JP Morgan Latam 2011

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Latin America Equity Research12 November 2010

LatAm Year Ahead 2011Stay Invested

Head of Latin America Research

Ben LaidlerAC

(1-212) 622-5252

[email protected]

J.P. Morgan Securities LLC

Contents

Strategy .......................................................

Sectors.........................................................4Economics and Commodities ....................1

LatAm Data................................................1For a complete list of contributors tothis report, please see table ofcontents on page 3.

See page 158 for analyst certification and important disclosures, including non-US analyst disclosures.J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware thathe firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a singfactor in making their investment decision.


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2

Latin America Equity ResearchNovember 2010

Ben Laidler(1-212) [email protected]

LatAm Year Ahead 2011 Stay InvestedWhat to own

Brazil

Colombia

Argentina

Off-Index

Discretionary

Financials

Telecoms

Focus on sectors within countries rather than country

recommendations.

What to avoid

Chile

Peru

Materials

Utilities

Staples

A detailed view of our country and sector recommendations

within LatAm is available on page 14. For more detail

lease see country and sector pages.

10 Top Analyst Picks(See page 16)

Top Picks Country To PT (%)

Vale Brazil 49.4

PDG Realty Brazil 41.6

Cemex Mexico 35.7

Bradesco Brazil 34.9

Santander Brasil Brazil 34.7

Corporacion Geo Mexico 32.3

ICA Mexico 32.1

Grupo Mexico Mexico 31.1

Copasa Brazil 29.0

Brasil Foods SA Brazil 26.9

10 Stocks to Avoid(See page 17)

Stock to avoid Country To PT (%)

Ecopetrol Colombia (36)

SQM Chile (28)

Grupo Financiero Inbursa Mexico (24)

Telmex SA Mexico (21)Fibria Brazil (13)

CPFL Energia Brazil (6)

IAM Chile (4)

Bancolombia Colombia (2)

Buenaventura Peru (1)

Eletropaulo Brazil 0

Source: J.P. Morgan. Note: To PT = Returns to analyst price target from 28 Oct 2010.

The year-ahead process

The goal of this document is to present our key strategy themes for 2011 using most- and least-favored stocks from J.P.

Morgans LatAm equity research team.

This 150+ page handbook includes strategy sections from our country strategists as well as overviews on the outlook foreach major company sector and the analysts top picks and stocks to avoid for the year ahead. Analysts were asked to pick1-2 large cap stocks that should lead performance in 2011 as well as a large cap stock they expected to underperform.

We are positive LatAm into 2011. Macro fundamentals are robust, credit conditions very supportive, EM fund inflows

expected to remain strong. Valuations are not stretched, and the earnings backdrop robust. Risks range from the fiscal and

interest rates outlook in Brazil, to the security situation in Mexico, and the presidential elections in 2011 in Argentina and

Peru. Capital control risks also remain real, especially in Brazil.


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LatAm Strategy

We are positive LatAm into 2011. Macro fundamentals

are robust, credit conditions very supportive, EM fund

inflows expected to remain strong. Valuations are not

stretched, and the earnings backdrop robust. Risks range

from the fiscal and interest rates outlook in Brazil, to the

security situation in Mexico, and the presidential

elections in 2011 in Argentina and Peru. Capital control

risks also remain real, especially in Brazil. We are

overweight Brazil relative to MSCI LatAm index, as

valuations are reasonable, flows returning, and market

overhangs such as the Petrobras offering and the

presidential election are lifting. We also see

outperformance from Colombia and Argentina. We areneutral Mexico, and underweight Chile. We focus on

domestic stocks for which we see good growth and

reasonable valuations, such as financials and

homebuilders.

Fundamentals to remain robust: 2010 and 2011 GDP

growth expectations have been rising, and are above

long-term potential GDP growth. This has been

supporting the earnings revision cycle. Inflation

expectations have also been rising, and Central Banks

are expected to gradually tighten policy in 2011, within

the constraint of appreciating currencies but partly offset

by output gaps remaining in some countries. Long-termREERs point to the undervaluation of the Mexican Peso,

and overvaluation of the Brazilian Real. For more on

economics teams view, please see Latin America

Outlook Presentation.

LatAm GDP outlook

2010e 2011e Long-termForecast Current Forecast Current potentialJan-10 forecast Jan-10 forecast GDP growth

LatAm 4.4 5.7 3.4 4.1 3.4 Argentina 4.0 8.5 3.0 5.5 3.5Brazil 6.2 7.5 4.0 4.5 4.0Chile 5.0 5.5 5.0 6.0 4.2

Colombia 3.0 4.5 4.0 4.1 4.5Ecuador 2.0 2.5 3.0 3.0 3.0Mexico 3.5 4.5 2.5 3.5 2.5Peru 5.5 8.2 6.0 6.0 6.0Venezuela 1.0 -2.2 2.5 1.0 3.0

Source: J.P. Morgan Economics.

Ben LaidlerAC

(1-212) 622-5252

[email protected]


Bloomberg JPMA LAIDLER

LatAm inflation outlook2010e 2011e

Forecast in Current Forecast in CurrentJan-10 forecast Jan-10 forecast

Latin America 7.2 7.3 6.8 7.3 Argentina 9.0 10.5 10.0 Brazil 4.7 5.4 4.6 5.1Chile 2.5 3.8 3.0 3.4Colombia 3.8 2.7 4.0 4.0Ecuador 4.0 3.4 3.8 3.8Mexico 5.1 4.8 4.0 4.0

Peru 2.0 2.4 2.5 2.5Venezuela 40.0 33.0 40.0 35.0


Credit conditions remain supportive: This could

support a meaningful multiple rerating and increased

equity fund flows and is already altering corporate

behavior. The strong outperformance of EM corporates

has significantly improved relative valuations. The lower

LatAm cost of equity has pushed up fair value for

stocks. Regional corporates are responding by

releveraging and stepping up M&A activity, and

financials are boosting capital. EM corporates are seeing

strong fund inflows. This is a mirror of what equities areseeing. We believe the drivers here are sustainable into

2011, with risk-free rates likely to stay very low, EMBI

spreads tight, and the EM growth premium high. See our

recent note for details: LatAm Strategy Credit rally

supports equities.

LatAm fair value vs 12m fwd P/E

5.0

7.0

9.0

11.0

13.0

15.0

03 03 04 05 06 07 08 09 10

12 mth Fw d PE Gordon Grow th

Source: MSCI, IBES, Datastream.
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Implied P/E LatAm corps & equities

0.0

3.0

6.0

9.0

12.0

15.0

18.0

21.0

2001 2003 2004 2005 2006 2007 2008 2009 2010

Cembi Latin HY Cembi Latin IG MSCI LatAm CEMBI LatAm Broad

P/E:

CEMBI Latin IG - 19.5x

CEMBI Latin - 17.4x

CEMBI Latin HY- 12.6x

MSCI LatAm - 11.9x

Source: J.P. Morgan, MSCI, Datastream. * 12m fwd MSCI LatAm P/E and inverse of J.P. Morgan CEMBI Corporate Bond Yields.

EM fund flows continue strong: Year-to-date equity

fund flows into EM have exceeded US$70 billion, above

the previous record of US$64bn in 2009. These flows

have been focused on ETF products and on EM and Asia

funds. Flows into LatAm, as proxied by LatAm funds,

have been poor. Fund flows should continue strong, as

both global equity allocations increase, EM allocations

within global equities are built, and LatAm flows withinEM recover as Brazil overhangs lift. This is a

phenomenon across the asset class and has arguably been

more powerful in corporate and FX markets so far. We

generally see this as another source of upside risk to

multiples. Risk here is from issuance, which has been

high. Please see our weekly fund flows product for

details: Herd Instinct.

GEM fund cumulative US$bn flows

22.4

40.8

(39.4)

64.469.7

(60)

(30)

0

30

60

90

120

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2006 2007 2008 2009 2010

Source: EPFR Global.

2010 LatAm fund flows, US$mn

(2,500)

(1,500)

(500)

500

1,500

2,500

Jan 10 Feb 10 Apr 10 May 10 Jul 10 Aug 10 Oct 10

ETF Flows

Total Flows

Source: EPFR Global, J.P. Morgan.

Capital control risks: Virtually every EM CB has

intervened, and a number already have controls. Pressure

will likely continue, as we expect more FX appreciation,

with US$ weakness to persist and EM inflows to build.

We see real capital controls, such as unremunerated

reserve requirements and minimum holding periods, as

unlikely. An increase in transaction costs such as

Brazils 2% equity IOF is a last resort, but arguably

near inevitable in this flows environment. It is not

enough to change our positive view on Brazil, wherethe

potential upside beats a moderate potential transaction

cost increase. For details see our report: The threat from

capital controls.
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Other risks:Brazil fiscal and rates outlook.In the short

term we await to see the composition of Dilma

Rousseffs first cabinet and the outlines of fiscal policy

going forward. This is important as an early indication of

the policy direction of the new administration at a timewhen inflation expectations are drifting higher and the

economy is growing above potential.Mexico security

concerns.Investor angst here is high. We see this as an

unfortunate issue that detracts from growth (1-1.5%pa)

at a bad time, with the economy weak. We believe

greater concerns here are likely overdone, with violence

localized and largely between cartels. The risk is that this

spreads to Mexico City or cartels decide to openly target

the State and civilians.The electoral calendar in 2011 is

significant.Peru presidential elections are in April, with

three centrist candidates leading in the polls and leftist

Ollanta Humala currently 4th. He is likely to rise

somewhat (and this could unnerve markets) though

unlikely to ultimately prevail. Argentina also goes to the

polls in October. The political environment has been

thrown open by the unexpected death of ex-President

Kirchner. This potentially opens the way for a more

market-friendly candidate, possibly from within the

Peronist party.

Valuations are not stretched: We do not see LatAm

valuations as demanding, with most metrics within

historical ranges or at discounts to peers. LatAm is

currently trading on 11.9x 12m forward P/E, compared

to 11.6x for emerging markets and 11.5x for globalequities. This 12m forward P/E is at the top end of the

regions 15-year average. As highlighted before, the

current regional cost of equity would argue for

significant multiple expansion from these levels. When

comparing EM countries we are also careful to adjust for

index composition. This makes commodity-heavy

indices such as Brazil more expensive and staples-heavy

indices such as Mexico and Chile somewhat cheaper.

15-year MSCI LatAm 12m fwd P/E

5.00

7.00

9.00

11.00

13.00

15.00

95 97 98 99 00 01 02 03 04 05 06 07 08 10

EM Latam Av erage +1SD -1SD

Source: IBES, MSCI, J.P. Morgan.

Sector-neutral P/E

Sector-Neutral P/E 12 Mth Fwd P/E Diff

Chile 16.0 17.8 (1.8)Mexico 14.5 15.3 (0.9)Indonesia 14.8 15.3 (0.5)Korea 9.9 10.0 (0.0)South Africa 11.8 11.7 0.2EM 11.9 11.6 0.3Turkey 11.4 10.9 0.5India 17.7 17.0 0.6Brazil 12.3 11.1 1.2China 14.3 12.0 2.3Taiwan 15.6 12.9 2.8Russia 11.8 6.6 5.2

Source: MSCI, IBES, J.P. Morgan. Sector-neutral P/E multiplies the country sector P/E by

the MSCI Emerging Markets Index sector weight.

LatAm enjoyed a strong earnings recovery cycle in

2010. We expect this to stabilize in 2011. LatAm

earnings growth (local currency) is forecast at 21% for

next year versus 15% for developed markets. This is a

high number, and we see risks as balanced. Commodity

earnings have been easing especially in steels and

Petrobras. Domestic earnings have been moving higher

as GDP expectations are raised, and earnings remain

below all-time highs despite higher nominal GDP

growth. Forecasts for Mexico and Brazil are very similar

(~20-21%).

LatAm EPS growth expectations

EPS Growth Expectations %

2010e 2011e 2012eColombia 29.4 52.5 5.0Peru 27.3 31.6 13.1S.Africa 26.5 27.1 17.8India 23.4 22.7 17.6Brazil 16.3 21.6 11.5EM Latam 15.8 21.4 16.1Indonesia 20.3 20.9 13.5Mexico 9.0 20.4 16.3EM 30.6 17.2 14.0Malaysia 29.4 15.7 11.2Russia 29.8 15.4 17.1Global 36.2 15.3 13.2DW 37.2 15.0 13.0China 26.7 14.9 16.4EMEA 25.0 14.7 15.6EM Asia 40.7 14.6 13.9

Korea 51.4 13.1 11.1Chile 23.0 11.2 7.1Taiwan 89.1 9.4 11.2Turkey 18.5 8.2 13.6

Argentina 5.4 6.4 18.1Czech -4.8 3.3 5.7

Source: MSCI, IBES, J.P. Morgan.


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MSCI LatAm EPS revision cycle

80.0

90.0

100.0

110.0

120.0

130.0

140.0

150.0

Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10

2011 EPS 2010 EPS


MSCI Brazil domestic vs commodity 12m fwd earnings integer

60.0

90.0

120.0

150.0

180.0

Jan 07 Aug 07 Mar 08 Oct 08 May 09 Dec 09 Jul 10

Brazil Commodities Brazil Domestics


Attractive risk/reward for 2011 justifies continued

bullish positioning. We run three valuation scenarios for

2011. The MSCI LatAm potentialupside is 53% and thepotential downside 14%. For details see our report:Measuring the risk/reward.

1. The positive view is that lower risk-free rates aresustainable for 2011, as we forecast, and this justifiesfurther multiple rerating. This could be significant. OurGordon-growth fair value target is near 15.0x earnings,

over 30% above current multiples. This indicator hastracked well historically. Upside here is concentrated inBrazil. This targets 53% upside for the region and 70%for Brazil. Mexico is penalized by a potentially tooaggressive 2.5% potential GDP growth.

2. The mid-case assumes current multiples are fair, atthe top end of long-term historical ranges, and consensusearnings growth correct, at a reasonable premium tonominal GDP growth. This targets respectable 18%upside, with all countries closely clustered. This wouldbe our Mexico base case.

3. The cautious view assumes both a derating and thatearnings fall. A derating scenario back to long-termhistorical multiples (down 14%, from 12.0x to 10.5xearnings) and a 20% fall in index earnings versus currentexpectations, as we assume earnings growth only in linewith nominal GDP growth. This shows 14% downsidefor the region, led by Colombia, with Chile defensive.

Our baseline view is somewhere between the more

bullish two scenarios, looking for even lower Treasuryyields and tight EM spreads, whilst the relativeEmerging growth and earnings premium remain high,continuing to attract flows and support multiples. QE2and recent developed market data have reduced

downside tail-risks.

Summary year-end 2011 target and index levels

Positive Target % Upside Mid-Case Target % Upside Cautious Target % Upside

LatAm 122,500 53 94,500 18 69,000 (14)Brazil 122,000 70 84,500 18 61,500 (14)Mexico 39,500 8 42,500 17 31,600 (13)Chile 5,450 8 5,700 13 4,700 (6)Colombia 16,000 1 18,000 14 10,600 (33)

Argentina 2,300(31) 3,950 19 3,275 (1)Peru 41,300 101 24,500 19 16,500 (20)

Source: J.P. Morgan estimates.
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We remain overweight Brazil, with valuations

significantly derated, strongly returning flows, and

multiple overhangs (election, rate cycle, Petrobras, China

slowdown) reduced. Fiscal policy and equity IOF risks

remain but are manageable. The focus remains ondomestic stocks, especially those with growth at

reasonable multiples, such as financials and

homebuilders. We have good growth visibility, the

earnings revision cycle remains positive, and valuations

ex-staples are all cheap/fair. Top-performing staples and

retailers are expensive and will likely keep performing in

this environment if they can continue delivering on

earnings. However, this does not mean the risk/reward is

attractive. We are selective and own CBD. We see cheap,

underowned, but low-growth sectors such as utilities

and telecom as value traps but have continued to

selectively add where we see pockets of growth (such as

NII Holdings and TSU). In our model portfolio, we are

neutral energy (positive oil and E+P but cautious

Petrobras), and underweight materials we are positive

Vale but own no Steels. The sector is cheap (though

earnings are falling), underowned, and benefiting in the

short term from perceived QE upside, though global

growth remains subpar and the sector chronically

oversupplied.

Brazil macro outlook


Brazil interest rate futures

9.5

10.0

10.5

11.0

11.512.0

12.5

13.0

Feb 10 Apr 10 Jun 10 Aug 10 Oct 10

Jan-11 Jan-12

Source: Bloomberg.

We are neutral Mexico. The market has performed well

in the last month on signs of a bottoming in US growth

expectations (we took our global growth numbers up for

the first time since April) and moderate Mexican

consumer acceleration. We do not see Mexico asunderweight, with the market well supported by a

gradual US growth reacceleration, high equity market

correlation, undervalued currency, easy monetary policy,

and valuations less expensive than they seem. However,

the traditional drivers of Mexican outperformance are

lacking major market sell-off, strong US data surprise,

or strong local consumer recovery. We focus on

domestic recovery plays Televisa, First Cash, AMX

and special situations Cemex and ICA.

US Economic Activity Surprise Index

(40.0)

(30.0)

(20.0)

(10.0)

0.0

10.0

20.0

30.040.0

Jan 09 May 09 Sep 09 Jan 10 May 10 Sep 10

Source: Bloomberg, J.P. Morgan.

Mexico consumer confidence and formal employment

Source: J.P. Morgan Economics, INEGI, IMSS.


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In the smaller markets, we struggle to see a sustainable

second leg to the well-known (and very positive)

Chilean story. Valuations are high, and the stocks we

want to own (banks/discretionary) are even pricier. We

do see further fundamental upside in Colombia on theongoing reform agenda, investment grade outlook, and

capital markets development, but would play this off

index (through Copa and Pacific Rubiales) given high

on-index valuations. We remain exposed to Argentina.

Valuations have become expensive at first glance, but

the outlook for real political change however moderate

means the market still likely has upside. Penetration

rates are low and nontraditional valuation metrics

(franchise value, replacement cost) attractive. We stick

with GF Galicia.

12 mth fwd P/E relative to MSCI LatAm: Smaller markets at

premium to LatAm

0.2

0.7

1.2

1.7

2.2

2.7

3.2

3.7

J an-03 Feb-04 Mar-05 Apr-06 M ay -07 J un-08 J ul-09 Aug-10

Chile Argentina Peru Colombia

Source: IBES, Datastream, MSCI.

Colombia pension fund equity exposure to rise onmultifunds/demographics

Estimated End-2010

AUM Equity % Limit % Cushion %

1 0.0 0.0 NM 0.0 20.0% 0.0 NM

2 90.6 39.4 43.5% 40.8 45.0% (1.4) -1.5%

3 0.0 0.0 NM 0.0 70.0% 0.0 NM

Total 90.6 39.4 43.5% 40.8 45.0% (1.4) -1.5%

Pro Forma 2011

AUM Equity % Limit % Cushion %

1 4.5 0.9 20.0% 0.9 20.0% 0.0 0.0%

2 53.4 24.0 45.0% 24.0 45.0% 0.0 0.0%

3 32.6 22.8 70.0% 22.8 70.0% 0.0 0.0%

Total 90.6 47.8 52.8% 47.8 52.8% 0.0 0.0%

Source: Superfinanciera and J.P. Morgan estimates.

Can Cristina maintain her currently positive image?

0.0%

20.0%

40.0%

60.0%

J-08 M-08 S-08 J-09 M-09 S-09 J-10 M-10 S-10

Source: Management y Fit and J.P. Morgan.


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Latin America Model Portfolio by Sector

Change Port. MSCI Dev. P/E P/E EPS ROE AnalystTicker Price* 1M YTD Weight (%) 10E 11E Growth 10E

(%) (%) (%) (%) (x) (x) 10E (%)Discretionary 667.8 2.1 9.2 13.0 5.3 7.7 17.6 13.8 27.9 16.1Gafisa GFSA3 BZ 14.3 2.8 0.9 5.0 0.4 4.6 17.0 12.7 31.3 9.3 Adrian E HuertaPDG Realty PDGR3 BZ 22.2 5.7 28.0 5.0 0.8 4.2 15.2 9.8 67.8 13.3 Adrian E HuertaTelevisa TV US 22.9 21.1 10.3 3.0 1.2 1.8 22.4 17.5 16.1 20.0 Rajneesh JhawarStaples 628.8 3.4 21.9 9.7 11.6 -1.9 24.0 19.8 21.5 12.9CBD PCAR5 BZ 66.1 11.1 1.7 6.0 0.4 5.6 30.5 24.9 -7.7 6.9 Andrea TeixeiraCencosud CENCOSUD CI 3717.2 14.0 116.1 3.7 0.8 2.9 38.9 30.3 78.6 8.0 Andrea TeixeiraEnergy 1161.3 2.6 -15.5 17.0 16.6 0.4 10.9 10.2 7.1 9.7OGX OGXP3 BZ 22.9 0.7 33.6 4.0 1.9 2.1 nm nm -96.4 2.1 Sergio TorresPacific Rubiales PRE CN 33.4 18.0 116.4 3.0 0.0 3.0 37.2 13.8 -266.7 18.2 Sergio TorresPetrobras PN PETR4 BZ 27.0 -1.4 -26.4 10.0 13.0 -3.0 8.3 10.4 -1.8 10.3 Sergio TorresFinancials 1064.7 3.3 22.0 27.0 22.3 4.7 14.7 12.3 19.6 16.2GF Galicia GGAL US 15.1 51.9 162.8 2.0 0.0 2.0 24.8 17.6 24.5 14.5 Saul MartinezCetip CTIP3 BZ 19.1 17.6 33.7 5.0 0.0 5.0 31.2 23.5 22.0 38.2 Frederic de MarizBradesco BBDC4 BZ 36.5 6.9 21.4 10.0 4.5 5.5 14.1 12.7 26.3 21.8 Saul Martinez

First Cash FCFS US 29.5 10.4 32.9 3.0 0.0 3.0 17.2 14.7 23.7 18.7 Ben LaidlerSantander Brasil SANB11 BZ 25.0 5.9 4.6 7.0 0.5 6.5 15.4 11.7 23.7 11.6 Saul MartinezIndustrials 277.0 3.8 28.5 6.0 4.6 1.4 27.4 22.0 24.6 10.2Copa CPA US 50.6 -3.8 -7.1 3.0 0.0 3.0 10.6 7.7 3.2 na Jamie BakerICA ICA* MM 33.3 8.2 9.2 3.0 0.0 3.0 31.1 22.5 -8.5 3.7 Adrian E HuertaMaterials 1219.1 3.0 12.3 14.3 24.4 -10.1 13.3 9.5 40.1 15.6Cemex CX US 9.2 10.7 -19.1 3.0 1.0 2.0 nm nm -233.3 -0.8 Adrian E HuertaVale PN VALE/P US 28.9 3.7 16.4 11.3 11.0 0.3 9.6 7.0 202.0 23.3 Rodolfo R. De AngeleTelecoms 588.6 3.6 8.1 13.0 8.7 4.3 12.4 10.7 15.4 27.1

AMX AMX US 58.0 6.6 23.4 6.0 6.4 -0.4 15.8 13.5 -24.9 25.0 Andre BaggioNII Holdings NIHD US 42.6 0.3 26.9 5.0 0.0 5.0 25.5 13.0 -26.4 8.9 Andre BaggioTIM Participacoes TSU US 34.1 4.5 14.8 2.0 0.2 1.8 31.0 15.0 -41.9 5.2 Andre BaggioUtilities 383.9 2.3 9.2 0.0 5.5 -5.5 11.7 10.7 8.8 8.7EMF LATAM 79524.0 3.1 11.3 100.0 100.0 0.0 14.2 11.6 15.8 13.9

Source: Bloomberg, MSCI, J.P. Morgan estimates. All estimates are for the calendar year. Updated as of 3 November 2010.

LatAm Model Portfolio sector allocation relative to MSCI Emerging Latin America Markets Index

-12 -10 -8 -6 -4 -2 0 2 4 6 8 10

MaterialsUtilities

Staples

Energy

Industrials

Telecoms

Financials

Discretionary

Source: MSCI, J.P. Morgan estimates. Updated as of 3 November 2010.


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LatAm Model Portfolio country allocation relative to MSCI Emerging Latin America Markets Index

-4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0

Chile

Peru

Mexico

Argentina

Colombia

Brazil

Source: MSCI, J.P. Morgan estimates. Updated as of 3 November 2010.

Historical changes to model portfolio

Bought Sold

Nov 10 TIM Participacoes BM&F BovespaSep 10 Cetip, OGX, Cemex Banrisul, Banorte, Urbi

Aug 10 GF Galicia, Banrisul, Cencosud Lan Airlines, OGX, Banco MacroJul 10 Televisa, Banorte Cemex, TerniumJun 10 Gafisa, Copa Holdings Metalurgica Gerdau, TenarisMay 10 NIHD, Cemex, First Cash Financial Vivo, Grupo Mexico, Banorte

Mar 10 BM&F Bovespa, Metalurgica Gerdau, Vivo, Pacific Rubiales Cielo, Gerdau, Silver WheatonFeb 10 None NoneJan 10 ICA, CBD Cemex, Lojas Renner, GafisaNov 09 Santander Brazil, Cielo, Lan Airlines BM&F Bovespa, Banco do Brasil, Santander ChileOct 09 OGX, Silver Wheaton ALL, TelevisaSep 09 Itauunibanco, Geo, ALL Banco Bradesco, Urbi, TAM

Aug 09 Gerdau, Gafisa Bradespar, GVTJun 09 BM&F Bovespa, Banco Macro Porto Seguro, CredicorpMay 09 Ternium, Grupo Mexico Copa Holdings, Femsa. Apr 09 Lojas Renner, Banorte, Santander Embraer, Walmex, EntelMar 09 Banco do Brasil, ALL, Tenaris, Geo Bradesco, SLC, Ternium, AsurFeb 09 Banco Itau, Entel, Slc Agricola, Cemex Unibanco, Urbi, Gafisa, Santander ChileDec 08 Porto Seguro, Bradesco, Credicorp Telecom Arg., CCR, Banco do BrasilOct 08 Asur, Walmex, Bradespar, Urbi Banorte, Lojas Renner, HomexSep 08 GVT,PDG Realty CTC, Coeur d'Alene, Rodobens

Aug 08 Homex Megacable, UrbJul 08 Embraer VCPJun 08 Petrobras PN ADR, CCR, CTC, Coeur d'Alene Petrobras ON, NETC, Silver Wheaton Apr 08 Banco do Brasil, Megacable B2WFeb 08 Urbi, Rodobens, Gafisa, Telecom Argentina Cesp, Company SA, Cyrela

Source: J.P. Morgan Strategy.


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Analysts Top Stocks to Avoid

Top stocks to avoid

Name Share Price % Change Bloomberg JPM Analyst Mkt Cap, P/E (X) P/E (X) Price Target to target Ticker Rating US$ MM 2010E 2011E

BrazilCyrela Brazil Realty 22.8 29.0 30.3 CYRE3 BZ UW Adrian E Huerta 5,536 12.1 9.9 Eletropaulo 29.9 30.0 0.0 ELPL6 BZ UW Anderson Frey 3,229 4.8 8.4 Fibria 30.0 26.0 -16.7 FIBR3 BZ UW Debbie Bobovnikova 8,587 17.1 96.9 Minerva SA 6.1 8.1 34.1 BEEF3 BZ N Alan Alanis 376 10.6 5.8 Panamericano 7.7 10.0 37.7 BPNM4 BZ UW Frederic de Mariz 1,043 12.1 7.2 Tele Norte Leste 48.5 57.0 14.9 TMAR5 BZ N Andre Baggio 7,699 5.6 6.7 Usiminas 21.0 26.0 13.3 USIM5 BZ UW Rodolfo R. De Angele 14,775 20.5 11.1 MexicoConsorcio Ara 7.6 9.0 15.5 ARA* MM UW Adrian E Huerta 829 11.5 9.9 Grupo Inbursa 53.9 41.0 -21.6 GFINBURO MM UW Saul Martinez 14,247 25.3 21.0 Organizacion Soriana 37.2 31.0 -17.6 SORIANAB MM UW Andrea Teixeira 5,536 21.6 18.9 Telmex SA 15.2 12.0 -24.3 TMX US UW Andre Baggio 14,410 12.7 13.2 ChileIAM 747.0 720.0 -4.0 IAM CI N Anderson Frey 1,561 16.1 16.1 SQM 51.5 37.0 -29.4 SQM US N Brian P Chase 13,799 43.6 30.4 ColombiaBancolombia 66.0 65.0 -3.9 CIB US UW Saul Martinez 13,322 20.0 17.9 Ecopetrol 4360.0 2795.0 -39.9 ECOPETL CB UW Sergio Torres 102,728 22.1 14.9 PeruBuenaventura 51.7 46.0 -16.9 BVN US N John Bridges 15,262 19.8 14.6 ArgentinaEdenor 10.3 na na EDN US UW Anderson Frey 485 13.3 12.2

Source: Bloomberg, J.P. Morgan estimates. J.P. Morgan ratings: OW = Overweight; N = Neutral; UW = Underweight.


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Emerging Market Equity Strategy

The Drivers

1. The declining EM risk premium continues

2. Strong demand from EM credit continues

3. High nominal growth and nominal FX appreciation

4. DM neither a driver nor a drag

Potential Returns

MSCI EM end-2011 target 1500 (+25%) Forward PE at 1500 is 13 (based on consensus 2012

EPS)

Current credit conditions, FX appreciation, earningsgrowth, and earnings estimate revisions provide upside

Other targets

KOSPI 2300, NIFTY 7000

Investment themes

1. China drifts away from the Asian growth model

2. Structural OW on domestic demand

3. FDI in non-China EM increases

4. Growth premiums continue to expand

5. CEMBI Surfers still riding in 2011

6. Warning flags: Real credit growth and core CPI

7. Beware co-investing with governments

8. Liquidity without a valuation anchor

9. Higher REER bad for exporters margins

Risks

Market Risks Lack of valuation cushion Bond market volatility High correlationPolicy and Political risks

Capital controls

Anti-asset inflation policies Trade wars Leadership change in China, Thai and Philippines

elections

Strained social contractEconomic risks

Uncertain outlook for commodities Unintended consequences of QE2 Public sector debt stress in developed economies

Key issues for 2011 Briefing notes

1. Scale of emerging markets

2. Capital controls and FX intervention

3. Western-China-driven growth

4. Strength of consumption in China

5. Chinas infrastructure investment

6. Will China have a housing inventory problem?

Market Performance

MSCI EM and MSCI World performance

50

250

450

650

850

1050

1250

88 90 92 94 96 98 00 02 04 06 08 10

MSCI EM

MSCI World

Source: Bloomberg, 8 November 2010.


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Emerging Market EquityStrategyWe are bullish on EM equities. Our end 2011 target for

MSCI EM is 1500 (+25%). Based on consensus 2012

EPS the forward PE at 1500 is 13. Current credit

conditions could support a larger re-rating (please see

page 27 for potential returns). MSCI EM life high is

1338 (29 October 2007).

What about the biggest bull market of your career?

Between 11 March 2003 and 29 October 2007 MSCI

EM increased from 270 to 1338; +395%, or an

annualized return of 38%. On 2 March 2009 EM was

475. The index is 140% higher today. To match the

2003/7 bull market MSCI EM would need to be 2351 by20 October 2013. This requires an annualized return

of 21%.

In last years Emerging Markets Year Ahead our end-

2010 MSCI EM target was 1200. The index is within 5%

of this target. But the ride was not smooth; between 15

April and 25 May the index declined by 19% to 855.

Zero interest rates, QE2, currency wars, and high

correlation across asset classes are likely to lead to

volatility in 2011. Even with this years volatility, EM

volatility-adjusted returns are the highest for growth

assets.

Our asset allocation starts with long-term trends (EM

consumer, Chinas changing economic policy, sector

RoEs and investment cycles, currencies, etc.) combined

with short-term tactical allocation driven by market

factors (relative valuations and performance, retail

activity, consensus positioning). Benchmark composition

often represents historical rather than future growth

trends. We are bullish on the Brazilian and Chinese

domestic economies yet have been underweight these

markets in 2010. We have been overweight Brazilian and

Chinese domestic demand but underweight the larger

sectors, i.e., energy, materials and Chinese SoEs. As was

the case in 2010, focus on sectors within countries

rather than simple country asset allocation (see page

26).

Investors are seeking carry, growth and momentum.

Both emerging fixed income and equity markets offer

this. For now it is foolish to fight the trend. But

remember the risks (see page 31). QE2 is an experiment.

Chinas ability to rebalance the driver of growth from

investment to consumption is also an experiment.

Monitor the data; core inflation, property sales, actual

commodity demand rather than financial demand, etc.

MSCI EM performance

200

400

600

800

1000

1200

1400

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

Source: Bloomberg.

Valuations in EM trend rather than mean revert

7

12

17

22

27

32

37

42

88 89 90 91 92 93 95 96 97 98 99 00 02 03 04 05 06 07 09 10

Forw ard PE based on Trend EPS

Forw ard PE based on

Consensus EPS

Source: Datastream, MSCI, IBES. Note: MSCI EM fwd PE based on trend and consensusEPS. The trend EPS is calculated by plotting a trend line through the log chart of MSCI

EM realized EPS.

Higher risk-adjusted returns in EM

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10

EM

World

US

Source: Bloomberg

Note: EM, US and World: Three-month rolling returns adjusted for 90-day volatility.


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There is limited statistical evidence of valuations mean

reverting in EM (see figure on previous page). Investors

should focus on factors that are currently driving a re- or

derating. The rerating factors are:

1. Expanding growth premium in a low-growth world

2. Equities are cheap relative to sovereign andcorporate bonds

3. Accelerating investment and consumption growth inkey EMs

4. Lower relative risk profile of EM versus DM

Base Case

In the risk section on page 31 we highlight the risks to

our base case.

The declining EM risk premium continues

Emerging economies survived the big ugly experiment

of an extreme external demand shock and a credit crisis.

This hit EM economies when they were a year into a

tightening cycle. In passing this test and with the

economies recovering ahead of developed economies,

the risk premium demanded for EM should decline. Note

that stock-specific risk (corporate governance,

transparency, policy risk, etc.) is still higher.

Strong demand for EM credit and carry continues

Investor appetite for risk has slowly increased since 9

March 2009. The bias is corporate credit for yield andemerging markets for growth. EM US dollar and local

currency credit offers both and is thus attracting large

flows relative to its market cap. J.P. Morgan forecast for

this to continue in 2011. We maintain ourCEMBI

surfer theme of favoring current account deficit

markets.

High nominal growth and nominal FX appreciation

Data support positive nominal GDP revisions. These

data include strong retail sales, car sales and loan

growth. EM Central Banks are slowing FX appreciation

but not reversing the trend.

DM neither a driver nor a dragFocus on the local EM dynamics rather than swings innet exports. Economic expansion in the US and EuroArea resumed in 3Q09. J.P. Morgan forecast 2011 GDPgrowth of 2.5% and 1.5% for the US and Euro Arearespectively. This growth may be politicallyunacceptable as it is too slow to reduce unemployment,but for EM, slow DM growth is a benign to positivebackdrop. It is benign for external demand and positiveas interest rates remain low.

EMBI and earnings yield spread between EM and DM

0

200

400

600

800

1000

1200

1400

1600

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

-1

0

1

2

34

5

6Earnings Yield Spread betw een

EM and DM (RHS)

EMBI Spread (LHS)

Source:Bloomberg, MSCI.

EM net debt inflow (Cum. USD bn)

34

-14

31

59

-20

0

20

40

60

80


2007

2008

2009

2010

Source: J.P. Morgan estimates and EPFR Global.

EM net equity inflows (Cum. USD bn)

41

-40

6469

-60

-40

-20

0

20

40

60

80


2007

2008

2009

2010

Source: EPFR Global.


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Investment Themes

China drifts away from the Asian growth model

China is a souped-up version of the Asian growth model.

Investment rather than consumption drives growth. Thisrequires a transfer of wealth from the household sector to

the corporate sector through low wages, low return on

savings and undervalued currency. 2010 policy and the

12th Five-Year Plan all point to a move toward

consumption. This is a long-term positive. But it may

mean that the growth in Chinese commodity demand is

overestimated. Beneficiaries of the change are a small

part of the benchmark, which may result in ongoing

underperformance of MSCI China.

Structural OW on domestic demand

This is where the growth is (globally). We acknowledge

that these stocks do trade at a premium and the call isconsensus.

Beware co-investing with governments

A third of MSCI market cap is companies in which

governments are the controlling shareholder. It can be

profitable being a minority shareholder in these

companies when the major shareholder offers favorable

policies and is focused on returns. With todays flood of

capital into EMs, investor-friendly policies may not be a

top priority and thus these companies could be at risk

from politically expedient policies.

SoEs are 79% of MSCI China market cap. Policiesdesigned to boost consumption by increasing the

household income-to-GDP ratio will reduce the ratio of

profits to GDP. SoEs in our view are particularly

vulnerable to policy risk. Our structural bias is to be

underweight SoEs. Russian oils stocks

underperformance is notable, with Rosneft, Lukoil and

Gazprom unchanged year to date. In contrast, Russian

financials are up 25% ytd. Gazprom, with one-sixth of

the worlds oil reserves, has a 2011e PE of 4. Russian

energy stocks are unlikely to rerate while the market

fears higher taxes.

Household income growth lagging tax and profits

343%

512%

748%

258%

0%

100%

200%

300%

400%

500%

600%

700%

800%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

GDP

GovernmentProfits

Income

Source: J.P. Morgan economics. Note: Income proxy is the change in urban per capita

household income; Profits are the growth in aggregate industrial profits.

EM and US as a share of global consumption%

20

25

30

35

40

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

US

EM

Source: J.P. Morgan economics.

Ownership structure in MSCI EM

Family

19%Cross

Institutional

27%

MNC

5%

Government

30%

Source: MSCI, Datastream, J.P. Morgan Strategy.


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FDI in non-China EM increases

Higher labor cost, strengthening Renminbi and tensions

between Japan and China improves the attractiveness of

other emerging markets for FDI. The main beneficiaries

are ASEAN, Turkey and Mexico. Note in table belowthat a small change in Chinas share of FDI could lead to

a large increase in FDI in ASEAN.

FDI into China and ASEAN

US$ billions

China Indonesia Malaysia Philippines Thailand

2007 138.4 6.9 8.6 2.9 11.32008 147.8 9.3 7.2 1.5 8.62009 78.2 4.9 1.4 1.9 6.0

Source: CEIC.

Warning flags: Real credit growth and core CPI

Central banks responding to inflation have always endedthe bull market in EM. As of now EM central banks have

maintained a pro-growth bias even when headline

inflation is higher than the target level. Each week we

publish a detailed table on inflation in our dashboards.

The warning flags are a combination of higher real credit

growth and rising core CPI. These conditions increase

the probability of the central bank moving to a policy

designed to slow growth in order to fight inflation. EM

equities are growth assets. Lower growth and higher

discount rates result in a derating.

Real credit growth and Core CPIReal Credit Growth %oya Core CPI %oya

China 15 0.7Brazil 14 5Korea 3 2Taiwan 4 0.7India 9 9South Africa 2 3Russia 0.1 5Mexico 3 4Malaysia 11 1.1Indonesia 14 5Turkey 16 4Thailand 4 1.1

Source: CEIC, J.P. Morgan economics, Bloomberg and central bank websites, September

2010. Note: Credit growth as of June 2010 for China, Korea, Taiwan, India, Malaysia,

Indonesia, Thailand and August 2010 for Brazil.

Growth premiums continue to expandLack of developed world growth combined with lowdiscount rates supports high growth premium. Maintain astructural bias to high growth themes; EM consumer.Compare valuations with other growth stocks rather thanmarkets.

CEMBI surfers still riding in 2011

Demand for EM credit remains strong (see Error!

Reference source not found.). The yield on the

emerging market corporate bond indices (CEMBI) is

5.3%; this is lower than the average investment gradebond yield in past decade (JULI). Our bias is to own

current account deficit markets when credit conditions

are favorable; OW India and Turkey.

EM equities cheap relative to bonds

5

8

11

14

17

20

01 02 03 04 05 06 07 08 09

CEMBI (1/y ld) Fw d PE

Source: MSCI, Bloomberg, J.P. Morgan Indices.

Note: The inverse of the CEMBI yield is used to compare PEs with EM corporate bond

yields.

Liquidity without a valuation anchor

The range of valuations since late 2007 is extremely

wide. Correlation of risk asset is high, indicating that

asset-specific fundamentals are secondary to general

market trend. Higher commodity prices are partlyjustified by monetary conditions rather than supply or

demand. Equities are inexpensive relative to bonds but if

economic activity improves then bonds are expensive.

Risk assets march in step: Correlation with MSCI US

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

JPM TR Energy

JPM Precious Metals TR

JPM Industrial Metals Index

Source: Bloomberg, J.P. Morgan indices.

Note: Three year correlation of monthly returns of MSCI US vs. JPMCI Energy, Precious

metals and Industrial metals.


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The lack of valuation anchors in equities, bonds,

commodities and currencies means a wide range of

possible returns and high volatility. It is critical to keep

monitoring the fundamentals while acknowledging that

the near term drivers of markets are dominated bymomentum and casual relationships between asset

classes. When implied volatility is low, consider buying

protection. Remember that the 2003/7 EM bull market

had five 15-20% corrections.

YTD Returns and Correlation with MSCI USYear to date

return3 year correlation of monthly

returns with MSCI USTopix -6 0.8Energy -4 0.6US cash 0.2 -0.4GSCI TR 4 0.6Global Gov Bonds 6 -0.3MSCI Europe 7 0.9EM FX 8 0.8US Fixed Income 9 0.2MSCI AC World 9 1.0EM Local Bonds 10 0.5US High Grade 11 0.4S&P500 12 1.0MSCI EM 15 0.9EM $ Corp. 16 0.6EMBIG 17 0.7Gold 27 0.1

Source: Bloomberg.

Higher REER bad for exporters margins

Capital-flows support EM FX appreciation. Nominal

appreciation combined with inflation differentials results

in a real effective exchange rate appreciation. In China

there have been a number of large wage increases in

foreign owned export factories. This is bad for margins.

Avoid export industries in Brazil and China with a large

labor cost.

Movement in major currencies

-20 -10 0 10 20 30 40 50 60 70

HKD

CN Y

PHP

TWD

INR

RU B

MYR

JPY

SGD

TR Y

THB

HUF

MXN

CZ K

PLN

IDR

KRW

BRL

ZAR

AUD

Av g 05-07 Mar low

Source: Bloomberg.


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Focus on sectors within countries rather than country recommendations

The table below provides a level summary of our views on sectors within countries. Financials is 26%, Materials is 15%and Energy is 14% of EM. All recommendations are relative to EM. The Industrials sector consists of an eclectic group of

stocks. We do not rate the sector.Key country and sector recommendations, performance and fundamentals

Country/Sector Wt Rec Demand Performance(USD Returns)

PE EPS Growth(%)

EPSCAGR

EPSCAGR

PEG DY(%)

RO(%

Classific-ation

Jan 06to date

EM lowto date

12M YTD 10E 11E 10E 11E (06-11) by SD Ratio 10E 10

EM 100 -- 64 154 24 17 13.5 11.6 28.4 16.3 8.4 0.5 1.7 2.4 14.China 18.5 N 149 167 15 12 14.3 12.2 26.8 17.6 14.1 0.9 1.1 2.5 16.China Financials 7.2 N DD 215 173 9 10 12.9 10.6 25.7 21.7 26.2 1.1 0.5 2.9 17.China Energy 3.2 UW GPT 144 236 27 21 12.6 11.4 26.2 10.4 10.4 0.7 1.3 3.2 17.China Telecom 2.1 UW DD 111 53 12 14 12.9 12.1 3.0 6.9 9.3 0.8 1.4 3.3 15.China Industrials 1.5 n/a 50% DD 92 176 17 15 14.9 13.6 64.7 10.1 10.5 0.2 1.7 1.8 11.China CS 1.1 OW DD 303 225 36 14 22.7 18.8 13.7 20.9 17 1.5 1.2 1.6 17.China Materials 1.0 UW GPT 132 335 9 8 17.0 12.5 54.2 36.2 2.5 0.1 7.6 1.4 11.China CD 1.0 OW DD 133 272 28 11 18.4 15.6 38.3 18.1 13.4 0.8 1.5 1.8 21.Brazil 16.2 N 146 190 9 7 13.5 11.2 15.5 20.1 9.2 0.6 1.5 2.6 14.Brazil Financials 4.3 OW DD 159 260 25 21 14.6 12.3 17.2 18.8 10.7 0.6 1.4 2.7 16.Brazil Materials 4.0 N GPT 201 219 13 11 11.5 8.1 87.8 41.5 14.6 0.2 1.1 2.4 17.Brazil Energy 3.7 UW GPT 130 126 -18 -17 11.6 12.0 -15.0 -3.1 0.7 0.0 13.4 1.9 10.Brazil CS 1.4 N DD 185 227 29 25 23.5 19.0 21.3 23.6 16.2 0.3 1.7 2.5 12.Korea 13.4 UW 28 163 32 19 10.6 10.0 46.7 5.3 10.3 0.3 1.0 1.0 14.Korea IT 3.4 UW GC/C 11 155 23 7 9.5 10.6 82.8 -10.4 11.0 0.0 0.8 0.1 17.Korea Financials 2.1 UW DD -17 92 5 3 10.6 8.8 61.7 19.5 1.6 0.0 8.0 2.2 10.Korea Industrials 2.3 n/a 60% DD 72 226 51 39 13.9 12.1 42.3 14.3 9.9 0.3 1.4 1.0 12.Korea Materials 1.9 N GPT 192 270 43 17 10.1 9.7 22.9 3.2 13.7 1.7 0.7 1.1 15.Korea CD 2.1 OW GC 55 283 70 49 10.6 8.9 9.2 18.9 27.4 0.5 0.4 0.7 17.Taiwan 10.5 N 19 102 21 8 14.1 12.7 86.7 11.5 4.3 0.1 3.5 3.4 13.Taiwan IT 6.0 N GC/C 4 97 16 1 12.6 11.4 125.1 10.5 3.4 0.0 4.1 3.4 16.Taiwan Financials 1.6 OW DD 6 117 11 6 19.6 15.0 29.0 30.6 20.1 0.0 1.1 2.6 6.9Taiwan Materials 1.4 N GPT 87 114 37 24 16.8 15.4 28.9 9.3 -0.8 0.0 NM 3.9 11.India 8.1 OW 123 186 39 25 20.8 17.0 19.8 22.2 12.7 0.8 1.9 1.2 16.India Financials 2.3 OW DD 153 209 48 42 24.9 19.8 17.5 25.3 15.7 1.6 1.7 1.0 11.

India IT 1.3 OW GCap 84 171 50 27 24.8 20.4 15.8 21.2 13.3 1.3 2.0 1.3 24.India Energy 1.1 OW GPT 202 140 23 10 16.5 13.2 40.1 24.7 12.7 0.9 1.7 1.1 15.South Africa 7.4 N 53 182 36 24 14.6 11.6 28.0 25.8 8.9 0.4 2.1 2.9 15.SA Materials 1.9 UW GPT 33 210 31 16 19.5 12.5 236.8 55.8 20.3 0.2 4.4 1.9 12.SA Financials 1.9 N DD 39 162 35 23 12.3 10.4 14.9 18.7 3.9 0.2 3.4 4.1 12.SA Cons Discr 1.0 OW DD 106 320 58 40 17.0 14.1 19.3 20.8 11.9 1.2 1.8 1.9 17.SA Telecom 1.0 OW DD 60 147 25 19 12.9 10.8 18.5 19.0 9.1 0.7 1.6 3.2 20.Russia 6.0 N 5 154 10 8 7.8 6.2 44.0 25.0 6.8 0.3 1.2 1.9 13.Russia Energy 3.3 UW GPT -20 115 -3 -2 5.6 4.8 25.9 16.2 6.2 0.4 0.9 2.2 14.Mexico 4.3 UW 58 136 31 21 17.8 14.8 7.4 20.4 5.5 0.3 4.3 2.4 16.Mexico Telecom 1.6 N DD 86 116 27 24 13.5 11.7 13.7 15.5 16.4 1.5 1.1 3.9 41.Mexico CS 1.1 UW DD 100 144 40 19 23.2 19.3 -5.0 20.4 18.7 0.6 1.3 1.4 14.Malaysia 2.8 OW 108 108 33 32 17.7 14.8 25.7 19.7 7.6 0.3 2.4 3.1 12.Indonesia 2.3 N 227 259 48 36 17.4 14.7 19.9 17.7 18 1.1 1.1 2.3 24.Turkey 1.8 OW 55 225 57 43 11.6 10.8 18.4 8.0 12.8 0.8 0.9 2.4 17.Turkey Financials 1.1 OW DD 78 316 69 50 10.7 10.2 14.4 5.1 20 0.8 0.5 1.8 18.Thailand 1.7 OW 101 224 72 58 15.2 13.2 17.2 15.0 5.9 0.2 2.6 3.0 15.

Chile 1.7 N 145 174 56 41 19.7 17.2 22.3 15.0 18.2 1.5 1.2 1.7 11.Poland 1.6 N 19 94 23 19 13.7 11.7 25.0 16.7 1.1 0.1 12.8 3.2 11.Philippines 0.5 OW 123 159 48 40 18.8 16.4 18.1 14.2 4.3 0.3 4.8 3.4 16.Hungary 0.4 N 1 134 6 4 12.9 10.0 -3.4 29.6 -4.9 -0.2 NM 3.0 10.Czech Republic 0.4 N 25 54 -10 -3 10.8 10.2 -2.4 5.5 8.7 0.6 1.2 6.4 17.

Source: MSCI, IBES, Bloomberg, J.P. Morgan, 5 November 2010. Note: Outperformance of more than 2% vs. MSCI EM.Underperformance of more than 2% vs MSCI EM. DD=Domestic

Demand, GPT=Global Price Takers, GC/C=Global Capex/Consumer, GC=Global Consumer, GCap=Global Capex.


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Potential Returns andEarnings Estimates

End-2011 strategy team index forecasts MSCI EM 1500 (+25%)

Base case

Current MSCI EM forward PE 11.6

2012 MSCI EM EPS 112 (before currencyappreciation)

EM FX appreciation 5%

10% re-rating to forward PE 13

Statistical warning

EM equity markets valuations trend rather than mean-

revert. Indices also evolve with sector compositionchanging. The growth characteristics of stocks also

change and thus their valuations. Prior to the mid-90s

current account crisis, fixed exchange rates and high

nominal growth supported high valuations. Investors

should be suspicious of statistical justification for index

targets.

Pick your methodology

To illustrate the impact of different methodologies on

potential returns we calculate index targets using six

assumptions:

1. Current earnings to bond yield ratio usingSeptember 2011 yield forecast and end-2011e PE.

5. Five-year average earnings to bond yield ratio usingSeptember 2011 yield forecast and end-2011e PE.

6. Current forward PE multiplied by 2012e EPS basedon the lower of 2012e EPS growth or potential

nominal GDP.

7. Current forward PE multiplied by 2012 EPS forecast.

8. Three-year average PE multiplied by 2012 EPSforecast.

9. Gordon Growth model theoretical PE multiplied by2012e EPS. This generates PE in excess of 30 for six

markets as local bond yields in these countries are

very low relative to nominal GDP growth and RoE.

Current forward PE with standard deviation ranges

Index CurrentFwd PE

Avg10Y

+1 SD -1 SD TopDecile

BottomDecile

EM 11.7 10.7 12.2 9.2 12.6 8.8EM Asia 12.7 11.5 13.3 9.7 14.0 9.3Latam 11.8 10.0 11.7 8.4 12.3 8.0EMEA 9.3 9.8 11.4 8.2 11.7 8.0China 13.0 13.1 16.3 9.8 17.3 9.9India 17.2 14.1 17.3 10.8 18.0 9.9Indonesia 14.9 9.6 12.9 6.2 13.7 5.0Korea 9.9 9.1 10.9 7.2 11.6 6.5Malaysia 15.0 14.1 15.5 12.7 15.9 12.3Philippines 16.6 13.9 16.1 11.7 17.1 11.5Taiwan 12.8 14.3 18.0 10.6 20.4 11.4Thailand 12.3 10.4 11.8 9.0 12.1 8.9Brazil 10.5 8.0 10.4 5.6 11.7 5.3Mexico 15.1 12.1 13.8 10.4 14.1 9.8Chile 17.4 15.6 17.6 13.5 18.2 12.8S Africa 11.7 10.0 11.4 8.7 11.7 8.1Russia 6.4 7.9 10.3 5.6 11.1 4.6Turkey 11.2 9.1 11.2 7.1 11.7 6.5

Source: MSCI, IBES, Datastream, 5 November 2010.Note: Current PE > +1SD in red.

Consensus Earnings Growth Forecast (%)

Index Consensus Earning Growth (%) EPS grow10E 11E 12E CAGR 11

EM 30.6 17.2 14.0 8.2Brazil 18.4 21.0 11.0 9.0Chile 23.1 12.0 11.0 18.3China 26.7 14.9 16.4 14.3Czech Republic (4.8) 3.3 5.7 9.1Hungary (2.9) 29.8 21.9 (4.9)India 23.4 22.7 17.6 10.6Indonesia 20.3 20.9 13.5 18.3Korea 51.4 13.1 11.1 8.6

Malaysia 29.4 15.7 11.2 7.8Mexico 2.9 28.9 13.1 5.7Peru 27.3 31.6 13.1 8.4Philippines 22.2 12.2 14.8 4.4Poland 23.9 16.9 9.3 1.1Russia 29.8 15.4 17.1 6.8South Africa 26.5 27.1 17.8 9.0Taiwan 89.1 9.4 11.2 5.4Thailand 19.1 18.7 15.9 7.2Turkey 18.5 8.2 13.6 12.9

Source: MSCI, Datastream, IBES, J. P. Morgan, 5 November 2010.


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Pick your methodology and thus your return: Percentage return to end-2011 targets based on multiple methodologies

IndexLevel

(1)CurrentEY/BY

(2)5yr avgEY/BY

(3)FWD PE

2010 EPS= GDP

(4)CurrentFWD PE

(5)3year

averageFWD PE

Median Max Min Range ofreturns

(6)GordonGrowth

PE

Brazil 249321 14 0 7 14 11 11 14 0 14 (38)Chile 5942 13 31 6 13 (1) 13 31 (1) 33 (21)China 73 15 5 11 18 15 15 18 5 12 169India 839 25 2 12 29 8 12 29 2 27 110Indonesia 4672 10 27 8 14 (7) 10 27 (7) 34 127Korea 543 4 20 5 11 7 7 20 4 16 153Malaysia 558 14 8 8 14 3 8 14 3 11 123Mexico 33913 18 10 6 18 (6) 10 18 (6) 24 (2)Philippines 774 29 41 7 20 (5) 20 41 (5) 47 115Poland 1904 12 6 6 12 2 6 12 2 10 39Russia 815 20 85 7 20 42 20 85 7 79 486South Africa 808 16 9 7 22 (1) 9 22 (1) 23 17Taiwan 301 6 63 6 14 42 14 63 6 57 172Thailand 425 8 15 7 24 (12) 8 24 (12) 36 165Turkey 1038342 15 59 7 15 (15) 15 59 (15) 74 51

Source: MSCI, IBES, Datastream, Bloomberg, J.P. Morgan. 5 November 2010

Note: All returns are local currency; please email [email protected] for the assumptions.

Consensus EPS estimates and revisions since the beginning of 2010

Index Actual Current Consensus EPS Consensus EPS beginning of this Year Revision in Consensus EPS (%)08 09 10E 11E 12E 10E 11E 12E 10E 11E 12E

EM 58 65 84 98 112 77 93 104 9.3 6.0 7.5Brazil 15593 16618 19678 23812 26435 17942 21381 25574 9.7 11.4 3.4Chile 236 247 303 339 376 276 317 381 9.5 6.9 (1.2)China 3.31 3.76 4.79 5.51 6.41 4.64 5.39 6.03 3.3 2.1 6.2Czech 34.7 34.7 33.0 34.1 36.0 33.8 36.0 37.2 (2.4) (5.2) (3.1)Hungary 170 106 103 134 163 116 150 171 (11.1) (11.1) (4.4)India 29 34 42 51 60 42 50 61 (0.5) 2.3 (1.1)Indonesia 213 224 269 325 369 261 309 369 3.1 5.4 (0.0)Israel 18 21 27 31 37 28 33 34 (4.7) (4.5) 8.5

Korea 22 35 49 55 61 47 52 55 5.0 6.5 11.6Malaysia 31 25 32 37 41 30 35 39 5.3 6.6 5.4Mexico 1446 1713 1763 2272 2588 2063 2440 2834 (14.6) (6.9) (8.7)Peru 63 71 90 119 135 89 102 111 1.5 16.6 20.8Phi 30 34 42 47 54 41 46 70 2.5 1.1 (22.6)Poland 148 109 136 159 173 116 144 158 16.5 9.9 10.1Russia 111 91 118 136 159 98 144 151 19.8 (5.8) 5.4S Africa 57 42 52 66 78 56 71 85 (6.6) (6.9) (8.0)Taiwan 7.0 11 21 23 26 17 22 24 23.2 8.1 10.6Thailand 19 24 28 33 39 27 31 35 5.3 6.2 11.2Turkey 70564 72915 86436 93550 106291 78669 93247 108651 9.9 0.3 (2.2)

Source: MSCI, Datastream, IBES, J. P. Morgan, 5 November 2010.


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Dissection of EM EPSgrowth

The objectiveDisaggregate the EM EPS growth into countries, sectors

and key sectors in countries.

Main observations on 2011e EPS growth

MSCI EM weighted and median EPS growth is17%. This is 5% higher than our economists 2011

nominal GDP growth forecast of 12%.

Financials and materials are the highest contributorsto 2011e earnings growth.

The contribution of IT and healthcare is the lowest(see top table, next page).

Two sectors contribute c20% of MSCI EM 2011eEPS growth; Brazilian steel and Russian oil & gas

sectors (2011e EPS growth for Vale, Sider and

Gazprom is estimated by IBES to be 41%, 44% and

23% respectively).

Note that the weighted EPS growth for Taiwanelectronic components is high at 62% (primarily due

to losses or low profits at AU Optronics, ChimeiInnolux, Chunghwa picture tubes, E-Ink). Themedian EPS growth is 24% (see second table onnext page).

Dataset

IBES EPS forecasts for MSCI EM constituents

CalculationThe indexs calendar year EPS is calculated using the

profit-weight of the constituents.

Index EPS = I x ( (C-EPS x FFS) / (FFS x P))

where C-EPS = Index constiuents EPS, FFS = free float

shares for the constituents, I = index level and P =

current market price.

The check

Median EPS growth of the index constituents:

Reviewing the median helps identify sectors in which a

single stocks impact on weighted EPS growth is large.

This could be due its large weight in the index or moving

from loss to profit.

Emerging markets earning growth and contribution

Country Mkt Cap Earnings weights (%) Index EPS Growth Median EPS Growth Contribution to Earning growth (%)Weight 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E

Brazil 16.2 16.4 16.9 16.6 18.4 21.0 11.0 18.4 24.1 19.0 9 20 15Russia 6.0 11.2 12.4 12.4 29.8 15.4 17.1 33.4 34.5 15.4 13 20 13China 18.7 17.0 16.7 17.1 26.7 14.9 16.4 25.0 21.1 18.8 15 15 20South Africa 7.4 6.9 7.4 7.6 26.5 27.1 17.8 14.4 19.4 18.3 6 10 9Korea 13.2 17.6 16.2 15.7 51.4 13.1 11.1 31.8 14.3 12.9 24 8 13India 8.1 5.3 5.5 5.8 23.4 22.7 17.6 12.9 19.3 20.2 4 7 8Taiwan 10.5 10.3 9.6 9.5 89.1 9.4 11.2 25.3 13.3 10.0 20 6 8Mexico 4.4 3.1 3.4 3.4 2.9 28.9 13.1 15.6 17.2 12.4 0 5 4Indonesia 2.3 1.8 1.9 1.8 20.3 20.9 13.5 18.7 20.4 12.0 1 2 2Malaysia 2.8 2.2 2.2 2.1 29.4 15.7 11.2 19.7 12.5 10.0 2 2 2Thailand 1.8 1.6 1.6 1.6 19.1 18.7 15.9 15.5 19.9 15.7 1 2 2Poland 1.6 1.5 1.5 1.5 23.9 16.9 9.3 15.0 20.5 13.8 1 2 1Chile 1.7 1.2 1.2 1.1 23.1 12.0 11.0 33.8 16.5 8.9 1 1 0Peru 0.8 0.5 0.6 0.5 27.3 31.6 13.1 23.4 34.8 18.1 0 1 1Colombia 0.9 0.4 0.5 0.5 29.4 52.5 5.0 30.4 33.3 25.0 0 1 0Turkey 1.9 2.2 2.0 2.0 18.5 8.2 13.6 13.5 8.7 14.2 1 1 2Hungary 0.4 0.4 0.5 0.5 (2.9) 29.8 21.9 (0.9) 20.3 10.0 0 1 1Egypt 0.4 0.5 0.5 0.6 32.7 19.6 42.9 34.9 17.5 19.4 1 1 1Philippines 0.5 0.4 0.3 0.3 22.2 12.2 14.8 20.7 14.3 12.5 0 0 0Czech Republic 0.4 0.5 0.4 0.4 (4.8) 3.3 5.7 (7.8) 5.0 7.7 0 0 0Morocco 0.2 0.1 0.1 0.1 4.1 10.7 9.2 (0.4) 12.7 13.0 0 0 0Source: IBES, Datastream, J.P. Morgan calculations. Note: Sorted by 2011e earning growth contribution.


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EM Sectors earning growth and contribution

EM Sectors Mkt Cap Earnings weights (%) Index EPS Growth Median EPS Growth Contribution to Earning growth (%)Weight 2010 2011 2012 2010 2011 2012 2010 2011 2012 2010 2011 2012

Financials 26.3 24.1 25.2 25.9 25.1 22.2 16.8 20.7 19.4 16.1 19 31 31Materials 14.6 13.8 15.3 15.2 63.7 31.0 16.4 31.0 23.7 15.5 21 24 14Energy 14.3 19.9 19.3 18.8 11.8 10.2 9.0 21.5 15.5 14.0 13 15 16Utilities 3.4 2.8 3.5 3.3 7.4 26.5 14.2 1.9 13.2 9.0 -1 7 2Consumer Discretionary 6.8 6.4 6.4 6.5 28.6 15.5 13.7 19.5 17.2 16.1 6 6 7Telecommunication Services 7.8 8.3 7.9 7.7 7.4 10.7 10.7 7.0 6.7 9.1 3 5 6Industrials 7.3 6.6 6.4 6.4 47.5 13.9 15.4 20.7 15.2 16.8 9 5 6Consumer Staples 6.7 4.4 4.2 4.2 18.1 11.4 16.1 18.1 17.2 14.3 3 3 4Information Technology 11.9 13.6 11.9 11.9 118.5 7.6 13.2 33.3 15.4 12.4 27 3 11Health Care 0.8 0.5 0.5 0.5 32.7 15.6 13.8 14.3 17.6 19.9 0 0 1EM 100 100.0 100.0 100.0 30.6 17.2 14.0 19.9 17.5 14.8 100 100 100

Source: IBES, Datastream, J.P. Morgan calculation. Note: Sorted by 2011e earnings growth contribution.

Countries sub-industry contributing 70% of EM earning growth

Country Sub-Industry Mkt Cap Earnings weights (%) Index EPS Growth Median EPS Growth Contribution to Earning growth(%)

Weight 2010 2011 2012 2010 2011 2012 2010 2011 2012 2010 2011 2012

Brazil Steel 3.8 4.6 5.6 5.5 107 42.0 11.7 47.7 41.1 13.9 10 11 5Russia Integrated Oil & Gas 2.9 7.4 7.3 7.2 24.6 15.6 13.2 17.4 4.1 11.5 6 7 7China Diversified Banks 4.5 5.1 5.1 5.4 22.1 17.5 20.2 25.0 17.4 17.8 4 5 7Russia Diversified Banks 1.0 0.8 1.3 1.3 456 95.0 15.4 456 95.0 15.4 3 4 1Brazil Diversified Banks 3.7 3.6 3.6 3.7 17.8 19.1 15.0 23.8 17.1 14.9 2 4 4Korea Diversified Banks 1.2 1.5 1.9 1.9 77.8 43.6 16.8 65.2 15.0 11.8 3 4 2South Africa Gold 0.9 0.5 0.7 0.7 (377) 82.8 6.1 (3.7) 79.1 17.8 3 2 0Taiwan Electronic Components 0.9 0.6 0.8 0.9 (202) 61.0 36.7 46.4 24.2 13.7 4 2 2Korea Electric Utilities 0.2 (0.1) 0.2 0.3 623 (437) 40.7 NM NM 40.7 (0) 2 1Russia Div. Metals & Mining 0.4 0.4 0.6 1.0 NA 84.6 84.7 NM 84.6 84.7 0 2 4Brazil Homebuilding 0.5 0.7 0.8 0.9 52.1 37.8 22.6 64.6 35.2 23.8 1 1 1Mexico Wireless Telecom 1.5 1.5 1.5 1.4 18.0 14.3 12.5 18.0 14.3 12.5 1 1 1Mexico Construction Materials 0.2 (0.2) 0.0 0.0 (194) (120) 100.0 NM NM 100.0 (1) 1 0S Africa Wireless Telecom 0.9 1.0 1.0 1.0 23.2 20.0 13.0 23.3 15.8 9.0 1 1 1Russia Oil & Gas E&P 0.4 0.9 0.9 0.9 8.7 21.1 7.6 8.7 21.1 7.6 0 1 0

China Life & Health Insurance 1.6 0.8 0.8 0.9 9.8 24.2 24.1 13.6 25.4 24.7 0 1 1Taiwan Electronic Mftg Services 0.9 0.8 0.9 0.9 27.5 21.8 18.8 4.2 18.5 18.8 1 1 1South Africa Diversified Banks 0.7 0.8 0.9 0.9 14.4 21.9 23.0 11.0 20.2 24.2 0 1 1Taiwan Diversified Banks 0.8 0.7 0.8 0.7 63.4 25.0 2.2 34.0 25.0 0.0 1 1 0S Africa Precious Metals 0.6 0.4 0.5 0.5 43.1 48.3 22.1 16.7 41.2 26.3 0 1 1India Diversified Banks 1.3 0.7 0.7 0.8 18.4 23.0 23.6 19.7 22.9 23.7 0 1 1India Steel 0.5 0.5 0.5 0.6 56.3 33.3 19.9 11.7 20.0 21.9 1 1 1China Real Estate Development 0.9 0.9 0.9 0.9 18.9 17.2 25.6 22.8 19.4 24.3 1 1 2Russia Steel 0.3 0.2 0.3 0.4 (571) 61.7 29.2 504 55.5 29.3 1 1 1South Africa Int Oil & Gas 0.7 0.9 0.9 0.9 15.4 17.2 20.5 15.4 17.2 20.5 0 1 1China Oil & Gas E&P 1.2 1.1 1.1 1.0 71.9 12.8 6.4 74.1 22.5 15.1 2 1 0Korea Construction & Eng. 0.6 0.5 0.5 0.6 67.9 28.8 16.1 29.9 13.8 18.1 1 1 1Poland Diversified Banks 0.7 0.5 0.5 0.6 24.0 29.0 19.4 25.8 28.2 18.5 0 1 1India It Consulting & Other svs 1.3 0.7 0.7 0.8 12.3 19.1 19.8 11.2 18.5 20.7 0 1 1Mexico Div Metals & Mining 0.3 0.3 0.4 0.4 52.8 45.5 18.8 52.8 45.5 18.8 0 1 0Indonesia Coal & Consumable 0.3 0.2 0.3 0.3 20.0 58.0 1.9 (10.3) 52.3 1.2 0 1 0India Oil & Gas R&M 0.9 0.7 0.7 0.7 16.9 19.0 14.0 22.2 17.4 10.5 0 1 1

Korea Steel 0.9 1.4 1.3 1.2 24.3 9.1 9.2 34.3 7.0 8.3 1 1 1Thailand Diversified Banks 0.6 0.6 0.6 0.6 19.9 21.0 14.5 19.9 25.9 14.7 0 1 1Korea Auto Manufacturers 1.0 1.4 1.3 1.2 55.1 8.7 7.3 50.5 9.7 7.0 2 1 1Colombia Diversified Banks 0.2 0.2 0.2 0.2 36.9 66.3 (8.2) 36.9 66.3 (8.2) 0 1 (0)China Coal & Consumable Fuels 0.9 0.8 0.7 0.7 35.0 14.5 13.7 45.1 13.7 11.8 1 1 1Russia Wireless Telecom 0.4 0.4 0.4 0.5 132.6 27.5 20.0 25.0 35.6 29.3 1 1 1Taiwan Communications Equip 0.5 0.4 0.4 0.4 66.7 29.0 11.9 19.2 47.7 (13.8) 1 1 0Brazil Packaged Foods & Meats 0.3 0.2 0.2 0.3 81.9 61.5 35.9 223.1 46.2 41.4 0 1 1

Source: IBES, Datastream, J.P. Morgan calculation. Note: Sorted by 2011 earning growth contribution.


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Risks to our strategyMarket risks

Lack of valuation cushionOur strategy is biased toward growth with good

momentum but at a valuation premium. A growth

premium is justified in a world where growth is in short

supply. High valuations are vulnerable to a reversal in

EM portfolio flows and stock-specific risk.

Bond market volatility

The Feds objective with QE2 is to lower bond yields.

The result is that bonds are expensive relative to J.P.

Morgans growth forecasts. Higher US growth could

lead to a spike in bond yields.

High correlationHigh correlation between risk assets may propagate

volatility. A counter-trend rally in the US dollar may

drive that volatility.

Policy and Political risks

Capital controls

Strong foreign inflows and continued FX appreciation

have prompted EM central banks to implement capital

control measures. These include: 1) Increase in IOF tax

on foreign purchase of fixed income instruments from

2% to 6% in Brazil; 2) One-month minimum holding

period restriction on SBI bonds in Indonesia; 3) 15%withholding tax on foreign bond holders in Thailand; 4)

Restrictions on forward currency positions of foreign

bank branches and local banks in South Korea. For

equity investors, controls designed to reduce the

effective carry in fixed income markets are ok. Broader

capital controls which reduce the ability of equity

investors to buy and sell would be negative as they

reduce liquidity and increase volatility.

Anti-asset inflation policies

Central banks are targeting asset prices in EM to counter

asset inflation. These policies introduce economic and

sector-specific risks. Note how poorly real estate stockshave performed in EM despite low interest rates.

Trade wars

High US unemployment, Chinas large current account

surplus and polarized politics in the US increase the risk

of a trade war.

Politics: Elections and change of leadership in Brazil

and China

Leadership change in China will occur in 2012. The

transition may result in confusion on policy. Brazils

new president needs to maintain reform momentum anddevelop infrastructure.

2011 election calendar

Jan Feb Mar AprPeruPresidential &Legislative

May JunVietnamPresidential

TurkeyParliamentary

Jul AugPhilippines Subnational -Legislative

Sep Oct

ArgentinaPresidential

PolandParliamentary

Nov Dec

RussiaParliamentary

ThailandParliamentary(Tentative)

Source: IFES.

EM CPI and earnings yield

3

4

5

67

8

9

10

11

12

Jan-02 Jun-03 Nov -04 Apr-06 Sep-07 Feb-09 Jul-10

3

6

9

12

15

EM central banks'

av erage target range ceiling

EM CPI %oya

(LHS)

MSCI EM 12m Fwd PE

(RHS inv erted)

Source: J.P. Morgan economics, IBES, MSCI, November 2010. Note: CPI data is to

August 2010.

Strained social contract

Political and regulatory risk is high. The corporate sector

has emerged from the global recession and credit crunch

stronger than the households. Note that profits as a share

of GDP are near cyclical highs but unemployment is10%. Policy makers constrained by high fiscal deficits

are likely to redress this imbalance through higher taxes

and increased regulation. This would add to business

costs and delay normal investment decisions, threatening

the recovery.


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As is the case in the US, Chinese corporate share of GDP

increased while the household share decreased. Labor

disputes and subsequent large pay increases may start to

reverse this trend. This rebalancing is healthy and should

move China to a more sustainable growth model. Butnear term the result is likely lower profit margins.

Economic risks

Uncertain outlook for commodities

Our commodities and energy underweight is driven by a

combination of long-term economic cycles and a

potential inflection point in the growth of Chinese

material demand. The timing is complicated by the large

influence of financial investors on commodity markets.

The timing risk in a bearish view on commodity

companies is high. Industrial metal prices rallied since

May while global leading indicators fell. Correlation ofcommodities to risk assets (equities) is high today.

Momentum in a world of zero interest rates is an

attractive attribute. An UW commodity call is unlikely to

work at this point. When it does eventually, the

correction may prove to be violent as financial investors

exit.

Unintended consequences of QE2

If QE2 results in a sharp increase in commodity prices it

may choke off growth and ultimately be

counterproductive.

Peripheral Europe sovereign stressGreek, Irish and Portuguese bond spreads to German

bunds are at record highs. Sovereign stress could disrupt

risk appetite as it did in 2Q10.

US state and municipal stress

US states and municipalities are required to balance their

budgets. The result may be rising unemployment as US

local government downsizes. This would place a larger

burden on the private sector to create jobs.

Strained social contract: US profit share and unemployment

8

10

12

14

1618

20

22

70 75 80 85 90 95 00 05 10

0

3

6

9

12

% sa

Unemployment rate (inverted)

Profit share

Source: J.P. Morgan. Note: Chart shows % share of gross value added, J.P. Morgan

forecast for 2010.

Shares outstanding in commodity ETF

30000

60000

90000

120000

150000

180000

210000

Dec -07 M ay -08 Oc t-08 M ar-09 Aug-09 Jan-10 Jun-10 N ov -10

Source: Bloomberg, DBCSO Index.

Peripheral stress in Europe

0

1

2

3

4

5

6

7

Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10

0

2

4

6

8

10

Greece (RHS)

Ireland (LHS)

Source: Bloomberg

Note: Spread of Greek and Irish 10-year bond yields to German bunds.


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Brazil Strategy

Key country dynamics

Domestic growth and Chinas demand for commoditiesare the main drivers for Brazil in 2011, together with a

clearer definition of policies to be adopted by the newly

elected government. The exchange rate is an important

focus, with capital control risks on the rise.

Growth characteristics and how they are changing

Credit growth at around 20% combined with the best

labor market in a generation provides for a sturdy

outlook for consumption in 2011. We forecast GDP of

4.5% in 2011, on top of 7.5% in 2010e. Strong growth is

adding to inflation risks, and we expect a rise in interest

rates in 2011. Although GDP is little influenced by

commodities (exports = 11%), Brazils two largestcompanies are commodity driven. Over the next few

years, investment (under 18% of GDP) will need to rise

to meet the countrys need for more capacity and

infrastructure. This would also allow for faster

sustainable growth in the years to come.

Drivers of returns Multiples and growth

Valuation is not an impediment to Brazils performance.

The country is trading in line with the five-year average,

with commodities cheaper than domestics but with the

latter likely delivering more growth in the short/medium

run. Flows are key for performance and are catching up

in 4Q 2010 after being lackluster most of the year. With

major hurdles behind (large capitalizations, elections)

and DM prospects of a muddle-through, inflows into

Brazilian equities are likely to be boosted in 2011.

Recommendations

We recommend exposure to domestic names and are

focused on financials and homebuilders. Although we

like discretionary, we feel that there are better entry

points considering the strong performance of late. In

financials, Bradesco is our top pick, a blue chip, large

cap bank that can better withstand the rise in interest

rates as about 30% of its business is insurance. Inhomebuilders, we like PDG: the stock is cheaper than

peers, benefits from the Agre acquisition are not fully

priced, the company is fully exposed to the high-growth

lower-income segment. On the commodity side, we

likeVale: it is cheap, with risks mostly priced in already,

while China appears to be rebounding. In the oil and gas

sector, we recommend OGX as the better vehicle to get

exposure to offshore as more of the companys findings

are turning into reserves.

Emy Shayo ChermanAC

(5511) 3048-6684

[email protected]

Banco J.P. Morgan S.A.

Bloomberg JPMA SHAYO

Household consumption rising above GDP (4Q/4Q rolling average)

-1.0%0.0%1.0%

2.0%3.0%4.0%5.0%6.0%7.0%8.0%

1Q-03 1Q-04 1Q-05 1Q-06 1Q-07 1Q-08 1Q-09 1Q-10

GDP Househo ld Consumption

Source: IBGE.

Unemployment rate (%)

6

7

8

9

10

11

Jan-0

6

Jul-06

Jan-0

7

Jul-07

Jan-0

8

Jul-08

Jan-0

9

Jul-09

Jan-1

0

Jul-10

Source: IBGE.

BRL (rh, inverted scale) versus BZ Commodity Export Index (lh)

150

200

250

300

350

400

450

500

2/4/05 9/2/05 3/31/06 10/27/06 5/25/07 12/21/07 7/18/08 2/13/09 9/11/09 4/9/10

1.5

1.6

1.7

1.8

1.92.0

2.1

2.2

2.3

2.4

2.5

BZ Commodity Index

BRL

Source: Bloomberg; J.P. Morgan.

Foreign Net Inflows into Brazilian Equities (secondary) R$bi

-1.09

2.211.65

4.04

1.14 0.930.51

-2.10

-1.25

3.15

-1.08-1.51

-0.15

3.51

-0.60

3.14

1.60

-3

-2

-1

0

1

2

3

4

5

Jun-0

9

Jul-09

Aug-0

9

Sep-0

9

Oct-09

Nov-0

9

Dec-0

9

Jan-1

0

Feb-1

0

Mar-10

Apr-10

May-1

0

Jun-1

0

Jul-10

Aug-1

0

Sep-1

0

Oct-10

YTD 2010 = R$4.7 bi

YTD 2009 = R$19.2 bi

Source: BM&FBovespa; Bloomberg.


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Top picks and stocks to avoid

Mkt cap P/E (x) EPS Div. yield ROEPrice Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%)

Top picksBradesco 34.8 BBDC4 OW 73,018 13.5 12.1 2.59 2.88 2.9% 21.2%PDG Realty 10.6 PDGR3 OW 7,144 14.5 9.4 0.73 1.13 1.7% 19.2%

VALE 31.8 VALE OW 173,421 10.9 7.7 2.92 4.13 2.9% 23.3%OGX 21.7 OGXP3 OW 42,952 nm nm 0.06 0.02 0.0% 0.6%Stocks to avoidUsiminas 21.0 USIM5 UW 14,775 20.5 11.1 1.02 1.88 3.1% 8.8%Eletropaulo 29.9 ELPL6 UW 3,229 4.8 8.4 6.29 3.54 13.8% 18.0%Tele Norte Leste 48.5 TMAR5 N 7,699 nm nm 8.60 7.21 8.9% 14.9%

Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.

MSCI Brazil absolute and Relative to EMF Index

0

200

400

600

800

1000

1200

1400

Dec-02 Mar-04 May -05 Aug-06 Oct-07 Jan-09 Mar-10

Absolute Relative to MSCI EMF Index

Source: MSCI, Datastream.

MSCI fair value range

(135082)

(119256)

(124074)

(212792)

(196127) (326196)

(89127)(277670)

(273109)(445307)

(339385)

(211296)

50000 150000 250000 350000 450000

FWD PE

PE

PB

DY

BY/EY

BY/DY

Source: MSCI, IBES, Datastream, J.P. Morgan.

Currency outlook (BRL/USD)

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2.8

3.0

Dec 04 Apr 06 Jul 07 Nov 08 Feb 10 Jun 11

Consensus

J.P. Morgan

J.P. Morgan forecast:

end Dec 10: 1.70

end Mar 11 : 1.80

end Jun 11: 1.82


MSCI EPS integer over time

80

90

100

110

120

130

140

150

Feb-09 Jul-09 Dec-09 May -10 Oct-10

2010

2011



32/160

Ben Laidler

(1-212) 622-5252

[email protected]

32


Mexico Strategy


The key constraints on Mexican equities are structurallylower US GDP growth and a lackluster Mexican

consumer rebound. This is offset by a cheap currency,

easy monetary policy, a gradual reacceleration of US

economic growth at least into mid-2011 and a high

market correlation with US equities. Additionally, we

view some concerns as currently overdone such as the

fiscal situation (oil production has stabilized) and

security environment (violence localized) whilst others

are not such as Mexicos declining equity market

relevance on lack of issuance.


Mexican GDP growth is set to slow next year (to 3.5%from an estimated 4.5% in 2010), along with the US

(2.7% GDP growth to 2.5% in 2011e). Manufacturing

and IP, which led the sharp growth recovery from the

-6.5% seen in 2009, should slow and domestic demand

increasingly come to the fore. Consensus MSCI Mexico

earnings growth could be at risk, with expectations for

18% growth versus only 12% this year. Growth is

expected to be led by staples and materials.


Mexico is trading at the high end of traditional valuation

ranges, and we do not see room for significant multiple

expansion. The valuation premiums to other markets are

lower than they seem, often just reflecting Mexicos high

staples and telecom index composition. Whilst the

traditional drivers of Mexican outperformance 1)

significant market weakness, 2) strong US macro

surprise, 3) strong Mexico consumer recovery look

absent to us in 2011, we do expect respectable absolute

performance. Local investors remain underweight the

market and are seeing robust inflows. Foreign investors

remain moderately overweight.

Recommendations

Our strategy focus is on stocks exposed to thestrengthening domestic demand environment at

reasonable valuations. We also like a number of special

situations exposed to recovering infrastructure segments.

We would avoid very defensive staples with high

valuations and low gearing to the strengthening

consumer.

Ben LaidlerAC

(1-212) 622-5252

[email protected]


Bloomberg JPMA LAIDLER

Contributions to GDP growth, 2008-2011e


Mexico 12 mth fwd PE

7.00

9.00

11.00

13.00

15.00

17.00

95 97 98 99 00 01 02 03 04 05 06 07 08 10

Mex ico Average +1SD -1SD

Source: MSCI, IBES, Datatsream.

Mexico consumer confidence and formal employment

Source: J.P. Morgan Economics, INEGI, IMSS.


33/160

Ben Laidler

(1-212) 622-5252

[email protected]

33


Top picks and stocks to avoid

Mkt cap P/E (x) EPS Div. yield ROEPrice Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%)

Top picks America Movil 57.1 AMX OW 119,244 15.8 13.4 44.98 52.72 0.7% 26Cemex 8.8 CX OW 9,800 nm nm -0.16 0.02 0.0% 0.1%Grupo Televisa 22.2 TV OW 13,699 22.0 17.2 12.54 16.02 1.4% 23.0%ICA 32.5 ICA* OW 1,781 30.4 22.0 1.07 1.48 0.0% 4.9%First Cash Financial 29.4 FCFS OW 913 17.1 14.6 1.72 2.01 0.0% 17.9%Stocks to avoidTelmex 15.2 TMX UW 14,410 12.7 13.2 18.51 17.30 5.0% 37.0%Grupo Inbursa 53.9 GFINBURO UW 14,247 25.3 21.0 2.13 2.57 1.4% 12.2%Consorcio Ara 7.6 ARA* UW 829 11.5 9.9 0.66 0.77 1.3% 10.1%

Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.

MSCI Mexico absolute and relative to EMF Index

0

50

100

150

200

250

300

350400

450

500

Dec-02 Mar-04 May -05 Aug-06 Oct-07 Jan-09 Mar-10

Absolute Relative to MSCI EMF Index


MSCI fair value range

(196457)

(20184)

(14776)

(24866)

(25349)

(17980) (22590)

(29973)

(25937)

(125613)

(41784)

(33101)

0 50000 100000 150000 200000 250000

FWD PER

PER

PBR

DY

BY/EY

BY/DY

Source: MSCI, IBES, Datastream, J.P. Morgan.

Currency outlook (MXN/USD)

9.0

10.0

11.0

12.0

13.0

14.0

15.0

16.0

Dec 04 Apr 06 Jul 07 Nov 08 Feb 10 Jun 11

J.P. Morgan

Consensus

J.P. Morgan forecast:

end Dec 10: 12.50

end Mar 11: 12.50

end Jun 11: 12.25


MSCI EPS integer over time

70

75

80

85

90

95

100

105

Feb-09 Jul-09 Dec-09 May -10 Oct-10

2010

2011



34/160

Ben Laidler

(1-212) 622-5252

[email protected]

34


Chile Strategy


Chile will look to build on the momentum of an historic2010, which saw the inauguration of center-right Piera

(after 20 years of the center-left Concertacion), an 8.8-

magnitude earthquake (5th largest in history), World

Cup success (advancing to the round of 16), the

countrys 200-year anniversary and the unprecedented

extraction of 33 miners trapped underground for 68 days.

Confidence is running high, and the country appears to

be entering a period of renewal, which could accelerate

the path to developed country status (possibly by the end

of the decade). However, with expectations mounting,

there is room for disappointment, especially if

social/political differences get in the way of progress.


For the first time in recent years, Chile is expected to

lead regional growth in the coming year on the back of

an aggressive Piera pro-growth agenda, accelerated by

ongoing earthquake reconstruction efforts. This should

be further helped by supportive demand dynamics out of

China and expansionary fiscal policies (benchmark rate

not likely to surpass 4.25% lowest YE11e level in the

region), not to mention micro-level incentives for

investment by both locals and foreigners.


The top-down scenario remains attractive, but valuations

are lofty at nearly 18x forward P/E, representing a 50%

premium to LatAm, which is just ahead of historical

levels (despite recent factors that are working to close

the spread such as the move to IFRS and regional

expansion). As the Chile premium suggests, performance

is largely tied to supportive domestic flows (and limited

foreign ownership). This support was strong in 2010

given weakness elsewhere. In the event that key markets,

such as Brazil, China and the US, perform well in 2011

(especially relative to domestic fixed income), this will

likely limit domestic flows, specifically from pension

funds, which may be forced to trim domestic equity

positions to remain within their limits.Recommendations

Although we like the Chile growth profile, we focus on

names that are expanding abroad (Falabella, CCU). We

also find copper play Antofagasta at an attractive

valuation with significant growth potential. We avoid

utility IAM, given strong relative outperformance in the

utilities sector and potential Aguas Andinas share sale

overhang. We also see limited upside after the

speculative rise in SQMs share price.

Brian P. ChaseAC

Documents

JP Morgan Latam 2011