JPM U S Year Ahead 2012 2011 12 10 738272

North America Equity Research
9 December 2011
U.S. Year Ahead 2012

A Year of Gradual Healing
PortfolioStrategy Thomas J Lee, CFA AC
(1-212) 622-6505 thomas.lee@jpmorgan.com
Director of U.S. Equity Research Noelle V. Grainger

(1-212) 622-6504 noelle.grainger@jpmorgan.com J.P. Morgan Securities LLC
Bloomberg JPUS2012 <INDEX> <GO>

Bloomberg subscribers can use the ticker JPUS2012 to access tracking information on a basket created by the J.P. Morgan Delta One desk to leverage the theme discussed in this report. Over time, the performance of JPUS2012 could diverge from returns quoted in this report, because of differences in methodology. J.P. Morgan Research does not provide research coverage of this basket and investors should not expect continuous analysis or additional reports relating to it. For information on JPUS2012, please contact your J.P. Morgan salesperson or the Delta One Desk.
See page 152 for analyst certification and important disclosures, including non-US analyst disclosures.
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North America Equity Research December 2011
US Year Ahead 2012
Table of Contents
Macro Portfolio Strategy ............................................................................. 5 Economics..................................................................................... 50 Equity Strategy Small Cap........................................................... 52 Equity Technical Strategy............................................................... 55 Equity Quantitative Strategy ........................................................... 63 Accounting & Valuation .................................................................. 67 Equity Derivatives .......................................................................... 70 Delta One Strategy ........................................................................ 74 Capital Goods/Industrials Aerospace & Defense .................................................................... 81 Boeing Company (BA) Airfreight & Surface Transportation................................................. 82 Union Pacific (UNP) Electrical Equipment & Multi-Industry.............................................. 83 SPX Corp (SPW) Engineering & Construction............................................................ 84 Chicago Bridge & Iron (CBI) Environmental Services.................................................................. 85 Clean Harbors (CLH) Waste Connections (WCN) Machinery...................................................................................... 86 Deere & Co. (DE) Consumer Airlines .......................................................................................... 87 United Continental Holdings (UAL) Autos & Auto Parts......................................................................... 88 Visteon (VC) Beverages ..................................................................................... 89 PepsiCo (PEP) Food Manufacturing ....................................................................... 90 J.M. Smucker Co. (SJM) Food Retail .................................................................................... 91 The Fresh Market (TFM) Gaming.......................................................................................... 92 Las Vegas Sands (LVS) Homebuilding & Building Products.................................................. 93 Lennar (LEN) Owens Corning (OC) Household & Personal Care Products............................................. 94 Procter & Gamble (PG)
2
Consumer (Contd) Lodging.......................................................................................... 95 Wyndham Worldwide (WYN) Restaurants ................................................................................... 96 Brinker International (EAT) Retailing Broadlines, Apparel & Footwear .................................... 97 Macys (M) Retailing Hardlines/Discounters ................................................... 98 Costco (COST) Retailing Specialty....................................................................... 99 Ulta Salon, Cosmetics & Fragrance, Inc. (ULTA) Tobacco....................................................................................... 100 Reynolds American (RAI) Energy Electric Utilities & Independent Power Producers .......................... 101 NRG Energy (NRG) Energy MLPs ............................................................................... 102 Buckeye Partners (BPL) North American Integrated Oils & Major Producers........................ 103 Nexen (NXY) Oil & Gas Exploration & Production............................................... 104 Denbury Resources (DNR) Pioneer Natural Resources (PXD) Oilfield Services & Equipment....................................................... 105 Halliburton (HAL) Financials Asset Managers, Brokers, and Exchanges .................................... 107 Invesco Ltd. (IVZ) Franklin Resources (BEN) Avoid Banks Large Cap....................................................................... 108 Citigroup (C) Banks Mid- and Small Cap ........................................................ 109 First Horizon (FHN) Insurance Life ........................................................................... 110 Prudential Financial (PRU) Insurance Non-Life.................................................................... 111 Allstate Corp. (ALL) REITs/Real Estate Services.......................................................... 112 Public Storage (PSA) Specialty & Consumer Finance..................................................... 113 American Express (AXP)
US Year Ahead 2012
Health Care Biotechnology ...............................................................................115 Celgene (CELG) SMid Biotechnology ......................................................................116 Onyx Pharmaceuticals (ONXX) Healthcare Facilities......................................................................117 HCA Inc. (HCA) Healthcare Information Technology ...............................................118 Accretive Health (AH) Healthcare Technology & Distribution ............................................119 CVS Caremark (CVS) Life Sciences Tools & Diagnostics .................................................120 Agilent (A) Managed Care ..............................................................................121 UnitedHealth (UNH) Medical Supplies & Devices ..........................................................122 St. Jude Medical (STJ) Pharmaceuticals Major...............................................................123 Pfizer (PFE) Pharmaceuticals Specialty..........................................................124 Mylan (MYL) Materials Chemicals Specialty, Commodity & Agricultural...........................125 DuPont (DD) Coal..............................................................................................126 Consol Energy (CNX) Gold & Precious Metals.................................................................127 Goldcorp Inc. (GG) Metals & Mining ............................................................................128 Freeport-McMoRan (FCX) Paper & Packaging .......................................................................129 Crown Holdings (CCK) Media & Telecom Information Services/Radio & TV Broadcasting..............................131 Verisk Analytics (VRSK) Internet.........................................................................................132 Google (GOOG) Media ...........................................................................................133 Viacom (VIAb) Telecom, Cable & Satellite ............................................................134 Comcast (CMCSA)
Technology Alternative Energy LED ............................................................. 135 Cree (CREE) Alternative Energy Solar PV....................................................... 136 First Solar (FSLR) Avoid Applied & Emerging Technologies ................................................ 137 Zipcar (ZIP) Business & Education Services .................................................... 138 Robert Half International (RHI) Communications Equipment & Data Networking............................ 139 Riverbed (RVBD) Computer Services & IT Consulting .............................................. 140 MasterCard (MA) IT Hardware................................................................................. 141 Apple (AAPL) Semiconductor Capital Equipment ................................................ 142 Lam Research (LRCX) Semiconductors ........................................................................... 143 Texas Instruments (TXN) SMid Semiconductors................................................................... 144 Broadcom (BRCM) Software ...................................................................................... 145 Citrix Systems (CTXS) Avoid Red Hat (RHT) Avoid Software Technology.................................................................... 146 Equinix (EQIX) Technology Supply Chain............................................................. 147 Jabil Circuit (JBL) Disclosures .................................................................................. 152 Note: Unless otherwise noted, all stock prices and coverage lists in this report are as of the close on December 6, 2011, and target prices for December 2012.
US Year Ahead 2012
US Year Ahead 2012
Portfolio Strategy
Eight Reasons to Be Contrarian in 2012; YE Target 1430
Thomas J Lee, CFA AC
(1-212) 622-6505 thomas.lee@jpmorgan.com
Macro
Equities Rise Despite Uncertainty

2011 is a year most investors would like to forget. Even though equity markets are essentially flat year to date, the S&P 500 saw a 300-point range (a 9% rally followed by a 22% drop, followed by a 20% rally). Multiple events contributed to this: Japan floods, Arab spring, Peripheral Europe, and U.S. AAA downgrade. However, despite this (Italian yields even broke above 8%), surprisingly U.S. equity markets are flat for the year. We believe this is a testament to a combination of: 1) U.S. economic resilience; 2) U.S. corporate financial strength and pricing power; and 3) severe relative undervaluation of equities (supporting prices).
Daniel M McElligott
(1-212) 622-5598 daniel.m.mcelligott@jpmorgan.com
Katherine C Khor
(1-212) 622-0934 katherine.khor@jpmorgan.com J.P. Morgan Securities LLC
Eight Reasons to Be Contrarian (Optimistic) in 2012

The consensus view is that visibility remains murky with significant tail risks (European systemic crisis, China hard landing, U.S. fiscal tightening) and the outlook for equities is generally muted (see Figure 15) with only one strategist seeing equities in 2012 exceed the 1371 high of 3/11. However, we have eight reasons to be constructive, as shown below. 1. J.P. Morgan Fixed Income Strategists are constructive for 2012 on High Grade, High Yield, MBS, ABS, and CMBS. Given equities are the junior piece of the capital structure, this is positive for equities (Figure 14). 2. Consensus is cautious about 2012. 3. The J.P. Morgan base case is for the Euro crisis to abate by 2H12 with Europe potentially exiting recession by mid-year. Historically, equities have bottomed 69 months ahead of a return to growth. 4. EBIT margins should expand 100-150bps in 2012, bolstering net profit margins by 60-90bps to 10%, setting a new high for profit margins and driving 2012E/2013E EPS of $105/$110. 5. Corporates are likely to ramp up total cash return by as much as $250bn in 2012. For the past five years, corporates have represented 97% of the incremental inflows into equities. 6. U.S. housing should see a further advance in its recovery in 2012, driven by expanding household formation rates. Vacancies are at five-year lows and other factors are also supportive. 7. The 2012 U.S. election cycle should be positive for equities. Stocks have historically done well when an incumbent has had low approval ratings going into an election year (positive returns in seven of eight years). 8. China entering selective easing cycle sets the stage for a Cyclical upturn in EPS.
US Year Ahead 2012
Establishing Year-End 2012 Target of 1430; Favor Cyclicals and Financials

We believe the S&P 500 will reach 1430 by the end of 2012. This based on a target multiple of 13.0x estimated 2013 EPS of $110. From any historical lens, this P/E multiple appears conservative, representing an earnings yield of 7.7% (compared to JULI HG yield of 4.4%). We see Cyclicals and Financials outperforming, with Financials as our top pick for 2012.
65 Analyst Best Ideas

We have compiled J.P. Morgans 65 best long and 4 avoid ideas (Figure 9).
US Year Ahead 2012
Valuation: See S&P 500 Trading to 13.0x 2013E EPS or 1430

2012 Price Target Reflects 13x 2013E EPS of $110
We believe the S&P 500 will reach 1430 by the end of 2012. This based on a target multiple of 13.0x estimated 2013 EPS of $110. From any historical lens, this P/E multiple appears conservative, representing an earnings yield of 7.7% (compared to JULI HG yield of 4.4%). Similar to last year, we see greater variability in the P/E ratio, rather than in the EPS forecast. Over the course of 2011, top-down forecasts for 2011 EPS actually rose by $5.29 ($97.38 now vs. $92.09 in December 2010), but P/E ratios fell. For 2012, we show our target P/E multiple and EPS forecast in Figure 1 below. We also highlight the upside and downside factors to the P/E multiple, namely macro factors that could weigh on P/E multiples. As shown, if investors become comfortable with Europe and U.S. Congress, and gain conviction in a strong U.S. housing recovery, P/E multiples could expand further towards 14x. A P/E multiple of 14x, by the way, compares to a typical multiple of 13.9x in the fourth year of a bull market (Figure 2).
Figure 1: J.P. Morgan Year-End 2012 Price Target Scenarios for S&P 500
$ per share
YE '12 P/E Upside 14.00X
2013 EPS $115
Target 1,600
Europe recession ends ECB bazooka US housing recovers Congress compromises US govt ends attack on banks
Base
13.00X
China hard landing Europe bank crisis US enters recession Obama gains in polls
$110
1,430
Downside
Source: J.P. Morgan.
12.00X
$95
1,150
US Year Ahead 2012
P/E Multiple of 13.0x In Line with Historical Average P/E 46 Months into a Bull MarketThus, Target P/E Is Consistent
Our target multiple of 13.0x is in line with levels in prior bull markets. Take a look at the analysis in Figure 2 below which looks at P/E ratios 46 months into prior bull markets, even those that have become bear markets. Our target multiple of 13.0x is in line with the historical average of 13.1x 46 months into prior bull markets (even those that ended a long time before that). And for those that have remained bull markets, the P/E ratio was closer to 13.9x, or higher than our target P/E of 13.0x. Also, since 1900, the average P/E multiple has expanded by 2.2x by month 46 if a bull market remained intact while multiple expansion was generally only 1.0x by month 46 across all bull markets examined. In contrast, the current bull market has not seen any P/E multiple expansion and our target P/E of 13.0x represents no increase in multiple.
Figure 2: P/E Ratios During Fourth Year of a Bull Market
P/E ratio average for months 40-46 since 1900
Avg P/E: Months 40-46

19.1x 16.6x 16.7x 15.5x 14.7x 15.1x 15.1x 19.4x
25.0x
14.0x
14.3x
13.2x
11.8x
12.9x
9.7x
7.9x
8.4x
10.0x 5.0x 0.0x
6.9x
9.3x
15.0x
10.1x
11.3x
13.0x
13.1x
1.0x
20.0x
13.4x
DELTA (avg P/E for months 40-46 less avg P/E for months 0-6 of a bull market)
12.0x 8.0x 4.0x 0.0x -4.0x -8.0x
8.4x
5.9x
3.5x
-2.9x
3.5x
4.4x
5.4x
-2.3x
0.4x
0.8x
1.7x
2.3x
5.5x
8.9x
-2.1x
-5.9x
-4.8x
1900 -1.9x
1966 -0.2x
-3.6x
-4.4x
2002 -1.8x
2009 0.0x
Source: J.P. Morgan and FactSet.
Avg: if Bull intact
1903
1907
1914
1917
1921
1932
1933
1935
1938
1942
1949
1957
1962
1970
1974
1978
1982
1987
1990
Avg: all
2.2x
Avg: if Bull intact
1900
1903
1907
1914
1917
1921
1932
1933
1935
1938
1942
1949
1957
1962
1966
1970
1974
1978
1982
1987
1990
2002
2009
Avg: all
13.9x
13.9x
US Year Ahead 2012
And Equity Risk Premium Points to Equities Being Undervalued

Valuation for stocks continues to remain extremely attractive, in our view. We believe the most notable distortion is that the equity risk premium remains elevated. The figure below shows the equity risk premium is at a 50-year high. The current equity risk premium is 6.27%, well above the 50-year average of 2.55% and the ten-year average of 3.55%. The current equity risk premium is also higher than at the major stock market lows of 1974, 1980, and 2009. It is even higher than the levels seen at the heights of the Asia and subprime crises. The equity risk premium is also virtually unchanged since the March 2009 low, despite substantial improvement in the economy. This indicates that investors currently show little trust in equities and reflects a general fear of capital investment, both physical and financial. The implication, though, is the risk/reward for equities is attractivethat is, the margin of error is greater for equities when the equity risk premium is high. While some may argue this is a result of extreme risk aversion, this again points to our argument that unless things worsen, this relationship is likely to narrow, thus favoring stocks.
Figure 3: Equity Risk Premium
Using a Dividend Discount Model to derive the real S&P 500 Equity Discount Rate implied by S&P 500 prices This discount rate (EDR) is a risk-free rate. The Equity Risk Premium is the difference between the Equity Discount Rate and the 10-yr real bond yield (10-yr nominal UST yield minus 10-yr Philly Fed inflation expectations)
Equity Risk Premia 7.0 6.0 5.0 4.0 3.0 2.0 1.0 (1.0) (2.0) '57 '59 '62 '64 '67 '69 '72 '74
10yr Avg Market low Market low
Asia Crisis Subprime Crisis
Market Crisis low 9/11 6.27
Euro
10yr Avg 3.82
'77
'79
'82
'84
'87
'89
'92
'94
'97
'99
'02
'04
'07
'09
'12
Source: J.P. Morgan Global Asset Allocation Team.
US Year Ahead 2012
2012 Expected to Look More Like 2009

Fourth Year of Bull Markets Has Seen Less Variation in Performance
We compiled the composite return of the eight bull markets (which lasted at least 34 months) below to highlight the typical return in the fourth year of a bull market. The average was 15% and implies a YE level of 1448, which is slightly above the 1430 target we set for 2012. This contrasts with 2010 and 2011, which saw major volatility in performance. Both 2010/2011 started with a 9% rally, followed by a double-digit decline, and ended with a rally. Consensus sees a tough 1H12 and rally in 2H (similar to composite) which we believe is less likely to happen. Rather, we see either steady gains through 2012 or markets stronger in 1H. Either way, we think it makes sense to be long at the start of the year.
Figure 4: Price Performance of the S&P 500 in 2009-2012
2012 is a composite of Bull Markets that lasted at least 34 months
2009
1,200 1,100 1,000 900 800 700 600 12/08
2010
1,300 1,250 1,200 1,150 1,100 1,050 1,000 12/09
2011
1,700 1,600 1,500 Actual S&P 500 Bull Mkt Composite
2012
1,750 1,650
+9% -17% +24%
1,400 1,300 1,200 1,100
+9%
1,550 1,450
Composite and High/Low range of Bull Mkts lasting at least 34 months
-22% +17% (+26%)

2/11 4/11 6/11 8/11 10/11 12/11
1,350 1,250 1,150
51% Avg gain of 15%

4/12 6/12 8/12 10/12 12/12
+67%
1,000 900 800
-8%
2/12
2/09
4/09
6/09
8/09
10/09 12/09
2/10
4/10
6/10
8/10
10/10 12/10
700 12/10
1,050 12/11
Composite for Bull Markets that lasted at least 22 months 26% upside shown would be to reach 1350 YE target
Composite for Bull Markets that lasted at least 34 months Assume 2012 starts the y ear at 1,255 (current lev el)
Source: J.P. Morgan and Bloomberg. Note: Composite is for bull markets that lasted at least 34 months.
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US Year Ahead 2012
No Fourth Year of a Bull Market Saw DeclinesBut Issue Today Is Risk of a Systemic Crisis
We have detailed below the eight bull markets (which were entering their 34th month). Note that the markets fall into two categories. Equity markets with modest gains (1952-53, 1965-66, 1993-94, and 2005-06) with 3-5% gains. And those with strong gains (1924-25, 1945-46, 1960-61, and 1985-86). Given the tepid 2011 performance, along with P/E of around 11.3x 2013E EPS, we expect returns to be stronger than single-digits.
Figure 5: Bull Markets Lasting at Least 34 Months
Since 1900
Bull Market Length of Bull Start of Bull End of Bull Market 1 8/24/1921 Market Market (months) 9/3/1929 96.4 49.1 97.1 49.7 43.6 60.5 113.6 60.1 71.3
Months 34-46 Date 34 Months after Start Date 46 Months after Start Perf months 3446 37% 26% 3% 21% 5% 26% 2% 3% 15% 100% 12/2011 1/2013
P/E P/E (NTM) as of Month 34 7.9x 15.2x 9.8x 18.4x 16.4x 12.6x 15.4x 14.9x 13.8x
of Bull Mkt of Bull Mkt 6/1924 6/1925 2/1945 4/1952 8/1960 4/1965 6/1985 8/1993 8/2005 2/1946 4/1953 8/1961 4/1966 6/1986 8/1994 8/2006
2 4/28/1942 5/29/1946 3 6/13/1949 7/12/1957 4 10/22/1957 12/12/1961 5 6/26/1962 2/9/1966 6 8/12/1982 8/25/1987 7 10/11/1990 3/24/2000 8 10/9/2002 10/9/2007 Average % Times Up 9 3/9/2009 12/31/2011
33.8
12.0x
Source: J.P. Morgan and Bloomberg.
11
US Year Ahead 2012
Sectors: Overweight Cyclicals, Financials

In our view, the framework for 2012 may look a bit like 2009emergence from a financial crisis and the potential for an acceleration of the business cycle (driven by Europe exiting recession and China easing). Thus, intuitively, we see Cyclicals and Financials outperforming. Financials are arguably the most non-consensus call. After all, given the plethora of risks, investors are reluctant to own them. However, as shown in Figure 6 below, note that Financials have done well in most past scenarios (post-Lehman, housing bottoms, election year). This is also intuitive. If Europes crisis is resolved, the largest beneficiaries should be Financials. Housing is a major lever for Financials. And the prospect for Republican gains in the upcoming elections would likely also favor Financials. In addition, Cyclicals broadly have outperformed under most scenarios.
Figure 6: Sector Rationale Cyclicals and Financials Look Attractive
Cyclicals: Tech, Materials, Discretionary, Industrials; Near Cyclicals: Energy, Financials Cyclical or Driver for 2012 Post-financial crisis (a la 08) Defensives? % Rel. Chg./ (Win Ratio) 1,400-7,700bp (100%) 1,200bp (100%) Discretionary (2,300bp), Technology/Materials/Staples (1,000bp), Financials (700bp) Best Sectors (12-Mo Relative Performance) Financials (7,700bp), Discretionary (3,100bp), and Industrials (2,700bp)
Financials/ Cyclicals Cyclicals/ Financials
Macro-related
Housing bottoms in 2012
2012 Election year with Presidential approval rating <50%
Cyclicals, Financials and Energy Cyclicals Cyclicals, Financials and Energy
200bp-700bp (100%/75%)
Financials (700bp), Technology (500bp), Industrials (300bp), Energy (200bp)
Current P/E below 40-yr average
N/A N/A
Technology (30% below LT trend), Materials (9%) Financials (1800bp underperformance in 2011), Materials (970bp), Industrials (310bp)
Other
2011 Underperformers (buy the losers)
Source: Bloomberg, FactSet, and Datastream.
12
US Year Ahead 2012
Sector Earnings and Outlook

We think a Cyclical bent makes sense in 2012 given the characteristics/catalysts outlined in Figure 6 above. A summary of our sector views is shown in the following table. Not surprisingly, we recommend overweight positions in Cyclicals (Materials, Industrials, Discretionary, Technology) as well as Financials and Energy. We also continue to believe investors should overweight Health Care. We are looking for 2012/2013 EPS slightly below bottom-up consensus (about $2/$10, respectively). Basically, we are slightly below consensus EPS for most sectors. Financials are projected to have the fastest EPS growth (13%) of the ten sectors. For 2012, the next-fastest year-over-year EPS growth is expected for Basic Materials and Industrials. As for anticipated upside, we see most groups offering double-digit returns with the exception of Utilities and Telecom. For Utilities, we see upside of around 8%purely driven by P/E expansion. The group currently trades at a P/E multiple of 14x (124% relative P/E) and we look for that to reach 15.0x by YE 2012.
Figure 7:2011/2012/2013 Estimated EPS and Target P/E Multiples by Sector
$ per share
B/U consensus JPM Strategy EPS JPM Strategy Rating Cyclicals Materials Industrials Discretionary Technology OW OW OW OW
EPS % (JPM) 11E 12E 13E v s. vs. vs. '10 '11E '12E 32% 11% 21% 11% 11% 9% 17% 10% 39% 3% 6% 13% 6% 3% 6% 1% 3% 10% 3% 2% 15% 16% 7% 6% 6% 9% 6% 5% 3% 6% 4% 2% 9% 0% 5% 5% 6% 4% 3% 3%
2013 P/E
Relative 2013E P/E
Point Contribution Current Upside % Upside 15% 13% 13% 19% 14% 18% 10% 17% 8% 7% 15% 14% 16% 16% 12% 353 bp
2012E 2013E 2011E 2012E 2013E 4.02 10.78 9.84 21.22 14.72 18.40 10.73 12.67 2.32 3.26 4.59 12.27 11.13 24.11 16.37 20.47 11.59 13.58 2.67 3.47 3.55 9.40 8.90 19.55 14.30 14.70 10.00 12.15 2.00 3.20 3.95 10.40 9.70 21.50 14.75 16.65 10.30 12.30 2.20 3.25 4.20 11.30 10.30 22.50 15.15 17.65 10.70 12.55 2.40 3.25
10.4x 11.5x 12.9x 11.0x 10.0x 9.3x 14.1x 11.2x 15.6x 14.0x 11.3x 11.7x 11.4x 9.7x 13.0x -1.5x
12.0x 13.0x 14.6x 13.0x 11.4x 11.1x 15.6x 13.1x 16.9x 15.0x 13.0x 13.4x 13.2x 11.2x 14.6x -1.3x
92% 101% 114% 97% 89% 83% 125% 99% 138% 124% 103% 101% 85% 115% -14%
92% 100% 112% 100% 88% 85% 120% 101% 130% 115% 103% 102% 86% 112% -10%
94% 95% 101% 132% 83% 75% 103% 115% 91% 71% 98% 105% 79% 95% 10%
44 129 133 247 152 165 151 141 37 46 1,244 1,079 552 317 375 178
Near Cyclicals Energy OW Financials OW Defensives Staples HealthCare Telecom Utilities S&P 500 S&P ex-Fin Cyclicals Near Cyclicals Defensives Cyclicals vs. Defensives UW OW N UW
107.95 120.26 89.55 99.79 45.86 33.12 28.97 16.89 52.10 36.84 31.32 20.78
97.75 105.00 110.00 83.05 88.35 92.35 41.40 29.00 27.35 14.05 45.55 31.40 28.05 17.50 48.30 32.80 28.90 19.40
18% 10% 20% 8% 5% 3% 13% 7%
Source: J.P. Morgan, FactSet, and Datastream.
Point
LongTerm Current Target Current Target Avg
7 17 17 46 21 30 16 24 3 3 185 154 87 51 46 41
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US Year Ahead 2012
J.P. Morgan Industry Outlook by Analyst

We have summarized below the 2012 outlooks of J.P. Morgans U.S. fundamental equity analysts, based on our interpretation of their contributions to this report.
Figure 8: J.P. Morgan Fundamental Analyst Conviction Levels
HC = High Conviction, N = Neutral, LC = Low Conviction
CYCLICALS Materials OW Gold & Precious Metals / Bridges Metals & Mining / Gambardella Chemicals / Zekauskas Coal / Bridges Paper & Packaging / Gresh Industrials OW Business & Education Svcs / Steinerman Airlines / Baker Airfreight/Surface Transport / Wadewitz Machinery / Duignan Engineering & Construction / Levine Env ironmental Services / Levine Aerospace & Defense / Nadol Electrical Equip & Multi-Industry / Tusa Discretionary OW Gaming / Greff HC Info Svcs/Radio/TV Broadcasting / Meltz HC Internet / Anmuth HC Lodging / Greff N Restaurants / Ivankoe N Autos & Auto Parts / Patel N Media / Quadrani N Homebuilders & Building Products / Rehaut C L Hardlines / Horvers LC Specialty Retail / Tunick LC Broadlines, Apparel & Footw ear / Boss LC T echnology OW LED (Alt Energy) / Blansett SMid Semiconductors / Sur Semiconductors / Danely Technology Supply Chain / O'Brien Semiconductor Capital Equip / Blansett Software Technology / Auty Applied and Emerging Tech / Coster Computer Svcs & IT Consulting / Huang Communications Equipment / Hall Solar Alt Energy) / Blansett IT Hardware / Moskowitz Software / DiFucci
HC HC N LC LC
HC N N N N N LC LC
HC HC HC HC N N N N LC LC LC LC
NEAR-CYCLICALS Energy OW Energy MLPs / Tonet Oil Services & Equipment / Anderson Integrated Oil & Gas / Minyard Oil & Gas E&P / Allman
HC N N N
Financials OW Life Insurance / Bhullar HC REITs / Michael Mueller & Anthony Paolone HC Small/Mid Cap Banks / Alexopoulos HC Asset Managers / Worthington N Large Cap Banks / Juneja N Non-Life Insurance / Heimermann N Exchanges / Worthington LC Specialty & Consumer Finance / Shane LC
DEFENSIVES HealthCare OW Healthcare Tech & Distribution / Gill SMid Biotechnology / Kasimov Pharmaceuticals (Major) / Schott Pharmaceuticals (Specialty) / Schott Managed Care / Rex Healthcare Information Tech / Rahim Biotechnology / Meacham Medical Supplies & Devices / Weinstein Life Sciences Tools / Peterson Healthcare Facilities / Rex
HC HC HC HC N N N N LC LC
Telecom N Telecom, Cable, & Satellite / Cusick
Staples UW Tobacco / Maile HH & Personal Care Products / Faucher Bev erages / Faucher Food Manufacturing / Goldman Food Retail / Goldman
N LC LC LC LC
Utilities UW Utilities / Smith
LC
Note: Analyst conviction levels are based on our interpretation of the analysts sector contributions to this report.
14
US Year Ahead 2012
J.P. Morgan Analysts Best Ideas for 2012

65 Long and 4 Avoid Stock Ideas
J.P. Morgans fundamental equity analysts have also provided 65 long stock picks that represent each analysts best idea for 2012 (Figure 10 through Figure 12). J.P. Morgans analysts have also provided 4 avoid stock picks as their best ideas for 2012.
Figure 9: 65 LONG and 4 AVOID Stock Ideas from J.P. Morgan Fundamental Equity Analysts
Sorted alphabetically within each sector
LONG STOCK IDEAS CYCLICALS Materials 1 2 3 4 CCK DD FCX GG NEAR-CYCLICALS Energy 1 2 3 4 5 6 *NXY BPL CNX DNR HAL PXD DEFENSIVES Staples 1 2 3 4 5 6 COST CVS PEP PG RAI SJM
AVOID STOCK IDEAS CYCLICALS Technology 1 CTXS 2 FSLR 3 RHT NEAR-CYCLICALS Financials 1 BEN
Discretionary 1 2 3 4 5 6 CMCSA EAT LEN LVS M ULTA
7 VC 8 VIAb 9 WYN Industrials 1 BA 2 CBI 3 CLH 4 5 6 7 8 9 DE OC RHI SPW UAL UNP T echnology 1 AAPL 2 BRCM 3 4 5 6 7 8 CREE EQIX GOOG JBL LRCX MA
7 TFM Financials 1 ALL 2 AXP 3 C 4 FHN 5 IVZ 6 PRU 7 PSA HealthCare 1 A 2 AH 3 CELG 4 HCA 5 6 7 8 9 MYL ONXX PFE STJ UNH
10 VRSK 11 WCN 12 ZIP
9 RVBD 10 TXN
Utilities 1 NRG
15
US Year Ahead 2012
Figure 10: Top LONG Stock Ideas from J.P. Morgan Fundamental Analysts (1 of 3)
Priced as 12/6/2011; sorted by implied upside within each sector
JPM Coverage Current Name Industry Ticker Price CYCLICALS: Materials, Industrials, Discretionary, Technology Materials 1 2 3 4 Freeport-McMoRan CopperMetals &Inc. & Gold Mining Crown Holdings Inc. Goldcorp Inc. Containers & Packaging Metals & Mining FCX CCK GG DD $40.54 $33.14 $52.11 $47.94 $38,428 $5,010 $42,195 $44,293 OW Michael F. Gambardella $61.00 OW Phil Gresh, CFA $44.00 OW John Bridges CFA, ACSM $63.00 OW Jeffrey J. Zekauskas $57.00 50% 33% 21% 19% Market Cap JPM Rtg JPM Analyst Target Implied Price Upside
EPS and Valuation 2012E EPS P/E ('12E)
P/B
$4.77 $3.16 $3.16 $4.35
8.5x 10.5x 16.5x 11.0x
2.50x 2.02x 3.92x
E.I. DuPont de Nemours &Chemicals Co. Industrials
5 6 7 8 9
United Continental HoldingsAirlines Inc. Zipcar Inc. Owens Corning Deere & Co. Road & Rail Building Products Machinery Robert Half International Inc. rofessional Services P
UAL ZIP RHI OC DE
$20.13 $14.43 $27.48 $28.98 $78.38 $39.47 $32.83 $61.36 $62.82 $102.84 $70.87 $38.06
$6,660 $567 $3,929 $3,503 $32,443 $3,888 $3,673 $3,256 $3,205 $49,680 $52,673 $6,224
OW Jamie Baker OW Paul Coster, CFA
$45.00 124% $30.50 111% 46% 35% 28% 27% 22% 20% 19% 16% 13% 10%
$5.32 $1.44 $2.69 $7.78 $3.03 $1.65 $2.50 $5.24 $7.79 $4.95 $1.91
3.8x 19.1x 10.8x 10.1x 13.0x 19.9x 24.5x 12.0x 13.2x 14.3x 19.9x
2.88x 2.63x 4.96x 0.94x 4.77x 3.33x 2.63x 3.87x 1.42x 2.68x 8.82x
$0.12 123.3x
OW Andrew C. Steinerman $40.00 OW Michael Rehaut, CFA$39.00 OW Ann Duignan OW Scott Lev ine OW Scott Lev ine $100.00 $50.00 $40.00
10 Chicago Bridge & Iron Co. Construction & Engineering CBI N.V. 11 Waste Connections Inc. 12 Clean Harbors Inc. 13 SPX Corp. 14 Union Pacific Corp. 15 Boeing Co. Commercial Services & Supplies WCN Commercial Services & Supplies CLH Machinery Road & Rail Aerospace & Defense SPW UNP BA VRSK
OW Rodney C Clayton, CFA $73.50 OW C. Stephen Tusa, Jr CFA $75.00 OW Thomas R. Wadewitz 119.00 $ OW Joseph B. Nadol III $80.00 OW Michael A. Meltz, CFA $42.00
16 Verisk Analytics Inc. Cl A Professional Services Discretionary 17 Las Vegas Sands Corp. 18 Viacom Inc. Cl B 19 Brinker International Inc. 20 Comcast Corp. Cl A 22 Visteon Corp. 23 Macy's Inc. 24 Lennar Corp. Cl A
Hotels Restaurants & Leisure LVS Media Media Auto Components Multiline Retail Household Durables VIAb Hotels Restaurants & Leisure EAT
$45.58 $42.81 $23.78 $35.84 $56.30 $32.95 $19.27 $72.93
$33,397 $21,439 $1,914 $48,527 $5,520 $2,900 $13,833 $3,000 $4,514
OW Joseph Greff OW John Ivankoe OW Joseph Greff
$64.00 $31.00 $46.00
40% 31% 30% 29% 28% 21% 9% 9% 10%
$2.57 $4.29 $1.84 $1.86 $2.86 $4.94 $3.17 $0.81 $2.27
17.7x 10.0x 12.9x 12.5x 12.5x 11.4x 10.4x 23.9x 32.1x
4.43x 2.77x 5.04x 1.35x 2.28x 2.11x 2.37x 1.35x 8.51x
OW Alexia S. Quadrani $56.00 OW Philip Cusick, CFA $30.00 OW Himanshu Patel, CFA $68.00 OW Matthew R. Boss, CPA $36.00 OW Michael Rehaut, CFA$21.00 OW Brian J. Tunick $80.00
CMCSA $23.19 VC M LEN ULTA
21 Wyndham Worldwide Corp.H otels Restaurants & Leisure WYN
25 Ulta Salon Cosmetics & Fragrance Inc. Specialty Retail
16
US Year Ahead 2012
JPM Coverage Current Price Market Cap $2,977 $14,629 $5,124 $45,062 $4,859 $34,759 $4,145 JPM Rtg JPM Analyst Target Implied Price Upside 87% 50% 34% 31% 17% 17% 15% 13% 8% 5%
EPS and Valuation 2012E EPS $1.18 $2.68 $34.67 $1.87 $21.69 $2.68 $2.30 $43.86 $1.13 $2.60 P/E ('12E) 21.8x 11.2x 11.3x 23.0x 17.1x 38.2x 13.3x 14.2x 23.6x 8.0x
Name Technology 26 Cree Inc. 27 Broadcom Corp. 28 Apple Inc. 29 Lam Research Corp. 30 MasterCard Inc. Cl A 31 Equinix Inc. 33 Google Inc. Cl A 35 Jabil Circuit Inc.
Industry
Ticker
P/B 1.19x 2.63x 4.74x 2.19x 7.89x 2.40x 3.15x 3.68x 5.99x 2.27x
Semiconductors & Semiconductor Equipment CREE $25.68 Semiconductors & Semiconductor Equipment BRCM $30.10 Computers & Peripherals AAPL IT Services MA Semiconductors & Semiconductor Equipment LRCX $42.86 $371.30 $102.48 Internet Software & Services QIX E Internet Software & Services OOG G
OW Christopher Blansett $48.00 OW Harlan Sur OW Mark Moskowitz $45.00 $525.00
$390.95 $363,352
OW Christopher Blansett $56.00 OW Tien-tsin Huang, CFA435.00 $ OW Sterling Auty, CFA $120.00 OW Christopher Danely $35.00 OW Doug Anmuth OW Rod Hall, CFA OW Steven J. O'Brien $705.00 $29.00 $22.00
32 Texas Instruments Incorporated Semiconductors & Semiconductor Equipment TXN $30.42 34 Riverbed Technology Inc. Communications EquipmentRVBD $26.74
$623.77 $159,686
Electronic Equipment Instruments & Components $4,343 JBL $20.86
NEAR-CYCLICALS: Energy, Financials Energy 36 Nexen Inc. 37 Consol Energy Inc. 39 Denbury Resources Inc. 40 Halliburton Co. 41 Buckeye Partners L.P. Financials 42 Citigroup Inc. 43 Allstate Corp. 44 Prudential Financial Inc. 45 INVESCO Ltd. 47 American Express Co. 48 Public Storage
Oil Gas & Consumable Fuels *NXY Oil Gas & Consumable Fuels CNX Oil Gas & Consumable Fuels DNR Energy Equipment & Services HAL Oil Gas & Consumable Fuels BPL
C$15.92 C$8,404 $40.80 $94.40 $16.86 $35.57 $63.40 $9,254 $11,503 $6,603 $32,730 $5,449
OW Katherine Lucas Minyard, CFA 95% C$31.00 OW John Bridges CFA, ACSM $79.00 OW Joseph Allman, CFA$167.50 OW Joseph Allman, CFA $28.50 OW Jeremy Tonet $74.00 94% 77% 69% 17%
C$2.02 $3.73 $4.70 $1.26 $4.10 $3.49
7.9x 10.9x 20.1x 13.3x 8.7x 18.2x
1.00x 2.70x 2.17x 1.38x 2.65x 2.32x
38 Pioneer Natural Resources Oil Gas & Consumable Fuels Co. PXD
OW J. David Anderson, PE, CFA 63% $58.00
Diversified Financial Services C Insurance Insurance Capital Markets Consumer Finance ALL PRU IVZ FHN AXP
$29.75 $27.12 $51.41 $20.67 $7.43 $48.56
$86,808 $13,705 $24,163 $9,322 $1,959 $56,402 $22,087
OW Vivek Juneja
$54.00
82% 47% 28% 14% 13% 8%
$4.42 $3.67 $7.00 $1.78 $0.66 $4.15 $3.84
6.7x 7.4x 7.3x 11.6x 11.3x 11.7x 33.7x
0.49x 0.76x 0.66x 1.17x 0.80x 3.14x 4.25x
OW Matthew G Heimermann $40.00 OW Jimmy S. Bhullar, CFA $66.00 OW Steven Alexopoulos, CFA $8.50 OW Richard Shane $55.00 OW Michael W. Mueller, $140.00 CFA
OW Kenneth B. Worthington, CFA 26% $26.00
46 First Horizon National Corp. ommercial Banks C
Real Estate Inv estment Trusts (REITs)$129.12 PSA
17
US Year Ahead 2012
JPM Coverage Current Name Industry Ticker DEFENSIVES: Staples, HealthCare, Telecom, Utilities Staples 49 Fresh Market Inc. 50 CVS Caremark Corp. 51 Procter & Gamble Co. 52 J.M. Smucker Co. 53 PepsiCo Inc. 55 Reynolds American Inc. HealthCare 56 HCA Holdings Inc. 57 Accretive Health Inc. 59 Mylan Inc. 60 St. Jude Medical Inc. 61 UnitedHealth Group Inc. 62 Pfizer Inc. 63 Celgene Corp. Health Care Providers & Services HCA Health Care Providers & Services AH Pharmaceuticals MYL $23.24 $23.00 $36.98 $19.81 $36.95 $48.29 $62.21 $42.40 $10,146 $2,259 $12,840 $8,449 $11,787 $51,478 $27,617 $2,698 OW John Rex OW Atif Rahim OW Chris Schott, CFA OW Michael Weinstein OW John Rex OW Chris Schott, CFA OW Geoff Meacham OW Cory Kasimov $38.00 $35.00 $28.00 $48.00 $60.00 $25.00 $75.00 $48.00 64% 52% 43% 41% 30% 24% 24% 21% 13% Food & Staples Retailing TFM Food & Staples Retailing CVS Household Products Food Products Beverages Tobacco PG SJM PEP RAI $40.55 $38.27 $76.67 $88.06 $41.63 $1,946 $49,813 $8,728 $38,162 $24,267 OW Ken Goldman OW Lisa C. Gill OW John Faucher OW Ken Goldman OW John Faucher OW Rae Maile $55.00 $50.00 $75.00 $86.00 $72.00 36% 31% 16% 12% 11% 7% Price Market Cap JPM Rtg JPM Analyst Target Implied Price Upside
EPS and Valuation 2012E EPS P/E ('12E) P/B
$1.32 $3.21 $4.20 $5.55 $4.63 $3.87 $2.96
30.7x 11.9x 15.4x 13.8x 14.0x 22.8x 14.1x
18.15x 1.34x 2.73x 1.64x 4.28x 3.19x 3.61x
$64.84 $178,396 $64.65 $101,074
54 Costco Wholesale Corp. Food & Staples Retailing COST
OW Christopher Horvers, $94.00 CFA
$3.46 $0.70 $3.18 $2.37 $3.57 $4.77 $2.31 $4.50 -$1.05
6.7x 33.1x 11.6x 8.4x 10.3x 10.1x 8.8x 13.8x 10.83x 2.98x 2.43x 2.66x 1.83x 1.73x 4.94x 4.55x
58 Agilent Technologies Inc. Life Sciences Tools & Services A Health Care Equipment & Supplies STJ Health Care Providers & Services UNH Pharmaceuticals Biotechnology PFE CELG ONXX
OW Tycho W. Peterson $53.00
$20.23 $155,507
64 Onyx Pharmaceuticals Inc.Biotechnology Utilities 65 NRG Energy Inc. Average

Independent Power Producers & Energy Traders $4,454 NRG $19.37
OW Andrew Smith
$33.00
70% 34%
$0.97
20.0x 13.0x
0.59x 2.64x
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US Year Ahead 2012
Figure 13: Top AVOID Stock Ideas from J.P. Morgan Fundamental Analysts
JPM Coverage Current Name Industry Ticker Price CYCLICALS: Materials, Industrials, Discretionary, Technology Technology 1 2 3 First Solar Inc. Citrix Systems Inc. Red Hat Inc. Semiconductors & Semiconductor Equipment FSLR $46.11 Software Software CTXS RHT $73.23 $50.55 $3,985 $13,657 $9,748 UW Christopher Blansett $40.00 UW John DiFucci UW John DiFucci $53.00 $32.00 -13% -28% -37% Market Cap JPM Rtg JPM Analyst Target Implied Price Upside
NEAR-CYCLICALS: Energy, Financials Financials 4 Franklin Resources Inc. Average

Capital Markets
BEN
$100.52
$22,168
UW Kenneth B. Worthington, CFA 10% $111.00 -17%
19
US Year Ahead 2012
Risks: 4 Thesis Changers to Downside

What Would Negate Our Positive Thesis Beyond Valuation? Swing Factors Fairly Straightforward
Euro-area crisis morphs into a systemic bank crisis. Europe entering a recession is built into our base case, and a reason we see $105 in 2012 EPS (vs. trend of $110115). But our view would be altered if Europes crisis spread beyond European banks and became a systemic global crisis. That is not the case; in fact, U.S. global banks are gaining market share as Euro banks delever. China hard landing. Similarly, we do not see a hard landing in China in 2012. A hard landing is a level of growth too slow to prevent a significant rise in unemployment rates and social unrest. Our China team does not see significant risk of a hard landing. This partly stems from better inflation readings, but also supported by the major government measures such as Rmb 1.8tr hydraulic resource investment, subway projects, as well as affordable housing programs. Oil at $150 from Middle East tension. In 2008, the surge in oil by itself was enough to cause a recession in the U.S. The catalyst for such a move in 2012 could follow any military action in the Middle East. While oil has been surprisingly stable, Colin Fentin, J.P. Morgans Global Commodity Strategist, does not see the risk of a surge in oil to these levels (he does see a 10% rise in S&P GSCI) given higher production, but of course the Middle East is the wildcard. Jobless claims above 470k. Lastly, if U.S. labor markets deteriorate, this would undermine a U.S. recovery thesis. After all, if corporate profits continue to expand but labor remains weak, this would likely result in the U.S. slipping back into recession. Historically, a 20% rise in claims from a cycle low has been a good harbinger of a recessionthe key level is 470k on the four-week average. Fortunately, four-week claims have been moving in the other direction, signaling strengthening of labor markets.
20
US Year Ahead 2012
#1: Risky Markets Expected to Rally in 12

Risky Assets Generally Have a Positive Outlook...
Surprisingly, despite the Eurozone uncertainty, J.P. Morgans Fixed Income teams see meaningful positive returns in their markets in 2012. This is positive for equities.
We have highlighted 2012 Outlook for risky assets based on targets established by J.P. Morgan Fixed Income and Equity Strategists and are summarized on Figure 14. As a framework, we view equities as the junior piece of the capital structure and the resulting value is based on the residual of macroeconomic and credit outlooks. Every strategist sees positive returns in their markets with the exception of Treasuries (10-year expected to rise to 2.5%). This bodes well for equitiesthink of it conversely, if credit was to have a negative outlook, how could equities necessarily rise? Notably, U.S. High Yield strategist Peter Acciavatti sees HY spreads rallying to 700bp and U.S. High Grade strategist Eric Beinstein sees investment grade rallying to 175bp, both new cycle lows. These are particularly correlated to equities, and thus are bullish.
Figure 14: 2012 Outlook for Risky Assets

Spreads in Fixed Income; Index Targets for Equities J.P. Morgan Risky Asset Treasuries (10-year) Strategist Belton/ Ramaswamy JULI Investment Grade Beinstein Current Target Delta Rationale Flight-to-quality rally in 1Q and trend higher Equity implication
2.04 246 776 56 330 14 442 476
2.50 175 700 35 225 11 350 400
+0.46 -71bp -76bp -19bp -105bp -3bp -98bp -76bp 10%
Neutral VERY Positive VERY Positive Positive Positive Positive Positive Positive Mixed Positive Positive
Wide divergence between strong corporate metrics and wide spreads lead to eventual rally
High Yield
Acciavatti
Defaults remain historically low
Fixed Income
MBS (MBS L-OAS) 10Y AAA 30% CMBS (2007 Vintage) 3Y AAA Credit Cards Emerging Markets Index (Fixed Income) Corporate EM Index (Broad) Commodities (S&P GSCI) EMEA (MSCI Europe) Asia (MSCI EM)
Jozoff Reardon
Solid fundamentals and wildcard of QE3 for mortgages Cautiously optimistic due to cheap fundamental credit risk
Sze Chang
Fundamentals remain solid 5%-10% total return in 2012, better fundamentals, low financing risk
Chang Fenton Matejka Mowat
Attractive yields against tail risks from Eurozone crisis Darker near-term outlook Relative value Supportive policy
1017 969
1150 1150
13% 20%
21
US Year Ahead 2012
#2: Consensus Is Cautious About 2012

In general, consensus is more cautious about 2012 compared to last year (when consensus was looking at 2011). There are many ways to illustrate this, but perhaps the simplest illustration is to look at top-down Strategists forecasts from Bloomberg (Figure 15, NI WGT <GO>). The mean year-end target is 1351. In some ways, this is a slightly bearish view. Why? This is lower than the April 2011 high of 1363given fixed income markets are forecasting spreads to be even tighter by YE 2012 vs. April, this implies even greater relative underperformance of equities. This also implies a YE 2012 P/E ratio of 11.2x, which would be the lowest P/E since 1950 for any market into its 46th month (the age of the bull market by December 2012) (see Figure 2). While not apparent from the figure below, the YE 2012 target is actually lower than the year-ago 2011 forecast of 1377 (as of December 2010).
Figure 15: Comparison of S&P 500 Targets for 2012
2012 based on those strategists that have established 2012 targets
1,375
1,400
1,500
1,350 S&P 500 Price Target
1,430
1,500
1,600
07 high
1,349
1,400 1,300 1,200 1,100 1,000 Broker 7 Broker 6

1,250
1,325
1,330
1,340
08 high 10 high
1,190
Broker 10
Broker 2
Broker 4
Broker 1
Broker 3
Broker 9 J.P. Morgan Broker 5 Thomas Lee
Avg
Source: Bloomberg NI WGT <<GO>>.
Bottom LineConsensus Is Cautious on 2012, a Contrast to a Year Earlier, When Consensus Was Bullish on 2011
Our takeaway is that the market is in a better position to be surprised on the upside given lowered expectations. A year ago, the Street was bullish on 2011 and perhaps, in retrospect, that was a very obvious caution sign. Today, the confidence in the 2012 outlook is low, given the myriad macro issues. And, thus, the market is likely better positioned for an upside surprise.
22
US Year Ahead 2012
#3: Euro Crisis to Abate by 2H12

J.P. Morgan Fixed Income Sees Euro-Crisis Abating by 2H12
Our Global Fixed Income team recently published its 2012 outlook. It sees 2012 as a bifurcated yeara worsening of the crisis in Europe, pushing spreads wider, followed by a coordinated response from ECB/EU/IMF that results in tightening of spreads. In the teams words: In our view, the crisis is likely to worsen in 1H12, before the ECB feels compelled to step in and stabilize markets by monetizing debt . . . We expect that the eventual response from the ECB, IMF and EU will be on a scale sufficient to ultimately stabilise peripheral yields in 2H12. Pavan Wadhwa, Global Fixed Income Strategist from Global Fixed Income Markets 2012 Outlook dated 11/24/11 Thus, the outlook for Europe in 2012 starts with the crisis worsening and then taking a turn for the positive. Granted, there is a lot of progress that needs to be made to get there. But consider that the pressure on markets today has resulted in the turnover of two governments (Greece and Italy) and, arguably, this pressure is working in favor of the core nations forcing change among the peripheral countries. The obvious risk is that the crisis spreads to banks and beyond and, thus, the ultimate response is not able to contain this. However, this is not the base case of our Fixed Income strategists. As for equities, a resolution of the crisis would be positive. And a rally in spreads should be positive for equities.
But the Current Situation Is a Negative Feedback Loop

What had started as a peripheral debt crisis in Europe in early 2010 has spread and engulfed the entire region in a crisis that seems very difficult to extinguish. There is plenty of blame to spread around from slow reforms of policymakers, lagged responses by ECB, to reluctance of core countries to support weaker countries for fear of socializing debt, to Euro banks with excessive exposure to sovereign paper. The fact is that cross-border capital allowed the weakness in the peripheral regions to quickly transmit through the rest of Europe. And as the feedback loop, produced by Pavan Wadhwa, J.P. Morgan Global Fixed Income Strategist, and his team shows, this has amplified the crisis (Figure 16).
The ECB Potentially the Cure: JPM Estimates 70Bn/Month Needed or Double Current Rate of Purchases...
J.P. Morgans Global Fixed Income team believes the crisis has spread so widely that the only institution that can end this crisis is the ECBthat is, it has the firepower to short circuit this feedback loop. However, there are multiple reasons it remains reluctant to intervene. Among the known reasons for its reluctance: 1) playing a larger role is deemed socializing the debt and provides a disincentive for structural reform; and 2) a larger role blurs the line between monetary and fiscal policy.
23
US Year Ahead 2012
For a variety of reasons, Wadhwa believes that the current official resources (IMF, EFSF, etc.) are not sufficient to fund both Italy and Spain if they both lose market access (see pages 13-14 of Global Fixed Income Markets 2012 Outlook dated 11/24/11) and therefore the ECB eventually needs to step in. Wadhwa estimates there is about 1 trillion of funding (350bn of primary plus 650-700bn of secondary selling less 135bn of private sector resources) or about 75bn per month of excess supply. This implies the ECB would need to double its current rate of purchases (from 35bn/month) to eliminate this imbalance.
Figure 16: The Negative Feedback Loop in Europe . . . Negative Trifecta
From 2012 Global Fixed Income Outlook by Pavan Wadhwa
Doubling of Rate of Purchases Does Not Seem UnfathomableBut JPM Believes Markets Will Need to Force ECBs Hand
At the moment, the view is that the ECB is not willing to commit to larger-scale purchases, based on self-imposed limits and the arguments noted above. However, there is no actual capacity constraint. In other words, there is no limit to how much the ECB would allow its balance to expand (beyond sterilization), but it does increasingly take on peripheral credit risk as it does so. And Germany and other parties have not been supportive of broadening commitment. From an equity market perspective, this suggests that markets are likely to react very positively if the ECB finally succumbs to market pressure. However, what will markets do in the interim? It is our view that, if the European situation stabilizes, equity markets will drift upthe reason being that global economic momentum remains and there still exists the positive option of an ECB intervention. And, if the situation worsens, it simply pushes us closer to ECB intervention, in our view. The main risk, in this view, is if the situation deteriorates to the point that even the ECB cannot intervene. However, we do not think we are at that juncture.
24
US Year Ahead 2012
While certainly a possibility, we believe those countries will see sufficient pressure from global policymakers to act prior to this.
But Europes Economy Is Slipping into Recession

Europes economy continues to contract, a natural by-product of rising funding costs (both sovereign and corporate), de-leveraging by banks, lagged policy response, and deteriorating business confidence. While the region managed to post 0.8% growth in 3Q, J.P. Morgan economists expect 4Q GDP to show contraction of at least -1% and negative growth until 4Q12. The weakening in the outlook is best seen in the downturn of the Euro-area PMIs. While the headline (Euro area) actually rose slightly in November, the country area data show that France is really the only country with an upturn in PMI and the rest of the region is likely weakening. The ECB is also likely to cut rates, following the downturn in the PMIs. J.P. Morgan forecasts a 25bp cut in December (2011) followed by moves in March 2012 and June 2012, resulting in its main policy rate falling to 0.50% and a similar narrowing of its interest rate corridor to +/- 25bp, resulting in a deposit facility rate of 0.25%.
Figure 17: Euro-Area PMIs Point to Recession . . .
From Global Data Watch dated 11/25/11
Figure 18: . . . And Likely Further Cuts by ECB

From Global Data Watch dated 11/25/11
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US Year Ahead 2012
What Outperformed After March 2009 Post-Lehman?

We compiled a list of the groups that outperformed following the lows established in 2009 (post-Lehman), as we think these groups should also be poised to outperform once the crisis in Europe reaches a resolution. Financials appears to be the sector with the most upside potential, as it outperformed by 77% following the March 2009 low. Cyclicals overall performed strongly, not surprisingly, outperforming by 22% on average. On the downside, Defensives overall underperformed by -34% on average, with Telecom leading to the downside with -49% underperformance.
Figure 19: 2011 YTD Sector Performance
% change YTD
Figure 20: Sector Performance After 2009 Market Lows

Forward 12-mo performance
Rank Sector S&P 500 1 2 3 4 5 6 7 8 9 10 Utilities Staples HealthCare Discretionary Energy Technology Telecom Industrials Materials Financials Cyclicals Near-Cyclicals Defensives
Absolute Relative Perf Perf -1.1% 10.0% 7.4% 6.0% 4.2% 3.1% 2.7% -3.2% -4.1% -10.7% -19.4% -2.0% -8.2% 5.0% 11.1% 8.4% 7.0% 5.2% 4.1% 3.8% -2.2% -3.1% -9.7% -18.3% -0.9% -7.1% 6.1%
Cyclicals and Near-Cyclicals underperformed sharply in 2011, and thus appear poised to outperform in 2012 once the European debt crisis is resolved.
Fwd 12-mo Perf after Rank Sector S&P 500 Relative Perf Financials Discretionary Industrials Technology Materials HealthCare Staples Energy Utilities Telecom Cyclicals Near-Cyclicals Defensives
3/09 Low 69%
1 2 3 4 5 6 7 8 9 10
77% 31% 27% 15% 14% -23% -27% -30% -36% -49% 22% 24% -34%
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US Year Ahead 2012
#4: Corporate Profit Margin Expansion

Still See Upside to Our 2012E/2013E EPS of $105/$110
We remain comfortable with our EPS forecast for 2012 EPS of $105, which is above top-down consensus of $102 and below bottom-up consensus of $108. As shown in Figure 21 below, S&P 500 EPS in 2011 is expected to surpass the prior high of $88 in 2007. The question for investors is whether to be thinking about a downturn in earnings given EPS is already at prior highs. Granted, we realize that with Europe in recession, there remains heightened risk of downside to earnings.
Figure 21: S&P 500 Annual EPS
Since 1990
$97.75 2011E
$120.00 $100.00
$88.18
$67.10
$76.28
$85.12
$65.47
$51.02
$55.12
$44.85
$23.42
$20.00 $0.00
1990
1991
$18.49
$40.00
1992
$22.77
1993
$28.07
1994
$32.68
1995
$38.74
$60.00
1996
$41.02
1997
1998
$44.33
1999
2000
2001
$45.16
2002
$47.94
2003
$55.44
$80.00
2004
2005
2006
2007
2008
2009
$60.80
2010
$85.28
Prior peak EPS
2012E
$105.00
But there are other reasons we see upside to profit margins. Specifically: While net income margins are approaching the prior peak of 9% (Figure 22), S&P 500 EBIT margins at 15% are still below prior peak of 18%. S&P 500 profit recovery is tracking slightly below that in prior earnings recovery cycles (Figure 24), suggesting that S&P 500 companies are not over-earning. Finally, we believe quality of earnings is higher today as inventory profits are running at only 3% of overall earnings compared to 15% seen during the 1970s and 1980s.
EBIT Margins Have Room to Expand Further

We realize the pushback is that net income margins already exceed their prior peak at 9.2% compared 8.8% in 2007 (Figure 22). On the other hand, EBIT margins at 15% (as a percentage of sales) are still below the prior peak of 18% in 2007. The reason for this is that interest expense and taxes (as a percentage of sales) are well below levels in 2007. We think such levels are somewhat sustainable given debt levels (as a percentage of sales) are lower than in 2007 and current low interest rates. EBIT margins still appear set to expand. Intuitively, this should result from operating leverage as sales expand. Currently, only 78% of S&P 500 companies
27
2013E
$110.00
US Year Ahead 2012
have re-attained prior peak EBIT margins. And those 78% have already exceeded the prior peak by 6% (index 100 = prior peak). At the sector level, 91% of Defensives are already operating at prior peak EBIT margins, compared to only 78% of Cyclicals and 66% of Near Cyclicals.
Figure 22: S&P 500 EBIT Margin and Net Income Margin
Since 2006
EBIT Margin Prior Peak EBIT Margin 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 12/06 4/07 8/07 12/07 4/08 8/08 12/08 4/09 8/09 12/09 4/10 8/10 12/10 4/11 8/11
Net Income Margin Prior Peak Net Income Margin
Prior Peak EBIT Margin, 17.5% 15.4% Prior Peak Net Income Margin, 8.8%
9.2%
Those Companies that Have Reached Prior EBIT Margin Peak Have Seen EBIT Margins Continue to Surge
Finally, consider Figure 23 below. We have plotted the composite EBIT margin of the 78% of companies that have exceeded prior peak EBIT margins. As this figure shows, their EBIT margins are above the prior peak and are continuing to expand. In other words, the prior peak is not a constraint. In the meantime, the 22% that have not exceeded the prior peak have seen EBIT margins continue to expand as well and at a faster pace. Thus, we see no reason why EBIT margins cannot improve again in 2012, pointing to EPS growing faster than sales.
28
US Year Ahead 2012
Figure 23: Indexed S&P 500 EBIT Margin

Since 2006
Indexed at 100 at Prior Peak for S&P 500 EBIT Margin in 2Q07
S&P 500 78% of cos that have Reattained Peak EBIT margin 22% of cos that have NOT Reattained Peak EBIT margin S&P 500 Pro-forma 106 19% 17% 91
LTM EBIT margin
EBIT Margin (% Sales)

S&P 500 78% of cos that have Reattained Peak EBIT margin 22% of cos that have NOT Reattained Peak EBIT margin S&P 500 Pro-forma
110
Indexed LTM EBIT margin
100 90 80 70 60 50 40 12/06 7/07 2/08 9/08 4/09 11/09 6/10 1/11 8/11 3/12 10/12 68
17% 15% 13%
15% 13% 11% 9% 7% 12/06 7/07 2/08 9/08 4/09 11/09 6/10
1/11 8/11 3/12 10/12
Source: J.P. Morgan and FactSet. Note: S&P 500 pro forma assumes companies that had re-attained peak EBIT margin by 3Q11 have flat EBIT margin through YE2012, while companies that had not re-attained peak EBIT margin by 3Q11 have re-attained peak EBIT margin by YE2012.
Current Profit Recovery In Line with Past Recoveries

Currently, our 2012 EPS forecast of $105 puts 2012 EPS at 118% of 2007s peak EPS (see Figure 24). This recovery in profits is actually below what has typically been seen in EPS recoveries following the Great Depression. We indexed earnings so that 100 was the prior peak in EPS (prior cycle). The composite EPS recovery since the Great Depression has been for EPS to reach 123% of prior peak in 22 quarters (2012 equivalent). Thus, the current recovery does not indicate an unprecedented surge in earnings.
Figure 24: S&P 500 EPS vs. Prior Peak
Indexed at 100 at prior peak EPS; since 1900
Peak in EPS 140
6/2007
Composite
Composite (post-Great Depression) 134 123 117 118 106
141
BU Consensus
Indexed S&P 500 EPS
120 100 80 60 40
126
-10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 Quarters since Peak EPS

Source: J.P. Morgan, FactSet, and Shiller.
YE 2012
YE 2013
YE 2014
29
US Year Ahead 2012
#5: De-Equitization of Markets Taking Place

Expect 28% Increase, or $250Bn Upside in Total Cash ReturnLooking at 2011 vs. 2007
We compared cash return statistics this year compared to 2007 (when S&P 500 profits were last near this level), and in our view the implication is that corporates are likely to vastly ramp up cash return activity. Our current EPS estimate for 2011 of $97.75 compares to profits of $92.15 in 2007, or 6.1% higher. Profits are not forecast to peak until after 2013 (i.e., 20142015). Buybacks totaled $711bn in 2007 and are only $574bn currently. But to true up to the 2007 implied level, buybacks would need to increase by 31% to $754bn. Dividends totaled $349bn in 2007 and are only $305bn currently. But to true up to the 2007 implied level, dividends would need to increase by 21% to $370bn. Total cash return totaled $1.1 trillion in 2007 and only totals $880bn currently. But to true up to the 2007 implied level, total cash return would need to increase by 28% to $1.1 trillion.
Figure 25: Dividends and Buybacks Likely Ramp Up . . .
2007 vs. 2011(annualized), $bn where applicable
EPS
$98
Buybacks
Implied level $754 $711
Dividends
Implied level $370 $349
Total Cash Return $245b implied Implied level increase in $1,125 total return
$1,060
$92
$305 $574
$880
2007
Source: FactSet.
2011
2007
2011 (annualized)
2007
2011 (annualized)
2007
2011 (annualized)
YTD 41% of Income Has Been Returned to Shareholders, Below 51% Long-Term Average and 78% in 2007
As we are all aware, S&P 500 profits are at all-time highs, with expected 2011 EPS of $97.75 surpassing the prior record. Despite this record high, corporate cash return is not anywhere close to prior highs. We define corporate cash return as buybacks and dividends. We compiled all stock activity for all 15,000 U.S. companies that are publicly traded (even those no longer trading) and plotted the data in Figure 26 below. Corporate cash return as a percentage of profits (we used NIPA corporate profits for this exercise, which is a fairly comprehensive measure of corporate net income) is currently about 41% of profitsamong the lowest levels since 1990 and well below the 20-year average of 51%.
30
US Year Ahead 2012
As noted in Figure 26, during the later years of an expansion, this figure has tended to rise to 65-80%. In 2007, companies distributed 78% of profits via buybacks and dividends, and in 2000 distribution totaled 84%. In dollar terms, this implies a buyback level in the range of $1.1-1.2 trillion, up substantially from $880bn currently. An increase in corporate buybacks of $300-400bn is no different than a similar increase in the dollar amount of inflows from retail mutual funds. This would be equal to the largest single year of inflows into equities by mutual funds.
Figure 26: Year to Date 41% of Corporate Profits Have Been Used to Buy Back Stock or Pay Dividends . . . Below 20-Year Average of 51%
Since 1990
Recession 90% 80% 70% 60% 50% 40% 30% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 37% 38% 32% 37% 33% 2009 2010 2011 annualized 48% 43% 43% 46% 57% 59% 52% 46% 47% 54% 65% 65% 63% 55% LT Avg 51% 41%
Mature stages
Mature stages
LT Avg
Cash Return as a % of CorpProfits 84%
78%
Towards 70%80%...
Source: FactSet. For % of profits, we compiled data on all companies since 1990 (~15,000 total securities). For profits, we used NIPA data from BEA.
Corporate Cash Return Likely to Dramatically Increase Buybacks and Dividends in Coming Quarters
Below we have compiled total cash return for the 15,000 companies since 1990 in Figure 27. The current figure is $880bn annualized with buybacks representing $574bn and dividends $305bn. The prior record year for total cash return was 2007, with a total of $1.06 trillion returned to shareholders via buybacks and dividends. On an annualized basis, 2011 is tracking below that level, with a total of $880bn. As for composition, we believe the delta in corporate cash return is likely to represent buybacks. Note that the current ratio of buybacks as a percentage of cash return is 65%. There are also incentives for companies to buy back stock versus paying dividendsnamely, the equity earnings yield is much higher than corporate bond yields. In other words, we do not see why corporates would want to accelerate buybacks given their equity is so cheap relative to credit.
31
US Year Ahead 2012
Figure 27: Buybacks and Dividends Are the Second Highest on Record . . .
Since 1990
Recession 70% 60% 50% 40% 30% 20% 36% 31% 22% 26% 27% 29% $363 $372 $353 $324 $329 $350 $491 48% 42% 52% 53% 53% 48% 47% 46% $706 54% 58% $858 Buybacks Dividends Buybacks as a % of Cash Return 65% 67% $1,060 59% 55% 56% $880 $652 65% $1,200 $1,000 $800 $600 $400
$349
$302
$299
$311
$587
$225
$190 $173
$186 $167
$157 $168
$153 $176
$143 $155
$365
$80$142
0%
$29 $103
$37 $107
$43 $113
$45 $101
$49 $121
$266
10%
$323
$145 $132
$144
$107 $148
$156
$170
$407
$450
$222
$160 $190
$556
$254
$196 $176
$574
-5.6 -6.3 12/10
$298
$711
$264
$287
$305
$761
$200 $0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 annualized
Source: FactSet. For % of profits, we compiled data on all companies since 1990 (~15,000 total securities). For profits, we used NIPA data from BEA.
S&P 500 Shares Have Fallen to Levels Not Seen Since 2001
The share count of the S&P 500 (ex-Financials) has declined since 2008, the first time this has occurred since 1990 (Figure 28). The share count has declined by 3% since 2006, highlighting the important role of corporates as the real incremental buyers of stocks (Figure 29). Since 1990, shares outstanding have increased 3-4% annually, thus, the recent declines are a substantial change in trend. As noted below, shares outstanding are currently at levels not seen since 2001. This is the first time since 1991 the share count is lower than it was a decade ago.
Figure 28: Share Count of S&P 500 Since 1991
Ex-Financials; data are for 355 current constituents of S&P 500 with data available since 1991
220 210
S&P 500 shares outstanding (b)
Figure 29: Five-Year % Change in S&P 500 Share Count

Ex-Financials; data are for 355 current constituents of S&P 500 with data available since 1991
30.0 25.0 20.2 20.0 15.0 10.0 5.0 0.0 -5.0 -10.0 12/96 12/98 12/00 12/02 12/04 12/06 -6.9 12/08 0.0 -4.4 15.6 15.3 15.1 23.9 25.8 27.6 27.6 21.3 14.9 10.1 S&P 500 ex Financials
200 190 180 170 160 150

166 170 173 176 179 182 186 189
12/91 12/93 12/95 12/97 12/99 12/01 12/03 12/05 12/07 12/09 9/11
Source: FactSet.
Source: FactSet.
32
5-year Delta in S&P 500 shares outstanding (b)
196
S&P Shares are back to 500 ex levels not seen since 2001
203 208 213 216 217 218 218 213 209 213 212 212
US Year Ahead 2012
33% of S&P 500 Companies Have Bought Back at Least 10% of Shares in Past Five Years
The reduction in shares outstanding for S&P 500 companies has also been widespread throughout the index, with 33% of S&P 500 companies (ex-Financials) reducing share count by 10% since 2006 (Figure 30). The companies with the top 20 reductions in share count have seen shares outstanding fall by an average of 35% (Figure 31).
Figure 30: Distribution of Companies by Five-Year Change in Shares Outstanding
% of companies in S&P 500 (ex-Financials) based on 5-year change in shares outstanding 33% of cos bought
35% 30% 25% % of companies 20% 15% 11% 10% 5% 0% <-10% <-20% -20% to -10% to -5% to 0% to 5% to >10% -10% -5% 0% 5% 10% % chg in Shares Outstanding (Now vs. 5 years ago)
Source: FactSet.
Figure 31: 20 Largest Decline in Share Count (% Change) Since 2006

% change in shares
Shares Outstanding Sector Name 1 Novellus Sy stems Inc. 2 WellPoint Inc. 3 AutoZone Inc. 4 DIRECTV Ticker NVLS WLP AZO DTV TRV BIG CPWR GPS VRSN GICS 5yrs ago 45 35 25 25 40 25 45 25 45 30 35 40 25 35 40 35 25 40 35 45 124 621 71 1,219 690 109 352 822 244 478 589 412 208 393 147 522 154 556 337 2,732 Current 67 349 40 715 413 67 218 527 159 312 387 278 141 272 102 362 107 397 243 2,002 Delta -57 -271 -31 -503 -277 -42 -134 -295 -85 -166 -202 -134 -66 -121 -45 -160 -47 -159 -94 -730 % chg -46% -44% -44% -41% -40% -38% -38% -36% -35% -35% -34% -32% -32% -31% -31% -31% -30% -29% -28% -27% -35%
33%
back at least 10% of shares
22%
20% 15% 15% 11% 7%
5 Travelers Cos. Inc. 6 Big Lots Inc. 7 Compuware Corp. 8 Gap Inc. 9 VeriSign Inc.
10 Coca-Cola Enterprises Inc. CCE 11 Medco Health Solutions Inc. MHS 12 Chubb Corp. 13 AutoNation Inc. 14 AmerisourceBergen Corp. 15 Torchmark Corp. 16 Aetna Inc. 17 Sears Holdings Corp. 18 Loews Corp. 19 Biogen Idec Inc. 20 Hewlett-Packard Co. Total
Source: FactSet.
CB AN ABC TMK AET SHLD L BIIB HPQ
U.S. Corporate Buybacks 6x Larger than European Corporate Buybacks

U.S. corporates have been much more aggressive at buying back their shares than European companies. To get a better sense for this, take a look at Figure 32 and Figure 33. Over the past five years U.S. corporates have executed buybacks equal to about 4% of market cap, a trend that has been steadily accelerating since 1995 when the level was closer to 1.5%. In contrast, European corporates have bought back shares amounting to 0.7% of market cap and this level has been consistent for the past 15 years. Thus, U.S. corporates have been buying shares at 6x the rate of European companies. This is obviously a significant difference and one reason we believe U.S. equities have outperformed European equities.
33
US Year Ahead 2012
Figure 32: U.S. Corporate Buybacks vs. European Corporate Buybacks

Buybacks as a % of Total Market Cap
US Corporate Buybacks as a % of Wilshir 5000 Market Cap e Europe Corporate Buybacks as a % of EuropeTotal Market Index 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 1996-2000 2001-2005 2006-2011 all Periods
Source: J.P. Morgan and DataStream. Europe data is based on the Datastream Europe Total Market Index. 2011 data is annualized.
Figure 33: U.S. Corporate Buybacks vs. European Corporate Buybacks

U.S. Corporate Buybacks/European Corporate Buybacks
1996-2000 6.0x 5.5x 5.0x 4.5x 4.1x 3.8x 2001-2005 2006-2011 5.6x all Periods
3.9%
2.6% 2.0% 1.5% 0.6% 0.7%
4.0x 3.5x 3.0x 2.5x 2.4x
0.5%
0.6%
2.0x 1.5x 1.0x 1996-2000 2001-2005 2006-2011 all Periods

Source: FactSet and Datastream. Europe data is based on the Datastream Europe Total Market Index. 2011 data is annualized.
Corporates the Incremental Buyers of Equities: 83% of All Inflows to Equities Have Been from Corporates
This leads us to the next critical point. Corporates really have been the incremental buyers of stocks. Take at look at the chart below, showing that since 1990 buybacks and dividends have been the largest incremental source of market demand. In total, there have been $11.5 trillion of total incremental flows into equities since 1990. Of this, mutual fund inflows totaled $1.9 trillion while $9.6 trillion came from corporates. We have not been able to obtain a similar figure for hedge funds, but it should be necessarily smaller. Look at how this has evolved in the past five years. In 2005-2009, for instance, corporate buybacks represented 60% of the total. Think about that: the real incremental buyers for stocks have been corporates. By the way, this figure, as we noted in the previous section, is likely to ramp up dramatically. Thus, we see the upside bid to equities continuing.
Figure 34: Corporates Have Been Incremental Buyers of Stocks
Since 1990; 2011 numbers are annualized
Buybacks $900 $750 $600 $450 $300 $150 $0 -$150 Dividends Mutual Fund Flows into Equities $11,528 $818 $705 $24 $1,920 $305 $296 $496 $4,381 $127 $185 $489 $470 $5,227 $184 -$61 Total
Figure 35: Corporates Have Been Incremental Buyers of Stocks

Since 1990; 2011 numbers are annualized
Buybacks 95% 75% % of Flows 55% 35% 15% -5% -25% 1990-1994 1995-1999 2000-2004 2005-2009 2010-2011
Source: FactSet and Investment Company Institute (ICI).
Dividends 38% 33% 30%
33%
$billions
$484 $224 $75 $109 $41 $183 $159 $143
Mutual Fund Flows into Equities 3% 17% 26% 37% 42% 38% 37% 60% 67% -9% Total 45%
49% 18%
83% of inflows are Corporates
37%
1990-1994 1995-1999 2000-2004 2005-2009 2010-2011

Source: FactSet and Investment Company Institute (ICI).
34
US Year Ahead 2012
#6: U.S. Housing Affirms Recovery in 2012

Our thesis has been that U.S. housing markets would stabilize in 2011, with shortages developing given the extremely low level of starts (see Positive on Housing Food Chain, Positive on Housing Food Chain II, and Housing Food Chain: Part III). While a bit slower to develop, evidence of a 2011 recovery is mounting: Building permits hit a three-year high at 653k (October) (Figure 36). NAHB Homebuilder sentiment hit a four-year high of 20 (November) (Figure 37). Vacancy rate of homes fell to 2.4%, the lowest since mid-2006 (Figure 38). Mortgage delinquencies (MBA) at 7.99% are the lowest since 3Q08 (Figure 39).
Figure 36: Building Permits Are Breaking Out of Prior Range . . . .
NHSPATOT Index GP <GO>
Figure 37: Homebuilder Sentiment Is the Best Since Early 2008

USHBMIDX Index GP <GO>
Breakout to 3-yr high

Distortion from homebuyer tax credit Distortion from homebuyer tax credit
Breakout to 4-yr high
3-yr range
3-yr range
Source: Bloomberg.
Source: Bloomberg.
Figure 38: Vacancy Rate of Homes

HVRAHOME Index GP <GO>
Figure 39: % Mortgages Delinquent MBA

DLQTDLQT Index GP <GO> MBA % mortgages delinquent
Lowest since 2006
Fewest since 3Q08
Pre-Bubble
Source: Bloomberg.
Source: Bloomberg.
35
US Year Ahead 2012
EXCESS HOUSING BASED ON VACANCY RATE, NOT SHADOW INVENTORY
Excess Home Supply Declined from 1.4MM to 1.1MM Recently

We updated our analysis using current data (but using pre-2007 as target levels) and compared this to 3Q10. What is notable in Figure 40 is that the total excess units have declined from 1.4mm to 1.1mm. We added another element of vacancy analysis called vacant other. This category of other + temp occ by URE (Usual Residence Elsewhere) could include homes held by banks and investors, and thus worth including in our view. As shown, this category is about 600k above the long-term trend. Of the 316k drop in excess homes, 71% or 224k is attributable to a drop in excess rental vacanciesin other words, there was a 904k increase in occupied rental units and a 132k drop in vacant rental units, or a net increase in rented units of 1.2mm (rental formation). The number of vacant homes declined slightly in the past year, by 87k, suggesting that the rise in rental demand was not all migrations from homeowners to renters.
Figure 40: Excess Inventory Has Declined from 1.4MM to 1.1MM
000s
Excess housing, in our view, is best gauged by looking at vacancy rate, not shadow inventory.
In 2010, we calculated estimated excess homes using the notion of vacancy rates. We used vacancy rates, rather than shadow inventory or foreclosure data, as the latter are better measures, in our view, of pricing supply/demand, rather than fundamental demand.
Why? The occupancy rate of homes that are delinquent today is close to 100% (primary residence); therefore, as these homes move through the foreclosure process, the occupant eventually needs to find shelter.
Homeowner: Calculating excess supply + + (a) (b) + Owner occupied home Sold but awaiting occupancy Vacant y ear-round for sale only Total homeowner units Current vacancy rate Target: 2005 Vacancy Rate Target homes vacant = Estimated excess housing units
3Q10 75,511 539 1,950 78,000 2.60% 2.00% 1,560 390
3Q11 75,250 512 1,863 77,625 2.40% 2.00% 1,553 311
Delta (261) (87) (375)
Thus, while the home will be liquidated, creating supply from a price perspective, the occupant will need to find a new shelter. In other words, this is not an excess home from a fundamental supply/demand perspectivethe occupant simply moves to another shelter.
(c ) (d )=(b) * (c) (e) = (b) - (d)
(8) (80)
Rentals: Calculating excess supply + (a) (b) + + Rental occuppied units Rented but awaiting occupancy Vacant y ear-round for rent only Total rental units Current vacancy rate (c ) (d )=(b) * (c) (e) = (b) - (d) = Target: 2005 Vacancy Rate Target rentals v acant Estimated excess rental units 37,395 467 4,371 42,233 10.30% 9.60% 4,054 317
Large increase in occupied rentals

38,299 652 4,239 43,190 9.80% 9.60% 4,146 93 (224) 904 (132) 957
Others: Vacant for "other supply" (a) (b) (c ) = (a) - (b) = Other + Temp occ by URE Target: Other + Temp occ by URE Estimated excess rental units Total excess units of housing
Source: J.P. Morgan and US Census Bureau. 2011 data are the latest available data, as of 4Q10.
4,843 4,150 693 1,400
4,830 4,150 680 1,083
(13) (13) (316)
36
US Year Ahead 2012
Household Formation Is Recovering as Well

In order to reduce excess housing inventory of 1.1mm (and therefore establish a sustainable basis for a housing recovery), there needs to be a recovery in household formation. However, this is still below the long-term average of 1.242mm (1959-2006) and reflects weak labor markets impairing household formation. A rise to the longterm average (Figure 41) would represent a doubling of household formation rates.
Figure 41: Household Formation Rates Are Slowly Recovering Are But Not at Normalized Levels
YoY change in household formation
3,000 2,500 YoY Household Formation LT avg ('59-'06)
YoY Household Formation
2,000 1,500 1,000 500 0 (500) 1/01 3/02 5/03 7/04 9/05 11/06 1/08 3/09 5/10 7/11 9/12 9/11 330 LT avg ('59-'06), 1,262
Trending higher
Source: Bloomberg and Datastream.
Figure 42: Household Formation vs. Employment Growth

Jobs and Households formed per net adult chg
HH formation per Net Adult Chg
Recession HH Formation per Net Adult chg Increase in Nonfarm Payrolls
Figure 43: Following Labor, HH Formation

Households formed per net adult chg
From trough HH Formed/ Net Adult chg Year of Trough
1,500 2,000
1.10 0.90 0.70 0.50 0.30 0.10 0.54 0.47 0.27 0.16 0.22 0.42
2,000 0 (2,000) (4,000)
Increase in Nonfarm Payrolls
1.30
4,000
in Ratio 1962 1966 1974 1982 1989 1995 b Avg All Years 2009 (today)
0 0.27 0.54 0.47 0.16 0.22 0.42 0.35 0.19
1 0.69 0.71 0.60 0.50 0.44 0.67 0.60 0.16
2 0.92 0.82 0.47 0.70 0.63 0.84 0.73 0.41
3 1.24 0.53 0.65 0.69 0.36 0.67 0.69
4 0.54 0.54 0.43 0.48 0.41 0.55 0.49
5 0.71 0.55 1.14 0.87 1.23 0.67 0.86
0.16
(6,000)
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
a b
Implied HHs formed Incr. Adults HH/adult (see above)
2011e 2012e 2013e 2014e 2.6mm 2.6mm 2.6mm 2.6mm 0.73 0.69 0.49 0.86 1.9mm 1.8mm 1.3mm 2.2mm
a*b Implied HHs Formed

This should bode well for household formation. As one can see, household formation varies with labor market conditions. The long-term average of households formed per net adult is 0.61, but in any year this ratio varies and has plunged during recessions but recorded similar bounces during labor recoveries. This ratio fell to cycle lows during the 2009 recession and has been slowly recovering.
37
US Year Ahead 2012
By the third year into a recovery, this ratio has recovered to the long-term average The pace of that recovery is illustrated in Figure 43 on the right. As one can see, households formed per net adult change accelerate meaningfully as labor market conditions improve.
Rent/Own Affordability Ratio Shows Owning Is Cheaper

Houses are inexpensive when comparing the cost of ownership vs. the cost of renting, suggesting households are better off owning than renting at this point. During the housing bubble of 2005-2007, the cost of owning greatly exceeded the cost of renting as housing prices became extremely elevated (see Figure 44). However, the sharp decline in home prices, combined with lower mortgage rates, has pushed the cost of owning well below the cost of renting again, with renting now 18% more expensive than owning.
Figure 44: Cost of Owning vs. Cost of Renting
Since 1990
$1,350 $1,250 $1,150 $1,050 $950 $850 $750 $650 $550 12/90 8/93 4/96 12/98 8/01 4/04 12/06 8/09 4/12 1998 2000 2002 Cost of Renting, 3Q11, $1,004
Cost of Owning Cost of Renting
18% more expensive to rent

Cost of Owning, 3Q11, $858
Source: J.P. Morgan REITS Research.
Lending Standards Have Finally Started to Ease

One of the biggest obstacles to a housing recovery so far has been the difficulty for many households in obtaining a mortgage in order to purchase a home. In response to the lending practices that helped fuel the housing bubble, banks and mortgage lenders have been continuously tightening lending standards for the past few years. As shown in Figure 45, bank mortgage loan standards have tightened in just about every quarter since the end of 2006. However, the net percentage of bank officers tightening standards has fallen sharply since late 2008.
38
US Year Ahead 2012
Figure 45: Bank Mortgage Loan Standards Easing

% of respondents tightening standards; Federal Reserve Senior Loan Officer Opinion Survey
Mortgage Loan Standards Prime Mortgage Loans Non-Traditional Mortgage Loans
Net % of Respondents Tightening Standards
80.0%
60.0%
Tightening lending standards
40.0%
20.0%
0.0%
Easing lending standards -20.0% 9/90 9/91 9/92 9/93 9/94 9/95 9/96 9/97 9/98 9/99 9/00 9/01 9/02 9/03 9/04 9/05 9/06 9/07 9/08 9/09 9/10 9/11
Household Leverage Back to Level in Mid-1990s, Creating Room for Taking on Mortgage Debt
U.S. households have repaired their balance sheets substantially during this economic downturn, reducing debt leverage significantly since the beginning of 2008. Figure 46 below shows the Household Total Financial Obligations Ratio. This ratio has fallen from 18.9 in 3Q07 to 16.1 as of 2Q11, bringing household debt leverage back to the best level since 4Q 1993.
Figure 46: Household Total Financial Obligations Ratio
Ratio of debt payments (payments on mortgage and consumer debt, auto lease payments, rental payments on tenant-occupied property, homeowner insurance, and property tax payments) to disposable personal income
At 16%, this ratio is comparable to levels seen during the early to mid-90s. Households have made rapid progress in deleveraging over the last few years.
Household Total Financial Obligations Service Ratio

Higher Debt
Current
Long-Term Avg 9/07 18.9
5yr Avg
19.0 18.5 18.0
Debt Ratio
17.5 17.0 16.5 16.0 15.5 15.0 3/80 3/82 3/84 3/86 3/88 3/90 3/92 3/94 3/96 3/98 3/00 3/02 3/04 3/06 3/08 3/10 12/93 16.1 Long-Term Avg 17.2 6/11 16.1
Lower Debt
39
US Year Ahead 2012
What Groups Outperformed When U.S. Housing Starts Accelerated?

Sector Strategy: Buy Cyclicals, particularly Discretionary
Following the trend of declining demand for housing, the supply of new housing has also dropped off significantly, as housing starts still remain near the lowest levels in the past 50 years.
Figure 47: Total U.S. Housing Starts
Discretionary has outperformed by 23% on average with a 100% win ratio following a trough in housing starts.
In 000s
Recession 3,000 2,500
Housing Starts
Housing Starts
Current
Trough
Energy has been the biggest laggard, underperforming by -22% on average.
2,000 1,500 1,000 500 0 1/59 1/62 1/65 1/68 1/71 1/74 1/77 1/80 1/83 1/86 1/89 1/92 1/95 1/98 1/01 1/04 1/07 1/10 10/66 843 2/75 904 11/81 837 1/91 798 628
U.S. housing starts have hit multi-decade troughs four times since 1959, as indicated in Figure 47 above. These troughs marked turning points in construction activity for U.S. housing and, along with it, U.S. economic activity. In the table below we have highlighted those groups that have historically outperformed when U.S. housing activity picked up (since 1973). Cyclicals in general have outperformed by 12%, led by Discretionary which has outperformed by 23% with a 100% win ratio.
Figure 48: Sector Performance After Trough in Housing Starts
Forward 12-month performance
Rank Sector S&P 500 1 2 3 4 5 6 7 8 9 10 Relative Perf Discretionary Technology Materials Staples Financials Industrials H ealthCare U tilities Telecom Energy Cyclicals Near-Cyclicals Defensives
Source: J.P. Morgan and Datastream.
2/1975 11/1981 1/1991 22% 10% 19% 17% -4% 29% -9% -10% 7% -22% -7% -11% -13% 12% -12% -12% 41% 39% -3% 23% 10% 10% 16% -1% -6% -34% 22% -12% 8% 11% -4% 3% 14% 22% -2% 19% -4% -15% -18% 2% 2% 3%
% Times Avg Outperform 17% 100% 23% 10% 10% 10% 7% 5% 4% -4% -10% -22% 12% -7% 0% 100% 33% 67% 67% 67% 67% 67% 0% 0% 0% 100% 33% 67%
40
US Year Ahead 2012
#7: U.S. Political Outlook Win-Win for Equities in Election Year

2012 Likely to Be Win-Win: Either Electoral Change or Better Economy Keeping Incumbents in Office
Investors have grown frustrated with Washington, as contentiousness and indecision have weighed on the U.S. economy and equity markets. Moreover, programs like Health Care Reform and Dodd-Frank, among others, have added uncertainty to the outlook for certain sectors. And, of course, the failure of the Super Committee speaks to the environment in Washington. However, as we look to 2012, we see an election year as a likely net positive going forward. Why? Our logic is simple: Electoral change likely positive for equities. Given presidential and congressional approval ratings near historically low levels (see, for example, Figure 49), 2012 creates the potential for electoral change, with a good chance of change in the House and Senate and potentially in the White House. Markets could embrace such change as it might be interpreted as likely to result in an era of deregulation/deinterferencethis should be good for equities. Conversely, if the economy recovers with incumbents remaining in office, this would also help equities. An improving economy would be good for equities. Historically equities have performed well when approval ratings leading into election year have been low. Currently, President Obamas approval rating of 43 is below the long-term average (since 1940) at the start of an election year.
Figure 49: Presidential Approval Ratings into an Election Year: President Obama Below Long-Term Average
Approval rating as of 12/31 of year prior to election
Presidential Approving Rating at Start of Year 90% 80%
President Approval Rating
Avg
76% 64% 66% 53% 66%
77% 63% 56% 48% 49% 46% 52% 49% 46% 42% 32% 60% Avg 53% 43%
70% 60% 50% 40% 30% 20% 10% 0%
23%
FDR (D) '40
FDR (D) '44
Eisenhower (R) '56
Eisenhower (R) '60
Truman (D) '48
Truman (D) '52
Nixon (R) '72
Carter (D) '80
Reagan (R) '84
Reagan (R) '88
Johnson (D) '64
Johnson (D) '68
Bush Sr (R) '92
Bush Jr (R) '04
Source: J.P. Morgan, Bloomberg, and Gallup.
Bush Jr (R) '08
Obama (D) '12
Clinton (D) '96
Clinton (D) '00
Ford (R) '76
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US Year Ahead 2012
Markets Have Rallied in Election Years When Presidential Approval Rating Was Below 50
In Figure 50 we have plotted the presidential approval rating at the start of an electrion year and equity returns for that same year: There have been eight elections of 19 when approval ratings were below 50%. Of these eight instances, stock market returns were positive seven times in the election year. The sole exception was 2008. And we would argue that 2008 was likely an exception as that was the only time when the U.S. economy was in recession. The other seven years are shown in Figure 51, and, as shown, the average gain for the S&P 500 in the election year was 13%. We believe this reflects investor optimism that changes could take place in Washington during such an election year. Bottom line: The disappointment from the Super Committee, in our view, is likely to solidify investor expectations that voter frustration could result in electoral changes.
Figure 50: Presidential Approval Ratings and Election Year Stock Market Returns
30% 80 20% 96 52 92 0% -10% -20% -30% -40% 20% 30% 08 40% 50% 60% 70% 80% Presidential Approval Rat ng at Start of Year i Approval rating below 50 76 72 88 68 84 48 00 40 04 56 60 44 64
Figure 51: Expansion Years Returns When Approval Rating Was Low in Election Year (<50%)
Before Election
After Election
S&P 500 Perf S&P 500 Annual Perf 20.3% 19.1% 15.8% 12.4% 11.8% 7.7% 4.5% 13.1% 100%
S&P 500 Perf in that year
10%
Year 1 1996 2 1976 3 1972 4 1988 5 1952 6 1968 7 1992
President Clinton Ford Nixon Reagan Truman Johnson Bush Sr
Party Democrat Republican Republican Republican Democrat Democrat Republican
President Clinton Carter Nixon
Party Democrat Democrat Republican
Bush Sr Republican Eisenhower Republican Nixon Clinton Republican Democrat
Sole exception
Avg % times up
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US Year Ahead 2012
Financials Have Consistently Outperformed During Election Years

Sector Strategy: Buy Financials
We also looked at sector performance during Presidential election years in the midst of an expansion in which the Presidents approval rating was low at the start of the year (<50%). Financials was the clear beneficiary, outperforming by 7% on average with a 100% win ratio. This is likely due to low expectations for the economy at the start of the year (signified by a low approval rating) combined with investor optimism regarding potential changes as a result of the upcoming election. Cyclicals overall also outperformed by 2%, again likely due to improving investor optimism during Presidential election years.
Figure 52: Sector Performance During Non-Recession Presidential Election Years When Presidential Approval Rating Was Low at Start of Year (<50%)
Since 1973
Financials outperformed by 7% on average with a 100% win ratio.
Cyclicals overall outperformed by 2% and Near-Cyclicals outperformed by 5%.
Defensives were big laggards, however, underperforming by -4% on average with only a 25% win ratio. The worst sectors on average were Utilities and HealthCare, both underperforming by 7%.
Rank Sector S&P 500 Abs Perf Relative Perf 1 2 3 4 5 6 7 8 9 10 Financials Technology Industrials Energy Discretionary Staples Telecom Materials HealthCare Utilities Cyclicals Near-Cyclicals Defensives
1976 19%
1988 12%
1992 4%
1996 20%
% Times Avg Outperform 14% 100%
4% 1% 6% 8% -5% -10% 6% -3% -17% -2% 0% 6% -6%
1% -13% -6% 4% 7% 2% 3% -6% 1% -4% -5% 2% 0%
15% 7% 4% -5% 14% -2% 8% 7% -10% -2% 8% 5% -2%
8% 23% 10% 3% -7% 4% -23% -4% 1% -20% 5% 5% -9%
7% 5% 3% 2% 2% -1% -2% -2% -7% -7% 2% 5% -4%
100% 75% 75% 75% 50% 50% 75% 25% 50% 0% 50% 100% 25%
43
US Year Ahead 2012
#8: China Entering Selective Easing Cycle

Debate continues on whether China can avoid a hard landing given growing imbalances in the economy (e.g., property prices, construction boom). Similarly, with headline inflation easing in China (5.5% vs. 6.1% prior month), our China strategists believe China is in a better position to begin easing interest rates (via RRR). Chinas economy becoming less dependent on exports The negative impact of external drags on China should be less severe than in past years, however, as Chinas economy has transformed over the past few years, with exports contributing a much smaller amount to economic growth. Instead, Consumption and Capital Formation have become more important drivers (Figure 53).
Figure 53: Chinas Economic Drivers
Chinas GDP growth by expenditure, percentage points
15.0
%point contribution to China GDP Growth
Final Consumption
Gross Capital Formation
Net Exports
13.0 11.0 9.0 7.0 5.0 3.0 1.0 -1.0 -3.0 -5.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1Q11 2Q11 3Q11
Exports have become a much less significant driver of economic growth in China in recent years.
Source: J.P. Morgan Research, from China Amidst Softening Global Growth, slide 2 from October 2011 by Jing Ulrich, Chairman of Global Markets, China.
Inflation Cooling Off, Providing Support for Easing Monetary Policy

Inflation in China has begun to ease recently, with CPI rising only 5.5% yoy in October vs. 6.1% the month prior and the cycle high of 6.5% in July. Pipeline inflation pressure has also benefitted recently from the moderation in global commodity prices, according to Frank Li, J.P. Morgans Chief China Strategist.
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US Year Ahead 2012
Figure 54: China Headline CPI, Food Prices, and Non-Food CPI Inflation
%oya
Inflation is cooling off, both in CPI and PPI, which has benefitted from a moderation in global commodity prices.
Source: J.P. Morgan Asia Pacific Equity Research, from "China Strategy: A Powerful rebound ahead", December 2011 by Frank Li, J.P. Morgan Chief China Strategist.
China Likely to Avoid a Hard Landing

China will likely avoid a hard landing, according to Frank Li, J.P. Morgans Chief China Strategist. Lis view is that Chinas economy has seen steady moderations in 2Q and 3Q, yet we see very little risk of hard landing, thanks to the economic housing projects and many 12th Five Year Plan related investment projects. Some examples of the governments supportive measures that are likely to help engineer a soft landing, according to Frank Li, are: Chinas massive Rmb1.8 trillion hydraulic resource investments. On October 13, China Development quoted the senior officials from Chinas Ministry of Hydraulic Resources as saying that China has planned Rmb1.8 trillion in investments for hydraulic resources. The building of more subways in tier one cities such as Beijing and Shanghai, and the building of new subway projects in 30 provincial capital cities. FAI projects from local governments, especially in western and central China.
Figure 55: China RRR Set to Move Down in 2012 as Inflation Cools
Since 1986
25.0% 20.0% 15.0% 10.0% 5.0% Required Reserve Ratio CPI YoY % chg 30.0% 25.0% 20.0% China CPI YoY % chg China Policy Rate
China Policy Rate
Figure 56: China One-Year Working Capital Rate Set to Be Flat/Up in 2012
Since 1986
China - 1-year working capital rate 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 1/86 9/88 5/91 1/94 9/96 5/99 1/02 9/04 5/07 1/10 9/12
Source: J.P. Morgan Economics.
CPI YoY % chg 30.0%
JPM Forecast
JPM Forecast
25.0% 20.0% 15.0% 10.0% 5.0% 0.0% -5.0%
15.0% 10.0% 5.0% 0.0%
0.0% -5.0% 1/86 1/89 1/92 1/95 1/98 1/01 1/04 1/07 1/10 1/13
Source: J.P. Morgan Economics.
China CPI YoY % chg

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US Year Ahead 2012
Sector and Style Analysis

Heading into 2012 with a bullish stance on equities overall, we continue to recommend a Cyclical/Financials tilt, as these groups look poised to outperform the overall market in 2012.
2011 Saw a Reversal of Outperformers of 2009-2010

As mentioned earlier, 2011 is a year most investors would like to forget. At the sector level, there was a sharp reversal of leadership between the groups that had outperformed since the start of the bull market in March 2009 and the groups that led in 2011. Since March 2009, Cyclicals and Financials were the clear leaders, with Cyclicals outperforming by 33%, led by Discretionary at 61% outperformance. Financials also performed strongly, outperforming by 23% since the March 2009 low.
Sector leadership reversed sharply in 2011, with Cyclicals and Financials moving from leaders to laggards, but we expect this trend to reverse again to favor these groups in 2012.
Figure 57: Sector Relative Performance
So far in 2011, however, this trend has sharply reversed, with Defensives the clear leaders, outperforming by 6%, while Cyclicals and Near-Cyclicals have underperformed. Financials have had a particularly rough year, underperforming by 18%. We expect this trend to reverse again in 2012, as the framework for 2012 is likely to look a bit like 2009emergence from a financial crisis and the potential for an acceleration of the business cycle (driven by Europe exiting recession and China easing). Thus, intuitively, we see Cyclicals and Financials outperforming again in 2012.
YTD performance and performance since 3/9/2009 relative to S&P 500
Relative Performance Since 3/9/2009

S&P 500 Abs Perf Discretionary Industrials Technology Financials Materials Energy -15.9% Staples -20.8% Utilities -29.9% HealthCare -31.3% Telecom -42.5% Cyclicals Near-Cyclicals Defensives 83.9% 60.9% 33.4% 24.2% 22.8% 12.7% S&P 500 Abs Perf
YTD Relative Performance

-1.1% 11.1% 8.4% 7.0% 5.2% 4.1% 3.8% -2.2% -3.1% -9.7%
Utilities Staples HealthCare Discretionary Energy Technology Telecom Industrials Materials Financials -18.3% Cyclicals Near-Cyclicals Defensives -25%
32.8% 3.4% -31.1% -60%-40% -20% 0% 20% 40% 60% 80% 100%
-0.9% -7.1% 6.1% -15% -5% 5% 15%
46
US Year Ahead 2012
Materials, Technology, and HealthCare Attractive on Relative P/E

Stocks look very attractively valued overall, as mentioned earlier, but valuations at the sector level vary significantly. Technology is currently the most attractive sector on valuation, based on comparing the current relative P/E of the sector to the long-term average relative P/E. Materials and HealthCare are also attractively valued on this metric. Utilities and Telecom are currently the most overvalued on relative P/E compared against the long-term average relative P/E. This likely reflects investor rotation into Defensives in 2011 to avoid some of the market volatility, thus driving up the relative valuation of Defensives in general. Overall, valuation appears to favor Cyclical sectors, supporting our case for outperformance of Cyclicals in 2012.
Figure 58: Relative P/E Compared to Long-Term Average
Since 1973; P/E of each sector divided by S&P 500 P/E
Current and Long-Term Avg P/E

Current Materials 85% LT Avg 94% 95%
Cyclicals
Discretionary Technology
107% 101% 102% 132%
Cyclicals
Industrials
106%
Delta of Current Minus Long-Term Avg P/E Delta Materials and Technology Materials -9% currently have Industrials 11% attractive valuations.
6% -30% Technology
Discretionary
Near Cyclicals
Energy Financials
Near Cyclicals
83% 83% 79% 75%
Energy Financials
1% 4%
Staples
Defensives
109% 103% 112% 115% 91% 71% 70% 90% 107% 110% 130% 150% 126%
Staples HealthCare Telecom Utilities -40% -20% 0% -3%
6%
Defensives
HealthCare Telecom Utilities 50%
34% 36% 20% 40%
Relative P/E
Relative P/E
Valuation of Defensives overall, particularly Utilities and Telecom, is currently less attractive, as investors rotated into Defensives in 2011
47
US Year Ahead 2012
Style Performance: Reversal of Style Leadership in 2011

Similar to the rotation in sector leadership in 2011 discussed earlier, 2011 also saw a sharp reversal in Style leadership. Riskier styles that have outperformed overall since the March 2009 low underperformed sharply in 2011. The top eight styles since March 2009 are highlighted in dark blue on the left side of Figure 59 below. In general, these styles are riskier as they typically have more volatility and are less consensus stocks. These styles that outperformed the S&P 500 have hit extreme levels since March 2009, with five of the eight outperforming by 100% or more. In 2011, however, these eight leading styles sharply underperformed. Only one of these eight styles (Citi Pure Growth) actually outperformed in 2011. Instead, less risky styles such as Defensives, Low Beta, High Quality, and Large Cap all outperformed. Similar to our sector outlook, we expect this trend of style leadership to reverse again in 2012, thus favoring riskier styles in 2012.
Style leadership reversed sharply in 2011, with riskier styles such as High Beta and Low Price changing from leaders to laggards, but we expect this trend to reverse again to favor these groups in 2012.
Figure 59: Style Relative Performance
YTD performance and performance since 3/9/2009 relative to S&P 500; Performance since 3/9/09 assumes rebalancing of styles at each year-end (12/31/09 and 12/31/10); Top 8 Styles since 3/9/09 are highlighted in dark blue on both charts below
Performance Since 3/9/2009

Market Cap Smaller Broken (low P/200d mavg) Beta Higher Price Lower P/B cheaper Citigroup Pure Growth Less Liked EV/EBITDA cheaper P/E cheaper Cyclical Citigroup Pure Value S&P Low Quality P/E more expensive S&P High Quality EV/EBITDA more expensive P/B more expensive Price Higher Defensive -0.9% More Liked Market Cap Larger -0.9% Beta Lower -13.8% Momentum (high P/200d mavg) -12.8% 151.6% 151.4% 136.8% 125.7% 111.8% 85.5% 92.7% 86.6% 85.0% 63.5% 58.7% 53.5% 42.6% 35.4% 28.9% 20.5% 2.0% 0.0%
YTD Performance
Defensive Beta Lower P/B more expensive S&P High Quality Price Higher Citigroup Pure Growth More Liked Market Cap Larger P/E more expensive -1.7% EV/EBITDA cheaper -1.8% Citigroup Pure Value -1.9% Cyclical -2.2% Broken (low P/200d mavg) -2.2% Market Cap Smaller -2.5% P/E cheaper -3.2% Less Liked -4.2% S&P Low Quality -5.3% EV/EBITDA more expensive -5.7% Momentum (high P/200d mavg) -7.0% P/B cheaper -7.1% Price Lower -7.3% Beta Higher -10.7% -15% -10% -5% 0% 6.4% 5.8% 4.2% 3.7% 3.7% 2.0% 0.4% 0.3%
-50% 0% 50% 100% 150% 200%
5%
10%
48
US Year Ahead 2012
Valuation of Styles Suggests Cheap Stocks Even Cheaper than Usual

We also looked at the relative valuation of the Styles to identify those groups that have performed well since the March 2009 low but are still attractively valued. For valuation, we compared the current relative P/E of each style (vs. S&P 500) against the ten-year average relative P/E. Low Momentum (Low Price/200-Day Moving Avg), Low Price, Cheap EV/EBITDA, and Cheap P/E are all currently attractive based on relative valuation (vs. ten-year average) and have all outperformed sharply since March 2009. Smaller Market Cap and High Beta also look relatively attractively valued (only slightly more expensive on a relative basis than the ten-year average) and have been two of the top styles since March 2009. Thus, as the market sees a reversal again in 2012, these two groups, in particular, should be poised for outperformance, in our view.
Figure 60: Style Performance vs. Valuation
X-axis is performance relative to S&P 500 since 3/9/09; Y-axis is the # of standard deviations that current relative P/E (2013E) is from the ten-year avg. relative P/E
High Momentum 1.40 Low Beta Expensive P/E
# of Std Dev from 10yr Avg Relative P/E
Low Momentum, Cheap P/E, and Cheap EV/EBITDA are currently attractive on relative valuation despite having already outperformed the market strongly since March 2009.
Expensive
0.90
Expensive P/B Defensive Expensive EV/EBITDA High Price S&P High Quality Less Liked
0.40
More Liked Mkt Cap Larger
Pure Value Cyclical S&P Low Quality
Pure Growth High Beta Cheap P/B Mkt Cap Smaller
-0.10
Cheap
Cheap EV/EBITDA -0.60 -15% Cheap P/E 5% 25% 45% 65% 85% 105% 125%
Low Price Low Momentum 145%
Relative Perf since 3/9/09

Source: J.P. Morgan and FactSet. Note: Ten-year average relative P/E is calculated using the stocks that currently fall into each style category and looking at those stocks relative P/E over the past ten years.
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US Year Ahead 2012
Economics
2012 U.S. Outlook: A Year of Gradual Healing
Robert Mellman
(1-212) 834-5517 robert.e.mellman@jpmorgan.com
Michael Feroli
(1-212) 834-5523 michael.e.feroli@jpmorgan.com JPMorgan Chase Bank NA
The economic recovery which began in the middle of 2009 has now entered its third year, and so far GDP growth in the first nine quarters of this expansion has averaged 2.4%. In both 2010 and 2011, the summertime produced a growth scare, which subsequently faded as the data stabilized, but not before the Federal Reserve was prompted to take additional actions to support the recovery. As was the case in 2010, as we come to the end of the year concerns about another recession have diminshed. One important reason why the economy has been able to continue moving forward after the debt ceiling disruption of the summertime is the still-depressed levels of cyclically sensitive spending. The bouncback from low levels appears to be a central factor behind the strength in capital spending, which has been a major force behind the recovery thus far. While capital spending is now returning to more normal levels, investment in housing and other structures remains unsustainably low, and should be a ballast for growth going forward. Even so, two risks loom over the 2012 outlook. The first risk relates to spillovers from the economic and financial crisis in Europe. Around 20% of U.S. exports are destined for Europe, and the economic contraction will surely impact demand from that market. If that were the only transmission channel the risks would appear to be contained. However, the potential financial spillovers could be larger. Thus far, most measures show only a modest impact of the European crisis on domestic credit availability. Nonetheless, if conditions in Europe worsen the U.S. economy would not be immune from a seizing up of global financial markets. The second risk is tightening of domestic fiscal policy. The recession produced an unprecendented fiscal policy response, as the federal deficit increased to 10% of GDP. The political tolerance for such large deficits has lessened recently, and several temporary fiscal stimulus measures are set to fade in 2012, which could subtract one to two percentage points from GDP growth next year. There has been some talk about extending these measures, but so far nothing has been agreed upon. The anticipated drag from fiscal policy is the main reason behind our view that growth will be below potential in 2012, when we anticpate growth will average 1.75%. This expected tightening of fiscal policy is likely to hit the economy where it is weakest: the household sector. Slack conditions in labor markets have eroded labors bargaining position, resulting in very tepid wage gains. This outcome has been positive for corporate profitswhich have received significant lift from restrained unit labor costsbut has held back consumers purchasing power. With wage inflation contained, the possibility of a wage-price spiral has been removed. The periodic episodes of higher headline inflation experienced in this expansion have not translated into lasting increases in underlying inflation. In the spring months of 2011, higher commodity prices, as well as temporarily higher prices of autos after the Japanese earthquake, gave a boost to core inflation. More recently, however, core inflation has eased back lower. With unemployment expected to remain elevated throughout 2012, we foresee more of the same on the inflation front: low wage inflation leading to low consumer price inflation.
50
US Year Ahead 2012
The low rate of inflation has given the Fed leeway to be creative in supporting the recovery. The two experiments this year were the giving a specific datemid2013for the zero rate funds guidance, and Operation Twist. We think the most likely next step for the Fed is to replace the mid-2013 rate guidance with language that is more explicitly dependent on a limited number of observable economic variables, particularly the unemployment rate. While we are not forecasting more asset purchases in 2012, the risk of this is high and rising (subjectively wed put it at around 40%). Moreover, Fed officials have shown an increasing openess to considering returning to MBS purchases. A significant setback in Europe, or an unwelcome fall in inflation expectations, could be all that is required for QE3.
51
US Year Ahead 2012
Equity Strategy Small Cap

A Year that Begins with Shattered Confidence Is Likely to End with Gains
Bhupinder Singh AC
(1-212) 622-6406 bhupinder.b.singh@jpmorgan.com J.P. Morgan Securities LLC
The market was completely bipolar this year with the Russell 2000 seeing doubledigit gains in 1H11 and a new record high, which quickly reversed into losses by 2H11. This period of high volatility is uncommon during the mid-cycle of an economic recovery, which is more characterized by yawnful up moves rather than recurring fears of a double dip. As we head into 2012, however, we believe the dark clouds will begin to lift as policymakers around the world are forced to action. Their actions are likely to inject hope and confidence that result in improving visibility, lower equity risk premia, and much higher equity prices. Overall, we remain constructive and believe U.S. small-cap companies will muddle through given the following backdrop and are likely to reach new all-time highs in 2012. 1) Negative real rates positive for the economy and risky assets With unemployment stubbornly high and inflation nowhere in the picture, the Fed should continue to keep policies favorable for the economy. This means real rates should remain negative, yield curve steep, and loan growth incrementally positive, which should support risky assets. This economic recovery never got a fair chance to air its wings due to the number of confidence crises and exogenous shocks; however, the persistent cyclical tailwinds were clearly evident in 3Q GDP growth and corporate earnings. This stop-and-go recovery means that this cycle will likely be longer, but growth will be lower. 2) Fundamentals encouraging with growth above investors grave expectations Based on consensus estimates, the median top-line growth for Russell 2000 is expected to be a healthy 7-9% in 2012 (Figure 61). This growth is not aggressive if nominal GDP growth comes in above 3%, as expected by J.P. Morgan Economists. Revenue growth coupled with productivity gains and limited wage inflation is likely to drive further margin expansion in 2012. All told, Russell 2000 EPS growth is likely to come in near 20%.
Figure 61: Russell 2000 Revenue Growth

Actual and Estimated Y/Y Growth
Figure 62: Incremental Net Income Margin

Last Ten Years
Estimates 20%
Quarterly Revenue Grwoth (YoY)
Russell 2000
R2K ex-Financials
Incremental Net Income Margin (bp) 400bp 300bp S&P 600 Net Income Margin 4.9% 6.0% 5.0% 6/11, 3.7% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% 6/03 12/04 6/06 6/09, -2.5% 12/07 6/09 12/10 -3.0%
15% 10% 5% 0% -5% -10% -15% 3/04 6/05 9/06 12/07 3/09 6/10 9/11 12/12
10% 8% 8% 7% 8% 9%
Incremental Margin (bp)
200bp 100bp 0bp -100bp -200bp -300bp -400bp 12/01
Source: Factset and J.P. Morgan.
52
Margin (LTM)
US Year Ahead 2012
3) Rich in cash and unlevered by historical standards Over the past two years, small caps have reduced credit risk substantially by extending maturities well into the future and/or paying off debt. In fact, the cash levels for small caps are near record level at around 10% of total assets while debt is near record low at 19% of total assets. If a slowdown were to materialize in 2012, these strong metrics should help to keep default rates low.
Figure 63: Cash as % of Total Assets S&P 600
Since 1996
11.5% 11.0% 10.5% 11.0%
27%
Figure 64: Debt as % of Total Assets S&P 600

Since 1996
27% 26% 25% 25% 25% 25% 24% 24%
The 15-yr average is 8.3%

10.4%
Debt as % of Total Assets
25%
24%
Cash as % of Total Assets
10.0% 9.5% 9.0% 8.5% 8.0% 7.5% 7.0% 8.1% 7.7% 7.5% 7.2%
1996 1997 1998 1999 2000
24%
9.9%
23%
23%
9.1% 8.7% 8.3% 8.0% 8.4% 7.9% 7.6%7.6%
21%
21%
21% 20% 19% 19%
7.8%
19%
The 15-yr Average is 23.5%
Current
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
17%
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Current
4) Technicals to become more favorable in 2012 The increasing volatility and record equity risk premium resulted in outflows from small caps totaling -$13bn year to date and M&A activity remained relatively subdued. However, the increasing rate of stock repurchases was encouraging with a record number of companies participating in 3Q11. In total, Russell 2000 companies bought back $22bn of stock, higher than the outflows seen from the asset class YTD. With improving visibility and declining volatility, we see: 1) M&A activity being more robust in 2012 with cash-rich U.S. corporates and underinvested PE firms; 2) flows reversing or stabilizing; 3) U.S. stocks likely to be seen as relative safe havens, especially with minimal international exposure by small caps; and 4) stock repurchase activity increasing with rising cash balances and high ROE.
Figure 65: Small-Cap Repurchases vs. Fund Flows
YTD
$25,000
Cumulative ($'s in million)
$15,000 $5,000 ($5,000) ($15,000) ($25,000)
The rate of buyback activity is increasing...
Buybacks, $21,949
Fund Flows, ($12,948)

...while Funds Flows remain negative.
1/11 2/11 3/11 4/11 5/11 6/11 7/11 8/11 9/11 10/11 11/11 12/11
Source: Factset and J.P. Morgan. 53
US Year Ahead 2012
5) Valuation more attractive both on an absolute and relative basis Russell 2000 now trades at only 8.0x on an EV/EBITDA basis (2011E) compared to 8.5x at beginning of the year and the ten-year average of 11.9x (see Figure 66). On a P/E basis, the Russell 2000 trades at 14.8x NTM EPS (vs. 15.6x at beginning of the year).
Figure 66: Incremental EBITDA Margin S&P 600
Last Ten Years
EV/EBITDA 2011E Cyclicals: Technology Industrials Discretionary Materials Defensives: Healthcare Staples Utilities Telecom Other: Financials Energy Index 7.0x 7.6x 7.0x 7.0x 5.8x 9.6x 13.4x 8.6x 8.2x 5.3x 9.7x 15.4x 6.4x 8.0x 2012E 3.9x 1.9x 5.9x 6.1x 5.1x 8.6x 12.1x 7.1x 7.5x 4.8x 8.0x 13.3x 5.0x 5.2x P/E 2011E 16.6x 17.2x 15.9x 18.0x 12.9x 54.1x 24.6x 18.4x -75.2x 21.0x 19.1x 29.5x 21.0x 2012E 12.8x 14.7x 11.9x 12.6x 10.4x 35.2x 15.1x 16.9x 54.2x 12.9x 12.5x 14.1x 14.8x
258.8x 103.2x
Investment Strategy
If the nominal GDP growth is at least 2% in 2012, we believe small caps are likely to deliver strong cash flow driven by revenue growth and continued margin expansion. These positive fundamentals coupled with declining equity premium and improving technicals should push the Russell 2000 to all-time highs. In this environment, we recommend investors overweight Small vs. Large, as small caps are likely to outperform large caps given the stronger growth and declining volatility from improving visibility, and overweight Growth vs. Value, as we are in the growth phase with investors chasing emerging ideas in this low-growth environment. We prefer Cyclicals over Defensives due to superior growth and lower valuation, especially after the sharp underperformance in 2011. At the sector level, we recommend Industrials and Technology over Consumer, given our view that U.S. Corporates are healthier than U.S. Consumers, and Materials over Energy with Chinas soft landing but both sectors should outperform the Russell 2000 in 2012.
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Equity Technical Strategy

2012 Outlook: 1100-1350 Trading Range for S&P 500; 600-800 for the Russell 2000
Michael Krauss AC
(1-212) 834-5103 michael.krauss@jpmorgan.com
Introduction
Our goal with this 2012 Outlook is to present a most probable base case and less probable extreme bullish and bearish tail risks, combined with likely Treasury and U.S. Equity targets under each scenario. As the financial markets are increasingly being driven by the gridlock of U.S. and European political and policy decisions, forecasting outcomes has become increasingly uncertain. Market participants in recent months have become increasingly neutral, retaining fewer risk positions, given the difficulty in anticipating global policy outcomes. Indeed, facts are changing almost daily in nearly manic-depressive fashion. Market whipsaws from risk-on to risk-off and back again have become commonplace from week to week, penalizing performance for many. From the technical analysis side, we have often provided singular annual roadmaps, when our confidence levels were high. That is not the case for this 2012 Outlook. Rather, we will attempt to lay out our most confident targets/ranges, and then the less likely bullish and bearish extremes. The markets now are like ships caught in the treacherously stormy seas of headline risk. We shall try our best to help navigate these difficult markets with flexible technical analysis views, furthering the goal of getting to a safe harbor, while avoiding a shipwreck against the rocks. More than any time in history mankind faces a crossroads. One path leads to despair and utter hopelessness, the other to total extinction. Let us pray that we have the wisdom to choose correctly Woody Allen
David Cohen, CFA

(1-212) 622-5338 david.e.cohen@jpmorgan.com J.P. Morgan Securities LLC
S&P 500 Index Outlook

2011 Outlook Reviewed: S&P 500 Index While our S&P 500 forecast for this year turned out to be more accurate than our ten-year yield forecast, looking back, it would have been better to have kept our S&P 500 scenario for the year from the 2011 Outlook, than to have made some subtle changes during March-April in our weekly U.S. Equity Technical Strategist report. Specifically, in the 2011 Outlook (written when the S&P 500 was at 1,175), we suggested that the SPX would peak for the year at 1,300-1,350 around mid-year, and then see a substantial correction down to a 1,100-1,130 yearly bottom in 2H (Figure 67). This roadmap was not far off, as the S&P 500 peaked for the year at 1,371 in May and bottomed at 1,075 in October.
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Figure 67: SPX Roadmap Used in 2011 Outlook Last Year: A 1,350 Best Case Mid-Year Peak and a Down 2H
S&P 500 Index Monthly Bars
Source: CQG and J.P. Morgan.
Unfortunately, we somewhat changed our preferred scenario in March-April. We suggested a 1,350-1,370 Sell in May and Go Away peak, then a May-September correction that would hold 1,200-1,220 key 2010 range highs, which would be followed by 1,400-1,430 new highs by year-end. After properly suggesting summer rally sales at 1,340-1,360, we were forced to turn bearish below 1,200 in July, and eliminate the 1,400s year-end target. On a positive note, we suggested buying in late September/mid-October amid 1,060-1,080 targets, for a rally towards 1,275 by yearend. That bottom and subsequent rally was accomplished in just three weeks, leading to a more neutral bias into year-end. 2012 Outlook Targets: S&P 500 Index For this 2012 Outlook, our base case assumption is for the S&P 500 to form a 1,350 to 1,100 trading range into December 2012 (Figure 68). It will be difficult for Equities to sustain back above the 1,300-1,350 trendlines, as long as the European sovereign debt crisis and recession lurk in the background. Similarly, it will be tough to move below strong 1,075-1,100 clustered support, as long as the U.S. avoids an economic recession, earnings stay elevated, and investors remain defensively positioned. We give this outcome a likelihood of 80%. Indeed, with this years range defined at the 1,371 May 2 peak and 1,075 October 4 low, it is reasonable for 2012 to form an inside range year, in our view.
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Figure 68: We See a 1,350 to 1,100 Base Case Scenario for the S&P 500 in 2012 (80% Likelihood)
For next year, resistance near our anticipated 1,350 2012 range high includes: 1,300 right shoulder channel symmetry with the July 2010 low/October 2011 low/April 2010 high (Figure 69), 1,325 May-July weekly downtrendline, 1,342 October 2007May 2011 monthly downtrendline (Figure 68), 1,348 violated March 2009-July 2010 monthly uptrendline (Figure 68), 1,353 March 2009-July 2010 0.618 upside swing target, 1,355 parallel internal channel high on the quarterly bar chart off the 4Q02 low, 1Q09 low, and 1Q00 high (Figure 71). Just above, 1,371 is the May top, and 1,400 is the channel high off the July 2010 low/October 2011 low/May 2011 high (Figure 70).
Figure 69: S&P 500 Index Weekly Chart Parameters
S&P 500 Index Weekly Bars
Figure 70: S&P 500 Index Monthly Momentum Gauges Are Currently in a Bearish Setup
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Figure 71: This Years 1,371 May Top in the S&P 500 Stopped Exactly on This 1Q00 Internal Channel High
S&P 500 Index Quarterly Bars
On the downside, key supports near our anticipated 1,100 range low include: 1,121 is the October rally 78.6% retrace (Figure 69), 1,113 is the rising 200 month MA (Figure 68), 1,100 is the May-October 0.618 downswing measure, 1,106 is the declining 40-month MA (Figure 68), 1,101 is the March 2009 38.2% retrace, and 1,075 is both the October low and January 2009-July 2010 weekly internal trendline (Figure 68). We respect the fact that the S&P 500 has made higher annual lows in each of the past three years, 666 in March 2009, 1,011 in July 2010, and 1,075 in October 2011 (Figure 70). S&P 500 Bullish versus Bearish Alternatives A more optimistic Equity case for 2012 would necessitate several of the following fundamental and policy outcomes: positive resolution of the European crisis, ECB quantitative easing, upward revisions to the J.P. Morgan U.S. Economic forecast, U.S. fiscal policy stimulus, Fed QE3, and a China soft landing. We estimate a likelihood of only 8% for this outcome. Under the above global risk-on situation, the S&P 500 technically targets 1,500. Here: 1,473 is where the March 2009 bull market would equal the October 2002October 2007 bull market, 1,510 March 2009-October 2011 0.618 upswing measure (Figure 72), 1,511 is the parallel internal channel high on the quarterly bar chart off the 4Q02 low, 1Q09 low, and 4Q07 top, and 1,564 March 2009-July 2010 equal upswing measure (Figure 72). Longer term, 1,600 is the trendline off the January 2000 and October 2007 peaks (Figure 72), 1,780 is the March 2009-October 2011 equal upswing (Figure 72), and 1,907 is the March 2009-July 2010 1.618 swing parameter (Figure 72).
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Figure 72: We See Potential Upside for the S&P 500 Near 1,500 in a Global Risk-On Scenario (Only 8% Likelihodd)
A more pessimistic Equity case for 2012 would arguably necessitate global contagion from an unraveling of the European debt crisis, if not a dissolution of the EU itself; a U.S. economic recession, zero U.S. fiscal policy stimulus given continued partisan rancor from Congress and the President, and a Chinese hard landing. We ascribe this outcome a likelihood of only 12%, yet that is higher than the bull case. The bear global risk-off case technically targets 950-1,000, and possibly 800 (Figure 73): 1,025 is the quarterly chart internal trendline with four points of contact since October 1998 (Figure 71), 1,019 is the March 2009 50% retrace, 1,011 is the July 2010 bottom (Figure 72), 997 is the May-October equal downswing measure (Figure 73), 956 is the June 2009 high breakout, 936 is the March 2009 61.8% retrace (Figure 73), 814 is the May-October 1.618 downswing collapse measure (Figure 73), and 785 is a downside projection from a potentially developing two-year Head and Shoulders top pattern (Figure 73). Repeating the last sentence of both the 2010 and 2011 Outlooks, We do not expect the 666 cycle low breaking, absent a global depression.
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Figure 73: We See Downside to 950-1,000 (Maybe 800) in a Global Risk-Off Scenario (Only 12% Likelihood)
S&P 500 Index Weekly Bars
Absent a resolution to the European debt crisis, and a market-friendly outcome to the November 2012 presidential election, we believe it will be extremely difficult to exceed this Mays 1,371 S&P 500 peak during 2012. If our favored 1,100-1,350 range proves incorrect, it is technically more likely that the downside support breaks, rather than the upside barrier. To that end, note that we did give slightly higher likelihood to the bear case than the bull case. There are four main factors for this defensive rationale: Monthly momentum retains a July sell signal (Figure 70). These signals have tended to last 7-9 months on average, which in this case would last into FebruaryApril 2012. If correct, then the typical Equity seasonality would not work in 2012, like it did in 2011. Equity seasonality typically sees a decline from May until October, and then a rally into May. Seasonality only works when the underlying technical, sentiment, and momentum conditions are supportive of the seasonal influence. This year, May peaked in our target zone of 1,350-1,370 by mid-year (U.S. Equity Technical Strategist), with distinct weekly momentum loss, and ebullient sentiment. Oppositely, the October seasonal bottom achieved our target low of 1,060-1,080 in late September/mid-October, with diverging weekly momentum, and alarming pessimism. The 1,270 200-day moving average is falling with the major market averages trading below the moving average (Figure 69). To many technicians, that is the definition of a bear market. To us, the slope of the line is more important than the level, and changing the slope of the line can take months. A bull market would require the slope of the 200-day moving average to start rising, and for the market to sustain back above it. The Elliott Wave pattern interpretation is bearishly concerning, as the May-toOctober downtrend from 1,371 to 1,075 was an impulsive five-wave decline, and the subsequent rally to 1,293 has so far been a corrective three-step affair (Figure 73). Under Elliott, another five-wave decline is needed to either complete
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a large corrective ABC decline from May (ultimately macro bullish), or start a very negative progression of a larger five-wave collapse (macro bearish). Either way, when subjectively interpreting Elliott Waves, sequences of five-wave declines and three-wave rallies are symptoms of bear markets that are incomplete. Note that at 997, equal downswings from the May and the October highs would measure in a large ABC decline (Figure 73). There is a possibility that the S&P 500 has been forming a massive two-year Head and Shoulders Top pattern (Figure 73). The risk in this symmetrical pattern is that the April 2010 peak is the left shoulder, the May 2011 top is the head, and the October 2011 rally is the right shoulder (Figure 73). The 1,075 July 2010-October 2011 uptrendline would be the neckline (Figure 73). A parallel channel off the neckline, touching the 1,220 April 2010 high provides interesting symmetry with the 1,293 October 2011 peak (Figure 73). Decisive weekly closes above 1,325-1,350 on superior advance-decline breadth would invalidate this foreboding pattern, which theoretically measures to 785 on a neckline breakdown (Figure 73).
Russell 2000 Index Outlook

The Russell 2000 small-cap index peaked at an 868 all-time high on May 2, with a bearish key reversal day rejecting the top end of a 1998-2009 annual chart channel high, after slightly exceeding the 856 July 2007 top (Figure 74). The RTY risks a 2011 downside reversal year with a December close below 2010s 783.65 annual close (Figure 74). This would favor some additional weakness in 2012.
Figure 74: Russell 2000 Is Likely to Complete an 868 2011 Bearish Reversal Year at the End of December
Russell 2000 Index Yearly Bars
Like the S&P 500, the Russell 2000 is most likely to trade within this years range in 2012. The 602 bottom on October 4 scored a bullish key reversal day, and substantially held major supports: 605 March 2009 50% retrace (Figure 75), 596 150-month moving average (Figure 75), 596 May-August fifth-wave down target (Figure 76), 593 March 2000-April 2004 internal trendline (Figure 74), 588 July 2010 low (Figure 76), 547-553 August-November 2009 lows (Figure 76), and 543 March 2009 61.8% retrace (Figure 75).
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Figure 75: Russell 2000 Index Monthly Parameters

Russell 2000 Index Monthly Bars
Figure 76: Russell Index Rejects 767-782 Key Resistance

Russell 2000 Index Weekly Bars
The October 4-October 27 rally surged 27.9% to 769, in 17 trading days. Despite this strong showing, the RTY lifted in a corrective ABC fashion, and failed squarely in the 767-782 major resistance band, which shall be a major roadblock in 2012. This barrier includes: 765 right-shoulder symmetry with the possible April 2010 left shoulder and May 2011 head, 766 May-October 61.8% retrace, 767 March-June Head and Shoulders Top neckline, 773 June low, 776 March low, 778 falling 40week moving average, and 782 April 2010 internal trendline (Figure 75 and Figure 76). Bulls need a weekly close above the 812 July 18 low breakdown/May 78.6% retracement to garner sufficient momentum to retest the 868 May peak, if not score new all-time highs towards the 910 1990-2009 monthly channel high, 927 March 2009-May 2011 0.618 swing projection, and 991 March 2009-July 2010 equal upswings (Figure 75). Finally, the November 2012 Presidential election outcome should be a very important driver for the S&P 500 in the final two months of 2012. While we have no political aims in this Outlook, we can see the SPX index about 100 points higher on average through 2013 under a Republican victory than a President Obama reelection. Increasingly, many investors feel the current Democratic administration has been regulatory heavy and unwilling to cut entitlements. At the margin, one would expect a shift to the Republicans to be welcomed by the Equity investor class.
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Quantitative Strategy
The Current Landscape and the Year Ahead
Dubravko Lakos-Bujas AC
(1-212) 622-3601 dubravko.lakos-bujas@jpmorgan.com J.P. Morgan Securities LLC
2011 has been a year when risk aversion has been the recurring theme. The market has essentially been oscillating back and forth between a risk-on and risk-off stance and has been very sensitive to headline news. Given these market conditions, not surprisingly, among the various popular investment styles in the U.S., Quality and Price Reversal have been leading the pack with stock selection factors, such as Earnings Dispersion, Earnings Revisions, ROE, Dividend/Buyback Levels, 30-Day/14-Day Price-Reversal/RSI, being the dominant drivers of returns (see figure Figure 77).
Figure 77: 2011 Cumulative L/S Factor Performance (Top Quintile Bottom Quintile) MSCI US
Source: Bloomberg, Compustat, I/B/E/S, MSCI, and J.P. Morgan.
Interestingly, Value as a style has continued its sideways-moving trend that began back in 2009. While it has yet again struggled to deliver this year, on a relative basis Value has held up a lot better in the U.S. than what we have seen in other global regions, such as Europe and Asia Pacific. Going forward, while there certainly may be room for bottom-fishing, especially in periods like the beginning of 2012 due to year-end/rebalancing effects, it is equally compelling to say that the Value pain trade might be here to stay for some more time. In fact, the level of dispersion in valuations across U.S. stockswhich can serve as a powerful barometer for style timingdoes not seem to provide a strong case for value to outperform in the upcoming period. While the level in valuation dispersions has been ticking up, it is still not significantly above historical levels and it is far off 2008 highs (see Figure 78).
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Figure 78: Level of Dispersion in Equity Valuations (Based on Stocks Fwd P/E) MSCI US
With a lot of macro/tail risks still prevailing, we might quite likely continue to face a sideways-moving market environment in the months and quarters ahead. As a result, we think it is fair to say that a similar factor performance landscape to the one we saw this year may indeed continue to prevail, with Quality as a style likely to remain a dominant driver of future returns. Moreover, Quality is not expensive from a valuation point of view relative to history and previous market crisis periods. The valuation spread between high- and lowQuality names has remained steady, suggesting there is room for the spread to expand and thus for higher-Quality names to outperform (see Figure 79).
Figure 79: Level of Dispersion in Equity Valuations (Based on Stocks Fwd P/E) Between Highand Low-ROE Names MSCI US
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In addition, in the current market environment where systemic risk has been the main driver of returns and stock-specific news has taken more of a back seat, getting ones systemic risk exposures right, such as Beta, has never been more important. The reason this matters to all stock pickers, whether quantitative or fundamental in nature, is because with stock return dispersions at historically low levels and stock return correlations simultaneously hitting record highs, the investor community has been presented with a very challenging stock pickers environment (see Figure 80). In fact, getting ones systemic risk/style exposures wrong could be quite costly and could easily wipe out gains realized through pure stock selection and incur additional losses.
Figure 80: Stock Return Dispersion and Correlation Levels MSCI US
A great example was the third quarter of this year which saw a relatively sharp unwinding of the beta traderotation from higher- to lower-beta nameswith Beta underperforming by more than 25% in that time period (see Figure 81).
Figure 81: Cumulative L/S Performance for BETA (Top Quintile Bottom Quintile) MSCI US
Source: Bloomberg, Compustat, I/B/E/S, MSCI, and J.P. Morgan. 65
US Year Ahead 2012
This has quite possibly been a painful ride for managers who did not have a tight grip on their portfolios Beta exposure (i.e., were long beta relative to market) and also possibly ones with a positive bias to valuethus implicitly capturing a positive Beta bias, as high-Beta names have been sold off and have become inexpensive on a relative basis. Unless one has strong skill in timing the market, we urge managers to be very careful with respect to managing their portfolios systemic risk/style exposures in the upcoming quarters and especially in an environment like the current one.
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Accounting & Valuation

Macro Uncertainty Takes Many Forms
Dane Mott, CFA, CPA AC
(1-415) 315-5905 dane.mott@jpmorgan.com
Amy Schmidt
(1-415) 315-6705 amy.m.schmidt@jpmorgan.com J.P. Morgan Securities LLC
We expect the key theme of macro uncertainty to continue to be an overhang on the markets into 2012. The actions or inactions of Congress and the Obama Administration, the U.S. Securities and Exchange Commission (SEC), the Federal Reserve, U.S. Financial Accounting Standards Board (FASB), the International Accounting Standards Board (IASB), and other key decision makers in 2012 will substantially influence the pace with which the macro uncertainty begins to abate. Heightened tax policy uncertainty will continue through 2012 Partisanship was a key political theme in 2011, and we expect it to be a dominant theme in 2012 as Congress and the Obama Administration focus on the November 2012 elections. We assign a very low probability to the potential for any substantive tax changes being enacted until after the elections. Our expectation is that extender legislation maintaining the status quo will likely be enacted to carry forward most expiring 2011 tax policies to the end of 2012. Based on history, there is a potential that many of the expiring 2011 tax provisions may not get extended until the first quarter of 2012. Some of the high-profile tax code provisions that will expire at the end of 2011 unless they are extended are: The temporary 4.2% Social Security payroll tax for employees (rather than the traditional 6.2% rate); The research and development tax credit; The state and local tax deduction for federal tax purposes; The biodiesel and ethanol tax credits; The Subpart F active financing exemption. As we move further into 2012, the focus will shift to 2013 tax policy, and the November elections will have a lot of influence on defining the landscape of that environment. We are not likely to have clarity on the likelihood of the extension of the Bush-era tax cuts that expire in 2012 until the outcomes of the November elections are known. In addition, any hope for substantive legislative actions such as substantive tax system overhauls or economic stimulus in the form of special incentives for U.S. multinationals to repatriate foreign earnings will likely get pushed to 2013 at the earliest due to their controversial nature. In December 2010, the Simpson-Bowles Deficit Commission called for substantial overhauls to the U.S. federal tax system. The Gang of Six made similar appeals. The drama related to the debt ceiling resulted in the creation of the 12-member Congressional Joint Select Committee on Deficit Reduction (the Super Committee) which was ultimately unsuccessful at agreeing on $1.5 trillion in spending cuts by its November 23 deadline; thus, automated federal spending cuts of $1.2 trillion are triggered that are to begin in 2013 and are to be spread evenly across defense and non-defense accounts. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 provided companies with 100% bonus depreciation in 2011 and 50% bonus depreciation in 2012. There could be some consequences in 2012 of the reduced
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bonus depreciation relative to 2011 levels since some activity that would have otherwise occurred in 2012 could have been accelerated into 2011 to take advantage of the tax benefit. If we approach the end of 2012 and it becomes likely that the 50% bonus depreciation will not be extended into 2013, some 2013 capital spending may be accelerated into 2012. Another ramification of the eventual end of accelerated depreciation periods will be that U.S. corporations will systematically have a historically low depreciation tax shield available to them in the initial period of a return to the traditional depreciation tax policy since depreciation from prior years capital expenditures will be largely exhausted. Heightened accounting standard uncertainty will continue through 2012 The U.S. Securities and Exchange Commission (SEC) had previously indicated that it would provide more guidance by year-end 2011 on the potential for the U.S. to move from U.S. GAAP to IFRS, but our sense is that this decision will likely get pushed out until 2012. The process to converge U.S. GAAP standards issued by the FASB and IFRS issued by the IASB began during the early 2000s. While convergence initially appeared to be a win-win for all stakeholders when the process began in earnest, deeper investigation of the differences between U.S. GAAP and IFRS, two financial crises (one starting in the U.S. and one starting in Europe), and the inability for the boards to agree on some key areas of joint projects have all called into question the ambitiousness of the convergence plans. Based on our conversations with various U.S. stakeholders, our sense is that there is less support for a move to IFRS in the United States than there was prior to the financial crises of 2008 and 2011. At this point, we think full adoption of IFRS by the U.S. is unlikely within the next five to ten years. Our sense is that the most likely arrangement will be a more explicit set of rules of engagement between the U.S. Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). In our view, the most viable proposal detailing how the future relationship between FASB and IASB could be structured is laid out in a comment letter from the Financial Accounting Foundation (FAF) to the SEC. The FAF is the organization with responsibility for the oversight, administration, and finances of the FASB. Currently, FASB and IASB are working on four key joint projects during 2012: 1) financial instruments, 2) insurance, 3) leases, and 4) revenue recognition. All four are controversial. We do not expect any of these proposals to be effective before 2015. The IASB and FASB recently released a joint exposure draft on revenue recognition that would result in all companies following one broad revenue recognition model if the standard is finalized. As we outlined in our joint note with Peter Elwin, J.P. Morgans European accounting analyst, these proposals could radically affect the way some companies account for revenues with serious implications on valuation multiples. Jointly issued exposure drafts for the insurance and leases projects are expected in the first half of 2012. The insurance proposal could dramatically change insurance accounting in the United States. The leases project looks to bring a portion of operating lease exposures onto companies balance sheets, thus making some balance sheets appear more leveraged. While financial instruments was identified as an urgent joint project in reaction to the 2008 financial crisis, we do not expect an exposure draft on this project during 2012. The boards have come to different conclusions on a number of key issues on this
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project, and the project takes on a multitude of complex issues. In addition, the boards must consider the effect of their decision on financial regulatory accounting since much of the regulatory accounting guidance references U.S. GAAP and IFRS measures. The success or failure of the boards to work together on the financial instrument project will likely have a large influence on the long-term viability of U.S. GAAP/IFRS convergence. The dark side of low interest rates: increased pension risk While in theory low interest rates can be a form of stimulus if they ultimately induce companies and consumers to borrow and spend, an unintended consequence of a long-term period of low interest rates is that it results in higher pension obligations and can result in an increase in the cash costs of running a pension plan. As shown in the following figure, the Moodys Aa rate is down approximately 400 basis points relative to its 8.14 level as of the end of May 2000. To the extent rate policy is reducing interest rates below where equilibrium levels would have been absent intervention, the implication is that rate policy may be exerting additional stress on companies with elevated pension risk and resulting in the need for incremental cash contributions being made to close funding gaps that would not have existed if interest rates had been higher. Under pension funding rules in the United States, discount rates can be based off of a 24-month moving average of corporate rates. The risk-free rate has decreased substantially during 2011 and has taken U.S. corporate rates down with it. The smoothing in the funding discount rate mitigates temporary decreases in rates through its 24-month average; therefore, cash flow effects are not immediate. To the extent the decline in investment-grade corporate rates during 2011 persists into 2012 and beyond, material cash funding requirements could materialize and put liquidity strains on some companies beginning as early as 2013. To identify companies with material levels of pension risk, see our October report.
Figure 82: Moodys Aa Corporate Bond Index, Month-End, December 1998-November 2011
8.50 8.00 7.50 7.00 6.50 6.00 5.50 5.00 4.50 4.00 3.50 Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Source: Moody's and J.P. Morgan estimates.
Dane Mott is a member of the FASBs Investor Technical Advisory Committee and two IASB advisory committees: the Capital Markets Advisory Council and the Employee Benefit Working Group. Dane Mott is also a former member of the IASBs IFRS Advisory Council. Amy Schmidt is a former Technical Manager at the IASB. JPMorgan Chase & Co. and its affiliates do not provide tax advice or advice on tax accounting matters. Accordingly, this material is not intended or written to be used, and cannot be used or relied upon, by any recipient in connection with promotion, marketing, or a recommendation for the purpose of avoiding U.S. tax-related penalties. Each client should consult his/her personal tax and/or legal advisor to learn about any potential tax or other implications that may result from acting on a particular recommendation.
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Equity Derivatives
2012 Global Volatility Outlook
Marko Kolanovic AC
(1-212) 272-1438 mkolanovic@jpmorgan.com
Adam Rudd
(1-212) 272-1215 adam.ch.rudd@jpmorgan.com
Amyn Bharwani
(1-212) 622-8030 amyn.x.bharwani@jpmorgan.com J.P. Morgan Securities LLC
During H1 2011, equities were in a low volatility regime with S&P 500 realized volatility reaching pre-Lehman low levels of ~12% (Figure 83). The low volatility regime of H1 was caused by a strong market performance in H2 2010 that triggered a record decline in equity correlations (Figure 84). Over the same time period, market liquidity reached new highs, and derivative hedging activity put downward pressure on realized volatility1. Given the positive macroeconomic sentiment and strong technicals (high liquidity, low correlation), even turmoil in the Middle East and the nuclear disaster in Japan in March did not result in a significant increase of equity volatility. At the end of July, renewed concerns about European sovereign debt, the sustainability of U.S. growth and fears of another global recession caused rapid market deterioration. Large risk on/off flows between government bonds and risky assets such as equities, commodities, and currencies caused cross-asset correlations to reach all-time high levels (Figure 84). These macro risk on/off flows were transmitted to equities largely through index trading, giving rise to a record level of equity correlation (stock-to-stock correlation).
Figure 83: S&P 500 Realized Volatility and the VIX Note distinct regimes of volatility in H1 and H2 2011, and different duration of 2010 and 2011 volatility spikes both related to European debt crisis
50 45 40 35
40
Figure 84: Cross-asset and equity correlations recently reached all-time high levels. High correlations are the main driver of equity index volatility.
70% 60%
Euro Debt EFSF QE2

Japan Libya Egypt
H2
Euro Debt
35
1Y Average Correlation of Risky Assets at All-Time High
H2 '11
30
3M Realized Volatility
50% 40% 30% 20%

Equity Correlations at All-Time Highs
VIX
30 25 20 15 10 Feb, 10
25
ECB? FED? IMF?
20
H2 '08 H2 '10
15
H1
10
Jun, 10
Nov, 10
Mar, 11
Jul, 11
Nov, 11
10% Nov, 01
May, 04
Nov, 06
May, 09
Nov, 11
Source: J.P. Morgan Equity Derivatives Strategy.
As most equity flows have been implemented with index instruments (e.g., futures and ETFs), equity volatility has been driven by risk on/off flows and the significantly reduced liquidity of equity index products. Figure 85 shows the liquidity of S&P 500 E-mini futures as measured by the number of contracts bid/offered within 5 futures ticks (1.25 index point). In August, liquidity dropped by more than 70% compared with the beginning of H1. It is interesting to note that the H2 changes in correlation (100% increase) and liquidity (70% decrease) were larger than changes in other equity risks, and were the key drivers of equity volatility, in our view.
See our H2 2011 Volatility Outlook for Discussion of Structural Pressure on Equity Volatility in H1 2011 due to long gamma positions.
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The drop in equity liquidity in H2 suggests that the current system has significantly reduced capacity to store equity risk. This may be related to regulations (e.g., elimination of proprietary desks, increased capital requirements) and changes in the structure of equity liquidity, i.e., the increased role of computerized trading in liquidity provision2. High levels of correlation and low liquidity further discouraged fundamental equity investors from trading stocks. For that reason, a significant amount of stock trading in H2 was the result of index and statistical arbitrage programs putting further upward pressure on correlations. This hostile risk on/off environment started undermining confidence in equities as an asset class, resulting in persistent outflows from U.S. equity mutual funds during H2 (Figure 85). In addition to liquidity and correlations, the impact of index options hedging was another driver of equity volatility3. These products are used by asset managers, pension funds, and hedge funds to reduce their equity risk exposure. The other side of these hedging transactions is taken by dealers who replicate their liability by daily delta hedging. Based on dealers exposure, hedging activity can increase market volatility (hedging of short gamma positions) or decrease market volatility (hedging of long gamma positions)4. Our estimates show that dealers were net long gamma in H1 2011, thus reducing market volatility by ~2 points. After the sharp drop in the market in August, the gamma exposure of outstanding protection became significantly short, putting upward pressure of ~3-4 points on short-term realized volatility (Figure 86).
Figure 85: Cumulative US mutual fund flows in 2011 (left axis), market liquidity as measured by the depth of S&P 500 futures (right axis)
$75 US Equity Mutual Fund Flows ($Bn) 12 Market Depth (1000s SPX E-mini Cts)
S&P 500 Hedged Gamma ($Bn) $5 $Oct 10 $(5) $(20) $(10) $(15) $(20) S&P 500 Hedged Gamma (Estimate, 30d MAvg.) $(30) Dec 10 Mar 11 May 11 Aug 11 Oct 11 $(10)
Figure 86: Estimated S&P 500 options gamma exposure (left axis), net futures speculative open interest (right axis)
$10 Futures Speculative OI $Futures Spec. Short Interest ($Bn) $10
10 $25 8 Jan, 05 $(25) Mar, 26 Jun, 14 Sep, 02 Nov, 21 6 4 $(75) 2 0
$(40)
$(125)
Figure 87 shows an extreme example of the gamma hedging impact during the second week of August. As the amount of gamma exposure reached record levels, and liquidity fell to the lowest point for the year (Figure 85 and Figure 86), gamma hedging flows caused a significant portion of market volatility that week. Figure 88 shows a more recent example from November 30th, when the market rallied on the coordinated action of central banks. A ~3% overnight move caused additional hedging flows that pushed the market another ~1% in the last hour of the trading day.
This liquidity can quickly disappear, such as during the flash crash in May 2010. Hedging of levered ETFs and other volatility products such as variance swaps and CPPI structures can also have an impact on market volatility. 4 See our report Impact of Derivatives Hedging, as well as a series of Market commentaries from August and September 2011.
3
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Figure 87: Impact of S&P 500 Gamma Hedging in Early August
Figure 88: Impact of S&P 500 Gamma Hedging on November 30th
Source: J.P. Morgan Equity Derivatives Strategy, Bloomberg.
Source: J.P. Morgan Equity Derivatives Strategy, Bloomberg.
In addition to poor liquidity and gamma hedging flows, large short interest in index products also contributed to market instability and higher volatility. Figure 86 shows record levels of speculative short interest in S&P 500 futures built up during the month of August. Stop-loss covering of shorts caused several market squeezes and contributed to end-of-the-day moves such as the one illustrated in Figure 88. Volatility in 2012 will largely depend on the pace with which the European sovereign debt crisis is addressed by policymakers, as well as changes in the outlook for global growth. As it is not possible to forecast these developments with certainty, we build our forecast based on historical trends, our views on the structural drivers of correlation and volatility, and J.P. Morgans 2012 fundamental projections for the macroeconomy, equities, and credit. Larger market crises and outbursts of equity volatility usually take a longer time to resolve. This gives rise to the familiar triangular shape of VIX spike patterns5. Comparing the current pattern of the VIX with the market crisis last summer (shown in Figure 83), one can notice that the current market crisis is taking a significantly longer time to abate6. This can be directly attributed to the lack of progress made by European policymakers, and in particular the reluctance of Germany to endorse employing ECB resources in removing the tail risk. While one could argue that volatility may persist and equities are entering a secular bear market, we believe a stabilizing solution in Europe will be agreed upon, eventually causing volatility to decline from current high levels. The current record levels of cross-asset correlations and equity correlations are not sustainable in our view. A prolonged period of risk on/off trading in illiquid markets is likely to cause significant underperformance for proponents of this approach and create divergences in valuations that will invite relative value investors. While many of the structural drivers should persist, we believe that the correlations will either collapse (with removal of tail risk, cyclical or seasonal effects), or will gradually wear off from the current extreme levels, in either case contributing to a decline in volatility during 20127.
5 6
More accurately, volatility tends to decay in an exponential, rather than linear, fashion. This is also true when comparing the current outburst of volatility with volatility patterns over the past 20 years. 7 See our report on the seasonality of equity correlations.
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Our forecast is that the average realized volatility of the S&P 500 in 2012 will decline to ~18.5% with a most likely range of ~15-20%. This represents a decline from the current high volatility regime (6-month realized volatility at 30%) into a medium volatility regime8. Another consideration in forecasting volatility is J.P. Morgans fundamental projections. While the outlook for the US economy (e.g., GDP, unemployment) points to the same level of volatility that we saw this year (12-month volatility of 23%), our credit and equity strategists argue for a significant reduction of credit risk and higher equity valuations in 2012, thus supporting our view of declining volatility (Figure 89). We believe that the premium of implied to realized volatility will stay elevated, due to reduced capacity of the system to store risk and high demand for downside and tail risk protection. Our forecast for the average spread of the VIX to realized volatility is 4.5 points.
Figure 89: S&P 500 Realized Volatility and Average VIX Forecast Volatility Asset Current Target Impact CDX Investment Grade 140 100 Lower CDX High Yield 800 550 Lower S&P 500 1245 1450 Lower US GDP 1.68 1.75 Neutral US Unemployment 8.6% 9.0% Neutral
S&P 500 Realized Volatility VIX 23.2% 27.5 18.5% 23 -4.7% -4.5
Here we define medium volatility regime relative to the past 5 years. Over the past 100 years, an 18.5% target volatility would still be higher than about 75% of observations and could be classified as a high volatility regime.
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Risks of Common Option Strategies

Risks to Strategies: Not all option strategies are suitable for investors; certain strategies may expose investors to significant potential losses. We have summarized the risks of selected derivative strategies. For additional risk information, please call your sales representative for a copy of Characteristics and Risks of Standardized Options. We advise investors to consult their tax advisors and legal counsel about the tax implications of these strategies. Please also refer to option risk disclosure documents. Put Sale. Investors who sell put options will own the underlying stock if the stock price falls below the strike price of the put option. Investors, therefore, will be exposed to any decline in the stock price below the strike potentially to zero, and they will not participate in any stock appreciation if the option expires unexercised. Call Sale. Investors who sell uncovered call options have exposure on the upside that is theoretically unlimited. Call Overwrite or Buywrite. Investors who sell call options against a long position in the underlying stock give up any appreciation in the stock price above the strike price of the call option, and they remain exposed to the downside of the underlying stock in the return for the receipt of the option premium. Booster. In a sell-off, the maximum realised downside potential of a double-up booster is the net premium paid. In a rally, option losses are potentially unlimited as the investor is net short a call. When overlaid onto a long stock position, upside losses are capped (as for a covered call), but downside losses are not. Collar. Locks in the amount that can be realized at maturity to a range defined by the put and call strike. If the collar is not costless, investors risk losing 100% of the premium paid. Since investors are selling a call option, they give up any stock appreciation above the strike price of the call option. Call Purchase. Options are a decaying asset, and investors risk losing 100% of the premium paid if the stock is below the strike price of the call option. Put Purchase. Options are a decaying asset, and investors risk losing 100% of the premium paid if the stock is above the strike price of the put option. Straddle or Strangle. The seller of a straddle or strangle is exposed to stock increases above the call strike and stock price declines below the put strike. Since exposure on the upside is theoretically unlimited, investors who also own the stock would have limited losses should the stock rally. Covered writers are exposed to declines in the long stock position as well as any additional shares put to them should the stock decline below the strike price of the put option. Having sold a covered call option, the investor gives up all appreciation in the stock above the strike price of the call option. Put Spread. The buyer of a put spread risks losing 100% of the premium paid. The buyer of higher ratio put spread has unlimited downside below the lower strike (down to zero), dependent on the number of lower struck puts sold. The maximum gain is limited to the spread between the two put strikes, when the underlying is at the lower strike. Investors who own the underlying stock will have downside protection between the higher strike put and the lower strike put. However, should the stock price fall below the strike price of the lower strike put, investors regain exposure to the underlying stock, and this exposure is multiplied by the number of puts sold. Call Spread. The buyer risks losing 100% of the premium paid. The gain is limited to the spread between the two strike prices. The seller of a call spread risks losing an amount equal to the spread between the two call strikes less the net premium received. By selling a covered call spread, the investor remains exposed to the downside of the stock and gives up the spread between the two call strikes should the stock rally. Butterfly Spread. A butterfly spread consists of two spreads established simultaneously. One a bull spread and the other a bear spread. The resulting position is neutral, that is, the investor will profit if the underlying is stable. Butterfly spreads are established at a net debit. The maximum profit will occur at the middle strike price, the maximum loss is the net debit. Pricing Is Illustrative Only: Prices quoted in the above trade ideas are our estimate of current market levels, and are not indicative trading levels.
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Delta One Strategy

J.P. Morgan U.S. Top Picks for 2012 Basket <JPUS2012>
Kapil Dhingra AC
(1-212) 272-7823 kapil.dhingra@jpmorgan.com
Introduction
The J.P. Morgan U.S. Top Picks for 2012 Basket (<JPUS2012> Index on Bloomberg) represents the portfolio of U.S. stocks that J.P. Morgan Equity Research Analysts have selected as their top ideas for 2012.
Marko Kolanovic
(1-212) 272-1438 mkolanovic@jpmorgan.com
Adam Rudd
(1-212) 272-1215 adam.ch.rudd@jpmorgan.com J.P. Morgan Securities LLC
Basket Methodology and Composition

Each of the stocks in the basket has been selected as a key stock to own in 2012 that should outperform its sector, according to our analysts. The rationale for each stocks selection is provided by the analysts in their individual sector notes. We have weighted the basket equally for all large-cap (>$5 billion market capitalization) and liquid (>$50 million average daily value traded) stocks. For smaller stocks with lower liquidity, we have used a sliding scale so that the amount of stock traded to enter the position should not be a substantial proportion of average daily volume. The basket is well diversified across sectors, with stocks selected by analysts covering a range of different industry groups. The charts below show the sector and industry group composition of the J.P. Morgan U.S. Top Picks for 2012 Basket. The constituents and their weights are shown in the table on the following page.
Figure 90: Sector and Industry Composition of the J.P. Morgan U.S. Top Picks for 2012 Basket
Energy 9% Materials 7% Utilities 2% Information Technology 16%
Basket Details
Bloomberg Ticker Benchmark Number of Components Weighting Scheme
JPUS2012 <Index> SPX Index 65 Proprietary
Bloomberg subscribers can use the ticker JPUS2012 to access tracking information on a basket created by the J.P. Morgan Delta One desk to leverage the theme discussed in this report. Over time, the performance of JPUS2012 could diverge from returns quoted in this report, because of differences in methodology. J.P. Morgan Research does not provide research coverage of this basket and investors should not expect continuous analysis or additional reports relating to it. For information on JPUS2012, please contact your J.P. Morgan salesperson or the Delta One Desk.
Industrials 17%
Consumer Staples 10%
Health Care 14% Consumer Discretionary 14%

Consumer Durables & Apparel 2% Automobiles & Components 2%
Financials 11%
Banks 2% Software & Services Household & 5% Personal Products 2% Pharmaceuticals, Biotechnology 8% Food Beverage & Tobacco 5% Diversified Financials 5% Media 3% Capital Goods 8% Health Care Equipment & Servic 5% Food & Staples Transportation Retailing 4% 4%
Technology Hardware & Equipmen 5% Utilities 2% Commercial & Professional Serv 6% Retailing 3% Real Estate 2% Insurance 3% Energy 9%
Semiconductors & Semiconductor 7% Consumer Services 5%
Materials 7%
Source: J.P. Morgan Derivatives & Delta One Strategy, S&P, Bloomberg.
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Figure 91: Composition of the J.P. Morgan Top Picks for 2012 Basket JPUS2012 <Index>
Ticker AAPL GOOG PG PFE PEP C CMCSA AXP BA UNH CVS UNP MA DD GG FCX COST LVS TXN HAL DE CELG PRU RAI VIAb PSA BRCM M ALL A STJ PXD HCA IVZ CNX SJM MYL NXY DNR UAL VRSK WYN BPL LRCX CCK EQIX ULTA NRG JBL RVBD RHI CBI WCN OC LEN CLH SPW CREE VC ONXX AH TFM FHN EAT ZIP Name Apple Inc Google Inc-Cl A Procter & Gamble Co/The Pfizer Inc Pepsico Inc Citigroup Inc Comcast Corp-Class A American Express Co Boeing Co/The Unitedhealth Group Inc Cvs Caremark Corp Union Pacific Corp Mastercard Inc-Class A Du Pont (E.I.) De Nemours Goldcorp Inc Freeport-Mcmoran Copper Costco Wholesale Corp Las Vegas Sands Corp Texas Instruments Inc Halliburton Co Deere & Co Celgene Corp Prudential Financial Inc Reynolds American Inc Viacom Inc-Class B Public Storage Broadcom Corp-Cl A Macy'S Inc Allstate Corp Agilent Technologies Inc St Jude Medical Inc Pioneer Natural Resources Co Hca Holdings Inc Invesco Ltd Consol Energy Inc Jm Smucker Co/The Mylan Inc Nexen Inc Denbury Resources Inc United Continental Holdings Verisk Analytics Inc-Class A Wyndham Worldwide Corp Buckeye Partners Lp Lam Research Corp Crown Holdings Inc Equinix Inc Ulta Salon Cosmetics & Fragr Nrg Energy Inc Jabil Circuit Inc Riverbed Technology Inc Robert Half Intl Inc Chicago Bridge & Iron-Ny Shr Waste Connections Inc Owens Corning Lennar Corp-A Clean Harbors Inc Spx Corp Cree Inc Visteon Corp Onyx Pharmaceuticals Inc Accretive Health Inc Fresh Market Inc/The First Horizon National Corp Brinker International Inc Zipcar Inc Industry Group Technology Hardware & Equipmen Software & Services Household & Personal Products Pharmaceuticals, Biotechnology Food Beverage & Tobacco Diversified Financials Media Diversified Financials Capital Goods Health Care Equipment & Servic Food & Staples Retailing Transportation Software & Services Materials Materials Materials Food & Staples Retailing Consumer Services Semiconductors & Semiconductor Energy Capital Goods Pharmaceuticals, Biotechnology Insurance Food Beverage & Tobacco Media Real Estate Semiconductors & Semiconductor Retailing Insurance Pharmaceuticals, Biotechnology Health Care Equipment & Servic Energy Health Care Equipment & Servic Diversified Financials Energy Food Beverage & Tobacco Pharmaceuticals, Biotechnology Energy Energy Transportation Commercial & Professional Serv Consumer Services Energy Semiconductors & Semiconductor Materials Software & Services Retailing Utilities Technology Hardware & Equipmen Technology Hardware & Equipmen Commercial & Professional Serv Capital Goods Commercial & Professional Serv Capital Goods Consumer Durables & Apparel Commercial & Professional Serv Capital Goods Semiconductors & Semiconductor Automobiles & Components Pharmaceuticals, Biotechnology Health Care Equipment & Servic Food & Staples Retailing Banks Consumer Services Transportation Analyst Mark A Moskowitz Douglas Anmuth John A Faucher Christopher T Schott John A Faucher Vivek Juneja Philip Cusick Richard Shane Jr Joseph B Nadol Iii John F Rex Lisa C Gill Thomas R Wadewitz Tien-Tsin Huang Jeffrey J Zekauskas John Bridges Michael F Gambardella Christopher Horvers Joseph R Greff Christopher Danely J David Anderson Ann Duignan Geoffrey Meacham Jimmy S Bhullar Rae Maile Alexia S Quadrani Michael W Mueller Harlan Sur Matthew Boss Matthew G Heimermann Tycho W Peterson Michael N Weinstein Joseph D Allman John F Rex Kenneth B Worthington John Bridges Kenneth Goldman Christopher T Schott Katherine Lucas Minyard Joseph D Allman Jamie N Baker Michael A Meltz Joseph R Greff Jeremy Tonet Christopher Blansett Phil M Gresh P Sterling Auty Brian J Tunick Andrew L Smith Steven J O'Brien Rod Hall Andrew C Steinerman Scott Levine Scott Levine Michael Rehaut Michael Rehaut Rodney C Clayton Charles Stephen Tusa Christopher Blansett Himanshu A Patel Cory William Kasimov Atif Rahim Kenneth Goldman Steven Alexopoulos John W Ivankoe Paul T Coster Wgt (% ) 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.500% 1.625% 0.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.625% 1.250% 1.625% 1.625% 1.250% 1.625% 1.625% 1.500% 1.625% 0.500% 0.625% 1.625% 1.500% 0.250% Mkt Cap ($Bn) $ 363.08 $ 199.53 $ 177.38 $ 155.20 $ 100.57 $ 81.13 $ 61.10 $ 55.53 $ 52.15 $ 51.34 $ 49.07 $ 48.49 $ 47.37 $ 42.98 $ 42.42 $ 36.34 $ 37.17 $ 35.46 $ 34.19 $ 30.49 $ 31.82 $ 27.21 $ 24.00 $ 23.52 $ 24.08 $ 22.83 $ 16.05 $ 13.56 $ 13.43 $ 11.95 $ 11.43 $ 10.78 $ 9.36 $ 9.10 $ 8.73 $ 8.67 $ 8.26 $ 7.72 $ 6.28 $ 6.52 $ 6.26 $ 5.38 $ 5.47 $ 4.99 $ 4.94 $ 4.78 $ 4.46 $ 4.28 $ 4.18 $ 4.01 $ 3.92 $ 3.82 $ 3.58 $ 3.33 $ 3.42 $ 3.12 $ 3.07 $ 2.72 $ 2.82 $ 2.55 $ 2.16 $ 1.89 $ 1.99 $ 1.91 $ 0.56 ADV ($M) $ 7,592 $ 2,147 $ 698 $ 997 $ 591 $ 1,461 $ 459 $ 399 $ 432 $ 397 $ 379 $ 329 $ 508 $ 380 $ 336 $ 805 $ 226 $ 734 $ 380 $ 562 $ 420 $ 217 $ 261 $ 129 $ 219 $ 130 $ 253 $ 284 $ 141 $ 173 $ 136 $ 171 $ 75 $ 118 $ 154 $ 62 $ 136 $ 48 $ 94 $ 133 $ 33 $ 96 $ 16 $ 113 $ 47 $ 74 $ 73 $ 55 $ 89 $ 129 $ 53 $ 51 $ 27 $ 49 $ 100 $ 28 $ 40 $ 92 $ 34 $ 45 $ 13 $ 18 $ 37 $ 43 $ 6
Source: J.P. Morgan Derivatives & Delta One Strategy, Bloomberg.
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Basket Performance Statistics

The daily returns of the J.P. Morgan U.S. Top Picks for 2012 Basket would have been closely correlated to those of the S&P 500 Index9 (~98% correlation over the last year). The basket would have outperformed the S&P 500 since the beginning of 2009 by an annualized return of ~4%, and it would have underperformed the S&P 500 this year (since December 31, 2010) by an annualized return of ~5.9%. The figures below show the hypothetical performance of the J.P. Morgan U.S. Top Picks for 2012 Basket as well as that of the S&P 500 Index since beginning of 2009 and the beginning of 2011. The basket has a beta of ~1.2 versus the S&P 500. The realized volatility of the basket would have been ~28% since the beginning of 2011, compared to ~23% for the S&P 500. The J.P. Morgan U.S. Top Picks for 2012 Basket has a dividend yield well below that of the S&P 500, given the relatively high weighting of lower-yielding stocks. In addition, the charts below show a scatter plot of daily returns of the J.P.Morgan U.S. Top Picks for 2012 Basket and those of the S&P 500 Index. We also show the 3M rolling beta and the 3M rolling correlation for the basket against the S&P 500 Index.
Figure 92: Performance of the J.P. Morgan U.S. Top Picks for 2012 Basket Since the Beginning of 2008
190 170 150 130 110 90 70 50 Dec-08
S&P 500 Index J.P. Morgan U.S. Top Picks for 2012 Basket
Figure 93: YTD Performance of the J.P. Morgan U.S. Top Picks for 2012 Basket
120 110 100 90 80 70 60 50 Dec-10
S&P 500 Index J.P. Morgan U.S. Top Picks for 2012 Basket
Jun-09
Dec-09
Jun-10
Dec-10
Jun-11
Feb-11
Apr-11
Jun-11
Aug-11
Oct-11
Source: J.P. Morgan Derivatives & Delta One Strategy, Bloomberg. Note: All price performance excludes commissions and fees. Past performance is not indicative of future returns.
Not all stocks in the basket have three years of price history (HCA, VRSK, VC, AH, TFM, ZIP). In such cases, we have substituted the basket with an equivalent quantity of cash for the purpose of the back test.
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Figure 94: 3M Realized Volatility of the J.P. Morgan U.S. Top Picks for Figure 95: 1Y Realized Dividend Yield of the J.P. Morgan U.S. Top 2012 Basket and the S&P 500 Index Picks for 2012 Basket and the S&P 500 Index
60% 50% 40% 30% 20% 10% 0% Mar-09 Aug-09 S&P 500 3M Volatility 3M Volatility of J.P. Morgan U.S. Top Picks for 2012 Basket
4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5%

Top Picks for 2012 Basket Dividend Yield S&P 500 Dividend Yield
Jan-10
Jun-10
Nov-10 Apr-11
Sep-11
0.0% Dec-08
Jun-09
Dec-09
Jun-10
Dec-10
Jun-11
Figure 96: Daily Returns of the J.P. Morgan U.S. Top Picks for 2012 Basket vs. Daily Returns of the S&P 500 Index
10% 8% Basket Daily Return (%) 6% 4% 2% 0% -2% -4% -6% -8% -10% -10% -5% 0% 5% 10% R = 96%
Figure 97: 3M Beta and 3M Correlation of the J.P. Morgan U.S. Top Picks for 2012 Basket vs. S&P 500 Index
100% 98% 1.4 1.3 1.2 1.1 1.0 94% 0.9 0.8 3M Correlation (Left) 90% Mar-09 Aug-09 Jan-10 Jun-10 3M Beta (Right) Nov-10 Apr-11 Sep-11 0.7 0.6
96%
92%
S&P 500 Daily Return (%)

Source: J.P. Morgan Derivatives & Delta One Strategy, Bloomberg. Note: All price performance excludes commissions and fees. Past performance is not indicative of future returns. Source: J.P. Morgan Derivatives & Delta One Strategy, Bloomberg. Note: All price performance excludes commissions and fees. Past performance is not indicative of future returns.
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Additional Basket Methodology

In order to keep the basket relevant to the investment theme, J.P. Morgan reserves the right to review the following at any time: Basket methodology. This is to ensure the rules of the basket remain relevant following any structural changes to the theme. This may include ensuring that the sector exposure of the basket remains broadly consistent with the investment theme. Basket change implementation. J.P. Morgan will consider extending the implementation of changes to the basket composition from one trading session to any period up to five trading sessions in the event that a material increase in the liquidity or capacity of the basket is required to minimize market impact. Corporate actions may affect the J.P. Morgan U.S. Top Picks for 2012 Basket. The composition of a custom basket is typically adjusted in the following manner: Cash merger. The divisor is adjusted, and we remove the merging company from the basket on the day of merger and redistribute gains into remaining companies according to recalculated market cap weights of surviving constituents in the basket. Stock merger. If the acquirer is a member of the basket, then the weight allocated to the acquired will transfer to the surviving entity on the close of the last day it trades. If the acquirer is not a part of the basket, then proceeds (losses) from the acquired company will be redistributed to the surviving basket constituents based on the recalculated weighting on the close of its last trading day. Spinoffs. The spinoff company and parent will be included in the basket, and both the spinoff and parent company weights will be readjusted according to new market capitalizations after the spinoff date. Tender offers and share buybacks. The company remains in the basket and its weight is adjusted according to the impact the tender/buyback has on the stocks market value. Delisting/insolvency/bankruptcy. The company is removed from the basket as of the close of the last trading day, and the proceeds (losses) will be redistributed into remaining companies according to re-calculated weights of remaining companies in the basket. If a stock trades on pink sheets it will not be included in the basket.
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Aerospace & Defense
Capital Goods/Industrials
Commercial Aero Looks Solid Despite Uncertainty; Defense Down-Cycle Just Starting
Joseph B. Nadol AC
(1-212) 622-6548 joseph.b.nadol@jpmorgan.com
Seth M. Seifman, CFA

(1-212) 622-5597 seth.m.seifman@jpmorgan.com
Christopher Sands
(1-212) 622-9224 christopher.sands@jpmorgan.com J.P. Morgan Securities LLC Joseph B. Nadol Alliant Techsystems Inc. Boeing Company Bombardier CACI International Inc Comtech Telecommunications Embraer SA Exelis Inc. General Dynamics Corp. Goodrich Harris Corporation L-3 Communications Lockheed Martin Northrop Grumman Precision Castparts Raytheon Rockwell Collins SAIC Spirit AeroSystems TransDigm Group Inc United Technologies Wesco Aircraft Holdings, Inc.
ATK BA BBDb.TO CACI CMTL ERJ XLS GD GR HRS LLL LMT NOC PCP RTN COL SAI SPR TDG UTX WAIR
N OW OW N OW OW N N (rs) N N OW N OW OW OW N N N (rs) OW
Commercial aerospace fundamentals remain attractive, which should support stocks in 2012. Rate increases are scheduled to boost Boeing and Airbus deliveries by ~40% from 2011 to 2015, and demand driven by both air traffic growth, which has held up well amid the macro turmoil of recent years, and replacement looks like it should support these production levels. A global economic downturn is a key risk, but we believe it would have to be especially severe and include the emerging markets, which account for 55-60% of traffic growth, to derail planned rate increases. Aircraft finance is another risk due to turmoil in the banking system, particularly in Europe, but we also see this as manageable. In the aftermarket, we see potential for continued double-digit growth in 2012 following the strong rebound in 2011, as aftermarket sales are just now surpassing the 2008 peak despite 10% higher airline capacity. The business jet market remains bifurcated, as large-jet demand is recovering nicely, aided by emerging market customers, particularly in China, while light-jet demand remains anemic and will probably require more activity from U.S. customers in order to bounce, which we think will take some time yet. Defense fundamentals remain highly challenging, although the stocks appear to be heavily discounting a continued flow of bad news given their relatively strong performance in the wake of the Congressional Super Committees inability to reach an agreement. Nonetheless, we believe the stocks will be stagnant as earnings estimates sag, and the best hope for outperformance in 2012 appears to be poor market performance overall. Efforts to amend the automatic defense cuts are under way, but the timing and substance of any resolution are unclear. Regardless of the outcome, we expect 2012 sales to decline in line with a 4-5% decrease in the addressable market, and earnings to further suffer from ~60bps on average of margin pressure (excluding pension). Looking into 2013, we again expect a 5% decline in the addressable market and organic growth in line with that, and we could see ~2-3% upside or downside to that depending on the outcome of the effort to reverse or reduce the automatic cuts. Our average defense EPS forecasts are 4% and 6% below Consensus for 2012 and 2013, respectively. While defense stocks could outperform in 2012 in a poor market environment, we dont believe the stocks will really start to work until the market gains confidence that the ~$1 trillion fiscal deficit will be cut to a more sustainable level, perhaps $300-400 billion, through entitlement reform and/or tax increases, and we see this as most likely at least a year away.
Best Idea Boeing Company (BA)

Boeing (BA) is our top pick for 2012. We see two keys to performance: sustainment of aircraft demand despite the global economic turmoil and execution on the 787 program. Commercial aircraft orders should remain strong, driven by conversion of commitments for the 737 MAX into firm orders, the launch of the 787-10, and a resurgence of 777 demand driven by delays and customer concerns on the A350. We see potential for a major cash flow turnaround as 787 cash burn abates. Improving cash flows increase financial flexibility as well, and we believe 2012 could see Boeings first dividend increase since 2008.
Boeing Company (BA) Overweight Dec 12 Price Target: $80
Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.)
$70.87 $80.65 $56.01 Dec $4.45 $4.50 $4.85 15.7 14.6 $52,673 Valuation: Target reflects ~14x 2013E EPS, in line with commercial aero stocks historically. Risks: Incremental problems with 787 production ramp, higher-than-expected R&D, renewed recession or macro shock lowering production rates. 81
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Airfreight & Surface Transportation

Rail EPS Growth Should Persist Amid Modest Economy; UNP Story the Most Resilient
Thomas R. Wadewitz AC
(1-212) 622-6461 thomas.r.wadewitz@jpmorgan.com
Michael R. Weinz, CFA

(1-212) 622-6383 michael.r.weinz@jpmorgan.com
Alexander K. Johnson
(1-212) 622-6513 alexander.k.johnson@jpmorgan.com J.P. Morgan Securities LLC Thomas R. Wadewitz Arkansas Best C.H. Robinson Worldwide Canadian National Railway Canadian Pacific Railway Con-way CSX Expeditors FedEx Corp Genesee & Wyoming Heartland Express J.B. Hunt Transport Services Kansas City Southern Knight Transportation, Inc. Landstar Norfolk Southern Old Dominion RailAmerica Swift Transportation Union Pacific United Parcel Service UTi Worldwide Werner Enterprises YRC Worldwide Michael R. Weinz, CFA Hub Group Pacer International
Against a backdrop of modest economic growth in 2012, we expect solid performance from the major railroad stocks as cost-side pressures from 2011 ease and solid pricing momentum continues. We anticipate only limited support for EPS performance from volume growth given a muted outlook for the economy. In our view, P/E valuation on our 2012 EPS estimates of 11.3-13.5x for the three major U.S. railroads (UNP, CSX, NSC) is attractive relative to a normal historical range of 11-15x and in light of our positive outlook for rail EPS performance in 2012. Among the other transports, we believe that the small package names FDX and UPS are attractive given a favorable domestic pricing story and operating costs that should remain muted. The small package names would likely be more interesting versus the railroads if economic growth surprises to the upside.
N UW N UW UW OW N OW OW N OW OW N OW OW N OW OW OW OW N OW N
ABFS CHRW CNI CP CNW CSX EXPD FDX GWR HTLD JBHT KSU KNX LSTR NSC ODFL RA SWFT UNP UPS UTIW WERN YRCWD
While we can identify a few truckload names with attractive company-specific stories such as WERN (cost side) and SWFT (valuation), and intermodal names (JBHT, HUBG) with attractive growth, we are generally cautious on the more cyclical industry groups within transportation including the less-than-truckload and truckload segments. In our view, sluggish economic growth in 2012 is a source of greater risk to the pricing stories in these less consolidated and more cyclical transport groups.
Best Idea Union Pacific (UNP)

Union Pacific (UNP) should realize a significant tailwind in 2012 from repricing ~$1.05bn in revenue of old contracts (legacy intermodal and coal) for which pricing is likely to rise sharply. We estimate that the combined revenue increase resulting from repricing the legacy contracts is ~$490mm in 2012 or ~$0.63/share, which contributes about ten percentage points to earnings growth. In our view, UNPs revenue mix is the most defensive of the rail group as 38% of the companys revenues come from the less economically sensitive agriculture and coal segments. UNPs exposure to PRB coal is likely to be more stable than the eastern rails due to moderate utility stockpile levels and little exposure to export coal demand. Risks to our earnings expectations and Overweight rating on UNP include increased price competition between the Western rails, which we believe is unlikely. Unfavorable regulatory and court rulings are also a risk to our positive view on UNP stock. A sharp slowing in the U.S. economy would be another risk to our volume and EPS growth forecasts and to our Overweight rating.
Union Pacific (UNP) Overweight Dec 12 Price Target: $119
HUBG PACR
OW N
$102.84 $107.89 $77.73 Dec $5.61 $6.52 $7.60 15.8 13.5 $49,680 Valuation: Target reflects 14x 2013E EPS, compared to long-term historical range of 11-15x and stronger range of 13-17x during the positive rail price story of 2004-2008.
82
US Year Ahead 2012
Electrical Equipment & Multi-Industry

Handoff to Late-Cycle Growth in Progress
C. Stephen Tusa, Jr CFA AC
(1-212) 622-6623 stephen.tusa@jpmorgan.com
Paul Mammola, CFA

(1-212) 622-6382 paul.mammola@jpmorgan.com
The EE/MI group has underperformed in 2011, down 9% compared to a 5% decline for the S&P 500. Despite cyclical upside, weaker performance has been slanted towards later-cycle stocks as the recovery for certain end markets was pushed to the right. The macro is still mixed, with uncertainties around developed market fiscal policy and a broader sovereign debt crisis leading to a lower-growth environment, which is reflected in our below-consensus estimates. While the current 11x group multiple looks inexpensive on consensus (15x heading into 2011), with this backdrop of uncertainty, we remain cautious, as we see structural issues as a relevant drag on valuation. Within this dynamic, valuation disparity in a shifting growth landscape presents opportunities heading into next year. We continue to favor later-cycle stocks for which sales/earnings should begin to outperform in 2012. Coincidentally, most of these names trade a discount, or are being unfairly punished for what we believe to be universal macro uncertainty, providing an entry point.
Drew Pierson
(1-212) 622-6627 drew.a.pierson@jpmorgan.com J.P. Morgan Securities LLC C. Stephen Tusa, Jr CFA 3M Danaher Dover Emerson Electric Co. Generac General Electric Co. Honeywell Hubbell Inc. Ingersoll Rand ITT Corp. Lennox International Motorola Solutions Rockwell Automation Roper Industries Sensata SPX Corp. Textron Tyco International WABCO Watsco Watts Water Technologies Wesco
MMM DHR DOV EMR GNRC GE HON HUBB IR ITT LII MSI ROK ROP ST SPW TXT TYC WBC WSO WTS WCC
N OW UW N N OW OW OW OW OW N N N OW OW OW OW N OW N OW
Best Idea SPX Corp. (SPW)

SPX Corp. (SPW) is one of the best ways to leverage the handoff from early- to late-cycle growth, in our view. The companys sales should end 2011 about 10% below the 2008 peak, making this one of the last to fully recover on our coverage list, and leaving the whole earnings cycle ahead. The stock has unperformed this year (-17% vs. group -9%) as the recovery for power and T&D end markets (~50% of sales) remained tenuous for most of 2011, but we continue to get clarity on endmarket and earnings momentum heading into 2012. Specifically, we see several factors working in SPWs favor in 2012 as end-market growth accelerates. First, the companys transformer business, which is at trough, and represents a $2.00 swing in EPS through the peak, is starting to turn: lead times have stretched to peak levels (8-12 months), pricing has been up for two straight quarters, and the book-to-bill in 3Q11 was over 2x, setting up a ramp for the business in mid-2012. Timing the improvement here has been delicate, but order data from SPX and commentary from peer ABB (each ~34% NA market share) solidify that the turn is here. Outside of transformers, restructuring efforts, recent pricing action, and demand from process end markets should help show mid-cycle profit levels for Flow, now the companys biggest business. The associated Clydeunion deal has moving parts (financing, revenue outlook), but is still expected to be accretive next year, padding EPS. Lastly, Thermal has been a risk given backlog degradation, but management has ring-fenced the issue, and mix is likely to act as a partial offset to sales pressure. In sum, we believe the turn in key end markets coupled with execution on Clydeunion/Thermal will help the shares multiple firm from what we view as an unwarranted 5% discount today.
SPX Corp. (SPW) Overweight Dec 12 Price Target: $75
$62.82 $87.13 $40.66 Dec $3.62 $4.40 $4.80 14.3 13.1 $3,205 Valuation: Target reflects ~13x 2013E EPS EPS, a 5% premium to the group vs. a ~10% discount historically, to account for a later-cycle business mix. Risks: Prolonged recovery in global infrastructure negatively affecting Thermal, muted recovery in short-cycle businesses like Flow, weak electricity demand leading a muted spending recovery on power transformers by utility customers.
83
US Year Ahead 2012
Engineering & Construction

An Unconventional Road to Recovery
Scott Levine AC
(1-212) 622-5609 scott.j.levine@jpmorgan.com
Rodney C Clayton, CFA

(1-212) 622-2873 rodney.c.clayton@jpmorgan.com
Ankit Varmani
(1-212) 622-5654 ankit.x.varmani@jpmorgan.com J.P. Morgan Securities LLC Babcock & Wilcox Co. Chicago Bridge & Iron Co. NV Eagle Materials Fluor Corp Jacobs Engineering Martin Marietta Materials Mistras Group Pike Electric Quanta Services, Inc. The Shaw Group, Inc TMS International URS Corporation Vulcan Materials BWC CBI EXP FLR JEC MLM MG PIKE PWR SHAW TMS URS VMC N OW N OW OW OW OW N OW N OW N N
Expecting an uneven global recovery; look for secular stories. The outlook for the global economy remains uneven and uncertain (with emerging markets expected to outgrow developed economies by 300-500bps), suggesting cyclical E&C stocks may not be viewed as particularly attractive in this environment. While the group indeed has cyclical qualities, several other factors influence spending on construction services, many of which (regulatory, budget, regional) may be unique to individual end markets (or E&Cs). Given this context, we favor E&Cs exposed to investment themes that we consider to be secular (i.e., non-cyclical) in nature, such as Natural Gas (particularly LNG) and Transmission & Distribution (T&D). Q3 results signaled no disruption in industry bookings momentum. Q3 results suggested that the E&Cs experienced little (if any) disruption to bookings due to any recent slowing in global economic conditions. Composite E&C book-to-bill (BtB) was ~1.2x in Q3, reflecting continued improvement in order trends, and suggesting that the recovery in activity levels remains intact. BtB and backlog have traditionally been important drivers of E&C stock performance, though execution has been a greater factor in recent quarters, and may remain a focus for investors in 2012, as E&Cs ramp up on projects booked during the early phases of the cycle. End-market variations could become more pronounced. We continue to favor E&Cs with exposure to private-sector markets, including commodity verticals such as Oil & Gas (particularly Upstream & Midstream) and Mining, given a stillfavorable hydrocarbon market backdrop and expectations of continued recovery in global demand (supporting a favorable bias toward CBI, FLR, and JEC). Within public-sector markets, we maintain a cautious outlook for most Federal markets (including work for the DoD and DOE), though were more optimistic on the Infrastructure market, as new Highway legislation could benefit E&Cs, as well as the Materials companies (particularly aggregates-focused MLM and VMC).
Best Idea Chicago Bridge & Iron (CBI)

Chicago Bridge & Iron (CBI) is our favorite name in E&C, due to its favorable business mix, including high exposure to attractive international energy markets (particularly global LNG) and limited exposure to domestic public-sector markets we view less favorably (given formidable budget and regulatory concerns). We consider CBIs business model as uniquely attractive, as the companys Lummus Technology and Steel Plate segments complement its more traditional EPC segment, enabling it to participate in projects in a greater variety of roles than many of its E&C peers. Although a competitive environment for contractors could limit further improvement in CBIs margins, we think the company should be able to remain toward the top of the peer group (including high-single-digit EBIT margins), assuming execution remains strong, consistent with recent quarters.
Chicago Bridge & Iron (CBI) Overweight Dec 12 Price Target: $50
$39.47 $45.12 $23.88 Dec $2.04 $2.52 $3.00 15.7 13.2 $3,888 Valuation: Target reflects 14.5x 2013E EPS, slightly below historical average, but above peer group average, reflecting exposure to fastgrowing international energy markets and improving execution. Risks: Slowdown in project flow, execution issues resulting in cost overruns on key projects, margin pressure in a more competitive environment, share issuance to support growth initiatives.
84
US Year Ahead 2012
Environmental Services
Focus on Fundamentals, Cash Flows in a Low-Growth Environment
Scott Levine AC
(1-212) 622-5609 scott.j.levine@jpmorgan.com
Rodney C Clayton, CFA

(1-212) 622-2873 rodney.c.clayton@jpmorgan.com
Ankit Varmani
(1-212) 622-5654 ankit.x.varmani@jpmorgan.com J.P. Morgan Securities LLC Scott Levine Casella Waste Systems Inc. EnergySolutions Progressive Waste Solutions Republic Services Inc Stericycle Inc. Waste Connections Waste Management Rodney C Clayton, CFA Clean Harbors
Defensiveness appealing in a low-growth environment. Waste stocks have traditionally performed well during periods of uncertainty, suggesting a likely good fit for the low-growth environment our strategists/economists envision for 2012. Our forecast assumes stable volumes, and we dont foresee much downside even in a recession, as the cyclical construction business is already at very low levels. Furthermore, cash flows tend to be resilient (often holding up better than earnings in downturns), suggesting this could be an appealing attribute if the recovery stalls. Cash flow deployment initiatives could enhance shareholder returns. Waste companies can utilize their cash flows to increase shareholder value in a number of different ways, including share buybacks (BIN and RSG increased their authorizations over the past summer, while WCN, WM, and SRCL are also active in this area) and dividends (WM and RSG sport yields of 4.3% and 3.2%, respectively). M&A is another lever for waste companies to supplement organic growth, with BIN, CLH, WCN, and SRCL among the more active acquirors in the group. Solid waste pricing is a risk worth monitoring. We view pricing as a risk for the group in 2012, as competition could intensify given the sluggish volume recovery. Signs of pricing pressure have become more evident in recent quarters (particularly in the municipal business), and easing inflation rates could limit index-based growth in 2012 (declines in diesel could also limit surcharge revenue). Also, recycled fiber prices (OCC, ONP) have fallen 25%+ in early Q4, suggesting the recycling business could turn from a tailwind to a headwind in 2012, unless trends reverse course.
CWST ES BIN RSG SRCL WCN WM
N N OW OW N OW N
CLH
OW
Best Idea Waste Connections (WCN)/Clean Harbors (CLH)

Solid Waste: We view Waste Connections (WCN) as an attractive stock for 2012, as its business model (which focuses on exclusive and secondary markets) provides comfort, as it insulates the company from any competitive headwinds that may emerge until volumes recover. Although WCNs premium valuation could limit potential upside relative to other solid waste names, cash flows remain supportive (FCF margins are toward the top of the peer group), and new acquisitions (not included in our estimates) offer potential upside to our forecasts.
Waste Connections (WCN) Overweight Dec 12 Price Target: $40
$32.83 $35.95 $25.96 Dec $1.24 $1.48 $1.67 22.2 19.7 $3,673 Valuation: Target reflects 10x 2013E EBITDA, above historical average, reflecting potential for above-average M&A and defensive growth profile. Risks: Rising cost headwinds, decline in pace of acquisitions, weak macro conditions in Western and Southern markets.
Specialty Waste: We believe Clean Harbors (CLH) offers attractive long-term growth prospects, supported by its market-leadership position in hazardous waste and accelerating secular growth profile in energy and industrial services. Furthermore, the company has demonstrated the ability to augment organic growth with an aggressive but disciplined and accretive acquisition program, which offers potential upside to our estimates (we do not forecast future acquisitions).
Clean Harbors (CLH) Overweight Dec 12 Price Target: $73.50
$61.36 $61.84 $38.08 Dec $2.43 $2.14 $2.45 28.7 25.0 $3,256 Valuation: Target reflects 9x 2013E EBITDA, above historical avg. given strong balance sheet and increasing scale in higher-growth acquired businesses. Risks: Increased competition and pricing erosion, acquisition and integration risk, lower oil and gas prices. 85
US Year Ahead 2012
Machinery
Agriculture Fundamentals Remain Strong; Overweight DE
Ann Duignan AC
(1-212) 622-0381 ann.duignan@jpmorgan.com
Michael Shlisky
(1-212) 622-6656 michael.d.shlisky@jpmorgan.com
Ingrid Aja, CFA

(1-212) 622-3730 ingrid.c.aja@jpmorgan.com J.P. Morgan Securities LLC Actuant Corp AGCO Corp. Caterpillar Inc. CNH Global Commercial Vehicle Group Cummins Inc Deere & Co. Eaton Corp. Illinois Tool Works Joy Global Kennametal Inc. Manitowoc Co. Modine Manufacturing Co. Navistar Int'l Oshkosh Corp. PACCAR Inc. Parker Hannifin Terex Corp Westport Innovations Inc. ATU AGCO CAT CNH CVGI CMI DE ETN ITW JOY KMT MTW MOD NAV OSK PCAR PH TEX WPRT N N OW N N N OW OW N N N N N N N OW N N N
The agriculture sector represents a decently defensive space, as agriculture commodity prices are less impacted by general macro trends and more influenced by strong global demand as well as supply-side volatility. Strong demand fundamentals are evidenced by the global food price index produced by the UN Food and Agriculture Organization (FAO) which reached a historic peak of 238 in February 2011, well above the peak of 213.5 reached in 2008. According to FAO, prices have since eased and in October the index registered 216; however, this is still 16% higher than in October 2010. Supply-side fundamentals have improved in recent months on the back of decent harvests around the world, and this should result in lower price inflation in 2012. That said, farmers around the world are benefiting from the current balanced supply and demand conditionsa positive for equipment demand.
Best Idea Deere & Co. (DE)

Globally, the fundamentals for farm cash receipts and thus farmer sentiment remain strong on the back of strong crop prices in North America, strong dairy and livestock prices in Western Europe, strong sugar and soybean prices in South America, and strong wheat prices in Eastern Europe. In North America, total cash receipts for 2012 are expected to be $374.2bn, down 2% y/y, but still at historically high levels; with the strong correlation between cash receipts and equipment sales, we expect North American farm equipment sales to remain elevated, though perhaps down slightly y/y. In Western Europe, equipment demand remains very strongrecovering after a significant decline in 2009 and 2010; in Brazil, equipment demand may be under some pressure due to the saturation of a program to support the sale of small-HP tractors to small farmers. That said, we believe that mix in Brazil will be positive as demand for large crop equipment, including sugarcane harvesting equipment, should remain solid. Deere & Co. (DE) recently posted an upside earnings report for F4Q11 and introduced an outlook for FY12 that was well above consensus expectations. Managements FY12 outlook included an expectation for equipment sales to be up 15% (implied sales of $33.9bn) vs. prior consensus of $31.6bn. Net income is expected to be $3.20bn vs. prior consensus of $2.96bn. Implied EPS for FY12 is $7.70 vs. prior consensus of $7.13as a result, we anticipate a high probability of continued upside to earnings as we go through 2012. We rate Deere Overweight and have a Dec-12 price target of $100, on solid endmarket fundamentals as well as compelling valuation. Our $100 price target represents a ~13x multiple on our FY12 EPS estimate of $7.90, as the multiple compresses toward cycle peak. This is also higher than those of other ag equipment companies, given DEs strong execution and share gains in key markets such as Brazil and Germany.
Deere & Co. (DE) Overweight Dec 12 Price Target: $100
$78.38 $99.80 $59.92 Oct $6.63 $7.90 $8.79 9.9 8.9 $32,443 Risks: Market share risk from aggressive competition, in Europe weather negatively impacting equipment spending and higher crop prices continuing to pressure the protein sector.
86
US Year Ahead 2012
Airlines
2012: Modeling for a Profitable Recession with Opportunities Ahead
Jamie Baker AC
(1-212) 622-6713 jamie.baker@jpmorgan.com
Consumer
Scott Tan, CFA

(1-212) 622-5541 scott.b.tan@jpmorgan.com
Joseph Abboud
(1-212) 622-7059 joseph.g.abboud@jpmorgan.com J.P. Morgan Securities LLC AerCap Holdings N.V. Air Lease Corp. Aircastle Limited Alaska Air Group, Inc. AMR Corp. Copa Holdings, S.A. Delta Air Lines, Inc. FLY Leasing Ltd. GOL Linhas Aereas Inteligentes S.A. JetBlue Airways Corp. Southwest Airlines Co. TAM S.A. United Continental Holdings US Airways Group, Inc. AER AL AYR ALK AMR CPA DAL FLY GOL JBLU LUV TAM UAL LCC OW N OW N N OW N N OW N (rs) OW OW
We continue to model for the unprecedented profitable recession. U.S. airlines have never produced profits in a U.S. recession. Call us stubborn, but we continue to model for just such an outcome in 2012, which lies at the root of our investment thesis. While it may appear unusual to stick with a recessionary outlook that differs from consensus GDP expectations, we believe there are good reasons to approach our modeling this way. For starters, in the post-war period, whenever U.S. GDP growth has been 1% or less for two consecutive quarters the economy was on the verge of entering a recession or already in one. More importantly, however, we believe if a strong value case can be made for airline equities when modeling for recessionary inputs, then upside equity potential in a firmer economic scenario should only bolster our thesis. The market appears to be modeling for something much worse. Airline enterprise values continue to flirt with levels last seen in 1H09, a period in which the lights were quickly being dimmed on the U.S. airline industry, in our view. Frankly, we are running out of plausible explanations. Current profits, functioning markets, strong liquidity, and two recent acts of consolidation stand in stark contrast to what the industry then faced. Its different this time. We have opined for some time that the industry has undergone significant, structural improvement. Unfortunately, one differentiating facet is that not many seem to careat least until AMRs recent bankruptcy filing. We view AMRs filing as a positive for the industry and believe continued profit production during a domestic downturn can help lift equities from their current funk. We also believe that the correlation between oil prices and GDP represents a natural hedge for airlines, and should reduce the historical operating margin range of -9% to +11% toward something closer to +6 to +9%. Ultimately, more stable and predictable profit streams should attract the types of longer-term investors that have shunned the space in the past, in our view.
Best Idea United Continental Holdings (UAL)

United Continental Holdings (UAL) continues to offer a compelling valuation, in our view, and remains one of our best ideas. With AMRs recent bankruptcy filing, we believe the benefits to UAL will prove most pronounced given UALs network overlap and a more favorable labor cost outcome. As such, we boosted our 2012 UAL estimates with additional revenue upside of ~$500mm and cost savings of $100mm leading to an EV/EBITDAR multiple valuation of 3.8x compared with the peer average of 5.1x. In addition, UAL is expected to generate roughly $10bn in unrestricted cash by year-end 2012 with forecasted net debt/LTM EBITDAR of 1.4x, the lowest leverage ratio among the legacies excluding Alaska. Lastly, while not immune to any unanticipated fuel or demand shocks, UALs liquidity profile is above average for similar airlines. We are maintaining our 2012 price target of $45.
United Continental Holdings (UAL) Overweight Dec 12 Price Target: $45
$20.13 $27.72 $15.51 Dec $4.31 $3.61 $6.97 5.6 2.9 $6,660 Valuation: Target reflects 50% weighting toward a P/E methodology using 7x multiple, at low end of Uniteds and Continentals historical average range of 8-10x, in addition to 50% EV/EBITDAR weight using 4.5x, reflecting historical multiple associated with our level of forecast profitability. Risks: Fluctuations in demand for air travel, variations in energy prices and labor-related job actions, lower-than-expected capacity reduction, UAL/CAL merger proving more costly than expected.
87
US Year Ahead 2012
Autos & Auto Parts

Global SAAR Signals Mixed as US-Europe Decoupling Evidence Builds
Himanshu Patel, CFA AC
(1-212) 622-3906 himanshu.patel@jpmorgan.com
Vivek Aalok
(1-212) 622-0798 vivek.x.aalok@jpmorgan.com
Amy Carroll
(1-212) 622-1206 amy.l.carroll@jpmorgan.com
Michael Kimlat
(1-212) 622-0458 michael.x.kimlat@jpmorgan.com J.P. Morgan Securities LLC American Axle Autoliv AutoNation, Inc. Avis Budget Group, Inc. Borg Warner Inc. CarMax Inc. Cooper Tire & Rubber Dana Holding Corporation Dollar Thrifty Automotive Ford Motor Company General Motors Gentex Corporation Goodyear Tire & Rubber Group 1 Automotive, Inc Harley-Davidson Harman International Hertz Global Holdings, Inc. Johnson Controls, Inc. KAR Auction Services, Inc. Lear Corporation Lithia Motors Magna International, Inc. Meritor, Inc. Penske Automotive Group, Inc. Sonic Automotive, Inc. Tenneco Automotive Tesla Motors Tower International TRW Automotive Visteon Corp. AXL ALV AN CAR BWA KMX CTB DAN DTG F GM GNTX GT GPI HOG HAR HTZ JCI KAR LEA LAD MGA MTOR PAG SAH TEN TSLA TOWR TRW VC OW OW N OW N OW N (rs) N OW N OW OW N OW (rs) OW N N N OW N N N N OW N OW OW
We believe the global auto sector continues to send mixed signals, but increasingly think 2012 expectations are near bottom. U.S. SAAR has generally trended up in recent months (November SAAR came in at 13.6mm vs. Octobers 13.3mm and Septembers 13.1mm) and is broadly consistent with better-than-expected U.S. economic data points (we note JPM estimated 2012 SAAR is 13.2mm vs. 2011 estimated SAAR of 12.7mm). The Western Europe PV SAAR, however, has been resilient (flattish in August through October) during the recent market swoon, despite steep regional confidence survey declines. It is not particularly farfetched, in our view, to fear a cliff-type event for European auto sales in the coming quarters, but the data flow in the past three months simply does not suggest such an event so far. Our conversations with a handful of suppliers/OEMs suggest 2012 guidance commentary is likely to be more conservative than current consensus estimates, specifically for Europe-heavy players. Further, commodities are likely to be guided flattish as relief in base metals is offset by resins/rare earths, European auto production guidance may be down 8% at the more prudent suppliers (versus IHSs -4% and JPM -5%), and Brazil has shown some signs of slowdown in recent months. We continue to favor stories that are largely non-SAAR dependent (i.e., VC, HAR, TSLA) though the prospect of a plunge in Europe SAAR would suggest all could potentially be had for less. We also like the global tire space (Cooper Tire and Goodyear) going into 2012 as volumes have fallen but stabilized sequentially in many critical tire sub-segments (e.g., U.S. consumer replacement), and pricing is not likely to fall fast despite the recent lurch down in raw materials. We also think GM and particularly Ford have neared a bottom, though these stocks cannot escape a high degree of capital market sensitivity given their large pension plans.
Best Idea Visteon Corp (VC)

We think Visteons timing on value-unlocking corporate actions may be accelerating. Visteon disclosed that it had retained Rothschild and Goldman as financial advisors, without any reference to their specific assignment, raising the question of why such an advisory assignment was disclosed at such a time. We believe VC made this disclosure primarily to signal to investors that it is serious about looking at portfolio restructuring actions. Also, the appointment of Harry Wilson (former U.S. Auto Task Force member with a workout/PE background) to the Board and Finance committee seems to suggest a similar theme on potential ways to unlock value and encourage management to accelerate portfolio optimization actions. We expect to hear of at least some actions in next six months. We believe the most likely outcome of events could encompass two main transactions and one minor transaction (though potential sequence is unclear): 1) divestiture of Lighting (small deal); 2) purchase of remaining 30% stake in Halla Climate Control; and 3) divestiture of both interior trim assets (50% Yanfeng joint venture and consolidated Interiors).
Visteon Corp (VC) Overweight Dec 12 Price Target: $68
$56.30 $76.72 $38.32 Dec $0.52 $3.93 $4.50 14.3 12.5 $2,900 Valuation: Target reflects 3.5x EV/EBITDA multiple on pure (before equity income) 2013E EBITDA, with equity and minority stakes at 10x P/E. Risks: High customer concentration, FX transaction risk, atypical shareholder base, higher commodity costs, strategic actions. 88
US Year Ahead 2012
Beverages
Another Tough Year Expected for Beverages
John Faucher AC
(1-212) 622-6443 john.faucher@jpmorgan.com
Neal Rudowitz
(1-212) 622-0094 neal.m.rudowitz@jpmorgan.com
Sofya Tsinis
(1-212) 622-6391 sofya.s.tsinis@jpmorgan.com
We remain unimpressed with the U.S. beverages sector. As we have stated all year, top-line growth remains fairly muted, and the profit outlook is even worse. We are below consensus for pretty much every name we cover, as we believe that raw materials and foreign exchange are not appropriately reflected. Consistent with our market strategists view, we recommend that investors underweight the sector, and would prefer HPC to beverages, although our enthusiasm for HPC is only slightly greater. If the economy does continue to improve, as our economic/strategy teams believe, this group should benefit, but likely not enough to meaningfully outperform. Demand is likely to remain weak. The biggest problem for this group over the past several years has been the persistent weakness in the low-end U.S. consumer. Both the non-alcoholic and beer segments have been steady decliners over the past several years, as they have never truly seen a rebound following the recession. In nonalcoholic beverages, we think consumers have continued to move away from bottled water and CSDs, and pricing has dampened volume growth as well. For beer, we think the sustained high unemployment rate for young men (2x the rate before the recession) is the biggest negative impact, along with heightened competition from spirits and wine. We look for non-alcoholic volumes to be flat in 2012, with beer down slightly. For the wine and spirits categories, we expect low-single-digit volume growth along with muted pricing and a slight mix benefit as discounting continues at the higher end. Raw materials are also likely worse than most think. While resins and aluminum may end up being favorable, we continue to be concerned about the overall raw material environment given very favorable hedges that most of these companies had in place for 2011. In particular, we think the CSD companies are likely to see strong inflation in corn costs. We expect juice costs to be flattish and PET costs are forecasted to also remain flattish with some potential relief in 2H. With the group up a little over 2% YTD, yet still outperforming the market, sentiment is weak, as valuations have come down across the board. When we see reductions in consensus, potential stabilization of demand could provide a catalyst for the group.
Peter K Grom
(1-212) 622-4876 peter.k.grom@jpmorgan.com J.P. Morgan Securities LLC John Faucher Coca-Cola Co. Coca-Cola Enterprises Dr Pepper Snapple Group Hansen Natural Corp. Molson Coors Brewing Company PepsiCo Neal Rudowitz Brown-Forman Corp Constellation Brands Cott Corp
KO CCE DPS HANS TAP PEP
N N N N N OW
BFb STZ COT
N N OW
Best Idea PepsiCo (PEP)

With a lack of Overweight-rated stocks (only three in beverages), PepsiCo (PEP) is our top pick. The stock has underperformed the group YTD (-0.8%), after several rounds of negative revisions. While we are below consensus for 2012 ($4.48 versus consensus of $4.63), we think the buy-side is mostly aware that numbers need to come down. KO is trading at a 15% premium to PEP, and we are looking for that discount to close as investors regain some confidence in PEP management if they can finally deliver on (lowered) numbers for 2012. Recent reductions in corn futures prices leave us more optimistic that PEP will be able to continue to raise advertising/ marketing support which should help keep top-line growth in the 4-5% range.
PepsiCo (PEP) Overweight Dec 12 Price Target: $72
$64.65 $71.89 $58.50 Dec $4.13 $4.39 $4.48 14.7 14.4 $101,075 Valuation: Target reflects 15x 2013E EPS, just under the five-year historical avg. multiple of 17x. Risks: Slowdown in international or Frito business, further increase in raw materials prices, namely energy and agricultural, more profound weakness in NA beverages. 89
US Year Ahead 2012
Food Manufacturing
Cost Inflation May Decelerate But Consumer Confidence Still Not Strong
Ken Goldman AC
(1-212) 622-0359 ken.goldman@jpmorgan.com
Priscilla Tsai
(1-212) 622-5331 priscilla.tsai@jpmorgan.com
We hold a mixed outlook for food manufacturing stocks in 2012. Tailwinds may include a less onerous level of cost inflation and corporate actions that could create a higher level of interest than normal in the group. Headwinds may include foreign exchange rates, less ability to take pricing, and consumers that are still cash strapped. Tailwinds We believe that cost inflation should be significantly lower in 2012 than in 2011 for most food manufacturers. Based on current futures prices for corn, soybeans, hogs, etc., we expect spot prices to be up ~2-3% y/y on average, much less than the ~10% some companies have cited lately. We also believe that, while not fundamental in nature, some corporate actions may generate interest in the group. Three U.S. companies have announced their intention to split in twoKraft, Sara Lee, and Ralcorpand all three splits could possibly occur in 2012. Headwinds Assuming that foreign exchange rates remain flat between now and the end of next year, we would expect currency to be a headwind to sales and earnings growth for most international food companies we cover. We also assume that conditions for the average U.S. consumer will not improve much next year, which could be another headwind for the group. Although food is a staple, it can be victimized by trading down and/or less pantry loading. Government austerity programs will not help in this regard. Lastly, we remain concerned about the global retail environment competitors in nations such as Australia are playing hardball with manufacturers on price and driving sales lower. We believe that the global retail environment will become even tougher in 2012, including in the United States, where retail comps may soften.
Jessica Schmidt
(1-212) 622-1205 jessica.l.schmidt@jpmorgan.com J.P. Morgan Securities LLC Ken Goldman Campbell Soup Company ConAgra Foods Dean Foods General Mills H.J. Heinz Co. Hershey J.M. Smucker Co. Kellogg Kraft Foods McCormick & Co., Inc. Mead Johnson Nutrition Pilgrim's Pride Sanderson Farms, Inc. Sara Lee Smithfield Foods, Inc. TreeHouse Foods Inc. Tyson Foods Jessica Schmidt Dole Food Co. Hain Celestial Group
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Best Idea J.M. Smucker Co. (SJM)

J.M. Smucker Co. (SJM) is our top pick for 2012. After navigating one of the food industrys most challenging cost-inflation periods in 2011, Smucker appears well positioned for strong growth in 2012. The company has a number of tailwinds next year, including decelerating raw material costs (vs. a COGS increase of 19% this year), benefits from the SLE coffee deal, accelerating savings from its restructuring program, and continued share repurchases. With over 60% of EBIT coming from SJMs coffee business and our expectations for lower coffee costs next year, we see this margin tailwind outweighing continued challenges from rising peanut prices. The company remains well positioned strategically as the branded leader in its categories and has proven its dedication to innovation and marketing, trends we believe should continue. With the stock currently trading at a P/E discount of 0.3x to the group median, we think the risk/reward profile is attractive given the companys strong market share, clean balance sheet, and long list of tailwinds heading into next year.
J.M. Smucker Co. (SJM) Overweight Dec 12 Price Target: $86
$76.67 $80.26 $61.16 Apr $4.69 $5.00 $5.61 15.3 13.7 $8,728 Valuation: Target reflects 14.4x CY2013E EPS, in line with group. Risks: Rising coffee costs pressuring margins, SLE deal not as accretive as forecast, greater-than-feared peanut butter elasticity.
90
US Year Ahead 2012
Food Retail
Beware the Comps
Ken Goldman AC
(1-212) 622-0359 ken.goldman@jpmorgan.com
Priscilla Tsai
(1-212) 622-5331 priscilla.tsai@jpmorgan.com
Jessica Schmidt
(1-212) 622-1205 jessica.l.schmidt@jpmorgan.com J.P. Morgan Securities LLC Ken Goldman Kroger Safeway SUPERVALU The Fresh Market Weight Watchers International Whole Foods Market
We expect input costs to come down significantly next year. Based on our JPM Raw Foodstuffs Index, we believe the worst of inflationary pressure is behind the grocers. By next year, we estimate food retailers may hit the sweet spot of lowsingle-digit cost inflation, which should create a favorable environment for margin expansion. Over the last 60 years, when the Food PPI declined month on month, the average food retail margin improved by 0.7% m/m. More importantly, price deceleration should help the bottom line. Historically, food retailers penny profits have been highest when inflation was in the low-single-digit range. However, pricing deceleration should hurt ID sales. We believe the food retail industry is likely to experience a revenue slowdown next year, partially due to our expectations for a significantly weaker pricing tailwind vs. 2011. While there is an argument to be made that lower prices could lead to better volumes, history shows that the relationship has not been 1:1, meaning that volumes generally do not rise as much as prices fall, and vice versa. The competitive environment remains a structural challenge for traditional grocers. We think traditional grocers will continue to lose share to alternative grocers. Club stores, discounters, dollar stores, niche grocers, etc., still have significant room for new store growth in the U.S. and continue to add more food to their mix, we believe. In addition, certain large supermarkets may accelerate their price investments, which could potentially pressure traffic at competitors. So on a relative basis, we see alternative retailers generally as better plays next year.
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Best Idea The Fresh Market (TFM)

The Fresh Market (TFM) is a true growth stock with strong fundamentals. In our opinion, The Fresh Market remains one of the best growth stories in the entire consumer space. Fundamentally, we think TFM is poised for significant growth and has found a nichethe higher-income consumer who is not as price sensitive and wants a quality shopping experience. We believe the company is likely to experience an EPS CAGR of ~28% over the next two years (FY12-13E), supported by its long runway for new store growth and margin expansion. We appreciate that other food retailers, namely Whole Foods (WFM Neutral), offer better ID sales, but we note that the stores are rather different, with WFM more focused on health and wellness and TFM more committed to a pleasurable shopping experience. While we are not making an argument for significant multiple expansion (with TFM currently trading around 29x FY12E on a consensus basis and 1x below WFMs ten-year average), we do not see it as inflated given the compelling case for continued earnings expansion.
The Fresh Market (TFM) Overweight Dec 12 Price Target: $55
$40.55 $46.85 $30.86 Jan $0.86 $1.07 $1.40 37.9 29.0 $1,946 Valuation: Target reflects 30x F2013E EPS, in line with WFMs average over last ten years. Risks: Worsening economy, leaving consumers with less discretionary cash, other grocers lowering prices, widening gap with TFM, eventual venture into California proving unsuccessful.
91
US Year Ahead 2012
Gaming
Asia Outlook Remains Solid LVS Positioned to Outperform in 2012
Joseph Greff AC
(1-212) 622-0548 joseph.greff@jpmorgan.com
James Omstrom, CFA

(1-212) 622-1306 james.omstrom@jpmorgan.com
Jonathan Mohraz
(1-212) 622-1111 jonathan.mohraz@jpmorgan.com J.P. Morgan Securities LLC Joseph Greff Ameristar Casinos, Inc. Bally Technologies, Inc. Boyd Gaming Group International Game Technology Las Vegas Sands Corp. Melco Crown Entertainment MGM Resorts International Penn National Pinnacle Entertainment Shuffle Master WMS Industries Wynn Resorts James Omstrom, CFA Scientific Games Corporation
Within the Gaming sector, we believe the most attractive fundamentals continue to be in Macau and Singapore, where gaming growth continues to remain robust, while near- to mid-term competitive supply remains relatively low. Year to date through November, gaming revenue growth in Macau is up 44% over prior-year levels, despite a staunch +57% growth comparison. While market-wide gaming revenue growth is expected to show signs of deceleration in December due to a difficult yearover-year comparison, we believe the market can still grow 30-35%. Given the solid trends in the mass and VIP gaming segments, as well as the opening of Sands Cotai Central (sites 5 and 6) in late 1Q12, which should help to accelerate market-wide growth, we expect Macau GGR growth to trend in the 15-20% range in 2012, slightly higher than buy-side expectations, in our view.
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The expected growth rate in Macau is significantly stronger than any gaming market in the U.S., where the mature nature of the business combined with high unemployment and a slow economic recovery continue to keep results muted. That being said, trends on the Las Vegas Strip continued to strengthen throughout 2011 and we believe this strength will accelerate in 2012, given solid convention and group business demand, as well as an increase in leisure travel. In addition, we remain very excited about the Singapore gaming market, which opened less than two years ago and consists of just two integrated resort casinos, one of which is owned by LVS. The initial growth of the Singapore market can be described as robust and going forward we believe the market-wide growth will remain solid given the depth of the Asian gaming customer base and limited capacity within the region. Recent trends point to continued strength in the mass and VIP gaming customer base, as well as increases in hotel and retail spend trends.
Best Idea Las Vegas Sands (LVS)

We continue to maintain our Overweight rating on Las Vegas Sands (LVS) and view it as one of the best ideas within the gaming space for the year ahead. We believe LVS is a solid risk-reward proposition at current levels, offering an attractive combination of EBITDA and earnings growth, free cash flow generation (9% yield on 2013E), and reasonable valuation (17.4x 2012E EPS). In our view, LVSs growth prospects are superior to those of any other company in our coverage universe, given its strong positioning in the growth markets of Macau (~47% of 2012E EBITDA) and Singapore (~42% of 2012E EBITDA), low exposure to the U.S. market (~11% of 2012E EBITDA), and no exposure to Europe. Furthermore, we believe there is potential for upside to estimates given Macau junket (VIP)related market shares gains beginning in 4Q11, as well as a staggered 2012 (beginning in late 1Q12) Sands Cotai Central opening, for which we believe there are relatively low investor expectations.
Las Vegas Sands (LVS) Overweight Dec 12 Price Target: $64
$45.58 $51.05 $36.05 Dec $1.00 $2.04 $2.62 22.3 17.4 $37,386 Valuation: Target reflects multiples of 10.0x 2013E LV EBITDAR, 15.0x 2013E Macau EBITDAR (adjusted for 70.3% interest), 15.0x 2013E Singapore EBITDAR, 15.0x Sands China royalty fees, and 90% of 9.0x our 2013E PA EBITDAR, less 2013E year-end net debt, consistent with LV/Macau-centric peers. Risks: Additional regulatory investigations related to FCPA compliance, potential restrictions relating to Macau travel, volatility related to investor expectations on monthly Macau results, executing Singapore VIP ramp.
92
US Year Ahead 2012
Homebuilding & Building Products

Selective Approach on Both Homebuilders and Building Products; Top Picks LEN and OC
Michael Rehaut, CFA AC
(1-212) 622-6696 michael.rehaut@jpmorgan.com
Jason A. Marcus
(1-212) 622-4906 jason.a.marcus@jpmorgan.com
William W. Wong
(1-212) 622-1442 william.w.wong@jpmorgan.com J.P. Morgan Securities LLC Beacon Roofing Supply Beazer Homes D.R. Horton Hovnanian Enterprises KB Home Lennar Masco Corp. MDC Holdings Meritage Homes Mohawk Industries NVR, Inc. Owens Corning PulteGroup Inc. Ryland Group Standard Pacific Stanley Black & Decker Toll Brothers USG Corporation Whirlpool BECN BZH DHI HOV KBH LEN MAS MDC MTH MHK NVR OC PHM RYL SPF SWK TOL USG WHR N UW N UW N OW UW UW N OW OW OW N N N N OW N N
Homebuilders While we estimate the builders are currently trading at 1.07x on an adjusted P/B basis, at the low end of their historical 1.0-2.0x range, given our outlook for the more challenged macro environment to persist at least over the next 6-9 months, as well as our more muted industry demand outlook for 2012, we believe valuations will likely remain depressed relative to historical averages over this period. As a result, we believe investors should use a fairly selective approach in terms of individual stock selection, given the more challenged macro and demand environments.
Best Idea Lennar (LEN) We continue to highlight Overweight-rated LEN as our top pick, as we believe the companys near industry-leading margins, solidly positive EPS, and accretive Rialto segment should drive further multiple expansion relative to its peers. At 1.18x book value (ex-adj. FAS 109), LEN is currently trading at a 12% premium to its larger-cap peers, which we believe is reflective of LENs higher margins and profitability, as well as additional accretion coming from its Rialto segment. Moreover, given our outlook for continued outperformance by LENs homebuilding operations, as well as further positive results from Rialto, we believe further multiple expansion relative to peers is likely. We apply a 1.23x P/B multiple to our end-2012 book value estimate of $17.54 (ex-adj. FAS 109) to reach a December 2012 price target of $21.00.
Lennar (LEN) Overweight Dec 2012 Price Target: $21
Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.) $3,464
$19.27 $21.54 $12.14 Nov $0.50 $0.52 $0.93 37.1 20.7 Risks: Larger-than-expected impairment charges, weaker-than-expected growth, lower-than-expected Rialto earnings.
Building Products Our more selective approach to the Building Products sector is based on two factors. First, the Street is largely in line or ahead of our 2012E, leaving little room for upside. Second, while not expensive, the groups P/E of 13.5x and 14.6x for 2011E and 2012E, and current EV/EBITDA at 7.5x, is not compelling either, in our view.
Best Idea Owens Corning (OC) At only 6.3x 2011E EBITDA, an 8% discount to its ten-year average and a 15% discount to peer levels, OCs valuation as attractive, in our view. We note that margins for one of its three main segmentsInsulationremain near trough levels and therefore represent a compelling upside opportunity, while we believe the Roofing segments margins can remain well above normalized levels at least through 2012. Lastly, OCs third main segment, Composites, should show further margin expansion in 2012. In addition, there is upside potential, in our view, to the Street consensus for 2012, as our estimate of $2.85 is above the Streets $2.69. Regarding our price target, we apply a 6.6x EV/EBITDA multiple to our 2012E EBITDA, resulting in a price target of $39.00. Our 6.6x multiple represents a 4% discount to its five-year average, which we believe is appropriate and reflects the recently more challenged visibility surrounding economic growth in both the U.S. and Europe.
Owens Corning (OC) Overweight Dec 2012 Price Target: $39
$28.98 $38.94 $18.67 Dec $1.57 $2.20 $2.85 13.2 10.2 $3,503 Risks: Greater-than-expected demand decline for composites, weaker-than-expected U.S. residential demand, higher raw materials costs. 93
US Year Ahead 2012
Household & Personal Care Products

Stay Picky as Numbers Come Down
John Faucher AC
(1-212) 622-6443 john.faucher@jpmorgan.com
Sofya Tsinis
(1-212) 622-6391 sofya.s.tsinis@jpmorgan.com
Neal Rudowitz
(1-212) 622-0094 neal.m.rudowitz@jpmorgan.com
Peter K Grom
(1-212) 622-4876 peter.k.grom@jpmorgan.com J.P. Morgan Securities LLC John Faucher Church & Dwight Clorox Colgate-Palmolive Energizer Holdings Estee Lauder Kimberly-Clark Newell Rubbermaid Inc. Nu Skin Enterprises Procter & Gamble SodaStream International Sofya Tsinis Tupperware Brands
As with the U.S. beverages sector, we remain unenthused with the state of the U.S. Household & Personal Care space, although with a slight preference to HPC. In the context of JPMs macro call, we advise investors to underweight the group. We continue to believe that 2011 was a tougher year than investors realize, as our large-cap names (ex EL) will fail to deliver their long-term, Fx-neutral EPS algorithms. Top line has generally been at the low end of expectations given continued weakness in developed markets, only partially offset by strong emerging market growth. Raw materials have also been a big drag on results, with most of the companies using foreign exchange to substitute for pricing. We expect 2012 to be another difficult year, as organic top line is likely to remain sluggish as developed markets remain below our longer-term targets due to continued weakness with the low-end consumer. The turn in foreign exchange to negative for 2012 should lead to a slowdown in reported EPS growth. At this point, we are below consensus on most of our large-cap and SMid-cap names.
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Our preference for HPC over beverages is due to pricing and raw materials. While not positive, the pricing and cost inflation outlooks are better for HPC than for beverages, in our view. On the pricing side, we generally see less risk despite some very competitive behavior on the part of most players, as the U.S. soft drink category still has more competitive pressure. In general, we are seeing pricing move up in the HPC categories. Pricing has turned positive on a reported basis for these companies, and should improve slightly on a sequential basis heading into calendar 2012. Raw materials should also be less of a drag as many oil-based raw materials are now projected to be just up slightly y/y, and could even be down in calendar Q2. We also would point out that productivity levels for HPC companies are generally higher, providing greater comfort surrounding the ability to drive some margin expansion. On the SMid-cap side we are generally more positive, as many of the individual stories are less reliant on macro factors. In particular, names like Tupperware and NuSkin have greater-than-average exposure to emerging markets, which should lead to organic top-line growth at the high end of the group, although this will obviously come with greater foreign exchange risk.
Best Idea Procter & Gamble (PG)

Our top pick for 2012 in HPC is Procter & Gamble (PG). While the more defensive nature of PG would seem to make it ill suited for this type of market, we think the underperformance in 2011 (-16% vs. the large-cap HPC group) leaves it well positioned to outperform its peers. We expect PG to accelerate core earnings growth from 4% in calendar 2011 to 14% in calendar 2012 through more pricing, better productivity, and SG&A leverage, as the ad-to-sales ratio has already been increased to above 11%. With the stock now trading at a 17% discount to the large-cap HPC group, we think there is room for the multiple to move up as well, as PG delivers four straight quarters of operating profit growth for the first time in four years.
Procter & Gamble (PG) Overweight Dec 12 Price Target: $75
$64.84 $67.72 $57.56 Jun $3.95 $4.15 $4.49 15.6 14.4 $178,396 Valuation: Target reflects approx. 16x CY13E EPS, similar to levels over past five years. Risks: Lower-than-anticipated benefit from costsaving initiatives and/or investment levels, slowdown in top-line growth, deterioration in innovation pipeline, larger-than-anticipated hit from mix, inability to take pricing, input costs.
94
US Year Ahead 2012
Lodging
No Slowdown in Sight WYN Positioned to Outperform in 2012
Joseph Greff AC
(1-212) 622-0548 joseph.greff@jpmorgan.com
Kevin Milota
(1-212) 622-0987 kevin.milota@jpmorgan.com
Jonathan Mohraz
(1-212) 622-1111 jonathan.mohraz@jpmorgan.com J.P. Morgan Securities LLC Joseph Greff Chesapeake Lodging Trust Choice Hotels International FelCor Lodging Trust Host Hotels & Resorts Inc. Hyatt Hotels Corporation LaSalle Hotel Properties Marriott International Orient-Express Hotels Starwood Hotels & Resorts Worldwide Strategic Hotels & Resorts Sunstone Hotel Investors Inc. Wyndham Worldwide Kevin Milota Carnival Corporation Gaylord Entertainment Royal Caribbean Cruises
Current fundamentals in the lodging sector remain sound and in our view do not imply a slowdown despite recent soft macroeconomic data in the U.S. and Europe. That said, it is early for any impact given that lodging fundamentals have historically lagged economic cycles. Recent 3Q11 earnings conference calls suggest approximately mid-single-digit RevPAR growth in 2012, consistent with our estimates. We are generally positive on the longer-term demand-supply equation, given low supply growth in the U.S. for the next few years, room rate upside relative to rates in the prior cycles peak, and secular growth internationally (emerging markets like China, India, and Brazil, among others). So far, no lodging operator that we know of has experienced cancellation increases, no-show increases, or increased attrition over the past monththings that lodging operators likely would experience at the beginning of a slowdown. We keep hearing words like yet when asked if the group has slowed or that it is still early (this is true, in our view) and that Fall will be a telling period on what impact, if any, there has been to business travel from potentially eroding business confidence. Our checks indicate that 2012 corporate rates should reflect mid-single-digit increases (likely slightly higher for markets like NYC, Hong Kong, Singapore, and London), though it is still early in the negotiations and we think that a mid-single-digit rate increase would be positive and better than whats priced in the stocks currently.
CHSP CHH FCH HST H LHO MAR OEH HOT BEE SHO WYN
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Best Idea Wyndham Worldwide (WYN)

Wyndham Worldwide (WYN) remains our top lodging pick given: (1) its substantial valuation discount to its peers, (2) its (still) underappreciated and improving free cash flow generation, (3) its solid balance sheet, and (4) not a lot of execution risk and high level of resiliency within its hospitality business model. We believe WYNs valuation discount to its lodging peers is undeserved and, over time, the discount will narrow (current discount of ~4.0 multiple points on an EV/EBITDA basis to its C-Corp peers on our 2012 estimates). We believe the WYN investment story is one of the least appreciated in our gaming, lodging, and leisure coverage universe. In short, we believe WYN possesses a very resilient and underappreciated set of hospitiality businesses with fairly low capital intensity that generate meaningful free cash flow ($600-700mm annually) which can be harvested to meaningfully shrink the share count (in a manner highly accretive to EPS given the shares low valuation) while maintaining investment-grade credit statistics.
Wyndham Worldwide (WYN) Overweight Dec 12 Price Target: $46
CCL GET RCL
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$35.84 $36.60 $24.76 Dec $2.00 $2.46 $2.80 14.6 12.8 $5,520 Valuation: Target reflects 11.0x 2012E Lodging EBITDA, 10.0x 2012E Vacation Exchange and Rentals EBITDA, 11.0x Property Management Fee EBITDA less corporate net debt plus value related to its timeshare receivables (100% of book value) and timeshare inventory value (100% of book value) less securitized timeshare debt (100% of book value). Risks: Greater-than-expected impact from slowing economy, greater-than-expected competition, timeshare development timing risk, timeshare financing issues.
95
US Year Ahead 2012
Restaurants
Cost-Saving Initiatives and FCF Opportunity Make Brinker Our Top Pick in 2012
John Ivankoe AC
(1-212) 622-6487 john.ivankoe@jpmorgan.com
Amod Gautam
(1-212) 622-6417 amod.gautam@jpmorgan.com
Shaurja Ray
(1-212) 622-2039 shaurja.ray@jpmorgan.com J.P. Morgan Securities LLC Arcos Dorados Holdings, Inc. Brinker International Chipotle Mexican Grill, Inc. Darden Restaurants DineEquity Inc. Domino's Pizza Inc Dunkin' Brands McDonald's P.F. Chang's China Bistro Starbucks Sysco Corporation Texas Roadhouse Inc. The Cheesecake Factory, Inc. The Wendy's Company Tim Hortons Inc. Yum Brands ARCO EAT CMG DRI DIN DPZ DNKN MCD PFCB SBUX SYY TXRH CAKE WEN THI.TO YUM N OW N OW OW OW OW OW N OW N OW N N N OW
In 2012, we believe the story in the restaurant sector will be much of the same compared to 2011. Slow employment and wage growth should continue to limit traffic growth while 4-5% commodity inflation should test restaurant operators ability to manage margins as effective pass-through pricing power is limited. In such a period, we recommend that investors own a combination of defensiveness with respect to volatile sales/margins with opportunity for cyclical-driven upside resulting either from a forward-looking stock market or actually improved near-term results. Specifically, we believe investors should own Yum Brands for solid global development, particularly in emerging markets, and FCF generation which should allow for 10%+ EPS growth in F12 and beyond. We also believe investors looking for U.S. consumer acceleration should participate in casual dinings cyclical upside potential but own Brinker specifically as the company provides highly visible costsavings opportunity which we expect will enhance margins by 60bps in F12 (June) and 130bps in F13. In addition, a 6%+ FCF yield in F12E and 10%+ in F13E should provide EPS support and potential for solid shareholder return, in our view.
Best Idea Brinker International (EAT)

Our top pick for 2012 is Brinker International (EAT). We visited management at an onsite visit at a Chilis in Raleigh in mid-November to showcase the new remodel package but more importantly Phase 2 of the kitchen of the future. We came away impressed with the companys better not bigger focus with all operational initiatives geared towardand succeeding indriving improved employee/ customer satisfaction to improve shareholder returns. We expect initiatives related to kitchen systems (to be completed by end-F12 for a 50bp impact) and kitchen equipment (500bps in F12, 300bps in 1H13 for a 100bp+ impact) to allow margin gains of 60bps for the year with further gains offset by a 3.54.5% commodity price increase offset by only 1-2 points of price. Further, comps of 2% in F12 should be driven by aforementioned pricing, a lapping of negative lunchdriven menu mix in January, and remodels. We expect the company to remodel 200 out of 800 units in F12 at a per-unit cost of $200-250k at an average 3-4%, or $100k, sales lift. In addition, we expect F12 earnings to be driven by previously bought-back stock. The company had an average 83.6mm shares outstanding in 1Q12 vs. a F11 average of 92.3mm. For the full year F12, we expect an average of 82.6mm shares, an 11% reduction from the F11 level. Valuation is also attractivestock too inexpensive for 20%+ earnings growth in each of F12E and F13E and 12% thereafter. We believe sales, margin, and overall EPS visibility has increased and that the companys C12E P/E multiple of 11.8x, the casual dining group low, has considerable opportunity for upside. Our $31 price target assumes EAT can trade at 14x F13E EPS, reflective of average earnings growth of ~20-25% over F12/13 and low-double-digit growth thereafter.
Brinker International (EAT) Overweight Dec 12 Price Target: $31
$23.78 $26.80 $19.50 Jun $1.52 $1.84 $2.25 12.9 10.6 $1,914 Risks: Reversal in SSS improvement at Chilis, margin initiatives that fail to provide anticipated benefits, higher-than-expected commodity costs. 96
US Year Ahead 2012
Retailing Broadlines, Apparel & Footwear

Balanced Approach to 2012 with Macys Our Top Idea
Matthew R. Boss, CPA AC
(1-212) 622-2630 matthew.boss@jpmorgan.com
In the midst of todays volatile macroeconomic backdrop, we recommend a balanced approach focusing on company-specific fundamentals, competitive forces, valuation, and investor sentiment. Four notable themes out of 3Q EPS: 1) credit the primary upside P&L driverall six retailers spoke to 3Q favorability (lower write-offs/bad debt); 2) gross margin pressure greater than expected with five of six department stores missing JPM projections (SKS the sole upside surprise), with headwinds including free shipping and increased promotions; 3) conservative Holiday/4Q tone with December (extra shopping day) expected to outpace November, with specific commentary related to need-based/event shopping and highly competitive/promotional backdrop; 4) tougher compares at high end to result in likely moderationSKS and JWN cited tougher upcoming compares leading to likely top-line and gross margin moderation. Balanced approach: Heading into 2012 we like OW-rated Macys (long-term core holding) and JCPenney (turnaround opportunity) on the long side and would use UW-rated Kohls (top-line inconsistency/peak gross margins) as a source of funds. Department stores 2012 puts and takes Focus on top-line: We expect 2012 to remain promotional for the moderate department stores, as the battle for market share is likely to heat up given the reemergence of JCPenney under the direction of new management. From a macro perspective, elevated unemployment levels in 2012 should continue to pressure spending at the middle/low end. Europes financial turmoil (JPM Eurozone base case is mild recession ending mid-2012) could negatively impact high-end spending (i.e., Saks), particularly given a potential slowdown in tourism (accounts for 25% of Saks New York Flagship store). That said, the silver lining may be easing top-line compares as the year progresses with 2H12 ~270bps easier than 1H (two-year stack). Eye on margins: On the cost side, while product cost inflation is expected to ease in 2H12, wage inflation in China could offset a portion of the upside opportunity. On the SG&A front, we anticipate continued spending around multi-channel online growth and believe the level of 2011 credit upside will be a tough act to follow.
Anne McCormick
(1-212) 622-4163 anne.e.mccormick@jpmorgan.com J.P. Morgan Securities LLC Dillard's, Inc. J.C. Penney Co., Inc. Kohl's Corp. Macy's, Inc. Nordstrom, Inc. Saks, Inc. DDS JCP KSS M JWN SKS N OW UW OW N N
Best Idea Macys (M)

At 10.1x our 2012E EPS of $3.25 and 5.5x EBITDA, Macys (M) trades at some of the cheapest multiples in retail today. We believe top-line momentum is sustainable for the next 3-5 years given the following drivers: 1) Omni-channel initiative in first inning; 2) My Macys in third inning; and 3) Magic selling also in first inning. While the promotional environment continues to heat up, we believe Macys can and will continue to win through focusing on its own strategy (brand, price, quality trio). On the margin side, the roll-out of Omni-channel functionality and price optimization in 2012 should begin to bear P&L fruit in 2H12, particularly in the fourth quarter. With annual free cash flow generation in excess of $1.7 billion, the prospect of an increased share repurchase plan post December represents another upside catalyst.
Macys (M) Overweight Dec 12 Price Target: $36
$32.95 $33.26 $21.69 Jan $2.11 $2.80 $3.25 11.8 10.1 $13,833 Valuation: Target reflects 11x 2012E EPS, 50bps above three-year average. Risks: Greater-than-expected downturn in household spending, change in competitive promotional landscape, excess clearance markdowns impacting gross margin more than expected.
97
US Year Ahead 2012
Retailing Hardlines/Discounters
COST: Strong Port in the Storm
Christopher Horvers, CFA AC
(1-212) 622-1316 christopher.horvers@jpmorgan.com
Aaron Goldstein
(1-212) 622-1336 aaron.goldstein@jpmorgan.com
Rachel Stubins
(1-212) 622-4245 rachel.stubins@jpmorgan.com
Mark Becks
(1-212) 622-5265 mark.a.becks@jpmorgan.com J.P. Morgan Securities LLC Christopher Horvers, CFA Advance Auto Parts, Inc. AutoZone, Inc. Bed Bath & Beyond Best Buy Costco Wholesale Corporation Dick's Sporting Goods Genuine Parts Company GNC Holdings Lowe's Companies, Inc. O'Reilly Automotive Office Depot OfficeMax Inc. PetSmart, Inc. RadioShack Staples Target Corporation The Home Depot Tractor Supply Vitamin Shoppe, Inc Wal-Mart Stores, Inc. Williams-Sonoma, Inc. Aaron Goldstein Cabela's Inc. hhgregg
AAP AZO BBBY BBY COST DKS GPC GNC LOW ORLY ODP OMX PETM RSH SPLS TGT HD TSCO VSI WMT WSM
UW N N N OW OW N OW N UW OW N N N OW N OW N OW OW N
Years of aggressive store expansion drove outperformance for many retailers. In contrast, now only a handful of retailers are expanding significantly (and are generally crowded stocks). From a lifecycle perspective, hardlines/big-box retailers fall into the mature/macro-driven bucket with low domestic footage growth (which increases dependence on the economy for their success). Looking into 2012, our outlook for discretionary retail is challenged with the dominant bull or bear points being either 1) macro-related or 2) related to Congress and the EU. We believe the consumer is likely to remain conservative (and retrench after Christmas) given little need to shop (particularly in 1Q), a stretched savings rate, and likely mounting credit card bills. Furthermore, job creation remains lackluster with nonfarm payrolls posting an anemic 1% y/y growth rate since early 2011. While the worst of the deleveraging process is likely past, it isnt over and we dont expect acceleration in spending trends, particularly for the low-end consumer, until more jobs are created. Overall, the uncertainties weighing on economic growth globally temper our outlook and we prefer to begin the year with a relatively defensive posture.
Best Idea Costo (COST)

Given this backdrop, two of the most highly sought-after attributes a company can have include the ability to drive sales and visibility into earnings. COST continues to have strong sales momentum due to 3-4% store growth and ~4% traffic growth driving market share gains. The latter is a function of impressive merchandising, a value-oriented consumer, roughly half of the mix being consumable, and a higherend customer base (household income of $96k per year). We forecast continued solid results with low- to mid-single-digit core comp growth expected for the foreseeable future. In addition to sales growth driving earnings, membership fees provide both stability and long-term visibility to EBIT margins, while the recently announced membership fee increase provides visibility into incremental earnings growth over the next eight quarters (~$0.08 in FY12E and ~$0.17 in FY13E or 3% and 4-5% incremental earnings growth, respectively). Net-net, we believe these factors should support a high multiple and a buy the dips philosophy. We particularly favor COST in early 2012 when the consumer is likely to pause after what we expect to be a strong holiday period (when retail industry sales are expected to be up nearly 4%). Our Dec-12 price target of $94 is based on a multiple of ~21x our fiscal 2013 EPS forecast of $4.44 (equating to ~9x on an EV/EBITDA basis).
Costco Wholesale Corporation (COST) Overweight Dec 12 Price Target: $94
CAB HGG
UW N
$88.06 $88.68 $68.53 Aug $3.30 $3.86 $4.44 22.8 19.8 $38,162 Risks: Consumers limiting spending on more discretionary product categories, rising product cost inflation and increased competitive pricing, decreased SG&A leverage, deterioration in membership renewal rates, missed or poorly executed store opening plans, high exposure to California.
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US Year Ahead 2012
Retailing Specialty
Cotton May Offer Some Relief in 2H12, But Generally Expect More of the Same Trends
Brian J. Tunick AC
(1-212) 622-6449 brian.tunick@jpmorgan.com
Ike Boruchow, Jr.

(1-212) 622-9758 ike.boruchow@jpmorgan.com
Simeon Siegel, CFA

(1-212) 622-0149 simeon.siegel@jpmorgan.com J.P. Morgan Securities LLC Brian J. Tunick Abercrombie & Fitch Aeropostale American Eagle Outfitters Ann Taylor Stores Ascena Retail Group Inc Chico's FAS, Inc. Citi Trends, Inc. Coach, Inc Francesca's Holdings Corp JoS. A. Bank Clothiers Inc Limited Brands, Inc. Men's Wearhouse Ross Stores rue21, inc. The Buckle Inc. The Children's Place The Gap, Inc. The Wet Seal, Inc Tiffany & Co TJX Companies Ulta Salon, Cosmetics & Fragrance, Inc. Urban Outfitters Ike Boruchow, Jr. Fossil, Inc. Signet Jewelers Vera Bradley
ANF ARO AEO ANN ASNA CHS CTRN COH FRAN JOSB LTD MW ROST RUE BKE PLCE GPS WTSLA TIF TJX ULTA URBN
N N N N N OW N OW N N OW OW N OW N N N OW N N OW OW
We believe that many of the same issues that impacted 2011 are set to continue to affect our coverage universe again in 2012. On the demand side, we still see a weak consumer confidence/employment backdrop for the lower-income demographics, a continuation of shopping closer to need, and uncertainty around fashion newness. On the supply side, the competitive landscape hasnt seen much relief in the past year and there has actually been some new store growth from select international retailers looking for growth in the United States. This backdrop continues to set up a highly promotional environment in which softline apparel retailers in the missy, junior, and kids space could continue to be challenged to improve returns. Among our coverage universe, specialty retailers that cater to the underserved mens/young mens market, and those that sell accessories and handbags or other categories like cosmetics and intimates should be better positioned. For the softline retailers as a group, some benefit should come in 2H12 as they start to feel the relief of lower cotton costs begin to hit their P&L. Labor costs are likely to remain elevated and freight costs are also unknown, but the fabric side of the equation could lead to high-single-digit declines in product costs versus 2H11. Beyond sourcing relief, the sector continues to look for growth to come from expansion into Europe, Asia, and Canada as those markets have so far shown to be higher-margin projects than additional openings in the saturated U.S. market. As U.S. growth continues to slow, the retailers are faced with the increasing burden of putting their volatile free cash flow to use. We also expect channel mixgrowth of ecommerce and factory outletcombined with the closing of some underperforming mall-based storesto be another potential way for retailers to improve returns.
Best Idea Ulta Salon, Cosmetics & Fragrance (ULTA)

We believe Ulta Salon, Cosmetics & Fragrance (ULTA) remains one of the few retailers that can more than double its 450-store base given favorable industry trends and a strong competitive position. ULTA should continue to benefit from market share shifts in the beauty industry away from traditional players and toward specialty stores, as the company offers one of the broadest product selections in beauty retail a major competitive advantage, in our viewalongside its salon service offerings. The continued additions of new prestige brands, an improved loyalty program, and increased recognition of ULTA as a beauty destination (continued rollout of marketing events) should support comp growth going forward. Another positive in the ULTA story is the fact that new stores open at 30% lower volume than mature stores, giving the store base a natural maturation curve to help support 3-5% annual comp growth. The company had stated that its long-term target is to achieve mid-teen operating margins over the next 3-4 years (vs. 8.0% in 2010) with the potential for $4.00-5.00 in EPS power over the next 3-4 years (~30% CAGR). As a result, ULTA remains one of the most compelling growth stories in retail, in our view.
Ulta Salon, Cosmetics & Fragrance (ULTA) OW Dec 12 Price Target: $80
FOSL SIG VRA
OW OW N
$72.93 $75.70 $32.01 Jan $1.17 $1.80 $2.30 40.5 31.7 $4,514 Valuation: Target reflects 35x 2012E EPS, given companys potential to generate 25-35% bottom-line growth for next several years. Risks: Ability to open new stores on timely basis, traffic levels, industry-wide level of promotions, departure of CEO having an impact on supply chain and relationships withspecific brand-name vendors. 99
US Year Ahead 2012
Tobacco
Continuing to Deliver
Rae Maile AC
(44-20) 7155 6102 rae.maile@jpmorgan.com J.P. Morgan Securities Ltd. Altria Group Lorillard Inc Philip Morris International Reynolds American MO LO PM RAI OW N N OW
The tobacco sector continues to offer scope for material, consistent profit growth over the medium term, we believe. As a result of consolidation in the global market there are just four major players, while in the U.S. the industry is dominated by just three players. Each of these companies has a stated target of consistently delivering medium-term profit growth to shareholders, driven by a focus on value growth rather than volume growth. In addition, each of the industry majors has an active share repurchase program, delivering further value to shareholders in addition to already generous dividends and ensuring that balance sheets do not strengthen further. Pricing remains the key driver of industry profitability, with the industry benefiting from higher rates of tax and duty which mask underlying manufacturers pricing decisions. With duty approximating 65% of retail prices, a manufacturers price increase of 5% implies a retail price increase of only around 2%. With the major manufacturers focusing on product innovationin packaging, filters, slims, superslims, blends, etc.price has become a much reduced source of competition. Although the sector has proven recession resilient it has not been wholly recession proof. As conditions improve we expect to see a lessening of downtrading pressures in developed markets and a stronger trend of uptrading in developing markets. Philip Morris International (PM) should continue to deliver its stated target for constant-currency EPS growth of 10-12% in 2012, helped by its continuing share repurchase program but mainly as a result of the favorable industry dynamics discussed above. In the U.S. domestic market we expect to see further evidence of a firm pricing agenda from the industry. For 2011 we estimate underlying tobacco consumption will have declined by only 2%, with a similar decline likely in 2012. With the benefit of pricing, the industry should be able to deliver mid-single-digit operating profit growth, and with the benefit of share repurchases (roughly $1bn per company) midto high-single-digit EPS growth.
Best Idea Reynolds American (RAI)

Reynolds American (RAI) remains our top pick in the sector given the expectation of mid- to high-single-digit EPS growth over the medium term. This expectation is driven by our view that the company can deliver modest revenue growth from its portfolio of brands; leverage and reduce its cost base; and repurchase its equity (having announced a $2.5bn program in November 2011 to run over the next two and a half years). In addition, the company stands to benefit more than peers from a resolution to ongoing negotiations with respect to overpaid Master Settlement Agreement sums, offering further upside to estimates, we believe.
Reynolds American (RAI) Overweight
Price 12/6/2011 $41.63 52-Wk Range High Low $42.18 $31.54 FY End Dec Last (A) $2.49 FY EPS Cur (E) $2.66 P/E Next (E) $2.84 Cur 15.7 Next 14.7 Mkt Cap (mil.) $24,267
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US Year Ahead 2012
Electric Utilities & Independent Power Producers
Energy
Electric Utilities Likely Underperform if Macro Call for Growth and Return to Equities Is Right
Andrew Smith AC
(1-713) 216-7681 andrew.l.smith@jpmorgan.com
Christopher Turnure
(1-212) 622-5696 christopher.turnure@jpmorgan.com
Michael Dandurand
(1-212) 622-6432 michael.j.dandurand@jpmorgan.com J.P. Morgan Securities LLC AGL Resources Ameren Corp American Electric Power Black Hills Corp. CenterPoint Energy CMS Energy Corp Consolidated Edison Constellation Energy Group Covanta Holding Corp. Dominion Resources Duke Energy Corp. Dynegy, Inc. Edison International Entergy Corp. Exelon Corp. Great Plains Energy Integrys Energy Group ITC Holdings NextEra Energy Inc. Northeast Utilities NRG Energy NV Energy Inc. Pepco Holdings PG&E Corp. Portland General Electric Co. Progress Energy Sempra Energy Southern Company UIL Holdings Corporation Vectren Corp Westar Energy Inc Wisconsin Energy Corp Xcel Energy AGL AEE AEP BKH CNP CMS ED CEG CVA D DUK DYN EIX ETR EXC GXP TEG ITC NEE NU NRG NVE POM PCG POR PGN SRE SO UIL VVC WR WEC XEL (rs) UW N N OW OW N (rs) OW N (rs) N N (rs) (rs) N (rs) OW N OW OW N N N (rs) N N N UW N N N
Growing economy likely pressures utility stocks Electric utility stocks were one of the best-performing sectors in 2011 as the UTY index gained 10.3% through 12/6/11 versus flat performance for the S&P 500 index. We believe the strong utility stock performance was driven by investors flight to the stable EPS profile of the regulated utility model along with attractive dividend yields. However, J.P. Morgan expects GDP growth to accelerate as 2012 progresses. If this happens, we expect investors to seek out stocks with greater leverage to the economic cycle, resulting in utility stocks underperforming. Return to U.S. equities would also pressure utility stocks J.P. Morgans U.S. Equity Strategist expects investors to return to U.S. equities in 2012. We believe utility stocks will also underperform if this occurs. Electric utility stocks have the second-highest fund flows of U.S. equities as a percentage of starting assets through November. We expect this trend to reverse if investors revisit U.S. equities more broadly as a return to U.S. equities likely signifies investor interest in stocks leveraged to an improving economic climate. Valuations and fund flows might offset some pressure We believe two factors might offset some of the pressure on utility stocks if J.P. Morgans economic outlook is accurate. Yield spread versus the U.S. 10-year Treasury is attractive Electric utility shares are near all-time-high valuations on a relative P/E multiple versus the S&P 500, trading at ~125% of the S&P 500 P/E multiple (the average is ~85%). However, the yield spread versus the U.S. 10-year Treasury is at historically attractive levels. We believe that the attractiveness of the yield spread may moderate some utility underperformance as declines in utility stock prices only amplify the attractiveness of the yield spread. Fund flows may be slow to reverse Electric utilities have the second-highest fund inflows of U.S. equity sectors as a percentage of starting assets this year. Based on our conversations with dedicated utility fund managers, it appears that much of the fund flows are driven by retail investors seeking relative security and yield. We believe these investors may be slower to rotate out of utility funds, and thus moderate some of the pressure on utility stocks in the event that utility stocks start to come under pressure.
Best Idea NRG Energy (NRG)

NRG Energy (NRG) matches a naturally short retail supply position with a naturally long power plant fleet. We project this drives stable EBITDA and FCF, which represents a FCF yield of ~20% today. The company should complete a balance sheet restructuring in 1Q12 that likely frees the company to buy back 20% or more of its shares outstanding. We also expect the stock to offer some upside if the macro environment discussed above occurs as NRG would benefit from higher power sales volumes.
NRG Energy (NRG) Overweight Dec 12 Price Target: $33
$19.37 $25.66 $18.22 Dec $1.84 $1.25 $1.75 15.5 11.1 $4,454 Valuation: Target reflects comparable asset transactions. Risks: Collapse in commodity costs or spike in fuel costs, failure to redeploy FCF in attractive investments or spending significant capital on pursuing construction of nuclear plant expansion, currently suspended. 101
US Year Ahead 2012
Energy MLPs
Low Interest Rates and Potential Market Turbulence Enhance MLP Value Proposition
Jeremy Tonet AC
(1-212) 622-4915 jeremy.b.tonet@jpmorgan.com
Alistair J Meadows
(1-212) 622-6442 alistair.j.meadows@jpmorgan.com
Tim Fisher
(1-212) 622-5403 tim.fisher@jpmorgan.com J.P. Morgan Securities LLC Buckeye Partners L.P. El Paso Pipeline Partners L.P. Enbridge Energy Partners, L.P. Energy Transfer Partners, L.P. Enterprise Products Partners, L.P. Gibson Energy Inc. Kinder Morgan Energy Partners L.P. Magellan Midstream Partners L.P. Nustar Energy L.P. Oiltanking Partners, L.P. ONEOK Partners, L.P. Plains All American Pipeline, L.P. Williams Partners, L.P. BPL EPB EEP ETP EPD GEI.TO KMP MMP NS OILT OKS PAA WPZ OW OW OW N OW N N N UW OW N OW N
The quest for yield is supporting MLP valuations. In this low interest rate environment, we believe MLPs offer an attractive value proposition on a relative basis. MLPs have historically traded at an average spread to the 10-year Treasury of ~300bps; the current 6.3% yield on the Alerian MLP Index represents a ~430bp spread over the 10-year Treasurys 2.0% yield. While rising interest rates will be an issue at some point in the future, Michael Feroli (J.P. Morgans U.S. Economist) does not expect the Fed to increase rates during 2012 and Terry Belton (J.P. Morgans U.S. Fixed Income Strategist) forecasts a modest increase in the 10-year (exiting 2012 at 2.5%). Though we do not expect MLPs to fully converge towards the historical spread (which would drive ~22% price appreciation), we believe current yields of 6-7% combined with median distribution growth of ~6% could lead to low-double-digit total returns without any revaluation required. As we view energy infrastructure MLPs as a play on energy demand (which exhibits low elasticity), we view these returns as particularly attractive in a choppy market. Secular trends in upstream development driving demand for new energy infrastructure. The secular trend towards liquids-rich production should continue to drive significant demand for new energy infrastructure. As producers focus on oil and liquids-rich production in the Eagle Ford, Bakken, Marcellus, and other emerging plays, new production likely will overwhelm existing infrastructure capacity and require new midstream buildout. MLPs appear well positioned to capitalize on such opportunities, allowing accelerating distribution growth in 2012. Midstream consolidation is fueling distribution growth. With supportive capital markets and continued low interest rates, we expect to see elevated M&A activity in the midstream space next year. While we would not rule out more transactions whereby MLPs acquire C-Corp brethren in the quest for growth (KMP/EP and ETE/SUG), we think consolidation among MLPs is more likely. After multiple LP/GP mergers over the past few years, we believe the MLP space is ripe for consolidation as larger players acquire MLPs without a GP. Buckeye Partners, one of the two MLPs under coverage without a GP, screens cheaper than peers on 2013E metrics, as BORCO expansions come online, and could provide asset diversification and strategic foothold in the northeast.
Best Idea Buckeye Partners (BPL)

Our top pick is Buckeye Partners (BPL). Buckeye has undertaken several key initiatives to transform the partnership, such as increasing asset utilization (Farm and Home acquisition), lowering BPLs cost of equity (acquiring the GP), and entering new complementary growth markets (BORCO acquisition). We believe that the market does not fully appreciate BPLs transformation and that management is actively looking to capitalize on Buckeyes lower cost of capital and new organic growth opportunity set. We expect projects coming on line will drive increasing distribution growth rates during 2H12, which we expect the market to reward with a higher valuation (lower yield), thereby driving attractive price appreciation.
Buckeye Partners L.P. (BPL) Overweight Dec 12 Price Target: $74
$63.40 $68.92 $54.51 Dec $2.46 $2.79 $3.43 22.7 18.5 $5,449 Valuation: Target reflects DCF using 1.25% terminal growth rate and required rate of return of 8.75%. Risks: Execution risk at BORCO, capital indigestion weighing on near-term performance, acquisition risk.
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US Year Ahead 2012
North American Integrated Oils & Major Producers

Will Value Work in 2012? Recommending OW-Rated Nexen as Top Pick (Again)
Katherine Lucas Minyard, CFA AC
(1-212) 622-6402 katherine.l.minyard@jpmorgan.com
Igor Grinman
(1-212) 622-6596 igor.grinman@jpmorgan.com J.P. Morgan Securities LLC Canadian Natural Resources Cenovus Energy Chevron Corp ConocoPhillips Exxon Mobil Corp Hess Husky Energy Lone Pine Resources Marathon Oil Murphy Oil Nexen Occidental Petroleum Suncor Energy Talisman Energy CNQ.TO CVE.TO CVX COP XOM HES HSE.TO LPR MRO MUR NXY.TO OXY SU.TO TLM.TO N N UW (rs) UW OW UW OW N N OW OW N OW
As we look ahead to 2012, we take a relatively longer view on investing in the sector, and maintain our stance that the better value lies in the higher-beta, riskier, and more volatile names within our coverage. Although uncertainty seems to dominate the overall investment mood, and we acknowledge a macroeconomic outlook shadowed by external (Europe) and internal (domestic fiscal policy) risks, an equity market outlook that suggests a wide range of potential outcomes, and a commodity outlook calling for near-term weakness in the energy and broader commodity space, we believe capital is best put to work over the course of 2012 in names offering a combination of strong potential upside, portfolio growth, oil price leverage, and catalysts, especially given our view that crude oil will hold between $110/bbl and $120/bbl in 2H12. At the risk of being repetitive, we are again selecting Overweightrated NXY as our top pick for the year ahead. Where to go when the defensive positioning has overstayed its welcome? As we have stated in recent research, we believe investors putting capital back to work in the sector will be more inclined to return to names offering a combination of attractive upside, expanding returns, and growing portfolios, but with some level of defensiveness and attractive dividend yield, and a handful of potentially favorable catalysts to focus investor attention on the underlying portfolios. What happens when the buybacks stop? According to our Equity Strategy team, corporates themselves have been the incremental buyers of stocks, with $3 of buybacks for every $1 of mutual fund flows. In our view, the shares that have performed courtesy of a large boost from share repurchases may well be on an unsustainable share price trajectory; that is, if repurchases are a symptom of corporates reluctance to embark on large-scale capital investments in a period of economic uncertainty, then an improving economic outlook that reduces uncertainty and encourages investment may well do so at the expense of future buybacks, removing one of the elements of share price support.
Best Idea Nexen (NXY)

We are again selecting Overweight-rated Nexen (NXY) as our top pick for the year ahead. We believe NXY offers a rich catalyst slate as new volumes from the Usan project come online in 1H12, delivering higher margins and loftier cash flows; exploration and appraisal activity continues, especially in the Gulf of Mexico and West Africa; production reliability improves at Long Lake and Buzzard; and investors move past the overhangs that have plagued NXYs share price performance in the last 12 months (down 29% vs. S&P 500 +3% and WTI +13%). Although NXYs below-market dividend yield (1.3%) is unlikely to attract capital alone, we believe the combination of upside, catalysts, and potentially changing investor sentiment underpin the outlook for 2012. With NXY shares offering >90% potential upside to our C$31/share price target, the highest in its peer group, we believe NXY is well positioned to outperform peers.
Nexen (NXY) Overweight Dec 12 Price Target: C$31
C$15.92 C$27.11 C$14.75 Dec C$1.16 C$1.83 C$2.79 8.7 5.7 C$8,396 Valuation: Target reflects DCF, based on our estimate of segment-level cash flows discounted at a WACC of 7.8%. Risks: Continued challenges at Long Lake, oil price retreat, unsuccessful exploration, outside-operated project slate, currency exchange rate risk.
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US Year Ahead 2012
Oil & Gas Exploration & Production

Cautious Economic View Leads to Conservative E&P Investing
Joseph Allman, CFA AC
(1-212) 622-4864 joseph.d.allman@jpmorgan.com
Jeanine Wai
(1-212) 622-6489 jeanine.wai@jpmorgan.com
Jessica Lee
(1-212) 622-9812 jessica.s.lee@jpmorgan.com J.P. Morgan Securities LLC Anadarko Petroleum Apache Corporation Approach Resources ATP Oil & Gas Berry Petroleum Brigham Exploration Company Cabot Oil & Gas Carrizo Oil & Gas Inc. Chesapeake Energy Cimarex Energy Co. Cobalt International Energy Concho Resources, Inc. Continental Resources, Inc. Delta Petroleum Corporation Denbury Resources Inc. Devon Energy El Paso Corp. EOG Resources, Inc. EQT Corporation EXCO Resources, Inc. Goodrich Petroleum McMoRan Exploration Company Newfield Exploration Company Noble Energy PDC Energy Penn Virginia Corporation PetroQuest Energy, Inc. Pioneer Natural Resources Plains Exploration & Production QEP Resources Quicksilver Resources Inc Range Resources Corp SandRidge Energy Inc. SM Energy Southwestern Energy Company Swift Energy Company Ultra Petroleum Corp Venoco, Inc. Whiting Petroleum Corporation Williams Companies APC APA AREX ATPG BRY BEXP COG CRZO CHK XEC CIE CXO CLR DPTR DNR DVN EP EOG EQT XCO GDP MMR NFX NBL PETD PVA PQ PXD PXP QEP KWK RRC SD SM SWN SFY UPL VQ WLL WMB OW OW N UW OW N N N N OW OW N N UW OW OW OW OW OW N OW OW OW OW OW OW OW OW OW N N OW N N OW N N UW N (rs)
Consistent with our economics team, we are cautious on the U.S. and global economy and, therefore, would recommend investors position themselves conservatively. During the 2008-2009 financial crisis and the economic stresses of 2H11, the large-cap E&Ps outperformed the mid-caps, which outperformed the small caps. We think investors generally should orient their E&P investing towards the more defensive names: larger cap with good balance sheets and efficient cost structures. Our favorite large cap is EOG Resources (Overweight rating, Dec 12 PT of $144.50), but two mid-caps appear to offer much more stock price upside potential and also have good balance sheets and efficient cost structures. Therefore, we highlight those names as our favorite stocks for 2012.
Best Idea Pioneer Natural Resources (PXD)

Pioneer Natural Resources (PXD) is one of our best ideas for 2012. On a NYMEX NAV basis, the company offers over 70% upside from the current stock price. One operational catalyst stands out: drilling results from its new Horizontal Wolfcamp Shale play. If Pioneer can deliver strong well results, the stock likely will perform well. Overall, PXD is growing at ~20%. In recent years, PXD has been one of the most disciplined companies (i.e., shutting down operations when costs got out of hand) and the companys balance sheet is strong.
Pioneer Natural Resources (PXD) Overweight Dec 12 Price Target: $167.50
$94.40 $106.07 $58.63 Dec $1.80 $3.98 $5.10 23.7 18.5 $11,503 Note: Target based on our estimate of NAV, which we calculate using a DCF model. Risks: Commodity price volatility, oilfield service cost inflation, oilfield leverage to crude, results from plays.
Best Idea Denbury Resources (DNR)

Denbury Resources (DNR) is one of our best ideas for 2012. The company is among the oiliest in our coverage group (93% of current production is oil). Since trough E&P stock prices in March 2009, DNR is up only 52% versus the EPX which is up 151% (WTI oil was close to $40/Bbl in March 2009 vs. $100 today). Using NYMEX futures, the stock offers some of the best upside to NAV among all E&Ps. As the company also thinks it is undervalued, it recently instituted a share repurchase program and budgets around $250mm of buybacks for 2012. Despite revisions to the timing and/or the magnitude of production ramp at two of its EOR fields, the data suggest that DNR generally is on track in the development of its EOR projects. Operational catalysts include production response from its Hastings and Oyster Bayou EOR fields (commencing production in the next few months) and the performance of its other EOR fields.
Denbury Resources (DNR) Overweight Dec 12 Price Target: $28.50
$16.86 $26.03 $10.20 Dec $0.61 $1.28 $1.33 13.2 12.7 $6,603 Note: Target based on our estimate of NAV, which we calculate using a DCF model. Risks: Commodity price volatility, oilfield service cost inflation, leverage to crude, performance of CO2 fields and EOR fields.
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US Year Ahead 2012
Oilfield Services & Equipment

North America Is Stronger Than You Think
J. David Anderson, PE, CFA AC
(1-212) 622-6684 jdavid.anderson@jpmorgan.com
Samantha Hoh, CFA

(1-212) 622-5248 samantha.k.hoh@jpmorgan.com
William S Thompson
(1-212) 622-9978 william.s.thompson@jpmorgan.com J.P. Morgan Securities LLC Baker Hughes C&J Energy Services Cameron Int'l Complete Production Services Diamond Offshore Dresser-Rand Dril-Quip Ensco plc Exterran Holdings FMC Technologies Halliburton National Oilwell Varco Noble Corp. Rowan Companies Schlumberger Transocean Weatherford International BHI CJES CAM CPX DO DRC DRQ ESV EXH FTI HAL NOV NE RDC SLB RIG WFT OW OW OW (rs) UW OW N N N OW OW OW OW OW OW N N
The Oilfield Services & Equipment sector is unlikely to outperform the broader market until two things occur: global macro issues abate and international upstream markets start growing again . . . both of which should happen by mid-2012. Beyond the next few quarters, we remain incredibly bullish on the fundamentals of the group, and continue to believe this group will outperform through the cycle based on a simple premise: each barrel of oil produced in the foreseeable future will cost more than the last. Global oil production is becoming increasingly service intensive, requiring ever-greater scale and the latest technology, often applied in harsh environments. Whether exploring and developing from oil and gas fields in 10,000ft of water or unlocking the potential of unconventional resources in shales, service companies should reap the benefits of increased spending with improving pricing. We take a portfolio approach to our sector, viewing large-cap services, offshore drillers, and capital equipment companies separately, as each has its own set of drivers and trades distinctly. We believe large-cap service companies are most attractive on valuation, trading about 40% below estimated fair value on normalized EPS and about $20/bbl below WTI oil prices using historical regressions. Our concern is whether this valuation gap can close with the overriding macro issues and the persistently weak international markets. We dont think so, instead favoring those names with the greatest potential for upside to earnings. That leads us to the North American land market, which has once again been left for dead . . . we couldnt disagree more.
Best Idea Halliburton (HAL)

Halliburton (HAL) is our top pick within the large-cap service sector, heavily discounted because of its high exposure to North America (60% of 12E revenue). Yes, this market is more cyclical than the others, but is by no means poised to turn down, in our view. North America is an oil market now, for which 60% of rigs are now drilling, compared to 83% drilling for natural gas at the last peak in 2008. We are forecasting the U.S. land rig count to grow 10% in 2012, with service intensity considerably higher than in 2008 (monthly revenue/rig). All the growth will be coming from horizontal oil and liquids plays that should be largely insensitive to oil prices above $70/bbl, while 50% of operators are major oil companies or large-cap E&Ps (i.e., steady spenders). We expect 2012 EPS estimates to have upside risk as the Street becomes convinced in the strength of the North American market, along with multiple expansion as the offshore and international land markets contribute more materially as the year progresses.
Halliburton (HAL) Overweight Dec 12 Price Target: $58
$35.57 $57.77 $27.21 Dec $2.06 $3.34 $4.45 10.6 8.0 $32,730 Valuation: Target reflects 13x 2012E EPS and assumes stock trades at a smaller discount to the group average due to its commanding position in North America and progress in its international operations. Risks: Potential and uncertain liability from involvement in Macondo blowout, sustainability of North American onshore recovery, biggest consensus long on Street, market consolidation putting HALs advantage in unconventional resources at risk, possibility of a large acquisition pressuring shares.
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US Year Ahead 2012
106
US Year Ahead 2012
Asset Managers, Brokers & Exchanges
Financials
Asset Managers Offer Opportunities; Exchanges Could Underperform in 2012

Kenneth B. Worthington, CFA AC
(1-212) 622-6613 kenneth.b.worthington@jpmorgan.com
Rahul Nevatia
(1-212) 622-6454 rahul.nevatia@jpmorgan.com J.P. Morgan Securities LLC Apollo Global Management Artio Global Investors BM&F Bovespa CBOE Holdings Charles Schwab CME Group Inc. Eaton Vance Corp Evercore Partners Inc. Federated Investors, Inc. Franklin Resources FXCM Invesco Ltd. Investment Technology Group Janus Capital Group Knight Capital Group LPL Investment Holdings NASDAQ Stock Market NYSE Euronext Och-Ziff Capital Management Penson Worldwide Pzena Investment Management T. Rowe Price Group, Inc The Intercontinental Exchange APO ART BVMF3.SA CBOE SCHW CME EV EVR FII BEN FXCM IVZ ITG JNS KCG LPLA NDAQ NYX OZM PNSN PZN TROW ICE OW N OW N OW OW N N UW UW OW OW OW UW N N (rs) OW N N OW OW
Asset Managers: The 2012 outlook is for modestly increasing earnings on what are still uncertain equity market conditions. Weak markets in 2H11 depressed asset levels and volatility acted as a deterrent to retail and institutional sales. As a result, asset managers experienced meaningful multiple contraction in 2011. However, we believe that valuations are especially inexpensive and are poised to bounce back if fundamentals improve slightly. As an investor, we recommend being positioned in asset managers that are especially inexpensive and are generating positive sales and good relative performance. Invesco (IVZ) fits these criteria. Franklin Resources (BEN) is the one to avoid, in our view, as its flagship Templeton Global Bond fund goes out of favor due to poor currency investments and negative returns. Exchanges: Exchanges posted record volume levels and earnings in 3Q and are expected to report better-than-usual earnings in 4Q, as uncertainty continues to plague the equity markets. Record volume levels and consolidation among the exchanges helped them outperform their financial sector peers in 2011. However, 2011 saw a number of macro events that are not expected to repeat in 2012 and, as a result, volumes are likely headed lower in 2012. While exchanges still act as defensive stocks in an uncertain market, we believe they will underperform the financial sector in 2012. Our top picks for 2012 are Intercontinental Exchange (ICE) and FXCM.
Best Ideas Invesco Ltd. (IVZ)/Franklin Resources (BEN)

For the short to medium term, the relative value pair Invesco Ltd. (IVZ) and Franklin Resources (BEN) is our favorite idea. Invesco remains on the road to a sales recovery after acquiring and merging Van Kampen funds. With its relatively inexpensive valuation, improvement in fund performance, outstanding performance of its UK- and Canada-based funds, and potential for added distribution to drive incremental sales in the coming quarters, we continue to see the stock as attractive. On the other hand, Franklins leading asset-gathering funds, led by the Templeton Global Bond fund, continue to meaningfully underperform peers as currency investments (both long and short) are working against the funds. We are concerned that the Global Bond fund will experience flat sales or redemptions as the one-year Lipper performance has now dipped to bottom quartile. Even if the Global Bond fund does not wind up posting significant redemptions, a slowdown in global fixedincome fund sales could result in overall net outflows for Franklin, something that was not expected when Global Bond fund was gathering about $10bn of sales per quarter over the last few quarters.
Invesco Ltd. (IVZ) Overweight Dec 12 Price Target: $26
$20.67 $27.50 $14.52 Dec $1.38 $1.64 $1.76 12.6 11.7 $9,322 Valuation: Target reflects 13x 2013E EPS, as valuation should recover as asset managers recuperate after a particularly weak 3Q. Risks: Market downturn, fee rate falling, meaningful appreciation of USD.
Franklin Resources (BEN) Underweight Dec 12 Price Target: $111

$100.52 $137.56 $87.71 Sep $8.64 $8.92 $9.30 11.3 10.8 $21,853 Valuation: Target reflects 12x C2013E EPS, a continued discount as sales continue to slow down. Risks: Aggressive deployment of cash on balance sheet, tax repatriation legislation, positive turn in sales of global equity funds and global fixed income funds.
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US Year Ahead 2012
Banks Large Cap

Several Headwinds Near Term; Capital Return, Continued Recovery to Help Later in 2012
Vivek Juneja AC
(1-212) 622-6465 vivek.juneja@jpmorgan.com
John P Grassano
(1-212) 622-5605 john.p.grassano@jpmorgan.com
Chris K Baydar
(1-212) 622-8115 christopher.k.baydar@jpmorgan.com J.P. Morgan Securities LLC Bank of America Bank of New York Mellon Corp. BB&T Corporation Citigroup Inc. Fifth Third Bancorp Northern Trust PNC Financial Regions Financial State Street SunTrust Banks, Inc. U.S. Bancorp Wells Fargo BAC BK BBT C FITB NTRS PNC RF STT STI USB WFC OW N N OW N N (rs) N N N OW OW
We expect a slow recovery in the United States and continued economic slowdown in Europe to create some headwinds for bank stocks early in 2012. However, positive results under a very harsh stress test and continued recovery in the U.S. combined with attractive valuations should provide a lift to bank stocks later in the year. Regulatory/political risk will likely remain high because it is an election year. We expect bank earnings to be driven by continued recovery in loan growth, continued but slower-paced improvement in credit costs, and some expense reduction plus benefit to EPS for some banks from share repurchases. These should offset net interest margin pressure, the biggest headwind to banks. We also expect benefit to some U.S. banks from divestitures of U.S. assets by European banks and de novo growth of business lines. Consolidation activity remains sluggish and large deals are unlikely in this environment, in our view. However, continued slow recovery in the U.S. could drive some small bank deals. The bank sector has lagged recently due to fears about multiple headwindsU.S. economy, Eurozone, and regulatory/political risk. As a result, the sector remains underowned. Given the uncertainty in the environment, we remain defensively positioned near term and recommend names such as US Bancorp and Wells Fargo due to relatively lower risk, good capital including continued capital return, and some drivers for revenue growth (portfolio acquisitions and growth/expansion of relatively newer businesses). We also expect Citigroup to recover in 2012 as it gets approval to return some capital despite the harsh stress tests. Citi has among the highest capital ratios in our universe. Even under the Feds harsh stress test, emerging markets are expected to recover sooner which should be a positive for Citigroup. Trust and processors: attractive valuations, but some headwinds. We expect trust bank stocks to remain under pressure near term due to pressure on revenues from weak markets and still-high expenses. Absolute low interest rates and legal/ regulatory challenges are added headwinds and expense savings are further out.
Best Idea Citigroup (C)

On a full-year 2012 basis, we recommend Citigroup (C) because it has been overly beaten down due to concerns about weak markets and fallout from the Eurozone including in the emerging markets. However, emerging markets should have a lesser impact and likely quicker recovery from a slowdown. In addition, despite the harsh stress test scenario, we expect C to begin returning capital via share repurchases in 2012 due to its strong capital position. Near term, C stock may remain under some pressure especially due to Eurozone issues. C continues to grow revenues and improve profitability of international revenues, with Asia consumer business reporting positive operating leverage in 3Q11 and Latin America business expected to do so in 4Q11. While growth in emerging markets will lead to higher credit losses, C has improved its risk management over the last few years and we believe losses should be manageable. Valuation remains attractive with C trading at 0.6x tangible book (near low of 0.3x during last recession) and 6.4x 2012E EPS.
Citigroup (C) Overweight Dec 12 Price Target: $54
$29.75 $51.50 $21.40 Dec $3.58 $4.17 $4.65 7.1 6.4 $86,980 Valuation: Target reflects 1x YE12E TBV, a discount to expected peer group multiple of 1.5x. Risks: Regulatory risk, slowdown in global economic growth, risks from government interference, deterioration in credit risk profile, changes in capital structure/adequacy, rating agency actions, performance of equity and fixed income markets. 108
US Year Ahead 2012
Banks Mid- and Small Cap

Risk/Reward Favors Going Long This Crisis; 15% Sector Upside with Many Attractive Plays
Steven Alexopoulos, CFA AC
(1-212) 622-6041 steven.a.alexopoulos@jpmorgan.com
Preeti S Dixit
(1-212) 622-9864 preeti.s.dixit@jpmorgan.com J.P. Morgan Securities LLC Astoria Financial BancorpSouth CapitalSource City National Corp Comerica Incorporated Cullen/Frost Bankers Inc. First Horizon National First Republic FirstMerit Corporation KeyCorp M&T Bank MB Financial New York Community Bank People's United Financial PrivateBancorp, Inc. Signature Bank Susquehanna Bancshares SVB Financial Synovus Financial Corp. TCF Financial Corporation Trustmark Corporation Umpqua Holdings Corporation Valley National Bancorp Washington Federal, Inc. Webster Financial Corporation Zions Bancorporation AF BXS CSE CYN CMA CFR FHN FRC FMER KEY MTB MBFI NYB PBCT PVTB SBNY SUSQ SIVB SNV TCB TRMK UMPQ VLY WFSL WBS ZION N UW N OW OW N OW OW OW OW N N N N OW OW (rs) OW N N OW N N N OW
With mostly indirect risk from Eurozone, we see 15% upside through 2012. Global markets have seen considerable selling pressure since mid-July largely in response to the Euro debt crisis. While most U.S. mid- and small-cap banks dont have direct exposure to either Eurozone countries or companies, a global risk-off trade has resulted in a flight to U.S. Treasuries, resulting in a flattening of the yield curve. Coupled with absent loan growth and more banks investing free cash flow into securities, the flattened curve is having a pronounced negative effect on net interest margins. With that said, however, with our average stock down 19% YTD, we believe the coming NIM storm is largely captured in valuations, particularly with the group trading at only 1.37x TBV. Contrasted to the financial crisis of 2008/2009 when many banks were forced to issue stock at historical lows, permanently diluting shareholders, given the indirect risk of the current crisis at hand, many mid- and small-cap banks are now actually buying back small amounts of stock at historical lowseven a small buyback has the potential to materially reduce the share count. Although the fiscal drag is expected to meaningfully detract from U.S. GDP growth in 2012 (could be -150 bps should current benefits expire), through 2012 we see a tremendous amount of uncertainty being lessened in regards to both the Euro debt crisis as well as the U.S. economic outlook. We believe this will open a window for investors to reduce underweight positions in mid- and small-cap banks through 2012. A shopping list of buying opportunities. With regional bank stocks trading off recent lows, we believe investors will now need to tolerate increased downside risk to position for this longer-term upside potential. Consequently, we believe investors should consider utilizing a buy-on-dips strategy. Given the anticipated fiscal drag in 2012, we suggest a portfolio of niche banks that can capture growth despite tepid macro conditions. In this group, we suggest FRC, SBNY, and SIVB. In the value bucket, we see many attractive values and point o a portfolio of CMA, FHN, KEY, PVTB, and ZION, with FHN our top pick owing to a very inexpensive valuation and multiple earnings levers. For income funds, we suggest FMER given the 4.5% yield.
Best Idea First Horizon (FHN)

Although we see many attractive values within the mid- and small-cap bank sector, First Horizon (FHN) moves to the top of our list of attractive bank stocks, for the first time. In addition to an inexpensive valuation, with FHNs stock trading below TBV at 0.85x, we like the multiple earnings levers. While weve known about these for some time, we needed to get comfortable on the risk profile at the bank given a sizeable home equity portfolio as well as mortgage putback risk. While credit has now improved for several quarters, in terms of the risk of mortgage putback, we believe the $100mm buyback plan announced in tandem with 3Q earnings was a milestone, given a conservative management team that feels comfortable reducing its strong capital position. In terms of earnings levers, while the stock is inexpensive on normalized 2015E EPS of $1.05, excluding mortgage repurchase provisions for 2015E, normalized EPS move to $1.35 (puts stock at 5.7x), and looking to long-term profitability targets could put the stock in the 3.5-4.0x range.
First Horizon (FHN) Overweight Dec 12 Price Target: $8.50
$7.43 $12.67 $5.38 Dec $(0.14) $0.49 $0.40 15.2 18.6 $1,959 Valuation: Target reflects 0.9x TBV, maintaining current discount to peers. Risks: Failure to deliver on previously outlined results, adverse scenario for private label, using excess capital to pay a sharp premium on an acquisition. 109
US Year Ahead 2012
Insurance Life
Macro Factors to Drive Near-Term Performance, But Long-Term Risk-Reward Is Favorable
Jimmy S. Bhullar, CFA AC
(1-212) 622-6397 jimmy.s.bhullar@jpmorgan.com
Erik J. Bass, CFA

(1-212) 622-2295 erik.bass@jpmorgan.com
Matthew P. Byrnes, CFA

(1-212) 622-0695 matthew.p.byrnes@jpmorgan.com J.P. Morgan Securities LLC Jimmy S. Bhullar, CFA AFLAC, Inc. American International Group Assurant, Inc. Genworth Financial, Inc. Hartford Financial Services Lincoln National MetLife, Inc. National Financial Partners Phoenix Companies Principal Financial Group Protective Life Prudential Financial Reinsurance Group of America Symetra Financial Torchmark Corp Unum Group Erik J Bass, CFA American Equity Investment Life CNO Financial Group
Our outlook for the life insurance sector is positive. While near-term stock performance is likely to be heavily dependent on moves in interest rates and the equity market, operating fundamentals are relatively healthy. Even if the current rate environment persists, we expect the group to generate a 10%+ ROE for the foreseeable future, and sales and net flows in most products are recovering. In addition, most companies have excess capital, and we expect management teams to continue repurchasing shares and raising dividends despite the macro uncertainty. Insurers balance sheets are better positioned to withstand poor equity and credit markets than in 2008-2009. Capital levels have steadily risen over the past few years (RBC 422% at YE10 vs. 370% at YE07). Also, insurers have increased holding company cash and reduced reliance on short-term funding. Investment portfolio risk seems manageable with reduced exposure to structured securities and minimal European holdings. Insurers also have more extensive hedging programs, although prevalence of equity market and interest rate guarantees remains a concern. Sales outlook mixed by product, but pricing trends are generally improving. We expect individual life sales to continue recovering, helped by new products and stable pricing. Sales of variable and indexed annuities should also rise at a healthy rate despite the weak market. On the other hand, top-line growth in group benefits (group life and disability) and retirement plans remains pressured by tepid employment growth. Fixed annuity sales are also likely to be pressured by low interest rates. Competition in most products appears rational, and we believe insurers should be able to raise rates to help offset lower investment portfolio yields. Sustained low interest rates are our primary fundamental concern. While declining yields will pressure investment income, insurers have several levers to offset the drag on earnings, including raising prices and reducing crediting rates. In addition, we do not anticipate significant near-term balance sheet charges (reserve increases or DAC and goodwill impairments) for most insurers related to low rates. Risk-reward appears attractive given current valuations. The life group is currently trading at roughly 0.8x BV (ex. AOCI), well below what we consider to be fair value based on our projected returns. In our view, if the sector can earn a 10% ROE, the group should trade close to book value. As a result, we expect multiples to expand as fears about insurers ability to withstand low interest rates dissipate.
AFL AIG AIZ GNW HIG LNC MET NFP PNX PFG PL PRU RGA SYA TMK UNM
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Best Idea Prudential Financial (PRU)

PRU is our top pick as we project an improving ROE, above-average EPS growth, and healthy operating trends will drive upside in the stock. We project returns to improve from 10.1% in 2011 to 11.5% in 2012 and 12.4% in 2013 as a result of organic growth, capital deployment, and accretion from the Star/Edison acquisition. In addition, PRU is generating robust sales and flows in its international insurance, annuities, and asset management businesses, which should enable the company to generate double-digit EPS growth for the next few years.
Prudential Financial (PRU) Overweight Dec 12 Price Target: $66
$51.41 $67.52 $42.45 Dec $6.90 $6.20 $6.95 8.3 7.4 $24,985 Valuation: Target reflects 1.1x YE2012E BV ex. AOCI (50% weight), 0.9x YE2012E total BV (25% weight), 8.0x 2013E EPS (25% weight). Risks: Accretion from Star/Edison below guidance, sizable variable annuity heding loss, further deterioration in disability margins.
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US Year Ahead 2012
Insurance Non-Life
Pricing Showing Signs of Life, But Need More to Expect Outperformance
Matthew G. Heimermann AC
(1-212) 622-6545 matthew.g.heimermann@jpmorgan.com
Donald H. Chen
(1-212) 622-2875 donald.h.chen@jpmorgan.com
Mei Feng A. Zhang

(1-212) 622-6445 meifeng.a.zhang@jpmorgan.com J.P. Morgan Securities LLC ACE Limited Allied World Assurance Company Holdings, Ltd. Allstate Corp. Aon Corporation Arch Capital Group, Ltd. Axis Capital Holdings, Ltd. Brown & Brown, Inc Chubb Corp. Endurance Specialty Holdings Everest Re Group, Ltd. Marsh & McLennan Cos., Inc. PartnerRe Ltd. Platinum Underwriter Holdings, Ltd. The Progressive Corp. Transatlantic Holdings Travelers Validus Holdings Willis Group Holdings plc XL Group PLC ACE AWH ALL AON ACGL AXS BRO CB ENH RE MMC PRE PTP PGR TRH TRV VR WSH XL OW OW OW OW UW N N UW OW N N N N N (rs) N (rs) N N
Commercial insurance prices in the United States, which were bottoming at mid-year 2011, now appear to be improving with positive rate gains being reported in a number of product and market segments. While this is clearly a positive development, rates need to rise further over a sustained period of time to significantly improve earnings prospects across the group, in our view. The market also seems to be lacking one of the convincing catalysts that has marked other periods of material pricing powerreserve inadequacies, asset pressures, low executive compensation, etc. As a result, we are skeptical that we are witnessing a traditional cycle turn. Rather, the industry appears to be in an environment in which incremental pressuresfalling investment yields, weak economic growth, catastrophe losses, and, more recently, normalizing loss cost trendshave finally resulted in underwriters pushing through small price increases. We believe the implications of this incrementalism are much less positive than past periods of commercial pricing power. Meanwhile, pricing trends in personal lines remain positive as do trends in a number of property reinsurance markets. Despite more constructive pricing trends, we believe it is premature to move from neutral to overweight the group. We believe the following factors are important to consider in the group today: 1) relative earnings prospects given continued ROE headwinds from low interest rates; 2) growth prospects, whether organic or via M&A given weak organic prospects; 3) capital flexibility for either capital management or acquisitions; 4) ROE leverage to the extent that pricing fundamentals improve further; and 5) valuation relative to current, intermediate, and normalized ROE levels.
Best Idea Allstate Corp. (ALL)

We believe Allstate Corp. (ALL) offers investors the best risk-reward opportunity in our sector, especially for those with medium time horizons. It is one of the only stocks we cover that is likely to generate significant bottom-line growth over the next few years given current pricing fundamentals. In addition, valuation appears to be discounting further EPS deterioration rather than improvement. We believe the stock and valuation can expand with earnings over time. In terms of EPS, we believe that EPS could reach a run rate of $5.00-plus exiting 2013 assuming normal catastrophes. We have identified three areas that should help ALL achieve this normalized EPS goal, including 1) returning homeowners margins, excluding catastrophes, to the levels of 2003-2007; 2) achieving underwriting profitability in Florida and New York auto, while holding margins stable in the rest of the country; and 3) growing life earnings in areas with high margins and low capital intensity. While the stock is still a show-me story, we see limited downside given the stock is trading at 6.8x 2012E EPS (versus its long-run average of 10.5x) and 0.77x tangible book (excluding AOCI) despite a 2012E ROE of close to 11%. The risk to our call is that commercial pricing trends accelerate creating margin expansion opportunities in other parts of the sector.
Allstate Corp. (ALL) Overweight Dec 12 Price Target: $40
$27.12 $34.40 $22.27 Dec $2.84 $0.75 $3.96 36.2 6.8 $13,705 Valuation: Target reflects residual income analysis based on prospective ROE (as defined by book value change adding back dividends) adjusted for operating and financial risks as well as historical valuation multiples and historical risk-adjusted returns. Risks: Expectations for stabilizing to improving EPS and capital levels prove optimistic, improved industry pricing may not continue, increased period of highfrequency/low-severity events continuing to pressure earnings, pressure on investment yields. 111
US Year Ahead 2012
REITs/Real Estate Services

Earnings Visibility, High Yields, and Good Total Return Prospects
Michael W. Mueller, CFA AC
(1-212) 622-6689 michael.w.mueller@jpmorgan.com
Anthony Paolone, CFA AC

(1-212) 622-6682 anthony.paolone@jpmorgan.com
Joseph Dazio, CFA

(1-212) 622-6416 joseph.c.dazio@jpmorgan.com
We think REIT stocks should deliver mid-teens total returns in 2012 with a combination of 4% dividend yields, 7% earnings growth in 2013, and about 3% valuation expansion from current levels. We believe there is some room for valuations to expand since 1) the pullback in stocks starting in July has been greater than the roughly 1% decline in 2012 FFO estimates stemming mostly from a weaker macro backdrop; 2) REIT stocks now trade at a slight NAV discount; and 3) the RMZ sits about 3% below our shorter-term tactical fair value of 790. Fundamentally, REIT portfolios should see occupancy increase at a slow clip (up 0100bps) and market rents should move up modestly (3-5%) in 2012. To the extent job growth picks up in 2H or trends higher than 100-150k/month, there could be upside to our core growth estimates. On the transaction side, we expect REITs to be active buyers as they continue to have better balance sheets than most private market counterparts. However, if equity prices remain under pressure, it will be more difficult for REITs to drive external growth initiatives as most will not want to increase leverage to do deals.
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Cindy True
(1-212) 622-6748 cindy.l.true@jpmorgan.com
Molly McCartin
(1-212) 622-6615 molly.mccartin@jpmorgan.com J.P. Morgan Securities LLC
Michael W. Mueller, CFA Acadia Realty Trust CBL & Associates Properties DCT Industrial Trust DDR Corp Equity One Inc. Federal Realty Investment Trust First Industrial Realty Trust General Growth Properties HCP, Inc. Health Care REIT Healthcare Realty Trust Jones Lang LaSalle Inc Kimco Realty Corporation Macerich Medical Properties Trust Pennsylvania REIT ProLogis PS Business Parks Public Storage Ramco-Gershenson Properties Trust Regency Centers Simon Property Group STAG Industrial, Inc. Tanger Factory Outlet Centers Taubman Centers Weingarten Realty Investors Anthony Paolone, CFA AIMCO Alexandria Real Estate Equities American Campus Communities AvalonBay Communities Boston Properties Brandywine Realty Trust Brookfield Office Properties Camden Property Trust CBRE Group, Inc Corporate Office Properties Cousins Properties Douglas Emmett, Inc. Duke Realty Education Realty Trust Entertainment Properties Trust Equity Residential Essex Property Trust Getty Realty Kilroy Realty Lexington Realty Trust Liberty Property Trust Mack-Cali Realty Mission West Properties Piedmont Office Realty Trust Post Properties Realty Income SL Green Realty Corp. UDR, Inc. Vornado Realty Trust Washington Real Estate Investment Trust 112
AKR CBL DCT DDR EQY FRT FR GGP HCP HCN HR JLL KIM MAC MPW PEI PLD PSB PSA RPT REG SPG STAG SKT TCO WRI AIV ARE ACC AVB BXP BDN BPO CPT CBG OFC CUZ DEI DRE EDR EPR EQR ESS GTY KRC LXP LRY CLI MSW PDM PPS O SLG UDR VNO WRE
From a capital flows point of view, REIT stocks should benefit from capital seeking relatively visible earnings streams and high cash dividends while the U.S. economy continues to face drags on growth and financial markets face global uncertainty. Some key risks we see to the group are: 1) capital rotation out of REIT stocks if the economy and financial uncertainties surprise on the upside; 2) Japanese investors reverse course and redeem massive investments in REIT stocks made over the last 12-18 months; and 3) commercial real estate debt markets widening out.
Best Idea Public Storage (PSA)

Public Storage (PSA) continues to be one of our top ideas in the REIT sector based on both our fundamental outlook for the company and its relative valuation. Our 2012 FFO estimate of $6.51 is $0.19 higher than the Bloomberg consensus as we believe that the combination of stronger-than-expected comp NOI growth and the deployment of retained cash flow should drive bottom-line earnings growth, higher than what the Street currently expects. From a valuation perspective, two things stand out to us. First, the stock trades at 22x our 2012 AFFO estimate which is less than a 10% premium despite being a blue chip with financial leverage that is just one-third of the overall REIT sector average. Second, in contrast to prior to the downturn, PSA offers a competitive dividend yield today (just 90bps below the group average) due to three dividend increases over the past 24 months that were driven by a rebound in earnings.
Public Storage (PSA) Overweight Dec 12 Price Target: $140
Price 12/6/2011 52-Wk Range High Low FY End 2010 (A) FY FFO 2011 (E) P/FFO 2012 (E) Cur Next Mkt Cap (mil.)
$129.12 $132.20 $97.04 Dec $4.72 $5.81 $6.51 22.2 19.8 $23,118 Valuation: Target reflects DCF model based on our normalized dividends driven by our AFFO estimates, assuming 8.5% discount rate and long-term growth rate of about 5%. Risks: Continued economic weakness taking a toll on occupancy or pricing power, inability to deploy capital into new investments.
US Year Ahead 2012
Specialty & Consumer Finance

The New Normal
Richard Shane AC
(1-415) 315-6701 richard.b.shane@jpmorgan.com
Jonathan Philpot
(1-415) 315-6725 jonathan.philpot@jpmorgan.com
Daniel Kim
(1-212) 622-6557 daniel.x.kim@jpmorgan.com J.P. Morgan Securities LLC American Capital American Express Annaly Capital Apollo Investment Apollo Residential Mortgage Ares Capital BlackRock Kelso Capital Capital One Discover Financial MFA Financial PennantPark Investment SeaCube Container Leasing Solar Capital TAL International ACAS AXP NLY AINV AMTG ARCC BKCC COF DFS MFA PNNT BOX SLRC TAL OW OW OW N N OW N (rs) N N N OW N N
A new normal for credit quality and growth Following two years of improvement, we believe credit performance has reached a cyclical peak (DQs and NCOs are likely to increase in 2012). We believe this will occur across asset classes (consumer, commercial, secured, and unsecured, with the possible exception of residential mortgage). As the credit tailwind begins to subside, we expect our coverage universe will encounter periods of data pointdriven volatility. Ultimately, we see long-term value in the group as normalized loss rates are likely to remain below historical levels. In order to maximize returns over the next 12 months, investors will need to be willing to embrace tactical entry points created by credit data. We also note that loan growth is likely to remain below historical norms as the supply/demand equilibrium for credit remains constrained.
Best Idea American Express (AXP)

Our best idea for 2012 is American Express (AXP). We believe the company is well positioned for an environment of normalizing credit and slow portfolio growth. This is based upon our thesis that high-end consumers are generally less sensitive to cyclical trends in terms of credit and spending. On the credit side, losses and delinquencies on the companys portfolio are 200bps and 140bps below the industry averages, respectively. We note that current loss levels are approximately 220bps below the companys historical average. Over the past year, domestic billed business has grown approximately 13% y/y, versus the industry average of approximately 9%. Finally, we note that in 2012, we expect the company to demonstrate additional operating leverage as credit tailwinds subside and Visa/MasterCard settlement payments expire. We are modeling operating expenses to fall to 71% of net revenues (versus 74% in 2011).
American Express (AXP) Overweight Dec 12 Price Target: $55
$48.56 $53.80 $41.25 Dec $3.38 $4.04 $4.12 12.0 11.8 $56,402 Valuation: Target reflects 11.9x our 2013 EPS estimate of $4.63, a discount to historical multiple of 17.5x (excluding 2009), in light of increased economic uncertainty. Risks: Economic backdrop remains fragile, Department of Justice lawsuit, sluggish growth outlook for credit card portfolio.
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US Year Ahead 2012
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US Year Ahead 2012
Biotechnology
Health Care
Fundamentals Intact, But Volatile Times Call for Selective Measures: Celgene Top Pick
Geoff Meacham AC
(1-212) 622-6531 geoffrey.c.meacham@jpmorgan.com
Anupam Rama
(1-212) 622-0105 anupam.rama@jpmorgan.com
Michael E Ulz
(1-212) 622-0900 michael.e.ulz@jpmorgan.com J.P. Morgan Securities LLC Acorda Therapeutics Inc. Alexion Pharmaceuticals Allos Therapeutics AMAG Pharmaceuticals Amgen Inc Amicus Therapeutics AVEO Pharmaceuticals, Inc. Biogen Idec Celgene Gilead Sciences Idenix Pharmaceuticals InterMune Ironwood Pharmaceuticals Medivation PDL BioPharma Pharmasset Regeneron Pharmaceuticals United Therapeutics Vertex Pharmaceuticals ViroPharma Incorporated ACOR ALXN ALTH AMAG AMGN FOLD AVEO BIIB CELG GILD IDIX ITMN IRWD MDVN PDLI VRUS REGN UTHR VRTX VPHM OW OW OW N OW N OW N OW OW OW OW OW OW N N N N N OW
Biotech fundamentals are intact, in our view, which is underscored by solid top-line performance in 2011 despite a challenging macro environment. Despite this performance, generalist interest overall in the sector is quite low. Looking to 2012, headlines regarding macro and biotech industryspecific concerns (EU sales exposure, U.S. biosimilars legislation, and pricing pressure on Medicare/Medicaid duel-eligible patients) could keep generalists on the sidelines. Given this, our overall view on the sector is to take a selective approach. We do believe there are names in biotech that retain the sectors inherent defensive naturewhich should garner interest from both generalists and specialists alike. These names have good underlying fundamentals, with potential meaningful clinical/regulatory catalysts (Alexion, Celgene, Gilead, and Viropharma).
Best Idea Celgene (CELG)

Our favored names in biotech are ones with solid underlying fundamentals and/or ones with meaningful potential catalysts. Indeed, our top pick for 2012, Celgene (CELG), has both. The demand trends for flagship drug Revlimid were impressive in 2011, particularly in the face of concerns regarding second primary malignancies (SPMs) associated with the drug in 1H11 (concerns that we had always felt were overdone). In 2012, we expect increased market penetration and share duration gains to continue to fuel Revlimid growth. Regarding clinical/regulatory catalysts, 2011 was a quiet year, but 2012 will be different. Our focus in early 2012 will be on the first-line maintenance filing in the EU, a substantial market opportunity. We do expect ultimate approval. Other meaningful potential catalysts for Celgene to monitor will be potential accelerated approval of pomalidomide in relapse/refractory multiple myeloma and Phase 3 data from apremilast in psoriasis/psoriatic arthritis. We do not currently include either of these opportunities in our model.
Celgene (CELG) Overweight Dec 12 Price Target: $75
$62.21 $68.25 $48.92 Dec $2.80 $3.79 $4.20 16.4 14.8 $27,617 Valuation: Target reflects 18x 2012E EPS, above large-cap group average of 13x, as we expect Celgene to continue to outperform its biotech peers. Risks: Vidaza or Abraxane sales fluctuating from quarter to quarter, additional data from clinical trials could come in below expectations, any negative developments with the IP for Revlimid.
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US Year Ahead 2012
SMid Biotechnology
Will 2012 Finally Be the Year for Resurgence in M&A Activity? ONXX Remains Top Pick
Cory W Kasimov AC
(1-212) 622-5266 cory.w.kasimov@jpmorgan.com
Matthew J Lowe, Ph.D.

(1-212) 622-0848 matthew.j.lowe@jpmorgan.com
Karen E Jay, Ph.D.

(1-212) 622-4668 karen.e.jay@jpmorgan.com J.P. Morgan Securities LLC Alkermes, Inc. Amylin Pharmaceuticals Arena Pharmaceuticals, Inc. Ariad Pharmaceuticals Array BioPharma Biodel Inc. BioMarin Pharmaceuticals Dendreon Emergent BioSolutions Exelixis, Inc Geron Corp Human Genome Sciences ImmunoGen Incyte Corporation Lexicon Pharmaceuticals MannKind Corporation Nektar Therapeutics Onyx Pharmaceuticals Orexigen Therapeutics Rigel Pharmaceuticals Savient Pharmaceuticals Seattle Genetics The Medicines Company VIVUS, Inc ALKS AMLN ARNA ARIA ARRY BIOD BMRN DNDN EBS EXEL GERN HGSI IMGN INCY LXRX MNKD NKTR ONXX OREX RIGL SVNT SGEN MDCO VVUS OW N N OW OW N OW OW OW N N OW N OW OW UW OW OW N OW N N N OW
We have a generally optimistic outlook for the small/mid-cap biotech group going into 2012. To date in 2011, the Nasdaq Biotechnology Index (NBI) has outperformed the broader market (NBI +8.6% vs. S&P 500 +0.3%), and we would note that SMid biotechs are not as reliant as most industries on the performance of the overall economy so long as they have access to capital. With that backdrop, we still expect investor risk appetite for the SMid biotechs to continue to be driven by high-profile clinical and regulatory catalysts, commercial performance, and the potential for M&A activity. The anticipated uptick in M&A once again failed to live up to expectations in 2011, although the recent proposed acquisition of Pharmasset (VRUS) by Gilead Sciences (GILD) could reignite investor optimism. Ultimately, we do believe theres a reasonable chance that biotech M&A activity could pick up in 2012 for the same reasons that have been tossed around for the last couple of years (patent cliffs for large pharma combined with plush pharma balance sheets and more mature biotech pipelines). Beyond a possible acceleration in M&A, attractive valuations and a potentially more robust IPO market could also facilitate increased investor interest. However, on the negative side, persistent investor skepticism surrounding launch stories could continue to be a theme next year. We believe it will be important for the overall performance of the sector that at least some of these commercial companies make strides in 2012. Within our universe alone, key launches to monitor include DNDNs Provenge, HGSIs Benlysta, SGENs Adcetris, INCYs Jakafi, and potentially AMLNs Bydureon (late January PDUFA date).
Best Idea Onyx Pharmaceuticals (ONXX)

Among our mid-cap companies, we continue to prefer ONXX and BMRN. However, when choosing between the two, we lean towards ONXX at this point as it is the more controversial name (at least in the near term) while BMRN has become more of a consensus long. ONXX shares have posted solid performance YTD in 2011 (up 12.5%) but 2012 could be a transformative year with the potential approval of wholly owned asset carfilzomib (CFZ) for multiple myeloma. Potential approval in 1H12 would be the major positive catalyst though we also believe that any regulatory setbacks could be met with money coming in from the sidelines (given long-term optimism). CFZs efficacy and safety profile has resonated well with doctors and we believe, based on early data, that there is a good chance the drug will be eventually be used across the entire spectrum of disease, boosting its value to ONXX. Weve also stressed that ONXX is about much more than just CFZ despite investors overwhelming focus on that product. Key to this view are the eight ongoing or recently completed studies evaluating Nexavar and regorafenib in six different tumor types. So far ONXX is 2-for-2 (positive Nexavar SPACE data and positive rego CRC data). We expect the next updates will be in 1Q for Nexavar in lung cancer (see our MISSION preview) and rego in GIST with the remaining four studies reporting out at varying times over the subsequent 12 months.
Onyx Pharmaceuticals (ONXX) Overweight Dec 12 Price Target: $48
$42.40 $46.07 $27.17 Dec $0.13 $0.72 $(0.34) 58.9 N/M $2,698 Valuation: Target reflects P/E analysis, real options scenario analysis, and risk-adjusted NPV analysis. Risks: Slower- and lower-thanprojected uptake of Nexavar in HCC setting, faster- and greater-than-expected erosion in RCC, failure of label expansion trials, greater-thanexpected competition in RCC and HCC markets, regulatory and/or commercial failure of carfilzomib in multiple myeloma. 116
US Year Ahead 2012
Healthcare Facilities
Economic Stability and Expansion Assist Long Term, While Budget Issues First
John Rex AC
(1-212) 622 6600 john.rex@jpmorgan.com J.P. Morgan Securities LLC Community Health Systems Inc. HCA Inc. Health Management Associates Inc. HealthSouth Corp Kindred Healthcare, Inc. LifePoint Hospitals Inc. Select Medical Corp. Skilled Healthcare Group Tenet Healthcare Corp. Universal Health Services Inc. Vanguard Health Systems CYH HCA HMA HLS KND LPNT SEM SKH THC UHS VHS N OW N N OW N N N OW N OW
Among the most levered in healthcare to economic stability/recovery, while that not the nearest-term event. Healthcare facilities stocks have been challenged this year, in part as the group has been under pressure with still persistently weak payor mix, light medical consumption patterns, and the threat (and reality) of budget cuts for government program business. However, with a cost structure much more heavily biased to semi-fixed costs than most of healthcare, facilities will ultimately be among those most levered to economic stabilization/recovery. Here in particular, and especially as we consider acute care, it is about payor mix. That is the potential, as more individuals gain employer-based coverage, to swap some of the current disproportionate mix of (low-paying) self-pay and/or government-support program business out for (much higher-paying) commercial. With virtually no cost-of-care differential, the leverage to earnings from such a shift is meaningful. Its the longerterm play in acute care, and while economic recovery is likely not viewed by most as a near-term event, our hospital volume work does show stabilization in mix. Beyond mix improvement, coverage expansion extends longer-term view. While likely to be much in focus in 1H12 as the Supreme Court takes up its review, we believe that ultimately most of the 2014 coverage expansion envisioned under the health reform law will occur. Recall that 34 million individuals are expected to gain coverage, and even if this trimmed somewhat, the benefit to lowering uncompensated care costs will be meaningful. Nearer term though, replaying the deficit talks is a potential headwind. At the end of November, the Super Committee announced that it had not found a compromise in the deficit reduction talks and technically (under sequestration at least) for now this means Medicare will take just a 2% cut beginning in 2013 and Medicaid will see no reductions at the federal level. Of course thats the technical prognosis, while the reality is probably more biased to the fact that Congress and the Administration will have to restart the discussion in 2012, an element that that we believe could factor again as a renewed visibility constraint. With the largely nonprofit acute-care sector running extremely slim margins, we believe it will ultimately be difficult to enact anything much more significant than 2%, but we see how the entire story may have to be revisited, and that potentially a nearer-term constraint on the stocks.
Best Idea HCA Inc. (HCA)

We currently rate HCA Inc. (HCA) Overweight, with a year-end 2012 price target of $38. HCA is the largest U.S. hospital system by a considerable margin, operating over 160 hospitals with nearly 39,000 beds, about 5% of the market. The companys facilitieswith a portfolio biased toward higher quality-ranked propertiesare mostly situated in urban markets with faster population growth, and often have one of the leading shares in those regions. Broadly, we favor such scale and urban market positioning, particularly as we look further ahead and consider leverage to a recovering job market and, out in 2014, coverage expansion.
HCA Inc. (HCA) Overweight Dec 12 Price Target: $38
$23.24 $35.37 $17.03 Dec $2.93 $2.67 $3.60 8.7 6.5 $10,146 Valuation: Target reflects 7x EV/EBITDA using our 2013E EBITDA, in line with our group average objective. Risks: Pressures on operating margins as currently running well above peer group, health reform coverage expansion getting derailed or scaled back, potential supply of shares from private equity investors. 117
US Year Ahead 2012
Healthcare Information Technology

Whats the Next Growth Driver Beyond Stimulus?
Atif Rahim AC
(1-212) 622-6671 atif.a.rahim@jpmorgan.com J.P. Morgan Securities LLC Accretive Health Allscripts Healthcare Solutions athenahealth Cerner Corp Epocrates MedAssets Quality Systems AH MDRX ATHN CERN EPOC MDAS QSII OW OW UW OW N N OW
The electronic health record (EHR) companies in our coverage universe (ATHN, CERN, MDRX, and QSII) have benefitted from the 2009 Stimulus Bill, which incentivizes healthcare providers to purchase EHRs and demonstrate meaningful use. Investors generally view stimulus-driven demand as priced into the shares at current levels, but we continue to believe there is upside to the names because Stage 2 requirements which are due to be finalized by mid-2012 point to sustained demand for the next 2-4 years, longer than many investors believe to be the case (we published a detailed report on this on June 16, 2011, titled Stage 2 Criteria Point to Sustained Demand; EHR Market Update). For investors that are looking for the next driver of growth, we believe initiatives under the Patient Protection and Affordable Care Act (aka Health Reform) will provide the next growth driver. Specifically, we believe health information exchanges (HIEs) and technology to allow development of accountable care models, as well as revenue cycle management (to offset reimbursement pressure) are the products and services that will experience increased demand. It is still early to quantify precisely how much demand will be generated given the dynamic nature of Health Reform and the fact that a number of rules have yet to be published. However, we intend to focus on this in the coming year as that is where the puck is moving.
Best Idea Accretive Health (AH)

Accretive Health (AH) is the best long idea in our coverage universe. At a high level, we like Accretive for its unique business model which requires no upfront or incremental investment from a hospital and yet delivers revenue gains to the hospital by bringing efficiency to the collection process. The recently announced Intermountain Healthcare deal is likely to go a long way in terms of generating brand recognition for the company. From a numbers standpoint, Accretive has the best topand bottom-line growth prospects in our coverage universe and trades at a 43% discount to our projected 55% earnings growth rate for the company through 2013. Also, for investors wary of the risk of multiple compression as the effect of the Stimulus wanes, we believe Accretive is an attractive option as the company has not experienced any material benefit from the Stimulus.
Accretive Health (AH) OW Dec 12 Price Target: $35
$23.00 $32.82 $13.20 Dec $0.24 $0.43 $0.73 53.5 31.5 $2,259 Valuation: Target reflects 34x 2013E EPS, as we expect the companys steady-state EPS growth in the 2014-2017 timeframe to be around 30-40%. Risks: Loss of key customers, competitive pressure from new entrants, regulatory changes, delays in signing on new customers, multiple contraction from execution missteps.
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US Year Ahead 2012
Healthcare Technology & Distribution

The Generics Wave Is Here: Expect Positive Benefit Across the Pharma Supply Channel
Lisa C. Gill AC
(1-212) 622-6466 lisa.c.gill@jpmorgan.com
Michael Minchak, CFA

(1-212) 622-6506 michael.minchak@jpmorgan.com
Gavin S. Weiss
(1-212) 622-5451 gavin.s.weiss@jpmorgan.com J.P. Morgan Securities LLC Lisa C. Gill AmerisourceBergen Cardinal Health CVS Caremark Corp. Express Scripts, Inc. Henry Schein Inc LabCorp McKesson Corporation Medco Health Solutions, Inc. Omnicare Inc. Owens & Minor, Inc. Patterson Companies PSS World Medical, Inc. Quest Diagnostics Rite Aid Walgreen Company Michael Minchak, CFA Catalyst Health Solutions, Inc. SXC Health Solutions
ABC CAH CVS ESRX HSIC LH MCK MHS OCR OMI PDCO PSSI DGX RAD WAG
N OW OW (rs) N N OW (rs) OW N N N N N N
Underlying earnings visibility remains strong, while a cyclical lift could drive incremental prescription usage and earnings upside. We remain positive on the pharmaceutical supply channel in general, based on favorable demographic trends and the near-term generics opportunity. The aging population should continue to help drive prescription utilization as the elderly utilize a significantly higher number of scripts per year than the overall average. In addition, generic launches are expected to ramp significantly in 2012, and we note that generics are generally more profitable across the pharmaceutical supply channel. While the weak economy and high unemployment rate have contributed to slower prescription growth over the past few years, a cyclical recovery could provide a potential source of upside to the companies across the pharmaceutical channel. Finally, we expect the PBMs, distributors, and retail pharmacies to continue to use strong free cash flows to repurchase shares, which could provide a cushion to earnings should a weak economy persist. The PBMs continue to be our favorite subsector, based on a sizeable expected benefit from the generics wave. The outlook for the PBMs remains strong, based on two key drivers: generics and specialty pharmacy. We believe the weak economy has led to plan designs that promote utilization of mail and generics, which are more profitable for PBMs. Further, the number of new generic launches will ramp over 2012, although due to the timing of launches and exclusivity periods, much of the benefit will be felt in 2H12. Finally, the specialty pharmacy opportunity remains strong, based on a robust biotech pipeline and ongoing demand from plan sponsors looking to rein in rising specialty drug costs. For pharmaceutical distributors, the longer-term trend remains favorable as well, especially if there is incremental prescription growth from a gradual recovery in the labor market. The drug distributors have highly fixed cost bases and incremental scripts are very accretive to the model, while the upcoming generics wave will also be an incremental positive. For the retail pharmacies, while top-line growth slowed with the economy, increasing prescription utilization and consumer spending driven by a cyclical recovery could drive near-term upside. In addition, generic utilization (based on new launches expected in 2012) and private-label sales should continue to benefit margins. Finally, we note that the weak economy has created consolidation opportunities for the large chains, as small chains and independents find it increasingly difficult to compete.
CHSI SXCI
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Best Idea CVS Caremark (CVS)

Our best idea for 2012 is CVS Caremark. We believe healthy PBM operating income growth (driven by generic launches, new business, and streamlining benefits) coupled with stability in the retail pharmacy and ongoing share buybacks should lead to accelerating earnings growth in 2012, which should lead to improved investor sentiment and multiple expansion. Further, based on marketplace developments, we believe the company is well positioned for share gains on the retail side and also a strong 2013 PBM selling season. In our view, valuation remains attractive, with shares currently trading at 12.1x our 2012 EPS estimate of $3.16, below the average historical forward P/E multiple, and also below our longer-term EPS growth forecast.
CVS Caremark (CVS) Overweight Dec 12 Price Target: $50
$38.27 $39.50 $31.30 Dec $2.68 $2.80 $3.16 13.7 12.1 $49,813 Valuation: Target reflects 14x blended multiple on 2013E EPS. Risks: Weak core productivity, slowdown in front-end sales, retail pharmacy reimbursement pressure, slowdown in prescription drug utilization, competitive pressure on PBM profitability, acquisition integration. 119
US Year Ahead 2012
Life Sciences Tools & Diagnostics

Seeking Favorable Risk-Reward After the Storm
Tycho Peterson AC
(1-212) 622-6568 tycho.peterson@jpmorgan.com
Evan Lodes
(1-212) 622-5650 evan.lodes@jpmorgan.com
Ramesh C Donthamsetty
(1-212) 622-6580 ramesh.c.donthamsetty@jpmorgan.com J.P. Morgan Securities LLC Accuray Affymetrix Agilent Technologies Bruker Corporation Charles River Laboratories Covance Gen-Probe Genomic Health Hologic ICON Plc Illumina, Inc. Intuitive Surgical, Inc. Life Technologies Corporation Luminex Mettler-Toledo Myriad Genetics Inc. Pacific Biosciences Inc. Qiagen N.V. Quidel ShangPharma Corp. Sigma Aldrich Sirona Dental Systems Inc SonoSite Thermo Fisher Scientific Varian Medical Waters WuXi PharmaTech ARAY AFFX A BRKR CRL CVD GPRO GHDX HOLX ICLR ILMN ISRG LIFE LMNX MTD MYGN PACB QGEN QDEL SHP SIAL SIRO SONO TMO VAR WAT WX N UW OW OW N OW N N OW N OW N OW N N N UW N N OW OW OW OW N N N OW
With two of the three core growth drivers (academic, pharma) for life science tool companies facing a secular shift to lower growth in the next several years, and the industrial market set for a mid-cycle slowdown (at best), we are taking a more cautious stance for our 2012 outlook. While we see opportunities to selectively own names in the group based on valuation and exposure to emerging markets, the life science tools industry is undergoing a secular change that could have meaningful impacts to sector multiples longer term. We continue to selectively favor stocks that appear to be discounting severe macro scenarios in the near term, despite company fundamentals remaining well positioned to benefit longer term from emerging market growth, operational excellence, and prudent capital deployment.
Best Idea Agilent (A)

We are Overweight on Agilent (A) due to the companys above-peer organic growth (e.g., 14% and 15% organic growth in FY2010 and FY2011, respectively), favorable geographic exposure (~30% exposure to Asia/ROW (ex-Japan)), credible management, operational excellence (targeting >30% incremental operating margins, >20% ROIC), and disciplined capital deployment. Importantly, we think the stock is fully discounting a serious downturn and believe risk/reward is favorable. Spun out of Hewlett-Packard in 1999, Agilent endured significant challenges during the 2000 tech bust, which led to restructuring and divestitures over the subsequent decade, including a further restructuring during the 2008/2009 financial crisis. We believe the company is now more profitable and less cyclical. After a strong FY2011 and given the difficult and highly uncertain macro environment, the company expects a more challenging FY2012 (~6% organic growth), although this is still above our expectations for peer growth next year. Given managements history of disciplined capital deployment, we expect the company to utilize its strong balance sheet (now ~$1.4bn net cash, though the vast majority trapped overseas) and robust cash flow toward favorable long-term opportunities in 2012.
Agilent (A) Overweight Dec 12 Price Target: $53
$36.98 $55.33 $28.67 Oct $2.95 $3.13 $3.44 11.8 10.8 $12,840 Valuation: Target reflects DCF analysis, assuming 2% terminal growth and WACC of 13.5%. Risks: Macro conditions, secular trends in electronic test and LS/CA instrumentation, competitive dynamics, Varian integration.
120
US Year Ahead 2012
Managed Care
Operating Themes Familiar, Regulatory Backdrop Likely Gets Some Focus
John Rex AC
(1-212) 622 6600 john.rex@jpmorgan.com J.P. Morgan Securities LLC Aetna Inc. AmeriGroup Corp. Centene Corp. Cigna Corp. Coventry Health Care Inc. Health Net Inc. Humana Inc. Molina Healthcare Inc. Sun Healthcare Group, Inc. UnitedHealth Group WellCare Health Plans Inc. WellPoint Inc. AET AGP CNC CI CVH HNT HUM MOH SUNH UNH WCG WLP OW N N OW N N N N N OW N OW
For 2012, operating themes are familiar, while regulatory considerations persist. For managed care, the underwriting margin outlook often dominates the stocks, while for the past couple of years this component has been quite favorable, on slack medical consumption against a stable commercial pricing environment. As a result, earnings upside for the group was significant again in 2011 and, at current consumption levels, we would expect favorable spread and resulting earnings upside again for 2012. To be sure, the question of competitive pricing pressures remains, with not-for-profit insurers (40%+ of the market) continuing to have record surplus capital levels and, as a result, pricing yields in some markets have moderated. However, in the context of these high surplus levels, the pricing actions are far more contained than one would normally expect and we credit continued uncertainty around 2014 health reform changes as having inserted a high degree of caution among such operators, a factor we expect to persist as a braking factor. As a result, we look for more of the same on the operating front (earnings upside), while for the stocks the first half 2012 will be somewhat crowded with regulatory events that could temper the response. On earnings, mostly about medical consumption. So while the commercial pricing environment is a bit softer, its still holding up comparably well and the focus for the 2012 margin outlook should really be mostly about medical consumption, this against the highly constrained current level, and we believe heavily tied to the economy and consumer confidence. As we write this, neither of these looks particularly prone to surge in the coming year and, moreover, we see an incremental mitigating element as employers once again adapt even greater levels of high-engagement offerings, these featuring increased out-of-pocket exposure for employees. Taking a look at government program books, while there was resurgence in cost ratios in the first half across the industry, the most recent reports exhibited more stability. First half of 2012 about the Supreme Court and the deficit. On the latter, even with the failed Super Committee efforts, we expect this to be in focus for much of 2012. Ultimately, though, we do not see a significant negative outcome for managed care, while such considerations seem to at least insert some overhang across healthcare stocks broadly. The first-half 2012 Supreme Court review of the health reform law, however, could appear somewhat binary, having the potential to act as a stalling factor, similar to the 2010 overhang as the regulations were being written, and the stocks unable to react to even quite meaningful earnings upside until that outcome was 100% assured.
Best Idea UnitedHealth (UNH)

We rate UnitedHealth (UNH) Overweight, with a year-end 2012 price target of $60. UNH is the most diversified name within the benefits business having wellestablished, market-dominant positions that span both employer/commercial and higher-growth government program lines. In addition, the company has a large and rapidly growing business in less regulated health-related services (non-insurance) business, now approaching 20% of earnings and with a target 30-40% composition.
UnitedHealth (UNH) Overweight Dec 12 Price Target: $60
$48.29 $53.50 $34.94 Dec $4.10 $4.56 $4.65 10.6 10.4 $51,478 Valuation: Target reflects 11.5x 2013E EPS, in line with group average objective. Risks: Implementation of regulations that will govern health reform law, potential for medical utilization to reaccelerate ahead of pricing yields, greater exposure to Medicare Advantage.
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US Year Ahead 2012
Medical Supplies & Devices

Outlook for 2012
Michael Weinstein AC
(1-212) 622-6635 mike.weinstein@jpmorgan.com
Christopher Pasquale
(1-212) 622-6590 christopher.t.pasquale@jpmorgan.com
MedTech stocks struggled in 2011. A combination of structural and cyclical pressures has resulted in weakening end markets and a slowing of industry growth rates. In 2012, we expect these pressures to continue, resulting in low- to mid-singledigit industry revenue growth and mid- to high-single-digit EPS growth. Absent a pickup in U.S. demand, 2012 is likely to bring incremental pricing pressure and make Europe the incremental risk to the industrys 2012 outlook. To date, Europe has been weak, but relatively stable. Downside demand risk from new austerity measures and a weaker Euro are both worth watching, with the potential to pressure 2012 earnings across the space. MedTech stocks are, of course, inexpensive, trading at 10.5x 2012E EPS and a 10.1% FCF yield. Moreover, the companies are generating ample cash and, in many cases, returning that cash to shareholders. Yet, with two-thirds of S&P healthcare stocks trading at less than 12x anticipated 2012 earnings, valuation and capital allocation alone arent likely to be enough to improve sector performance. In our view, either fundamentals will need to improve, or there will need to be an increased level of interest from strategic or financial sponsors.
Kimberly Gailun
(1-617) 310-0740 kimberly.w.gailun@jpmorgan.com
Ross Comeaux
(1-212) 622-1895 ross.w.comeaux@jpmorgan.com J.P. Morgan Securities LLC Michael Weinstein Abbott Laboratories Baxter Intl Becton, Dickinson & Co BioMimetic Therapeutics Boston Scientific Corporation C.R. Bard Inc. CareFusion Covidien Edwards Lifesciences Heartware International Johnson & Johnson Medtronic St Jude Medical Stryker Corp Tornier Zimmer Holdings Kimberly Gailun Insulet Corp Mako Surgical NxStage Medical, Inc. The Cooper Companies, Inc. Wright Medical Group Christopher Pasquale Hansen Medical Integra LifeSciences NuVasive, Inc. Thoratec Corp. Volcano Corporation
ABT BAX BDX BMTI BSX BCR CFN COV EW HTWR JNJ MDT STJ SYK TRNX ZMH
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Best Idea St. Jude Medical (STJ)

Our top pick as we enter 2012 is St. Jude Medical (STJ). St. Jude struggled in 2011 from a >10% contraction in the U.S. ICD market. This led to a series of downward revisions to Street estimates, which as we approach 2012 is still playing out, particularly on the heels of the unfavorable CardioMEMS panel. Yet, St. Jude still has, by our estimation, one of the best pipelines in large-cap MedTech. Over the next 12 months new product approvals should pave St. Judes entry into two major new markets: transcatheter aortic valve replacement and renal denervation for drugresistant hypertension. St. Jude is also at the front of entering or developing several other markets, including deep brain stimulation for Parkinsons and occipital nerve stimulation for chronic migraines. Because of the ongoing contraction of the ICD market and the timing of key approvals, St. Jude is looking more and more like a 2013 growth acceleration story, which, as visibility on new products increases, is likely to get increasing Street attention over the course of 2012. Near-term risks remain: 1) the ICD market has yet to bottom; 2) St. Judes ICD leads are undergoing increasing scrutiny, causing nearterm share loss; and 3) the St. Jude story is dependent upon EU and FDA approvals. Yet, with the stock trading at 10x 2012 estimates, the potential for a 2013 acceleration is far from reflected in the name, making the 12-month risk/reward in our view meaningfully skewed to the upside.
St. Jude Medical (STJ) Overweight Dec 12 Price Target: $48*
PODD MAKO NXTM COO WMGI
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HNSN IART NUVA THOR VOLC
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$36.95 $54.18 $33.54 Dec $3.02 $3.27 $3.45 11.3 10.7 $11,787 * Target and estimates as of December 9, 2011. Valuation: Target reflects 13x 2013E EPS, a premium to the large-cap MedTech average due to STJs superior top- and bottom-line growth prospects. Risks: Further weakening in the U.S. ICD market, pipeline delays for Portico or renal denervation program, increased pricing and reimbursement pressures in the U.S. and Europe.
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US Year Ahead 2012
Pharmaceuticals Major
Increasing Clarity on Trough Earnings Positive for Pharma in 2012
Chris Schott, CFA AC
(1-212) 622-5676 christopher.t.schott@jpmorgan.com
Jessica Fye
(1-212) 622-4165 jessica.m.fye@jpmorgan.com
Dewey Steadman, CFA

(1-212) 622-5350 dewey.d.steadman@jpmorgan.com J.P. Morgan Securities LLC Bristol-Myers Squibb Company Eli Lilly & Company Merck & Co., Inc. Pfizer Inc. BMY LLY MRK PFE N UW OW OW
We see the major pharma group as well positioned in 2012 based on what we expect will be increasing clarity on trough EPS as we move through a wave of significant patent expirations (Zyprexa, Lipitor, Singulair) as well as increased visibility on post patent cliff earnings growth based on continued pipeline newsflow/business development activity. Following several rounds of cost-cutting, we now expect the sector to maintain operating margins through its patent cycle. In addition, major pipeline data releases or new product launches across the group should increase the Streets confidence in the longer-term earnings power for the sector. Finally, we see capital deployment as an underappreciated catalyst with a notable increasing focus on returning cash to shareholders following a period of M&A digestion. We continue to see nearly all capital redeployment options (business development, share repurchase, dividend increases) as more attractive than the scenario that we (and the Street) currently have modelednamely significant growth of cash on the balance sheet. With valuation (particularly for Pfizer and Merck) continuing to reflect ongoing earnings erosion for the sector, we see an opportunity for multiple expansion across the sector.
Best Idea Pfizer (PFE)

Pfizer (PFE) offers an attractive mix of 1) inexpensive valuation (8.8x 12E EPS), 2) an approaching near-term new product cycle, 3) a high FCF/dividend yield, and 4) limited earnings risk, in our view. Along these lines, we continue to see an attractive entry point in PFE shares and reiterate our Overweight rating. Strong new launch cycle ahead. We believe the positive results from the ARISTOTLE study for Eliquis (atrial fibrillation) coupled with the recent approval of Xalkori (ALK-positive lung cancer) and positive Phase III data for tofacitinib (RA) at ACR represent the start of a significant new product cycle for Pfizer including four $1bn-plus product opportunities. Beyond these assets, we anticipate approval of Prevnar 13 in adults (January 2012) will represent an incremental positive catalyst for the shares. This core portfolio of pipeline assets will enable Pfizer to return to modest top-line growth beyond the companys 2012 patent expiration cycle, by our estimates. Beyond pipeline catalysts, we see the companys business unit divestitures as unlocking significant value and believe a December 2011 dividend increase represents another potential catalyst on the horizon.
Pfizer (PFE) Overweight Dec 12 Price Target: $25
$20.23 $21.45 $16.59 Dec $2.23 $2.28 $2.32 8.9 8.7 $155,507 Valuation: Target reflects DCF assuming 0% sector terminal growth and WACC of 9%. Risks: Failure to effectively integrate the Wyeth acquisition, potential for pipeline setbacks to put pressure on margins, challenges PFEs size presents to longer-term growth/management.
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US Year Ahead 2012
Pharmaceuticals Specialty
Generics Offering an Increasingly Favorable Risk/Reward
Chris Schott, CFA AC
(1-212) 622-5676 christopher.t.schott@jpmorgan.com
Dewey Steadman, CFA

(1-212) 622-5350 dewey.d.steadman@jpmorgan.com
Jessica Fye
(1-212) 622-4165 jessica.m.fye@jpmorgan.com J.P. Morgan Securities LLC Allergan Endo Pharmaceuticals Forest Laboratories, Inc Hospira, Inc. Impax Laboratories Medicis Pharmaceutical Corp. Mylan Inc. Perrigo Company Sagent Pharmaceuticals Teva Pharmaceuticals Valeant Pharmaceuticals Warner Chilcott Watson Pharmaceuticals Jessica Fye MAP Pharmaceuticals AGN ENDP FRX HSP IPXL MRX MYL PRGO SGNT TEVA VRX WCRX WPI N OW OW OW N OW OW N N OW OW OW OW
Generics: Heading into a record year of new product launches and with valuations near an all-time low, we see a number of opportunities in the generics group in 2012. We are anticipating accelerating U.S. growth for the group in 2012 driven by a combination of significant new product introductions and ongoing favorable pricing. In addition, we see Europe as less of an overhang on the sector as expectations have reset and volume growth is expected to accelerate as major products such as Lipitor, Zyprexa, and Diovan lose patent protection. While we anticipate strong results across the generic group, our Overweight-rated names in the sector include Mylan (MYL), Teva (TEVA), Watson (WPI), and Hospira (HSP), for which we see broadly improving news flow throughout the year. Specialty Pharmaceuticals: Merger activity represented a significant catalyst for the group over the past two years and we anticipate the same to be true in 2012 as the sector continues to consolidate in-market assets. We expect names such as Valeant (VRX) and Warner Chilcott (WCRX) to remain active on this front while merger integration will be a focus for Endo (ENDP), Medicis (MRX), as well as Valeant (VRX). In addition, new product launches from Endo (Opana TR) and Forest (linaclotide, aclidinium) represent potential catalysts within the sector.
Best Idea Mylan (MYL)

We see a very strong 2012 ahead for Mylan (MYL) driven primarily by the companys core U.S. business, which is poised for an extremely strong new product cycle next year. While we acknowledge that Mylans European business has been an ongoing overhang for the stock, expectations have generally moderated and we believe the impact from a downside scenario in Europe would have only a muted impact on Mylans bottom line, as was seen in 2011. With a highly diversified business that we believe is capable of delivering mid-teens EPS growth over the next several years, we remain Overweight MYL shares heading into 2012.
Mylan (MYL) Overweight Dec 12 Price Target: $28
MAPP
OW
$19.81 $25.46 $15.49 Dec $1.62 $1.99 $2.46 10.0 8.1 $8,449 Valuation: Target reflects 11.5x 2012E EPS, closer to our target sector multiple of roughly 12.5x 2012E EPS, reflecting ongoing core business strength and solid execution on cost-synergy objectives from the Merck KgaA/Matrix integration. Risks: Greater-than-expected generic competition for Mylans core base products, greater-than-expected European price erosion, generic competition for Epipen.
124
US Year Ahead 2012
Chemicals Specialty, Commodity & Agricultural
Materials
Gathering Strength
Jeffrey J. Zekauskas AC
(1-212) 622-6644 jeffrey.zekauskas@jpmorgan.com
Silke Kueck
(1-212) 622-6503 silke.x.kueck@jpmorgan.com
2012 Outlook: The agricultural markets are likely to be strong in the year-ahead period. Current drivers of domestic agriculture are low stocks-to-use ratios, high crop prices, and excellent farmer profitability. Moreover, ethanol consumption absorbs 40% of the domestic corn market. We believe that year-ahead agricultural fundamentals are likely to be more resilient when encountering economic volatility due to the long-cycled nature of agricultural balances. We believe that 2012 is likely to be a year of rebuilding profitability for North American chemical producers (commodity and specialty). Commodity chemical margins sharply weakened late in 2011 from peak-like levels in 2Q and 3Q. Broader commodity chemicals demand is currently weak due to seasonal factors, lower export demand, inventory destocking, and falling product prices. We expect commodity chemical margins to recover gradually in 2012 as supply and demand rebalance. We expect a healthy and improving multi-year earnings profile for Dow Chemical, LyondellBasell, and Westlake Chemical given the advantaged feedstock position of North American producers. This regional raw material advantage may become more apparent later in 2012 and beyond, as advantages accrue from the development of North American shale gas. We rate DOW, LYB, and WLK Overweight.
OW OW OW N OW N (rs) N N OW OW N OW N OW N N OW OW OW OW N N N OW N N N N OW N N OW
Olga Guteneva
(1-212) 622-6488 olga.v.guteneva@jpmorgan.com
Ben Richardson
(1-212) 622-6455 ben.richardson@jpmorgan.com
Youyou Yan
(1-212) 622-4951 youyou.yan@jpmorgan.com J.P. Morgan Securities LLC Jeffrey J. Zekauskas Agrium Air Products and Chemicals Albemarle Corporation Amyris, Inc. Ashland Inc. Avery Dennison Cabot Corporation CF Industries Holdings, Inc. Compass Minerals International, Inc. Dow Chemical DuPont Eastman Chemical Company Ecolab Inc. Ferro Corp Georgia Gulf H.B. Fuller Huntsman Corporation International Flavors & Fragrances LyondellBasell Industries Minerals Technologies Monsanto Novozymes Pall Corporation Polypore International Potash Corp. Praxair RPM International Inc. Scotts Miracle-Gro Co. Sherwin-Williams The Mosaic Company Valspar Corp WD-40 Company Westlake Chemical Corp. Silke Kueck Rockwood Holdings, Inc.
AGU APD ALB AMRS ASH AVY CBT CF CMP DOW DD EMN ECL FOE GGC FUL HUN IFF LYB MTX MON NZYMb.CO PLL PPO POT PX RPM SMG SHW MOS VAL WDFC WLK
Specialty chemical volume growth has stepped down with the economy since the end of August. We do not expect a robust earnings year for these companies generally in 2012 given contracting European export markets, a slower rate of domestic volume growth, and a slower rate of emerging market demand expansion. We rate ASH, APD, ECL, and IFF Overweight.
Best Idea DuPont (DD)

DuPonts large Agricultural and Performance Chemical (TiO2 and Refrigerants) segments, which account for about 70% of consolidated operating income, should perform well in an economic environment of little growth. Volume growth for agricultural seeds in 2012 is supported by a likely corn planting acre increase in the U.S. to 94 million versus 91.9 million in 2011. DuPont forecasts seed prices to grow ~5% in 2012 with additional benefits from a better product mix. DuPont is reinvesting with free cash from TiO2 and Agriculture, and is purchasing regional seed companies. DuPonts construction and auto-related operations in 2012 should compare well versus 2011 performance. DD has increased its exposure to growth markets in China, India, and Brazil and is executing well. We believe a $130mn cost saving target (2013) from the acquisition of Danisco could prove conservative. DuPont has made a successful transition to a new CEO and her team, which has an enhanced technology and operational focus. DuPont currently trades at 7.2x 2012E EBITDA, which compares to its Specialty Chemical peer range of 7.2-10.9x EBITDA for 2012E. The company trades at an 11.7x P/E multiple for 2012E compared to the peer group at 11.7-20.4x. DuPont should generate 7-8% of its share price in free cash flow in 2011 and about 6-7% in 2012. The dividend yield is 3.4%.
DuPont (DD) Overweight Dec 12 Price Target: $57
ROC
OW
$47.94 $57.00 $37.10 Dec $3.30 $4.00 $4.10 12.0 11.7 $45,291 Valuation: Target relects 8.5x EV/EBITDA on 2012E, implying 14x EPS, consistent with Specialty Chemicals peers. Risks: Cyclical company, customer inventory rebalancing, pension expense. 125
US Year Ahead 2012
Coal
Sector to Remain Choppy . . . We Like the Quality Names
John Bridges CFA, ACSM AC
(1-212) 622-6430 john.bridges@jpmorgan.com
Sadhak Bindal
(1-212) 622-2684 sadhak.x.bindal@jpmorgan.com J.P. Morgan Securities LLC Alliance Resource Partners Alpha Natural Resources Arch Coal, Inc. CONSOL Energy Peabody Energy ARLP ANR ACI CNX BTU OW N OW OW
The U.S. coal sector has been lifted by the international coking coal markets. We could see some pressure on coal prices in the near term unless Australian floods again interrupt supplies. J.P. Morgans commodity group recognizes the pullback in steel prices as a worry and something that must be watched. On a positive note, coking coal hasnt fallen as much as the scrap steel and iron ore prices. The thermal coal prices have also come under pressure, but the demand from China and India remains a wildcard. With international coal prices trading below Chinese domestic coal prices, we believe there could be some lift in Chinas imports once colder weather increases demand. Our economists highlight two major risks: 1) spillovers from the economic and financial crisis in Europe and 2) tightening of domestic fiscal policy. We believe under the prolonged negative sentiment scenario the coal sector could remain under pressure for longer. Reduced crossover coal demand will affect CAPP producers margins significantly and, with the region already facing regulatory pressures and high inflation, this could create a difficult situation for some of the miners. However, we feel the better-quality names will gain market share.
Best Idea CONSOL Energy (CNX)

We believe CONSOL Energy (CNX) is a special situation within the coal sector with some of the best remaining coal assets in Appalachia and a rapidly growing gas business. With its low-cost coal operations, the company is better placed than other miners in the region to take market share in a weaker market, in our view. The company also has large gas reserves in the Marcellus, Utica, and other shales. It has been doing deals to monetize these assets. CNX has completed joint ventures with Noble Energy to develop its Marcellus acreage and with Hess Corporation to develop its Utica acreage. The accelerated development of the gas properties helped by its JV partners is de-risking these properties. We believe the market has still not been able to value the coal/gas hybrid correctly and the company is trading at a discount to its actual value.
Consol Energy (CNX) Overweight Dec 12 Price Target: $79
$40.80 $56.32 $30.56 Dec $1.98 $2.90 $4.08 14.1 10.0 $9,254 Valuation: Target reflects sum-of-the-parts analysis using DCF values for coal and gas assets. Risks: Delay in expected global and U.S. recovery, continued oversupply of natural gas, high medical inflation or lower forecast rate of return on pension plan assets.
126
US Year Ahead 2012
Gold & Precious Metals

We Continue to Recommend Golden Insurance
John Bridges CFA, ACSM AC
(1-212) 622-6430 john.bridges@jpmorgan.com
Sadhak Bindal
(1-212) 622-2684 sadhak.x.bindal@jpmorgan.com J.P. Morgan Securities LLC Agnico-Eagle Mines Barrick Gold Coeur d'Alene Compania de Minas Buenaventura Gold Reserve Hecla Mining Jaguar Mining Kinross Gold Newmont Mining NovaGold Resources Pan American Silver Silver Wheaton Stillwater Mining AEM ABX CDE BVN GRZ HL JAG KGC NEM NG PAAS SLW SWC N OW N N N N N OW OW (rs) UW OW N
The gold price is up roughly 30% since the start of 2011 (currently $1,729/oz); it touched the $1,900/oz level during September. We believe the precious metal will remain attractive relative to most other assets in the current uncertain environment and expect the metal to outperform other industrial metals and its basier sister metal, silver. While the absolute value of gold could be depressed by money flows into the U.S. dollar, we see no change in the positive trend shown by the gold equities outperformance of the S&P 500 in the relative chart shown below.
Figure 98: HUI/SPX A Decade of Outperformance
0.6 0.5 0.4 0.3 0.2 0.1 0 Jan-00
Source: Bloomberg.
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
European problems could also prompt more stimulus. Our economists say a significant setback in Europe, or an unwelcome fall in inflation expectations, could be all that is required for QE3. If there is a QE3, gold prices and gold equities could benefit from the new money supply as the risk of inflation increases.
Best Idea Goldcorp Inc. (GG)

Goldcorp (GG) offers our favorite mix of solid production growth and lower-thanaverage geopolitical risk; GG is forecasting 60% growth in its production profile by 2015. The company has one of the best growth profiles with new ounces coming from the Cerro Negro, Pueblo Viejo, and lonore projects. The company has apparently resolved the issues at its flagship mine, Penasquito, and expects to ramp up to nameplate throughput in early 2012. We believe the company is well positioned to grow ounces per share and we continue to see value in the stock.
Goldcorp Inc. (GG) Overweight Dec 12 Price Target: $63
$52.11 $56.31 $39.04 Dec $1.36 $2.17 $2.75 24.0 18.9 $42,355 Valuation: Target reflects Black-Scholes call option value based on aplying a probability-weighted average gold price of $1,300/oz to the gold forward curve and our estimates of gold sales over the life of the known assets and the forecast cost structure. Risks: Further difficulties with high-pressure rolls at Penasquito, significant capital or cost overruns at joint development project (Pueblo Viejo), sharp fall in silver and base metals prices that affects economics of Penasquito.
127
US Year Ahead 2012
Metals & Mining

Stocks Discounting Significant Further Deterioration in Macro Fundamentals
Michael F. Gambardella AC
(1-212) 622-6446 michael.gambardella@jpmorgan.com
Tyler J. Langton
(1-212) 622-5234 tyler.j.langton@jpmorgan.com
Brian P. Ossenbeck, CFA

(1-212) 622-1023 brian.p.ossenbeck@jpmorgan.com J.P. Morgan Securities LLC Michael F. Gambardella AK Steel Alcoa Allegheny Technologies Arcelor Mittal Carpenter Technology Century Aluminum Company Cliffs Natural Resources Commercial Metals Dynamic Materials Freeport-McMoRan Copper & Gold Globe Specialty Metals GrafTech International Haynes International Metals USA Molycorp Nucor Corp. Reliance Steel & Aluminum Steel Dynamics, Inc. Teck Resources Thompson Creek Metals U.S. Steel Corp Worthington Industries Tyler J. Langton Inmet Mining
In general, most stocks in our coverage universe appear to be pricing in a recession for Europe, a stall/mild recession in the U.S., and a slowdown in Chinese growth, with the metal/mining stocks more levered to China/global growth and the steel stocks to U.S. growth. In contrast to what equities are discounting, our economists and strategists are looking for a more positive scenario for 2012. U.S. GDP growth is expected to remain positive, Europe should start to grow again by mid-2012, and easing inflation in China should allow for a more accommodative monetary policy. If the growth follows J.P. Morgans forecasts rather than the signals from equities, we would expect our stocks to rally strongly on the stronger-than-expected demand, especially as the lessening in uncertainty would likely cause purchasers to move away from their current cautious buying patterns. More specifically, companies with high levels of fixed costs should outperform those with more variable cost structures. On the steel side, we would expect integrated producers (such as X, MT, and AKS) to outperform the more variable-cost minimills and distributors. For the metal producers, miners with low (and more fixed) costs such as FCX in copper should do better than aluminum producers as their cost profiles also adjust to a greater extent with underlying commodity prices.
AKS AA ATI MT CRS CENX CLF CMC BOOM FCX GSM GTI HAYN MUSA MCP NUE RS STLD TCKb.TO TC X WOR
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Best Idea Freeport-McMoRan (FCX)

Since July 15th, the LME copper price is down 19% to $3.54/lb, while FCX is down 27% to $40.54. We believe, however, that FCXs stock price is pricing in too negative an outlook for copper prices and not fully valuing the financial strength and flexibility of the company. FCXs stock now appears to be pricing in a copper price for 2012 of $3.10/lb, as this number (assuming current gold and moly prices of $1,728/oz and $13.40/lb, respectively) would have the stock trading at its historical forward EV/EBITDA multiple of 5.5x. In addition, assuming current metal prices for all of 2012 would have FCX trading at a 2012E EV/EBITDA multiple of 4.5x and a FCF yield of 8%, by our estimates. We also dont believe FCXs current stock price is fully reflecting the companys strong balance sheet. As of 3Q11, the companys net cash position stood at $1.6bn, which (excluding the potential impact of the strike in Indonesia) we estimate would grow to roughly $2.7bn by the end of 2012 if current metal prices hold flat for the remainder of this year and next. With its regular quarterly dividend of $0.25/share, FCX has a dividend yield of 2.5%. However, if we were to include the supplemental dividend of $0.50/share that FCX paid on both December 30, 2010 and June 1, 2011 as regular payments going forward, FCXs dividend yield would increase to 4.9%. Finally, given the companys track record of shareholder-friendly actions (dividend increases, special dividends, and share repurchases), we would not be surprised to see the company take additional actions if the stock remains near these levels.
Freeport-McMoRan (FCX) Overweight Dec 12 Price Target: $61
IMN.TO
OW
$40.54 $60.75 $28.85 Dec $4.65 $5.01 $5.08 8.1 8.0 $38,428 Valuation: Target reflects 5.5x EV/EBITDA using 2012E, in line with FCXs long-term avg. forward multiple. Risks: Pullback in copper purchases by China, further deterioration in global economy, inability of company to cut costs quickly enough to preserve cash, increased copper supply, rise in U.S. dollar.
128
US Year Ahead 2012
Paper & Packaging

Stick with Relative Security at a Discount in a Volatile Market: CCK Top Pick
Phil M. Gresh, CFA AC
(1-212) 622-4861 phil.m.gresh@jpmorgan.com
Ariel Avila
(1-212) 622-8021 ariel.x.avila@jpmorgan.com J.P. Morgan Securities LLC Ball Boise Crown Holdings Domtar Graphic Packaging Greif International Paper Co. MeadWestvaco O-I Packaging Corp of America Rock-Tenn Silgan Holdings Sonoco Temple-Inland BLL BZ CCK UFS GPK GEF IP MWV OI PKG RKT SLGN SON TIN N N OW N N N N OW N OW OW N N N
In a macro environment in which our economists are forecasting <2% GDP growth in 2012, our overall view on the paper and packaging space is fairly cautious. As a reminder, the paper sector tends to exhibit GDP minus growth, even in containerboard, therefore we do not expect much in the way of pricing in 2012 (we currently assume flat pricing for containerboard, with some declines in pulp and paper). Packaging, on the other hand, tends to hold up better in a slow-growth environment, particularly since it has some exposure to faster-growing emerging markets with opportunities to improve penetration rates in beverage cans that could lead to end-market outperformance. Therefore, we would recommend investing in these higher-quality stocks that are likely to show lower earnings volatility, in particular CCK. On the paper side, if one wanted to invest here around the theme of potential consolidation in containerboard, we would recommend RKT, given that we see synergy upside over the next several quarters from its acquisition of SSCC.
Best Idea Crown Holdings (CCK)

Crown Holdings (CCK) is our top pick in the paper & packaging sector. While CCK is a consensus long (91% buys), it is hard to ignore the combination of its potential mid- to high-single-digit organic growth through 2013 and shareholderfriendly capital allocation. By 2013, CCK should be on track to gain 5-10 points of market share in key emerging markets such as Brazil and China, along with its dominant share in the Middle East and SE Asia, all of which should drive higher long-term earnings power and FCF generation once volumes are fully ramped. From a valuation perspective, CCK shares currently trade at 6.8x 2012E EBITDA, a discount to its recent average of closer to 7.5x forward EBITDA. While some of this reflects the overall discount in the market today, we think CCK shares look fairly inexpensive on a relative basis to the packaging group overall as well. Our December 2012 price target of $44 (33% upside, group 20% upside) represents a ~7.1x multiple on 2013E EBITDA, or an 8% premium to the groups 6.6x target multiple (discount to more recent group average multiple of 7x).
Crown Holdings (CCK) Overweight Dec 12 Price Target: $44
$33.14 $41.58 $28.68 Dec $2.24 $2.80 $3.10 11.8 10.7 $5,010 Risks: Overexpansion into emerging markets could lead to overcapacity, particularly if global economy slows, pricing risks in Western Europe, a function of increased competition due to Can-Packs entry into the United Kingdom, overcapacity resulting from weaker CSD trends and the end of can exports from North America to Brazil leading to pricing compression, shift from can to glass packaging in North America and Brazil as brewers focus on price over volume.
129
US Year Ahead 2012
130
US Year Ahead 2012
Information Services/TV & Radio Broadcasting
Media & Telecom
Remain Positive on Info Services Names in 2012; Auto & Political Ads Could Lift TV Names
Michael A. Meltz, CFA AC
(1-212) 622-0416 michael.meltz@jpmorgan.com
David Lewis, CPA

(1-212) 622-6435 david.m.lewis@jpmorgan.com
Nadia Lovell
(1-212) 622-4885 nadia.s.lovell@jpmorgan.com J.P. Morgan Securities LLC Michael A. Meltz, CFA Arbitron Belo Corp. CBS Corporation D&B Equifax Experian plc IHS Inc. Meredith Corporation Moody's Corp. Nielsen Holdings N.V. Sinclair Broadcast Group The McGraw-Hill Companies Thomson Reuters Verisk Analytics David Lewis, CPA FactSet Research Systems Gartner Inc. John Wiley & Sons Solera Holdings Nadia Lovell Clear Channel Outdoor Lamar Advertising Co. XO Group Inc
ARB BLC CBS DNB EFX EXPN.L IHS MDP MCO NLSN SBGI MHP TRI VRSK
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Information Services stocks should outperform in a sluggish economic recovery given rising secular demand, nice operating leverage, and market expansion opportunities. These companies provide need-to-have information for professionals, thus typically enjoy good pricing flexibility and high renewal rates. The group has limited exposure to the anticipated fiscal drag on households in 2012. A few educational/book publishers (e.g., McGraw-Hill, John Wiley) are exposed to state budget pressuresalthough both operators are diversified and benefiting from share gains. High diesel gas prices and European unemployment could limit Soleras near-term upside. In a financial spillover, the rating agencies would likely see the most estimate downside, depending on the duration. On the positive side, a modest improvement in housing investment could imply estimate upside for many of these stocks (VRSK, EFX)with improving revenue growth bolstered by highly fixed cost bases. We remain positive on the credit bureaus (Experian, Equifax), and also like a handful of esoteric research/database/analytics providers (Verisk, Gartner). Comparison for TV & Radio Broadcasters and Magazines will ease in 2012. We expect most operators to benefit from a rebound in auto advertising and strong political spending. For TV, we expect industry ad revenues to jump >10% due to Olympics and heavy political spendingwith a boost from the Presidential Election and the Supreme Court Citizens United campaign finance ruling. We assume 2-3% growth in underlying core TV advertising. Were keeping a close eye on Washington newsflow regarding spectrum incentive auctions, retransmission consent, and the FCC 2010 quadrennial review of media ownership laws. For Magazines, secular trends remain challenging and we expect modest advertising growth industrywide.
FDS IT JWa SLH
N OW OW OW
Best Idea Verisk Analytics (VRSK)

Verisk is a leading provider of risk management solutions and analytics to the insurance, mortgage, supply chain, and healthcare industries. Its databases and tools are used by customers to measure risk, predict losses, and prevent and detect fraud. The companys ISO brand dominates in its niche, with need-to-have databases, software, and tools for P&C insurers. A clearinghouse model results in high barriers to entry and above-average pricing power. VRSK has performed well year to date (+9% v. the S&P 500s -5%) and we see more room for upside in 2012. We find valuation attractive (17.8x 2013E EPS and 10.9x 2013E EBITDA). Subscription nature of business implies relatively less inherent leverage to an economic slowdown. Verisk generates nearly 70% of revenues from a subscription modelthis could limit downside if market volatility persists. Verisks key vertical, P&C customers (~58% of revenues), is steadily recovering. The company drives strong cash flow and maintains a healthy balance sheet (1.7x net debt/EBITDA). Diversifying with acquisitions of faster-growing Decision Analytics properties. Analytics (59% of revenues) lifted 12% in Q3. Verisk is rapidly expanding its addressable market into data solutions and analytics for emerging verticals including mortgage (~17% of revenues), healthcare (~15% of revenues), and supply chain.
Verisk Analytics (VRSK) Overweight Dec 12 Price Target: $42
CCO LAMR XOXO
N N N
$38.06 $39.75 $30.76 Dec $1.40 $1.70 $1.90 22.4 20.0 $6,273 Valuation: Target reflects 19-20x 2013E adj. EPS. Risks: Subscription-oriented revenue mix is late cycle and weighted to P&C insurance sector, acquisitions remain major part of growth strategy, insurance companies could trim business relationships with VRSK. 131
US Year Ahead 2012
Internet
Positive Outlook Given Strong Secular Growth and Emerging Trends
Doug Anmuth AC
(1-212) 622-6571 douglas.anmuth@jpmorgan.com
Kaizad Gotla, CFA

(1-212) 622-6436 kaizad.gotla@jpmorgan.com
Bo Nam
(1-212) 622-5032 bo.nam@jpmorgan.com
Our positive view on the U.S. Internet sector into 2012 is driven by strong secular growth, increased online accessibility via mobile devices and tablets, and strengthening of key trends including social, local, and video. While most Internet names in our coverage universe have high levels of exposure to discretionary consumer spending and are subject to the broader macro pullback, we believe the Internet economy is quite healthy and supported by the shift to online channels in both advertising and eCommerce. Strong secular growth to continue. With online advertising at ~18% of total ad spending and eCommerce at ~9% of total retail (in the U.S.), we believe these segments should continue to have many years of double-digit growth ahead on a global basis. The Internet economy will also likely be bolstered by monetization of online video content, virtual goods, applications, and cloud-based services.
OW N N OW OW OW N OW OW N OW N
Shelby Taffer
(1-212) 622-6518 shelby.x.taffer@jpmorgan.com J.P. Morgan Securities LLC Amazon.com Bankrate Inc eBay, Inc Google HomeAway Inc LinkedIn Corp Netflix Inc Pandora Media Inc Priceline.com QuinStreet, Inc. ReachLocal Yahoo Inc AMZN RATE EBAY GOOG AWAY LNKD NFLX P PCLN QNST RLOC YHOO
Platform/ecosystem competition to intensify. We believe Amazon, Apple, Google, and Facebook are emerging as primary platforms on which increasing amounts of online/mobile communications, advertising, and commerce are likely to be conducted. Notable characteristics of these major platforms include global reach, large and developing ecosystems, strong network effects, and revenue-generating, toll-booth capabilities. Looking ahead, we expect these platforms to continue to grow stronger as the rest of the Internet increasingly relies on them. Mobile devices leading confluence of key trends. We believe smartphone and tablet adoption has played a critical role in accelerating key industry trends including social, local, and mobile search. As smartphone penetration moves beyond the current ~30% global penetration rate and tablets approach mainstream adoption, we expect mobile devices to have an even bigger impact on Internet business models and eCommerce trends.
Best Idea Google (GOOG)

Google is our top pick on the strength of its core business fundamentals. We believe core search growth remains healthyin the high teens in 2012while Googles mobile and display businesses are taking significant share in higher-growth segments. Margin concerns and the MMI acquisition have been recent overhangs on the stock. However, we think the spending is appropriate given new managements focus on product and innovation, and strong mobile revenue numbers highlight the importance of Android and support the rationale for the MMI deal. We continue to believe Google shares represent strong large-cap growth at a compelling valuation.
Google (GOOG) Overweight Dec 12 Price Target: $705
$623.77 $642.96 $473.02 Dec $29.61 $36.65 $42.20 17.0 14.8 $202,031 Valuation: Target reflects 14x 2013E PF EPS, or 0.8x PEG on 2010-13E EPS CAGR of 19%. Risks: Potential for continued heavy investment spending, increasing competition from Facebook as source of traffic across Internet, continued competition for engineering talent, appification of mobile Internet, increased regulatory scrutiny.
132
US Year Ahead 2012
Media
Economic Uncertainty Continues, But Advertising Holding In and Valuations Appear Attractive
Alexia Quadrani AC
(1-212) 622-1896 alexia.quadrani@jpmorgan.com
Townsend Buckles, CFA, CPA

(1-212) 622-0461 townsend.buckles@jpmorgan.com
Monica DiCenso, CPA

(1-212) 622-0473 monica.dicenso@jpmorgan.com
Caroline Anastasi
(1-212) 622-0138 caroline.e.anastasi@jpmorgan.com J.P. Morgan Securities LLC Cinemark Discovery Communications Disney Gannett Company Harte-Hanks, Inc Interpublic Group of Companies National CineMedia, Inc. New York Times Company Omnicom Group Regal Entertainment Scripps Networks Interactive The E.W. Scripps Company The McClatchy Company Time Warner Valassis Communications Viacom WPP Group CNK DISCA DIS GCI HHS IPG NCMI NYT OMC RGC SNI SSP MNI TWX VCI VIAb WPP.L OW N OW N N OW N N OW OW N OW N OW OW OW N
Economic concerns continue to weigh on the Media sector as investors remain skittish and look for any signs of an advertising slowdown. Ad spending is highly correlated to GDP and generally lags movements in economic data by a quarter or two, so a modest deceleration in growth is expected heading into 2012. We currently expect global ad growth to approximate 4% in 2012, down slightly from 5% growth anticipated in 2011. Recent comments from top executives at some of the largest ad agencies indicate that budgets for 2012 look relatively healthy so far and advertisers are not meaningfully changing spending patterns heading into next year. While local will benefit from a boost in political spending in 2012 (possibly upwards of $4bn), core national advertising levels appear to be much healthier. As such, we favor those stocks in our universe with greater national ad exposure and particularly like cable assets given their growing share of ad spend and additional revenue stream of steady affiliate fees.
Best Idea Viacom (VIAb)

We find Viacom (VIAb) shares compelling heading into 2012 given the companys leading cable assets, discounted valuation, and substantial share buyback. In a healthy but sensitive macro environment, cable networks stand out as attractive earnings generators given their dual revenue streams of advertising and highvisibility affiliate fees. Viacoms leading cable assetsincluding Nickelodeon and MTVrepresent more than 90% of the companys earnings vs. its Filmed Entertainment division. Management has guided to high-single- to double-digit affiliate fee growth driven in part by meaningful digital content deals. On the advertising side, industry trends remain healthy heading into 2012 and while scatter has softened a bit recently, it continues to sell at nice premiums to a strong Upfront base. Viacoms network ratings have been weak which may put a lid on near-term ad growth but we believe this fact is well digested and anticipated. Finally, we expect profitability in the Cable business to expand nicely in the year ahead, boosted by the strong affiliate revenue growth and ongoing structural improvements internationally. Viacom plans to buy back at least $2.5bn in shares during F2012 (we estimate $2.8bn), representing over 10% of shares outstandingthe highest among its peers. Repurchases will be funded by robust free cash flow at over $2.5bn in F2012E, more than $1bn of cash, and a planned increase in leverage through debt issuance. We believe VIAb shares offer great value at just 10x our F2012E EPS, more than a 20% discount to its peers (DIS, TWX, CBS, SNI, and DISCA) and well below its own historical averages, for a high-teens EPS growth profile. Viacom also pays a nice dividend, yielding 2.3%. We look to a healthy ad market into 2012, continued aggressive buybacks, and improved ratings as catalysts to shares ahead.
Viacom (VIAb) Overweight Dec 12 Price Target: $56
Price 12/6/2011 52-wk range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.)
$42.81 $52.67 $35.13 Sep $3.61 $4.35 $5.11 9.8 8.4 $24,013 Valuation: Target reflects VIAbs three-year historical forward P/E of 11x applied to forward EPS. Risks: Weaker-than-expected advertising revenue, change in cable provider structure to tiering or a la carte, studio business tends to be volatile, concentration of ownership.
133
US Year Ahead 2012
Telecom, Cable & Satellite

Slowing Growth But Strong Capital Return Potential: Top Pick CMCSA
Philip Cusick, CFA AC
(1-212) 622-1444 philip.cusick@jpmorgan.com
Richard Choe
(1-212) 622-6708 richard.choe@jpmorgan.com
Derya Erdemli, CFA

(1-212) 622-8529 derya.erdemli@jpmorgan.com J.P. Morgan Securities LLC American Tower AT&T Cablevision CenturyLink Charter Clearwire Comcast Crown Castle DIRECTV DISH Network Frontier Leap Wireless MetroPCS NTELOS SBA Communications Sprint Nextel Telephone & Data Systems Time Warner Cable US Cellular Verizon Communications Windstream AMT T CVC CTL CHTR CLWR CMCSA CCI DTV DISH FTR LEAP PCS NTLS SBAC S TDS TWC USM VZ WIN OW (rs) N OW OW N OW OW OW N N OW OW OW OW N N N UW N
Wireless For 2012, we expect to see slower subscriber growth but continued strength in wireless data revenue growth from increased penetration of smartphones, sales of tablets, and higher ARPU driven by data. Smartphone penetration could exceed 75% at some carriers, up from 40-60% today, which should drive growth in ARPU. In addition, there could be incremental wireless data growth from tablets with the iPad continuing to be the dominant tablet, but new Android and Windows tablets gaining some traction. LTE data cards and MiFi devices could also drive 2012 growth mainly from Verizon, but also from AT&T as it launches markets. Wireline On the wireline side, we believe the biggest upside could come from a continued recovery in enterprise telecom spending. While we do not reflect a significant macroeconomic recovery in our estimates, we are seeing increased activity from enterprises for data, IP, and cloud services and slower declines in legacy services. We also expect cell tower backhaul revenues to continue to increase as wireless carriers ramp up their 4G network build and require higher throughput for handling the increase in data usage. However, government-related revenue could be at risk. Towers We expect tower companies to continue to benefit from the 4G network buildout by wireless carriers in 2012. 2011 business trends were strong and we expect that 2012 could be even better. AT&T and Verizon continue to rapidly build out LTE. Sprint has become more active after years of minimal leasing activity, and applications for amendments are rolling out for Network Vision upgrades. Cable and Satellite We maintain a positive view on the cable and satellite sector, as we find the over-thetop threat limited and believe that broadband growth will offset softness in the video market. Cash generation in the space is high, with free cash flow yields of 6.9% to 20.2% in 2012E and aggregate U.S. revenue and EBITDA growth of 4.1% and 2.5%, respectively, as expected. We also think the commercial business offers incremental growth potential vs. the slowing residential business.
Best Idea Comcast (CMCSA)

Comcast is our top pick in the telecom, cable, and satellite space with an Overweight rating and year-end 2012 price target of $30, implying 33.4% upside from current levels including an estimated 2.2% dividend yield. In our view, the companys solid cable segment growth combined with steady improvements at NBCU make for a strong and well-diversified cash flow stream. We expect that most of 2012E cash flowan 10.9% yield at current levelswill be available to capital-return projects including ramping the companys 2.2% dividend yield and 3.5% buyback, while maintaining leverage, currently 2.1x versus Comcasts target range of 2-2.5x.
Comcast (CMCSA) Overweight Dec 12 Price Target: $30
$23.19 $27.16 $19.19 Dec $1.18 $1.41 $1.64 16.4 14.1 $63,045 Valuation: Target reflects DCF analysis assuming WACC of 7.5% and perpetual growth rate of 0.5%, and doesnt give CMCSA any credit for value of its 50% carried interest in NBCU. Risks: Heavy telecom video competition continues to increase, over-the-top video creates potential for customers to cut basic video packages, NBC requires investment for further improvements, NBCU increases ad exposure, Roberts family voting control.
134
US Year Ahead 2012
Alternative Energy LED
Technology
LED Fundamentals Troughing, Lighting-Related Demand Growth to Lead the Way in 2012
Christopher Blansett AC
(1-415) 315-6708 christopher.r.blansett@jpmorgan.com
William Peterson
(1-415) 315-6711 william.c.peterson@jpmorgan.com J.P. Morgan Securities LLC Cree Rubicon Technology Veeco Instruments CREE RBCN VECO OW OW OW
We believe the LED industry will trough in C4Q11/C1Q12 and improve throughout 2012. However, we believe demand for LEDs for consumer electronics (CE) will recover slowly due to a significant structural oversupply and weak macro outlook for CE product demand while demand for LEDs for lighting will accelerate aggressively throughout the year as third-generation LED lighting products come to market, which further reduce product cost and have lower relative payback periods vs. prior product generations. In general, we recommend investors invest as far downstream toward LED-based lighting as possible as we believe LED-related companies with higher exposure to lighting will outperform LED companies that are more CE-centric. In general, the combination of third-gen LED lighting products, a greater number of utility-based energy efficiency subsidies, and legislative mandates for conventional lighting technologies in various countries should drive the long-awaited inflection in demand for LED-based lighting in 2012. Unsubsidized payback periods for third-gen LED lights vs. conventional incandescent and outdoor lighting technologies are very attractive and we think associated usage of these products will greatly increase, especially if there is an energy efficiency subsidy available. In addition, legislative drivers in numerous countries are limiting the availability of incandescent bulbs, which should only help to drive increased adoption of LED-based lighting products.
Best Idea Cree (CREE)

Cree is our top pick in the LED sector as roughly 75% of its revenue already comes directly from sales related to LED-based lighting. We expect this to increase further in 2012. Cree recently acquired Ruud Lighting, a lighting product manufacturer which we believe has the largest share of North Americas LED-based outdoor lighting market with its Beta LED product line. We expect the combination of Ruud Lighting and Crees internally developed, indoor LED-based lights will be the fastest-growing business for the company with a 50%+ CAGR over the next five years. In addition, Cree is a leading supplier of high-performance LED components used extensively by LED lighting product manufacturers. As these companies bring to market their own third-gen LED lighting products over the next six months, we expect demand for Crees LED components to accelerate significantly through 2012. We believe there is significant GM leverage in Crees business model due to a very high level of fixed costs in both COGS and Opex. We do not believe the Street understands the strong correlation between Crees utilization rates and its margins and, as a result, believe the Street is underestimating the improvement in margins and earnings that is likely to occur should Cree return to 90%+ utililization rates. In addition, Cree will begin to ramp production on 6 wafers at the beginning of C12, which will help to reduce its product cost basis at an accelerated rate. We also believe the need for very high performance LEDs to provide LED-based lighting products with a short payback period will limit competition for the next few years. Thus, we expect less pricing pressure for LEDs sold into LED lighting vs. those that are sold into traditional consumer electronics applications.
Cree (CREE) Overweight Dec 12 Price Target: $48
$25.68 $72.85 $23.03 Jun $1.37 $0.86 N/A 29.9 N/A $2,977 Valuation: Target reflects 29x C12E EPS, given expected revenue growth opp. of >30% over next few years. Risks: Weaker-than-expected demand for high-brightness LEDs, slower-than-expected penetration of LED-based lighting, stronger-than-expected competitive environment. 135
US Year Ahead 2012
Alternative Energy Solar PV

Long Investors Should Stay Away, 2012 Will Be Even More Difficult Than 2011
William Peterson
(1-415) 315-6711 william.c.peterson@jpmorgan.com J.P. Morgan Securities LLC Broadwind Energy First Solar, Inc. MEMC Electronic Materials SunPower BWEN FSLR WFR SPWR N UW UW UW
We continue to recommend long investors avoid the solar sector heading into 2012 as further subsidy reductions in major markets will continue to drive down returns on solar project investments, causing meaningful demand destruction in our view. Germany, Italy, and the U.S., which represent more than 50% of global solar demand, will all reduce their solar subsidies at the beginning of 2012. These subsidy cuts will cause a significant impairment in solar economics requiring a reduced capital cost to offset the lower subsidy levels. Given the already poor financials of most solar PV companies which are in the red or operating near breakeven, we do not believe the industry is in a position to reduce pricing further, in line with subsidy cuts, resulting in less demand in 2012 vs. prior years. We also believe financing costs will be higher in 2012 vs. 2011, also placing additional downward pressure on solar system returns and further inhibiting demand. The solar industry continues to be driven by subsidies and its outlook has little to do with the outlook for the global economy. Thus, as the subsidies go, so does the solar sector. In addition, the force behind the creation of the subsidies in the first place, rising electricity prices due to rising natural gas prices, is no longer a factor to help maintain the political willpower to keep them intact. In fact, the growing realization that we are at the beginning of a new era in global natural gas production enabled by the combination of horizontal drilling/fracking is likely to be a negative factor toward the subsidization of solar and all forms of renewable energy, as many governments around the world are now looking at the potential to produce significant amounts of natural gas domestically at rates significantly lower than current market prices. We also believe 2012 will be a year known for significant consolidation of the solar PV industry with companies with high product costs and/or poor balance sheets likely to disappear through bankruptcy or through acquisition by stronger players. Unfortunately, a weaning out of weak players is not likely to resolve the industrys woes as the problems are not simply due to overcapacity, but primarily due to the structural lowering of subsidy levels.
Best Idea First Solar (FSLR)

We rate First Solar Underweight and continue to believe the stock will remain under pressure as pricing conditions in the solar sector become even more difficult in 2012. Although the company has a strong U.S. pipeline of projects, a large percentage of its revenue comes from the sale of modules. We believe First Solar will see significant margin compression in its module business in 2012 as subsidies are reduced and as silicon waferbased peers see significantly lower polysilicon prices. We also believe First Solar will need to structurally raise its R&D spend in order to try and accelerate product improvement to keep pace with falling subsidies. This, in conjunction with significantly lower module margins, is likely to reset operating margins lower than most investors currently expect. We think long-only investors will continue to avoid FSLR and other solar stocks until uncertainty on subsidies and overcapacity is resolved. We think multiple contraction, due to a deteriorating growth outlook for the company, is likely to be the primary reason for stock price underperformance.
First Solar Inc. (FSLR) Underweight Dec 12 Price Target: $40
$46.11 $175.45 $40.05 Dec $7.71 $7.24 $5.13 6.4 9.0 $3,985 Valuation: Target reflects 0.9x C12E revenue. Risks: Faster-than-expected reduction in product cost, strong B/S assists project financing. 136
US Year Ahead 2012
Applied & Emerging Technologies

Hip to Be Zip
Paul Coster, CFA AC
(1-212) 622-6425 paul.coster@jpmorgan.com
Best Idea Zipcar (ZIP)

Auto-sharing is a secular growth market. The flexibility of auto-sharing yields consumers the benefits of auto ownership without the high cost and hassle, and engenders sustainable consumption in an urbanized, resource-constrained world. Frost & Sullivan forecasts tenfold growth in car-sharing members through 2016 and a revenue CAGR of 44% to $3.3 billion in the United States alone. Zipcar is the global leader in auto-sharing, with over 75% share of the market and competitive advantages through scale and reach, size of balance sheet, unrivaled transactional and customer data, differentiated technology infrastructure, and branded self-service experience. Zipcar plans to deploy in two new U.S. cities each year, and through the recent Streetcar acquisition has a beachhead to pursue the European market in 2012. ZIP should reach sustainable profitability in 2012. We expect ZIP to grow pro forma EBITDA ~90% in FY12E on revenue growth of ~24%, continuing the positive trajectory from FY11E which, at the midpoint of guidance, calls for pro forma EBITDA and revenue growth of ~125% and ~30%, respecitvely. We also expect ZIP to record net income of ~$5mm, compared to an estimated loss of ~$11mm in FY11. ZIPs established markets have grown ~23% year to date and pre-tax margins have increased by ~80bps to 20.9%.We expect this favorable trend in ZIPs established markets to continue with additional growth and leverage experienced as other existing markets mature. Macro resistant. ZIP was able to add members, grow revenue, and lower acquisition cost per new member during the 2008/2009 downturn. While it is certainly not completely immune from another downturn, we believe ZIPs experience during the last downturn compares favorably to those of traditional rental car companies, which experienced revenue declines on average during that timeframe.
Zipcar (ZIP) Overweight Dec 12 Price Target: $30.50
Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY PF EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.)
Mark Strouse, CFA

(1-212) 622-8244 mark.w.strouse@jpmorgan.com
Marija Krgovic
(1-212) 622-5552 marija.krgovic@jpmorgan.com J.P. Morgan Securities LLC Acacia Research Corp. Avid Technology Coinstar Inc. Comverge, Inc. Cubic Corp Diebold, Incorporated DigitalGlobe, Inc. Dolby Laboratories, Inc. DTS, Inc. Echelon Corporation Elster Group SE EnerNOC Inc. ESCO Technologies Inc. FLIR Systems Inc Garmin Ltd. GeoEye, Inc. iRobot Corporation Itron, Inc Ituran Location and Control Logitech International LoJack Corp NCR Corporation Nice Systems Novatel Wireless OmniVision Technologies Plantronics Inc Rambus Inc. RealD Inc. Sierra Wireless Inc. Synaptics Inc. TASER International Inc. TeleCommunication Systems, Inc. TeleNav, Inc. Trimble Navigation Verint Systems, Inc. Zebra Technologies Zipcar ACTG AVID CSTR COMV CUB DBD DGI DLB DTSI ELON ELT ENOC ESE FLIR GRMN GEOY IRBT ITRI ITRN LOGI LOJN NCR NICE NVTL OVTI PLT RMBS RLD SWIR SYNA TASR TSYS TNAV TRMB VRNT ZBRA ZIP OW N OW N N UW OW OW UW N OW N N UW UW N N OW UW N N OW OW N OW N N OW UW N UW N N OW OW OW OW
$14.43 $31.50 $14.00 Dec $(0.68) $0.05 $0.34 N/M 42.4 $567 Valuation: Target reflects 30x multiple assigned to 2014E PF EPS discounted back one year at WACC of 12%. Risks: Probable price-based competition from rental car companies, deteriorating unit economics as company enters new markets or existing markets approach saturation, auto-resale value introducing profit risk, execution challenges.
137
US Year Ahead 2012
Business & Education Services

Business Services/Staffing to Outperform in Decent Recovery; Education Finding Traction
Andrew C. Steinerman AC
(1-212) 622-2527 andrew.steinerman@jpmorgan.com
Jeffrey Y. Volshteyn
(1-212) 622-2940 jvolshteyn@jpmorgan.com
Molly R. McGarrett
(1-212) 622-5841 molly.r.mcgarrett@jpmchase.com J.P. Morgan Securities LLC Andrew C. Steinerman American Reprographics Company Apollo Group Bridgepoint Education Capella Education CDI Corp. Cintas DeVry Education Management G&K Services Iron Mountain ITT Educational Services Inc ManpowerGroup Resources Global Professionals Robert Half International Strayer Education UniFirst Jeffrey Y. Volshteyn Towers Watson
U.S. flexible staffing growth is solid amid low GDP. U.S. flex staffing growth has remained healthy throughout 2011, despite rather lackluster GDP. We sense that the threshold level of real GDP needed to generate favorable flex-staffing growth has dropped due to the enhanced secular attraction of flex staffing following the Great Recession. Still, we recognize that flex staffing in key European markets has slowed remarkably in late 2011, but is still modestly growing. Eurozone real GDP is more of a risk in those geographies. We have long maintained that flex staffing is concurrent with the economy and a leading read on the labor market. We continue to see solid prospects in staffing fundamentals, especially in the U.S. marketplace. Domestic demand continues to be strong in IT and other professional staffing, and commercial staffing is enjoying some solid seasonal lift in late 2011. Encouragingly, the labor supply is tightening within professional staffing, allowing staffers to push for higher bill rates in those areas. We also see operating leverage prospects tied to revenue growth. We sense margins of many staffing firms (e.g., MAN, RHI) could be 50%+ higher over the next couple of years, assuming a permissive economy. Staffing stocks more than discounting a normal recession. For example, U.S.centric RHI is currently trading at its normal recessionary EV/S multiple (based on valuation lows around the 2011 recession), while more European-exposed MAN is trading at an almost 30% discount to its normal recessionary level. So, assuming a conducive economy in 2012, staffers should see a powerful combination of expanding multiples, better margins, and revenue growth. DC storm for Education stocks has passed; the key is the trajectory of new enrollments. With new 2011 regulations finalized and Congress in gridlock, we do not expect much higher education change in DC during 2012, other than current uncertainty around Pell Grant funding. For-profit education institutions are eager to return their focus to operations and students. New enrollments (starts) are the leading indicator of the sector and have been pulled down by the exhausted consumer and negative media during 2011. Start declines have narrowed in Fall 2011 for the sector, and Apollo has already seen starts return to growth. We expect sector starts to rebound by mid-year 2012 and total enrollments to follow with a lag. We maintain that for-profit education institutions will reachieve healthy mid-term growth due in part to public sector supply constraints. We note that Education stocks now trade at 11x NTM EPS, still near the lowest level in a decade. We favor APOL and STRA.
ARC APOL BPI CPLA CDI CTAS DV EDMC GKSR IRM ESI MAN RECN RHI STRA UNF
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Best Idea Robert Half International (RHI)

Robert Half International (RHI) is the King Kong of accounting staffing with ~20% market share in the U.S. and should benefit from much faster growth and higher profitability than most staffing companies through the cycle. In addition, Robert Half primarily addresses mid-market companies, enabling it to command better pricing power. RHI is still trading at a normal recessionary multiple. Assuming a permissive economy, RHI should see expanding multiples, better margins, and strong revenue growth into 2012.
Robert Half International (RHI) Overweight Dec 12 Price Target: $40
$27.48 $34.26 $19.69 Dec $0.44 $1.05 $1.48 26.2 18.6 $3,929 Valuation: Target reflects 1.4x EV/S using 2012E revenues, below historical expansionary cycle multiple of 1.7x. Risks: Economic slowdowns and accounting staffing volatility, extended labor recovery causing continued stock volatility. 138
US Year Ahead 2012
Communications Equipment & Data Networking

Riverbed Our Top Pick in a Slowing World
Rod Hall, CFA AC
(1-415) 315-6713 rod.b.hall@jpmorgan.com
Joseph Park
(1-415) 315-6760 joseph.x.park@jpmorgan.com
Ashwin Kesireddy
(1-415) 315-6756 ashwin.x.kesireddy@jpmorgan.com J.P. Morgan Securities LLC
Rajat Gupta
(91-22) 6157-3347 rajat.gupta@jpmorgan.com J.P. Morgan India Private Limited Ciena Corp. Cisco Systems Corning F5 Networks Infinera Juniper Networks Motorola Mobility QUALCOMM Research in Motion Riverbed Tellabs CIEN CSCO GLW FFIV INFN JNPR MMI QCOM RIMM RVBD TLAB N N UW N UW N N OW N OW UW
Telecom Infrastructure Normally, telecom carriers would be the last to see the effects of a downturn since their customers typically reduce spending on everything else before they get to the telephone. However, we believe European carriers have been reducing capex ahead of the cycle. Of ten large carriers that we track in Europe six were already running below expectations on capex as of Q211 and this trend continued into Q3. Large builds like Sprint and AT&T (LTE) in the U.S. should help to partially offset this European effect but not completely, in our view. This adds up to a tough start to 2012 for equipment manufacturers and then an uncertain H2 given the continued threat of economic slowdown. As a result, we are cautious on most infrastructure names in early 2012 with the exception of Cisco (diversified into data networking). We also believe that optical networking companies like CIEN and INFN may see a pulse of investment with the advent of less-expensive 100G technology beginning in mid-2012. Data Networking We believe data-center virtualization will continue to be a major driver of growth in 2012. However, we see direct data centeroriented companies like FFIV as increasingly predictable in terms of their growth profile and so less attractive from a momentum point of view. We believe that key trends in 2012 will be increased spending on WAN optimization products like those of Riverbed as data centers consolidate. We also see the increasing complexity of various data center management/security/monitoring products as a key opportunity. Handsets We believe that handset demand will shift with the macroeconomy. However, smartphones should continue to become a larger proportion of overall handset demand in 2012. We see this trend as positive for Qualcomms chipset business and potentially also helpful to royalties as smartphones cause a temporary shift upward in overall market ASPs for 3G devices. RIM and Nokia are also making a run at the socalled 3rd OS position though we arent sure there is room for such in the market as Apple and Android continue to power ahead.
Best Idea Riverbed (RVBD)

We continue to like Riverbed (RVBD) against a backdrop of slowing growth. We believe the WAN optimization market which Riverbed leads will continue to experience rapid growth even in a slow economy. We see ongoing data-center consolidation driven by virtualization as the key driver for this growth. We also believe that WANOP benefits from the move of businesses toward cloud-based services and away from owned infrastructure. Both the consolidation trend and the migration to cloud-based services should, if anything, strengthen as companies look for more ways to reduce costs.
Riverbed (RVBD) Overweight Dec 12 Price Target: $29
$26.74 $44.70 $18.33 Dec $0.58 $0.89 $1.26 30.0 21.2 $4,145 Valuation: Target reflects 23x 2012E EPS, 34% premium to SMid-cap peers. Risks: Data-center consolidation does not drive uptake of WAN optimization as expected, macro risks to enterprise spending, increased competition from Cisco.
139
US Year Ahead 2012
Computer Services & IT Consulting

Expecting Better Performance as Regulation Uncertainty Shifts to Execution
Tien-tsin Huang, CFA AC
(1-212) 622-6632 tien-tsin.huang@jpmorgan.com
Reginald L. Smith, CFA

(1-212) 622-6743 reginald.l.smith@jpmorgan.com
Stephanie Davis
(1-212) 622-6591 stephanie.j.davis@jpmorgan.com J.P. Morgan Securities LLC
Tien-tsin Huang, CFA Accenture plc Automatic Data Processing Broadridge Cognizant Computer Sciences ExlService Holdings Inc. FIS Fiserv, Inc. FleetCor Genpact Global Payments Green Dot Heartland Payment Systems MasterCard MoneyGram Paychex Inc VeriFone Visa Inc. Western Union WNS Holdings Ltd. Wright Express Reginald L. Smith, CFA Alliance Data Cardtronics, Inc Puneet Jain Syntel, Inc. Virtusa Corp.
ACN ADP BR CTSH CSC EXLS FIS FISV FLT G GPN GDOT HPY MA MGI PAYX PAY V WU WNS WXS
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The Computer Services and IT Consulting coverage universe encompasses IT consulting, data processing, and payment processing and services companies. The payment processing space is characterized by recurring revenues that are generally insensitive to minor fluctuations in output and consumer spending (due to ongoing secular tailwinds). Payment processing companies have historically been a relative safe haven for investors during times of economic slowdowns or uncertainty, and we believe that theme will hold in 2012, should domestic fiscal policy tighten and growth moderate, as J.P. Morgan Economists predict. Regulation will continue to be the focus for the FinTech names, as financial institutions are likely to seek better economics in the coming year as regulatory pressures impact FI revenue streams. Slower growth and a continuation of elevated unemployment levels will likely be neutral to slightly negative for the HR and payroll providers, with innovation and strong sales execution serving as potential offsets to the tough macro backdrop. Finally, IT services stocks should benefit from a rising stock market, and an improving economic growth outlook throughout 2012. The potential for a mild recession in Europe is a risk but is likely priced in many IT services stocks.
Best Idea MasterCard (MA)

MasterCard (MA) is the number two credit and debit network worldwide and benefits from the ongoing global secular shift towards card-based and electronic payments. MasterCards business is highly defensable and characterized by recurring revenues, high incremental margins, low capital expenditures, and high free cash flow. Amid a backdrop of potentially slowing domestic GDP growth and European uncertainty, we believe MasterCard is the most compelling large-cap growth idea in our payment processing coverage universe due to its 1) reasonable valuation (shares trade in line with our multi-year earnings growth rate) and 2) attractive business model which is both defensive (MA can reduce discretionary operating expenses in the face of slowing volume growth) and offensive (the company benefits from improved consumer confidence and spending). Unlike Visa, MasterCard has limited exposure to debit-card regulation, and recently announced several new processing and issuer wins that provide built-in growth next year.
MasterCard (MA) Overweight Dec 12 Price Target: $435
ADS CATM
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$371.30 $384.99 $215.00 Dec $14.05 $18.58 $21.75 20.0 17.1 $47,628 Target reflects 17x 2013E EPS, in line with our multiyear EPS growth forecast, representing a slight discount to MAs historical PEG ratio. Risks: Material adverse impact from pending debit interchange regulation, unforeseen payment processing regulation in non-U.S. markets, increased competition from alternative payment processing providers, deceleration in GDV growth, increased pricing pressure, major issuer defection, larger-thananticipated legal settlements for pending legal/regulatory cases.
140
US Year Ahead 2012
IT Hardware
Macro Challenges May Worsen, But Apple Offers Partial Buffer to Weather the Storm
Mark Moskowitz AC
(1-415) 315-6704 mark.a.moskowitz@jpmorgan.com
Anthony Luscri
(1-415) 315-6702 anthony.s.luscri@jpmorgan.com
We first called out the increasing risk of macroeconomic pressures in our April 18 Quarterly Crossroads industry report, and we think that the duration and severity of the macroeconomic slowdown could be worse than investors anticipate. In our view, it is this disconnect that could drive many stock valuations lower in the near to midterm. Our view is based on 1) continued macroeconomic uncertainty, 2) our recent CIO survey, and 3) inputs from our primary research contacts. The J.P. Morgan Global Manufacturing PMI declined in November and remains at a depressed level. In our view, the recent reading does not provide a good setup for a year-end IT spending push or for the start to 2012. As austerity measures in the U.S. and EMEA likely usher in more fiscally disciplined spending and government infrastructure decreases, we expect all industry verticals, including technology, to be negatively affected in the next 12 months. We expect this dynamic to be compounded by any moderation in growth out of Asia-Pacific, especially China. Similarly, the J.P. Morgan CIO Survey published on September 29 pointed to tough times ahead. Spending cuts have begun, and the items that stand to be affected the most in a protracted downturn include hardware and services. Our latest research indicates that CIO budgets remain under pressure, including high-priority items, which points to a tepid spending environment exiting 2011. As a result, we prefer market share gainers, such as Apple, that stand to post above-peer revenue and earnings growth in spite of challenging times.
Mike Kim
(1-415) 315-6755 mike.j.kim@jpmorgan.com J.P. Morgan Securities LLC Mark Moskowitz Aeroflex Apple Inc. Brocade Dell Inc. EMC Emulex Corp. Fusion-io Hewlett-Packard IBM Lexmark International NetApp Orbotech QLogic Corporation Seagate Technology STEC Western Digital Xerox Corporation Anthony Luscri National Instruments
ARX AAPL BRCD DELL EMC ELX FIO HPQ IBM LXK NTAP ORBK QLGC STX STEC WDC XRX
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Best Idea Apple (AAPL)

Overweight-rated Apple (AAPL) remains one of our top picks in IT Hardware. We recommend that investors take advantage of the recent cooling-off period in the stock. Apple navigated the prior global downturn in 2008-09 better than most tech companies, and we think that Apples current model is even stronger. Breakout revenue growth, upward-trending margins, and incremental market penetration opportunities are offsets at Apple that most tech companies do not possess. Our current estimates point to above-peer revenue and earnings growth, despite current macroeconomic challenges and a large revenue base. Key drivers include increasing sales momentum for iPhone and iPad, as well as sustainable market penetration with the Mac, particularly MacBook Air. Geographically, Asia and Latin America also offer significant, multi-year growth opportunities. Add in iTunes and iCloud, and we think that Apples digital way of life underpins a formidable moat to fend off competitive and economic challenges. In our view, Apple is trading as a value stock and not as the high-growth story in large-cap equities. At 10.9x our C2012 EPS estimate, Apple is trading well below its three-year average of 16.2x.Our Dec-12 price target of $525 implies 34% upside from current levels. Apple is the only stock in our coverage list for which we expect both revenue and EPS estimates to have upside potential in the next 6-12 months.
Apple (AAPL) Overweight Dec 12 Price Target: $525
NATI
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$390.95 $426.70 $310.50 Sep $27.68 $35.17 $39.53 11.1 9.9 $363,353 Valuation: Target reflects a weighted blend of EV/EBITDA and P/E scenarios utilizing historical peak/trough multiples. Risks: Incremental macroe weakness or slowing expansion, disruption in competitive dynamics, gross margin pressure, slower rate of new product refreshes.
141
US Year Ahead 2012
Semiconductor Capital Equipment

Look for Fundamentals to Trough in C1Q12; Its Time to Load Up for the Next Cycle
We believe C1Q12 will be the fundamental trough quarter for the SemiCap sector and expect fundamentals to improve throughout the remainder of the year. We think its the right time in the cycle to get long SemiCap stocks. We expect C12 Wafer Fab Equipment (WFE) spending to return to C10 levels, likely troughing in C1Q12. Overall, for the year we estimate semi capex will decline 15-20% from C11 levels. With weaker macro demand as a backdrop, Foundry and Intel capex should decline meaningfully in C12 after a relatively large spend in C11. We expect NAND capex to be flat to modestly down given secular growth in end demand, and DRAM capex, which has been weak for a number of quarters, to remain relatively flat at low levels. Overall, we expect Foundry capex will decline the most of all segments y/y as factory utilization rates remain low exiting C11. That being said, SemiCap stocks generally discount fundamentals 3-6 months ahead and we think it is the right time in the cycle to take long positions in the sector. As it becomes more apparent that semi fundamentals have troughed in C4Q11/C1Q12, we believe investors will get more positive on the outlook for semi capex and SemiCap stocks.
William Peterson
(1-415) 315-6711 william.c.peterson@jpmorgan.com J.P. Morgan Securities LLC Applied Materials, Inc. KLA-Tencor Lam Research MEMC Electronic Materials Novellus Systems Photronics Veeco Instruments AMAT KLAC LRCX WFR NVLS PLAB VECO N N OW UW OW N OW
Best Idea Lam Research (LRCX)

Our top pick in Semiconductor Capital Equipment is Lam Research (LRCX) with its higher-than-average exposure to memory which we expect to outperform in terms of capex in 2012. Lam Research is poised to capitalize on share gain momentum in its core Etch equipment business as well as benefit from Single Wafer Wet and Bevel Clean, two equipment segments that are relatively small but have significantly outgrown the WFE market over the past ten years. In addition, with over $2bn in cash and short-term investments, Lam Research has been very vocal in regards to share repurchase; as of the end of C3Q11, LRCX had $575mn set aside for this activity. We expect aggressive share repurchase would increase EPS meaningfully in C12. Our Dec-12 price target of $56.00 for LRCX is based on 3.0x our C12 revenue estimate of $2.4bn. We believe 3.0x represents a forward-looking, cross-cycle average P/S multiple for LRCX. At this time, LRCX is trading at 2.2x our C12 revenue estimate.
Lam Research (LRCX) Overweight Dec 12 Price Target: $56
$42.86 $59.10 $34.92 Jun $5.86 $1.54 N/A 27.8 N/A $5,124 Risks: Protracted semi capex down cycle exacerbated by weak consumer demand, high exposure to Foundry & Memory and high level of volatility in memory pricing and associated capital spending of these customers, increased competition in Clean.
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Semiconductors
Semiconductor Fundamentals Bottoming, Driving Upside in 2012: Hop in the Minivan!
Chris Danely AC
(1-415) 315-6774 chris.b.danely@jpmorgan.com
Shaon Baqui
(1-415) 315-6766 shaon.i.baqui@jpmorgan.com
Venk Nathamuni
(1-415) 315-6783 venkatesh.r.nathamuni@jpmorgan.com J.P. Morgan Securities LLC Christopher Danely Advanced Micro Devices Altera Analog Devices Avago Technologies Cypress Semiconductor Intel Linear Technology Maxim Integrated Products Microchip Technology ON Semiconductor Corporation RF Micro Devices Texas Instruments Xilinx Venk Nathamuni Fairchild Semiconductor Intersil Corporation
As we approach 2012, we continue to see evidence of a bottom in semiconductor fundamentals, as multiple semiconductor companies and distributors have indicated orders remain stable and book-to-bill for 1Q12 appears to be close to parity. We believe we are in Phase II of the semiconductor upturn as companies have stopped lowering estimates, and we expect upside to Consensus estimates in 1Q12 as orders and fundamentals improve. As a result, we reiterate our positive stance on the sector and continue to recommend buying stocks ahead of the recovery. Phase I of the Upturn: Stabilizing ordersalready happened. Multiple semiconductor companies and distributors such as Intel, Texas Instruments, Microchip, ON Semi, Arrow, and Avnet have recently stated order rates continue to be stable, as they have been over the previous six weeks. Avnet stated its book-to-bill for 1Q12 is approaching parity, the first time in almost a year. Phase II: Companies stop lowering estimateshappening now. We believe we are now in Phase II of the upturnsemiconductor companies stop lowering estimates. We expect this to continue through the end of the year. Phase III: Orders improveexpected early 1Q12. We believe Phase III of the upturn will occur when several semiconductor companies report improving order rates as demand stabilizes and inventory needs to be replenished. Phase IV: Estimates start to move uplikely late 1Q12. We believe Phase IV of the upturn will be when semiconductor companies raise expectations on the back of a continued improvement in order rates. We expect Consensus estimates to rise in late 1Q12 as semiconductor companies raise guidance. Semis under-shipping end demand by at least 10%. The SIA data combined with 4Q11 guidance indicate semiconductor units should decline 6% during 2H11, far below the 5% unit growth for PCs and 8% unit growth for handsets. We believe this is hard evidence that semiconductors are under-shipping end demand, and should lead to a bounce in order rates during 1Q12 due to inventory replenishment. Same thing happened during last upturn in 2009. During the previous upturn in 2009, INTC and TXN orders stabilized in late 4Q08. In early 1Q09 both INTC and TXN lowered guidance, but neither stock traded down, and in late 1Q09 both companies orders improved. Subsequently, INTC and TXN raised guidance in 2Q09 on stronger demand and Consensus estimates rose.
AMD ALTR ADI AVGO CY INTC LLTC MXIM MCHP ONNN RFMD TXN XLNX
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Best Idea Texas Instruments (TXN)

Texas Instruments (TXN) is our top pick due to a bottom in fundamentals and upside potential to Consensus estimates throughout 2012. We also expect roughly 10% EPS accretion in C12 from its recent acquisition of National Semiconductor.
Texas Instruments (TXN) Overweight Dec 12 Price Target: $33*
$30.42 $36.71 $24.34 Dec $2.63 $1.83 $1.75 16.6 17.4 $34,759 * Target and estimates as of December 9, 2011. Valuation: Target reflects average of P/S and P/E based on historical trends. Risks: Sudden economic decline in a particular country or geographic region, weaker-than-expected global economic recovery.
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SMid Semiconductors
Signs of Bottoming in Demand and Market Segment Recovery Set Up a Positive 2012
Harlan Sur AC
(1-415) 315-6700 harlan.sur@jpmorgan.com
John S. Ahn
(1-415) 315-6758 john.s.ahn@jpmorgan.com
Despite some near-term challenges for our universe of SMid semiconductor companies, we believe that the same market segments (comm. infrastructure, enterprise server/storage, smartphones/tablets) that drove strong growth over the past couple of years will continue to provide attractive expansion opportunities in 2012, particularly for product cycledriven stocks like BRCM and CAVM. Looking back on 2011, the global macroeconomic uncertainty has resulted in pushouts of wireless infrastructure projects by carriers as well as more conservative deployment of enterprise IT capex by corporations. Also, the recent flooding in Thailand has placed a severe constraint on near-term HDD growth. However, we believe the market has already baked in these developments and is discounting a larger-than-warranted impact to 2012 revenues and earnings, setting the stage for a move up in SMid semi stocks. As 2011 draws to a close, we see positive indications that SMid semi companies could see a modest recovery in 1H12 and a stronger snapback in 2H12. In particular, commentary from several semi companies and distributors (CAVM, MRVL, TXN, FCS, MCHP, ARW) during the last earnings season suggests a bottoming in order rates and a return to more normal patterns. In terms of market segments, carriers likely will have better clarity regarding wireless network requirements in the New Year and should resume 3G and 4G network deployments in earnest during 1H. We also believe that IT spending will recover in 2012 as corporations take stock of the increasing demand on data processing/storage infrastructure. As for HDDs, we anticipate a modest recovery through the 1H, as getting capacity back online will likely be a protracted process lasting several quarters. We believe the 2H will exhibit a larger snapback in HDD shipments, given the pent-up demand over the course of the manufacturing recovery. The one market vertical that bucked the trend and remained strong through the macro sluggishness was smartphones/tablets, and we believe that it will continue to drive robust growth in 2012.
Saqib Jalil
(1-415) 315-6761 saqib.jalil@jpmorgan.com J.P. Morgan Securities LLC Broadcom Corporation Cavium Networks Entropic Communications Freescale Semiconductor LSI Corporation Marvell Technology Group Mellanox Technologies Micron Technology NVIDIA Corporation NXP Semiconductors PMC-Sierra SanDisk Corp BRCM CAVM ENTR FSL LSI MRVL MLNX MU NVDA NXPI PMCS SNDK OW OW N OW N OW N N N N N N
Best Idea Broadcom Corporation (BRCM)

Broadcom Corporation (BRCM) has a solid track record of significantly outgrowing the overall semiconductor market. Over the last five years, BRCMs revenues have grown 15% per year while the semi industry has grown only 4% per year, and BRCMs earnings have grown by 16% per year over the same period. In 2011, we estimate BRCMs revenues will grow nearly 8% compared to forecast growth of 1% for overall semi revenues by J.P. Morgans Large-Cap Semiconductor analyst, Chris Danely. We believe BRCM continues to exhibit solid fundamentals that will enable it to keep outperforming the market for the foreseeable future. In 2012, we anticipate the company will experience multiple new customer program ramps utilizing its combo connectivity, Ethernet controller and switch, microwave backhaul, and settop-box solutions.
Broadcom Corporation (BRCM) Overweight Dec 12 Price Target: $45
$30.10 $46.89 $29.17 Dec $2.70 $2.84 $2.80 10.6 10.8 $16,224 Valuation: Target reflects 13.5x run-rate 2H12E non-GAAP EPS, consistent with estimated 12-15% revenue and earnings growth for the foreseeable future. Risks: Ultra-competitive environment in WLAN & combo solutions, slower or delayed Nokia & Samsung 2.5G & 3G ramp. 144
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Software
Likely to Get Worse Before It Gets Better
John DiFucci AC
(1-212) 622-2341 john.s.difucci@jpmorgan.com
Darren Jue
(1-212) 622-4071 darren.r.jue@jpmorgan.com
Sandeep Madhur
(1-212) 622-6516 sandeep.madhur@jpmorgan.com
We agree with our economists view of the U.S. economy, but have a more pessimistic view of what the fallout of European, U.S. Federal government, and potential Financial Services weakness will mean for IT spending worldwide. While we agree with our strategists anticipation of a volatile 2012, we believe deep global macro forces will hamper progress. Therefore, we believe investors should position defensively to offset any potential downward market forces. This likely will dilute constructive moves, but in our view is worth the cost in such an uncertain time. We believe that almost half of worldwide IT and Software spending will see a net negative impact due to pressure from these macro forces, as we estimate that European governments account for 10-15%, the U.S. government for about 10%, and Financial Services (including Insurance) for about 20% of worldwide IT and Software spending. We have written extensively on this subject, with the most recent note, As Nero Fiddled . . . published October 24.
Kenneth R Talanian Jr.

(1-212) 622-1303 kenneth.r.talanian@jpmorgan.com
Marc P Griffin
(1-212) 622-5615 marc.p.griffin@jpmorgan.com J.P. Morgan Securities LLC BMC Software, Inc. CA Technologies Carbonite Inc. Citrix Systems, Inc. LogMeIn Microsoft Oracle Corp. PROS Holdings Qlik Technologies Inc. Quest Software Red Hat Inc salesforce.com SolarWinds Symantec Taleo TIBCO Software Inc VMware BMC CA CARB CTXS LOGM MSFT ORCL PRO QLIK QSFT RHT CRM SWI SYMC TLEO TIBX VMW UW OW OW UW OW N OW N OW OW UW N OW OW OW OW N
Best Ideas Avoid Citrix Systems, Inc. (CTXS)/Red Hat Inc (RHT)
In this context, our best ideas are to underweight CTXS and RHT. For CTXS, we believe the opportunity for Desktop Virtualization is much more cannibalistic than incremental, and is unlikely to be adopted by the masses of corporations given such an elusive ROI. In addition, some highly regulated industries that are most likely to adopt Desktop Virtualization for security, compliance, and control reasons are likely to see incremental pressure (Government, Financial Services, and Health Care). We believe RHT is misunderstood by investors, as the real business momentum of the company is exaggerated with a simple calculation of billings proxy. An annualized billings analysis is more appropriate, in our view. In addition, we believe Red Hat will not see leverage in the most important expense line of a software companySales & Marketingsince it has to pay its sales force high commissions on subscription renewals. For investors that are more optimistic on the market, we like Overweight-rated ORCL. ORCL is likely to experience a positive secular trend of its own making related to its Exadata product line. See our note, All That Remains Is . . . Exacution dated November 17.
Citrix Systems, Inc. (CTXS) Underweight Dec 12 Price Target: $53
$73.23 $88.49 $50.21 Dec $2.08 $2.46 $2.63 29.8 27.8 $13,657 Valuation: Target reflects DCF analysis incorporating our Base Case scenario for XenDesktop revenue. Risks: Embedded XenDesktop functionality could spur upgrade cycle, customers moving to reduce dependence on VMware, leverage to economic recovery.
Red Hat Inc (RHT) Underweight Dec 12 Price Target: $32*

$50.55 $53.42 $31.77 Feb $0.83 $1.05 $1.11 48.1 45.5 $9,748 * Target as of December 9, 2011. Valuation: Target reflects DCF scenario analysis. Risks: Emerging as one of a few server virtualization players, stops paying sales commission on subscription renewals, share gains in Linux market.
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Software Technology
Waiting for Macro Clarity So Investors Can Focus on Company Fundamentals
Sterling Auty, CFA AC
(1-212) 622-6389 sterling.auty@jpmorgan.com
Lauren Choi
(1-212) 622-6102 lauren.choi@jpmorgan.com
Saket Kalia, CFA

(1-212) 622-6477 saket.kalia@jpmorgan.com J.P. Morgan Securities LLC Sterling Auty, CFA Advent Software Akamai Technologies, Inc. Amdocs ANSYS, Inc. Aspen Technology Autodesk Blackbaud Inc Cadence Design Systems Check Point Software Comverse Technology CSG Systems Equinix Fortinet, Inc Intuit Motricity, Inc Neustar Parametric Technology Corp. Rovi SS&C Technologies Synopsys Inc VeriSign Websense Lauren Choi Ariba, Inc Synchronoss Technologies Saket Kalia, CFA Mentor Graphics Monotype Imaging
ADVS AKAM DOX ANSS AZPN ADSK BLKB CDNS CHKP CMVT CSGS EQIX FTNT INTU MOTR NSR PMTC ROVI SSNC SNPS VRSN WBSN
UW N N N OW OW N OW N N N OW N OW OW N OW OW OW OW N UW
After a very big 2010 when our software technology coverage outperformed the market by almost a factor of three times, 2011 has been almost a mirror image of the overall market with performance roughly flat year to date vs. the S&P 500 up 0.1% year to date. Looking to 2012, it appears that at least the first part will be much more about the macro backdrop than company fundamentals in terms of stock price performance, because if investors are highly confident in forward estimates we would expect share prices to be much higher than current levels. For those that believe a resolution of the European financial and economic situation can be achieved in the near term, we would point to high-quality cyclical names like Autodesk and Rovi. But for investors that are in the camp of believing another potential economic meltdown is imminent our most defensive name remains Neustar. For our favorite pick we are going with a stock we believe offers considerable upside in more favorable economic times, but provides some stability with its recurring revenue during choppy environments.
Best Idea Equinix (EQIX)

Sometimes having your head in the cloud is a good thing Equinix (EQIX) has established itself as the clear leader in the collocation segment of the data-center industry, and with several large trends providing a tailwind to growth, a stable recurring revenue model, and high margins, we believe this makes for an attractive investment opportunity. Our expectation for the data-center industry, which we currently estimate at $12bn of annual revenue, is growth of 15-20% for the next five years. Within that, we expect Equinix to continue to be the number one provider of collocation, one of the three main segments in the data-center industry. Demand for Equinix data-center solutions is being spurred by several large trends including enterprises moving more solutions to both private and public clouds and users digesting more content over the Internet given the rapidly increasing use of mobile devices like smartphones for Internet access (mobile data). Roughly 95% of revenue is recurring in nature and there is only approximately 8% customer churn each year; combine this with 45%+ EBITDA margins and this is a very attractive business model with high visibility and cash flow generation. Our Dec-12 price target of $120 is based on an EV/EBITDA multiple of 8.9x versus the average of 9.8x for the last three years.
Equinix (EQIX) Overweight Dec 12 Price Target: $120
ARBA SNCR
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MENT TYPE
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$102.48 $107.00 $78.78 Dec $2.78 $2.98 $3.48 34.4 29.4 $4,859 Risks: More customers opting for in-house or generic wholesale data-center capacity, recurring revenue leveling out, capital-intensity of business could have some expansion drag on incremental margin.
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Technology Supply Chain

We Favor Jabils Clear Growth and Margin Improvement Plan Amid the Uncertain Macro
Steven OBrien AC
(1-212) 622-6554 steven.obrien@jpmorgan.com J.P. Morgan Securities LLC Amphenol Fabrinet Flextronics General Cable Jabil Circuit Mitel Networks Molex Powerwave Technologies ShoreTel TE Connectivity APH FN FLEX BGC JBL MITL MOLX PWAV SHOR TEL N OW OW N OW N N N OW (rs)
We believe the EMS industry may be underappreciated with near-trough valuations over fears of a cyclical downturn and concerns aggressive competition could arise as new business pipelines slow. However, we expect EMS to see a growing addressable market driven by increased outsourcing from nontraditional sources such as the medical, industrial, and energy industries. We believe a weak macro environment could provide incentive for OEMs in these industries to move to variable cost structures and capture manufacturing and procurement savings. Also, we do not expect EMS competitors to chase growth via price as high margins and ROIC, not growth, are rewarded with premium valuations. Hence, we believe an investment strategy based on timing cyclical upturns may forego a compelling opportunity at current attractive valuations. We recognize that moderately high inventory levels for communications and networking, from which EMS companies still derive the majority of revenues (although not necessarily profits), could have a dampening effect during 1H12. But we see a trend toward supply chain consolidation in these industries benefiting larger EMS companies, such as Jabil Circuit and Flextronics. We expect electronic connector demand to reflect global GDP plus a small margin derived from content growth. While admittedly not exciting from a growth perspective, we believe connectors could be relatively stable during an uncertain 2012 due to diverse geographic revenue streams, low customer concentration risks, declining materials costs, and an early move toward supply chain inventory reduction which began in June. However, we remain concerned with Amphenols ~18% exposure to defense and Molexs 19% exposure to consumer electronics. We maintain our cautious view toward General Cable due to its 30% exposure to Europe and North Africa. A first-half 2012 recession could depress both demand and prices. We estimate nearly 75% of General Cables business is tied directly or indirectly to construction spending which may be finally nearing a bottom. While enterprise voice vendors VoIP call control systems provide compelling value through efficiency improvement and expense savings, we continue to believe rising employment is the primary catalyst for system upgrades. Hence, with J.P. Morgans expectation for elevated unemployment levels in 2012, ShoreTel and Mitel could face a challenging year. The government and education verticals represent over 10% of industry demand and tightening public sector spending may also be a headwind.
Best Idea Jabil Circuit (JBL)

We continue to believe Jabil Circuit (JBL) is positioned to deliver multi-year margin improvement while outgrowing peers. We expect above-peer growth to be driven by the burgeoning materials business, the after-market services business, as well as the increasing opportunities from industrial, medical, and cleantech industries where outsourced manufacturing penetration is low. These growth opportunities now represent 40% of JBLs revenue and carry margins substantially above the corporate average. Despite having a clear revenue growth and margin improvement strategy and delivering consistent results, Jabil trades at a discount to peers.
Jabil Circuit (JBL) Overweight Dec 12 Price Target: $22
Price 12/6/2011 52-wk range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.)
$20.86 $23.09 $13.94 Aug $2.34 $2.55 $2.83 8.2 7.4 $4,343 Valuation: Target reflects peer average 4.5x EV/EBITDA on 2012E. Risks: Slowing product demand resulting in fewer new outsourced manufacturing projects, OEMs choosing to manufacture more products in house. 147
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Stock Ratings and Prices of Companies Discussed in This Report

Ratings and prices for analysts second half best ideas appear on the corresponding sector page. Stock prices and ratings are as of the close on December 6, 2011.
Company Name Autodesk AK Steel Altera Alexion Pharmaceuticals Amylin Pharmaceuticals Amazon.com Air Products and Chemicals Amphenol Apollo Group Ashland Inc. athenahealth General Cable Progressive Waste Solutions Ltd. BioMarin Pharmaceuticals Cavium Networks Cerner Corp Ciena Corp. Comerica Incorporated Cisco Systems CSX Cooper Tire & Rubber Dendreon Dow Chemical Ecolab Inc. Equifax Estee Lauder Endo Pharmaceuticals EOG Resources, Inc. El Paso Corp. Experian plc Ford Motor Company FedEx Corp F5 Networks Flextronics Fluor Corp FirstMerit Corporation First Republic Forest Laboratories, Inc FXCM Gilead Sciences General Motors Goodyear Tire & Rubber Harman International Hess Human Genome Sciences Hospira, Inc. Hub Group Ticker ADSK AKS ALTR ALXN AMLN AMZN APD APH APOL ASH ATHN BGC BIN BMRN CAVM CERN CIEN CMA CSCO CSX CTB DNDN DOW ECL EFX EL ENDP EOG EP EXPN.L F FDX FFIV FLEX FLR FMER FRC FRX FXCM GILD GM GT HAR HES HGSI HSP HUBG Rating OW OW N OW N OW OW N OW OW UW N OW OW OW OW N OW N OW OW OW OW OW OW N OW OW OW OW N OW N OW OW OW OW OW OW OW OW OW OW OW OW OW OW Price $34.78 $8.68 $36.84 $65.05 $10.79 $191.99 $82.82 $45.50 $50.14 $57.11 $61.00 $26.73 $20.38 $33.59 $32.46 $61.06 $11.50 $25.89 $18.73 $21.83 $13.77 $8.66 $28.05 $55.58 $37.75 $112.22 $33.99 $104.89 $25.13 GBp834 $11.05 $82.67 $114.32 $5.98 $54.64 $14.49 $29.15 $30.05 $10.44 $39.80 $21.68 $14.27 $40.68 $60.42 $7.34 $28.14 $31.24 Company Name The Intercontinental Exchange International Flavors & Fragrances Incyte Corporation Infinera Intel Gartner Inc. J.B. Hunt Transport Services, Inc. J.C. Penney Co., Inc. Jacobs Engineering John Wiley & Sons Nordstrom, Inc. KeyCorp Kraft Foods Kinder Morgan Energy Partners L.P. Coca-Cola Co. Kohl's Corp. LyondellBasell Industries ManpowerGroup Microchip Technology Allscripts Healthcare Solutions The McGraw-Hill Companies Mitel Networks Martin Marietta Materials Motorola Mobility Molex Merck & Co., Inc. Marvell Technology Group Medicis Pharmaceutical Corp. Arcelor Mittal Noble Energy Nokia ADR Norfolk Southern Neustar Nu Skin Enterprises ON Semiconductor Corporation Oracle Corp. Philip Morris International PrivateBancorp, Inc. QUALCOMM Quality Systems Research in Motion Rock-Tenn Rovi Republic Services Inc Sprint Nextel Signature Bank Seattle Genetics Ticker ICE IFF INCY INFN INTC IT JBHT JCP JEC JWa JWN KEY KFT KMP KO KSS LYB MAN MCHP MDRX MHP MITL MLM MMI MOLX MRK MRVL MRX MT NBL NOK NSC NSR NUS ONNN ORCL PM PVTB QCOM QSII RIMM RKT ROVI RSG S SBNY SGEN Rating OW OW OW UW OW OW OW OW OW OW N OW N N N UW OW OW N OW OW N OW N N OW OW OW OW OW UW OW N OW OW OW N OW OW OW N OW OW OW N OW N Price $123.28 $54.02 $13.50 $7.01 $25.35 $37.20 $45.53 $33.30 $42.61 $47.48 $47.36 $7.33 $36.51 $78.72 $66.68 $50.73 $33.70 $37.77 $34.90 $19.36 $42.75 $3.13 $75.84 $38.85 $24.72 $35.40 $14.10 $33.50 $19.30 $98.38 $5.41 $74.86 $33.66 $49.15 $8.20 $31.73 $75.58 $9.76 $54.83 $36.63 $17.03 $57.06 $27.06 $27.15 $2.61 $59.36 $17.20
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Company Name ShoreTel SVB Financial Saks, Inc. Sara Lee Solera Holdings Stericycle Inc. Strayer Education Swift Transportation AT&T Teva Pharmaceuticals Tesla Motors Tupperware Brands United Parcel Service U.S. Bancorp Visa Inc. Varian Medical
Ticker SHOR SIVB SKS SLE SLH SRCL STRA SWFT T TEVA TSLA TUP UPS USB V VAR
Rating OW OW N OW OW N OW OW (rs) OW OW OW OW OW OW N
Price $6.10 $46.96 $9.73 $18.94 $45.90 $80.24 $98.73 $9.36 $29.17 $40.05 $34.87 $56.23 $71.80 $26.21 $95.37 $64.43
Company Name Vulcan Materials ViroPharma Incorporated Pharmasset Valeant Pharmaceuticals Verizon Communications Warner Chilcott Werner Enterprises Wells Fargo Whole Foods Market Westlake Chemical Corp. Waste Management Watson Pharmaceuticals U.S. Steel Corp Yum Brands Zions Bancorporation
Ticker VMC VPHM VRUS VRX VZ WCRX WERN WFC WFM WLK WM WPI X YUM ZION
Rating N OW N OW N OW OW OW N OW N OW OW OW OW
Price $33.90 $23.59 $128.13 $46.56 $38.32 $16.35 $24.27 $26.65 $69.83 $42.63 $31.61 $62.39 $28.27 $57.33 $16.32
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Disclosures
Disclosures A portion of this report is a product of the research department's Global Equity Derivatives and Delta One Strategy group. Views expressed may differ from the views of the research analysts covering stocks or sectors mentioned in this report. Structured securities, options, futures and other derivatives are complex instruments, may involve a high degree of risk, and may be appropriate investments only for sophisticated investors who are capable of understanding and assuming the risks involved. Because of the importance of tax considerations to many option transactions, the investor considering options should consult with his/her tax advisor as to how taxes affect the outcome of contemplated option transactions. 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
MSCI: The MSCI sourced information is the exclusive property of Morgan Stanley Capital International Inc. (MSCI). Without prior written permission of MSCI, this information and any other MSCI intellectual property may not be reproduced, redisseminated or used to create any financial products, including any indices. This information is provided on an 'as is' basis. The user assumes the entire risk of any use made of this information. MSCI, its affiliates and any third party involved in, or related to, computing or compiling the information hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of this information. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in, or related to, computing or compiling the information have any liability for any damages of any kind. MSCI, Morgan Stanley Capital International and the MSCI indexes are services marks of MSCI and its affiliates.
Risks associated with Leveraged and Inverse ETFs: Leveraged ETFs seek to provide a multiple of the investment returns of a given index or benchmark on a daily basis. Inverse ETFs seek to provide the opposite, or multiple times the opposite, of the daily returns, of an underlying index or benchmark. Leveraged and inverse ETFs usually reset daily and track their intended indices on a daily basis, but may fail to correlate over longer periods. Due to the effects of compounding and possible correlation errors, leveraged and inverse ETFs may experience greater losses than expected. Compounding can also cause a widening differential between the performance of an ETF and its underlying index or benchmark so that returns over periods longer than one day can differ in amount and direction from the target return of the same period. Consequently, these ETFs may experience losses even in situations where the underlying index or benchmark has performed as expected. Leveraged and inverse ETFs use aggressive investment techniques such as futures, forward contracts, swap agreements, derivatives and options that may increase ETF volatility and may cause a drag on performance. Investors holding these ETFs should therefore monitor their positions frequently -- i.e., in most cases, daily -- to look for possible divergences. Leveraged and inverse ETFs may not be suitable for all investors and should be used only by knowledgeable investors who understand the potential consequences of their strategies, including seeking daily leverage or daily inverse leveraged investment results. The Financial Industry Regulatory Authority has indicated that, in its view, inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets. Accordingly, prior to investing in these instruments, all potential investors and, particularly, retail investors, should evaluate whether the instruments are suitable for them in light of their risk tolerance and investment horizon, carefully read the prospectus and consult with a financial professional as needed. INVESTORS SHOULD NOT INVEST IN THESE INSTRUMENTS UNLESS THEY FULLY UNDERSTAND AND HAVE EVALUATED THE RISKS AND HAVE, INDEPENDENTLY OF JPM, DETERMINED THAT THE INVESTMENT IS SUITABLE FOR THEM.
Important Disclosures for Equity Research Compendium Reports: Important disclosures, including price charts for all companies under coverage for at least one year, are available through the search function on J.P. Morgans website https://mm.jpmorgan.com/disclosures.jsp or by calling this U.S. toll-free number (1-800-477-0406). 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.] In our Asia (ex-Australia) and UK small- and mid-cap equity research, each stocks expected total return is compared to the expected total return of a benchmark country market index, not to those analysts coverage universe. If it does not appear in the Important Disclosures section of this report, the certifying analysts coverage universe can be found on J.P. Morgans research website, www.morganmarkets.com.
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J.P. Morgan Equity Research Ratings Distribution, as of September 30, 2011

J.P. Morgan Global Equity Research Coverage IB clients* JPMS Equity Research Coverage IB clients* Overweight (buy) 47% 51% 45% 70% Neutral (hold) 42% 44% 47% 60% Underweight (sell) 11% 33% 7% 52%
*Percentage of investment banking clients in each rating category. For purposes only of FINRA/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.
Equity Valuation and Risks: For valuation methodology and risks associated with covered companies or price targets for covered companies, please see the most recent company-specific research report at http://www.morganmarkets.com , contact the primary analyst or your J.P. Morgan representative, or email research.disclosure.inquiries@jpmorgan.com . Equity 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. Registration of non-US Analysts: Unless otherwise noted, the non-US analysts listed on the front of this report are employees of non-US affiliates of JPMS, are not registered/qualified as research analysts under NASD/NYSE rules, may not be associated persons of JPMS, and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account.
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Equity Research Americas

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Lee, CFA Bhupinder Singh Michael Krauss Dubravko Lakos-Bujas Dane Mott, CPA Marko Kolanovic Joseph B. Nadol III Thomas R. Wadewitz C. Stephen Tusa, Jr., CFA Scott Levine Ann Duignan Jamie Baker Himanshu Patel, CFA Kenneth Goldman Joseph Greff Michael Rehaut, CFA John Faucher John Ivankoe Matthew R. Boss, CPA Christopher Horvers, CFA Brian J. Tunick Andrew Smith Jeremy Tonet Joseph Allman, CFA David Anderson, PE, CFA Katherine Lucas Minyard Kenneth B. Worthington, CFA Vivek Juneja Steven Alexopoulos, CFA Jimmy S. Bhullar, CFA Matthew G. Heimermann Michael W. Mueller, CFA Anthony Paolone, CFA Richard Shane Geoffrey Meacham Cory Kasimov Atif Rahim Lisa C. Gill Tycho W. Peterson John Rex Michael Weinstein Chris Schott, CFA Jeffrey J. Zekauskas John Bridges CFA, ACSM Michael F. Gambardella Phil Gresh Michael Meltz, CFA Doug Anmuth Alexia Quadrani Philip Cusick Christopher Blansett Paul Coster, CFA Andrew Steinerman Rod Hall, CFA Tien-Tsin Huang, CFA Mark Moskowitz Christopher Danely Harlan Sur John DiFucci Sterling Auty, CFA Steven J. O'Brien (1-212) 622-6505 (1-212) 622-6406 (1-212) 834-5103 (1-212) 622-3601 (1-415) 315-5905 (1-212) 272-1438 (1-212) 622-6548 (1-212) 622-6461 (1-212) 622-6623 (1-212) 622-5609 (1-212) 622-0381 (1-212) 622-6713 (1-212) 622-3906 (1-212) 622-0359 (1-212) 622-0548 (1-212) 622-6696 (1-212) 622-6443 (1-212) 622-6487 (1-212) 622-5260 (1-212) 622-1316 (1-212) 622-6449 (1-713) 216-7681 (1-212) 622-4915 (1-212) 622-4864 (1-212) 622-6684 (1-212) 622-6402 (1-212) 622-6613 (1-212) 622-6465 (1-212) 622-6041 (1-212) 622-6397 (1-212) 622-6545 (1-212) 622-6689 (1-212) 622-6682 (1-415) 315-6701 (1-212) 622-6531 (1-212) 622-5266 (1-212) 622-6671 (1-212) 622-6466 (1-212) 622-6568 (1-212) 622-6600 (1-212) 622-6635 (1-212) 622-5676 (1-212) 622-6644 (1-212) 622-6430 (1-212) 622-6446 (1-212) 622-4861 (1-212) 622-0416 (1-212) 622-6571 (1-212) 622-1896 (1-212) 622-1444 (1-415) 315-6708 (1-212) 622-6425 (1-212) 622-2527 (1-415) 315-6713 (1-212) 622-6632 (1-415) 315-6704 (1-415) 315-6774 (1-415) 315-6700 (1-212) 622-2341 (1-212) 622-6389 (1-212) 622-6554 thomas.lee@jpmorgan.com bhupinder.b.singh@jpmorgan.com michael.krauss@jpmorgan.com dubravko.lakos-bujas@jpmorgan.com dane.mott@jpmorgan.com mkolanovic@jpmorgan.com joseph.nadol@jpmorgan.com thomas.r.wadewitz@jpmorgan.com stephen.tusa@jpmorgan.com scott.j.levine@jpmorgan.com ann.duignan@jpmorgan.com jamie.baker@jpmorgan.com himanshu.patel@jpmorgan.com ken.goldman@jpmorgan.com joseph.greff@jpmorgan.com michael.rehaut@jpmorgan.com john.faucher@jpmorgan.com john.ivankoe@jpmorgan.com matthew.boss@jpmorgan.com christopher.horvers@jpmorgan.com brian.tunick@jpmorgan.com andrew.l.smith@jpmorgan.com jeremy.b.tonet@jpmorgan.com joseph.d.allman@jpmorgan.com jdavid.anderson@jpmorgan.com katherine.l.minyard@jpmorgan.com kenneth.b.worthington@jpmorgan.com vivek.juneja@jpmorgan.com steven.a.alexopoulos@jpmorgan.com jimmy.s.bhullar@jpmorgan.com matthew.g.heimermann@jpmorgan.com michael.w.mueller@jpmorgan.com anthony.paolone@jpmorgan.com richard.b.shane@jpmorgan.com geoffrey.c.meacham@jpmorgan.com cory.w.kasimov@jpmorgan.com atif.a.rahim@jpmorgan.com lisa.c.gill@jpmorgan.com tycho.peterson@jpmorgan.com john.rex@jpmorgan.com mike.weinstein@jpmorgan.com christopher.t.schott@jpmorgan.com jeffrey.zekauskas@jpmorgan.com john.bridges@jpmorgan.com michael.gambardella@jpmorgan.com phil.m.gresh@jpmorgan.com michael.meltz@jpmorgan.com douglas.anmuth@jpmorgan.com alexia.quadrani@jpmorgan.com philip.cusick@jpmorgan.com christopher.r.blansett@jpmorgan.com paul.coster@jpmorgan.com andrew.steinerman@jpmorgan.com rod.b.hall@jpmorgan.com tien-tsin.huang@jpmorgan.com mark.a.moskowitz@jpmorgan.com chris.b.danely@jpmorgan.com harlan.sur@jpmorgan.com john.s.difucci@jpmorgan.com sterling.auty@jpmorgan.com steven.obrien@jpmorgan.com
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JPM U S Year Ahead 2012 2011 12 10 738272

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North America Equity Research

U.S. Year Ahead 2012

Director of U.S. Equity Research Noelle V. Grainger

Bloomberg JPUS2012 <INDEX> <GO>

North America Equity Research December 2011

US Year Ahead 2012

North America Equity Research December 2011

US Year Ahead 2012

North America Equity Research December 2011

US Year Ahead 2012

North America Equity Research December 2011

US Year Ahead 2012

Equities Rise Despite Uncertainty

Eight Reasons to Be Contrarian (Optimistic) in 2012

North America Equity Research December 2011

US Year Ahead 2012

Establishing Year-End 2012 Target of 1430; Favor Cyclicals and Financials

65 Analyst Best Ideas

North America Equity Research December 2011

US Year Ahead 2012

Valuation: See S&P 500 Trading to 13.0x 2013E EPS or 1430

YE '12 P/E Upside 14.00X

2013 EPS $115

North America Equity Research December 2011

US Year Ahead 2012

Avg P/E: Months 40-46

10.0x 5.0x 0.0x

Source: J.P. Morgan and FactSet.

Avg: if Bull intact

Avg: if Bull intact

North America Equity Research December 2011

US Year Ahead 2012

And Equity Risk Premium Points to Equities Being Undervalued

10yr Avg Market low Market low

Asia Crisis Subprime Crisis

Market Crisis low 9/11 6.27

10yr Avg 3.82

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

North America Equity Research December 2011

US Year Ahead 2012

2012 Expected to Look More Like 2009

+9% -17% +24%

1,400 1,300 1,200 1,100

Composite and High/Low range of Bull Mkts lasting at least 34 months

-22% +17% (+26%)

1,350 1,250 1,150

51% Avg gain of 15%

1,000 900 800

North America Equity Research December 2011

US Year Ahead 2012

Source: J.P. Morgan and Bloomberg.

North America Equity Research December 2011

US Year Ahead 2012

Sectors: Overweight Cyclicals, Financials

Financials/ Cyclicals Cyclicals/ Financials

Housing bottoms in 2012

2012 Election year with Presidential approval rating <50%

Cyclicals, Financials and Energy Cyclicals Cyclicals, Financials and Energy

Financials (700bp), Technology (500bp), Industrials (300bp), Energy (200bp)

Current P/E below 40-yr average

2011 Underperformers (buy the losers)

Source: Bloomberg, FactSet, and Datastream.