 -$74 -$3,387 -$1,927 -$5,847 -$5,598 -$2,792 $1,909 -$12,328 $3,166 $2,695 $952 $1,223 $8,037
% chg yoy 16.3% 5.2% -1.1% -75.1% -7.4% -74.3% -64.7% -43.0% 170.1% -51.1% 156.8% 88.2% 25.7% 40.4% 68.0%
• $ chg qoq $3,358 $788 -$2,156 -$5,377 $897 $1,037 $650 -$676 $2,155 $566 -$1,092 -$405
% chg qoq 74.5% 10.0% -24.9% -82.7% 80.0% 51.4% 21.3% -18.2% 71.1% 10.9% -19.0% -8.7%
Sector Valuation
Despite the strong earnings outlook for the Materials sector, valuations have become
stretched over the past several months, suggesting valuations could be a drag for this
sector in 2010.
• The current P/10yr EPS of the Materials sector is 20% above the long-term
average and is also one standard deviation above the long-term average. This
suggests that there is limited support for valuation unless investors make a case
that the sector valuation can expand back to previous levels.
• At the peak of the commodity boom this sector saw much higher valuation, and if
valuations were able to return to the peak level from mid-2008, it would represent
45% upside for the sector.
Figure 105: Basic Materials: P/10-yr EPS
10-yr EPS
1.6x
Materials are elevated 1.2x

but are well below the
peak valuations . . . .
0.8x
0.4x
'84 '88 '92 '96 '00 '04 '08
Best and Worst Industries within Basic Materials

Most industries in Materials are unattractive on a relative valuation basis, but there
could still be catalysts from analyst upgrades, particularly in out-of-favor industries
such as Construction Materials.
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• Every industry within Materials is currently trading at a higher relative P/S than
the historical average over the past 15 years. This highlights the same point made
earlier, that valuations in this sector are currently stretched and unlikely to be a
catalyst in 2010.
• Instead, the potential positive catalyst for Materials is Street analyst upgrades, as
most industries in this sector are currently less liked than usual. Construction
Materials, in particular, is currently out of favor with Street analysts. As the
housing market recovers in 2010, analysts may begin to upgrade the stocks in this
industry, providing catalysts for outperformance.
Figure 106: Basic Materials: Comparative Valuation and Sentiment Matrix
(0.10)
Containers & Paper & Forest
Most industries in (0.05) Packaging Prdcts
Materials are
unattractive on a -
relative valuation basis,

but there could still be Expensive &
0.05 Chemicals
catalysts from analyst In-Favor
upgrades, particularly
0.10
in out-of-favor
industries such as
0.15
0.20 Metals & Mining
0.25
Cheap & Out
Construction
0.30 of Favor
Materials
0.35
0.0x 0.1x 0.1x 0.2x 0.2x 0.3x 0.3x 0.4x 0.4x 0.5x 0.5x
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Energy: Overweight
OPEC and crude
Comparisons get easier, still a strong secular story . . . .
Downstream demand
Global growth
Long term, Energy is a secular story of favorable supply/demand dynamics:
Dollar production is increasingly expensive (or, for the alarmists, in decline) while demand
tracks overall global economic growth, which means demand rises long term. In the
shorter term, the group is very sensitive to the price of oil and other commodities and
to the perception about the durability of the global economic expansion.
One of the challenges for the Energy story in 2009 was the seeming disconnect
between the upstream price of oil (up mostly) and weak demand for gasoline and
J.P. Morgan Analyst Coverage other end-products, meaning downstream refiners had little need to build oil
Analyst holdings. As one investor pointed out, there are only 500 real buyers of Oil globally,
Sector Analyst Conviction which are the downstream refiners. Oil inventories are improving but are still above
E&P Allman N
levels from a year ago (see Figure 107).
MLPs Liu N
Oil price Eagles N The natural gas market is similarly oversupplied (a condition since 2008) as most
companies covered by Joe Allman, J.P. Morgan E&P analyst, are expected to grow
Conviction Analyst conviction based on our natural gas volumes and private companies have increased their rig count.
about likelihood of outperformance by their Lawrence Eagles, Global Energy Strategist, believes the global demand for oil in
2010 is likely to increase by 2.1% from 84.6 (million b/d) to 86.4. The improving
demand coupled with higher price should make comparisons easier in 2010 as the
average oil price is projected to be $70.00 against a projected 2009 level of $62.42
(as per Lawrence Eagles). This suggests overall earnings should recover strongly by
61% during 2010 and 17% during 2011. More than half of the EPS growth for the
sector is expected to come from two companies: Exxon Mobil and Chevron Corp.
Similarly, for Natural gas, a cold winter could help with supply, but really, this group
is reflecting an anticipated rise in demand stemming from the US recovery.
Figure 107: US Crude Inventories coming down . . .

Million of barrels as of 2009 vs. historical trendsl
Energy: Overweight
Crude inventories have
been coming down
since April . . . .
Source: J.P. Morgan Energy Strategy, "Oil Markets Weekly," dated December 3, 2009, by Lawrence Eagles.
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Figure 108: Detailed Crude Oil Price Forecast
Source: J.P. Morgan Energy Strategy, "Energy Monthly," dated November 24, 2009, by Lawrence Eagles.

As a typically later cycle sector, Energy has not been a leading sector overall in 2009
but has been more of a leader so far in 4Q09 and may be poised for outperformance
in 2010.
• Although the Energy sector was up 10% in 2Q09 and 9% in 3Q09, it actually
underperformed the S&P 500 in both quarters, as the Cyclicals and Financials
were the leaders during that time. However, as we enter a later stage of this
economic recovery, the Energy sector is poised to outperform early in 2010 as
global energy demand recovers.
Figure 109: Quarterly Price Performance — Energy
1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 QTD
As a typically later -3% 17% 4% -3% 4% 35% 25% 9%

cycle sector, Energy -4% 7% 0% -12% -3% 19% 21% 8%
has not been a
leading sector overall -4% 4% 0% -13% -8% 18% 21% 7%
in 2009 but has been
more of a leader so -6% 2% -1% -14% -9% 18% 19% 7%
far in 4Q09 and may -8% -2% -9% -21% -9% 16% 17% 7%
be poised for
outperformance in -10% -3% -9% -23% -11% 15% 15% 7%
2010
-11% -5% -12% -23% -12% 10% 11% 6%
-12% -6% -16% -25% -12% 9% 9% 5%
-15% -8% -19% -26% -12% 9% 9% 5%
-15% -11% -23% -31% -22% 8% 5% 4%
-15% -19% -25% -38% -29% 2% 4% -2%

The Circle of Life composite score for the Energy sector has seen consistent
improvement throughout 2009, moving from the second-lowest-ranked sector back in
January to one of the highest-ranked sectors currently.
• The fundamental outlook for the Energy sector has improved steadily throughout
the year as consensus estimates for sales and earnings have been revised up
throughout the year to reflect the recovery in the global economy.
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• The sector also became more attractive in 2009 as relative valuations declined to
a more reasonable level. Short interest and FC mean rating also moved more in-
line with the overall S&P 500, making the sector more attractive on sentiment.
Figure 110: Circle of Life Metrics Monthly Changes — Energy Figure 111: Circle of Life Trending Composite Score — Energy
Price Performance
Sales Revision
1.0 Energy
Sales Momentum
0.5
Composite Score
Earnings Revision
Earnings Momentum
0.0
JULI Spreads

Short Interest

Total Delta 2 1 1 1 0 3 0 3 2
Composite Score (0.9) (0.7) (0.6) (0.4) (0.3) (0.3) 0.0 0.0 0.3 0.5

From an earnings perspective, Energy continues to face tough yoy comps over the
next few quarters, as earnings were particularly strong in mid to late 2008 when oil
peaked. However, the trough in yoy growth appears to be near in 3Q09 or 4Q09, with
sequential improvement throughout 2010.
• Earnings for the Energy sector are projected to decline by 60% from peak to
trough, as earnings have come down significantly since oil peaked back in July
2008. However, earnings are projected to recover strongly in 2010, rising by 61%
vs. 2009E. This still leaves earnings well below the peak level from 2008,
suggesting this sharp recovery is reasonable and doesn’t require oil to necessarily
return to $140 in order for the projection to be achievable.
Figure 112: Energy: Sector Earnings and % chg yoy
$ per share
$16.00 60%
Energy continues to face
tough yoy comps over $14.00 40%

the next few quarters, as
earnings were $12.00 20%
yoy % chg
particularly strong in
mid-to-late 2008, when oil $10.00 0%
peaked. However, the $8.00 -20%
trough in yoy growth
appears to be near, in $6.00 -40%
3Q09 or 4Q09, with
sequential improvement $4.00 -60%
throughout 2010E
$2.00 -80%
12/02 6/03 12/03 6/04 12/04 6/05 12/05 6/06 12/06 6/07 12/07 6/08 12/08 6/09 12/09 6/10 12/10
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Similar to the other sectors, the recovery in earnings in 2010 is driven by both top-
line growth and margin expansion.
• Consensus is currently projecting 18.7% yoy sales growth in 2010, a sharp

recovery from the 35.3% decline in sales in 2009. The estimate of sales of
$1,223b in 2010, however, would still be 23% below the peak level of $1,593b in
2008, suggesting the estimate for 2010 is achievable.
• From a bottom-line perspective, earnings are projected to grow by 49.8% in
2010, rebounding from a 55% decline in 2009. 2010E earnings, however, would
still be 33% below the peak level in 2008, highlighting that the estimate for 2010
is reasonable.
Figure 113: Consensus Outlook for Energy: Quarterly Sales and Earnings (1Q08 — 4Q10)
$ in mm
Energy
Sales $377,737 $457,748 $465,884 $291,678 $1,593,047 $223,933 $249,951 $277,942 $278,664 $1,030,490 $296,167 $310,324 $317,393 $299,416 $1,223,299
• $ chg yoy $99,821 $143,109 $140,357 -$76,298 $306,989 -$153,804 -$207,797 -$187,942 -$13,014 -$562,556 $72,233 $60,373 $39,450 $20,752 $192,809
% chg yoy 35.9% 45.5% 43.1% -20.7% 23.9% -40.7% -45.4% -40.3% -4.5% -35.3% 32.3% 24.2% 14.2% 7.4% 18.7%
• $ chg qoq $9,761 $80,011 $8,136 -$174,206 -$67,745 $26,018 $27,991 $722 $17,503 $14,157 $7,068 -$17,977
% chg qoq 2.7% 21.2% 1.8% -37.4% -23.2% 11.6% 11.2% 0.3% 6.3% 4.8% 2.3% -5.7%
Net Income $34,173 $41,143 $45,690 $17,674 $138,680 $13,593 $13,543 $17,303 $17,865 $62,304 $20,128 $22,969 $24,876 $25,346 $93,318
• $ chg yoy $6,888 $6,263 $17,069 -$15,503 $14,717 -$20,580 -$27,600 -$28,387 $191 -$76,376 $6,535 $9,426 $7,573 $7,481 $31,015
% chg yoy 25.2% 18.0% 59.6% -46.7% 11.9% -60.2% -67.1% -62.1% 1.1% -55.1% 48.1% 69.6% 43.8% 41.9% 49.8%
• $ chg qoq $995 $6,970 $4,547 -$28,016 -$4,081 -$49 $3,760 $562 $2,263 $2,841 $1,906 $470
% chg qoq 3.0% 20.4% 11.1% -61.3% -23.1% -0.4% 27.8% 3.2% 12.7% 14.1% 8.3% 1.9%
Sector Valuation
Energy valuations are in line with the long-term avg, suggesting the sector is neither
cheap nor expensive at the moment. However, the P/10yr EPS is contracting at the
moment and could have more downside based on past valuation cycles for the sector.
• In past valuation cycles for the Energy sector, the P/10yr EPS has troughed at
about 0.5x the multiple of the S&P 500. Given that the current valuation is 0.8x
the S&P 500’s multiple, this valuation could contract by 35% to be in line with
past trough levels. As a result, valuation are not likely to be a catalyst for the
Energy sector in 2010 and could become a drag on the sector.
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Figure 114: Energy: P/10-yr EPS

10-yr EPS
1.6x

Energy valuations 1.2x
are in line with the
long-term avg but are
contracting at the
moment and could
have much more 0.8x
downside based on
past valuation cycles
for the sector
0.4x
'84 '88 '92 '96 '00 '04 '08
Best and Worst Industries within Energy

There are only two industries in the Energy sector, Energy Equipment & Services
and Oil Gas & Fuels. Energy Equipment & Services is currently attractive as it is
cheaper than its long-term avg relative to the S&P 500 and it is out of favor with
Street analysts, leaving potential upside catalysts from analyst upgrades. Oil Gas &
Fuels, however, is currently trading at a more expensive multiple than the historical
avg and is currently in favor with Street analysts, suggesting valuations and
sentiment are more likely to be a drag for this industry.
Figure 115: Energy: Comparative Valuation and Sentiment Matrix

(0.05)
Oil Gas & Fuels
-
Energy Equipment & Expensive &
Services is currently 0.05 In-Favor

attractive as it is
cheaper than its
long-term avg 0.10
relative to the S&P
500 and is out of
0.15
favor with Street
analysts, leaving
potential upside Cheap & Out
0.20
catalysts from of Favor
analyst upgrades
0.25
Energy Equip &
Sv cs
0.30
-0.4x -0.2x 0.0x 0.2x 0.4x 0.6x 0.8x
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Consumer Discretionary: Overweight

Consumer Confidence
Improving consumer confidence likely to drive the sector higher. . .
Job Recovery
Credit availability
Consumer Discretionary is basically a catch-all group, but in general the companies
US housing market bottoms in this group have a high sensitivity to US economic activity and a particular
sensitivity to consumer spending. Thus, consumer confidence and employment
trends are key.
This is borne out in the data as well. As shown in Figure 116 below, in the six
J.P. Morgan Analyst Coverage months after a trough in private payrolls during previous five job cycles (1975, ’80,
Analyst
’83, ’91, 2003), the Consumer Discretionary has been the second-best-performing
Sector Analyst Conviction sector, with a relative return of 4.3% (vs. S&P 500).
Autos Patel HC
Figure 116: Consumer Discretionary a top sector once jobs turn positive
Advertising Quadrani HC
Broadlines Grom HC Relative performance
Food Grom N
Builders Rehaut HC
Bldg Prod. Betts HC Avg 6mos
Gaming Greff HC Relative
Lodging Greff HC Sector Perf The sector tilt favors Cyclical
Internet Khan HC sectors six months from the
1 Energy 5.9%
Media Khan LC time payroll turns positive
Restaurants Ivankoe N 2 Discretionary 4.3% . . . . Discretionary is the
Hardlines Horvers HC 3 Industrials 1.0% second-best-performing
Consumer Discretionary: Overweight

Specialty Tunick N sector . . . .
4 Technology -0.6%
TV Meltz HC
Education Steinerman HC 5 Financials -0.8%
6 Materials -0.8%
7 Utilities -1.2%
takeaways from discussions with analysts 8 Telecom -2.1%
about likelihood of outperformance by their
9 Staples -3.8%
10 HealthCare -4.6%
Source: Datastream and J.P. Morgan.
Retail spending plunged following the credit crisis (and following horrific net worth
destruction as housing prices fell). So paramount to this sector is how consumer
spending will recover in this expansion, and more specifically, whether there is any
pent-up demand. It seems to us the prevailing view is that there is a “new” normal
which is weaker spending. But evidence, we believe, is broadening that the “old”
normal is the “new” normal. For instance, take US Auto sales. Following the
completion of “cash for clunkers,” the payback should have pushed auto sales to
levels below those seen earlier in 2009 (as buyers were sated). Instead, as noted by
Himanshu Patel, J.P. Morgan Autos analyst, Auto SAAR (basically monthly auto
sales expressed annualized) has rebounded to 10.9mm and could creep up to 13mm
by 2011. In some ways, if credit availability improves and labor markets expand, this
could be surpassed in 2010.
Earnings are still one of the ultimate drivers for this group. According to Brian
Tunick, J.P. Morgan’s Specialty Retail analyst, the key to a sustained recovery in his
stocks is earnings growth. However, given that his companies have already done
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significant cost-cutting and limited square footage growth, earnings growth now
requires consumers to begin buying again and to switch back to nonpromotional
buying. This, according to Tunick, will require more consumer confidence about job
stability and lower unemployment.

Consumer Discretionary has been a middle-of-the-pack performer over the past two
years, never leading or being a drag relative to the overall S&P 500. The mild
performance in 2009 highlights the struggle in the sector between the upside the
sector should see due to its cyclicality and leverage to an economic recovery, which
is offset by concerns regarding consumer spending, which is hampered by high
unemployment.
As we head into 2010, the trend of unemployment and the recovery in consumer
spending are likely to be key drivers determining the performance of this sector in
2010.
Figure 117: Quarterly Price Performance — Consumer Discretionary

1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 QTD
Discretionary has been
a middle-of-the-pack -3% 17% 4% -3% 4% 35% 25% 9%
performer over the past -4% 7% 0% -12% -3% 19% 21% 8%
two years, never
leading or being a -4% 4% 0% -13% -8% 18% 21% 7%
significant drag relative
to the overall S&P 500 -6% 2% -1% -14% -9% 18% 19% 7%
-8% -2% -9% -21% -9% 16% 17% 7%
-10% -3% -9% -23% -11% 15% 15% 7%
-11% -5% -12% -23% -12% 10% 11% 6%
-12% -6% -16% -25% -12% 9% 9% 5%
-15% -8% -19% -26% -12% 9% 9% 5%
-15% -11% -23% -31% -22% 8% 5% 4%
-15% -19% -25% -38% -29% 2% 4% -2%

The composite score for Consumer Discretionary has seen gradual improvement
throughout 2009. Similar to the other Cyclicals, Discretionary has seen fundamental
improvements from upward sales and earnings revisions and tighter credit spreads as
well as an improvement in sentiment from analyst upgrades. The sector is currently
the highest-ranked sector on our Circle of Life metrics and is attractive on almost
every metric.
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Figure 118: Circle of Life Metrics Monthly Changes — Discretionary Figure 119: Circle of Life Trending Composite Score —
Discretionary
Price Performance
1.0 Discretionary
Sales Revision
0.5
Composite Score
Sales Momentum
Earnings Revision
0.0
Earnings Momentum
JULI Spreads (0.5)

FC Mean Rating

P/10Yr EPS
Total Delta 1 1 0 0 0 3 0 1 1
Composite Score 0.1 0.2 0.3 0.3 0.3 0.3 0.6 0.6 0.7 0.8

Discretionary earnings peaked back in late 2006, well before most other sectors’, as
the impact of the decline in housing and lower consumer spending hit this sector the
quickest. However, earnings in Discretionary also troughed slightly earlier, in 1Q09,
and are projected to rebound strongly in 2010, aided by a recovery in housing and
employment.
• Earnings declined by 75% peak to trough in the Discretionary sector, one of the
sharpest declines seen by any of the sectors. However, earnings (LTM) troughed
back in 1Q09 and have improved sequentially over the past two quarters and
should see positive yoy earnings growth by 4Q09.
• At the stock level, Ford (F-N/$8.86) is expected to contribute nearly 1/4 of the
EPS growth for the sector during 2010, followed by Pulte Homes (PHM-N/$8.93)
at 9%.
Figure 120: Consumer Discretionary: Sector Earnings and % chg yoy
$ per share
Discretionary earnings $7.00 200%

peaked back in late 2006,

well before most other $6.00 150%
sectors’, but also troughed
slightly earlier, in 1Q09, $5.00 100%
yoy % chg
and earnings are projected

to rebound strongly in 2010 $4.00 50%
$3.00 0%
$2.00 -50%
$1.00 -100%
12/02 6/03 12/03 6/04 12/04 6/05 12/05 6/06 12/06 6/07 12/07 6/08 12/08 6/09 12/09 6/10 12/10
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Consensus estimates for sales and earnings growth in 2010 show a situation similar
to those of the other Cyclicals, as top-line growth swings from negative to positive
and margins expand.
• Sales are projected to grow by 4.1% in 2010, rebounding from the 8% decline in
2009. Net income is projected to grow by a much faster pace of 25%, suggesting
Street consensus expects margins to continue expanding in 2010.
• There could also be upside to these consensus estimates if the employment
situation improves more than expected, allowing consumer spending to recover.
However, the net income estimate of $62.5b in 2010 would put earnings for the
sector back on par with peak earnings from 2007 ($62.1b), so current estimates
are already implying a strong recovery and thus upside to estimates could prove
difficult.
Figure 121: Consensus Outlook for Consumer Discretionary: Quarterly Sales and Earnings (1Q08 — 4Q10)
$ in mm
Discretionary
Sales $300,325 $309,205 $300,030 $305,667 $1,215,226 $258,011 $271,160 $283,116 $305,456 $1,117,742 $271,423 $283,031 $292,207 $317,436 $1,164,097
• $ chg yoy $3,810 $6,080 -$1,976 -$35,666 -$27,751 -$42,314 -$38,045 -$16,914 -$211 -$97,484 $13,412 $11,872 $9,091 $11,980 $46,355
% chg yoy 1.3% 2.0% -0.7% -10.4% -2.2% -14.1% -12.3% -5.6% -0.1% -8.0% 5.2% 4.4% 3.2% 3.9% 4.1%
• $ chg qoq -$41,008 $8,880 -$9,175 $5,637 -$47,656 $13,149 $11,956 $22,340 -$34,033 $11,608 $9,176 $25,229
% chg qoq -12.0% 3.0% -3.0% 1.9% -15.6% 5.1% 4.4% 7.9% -11.1% 4.3% 3.2% 8.6%
Net Income $12,903 $14,390 $11,784 $8,586 $47,663 $7,779 $11,857 $15,003 $15,379 $50,018 $12,841 $15,303 $16,661 $17,733 $62,538
• $ chg yoy -$2,110 -$1,679 -$3,808 -$6,843 -$14,440 -$5,124 -$2,533 $3,219 $6,793 $2,355 $5,062 $3,446 $1,658 $2,354 $12,520
% chg yoy -14.1% -10.4% -24.4% -44.4% -23.3% -39.7% -17.6% 27.3% 79.1% 4.9% 65.1% 29.1% 11.0% 15.3% 25.0%
• $ chg qoq -$2,526 $1,487 -$2,606 -$3,198 -$807 $4,078 $3,146 $375 -$2,537 $2,462 $1,358 $1,072
% chg qoq -16.4% 11.5% -18.1% -27.1% -9.4% 52.4% 26.5% 2.5% -16.5% 19.2% 8.9% 6.4%
Sector Valuation
Discretionary valuations have been relatively range-bound over the past few years, as
multiples were not elevated at the start of this recession and didn’t necessarily have
as far to fall. However, the multiple has declined somewhat over the past year and is
currently below the long-term avg, suggesting there may be upside for multiple
expansion.
• As the employment picture gradually improves over the next year and investors
gain more clarity on the outlook for the US consumer, valuations for the
Consumer Discretionary sector are likely to expand relative to the overall S&P
500. As the reflation of this sector occurs, the sector would need to rise 13% in
order for the P/10yr EPS to be in line with the long-term average.
• The valuation could also rise beyond the long-term average as it has in the past
and could rise 25% before the valuation reached a stretched point of one standard
deviation above the long-term average.
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Figure 122: Consumer Discretionary: P/10-yr EPS

10-yr EPS
1.6x

Discretionary valuations 1.4x
are currently well-below
the long-term avg
1.2x
1.0x
0.8x
'84 '88 '92 '96 '00 '04 '08
Best and Worst Industries within Consumer Discretionary

Relative valuations are mixed for the Discretionary industries, but in general most
groups are still out of favor with Street analysts, suggesting upgrades could continue
to be a driver for the sector in 2010.
• Media, in particular, appears attractive, as it is currently trading well below its

long-term average P/S, and is also out of favor with Street analysts, suggesting it
could have upside potential both on valuation and from analyst upgrades.
• Internet Catalog & Retail, on the other hand, is currently expensive relative to the
long-term average P/S and is also in favor with Street analysts, suggesting there
may be more catalysts to the downside than to the upside.
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Figure 123: Consumer Discretionary: Comparative Valuation and Sentiment Matrix

(0.80)
Expensive &
Distributors In-Favor
Relative valuations are (0.60)
mixed for the Internet & Catalog

Discretionary Retail
industries, but in (0.40)
general most groups
are still out of favor (0.20)
with Street analysts,
suggesting upgrades Automobiles Tex tiles Apparel &
could continue to be a - Hotels Restaurants
Multiline Retail Lux ury Goods
driver for the sector in & LeisureRetail
Div ersifiedSpecialty
2010 0.20 Media Consumer Serv ices Auto Components
Household Durables
Leisure Equipment &
0.40 Cheap & Out
Products
of Favor
0.60
-0.8x -0.6x -0.4x -0.2x 0.0x 0.2x 0.4x 0.6x 0.8x 1.0x
108
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Telecom: Neutral
Price competition Wireless is a Spring harvest as employment gains bolster fundamentals
Unemployment With each business cycle, Telecom Services is showing greater Cyclical DNA. We
M&A realize the high dividend yields argue for its defensive stature, but any examination
Interest rates
of volumes, pricing, bad debt, revenue visibility and even capital spending show
characteristics in common more with Industrials than with Staples. Moreover, in the
past decade, the industry’s leverage to wireless and broadband further solidifies its
Cyclical transition.
Wireless is a highly penetrated business and therefore the GDP-plus Beta has
J.P. Morgan Analyst Coverage diminished as the business is now more sensitive to employment trends (corporate
liability accounts), construction activity (for iDEN push to talk) and labor income
Analyst
(affecting low-end players such as Leap (LEAP-N/$14.60) and Metro PCS (PCS-
N/$6.69)).
Telecom McCormack N
Fortunately, this works in the group’s favor in 2010E, as the US recovery expands,
HC: High Conviction; N: Neutral; LC: Low payrolls improve, small business credit eases, households stress diminishes. Thus, we
Conviction. Analyst conviction based on our think the surprise in 2010 will be an underlying improvement in wireless dynamics
takeaways from discussions with analyst about
as the Cyclical drivers begin to positively affect pricing, unit volumes, bad debt
likelihood of outperformance by his sector vs.
overall market in 2010.
trends and overall dynamics.
The industry’s scale is vastly greater compared to past business cycles. The wireless
industry’s revenue and EBITDA dwarf those of wireline and media, which enables
the industry to wrest ever-greater pricing concessions from handset and equipment
vendors. But the maturity of the industry makes market share gains tougher for
struggling players.
We believe the opportunity in Telecom in 2010 is to look at the boneyard – where

valuations are rock bottom, investor revulsion is high and M&A potential greater.
This points us toward Sprint Nextel (S-N/$4.13) and the unlimited players Leap and
Metro PCS, as their business metrics were placed under great stress as
unemployment soared past 10% and as construction activity slowed – S and
LEAP/PCS have greater exposure construction workers and the lower-income
demographic, which means their addressable market was particularly hard hit.
Moreover, credit spreads have been stable in wireless, with the bonds of LEAP/PCS Telecom: Neutral
and even S mostly trading near par.
Why are we not OW Telecom? The benchmark is Integrateds, which is less

attractive
The broader benchmark of Telecom Services is dominated by the large integrated
carriers, where the secular decline of wireline buffets overall results. Moreover, as
the law of large numbers kick in, wireless is providing less of an incremental boost to
top line for telecoms compared to the top-line upside produced by stronger GDP in
other Cyclical groups. The telecom sector is expected to grow top line at an anemic
1% growth rate (based on consensus) and 6.4% EPS growth (see Figure 128). And
66% of the 2010 EPS growth in the sector is expected to come from AT&T.
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Telecom has been one of the biggest underperformers in 2009 as fundamentals have
been difficult during the downturn while the sector also lacks significant upside
leverage to the economic recovery.
The sector actually was one of the leaders in 4Q08 and 1Q09, as it did not experience
as much downside as other sectors. However, since the market bottomed in March,
Telecom has been one of the biggest underperformers and has only seen a 2-5% rise
in each of the past three quarters.
Figure 124: Quarterly Price Performance — Telecom

1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 QTD
Telecom one of the -3% 17% 4% -3% 4% 35% 25% 9%
largest underperformers
in 2009 -4% 7% 0% -12% -3% 19% 21% 8%
-4% 4% 0% -13% -8% 18% 21% 7%
-6% 2% -1% -14% -9% 18% 19% 7%
-8% -2% -9% -21% -9% 16% 17% 7%
-10% -3% -9% -23% -11% 15% 15% 7%
-11% -5% -12% -23% -12% 10% 11% 6%
-12% -6% -16% -25% -12% 9% 9% 5%
-15% -8% -19% -26% -12% 9% 9% 5%
-15% -11% -23% -31% -22% 8% 5% 4%
-15% -19% -25% -38% -29% 2% 4% -2%

The composite score for Telecom has gradually worsened over the past year, as the
fundamentals in this sector have not seen the strong improvement seen in other
sectors, particularly the Cyclicals.
• Early in 2009, the Defensives were the only sectors showing positive trends in
sales and earnings, as the outlook by Street analysts was relatively bleak overall.
However, over the course of 2009, the Cyclicals have seen steady upward
revisions to sales and earnings, while the Defensives such as Telecom have seen
very little, if any, improvement.
• Telecom has also lost support from a sentiment perspective as the sector has seen
relative downgrades and short interest has risen on a relative basis.
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Figure 125: Circle of Life Metrics Monthly Changes — Telecom Figure 126: Circle of Life Trending Composite Score — Telecom
Price Performance
Sales Revision 1.0 Telecom

Sales Momentum
0.5
Composite Score
Earnings Revision
Earnings Momentum
0.0
JULI Spreads

Short Interest

Total Delta -3 -1 -1 0 0 0 1 0 -1
Composite Score 0.4 0.1 0.0 (0.1) (0.1) (0.1) (0.1) 0.0 0.0 (0.1)

The earnings outlook for Telecom is not particularly optimistic over the next several
quarters as this is one of the few sectors that is projected to continue seeing negative
yoy earnings for several more quarters. Earnings growth (yoy) is projected to be
negative in every quarter in 2010, and full-year 2010 earnings are projected to
decline by about 1% vs. 2009, making this the only sector projected to have a decline
in earnings next year.
• This trend suggests that earnings will continue to be a drag for Telecom early on
in 2009. However, as we head into 2H10, when unemployment is likely to be
trending down, earnings could start to become a driver again as the upturn in
earnings nears.
Figure 127: Telecom: Sector Earnings and % chg yoy
$ per share
15%
$3.20
The earnings outlook 10%

for Telecom is not $3.00
particularly 5%
optimistic, with $2.80
yoy % chg
0%
trough earnings not
likely occurring until $2.60 -5%
mid-2010 and -10%
positive yoy earnings $2.40
growth not returning -15%
until 2011 $2.20
-20%
$2.00 -25%
12/02 6/03 12/03 6/04 12/04 6/05 12/05 6/06 12/06 6/07 12/07 6/08 12/08 6/09 12/09 6/10 12/10
The consensus outlook for sales and earnings in Telecom is similar, as growth at both
the top line and bottom line is projected to be relatively weak.
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• Sales is projected to grow by only 1.0% in 2010, well below the projected growth
for other sectors. Net income is projected by consensus to grow by 6.4% in 2010,
implying Street consensus is forecasting an expansion in margins in 2010,
although this expansion is much less than what is projected for other sectors.
Figure 128: Consensus Outlook for Telecom: Quarterly Sales and Earnings (1Q08 — 4Q10)
$ in mm
Telecom
Sales $70,126 $70,519 $71,387 $70,565 $282,598 $71,676 $72,028 $73,683 $73,537 $290,925 $72,996 $73,329 $73,682 $73,771 $293,777
• $ chg yoy $2,224 $1,233 $974 $62 $4,493 $1,550 $1,509 $2,296 $2,972 $8,327 $1,320 $1,300 -$1 $233 $2,853
% chg yoy 3.3% 1.8% 1.4% 0.1% 1.6% 2.2% 2.1% 3.2% 4.2% 2.9% 1.8% 1.8% 0.0% 0.3% 1.0%
• $ chg qoq -$377 $393 $868 -$822 $1,111 $352 $1,654 -$146 -$541 $333 $353 $89
% chg qoq -0.5% 0.6% 1.2% -1.2% 1.6% 0.5% 2.3% -0.2% -0.7% 0.5% 0.5% 0.1%
Net Income $6,824 $7,143 $6,304 $5,995 $26,265 $4,835 $5,101 $5,084 $4,799 $19,819 $5,106 $5,250 $5,339 $5,398 $21,093
• $ chg yoy $134 -$121 -$1,187 -$1,179 -$2,354 -$1,989 -$2,042 -$1,220 -$1,196 -$6,446 $271 $149 $255 $600 $1,274
% chg yoy 2.0% -1.7% -15.8% -16.4% -8.2% -29.2% -28.6% -19.3% -20.0% -24.5% 5.6% 2.9% 5.0% 12.5% 6.4%
• $ chg qoq -$350 $319 -$839 -$309 -$1,160 $267 -$17 -$286 $307 $145 $88 $60
% chg qoq -4.9% 4.7% -11.8% -4.9% -19.3% 5.5% -0.3% -5.6% 6.4% 2.8% 1.7% 1.1%
Sector Valuation
On a more optimistic side, valuations in Telecom are currently attractive on a
Price/10yr EPS basis, as the stocks in this sector are pricing in the current earnings
downturn rather than the full-cycle earnings potential of this sector.
• Valuations have become particularly attractive since April, and the current
relative P/10yr EPS is currently about one standard deviation below the long-term
average. This suggests that relative valuations for Telecom are likely near a
trough and should begin expanding at some point in the next year.
• If the P/10yr EPS were to recover back to the long-term average, it would suggest
16% upside for the sector. As a result, there could be upside for Telecom from a
valuation perspective even though the near-term outlook for earnings is not
particularly optimistic.
Figure 129: Telecom: P/10-yr EPS
10-yr EPS
1.2x
Valuations in Telecom
are currently attractive
on P/10yr EPS as the 1.0x

stocks are likely
reflecting the near-term
earnings outlook rather
than the full-cycle
0.8x
earnings potential of
the sector
0.6x
0.4x
'84 '88 '92 '96 '00 '04 '08
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Best and Worst Industries within Telecom

Within the Telecom sector, there are only two industries, which vary broadly on
current valuation and Street analyst sentiment.
• Wireless is currently the more attractive industry on these two metrics, as it is

currently cheaper based on relative P/S vs. long-term avg, and it is also less liked
than usual. This suggests that Wireless could be a good contrarian idea in 2010.
Figure 130: Telecom: Comparative Valuation and Sentiment Matrix
(0.15) Div ersified Telecom

Sv cs
(0.10)
Expensive &
In-Favor
(0.05)
Wireless is an
attractive contrarian
industry at the -
moment, as the
relative P/S is
cheaper than the 0.05
long-term avg and
Cheap & Out
the industry is less
liked by the Street 0.10 of Favor
than normal
Wireless Telecom
0.15
Sv cs
0.20
-1.8x -1.6x -1.4x -1.2x -1.0x -0.8x -0.6x -0.4x -0.2x 0.0x
113
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114
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Healthcare: Neutral from Underweight

Base case is Healthcare reform We are also moving Healthcare to Neutral from Underweight. The risk/reward for
Further policy risk Healthcare is attractive, as investors have enough visibility to model the "base case"
Unemployment of Healthcare reform in valuations, while improvements to the program are upside.
Moreover, the group's valuation of 11.1X P/’11E is at the low-end of historical
multiples. There is also potential for strategic and cost-driven M&A. While we see
little room for EPS upgrade, nor leverage to GDP, this warrants a Neutral stance and
an UW is no longer justified.
J.P. Morgan Analyst Coverage There are certainly going to be winners and losers with Healthcare reform and
Analyst investors at this point likely have sufficient details to model the "base case" and the
Sector Analyst Conviction related positives/risks to that scenario. Thus, in a way, argues that investors can
again look at Healthcare stocks on their fundamental and secular dynamics, outside
Biotech Meacham HC
Mgd Care Rex HC of Healthcare reform. From a secular perspective, the fact is Healthcare’s share of
Facilities Rex N GDP at 12% is likely to accrete at a slower pace in the next 5 years and the margin
Distribution Gill HC structure of the industry will change. One could make the case the industry is over-
MedDevice Weinstein N earning relative to its cost of capital.
Pharma Schott HC
SMid Biotech Kasimov HC
SMid MedTech Peterson HC Healthcare Technology and HMOs have leverage to positive payrolls . . . .
Healthcare Technology, covered by Lisa Gill, J.P. Morgan Healthcare Technology
HealthCare: Neutral from Underweight

& Distribution analyst, as well as PBMs have positive leverage to Healthcare reform,
and those groups similarly have positive leverage to an improving employment
about likelihood of outperformance by their outlook. And historically, these groups have a high degree of sensitivity to payroll
sectors vs. overall market in 2010. improvements (see “US Year Ahead 2010” dated 12/09/09), a surprise among
Healthcare stocks. Healthcare Technology have delivered better earnings
performance with many already surpassing prior peak in EPS and set to grow earning
15%-20% in 2010.
John Rex, J.P. Morgan Managed Care analyst, recently upgraded managed care
stocks as he believe the risks from Healthcare reform is priced into his names. Thus,
upside exists to the extent the labor markets improve (helping enrollments and other
metrics) and to the extent the programs are modified from their base case. Given the
9X P/E multiple and 6-8% normalized EPS growth, the logic is there.
Medical Devices likely becomes more attractive in 2H as investors begin to favor

steady and predictable earnings, rate insensitivity of the group, and comps improve.
In the meantime, valuations are reasonal, which supports a Neutral rather than UW
stance.
As for Pharmaceuticals, the group seems positioned to benefit from M&A which
structural changes needed in the Sector. The group likely appeals to value investors,
and again appears better positioned in 2H when relative visibility matters to equity
investors.
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Healthcare has been a surprising leader in 4Q09 as more clarity on the implications
of healthcare reform have taken some stress off the stocks in this sector. This is in
contrast to the past two quarters, when Healthcare, and the Defensives overall,
underperformed the S&P 500 in 2Q09 and 3Q09.
The recent outperformance by Healthcare may suggest that Healthcare may break out
from the other Defensives in the near-term, as it has more fundamental drivers now
that healthcare reform has become less of an uncertainty for the sector.
Figure 131: Quarterly Price Performance — Healthcare

1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 QTD
-3% 17% 4% -3% 4% 35% 25% 9%
Healthcare has been a -4% 7% 0% -12% -3% 19% 21% 8%
surprising leader in
4Q09 as more clarity on -4% 4% 0% -13% -8% 18% 21% 7%
the implications of -6% 2% -1% -14% -9% 18% 19% 7%
healthcare reform have
taken some stress off -8% -2% -9% -21% -9% 16% 17% 7%
the stocks in this
sector -10% -3% -9% -23% -11% 15% 15% 7%
-11% -5% -12% -23% -12% 10% 11% 6%
-12% -6% -16% -25% -12% 9% 9% 5%
-15% -8% -19% -26% -12% 9% 9% 5%
-15% -11% -23% -31% -22% 8% 5% 4%
-15% -19% -25% -38% -29% 2% 4% -2%

The downward trend of the composite score for Healthcare is similar to Telecom and
the Defensives in general, as relative fundamentals and sentiment have become less
positive for this sector over the course of 2009.
• The trend of sales and earnings revisions has been flat or down on a relative basis
over the course of the past year as the Cyclicals and Financials have seen the bulk
of upward revisions in 2009.
• Sentiment has also been less positive for the sector, as the relative FC mean
rating for Healthcare peaked earlier this year and the sector began seeing
downgrades on a relative basis.
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Figure 132: Circle of Life Metrics Monthly Changes — Healthcare Figure 133: Circle of Life Trending Composite Score —
Healthcare
Price Performance
1.0 Health Care
Sales Revision
0.5
Composite Score
Sales Momentum
Earnings Revision
0.0
Earnings Momentum
JULI Spreads (0.5)

FC Mean Rating

P/10Yr EPS
Total Delta -2 -2 -2 0 -2 -1 1 -2 1
Composite Score 0.8 0.6 0.3 0.1 0.1 (0.1) (0.2) (0.1) (0.3) (0.2)

The near-term earnings outlook for the Healthcare sector is relatively mild, as yoy
earnings growth is projected to be negative in 1Q10 and 2Q10 before recovering to a
modest 6% by 4Q10.
• The weaker earnings growth for Healthcare in 2010 reflects both the impact of
tougher comps since earnings held up well in 2009, as well as fundamental issues
would could negatively impact earnings in 2010 such as the flu and people
trading down to cheaper insurance plans. However, as discussed earlier, there
could be upside to earnings in this sector if unemployment trends better than
expected.
Figure 134: Healthcare: Sector Earnings and % chg yoy
$ per share
The earnings outlooks $13.00 JPM estimate --> 16%
for Healthcare is 14%
relatively mild, with $12.00
negative growth early on 12%

$11.00
in 2010 and only modest 10%
6% growth overall for $10.00
8%
full-year 2010E
yoy % chg
$9.00 6%
4%
$8.00
2%
$7.00
0%
$6.00 -2%
$5.00 -4%
12/02 6/03 12/03 6/04 12/04 6/05 12/05 6/06 12/06 6/07 12/07 6/08 12/08 6/09 12/09 6/10 12/10
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Consensus estimates for sales and earnings are similarly mild for 2010. While sales
are projected to grow at a respectable pace of 8.6% in 2010, this is well below the
pace projected for many other sectors next year. Earnings are also projected to grow
at a respectable pace of 12.6% in 2010, with most of the growth occurring in the first
half of the year. The higher projected earnings growth than sales growth implies that
the Street is projecting margins to expand in 2010, similar to other sectors.
Figure 135: Consensus Outlook for Healthcare: Quarterly Sales and Earnings (1Q08 — 4Q10)
$ in mm
HealthCare
Sales $235,258 $239,888 $239,222 $242,010 $956,378 $241,188 $247,357 $249,063 $259,016 $996,624 $264,106 $269,411 $272,271 $276,507 $1,082,295
• $ chg yoy $18,662 $20,124 $19,471 $9,094 $67,351 $5,929 $7,470 $9,841 $17,006 $40,246 $22,918 $22,054 $23,208 $17,491 $85,671
% chg yoy 8.6% 9.2% 8.9% 3.9% 7.6% 2.5% 3.1% 4.1% 7.0% 4.2% 9.5% 8.9% 9.3% 6.8% 8.6%
• $ chg qoq $2,342 $4,629 -$666 $2,788 -$822 $6,170 $1,705 $9,953 $5,089 $5,306 $2,860 $4,236
% chg qoq 1.0% 2.0% -0.3% 1.2% -0.3% 2.6% 0.7% 4.0% 2.0% 2.0% 1.1% 1.6%
Net Income $23,617 $23,391 $23,858 $23,666 $94,531 $23,658 $23,751 $24,764 $23,466 $95,639 $25,780 $26,877 $27,499 $27,519 $107,676
• $ chg yoy $713 $1,950 $1,382 $1,465 $5,510 $41 $360 $906 -$200 $1,108 $2,122 $3,127 $2,734 $4,054 $12,037
% chg yoy 3.1% 9.1% 6.1% 6.6% 6.2% 0.2% 1.5% 3.8% -0.8% 1.2% 9.0% 13.2% 11.0% 17.3% 12.6%
• $ chg qoq $1,417 -$227 $467 -$192 -$7 $92 $1,014 -$1,299 $2,315 $1,097 $621 $21
% chg qoq 6.4% -1.0% 2.0% -0.8% 0.0% 0.4% 4.3% -5.2% 9.9% 4.3% 2.3% 0.1%
Sector Valuation
Valuations in the Healthcare sector have become much more attractive over the past
year based on Price/10yr EPS, suggesting we may be near a trough in relative
multiples.
• Valuations in Healthcare are currently well-below the long-term avg, suggesting

there is room for upside from multiple expansion. However, it is unclear what
the drivers would be for multiple expansion in this sector given the upcoming
changes from healthcare reform that might warrant a lower multiple for the
sector.
• If multiples are able to recover back to the long-term average, this would
represent 12% upside for the sector. As a result, Healthcare could still have
upside if multiples are able to expand in 2010, despite the relatively mild outlook
for earnings growth.
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Figure 136: Healthcare: P/10-yr EPS

10-yr EPS
1.8x

Valuations in Healthcare
are relatively attractive
as they are well-below 1.5x
the long-term avg, but
there also do not appear
to be any drivers for 1.2x
multiple expansion in
this sector given the
upcoming changes from
healthcare reform
0.9x
0.6x
'84 '88 '92 '96 '00 '04 '08
Best and Worst Industries within Healthcare

Valuation and sentiment overall do not appear to be drivers for Healthcare, as most
industries are near historical relative valuation on P/S and Street analyst ratings are
in-line with the historical avg.
• Biotech appear to be one of the few contrarian areas in this sector. Biotech is
currently the cheapest industry based on the current relative P/S vs. its long-term
average relative P/S, and it is also relatively less liked by analysts than usual.
Both metrics suggest Biotech could be a contrarian idea in 2010.
119
(1-212) 622-6505 10 December 2009
Figure 137: Healthcare: Comparative Valuation and Sentiment Matrix

(0.20) Expensive
& In-Favor
Pharma
(0.10) Health Care
Valuation and sentiment Prov iders & Sv cs
overall do not appear to be

drivers for Healthcare as -
most industries are near Health Care Equip
Life Sciences Tools&
historical relative valuation Biotech
0.10 Supplies
& Sv cs
on P/S and Street analyst
ratings are in line with the
historical avg. Biotech 0.20
appear to be one of the few
contrarian areas in this
sector 0.30
Cheap & Out

0.40
of Favor
Health Care Tech
0.50
-8.0x -7.0x -6.0x -5.0x -4.0x -3.0x -2.0x -1.0x 0.0x 1.0x
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Consumer Staples: Underweight

Commodity prices One definitely needs to weigh the positives and negatives for Staples. The industry
Consumer/Unemployment relative pricing power, exposure to international markets, low volatility on top-line
International Growth and recent M&A make the group attractive. So there is a lot to like and with
Dollar effects
visibility lacking on a global recovery (at this point), the group is attractive.
M&A
But as we anticipate a strong US economic recovery in 2010, these same steady

characteristics seem a bit less attractive compared to the beta earned in Consumer
Discretionary or other Cyclicals. In other words, Staples continues to be most
attractive in a Recessionary and even U-shaped world, or in a world where valuations
are primary drivers. But this recession has affected the very stable everyday products
J.P. Morgan Analyst Coverage sold by Staples companies. According to John Faucher, J.P. Morgan’s Households
Products, Personal Care, and Beverages analyst, the consumer is doing worse than
Analyst
Sector Analyst Conviction what most staple stocks are currently reflecting. In fact, Wal-Mart (WMT-
OW/$54.07) pay cycle data show that a large portion of consumer purchases are
Beverages Faucher N
made within the first 12 hours of worker’s receiving paychecks, suggesting they are
HH Prod Faucher HC
Foods Bivens N struggling to get by.
Tobacco Bloomquist —
Likely,, this group could become more attractive in 2H10 as the growth visibility of
improved housing, auto sales, credit recovery, etc. plateau. Thus, our UW is more of
Conviction. Analyst conviction based on our a relative view. As cheap as Staples are on an absolute P/E basis, their relative P/E
takeaways from discussions with analysts to the S&P 500 is at the high-end (see Figure 143) of its historic range at 0.8X
about likelihood of outperformance by their relative P/E (above 1 std-deviation). We are using cyclically adjusted EPS for S&P
500.
Consumer Staples: Underweight

Longer term, the Beverages group is struggling from little or no unit growth. There
is relatively more growth potential for companies with greater international exposure,
as the consumer is faring better in areas outside of the US. Latin America continues
to be strong due to a combination of the impact of pricing and dollar tailwinds. As
for M&A, there is higher potential here given low valuations and accommodative
funding markets.
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Staples led the market in 2008 as the economy deteriorated, but it has
underperformed the S&P 500 in 2009, as it is less leveraged to the global economic
recovery.
• The sector has surprisingly outperformed the S&P 500 so far in 4Q09, but we do
not expect this to continue early on in 2010, as we believe the Cyclicals remain
relatively more attractive due to their greater leverage to a recovery in the
economy, payrolls, and housing.
Figure 138: Quarterly Price Performance — Consumer Staples
1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 QTD
-3% 17% 4% -3% 4% 35% 25% 9%
-4% 7% 0% -12% -3% 19% 21% 8%
Staples led the market in -4% 4% 0% -13% -8% 18% 21% 7%
2008 as the economy
deteriorated, but it has -6% 2% -1% -14% -9% 18% 19% 7%
underperformed the S&P
500 in 2009 as it is less -8% -2% -9% -21% -9% 16% 17% 7%
leveraged to the global -10% -3% -9% -23% -11% 15% 15% 7%
economic recovery
-11% -5% -12% -23% -12% 10% 11% 6%
-12% -6% -16% -25% -12% 9% 9% 5%
-15% -8% -19% -26% -12% 9% 9% 5%
-15% -11% -23% -31% -22% 8% 5% 4%
-15% -19% -25% -38% -29% 2% 4% -2%

Similar to other Defensives, the composite score of Consume Staples has trended
downward over the past year, as this sector has lagged the Cyclicals in terms of
improvements in 2009.
• Earnings and sales revisions and momentum for Staples have lagged behind the
Cyclicals, Energy, and Financials in 2009, since the earnings and sales for Staples
are steadier and have seen less volatility to their outlook. As a result, on a
relative basis, the fundamental outlook for Staples is less positive.
• Sentiment also turned against Staples in 2009, as the relative FC mean rating
peaked and began to see downgrades, while the relative short interest of Staples
began to rise.
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Figure 139: Circle of Life Metrics Monthly Changes — Staples Figure 140: Circle of Life Trending Composite Score — Staples
Price Performance
Sales Revision 1.0 Staples

Sales Momentum
0.5
Composite Score
Earnings Revision
Earnings Momentum
0.0
JULI Spreads

Short Interest

Total Delta -1 0 -3 1 0 1 -1 0 -1
Composite Score 0.3 0.2 0.2 (0.1) 0.0 0.0 0.1 0.0 0.0 (0.1)

The earnings progression for the Staples sector has been relatively stable over the
past year, with 2Q09 and 3Q09 only seeing small declines in yoy earnings growth
(on an LTM basis), a much better picture than the sharp yoy earnings declines seen in
other sectors. However, similar to the other Defensives, this relative earnings
stability also leaves relatively less room for earnings upside in 2010.
• Earnings growth should be about 6% for the Staples companies in 2010. This
growth rate is similar to the rate seen in this sector during most of 2005-2007,
highlighting the relative earnings stability of the sector.
Figure 141: Consumer Staples: Sector Earnings and % chg yoy
$ per share
Earnings in Staples JPM estimate -->
have been relatively $11.00 35%
stable throughout this 30%
$10.00
economic downturn
and recovery, leaving 25%
less upside potential in $9.00
20%
2010E
$8.00
yoy % chg
15%
$7.00 10%
5%
$6.00
0%
$5.00
-5%
$4.00 -10%
12/02 6/03 12/03 6/04 12/04 6/05 12/05 6/06 12/06 6/07 12/07 6/08 12/08 6/09 12/09 6/10 12/10
The consensus outlook for sales and earnings in Staples shows a similar picture to
the other Defensives, with only single-digit growth for both sales and earnings in
2010. Net income is projected to grow slightly faster than sales, at a yoy pace of
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7.0% for net income vs. 5.0% for sales, suggesting that the Street expects some
margin expansion in 2010, although much less than in other sectors.
Figure 142: Consensus Outlook for Consumer Staples: Quarterly Sales and Earnings (1Q08 — 4Q10)
$ in mm
Staples
Sales $339,539 $358,610 $357,047 $358,490 $1,413,686 $329,479 $345,770 $348,176 $369,632 $1,393,056 $347,685 $362,871 $365,498 $387,091 $1,463,145
• $ chg yoy $37,912 $32,174 $25,253 -$1,775 $93,564 -$10,060 -$12,840 -$8,870 $11,141 -$20,629 $18,206 $17,101 $17,321 $17,459 $70,088
% chg yoy 12.6% 9.9% 7.6% -0.5% 7.1% -3.0% -3.6% -2.5% 3.1% -1.5% 5.5% 4.9% 5.0% 4.7% 5.0%
• $ chg qoq -$20,727 $19,071 -$1,563 $1,444 -$29,012 $16,291 $2,407 $21,455 -$21,947 $15,186 $2,627 $21,593
% chg qoq -5.8% 5.6% -0.4% 0.4% -8.1% 4.9% 0.7% 6.2% -5.9% 4.4% 0.7% 5.9%
Net Income $19,005 $21,850 $21,983 $22,653 $85,491 $17,803 $20,888 $22,538 $22,904 $84,133 $19,892 $22,722 $23,722 $23,687 $90,024
• $ chg yoy $739 $1,272 $304 $519 $2,834 -$1,202 -$962 $555 $251 -$1,359 $2,089 $1,834 $1,184 $784 $5,891
% chg yoy 4.0% 6.2% 1.4% 2.3% 3.4% -6.3% -4.4% 2.5% 1.1% -1.6% 11.7% 8.8% 5.3% 3.4% 7.0%
• $ chg qoq -$3,129 $2,845 $133 $670 -$4,850 $3,085 $1,650 $366 -$3,012 $2,830 $1,000 -$35
% chg qoq -14.1% 15.0% 0.6% 3.0% -21.4% 17.3% 7.9% 1.6% -13.1% 14.2% 4.4% -0.1%
Sector Valuation
Valuations in the Staples sector are currently elevated based on the Price/10yr EPS
(relative to the overall S&P 500), suggesting multiples are more likely to contract on
a relative basis in 2010.
• Relative valuations in Staples expanded rapidly in 2007-2008 as investors fled to

safety. The P/10yr EPS has declined slightly since peaking back in early March,
but the current valuation is still more than one standard deviation above the long-
term average, suggesting Staples is still expensive.
• As a result, multiples still appear elevated and will likely contract further on a
relative basis. If the relative P/10yr EPS of Staples were to contract to the long-
term average, this would suggest 22% downside for the sector
Figure 143: Consumer Staples: P/10-yr EPS
10-yr EPS
1.0x
Relative valuations in 0.8x

Staples are currently
very elevated as they
expanded rapidly in
2007-2008, when 0.6x
investors fled to
relative safety
0.4x
0.2x
'84 '88 '92 '96 '00 '04 '08
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Best and Worst Industries within Consumer Staples

Most industries in Staples are unattractive on both valuation and sentiment.
• The most unattractive industry is Tobacco, which currently has a combination of

high valuation relative to its historical avg, and it also more liked than usual
based on FC mean rating. These two factors suggest it may be too expensive and
the favorable view by analysts may already be priced into the stocks.
• On the slightly more attractive side, Household Products, Personal Products, and
Food & Staples Retailing all are relatively well positioned based on valuation and
sentiment, suggesting these are the better contrarian industries within Staples.
However, even these industries do not appear particularly attractive on P/S and
FC mean rating.
Figure 144: Consumer Staples: Comparative Valuation and Sentiment Matrix
(0.25) Expensive &

Food Prdcts In-Favor
(0.20) Tobacco
Most industries in
Staples are (0.15)
unattractive on both
valuation and
sentiment (0.10) Household Prdcts
Personal Prdcts
Food & Staples
(0.05)
Retailing
- Bev erages
Cheap & Out
of Favor
0.05
-0.5x 0.0x 0.5x 1.0x 1.5x 2.0x
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Utilities: Underweight
Household and corporate health The fundamental outlook for the Utilities companies has improved in the past
Interest rates quarter. Utilities companies finally saw a sequential improvement in industrial use
Energy prices of electricity in 3Q, and several management teams also reported on their quarterly
M&A
conference calls that things appear to be getting better, according to Andrew Smith,
Regulatory outlook
Industrial activity J.P. Morgan’s Electric Utilities analyst. A recovery in industrial use (20% of total),
which is much more cyclical than residential (40% of total) and commercial (40%),
should help drive marginal demand for Utilities in an expanding economy (assuming
weather is not a major positive or negative swing factor).
The regulatory outlook is a key driver for this sector as many companies are
regulated. For the non-regulated Utilities companies, M&A could become a driver
J.P. Morgan Analyst Coverage next year, particularly for the Merchant Power companies, as there are attractive
Analyst M&A opportunities in this space, according to Andrew Smith.
We remain underweight Utilities as we see limited opportunities in this group in
Utilities Smith N
1H10. The independent power producers have some leverage to a strengthening
economy, but investors are likely to see other ways to capitalize on the economic
improvement.
takeaways from discussions with analyst about
likelihood of outperformance by his sector vs. Sector Price Performance
overall market in 2010.
Utilities has been one of the biggest underperformers in 2009, as it has little leverage
to the global economic recovery. We expect this underperformance to continue early
on in 2010, as we believe sectors such as the Cyclicals, Energy, and Financials are
likely to outperform in 1H10 due to their leverage to a strengthening global
economy.
Figure 145: Quarterly Price Performance — Utilities

1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 QTD
-3% 17% 4% -3% 4% 35% 25% 9%
Utilities: Underweight
Utilities has been one -4% 7% 0% -12% -3% 19% 21% 8%
of the biggest
underperformers in -4% 4% 0% -13% -8% 18% 21% 7%
2009 as it has little
leverage to the global -6% 2% -1% -14% -9% 18% 19% 7%
economic recovery -8% -2% -9% -21% -9% 16% 17% 7%
-10% -3% -9% -23% -11% 15% 15% 7%
-11% -5% -12% -23% -12% 10% 11% 6%
-12% -6% -16% -25% -12% 9% 9% 5%
-15% -8% -19% -26% -12% 9% 9% 5%
-15% -11% -23% -31% -22% 8% 5% 4%
-15% -19% -25% -38% -29% 2% 4% -2%
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The composite score for Utilities has gradually declined during 2009, along with the
Defensives overall, but the sector has seen some stabilization on the Circle of Life
metrics in recent months.
• As 2009 progressed and the economy began to recover, the relative earnings and
sales momentum of the Defensives, and Utilities in particular, declined as the
momentum shifted more towards the Cyclicals. As a result, the fundamental
rankings for Utilities gradually declined throughout the year.
• This relative decline of Utilities has stabilized in recent months, however, as
relative sales revisions actually improved in September and fund flows also
provided some support in October. Overall, however, Utilities is still currently
one of the lowest ranked sectors on our Circle of Life metrics, highlighting why
we favor the Cyclicals sectors in the near term.
Figure 146: Circle of Life Metrics Monthly Changes — Utilities Figure 147: Circle of Life Trending Composite Score — Utilities
Price Performance
Sales Revision
1.0 Utilities
Sales Momentum
0.5
Composite Score
Earnings Revision
Earnings Momentum
0.0
JULI Spreads

Short Interest

Total Delta -1 -1 -2 0 0 -2 0 1 0
Composite Score 0.0 (0.1) (0.2) (0.4) (0.5) (0.5) (0.7) (0.7) (0.6) (0.6)

The earnings progression for the Utilities has been relatively stable over the past
year, similar to the other Defensives but in stark contrast to the sharp declines we
saw in the Cyclicals, Energy, and Financials. However, this relative earnings
stability also leaves less room for earnings upside in 2010.
• Earnings growth should be about 5% for the Utilities companies in 2010, similar
to the pace of growth that this sector saw back in 2004 during the last economic
recovery. This relatively low earnings growth, coupled with relative high
valuations, is likely to lead to an underperformance of the sector.
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Figure 148: Utilities: Sector Earnings and % chg yoy

$ per share
Earnings in Utilities $3.40 JPM estimate --> 25%
have been relatively
stable throughout the $3.20 20%

economic downturn,
but upside is very $3.00 15%
limited as we head
into 2010, with only $2.80 10%
yoy % chg
5-6% projected
earnings growth $2.60 5%
$2.40 0%
$2.20 -5%
$2.00 -10%
12/02 6/03 12/03 6/04 12/04 6/05 12/05 6/06 12/06 6/07 12/07 6/08 12/08 6/09 12/09 6/10 12/10
The consensus outlook for Utilities is similarly mild, with 6% growth projected for
both sales and earnings in 2010. Unlike all of the other sectors, sales growth in
Utilities is actually projected to be slightly higher than net income growth in 2010,
implying that Street analysts are not projecting any margin expansion in 2010. This
further highlights why we do not currently favor Utilities, as the sector is not
particularly leveraged to the global economic recovery.
Figure 149: Consensus Outlook for Utilities: Quarterly Sales and Earnings (1Q08 — 4Q10)
$ in mm
Utilities
Sales $93,014 $84,217 $97,142 $86,856 $361,228 $88,094 $71,636 $79,606 $87,737 $327,073 $90,305 $78,365 $95,371 $83,084 $347,126
• $ chg yoy $6,037 $5,938 $8,750 $3,257 $23,981 -$4,920 -$12,581 -$17,536 $881 -$34,155 $2,211 $6,730 $15,765 -$4,653 $20,053
% chg yoy 6.9% 7.6% 9.9% 3.9% 7.1% -5.3% -14.9% -18.1% 1.0% -9.5% 2.5% 9.4% 19.8% -5.3% 6.1%
• $ chg qoq $9,415 -$8,798 $12,925 -$10,285 $1,238 -$16,458 $7,970 $8,131 $2,568 -$11,940 $17,006 -$12,287
% chg qoq 11.3% -9.5% 15.3% -10.6% 1.4% -18.7% 11.1% 10.2% 2.9% -13.2% 21.7% -12.9%
Net Income $7,407 $6,364 $8,686 $5,657 $28,113 $7,070 $6,393 $8,947 $5,524 $27,934 $7,182 $6,239 $10,040 $6,100 $29,562
• $ chg yoy $624 $336 -$534 -$241 $186 -$337 $29 $261 -$133 -$179 $113 -$154 $1,093 $576 $1,628
% chg yoy 9.2% 5.6% -5.8% -4.1% 0.7% -4.5% 0.5% 3.0% -2.4% -0.6% 1.6% -2.4% 12.2% 10.4% 5.8%
• $ chg qoq $1,509 -$1,043 $2,322 -$3,028 $1,413 -$677 $2,554 -$3,423 $1,658 -$943 $3,801 -$3,940
% chg qoq 25.6% -14.1% 36.5% -34.9% 25.0% -9.6% 39.9% -38.3% 30.0% -13.1% 60.9% -39.2%
Sector Valuation
Valuations in the Utilities sector remain elevated based on the Price/10yr EPS
(relative to the overall S&P 500), suggesting relative multiples are likely to contract
in 2010.
• Although valuations have improved since peaking back in early 2009, the current
valuation is still one standard deviation above the long-term average, suggesting
it is still elevated. As a result, multiples on this metric appear more likely to
continue declining in the near-term than expanding.
• If the relative P/10yr EPS of the Utilities sector continues to contract, the sector
could see downside of 21% in order to return to the long-term average P/10yr
EPS. As a result, valuations are likely to be a drag for Utilities early on in 2010.
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Figure 150: Utilities: P/10-yr EPS

10-yr EPS
1.1x

Valuations in Utilities
are elevated and 0.8x
suggest that relative
multiples are likely to
contract in 2010,
creating a drag for the
sector 0.5x
0.2x
'84 '88 '92 '96 '00 '04 '08
Best and Worst Industries within Utilities

Independent Power Producers & Energy Traders are the only industry in Utilities that
is attractive on valuation and sentiment. It is currently the cheapest industry, and it is
also the most out of favor industry. This combination suggests that this industry
could be a good fit for investors looking for a contrarian industry within Utilities.
Gas Utilities, Multi-Utilities, and Electric Utilities, on the other hand, are all more
expensive than the long-term average P/S and are more liked than usual, suggesting
these industries are expensive and are more likely to see downgrades than upgrades.
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Figure 151: Utilities: Comparative Valuation and Sentiment Matrix

(0.50)
Expensive &
(0.40) Multi-Utilities In-Favor
Electric Utilities

Ind Power Producers &
Energy Traders is the
(0.30)
only industry in Utilities
that is attractive on
valuation and sentiment.
(0.20)
(0.10) Gas Utilities
Cheap & Out

- of Favor
Ind. Pow er
Producers & Energy
0.10 Traders
-0.4x -0.2x 0.0x 0.2x 0.4x 0.6x 0.8x 1.0x 1.2x
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Appendix I: Technical Outlook

S&P 500 Index Outlook
Michael KraussAC
(1-212) 834-5103 The turn in the equities in March of this year occurred amid widespread pessimism
michael.krauss@jpmorgan.com and a bullishly forming technical backdrop. At the time, many investors felt that the
J.P. Morgan Securities Inc. World Financial System was collapsing, and a major Depression was unfolding. To
characterize the extreme bearishness at the time, the Daily Sentiment Index (MBH
Commodities, Winnetka Ill.) poll sported a record oversold 5% bulls on a 10-day
moving average basis. Similarly, Time magazine on March 9 (the day of our S&P
500 Major Bottom report), had an “End of the World” cover story on the economy
entitled “Holding On for Dear Life” (Figure 152). Finally, on March 10, the
Rasmussen Reports polling service found that 53% of Americans said it was likely
that the US would enter a Depression similar to the 1930s. This extreme negative
sentiment proved to be the key indicator in calling for a turn in the S&P in March of
this year.
Figure 152: A classic Time magazine cover showed excessive Figure 153: S&P 500 Index bull market stalling near our 1,100 2009
pessimism at the S&P March bottom Outlook objective and 1,109-1,121 resistance
Time magazine cover—March 9, 2009 S&P 500 Index—weekly bars
Appendix I: Technical Outlook

Source: J.P. Morgan, “US Fixed Income Markets 2010 Outlook,” dated November 27, 2009.
Source: CQG Inc.
In 2010, we expect the S&P 500 to spend much of the year in a sideways trading
range environment between 950 on the downside and 1,150/1,200 on the upside. Our
best case upside is 1,229-1,240. Having already met 1,113 on November 16, we
suggest that gains from here should be more of a struggle. The S&P 500 has a bevy
of big picture resistance parameters in 1,100 and 1,200 handles, including chart
congestion areas, and 2007-2009 bear market retracements.
The cyclical bull market in the S&P 500 from the 666 March 10 panic bottom is not
over, and keeps a bullish macro view above the 950 June high/Head and Shoulders
neckline breakout (Figure 154). We see buyers in the 1,000-950 zone for 2010.
Those overweight cash (which effectively yields zero), will likely be buying
weakness toward support levels, when conditions become oversold.
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Figure 154: S&P 500 Index sports a number of resistance levels between 1,121 and 1,229
S&P 500 Index—weekly bars
Source: CQG Inc.
Under our range theme, market timing, group dynamics, and stock selection will be
pivotal to 2010 performance. With the S&P 500 rising 67% over the past eight
months, buy and hold in 2009 led to excellent returns. In 2010, more frequent trading
behavior will be needed to achieve returns.
For us, the 2009 bottom and rally look similar to the 2003 bottom and rally. To that
end, we expect a 2010 trading range, akin to the 2004 trading range (Figure 155).
While swings in 2010 should be wider than the very narrow 2004 range, the spirit of
a range-type year after a huge surge is not uncommon. In this vein, from a
fundamental sense, our Global Asset Allocation Strategist, Jan Loeys, notes in his
November 4, 2009, Global Markets Outlook & Strategy (GMOS) publication that in
the past six US economic recessions back to 1969, the S&P 500 on average went
sideways for about a year, after the initial six- to eight-month market recovery
associated with the end of the recession (Figure 156). The S&P 500 tends to bottom
about three months before the recession ends, and J.P. Morgan assumes June was this
recession’s trough.
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Figure 155: Expecting a broad range for the S&P 500 in 2010 between Figure 156: GMOS chart shows the S&P going sideways for a year,
950 and 1,150/1,200; note 2004 range after the recovery phase at recession-ends
S&P 500 Index—weekly closes (log scale) S&P 500 Index— average of prior post-recession returns versus current
2004
Source for both figures: CQG Inc.
The weekly close LOG chart is also instructive for our 2010 S&P 500 trading range
scenario (Figure 155). Note the prior congestion areas built around both 950 and
1,150, indicated with the horizontal bands. The lower band at 950 had been the base
high in both the 2002-2003 and 2008-2009 bottoming patterns (Figure 155). In both
cycles, weekly closes above 950 affirmed new bull markets. The 950 area should
prove to be a floor for 2010. On the upside, the 1,150 area proved an important
inflection point in the 2001 to 2005 time frame: a low in April 2001, a high in
December 2001, a high in March 2002, a high in March 2004, and a low in April
2005 (Figure 155). Overall, it stands to reason that the S&P 500 can spend a good
deal of time in 2010 within the bands of the 950 to 1,150 range.
Near term, this week (November 20), is sporting a downside reversal from a new
1,113 bull market high, which has met our 1,100 2009 Outlook range high
target/Global FI Technical Strategist 2009 year-end objective. In addition, the
market is rejecting the 1,109 2007-2008 cycle downtrendline (Figure 153), and 1,121
50% bear market retracement from the 1,576 October 2007 top to the 666 March
2009 bottom (Figure 154). On a short- to medium-term standpoint, the market seems
tired. Momentum and breadth have been bearishly diverging. This makes sense, as
portfolio managers are booking the huge gains of the past eight months. Near-term
supports rest at 1,070-1,060, and the 1029 November 2 low.
Major resistance levels for 2010 include: 1,121—October 2007 50% bear market
retracement (Figure 154); 1,133- September 18 2008 low (Figure 153); 1,145—May
2008 61.8% retrace (Figure 154); 1,154—where the rally from March 2009 would be
.618 as long as the 2002-2007 bull market; 1,159—where the July rally from 869
would equal the 666 to 956 March to June rally (Figure 154); 1,200—July 15, 2008
low (Figure 153); 1,229—October 2007 61.8% bear market retracement (Figure
154); and 1,240—2008-2009 Head and Shoulders bottom rally target (Figure 157).
Again, the last two are perceived ceilings for 2010.
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Figure 157: The 1,240 S&P 500 Head and Shoulders Bottom rally objective is likely to mark a
ceiling
S&P 500 Index—weekly bars
Source: CQG Inc.
Under a worst-case scenario, sustained breaks below 950 would target 869-835. This
zone includes the 869 July 8 low, and 837 March 2009 61.8% retracement. We do
not see the 666 cycle low breaking, absent a global depression.
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US Equity Strategy Recent Publications

US Strategy Special Reports
Circle of Life: Raising YE09 Target to 1160: Raising ‘10E EPS to $80; Pro-Cyclical.. — 11/20/09 7 Reasons We Are Early in Cycle for Cyclicals – 6/25/09
Fund Managers trailing benchmarks more important to YE – 19 Ideas to leverage this – 11/05/09 Guide to Stock Bottoms: Part II – Shift to Offense. Top 3 Tech, Disc & Financials – 5/12/09
Hang on…fundamentals still improving. 3Q top-line beat not just FX. Payrolls is next catalyst – S&P 500 Model Book, Reducing ’09/’10 EPS to $57/$76 from $65/$80 – 3/24/09
11/3/09
Guide to Stock Bottoms: Part I, Bottoms best called on a “rear”-ward basis – 11/21/08
Surge in GDP per worker suggests positive payrolls by early 2010 – 10/29/09
The Franchise 16, Stocks to Own Beyond the Market Turmoil – 10/17/08
Circle of Life: Rising Tobin’s Q and HY Prices Heavily Favor Higher-Debt Equities – 10/22/09
The Recession Guidebook, Analysis of Index and 10 Sectors during recessions – 3/12/08
3Q09 Preview: The Bar Is Higher: Expect a 1% Top Line and 10% EPS Beat – 10/08/09
Investors wary of October. But 4 reasons we think month could be benign – 10/01/09
Heavy Issuance Behind Softness This Week? Seven Straight Monthly Gains a Charm? – 9/25/09
US SMid Cap Perspective
Circle of Life: 7 Reasons Cyclicals Still Justify “Fresh Money,” and 26 Stock Ideas – 9/18/09
2010 SMid Outlook: Stock picking to outperform again — 11/30/09
Cyclical revs Beta to GDP is 3x, implies upside to 3Q revs. 25 Top-line Beat ideas – 9/10/09
2009 SMid Conf Must-See Presentations — 11/30/09
Fewer NEGATIVE preannouncements bodes well for Sept. Focus on Top 10 Shorted – 9/03/09
Building a position in homebuilders; Adding KBH, HOV, and DHI to SMid Money – 11/13/09
Misconceptions about consumer role early in recovery – 8/19/09
Earnings Should Be a Catalyst for Further Outperformance of R2K – 10/15/09
Still a good idea to be non-Consensus. 10 OW by JPM, But Least Liked by Street – 08/13/09
Energy Stocks Should Outperform Oil; Adding OII, HOS, and HK to SMid – 8/27/09
Circle of Life: Upgrade Energy to OW from N; Downgrade Healthcare to UW from N – 8/06/09
Russell 2000 should catch up to S&P 500; Adding to JPM SMid Money List – 7/23/09
Slowing equity issuance tailwind for stocks, particularly Financials. 9 ideas – 7/30/09
Focus on Small-Caps over Large-Caps, Buy Theme Strategies – 6/11/09
Micro supporting Macro – Three reasons we like 2Q so far – 7/16/09
Contrarians gain. Adding GT, BDN and IOSP to SMid Money List – 4/23/09
2Q Preview: Micro meets Macro – 6 reasons 2Q to boost conviction on recovery – 7/09/09
The equity rally supports Russell 2000 Value over Growth – 03/20/09
Circle of Life: The right Cyclicals to leverage a move in ISM from 42 to 55 – 7/01/09
SMid Money List Update, Sprint Boost Unlimited could affect share gains – 1/16/09
Takeaways from European investors – Consensus bearish on consumer, recovery – 6/18/09
Consumer over Corporates. Adding to SMid Money List – 1/08/09
Circle of Life: Global economic recovery, revived corporate credit and investor flows – 6/04/09
Russell 2000 now performing in line with S&P 500 – 9/11/08
A global synchronized recovery justifies 1100 by YE. Investor flows turn positive – 5/28/09
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Companies Recommended in This Report (all prices in this report as of market close on 10 December 2009)
Apple Inc. (AAPL/$196.43/Overweight), Bank of America (BAC/$15.21/Overweight), Caterpillar Inc.
(CAT/$56.94/Overweight), Ford Motor Company (F/$9.05/Neutral), Google (GOOG/$591.50/Overweight), Leap Wireless
International (LEAP/$14.71/Neutral), MetroPCS (PCS/$6.90/Neutral), Pulte (PHM/$8.84/Neutral), Sprint Nextel
(S/$4.03/Neutral), U.S. Steel Corp (X/$46.07/Overweight), Wal-Mart Stores, Inc. (WMT/$54.69/Overweight)
Analyst Certification:
The research analyst(s) denoted by an “AC” on the cover of this report certifies (or, where multiple research analysts are primarily
responsible for this report, the research analyst denoted by an “AC” on the cover or within the document individually certifies, with
respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report
accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research
analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the
research analyst(s) in this report.
Important Disclosures
• Market Maker: JPMSI makes a market in the stock of Apple Inc., Google, Leap Wireless International, MetroPCS.
• Market Maker/ Liquidity Provider: JPMSL and/or an affiliate is a market maker and/or liquidity provider in Ford Motor
Company.
• Lead or Co-manager: JPMSI or its affiliates acted as lead or co-manager in a public offering of equity and/or debt securities for
Bank of America, Caterpillar Inc., Ford Motor Company, MetroPCS, Sprint Nextel, U.S. Steel Corp, Wal-Mart Stores, Inc. within
the past 12 months.
• Analyst Position: The following analysts (and/or their associates or household members) own a long position in the shares of Bank
of America: Thomas Lee. The following analysts (and/or their associates or household members) own a long position in the shares of
Leap Wireless International: Thomas Lee. The following analysts (and/or their associates or household members) own a long
position in the shares of MetroPCS: Thomas Lee. The following analysts (and/or their associates or household members) own a long
position in the shares of Pulte: Thomas Lee. The following analysts (and/or their associates or household members) own a long
position in the shares of Sprint Nextel: Thomas Lee. The following analysts (and/or their associates or household members) own a
long position in the shares of U.S. Steel Corp: Thomas Lee.
• Beneficial Ownership (1% or more): JPMSI or its affiliates beneficially own 1% or more of a class of common equity securities of
Bank of America.
• Client of the Firm: Apple Inc. is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the
company non-investment banking securities-related services and non-securities-related services. Bank of America is or was in the
past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company investment banking services, non-
investment banking securities-related services and non-securities-related services. Caterpillar Inc. is or was in the past 12 months a
client of JPMSI; during the past 12 months, JPMSI provided to the company investment banking services, non-investment banking
securities-related services and non-securities-related services. Ford Motor Company is or was in the past 12 months a client of
JPMSI; during the past 12 months, JPMSI provided to the company investment banking services, non-investment banking securities-
related services and non-securities-related services. Google is or was in the past 12 months a client of JPMSI; during the past 12
months, JPMSI provided to the company non-investment banking securities-related services and non-securities-related services.
MetroPCS is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company investment
banking services and non-investment banking securities-related services. Pulte is or was in the past 12 months a client of JPMSI;
during the past 12 months, JPMSI provided to the company investment banking services and non-securities-related services. Sprint
Nextel is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company investment
banking services and non-securities-related services. U.S. Steel Corp is or was in the past 12 months a client of JPMSI; during the
past 12 months, JPMSI provided to the company investment banking services. Wal-Mart Stores, Inc. is or was in the past 12 months
a client of JPMSI; during the past 12 months, JPMSI provided to the company investment banking services, non-investment banking
securities-related services and non-securities-related services.
• Investment Banking (past 12 months): JPMSI or its affiliates received in the past 12 months compensation for investment banking
services from Bank of America, Caterpillar Inc., Ford Motor Company, MetroPCS, Pulte, Sprint Nextel, U.S. Steel Corp, Wal-Mart
Stores, Inc..
• Investment Banking (next 3 months): JPMSI or its affiliates expect to receive, or intend to seek, compensation for investment
banking services in the next three months from Bank of America, Caterpillar Inc., Ford Motor Company, Google, MetroPCS, Pulte,
Sprint Nextel, U.S. Steel Corp, Wal-Mart Stores, Inc..
• Non-Investment Banking Compensation: JPMSI has received compensation in the past 12 months for products or services other
than investment banking from Apple Inc., Bank of America, Caterpillar Inc., Ford Motor Company, Google, MetroPCS, Wal-Mart
Stores, Inc.. An affiliate of JPMSI has received compensation in the past 12 months for products or services other than investment
banking from Apple Inc., Bank of America, Caterpillar Inc., Ford Motor Company, Google, MetroPCS, Pulte, Sprint Nextel, Wal-
Mart Stores, Inc..
141
(1-212) 622-6505 10 December 2009
• JPMorgan and/or its affiliates is acting as financial advisor to Ameriprise Financial Inc (NYSE: AMP) in connection with its
definitive agreement to acquire the long-term asset management business of Columbia Management from Bank of America Corp
(NYSE: BAC) as announced on September 30, 2009. The transaction is subject to customary regulatory reviews and approvals. It is
expected to close in the spring of 2010.
Apple Inc. (AAPL) Price Chart
357 Date Rating Share Price Price Target

OW $102 OW $155OW $210 ($) ($)
306
18-Jan-07 N 94.95 --
OW $104 OW $135
OW $170
15-Oct-08 OW 104.08 --
255
18-Dec-08 OW 89.16 104.00
N OW OW $100 OW $167.5
OW $220
204 14-Jan-09 OW 87.71 102.00
Price($) 06-Mar-09 OW 88.84 100.00
153 23-Apr-09 OW 121.51 135.00
09-Jun-09 OW 143.85 155.00
102 17-Jul-09 OW 147.52 167.50
22-Jul-09 OW 151.51 170.00
51
21-Sep-09 OW 184.02 210.00
20-Oct-09 OW 189.86 220.00
0
Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan
06 07 07 07 07 08 08 08 08 09 09 09 09 10
Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.
Break in coverage May 01, 1999 - Oct 18, 2001, and Sep 12, 2002 - Dec 02, 2003. This chart shows J.P. Morgan's
continuing coverage of this stock; the current analyst may or may not have covered it over the entire period.
J.P. Morgan ratings: OW = Overweight, N = Neutral, UW = Underweight.
Bank of America (BAC) Price Chart
Date Rating Share Price Price Target

95 ($) ($)
OW $17.5 OW $22
13-Jan-09 OW 11.43 17.00
76 OW $10 OW $21.5 17-Mar-09 OW 6.18 10.00
09-Jun-09 OW 12.06 17.50
OW $17 OW $20.5 08-Sep-09 OW 17.09 20.50
57
Price($) 09-Oct-09 OW 17.33 21.50
08-Dec-09 OW 15.89 22.00
38
19
0
06 07 07 07 07 08 08 08 08 09 09 09 09 10
Break in coverage Sep 12, 2002 - Jul 08, 2004. This chart shows J.P. Morgan's continuing coverage of this stock; the
current analyst may or may not have covered it over the entire period.
142
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Caterpillar Inc. (CAT) Price Chart
150 Date Rating Share Price Price Target

OW $40 OW $61 ($) ($)
125 25-Jan-07 UW 59.73 -

N N $32 OW $56 02-Jun-08 OW 82.64 94.00
23-Jul-08 N 74.98 --
100
UW OW $94 N $60 OW $43
22-Dec-08 N 41.78 60.00
Price($) 75 27-Jan-09 N 32.67 32.00
22-Apr-09 OW 31.39 40.00
22-Jul-09 OW 39.46 43.00
50
23-Sep-09 OW 54.34 56.00
21-Oct-09 OW 59.61 61.00
25
0
06 07 07 07 07 08 08 08 08 09 09 09 09 10
Break in coverage May 31, 2008 - Jun 02, 2008. This chart shows J.P. Morgan's continuing coverage of this stock; the
Ford Motor Company (F) Price Chart

($) ($)
18
10-Jul-07 OW 9.08 -
25-Apr-08 N 8.40 -
24-Jul-09 N 6.98 8.00
12 05-Nov-09 N 7.27 10.00
Price($) OW N N $8 N $10
0
06 07 07 07 07 08 08 08 08 09 09 09 09 10
This chart shows J.P. Morgan's continuing coverage of this stock; the current analyst may or may not have covered it
over the entire period.
143
(1-212) 622-6505 10 December 2009
Google (GOOG) Price Chart
1,225 Date Rating Share Price Price Target

OW $470 ($) ($)
1,050 05-Jan-09 OW 328.05 430.00
OW $409 OW $608
09-Apr-09 OW 362.00 409.00
875 17-Jul-09 OW 442.60 470.00
OW $430 OW $503
12-Oct-09 OW 524.04 503.00
700
Price($) 16-Oct-09 OW 529.91 608.00
525
350
175
0
06 07 07 07 07 08 08 08 08 09 09 09 09 10
Leap Wireless International (LEAP) Price Chart

N $16 ($) ($)
155
17-Aug-07 OW 54.47 119.00
OW OW $38 N $22 19-Sep-07 OW 77.68 --
124
09-Sep-08 OW 46.64 56.00
OW $119 OW $56 OW $50 OW $22 N $12 26-Jan-09 OW 24.89 50.00
Price($) 93 27-Feb-09 OW 24.88 38.00
07-Aug-09 OW 22.59 22.00
62 01-Oct-09 N 19.55 22.00
16-Oct-09 N 15.47 16.00
31 06-Nov-09 N 13.03 12.00
0
06 07 07 07 07 08 08 08 08 09 09 09 09 10
Break in coverage Apr 28, 2003 - Jul 28, 2005. This chart shows J.P. Morgan's continuing coverage of this stock; the
144
(1-212) 622-6505 10 December 2009
MetroPCS (PCS) Price Chart

70 ($) ($)
N
31-Aug-07 N 26.93 -
56 N $10 09-Sep-08 OW 17.17 22.00
07-Aug-09 OW 8.99 11.00
N OW $22 OW $11 01-Oct-09 N 9.36 10.00
42
Price($) 06-Nov-09 N 6.01 --
28
14
0
Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan
07 07 07 08 08 08 08 09 09 09 09 10
Initiated coverage Aug 31, 2007. This chart shows J.P. Morgan's continuing coverage of this stock; the current analyst
may or may not have covered it over the entire period.
Pulte (PHM) Price Chart
65
($) ($)
52 08-Jan-09 N 12.05 8.50

N $14 03-Sep-09 N 11.92 10.00
18-Sep-09 N 12.73 14.00
39 N $8.5 N $10
Price($)
26
13
0
06 07 07 07 07 08 08 08 08 09 09 09 09 10
145
(1-212) 622-6505 10 December 2009
Sprint Nextel (S) Price Chart

40 ($) ($)
12-Jan-07 OW 17.44 25.00
N 19-Sep-07 OW 17.90 --
30 02-Jun-08 N 9.36 --
OW $25 OW N N $4 10-Nov-08 N 3.23 4.00
Price($) 10-Dec-08 N 2.54 --
20
10
0
06 07 07 07 07 08 08 08 08 09 09 09 09 10
Break in coverage Jan 27, 2003 - Nov 07, 2003, and May 31, 2008 - Jun 02, 2008. This chart shows J.P. Morgan's
continuing coverage of this stock; the current analyst may or may not have covered it over the entire period.
U.S. Steel Corp (X) Price Chart

OW OW $49 ($) ($)
290 25-Apr-07 OW 103.04 115.00
OW $134 OW $56 06-Jun-07 OW 117.52 134.00
232 03-Aug-07 OW 95.64 --
OW $115 OW $80 OW $42.5 OW $55 28-Oct-08 OW 30.82 80.00
Price($) 174 19-Dec-08 OW 37.34 56.00
28-Jan-09 OW 31.49 49.00
116 12-Mar-09 OW 19.33 42.50
28-Jul-09 OW 41.27 55.00
58
0
06 07 07 07 07 08 08 08 08 09 09 09 09 10
146
(1-212) 622-6505 10 December 2009
Wal-Mart Stores, Inc. (WMT) Price Chart

98 OW $64OW $58 ($) ($)
04-Jun-07 OW 51.21 --
84 N OW $65
OW $59
OW $58
14-Aug-07 N 46.17 --
70 31-Oct-08 N 54.75 56.00
OW N $56
OW $62 OW $59
03-Nov-08 OW 55.97 65.00
Price($) 56 10-Nov-08 OW 55.18 64.00
13-Nov-08 OW 52.62 62.00
42
08-Jan-09 OW 55.54 59.00
28 09-Feb-09 OW 49.28 58.00
18-Feb-09 OW 48.24 59.00
14 10-Mar-09 OW 47.51 58.00
0
06 07 07 07 07 08 08 08 08 09 09 09 09 10
Explanation of Equity Research Ratings and Analyst(s) Coverage Universe:

J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the
average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Neutral [Over the next six to twelve
months, we expect this stock will perform in line with the average total return of the stocks in the analyst’s (or the analyst’s team’s)
coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of
the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] The analyst or analyst’s team’s coverage universe is the sector
and/or country shown on the cover of each publication. See below for the specific stocks in the certifying analyst(s) coverage universe.
J.P. Morgan Equity Research Ratings Distribution, as of September 30, 2009

Overweight Neutral Underweight
(buy) (hold) (sell)
JPM Global Equity Research Coverage 39% 46% 15%
IB clients* 56% 57% 42%
JPMSI Equity Research Coverage 38% 51% 10%
IB clients* 76% 72% 56%
*Percentage of investment banking clients in each rating category.
For purposes only of NASD/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold
rating category; and our Underweight rating falls into a sell rating category.
Valuation and Risks: Please see the most recent company-specific research report for an analysis of valuation methodology and risks on
any securities recommended herein. Research is available at http://www.morganmarkets.com , or you can contact the analyst named on
the front of this note or your J.P. Morgan representative.
Analysts’ Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon
various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which
include revenues from, among other business units, Institutional Equities and Investment Banking.
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Standardized Options, please contact your J.P. Morgan Representative or visit the OCC’s website at
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147
(1-212) 622-6505 10 December 2009
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148
(1-212) 622-6505 10 December 2009
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“Other Disclosures” last revised December 7, 2009.
Copyright 2009 JPMorgan Chase & Co. All rights reserved. This report or any portion hereof may not be reprinted, sold or
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North America Equity Research

2010 Outlook: Back to Business

See page 141 for analyst certification and important disclosures.

2010 Outlook: Visibility in 1H

What we do know is pessimism is pervasive; as A.C. Pigou notes, “the error of

6 areas where we differ from consensus . . .

2010 Outlook: Visibility in 1H

Headwinds and Tailwinds: Less visibility in 2H

• Payrolls turn positive consistently, likely in 1Q10;

Less visibility in 2H, but not necessarily bearish

Figure 1: Headwinds vs. Tailwinds: Bullish 1H, Neutral 2H10

2009 2010 2011

S&P 500 Earnings trend

Source: J.P. Morgan estimates.

YE Target of 1300 based on ’10E/’11E EPS of $80/$90

Establishing 2010 YE Target for the S&P 500 of 1300

Figure 2: S&P 500 Year-End 2010 Target of 1300

Based on 19 prior Bull markets, 95% possibility 2010 is

• 95% likelihood of an “Up” year: Of the 19 preceding bull markets, only 1

Figure 3: Stylistic roadmap for 2010E based on 19 Preceding Bull Markets

Year-End based on...

Average '00-09: 1,319

Source: J.P. Morgan estimates and Dow Jones.

Market Strategy: OW Cyclicals. Healthcare to N from UW

Best groups: Financials and Industrials

of Healthcare reform in valuations, while improvements to the program are likely to

Figure 4: 2010 Sector Ratings

Source: J.P. Morgan estimates. 5 = best. 1 = least.

Preceding Bulls 1900-2009

So what did we learn?

• 95% likelihood, based on past, of an “Up” year: Of the 19 preceding bull

Preceding Bulls 1900-2009

Top Quartile 33% 1,469

Intrayear gain of at least 19% possible and top quartile 37%

Bull market start Implied level of Low Middle Top

Top Quartile 37% 1,513

Intrayear drop to 1081 is typical of 19 prior bulls

Top Quartile 3% 1,135

32% possibility of a 10% correction, based on past, implied

• Of those 19 preceding markets, 6 saw at least a 10% correction. Thus, a

Figure 8: Possibility of a Correction Is 32%

RISKS: Upside and Downside to Outlook

RISKS: Upside and Downside to Outlook

The Base Case: 3.6% GDP growth in ’10E

The profile of growth in 2010 is a contrast with 2009

2010 growth is driven by capex, housing, export and inventory builds in 2H

The Base Case: 3.6% GDP growth in ’10E

Figure 9: Base Case of US Economic Outlook for 2010

As discussed by Bruce Kasman, J.P. Morgan Chief Economist, in the 2010

Figure 10: 2010 Recovery is ANEMIC vs. past DEEP DOWNTURNS . . . .

This GDP outlook produces closer to a “jobless” recovery . . . .

Dollar expected to remain weak for most of 2010

Reality check: 3 Ingredients for Upside

Reality check: 3 Ingredients for Upside

How to get this economy strengthening beyond a bounce?

Figure 13: Virtuous Circle of Demand, Liquidity, and Expansion

Source: J.P. Morgan.

1. Pent-up demand. Of course, innovation or a new secular theme could be the

Ingredient 1: Pent-up Demand? Yes

Figure 14: Four areas of potential pent-up demand . . .

Ingredient 1: Pent-up Demand? Yes

Source: J.P. Morgan estimates, Census Bureau, BEA, NAR.