MARKET

INSIGHTS
Dr. David Kelly, CFA Managing Director Chief Global Strategist J.P. Morgan Funds Tai Hui Managing Director Chief Market Strategist Asia J.P. Morgan Funds Geoff Lewis Executive Director Market Strategist Asia J.P. Morgan Funds Yoshinori Shigemi Executive Director Market Strategist Asia J.P. Morgan Funds Grace Tam, CFA Vice President Market Strategist Asia J.P. Morgan Funds

Quarterly Perspectives
Asia | 3Q 2013

J.P. Morgan Funds Management is pleased to present the latest edition of Quarterly Perspectives. This piece highlights key themes from our Guide to the Markets book and offers critical insights for engaging in portfolio discussions.
Both Quarterly Perspectives and Guide to the Markets are elements of our Market Insights program, which was developed to provide investors with a way to address the markets and the economy based on logic rather than emotion, ultimately helping investors to make rational investment decisions.

This quarters themes

1 2

The investment implications of the end of QE Market normalisation should favour cyclicals and emerging markets Asia dividend income theme: More than an investment fashion Abenomics third arrow of structural reforms

3 4

MARKET Market Insight Series INSIGHT at aSERIES glance

3Q | 2013
As of June 30, 2013

Guide to the Markets

ASIA

To download the PDF of the Guide to the Markets - Asia, please visit us at: www.jpmorganam.com.hk/guide

MARKET

INSIGHTS

Quarterly Perspectives

The investment implications of the end of QE

Overview The Federal Reserves current quantitative easing (QE) program represents the most extreme monetary stimulus ever applied to the US economy. This policy looks increasingly inappropriate given an improving economy and the problems a larger balance sheet will cause for nancial markets when the Fed needs to raise interest rates. Because of this, Fed Chairman Ben Bernanke has outlined a potential schedule for ending QE, suggesting that investors should position their portfolios for higher long-term interest rates. Fed over-easy Since last September the Fed has bought Treasuries and mortgage-backed securities at a monthly pace of USD 85bn, while reinvesting interest and maturing principal payments. This pace of purchases, if maintained, would boost the Feds assets from USD 2.9trn in early 2013 to USD 3.9trn by years end. These huge asset purchases combined with a federal funds rate at 0-0.25% and explicit guidance on the conditions necessary for Fed tightening represents the most extreme monetary stimulus ever applied to the American economy.

United States: Inflation and Unemployment

Inflation
Year-over-year % change
18%
Avg. since 1964 Headline CPI 4.3% Avg. since 1999 2.5% 2.0%

Unemployment Rate
5/2013 1.4% 1.7%

Global Economy

Falling unemployment has diminished the case for further quantitative easing.

Seasonally adjusted
12% 11% 10%
Unemployment

Avg. since 1964 6 1% 6.1%

Avg. since 5/2013 1999 6 3% 6.3% 7 6% 7.6%

15%

Core CPI

4.2%

12% 9% 9% 8% 7% 6% 3% 5% 0% 4% 3% '64

6%

-3% '64

'69

'74

'79

'84

'89

'94

'99

'04

'09

'69

'74

'79

'84

'89

'94

'99

'04

'09

Source: US Bureau of Economic Analysis, Census Bureau, FactSet, J.P. Morgan Asset Management Guide to the Markets Asia. Data reflect most recently available as of 30/6/13.

29

Guide to the Markets Asia, page 29

While it is unclear how much credit this stimulus is due for an improving US economy, there is no doubt that the economy is getting better. As shown in the chart above, the unemployment rate has now fallen by 2.4% since its peak in October 2009. Moreover, even modest job growth should continue to reduce the unemployment rate, since demographic changes have slowed labour force growth to a crawl. With home prices rising, scal threats abating, consumer condence improving and labour markets tightening, the case for further Fed stimulus is rapidly fading.

3Q | 2013
The Fed is also increasingly aware that its fast-expanding balance sheet carries dangers of its own. As shown in the chart below, the Fed has increased the size of its balance sheet without causing a surge in the money supply by paying banks interest on the reserves they hold with the Fed (as opposed to lending out to the private sector). However, this also implies that in order for the Fed to raise the federal funds rate (when it nally deems this appropriate), it will need to increase the interest paid on reserves in tandem.

United States: The Fed and the Money Supply

Feds Balance Sheet: Assets
USD trillions
4

Money Multiplier
M2 / Monetary Base
10x

Oth Other

Global Economy

9x 8x 7x 6x 5x

US Treasuries Agency MBS

6/2013: 3.3x

4x 3x

0 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13

2x

'04

'05

'06

'07

'08

'09

'10

'11

'12

'13

Feds Balance Sheet: Liabilities

USD trillions t illi
4

Federal Funds Rate & FOMC Interest Rate Projections

12% 10% 8% 6%

When the Fed needs to raise rates, the bigger their balance sheet, the more expensive it will be to maintain it and the more disruptive it will be to dismantle it.

Excess Reserves Other Liabilities Required Reserves

Long-term Fed Projection FOMC Projections 6/2013: 0.0%-0.25%

4%
1

2% 0%
'04 '05 '06 '07 '08 '09 '10 '11 '12 '13

'84

'88

'92

'96

'00

'04

'08

'12

'16

Source: Federal Reserve, FactSet, J.P. Morgan Asset Management Guide to the Markets Asia. Monetary base is defined as the total amount of a currency that is either circulated in the hands of the public or in the commercial bank deposits held in the central bank's reserves. Money multiplier defined as M2 divided by the monetary base. Fed projections are based on median of expectations of FOMC members. Data reflect most recently available as of 30/6/13.

32

Guide to the Markets Asia, page 32

The problem is that with banks holding a projected USD 2.5trn with the Fed by the end of 2013, if the Fed over the next few years raised the federal funds rate to a roughly neutral level of 4%, the 4% interest that they would then have to pay on bank reserves at the Fed would cost them USD 100bn per year, which could leave them in a net negative income situation. If they tried to avoid this by selling bonds and shrinking their balance sheet, they could cause long-term interest rates to spike. Conversely, if they postponed rate hikes altogether, they could set the economy up for ination. The bottom line is that the bigger the Feds balance sheet gets, the more expensive it will be to maintain and the more disruptive it will be to dismantle. Impacts of Fed tapering In the press conference following the June 18/19 FOMC meeting, Fed Chairman Ben Bernanke indicated that he expected that the Fed would begin to phase out QE later this year and end the phase out by the middle of 2014, when he expected the unemployment rate to be at roughly 7.0%. While a nine-month phase-out period may appear to be gradual, moving from USD 85bn per month to zero should put signicant upward pressure on long-term interest rates. This appears to already be recognized by many investors as interest rates moved up sharply in the wake of the Chairmans comments.

MARKET

INSIGHTS

Quarterly Perspectives
The US economy should be able to weather higher interest rates quite well. Even a substantial increase in mortgage rates from current levels should leave them at very affordable levels from an historical perspective, while increases in consumer interest income should offset increases in consumer interest expense, particularly when the Fed begins to raise short-term rates. While uncertainty about economic and nancial market impacts of higher rates could continue to impact the stock market in the short run, in the long run, stocks should be able to avoid too much pain from higher rates. Indeed, analysis of the impact of rate hikes on the stock market over the past 25 years suggests that, starting from very low levels (such as those that exist today), increases in interest rates have been associated with rising rather than falling stock prices.

Rate Rise Impact on Fixed Income and Equity Sectors

Price Impact of a 1% Increase in 10-Year Rates
Barclays fixed income sectors, 1994-2013
Hi h Yi High Yield ld 1 3% 1.3%

Price Impact of a 1% Increase in 10-Year Rates

S&P 500 GICS sectors, 1994-2013
Materials Info Tech Energy 2 0% 2.0% 1.5% 1.2% 1.0% 0.6% -0.7% -1.1% -1.5% -2.0% -2.5% -2% 0% 2% 4%

Rising interest rates should have different impacts across sectors.

EMD (USD)

-1.3%

MBS

-2.4% 2 4% Cons. Disc.

Munis

-2.5%

Industrials Financials Telecom

US Agg

-3 4% -3.4%

Other Asset ts and Investor Beh haviour

Investment Grade Corp.

-3.7% Cons. Staples

TIPS

-3.9%

Health Care Utilities

10-Year Treasury -7.7% -10% -5% 0% 5%

-4%

60

Source: Standard & Poors, US Treasury, FactSet, Barclays, J.P. Morgan Asset Management Guide to the Markets Asia. Simulated price impact of a 1% increase in the 10-year Treasury yield based on estimated equations using monthly data from 1994 2013, data permitting, where sector indices are regressed on 10-year yields and the S&P500. Note that the S&P500 is held constant in simulations. Fixed income sectors shown above are provided by Barclays Capital and are represented by Broad Market: Barclays US Aggregate (US Agg); Fixed Rate MBS Index (MBS); US Corporate (Investment Grade Corp); Municipals Bond Index (Munis); Emerging Markets Debt (EMD (USD)); Corporate High Yield Index (High Yield); Treasury Inflation Protection Securities (TIPS). Data reflect most recently available as of 30/6/13.

Guide to the Markets Asia, page 60

However, as shown in the chart above, within equity portfolios, low dividend, high beta sectors tend to do best when rates rise, while more defensive areas such as utilities tend to fare worse. Bond sectors generally are more vulnerable. However, within xed income markets, sectors with low duration and/ or higher credit risk (such as high yield bonds) tend to outperform at a time of rising rates.

Investment implications An improving economy and the rising long-term costs of an expanding balance sheet justify the Feds recent announcement of a schedule for ending QE. This reduction in monetary stimulus could push long-term rates higher, although from these levels, the bond market should be far more vulnerable to rising rates than the stock market. Investors should position themselves to weather higher rates not only in overall asset allocation, but also among sectors of the equity and xed income markets.

3Q | 2013

Market normalisation should favour cyclicals and emerging markets

Overview We believe that the US cyclical expansion has begun to broaden out as the effects of the scal drag start to fade after peaking in the rst half of 2013. The earnings cycle should improve and benet cyclical stocks in the US and Europe. Market dips and corrections due to Fed tightening fears and carry trade unwinding provide long-term investors with an opportunity to reposition their portfolios for better times ahead. Markets are wrong to give in to Fed tightening fears The latest economic data show a more vibrant US economy, improvement in sentiment in Japan and stabilisation in Europe (see the chart below for GDP growth forecasts from the IMFs World Economic Outlook). Nonetheless, investors have chosen instead to give in to fresh fears surrounding the unwinding of the Feds asset purchase program. The bears either believe the real economy would suffer due to reduced liquidity or the drop in liquidity would undermine risk assets, especially in emerging markets.

Global Growth
Emerging Market Real GDP Growth
Year-over-year % change
12%
2010 2011 2012 2013 2014 2015 Historical IMF Forecast

Global Economy

8% 4% 0% -4% EM China India Indonesia Turkey Brazil Korea

Historical 2010 2011 2012

An all-round stronger world economy in 2014 will be US led, with further strength in 2015 marking the 6th year of expansion

Russia

Mexico

Developed Market Real GDP Growth

Year-over-year % change
12% 8% 4%

IMF Forecast 2013 2014 2015

The IMFs April GDP forecast looks too low for Japan, the worlds 3rd largest economy.

0% -4% DM US Australia Canada UK France Germany Italy Japan

Source: J.P. Morgan Economics, J.P. Morgan Asset Management Guide to the Markets Asia. Forecasts are from the IMFs April 2013 World Economic Outlook. Data reflect most recently available as of 30/6/13.

24

Guide to the Markets Asia, page 24

Until May, the rally in nancial markets was unconvincing, characterised by a strong investor preference for lower risk assets such as credit, emerging market bonds and low beta defensive stocks like consumer staples, utilities and telecom. Since mid May, we have seen a repositioning of portfolios by international investors panicked into believing that a change in US monetary policy in the form of an end to large-scale asset purchases was rapidly approaching. This wholesale panic over the course of Fed policy triggered a knee-jerk move out of many of the carry trades fostered by years of zero interest rates and central bank liquidity expansion under QE, causing risk assets to sell off heavily. But investors should not fear that a move up in bond yields from abnormally low levels will cause the US economy or earnings to stall. Moderate increases in bond yields during mid-cycle expansions are the norm. They occur precisely because growth in markets, sales revenues, wages and company prots are strengthening.

MARKET

INSIGHTS

Quarterly Perspectives
So what happens next? With the Feds more explicit direction on the path of QE tapering, investors everywhere now realise that sooner or later government bond yields in the developed markets will start to trend higher. Many assets that were formerly regarded as safe havens by investors will be less trusted after the emergence of tapering fears shook markets. Of course, the Feds new timetable will put some additional pressure on developed market government bond markets, and US Treasury yields in particular are likely to trend higher in 2014. The earnings cycle is broadening out and defensives are no longer the only sectors holding the promise of positive earnings growth, with revisions already positive for nancials as a group. In terms of 2H 2013 performance, sector leadership within the equity market is likely to switch away from defensives towards nancials and cyclicals (see the chart below). Areas that could underperform, using historical analysis as a guide, include those sectors most sensitive to higher Treasury yields, such as utilities, health care, consumer staples and stocks that generally possess low operating prot gearing and high nancial leverage.

Global Sectors: Returns

2008
H e a lt h C a re - 2 1.4 % C o ns . S t p. - 2 4 .0 % Ut ilit ie s - 3 0 .4 %

So far in 2013, defensive stocks have strongly outperformed cyclicals and financials. This may be about to change. As the macro environment improves, higher beta cyclicals and emerging market equities should return to favour.

2009
M a t e ria ls 7 0 .1% IT 5 8 .1% C o ns . D is c . 4 3 .7 % F ina nc ia ls 3 6 .7 % Ene rgy 3 3 .3 % Indus t ria ls 2 9 .0 % C o ns . S t p. 2 4 .2 % H e a lt h C a re 19 .5 5% T e le c o m s 16 .5 % Ut ilit ie s 9 .7 %

2010
C o ns . D is c . 2 5 .2 % Indus tria ls 2 3 .8 % M a t e ria ls 2 1.6 % C o ns . S tp. 14 .2 % E ne rgy 11.5 % IT 11.3 % T e le c o m s 11.3 % F ina nc ia ls 6 .5 5% H e a lt h C a re 2 .9 % Ut ilitie s 0 .0 %

2011
H e a lt h C a re 8 .9 % C o ns . St p. 7 .8 % T e le c o m s - 0 .4 % E ne rgy - 3 .0 % IT - 4 .4 % Utilit ie s - 4 .6 % C o ns . D is c . - 5 .2 % Indus t ria ls - 10 .2 2% F ina nc ia ls - 19 .3 % M a t e ria ls - 2 1.5 %

2012
F ina nc ia ls 2 8 .7 % C o ns . D is c . 2 3 .5 % H e a lth C a re 17 .8 % Indus tria ls 16 .1% IT 15 .3 % C o ns . St p. 14 .5 % M a t e ria ls 11.0 % T e le c o m s 8 .1% 1% E ne rgy 2 .5 % Utilitie s 2 .4 %

2Q '13
C o ns . D is c . 5 .4 % H e a lth C a re 2 .7 % T e le c o m s 2 .1% IT 0 .4 % F ina nc ia ls -0 .1% Indus t ria ls - 0 .4 % Utilitie s -1.4 % C o ns . St p. -2 2 .1% 1% E ne rgy - 3 .7 % M a t e ria ls - 10 .3 %

5-yrs ('08 - '12) Cum. Ann.

C o ns . S tp. 3 3 .2 % H e a lt h C a re 2 3 .8 % C o ns . D is c . 2 1.4 % IT 7 .4 % Indus tria ls - 8 .4 % T e le c o m s - 10 .1% M a te ria ls - 13 .3 % E ne rgy - 14 .6 6% Ut ilitie s - 2 5 .4 % F ina nc ia ls - 3 0 .4 % C o ns . S tp. 5 .9 % H e a lt h C a re 4 .4 % C o ns . D is c . 4 .0 % IT 1.4 % Indus t ria ls - 1.7 % T e le c o m s - 2 .1% M a te ria ls - 2 .8 % Ene rgy - 3 .1% 1% Ut ilit ie s - 5 .7 % F ina nc ia ls - 7 .0 %

Global Sector Performance*

Index, rebased 2007 = 100
180 140 100 60
Financials Defensives Cyclicals

Equities

T e le c o m s - 3 5 .6 % E ne rgy - 4 2 .2 % C o ns . D is i c. - 4 2 .3 % IT - 4 4 .6 % Indus t ria ls -4 4 5 .0 0% M a t e ria ls - 5 1.9 % F ina nc ia ls - 5 3 .9 %

20 '07 '08 '09 '10 '11 '12 '13

Global Cyclicals vs. Defensives*

Index, rebased 2007 = 100
130
Cyclicals Outperformance

100

Defensives Outperformance

70 '07 '08 '09 '10 '11 '12 '13

36

Source: MSCI, FactSet, J.P. Morgan Asset Management Guide to the Markets Asia. Sector returns are total (net) returns based on MSCI indices in US dollar terms. 5-yr data are used to calculate cumulative net total return (Cum.), annualized net total returns (Ann.), reflecting the period from 1/1/08 31/12/12. * Based on MSCI AC World GICS Sectors. Cyclical sectors include Consumer Discretionary, Industrials, Information Technology, Materials and Energy. Defensive sectors include Consumer Staples, Utilities, Telecommunication Services, and Health Care. Data reflect most recently available as of 30/6/13.

Guide to the Markets Asia, page 36

Investment implications Despite investor fears of the Fed reining back its ultra-loose monetary policy over coming years, this should be seen as a healthy sign of US economic recovery, ultimately benetting economic growth globally. Cyclicals, value and higher beta equities should then start to attract more investor interest. Although immediate catalysts appear few, there is now good value to be found in a number of larger emerging markets, such as Brazil, Russia, Turkey and even unloved China.

3Q | 2013

Asia dividend income theme: More than an investment fashion

Overview Given the low, or even negative, real interest rate environment in many Asian economies, it is not surprising that there is an aggressive hunt for yield and income. In an environment where US dollar interest rates are set to rise in coming years, investors rotation from bond income to equity dividend income is set to continue. We believe investing in Asian dividend stocks is not just a trendy investment theme, but is actually an evergreen theme for all seasons. Income from dividends combined with potential capital appreciation could help to enhance investors total returns over the long run. The importance of dividends in generating total return Although the absolute amount of dividend income may seem modest on an annual basis, its contribution to total return is signicant on a cumulative basis over the longer term. In fact, dividends have accounted for around 40% of the annualised total return for the MSCI AC Asia Pacic exJapan Index over the past 10 years, thanks to the compounding effect of dividend reinvestment. For individual markets such as Australia and Taiwan, dividends have been even more important, contributing to half of the annualised total return over the same period. In addition to attractive yields, high dividend stocks in Asia have consistently outperformed the overall market since 2000. The rst and second quintiles, or the top 40%, of the MSCI AC Asia ex-Japan Index based on dividend yield, have outperformed the fourth and bottom quintiles, or the bottom 40%, by 530% since 2000 on a total return basis.

Asia Dividend Income

MSCI Asia ex-Japan: Performance by Dividend Yield
USD cumulative total return of quintiles with quarterly rebalancing (Jan. 2000 base = 100)
1,000 800
Top Quintile 2nd Quintile 3rd Quintile 4th Quintile Bottom Quintile All Stocks

Asian dividend stocks have not only contributed significantly to total returns, they have also consistently outperformed in the longer term.

600 400

Equities

200 0 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 Dividends Capital Appreciation '13

Total Return: Dividends vs vs. Capital Appreciation

Average annualized returns over 10 years
40% 30% 20% 10% 0%
2.6% 4.6% Japan 4.3% 5.2% 4.7% Taiwan Korea 11.0% 6.7% 9.6% Hong Kong 8.4% 8.4% Australia 7.8%

Asia Pacific
11.6% 11.0% 7.5% 18.0%

13.9%

Other EM
6.4% 9.2% 11 7% 11.7%

Regions

7.8% 22.0% 3.9% 6.0% 6.4% 7.4% Poland 11.8% South Africa 15.2%

6.9% 15.1% 16.0% 15.9% 3.2% 5.1% Mexico Turkey Brazil US 5.1% 4.4% Europe 9.6%

6.6% 10.9%

11.3% Malaysia

12.9%

China

Thailand Philippines

Indonesia

Russia

AC Asia EM Pacific ex (Emerging JP Markets)

Source: FactSet, MSCI, CLSA, J.P. Morgan Asset Management Guide to the Markets Asia. Data reflect most recently available as of 30/6/13.

48

Guide to the Markets Asia, page 48

MARKET

INSIGHTS

Quarterly Perspectives
Is it possible to have both dividend yield and earnings growth? Theoretically, higher dividend stocks should have lower earnings growth prospects, as companies return cash to investors instead of investing for the future. However, this relationship is less clearcut in practice. Although there is an overall negative relationship between dividend yield and EPS growth for many countries and regions, as shown in the chart below, there are a number of countries that offer both attractive yields and good earnings growth. Over the past three years, the average dividend yield of MSCI Asia Pacic ex-Japan was 3.0%, while average EPS growth was 13.8%. The US had almost the same average EPS growth (13.7%) over the same period, but its average dividend yield was lower (2.2%). Within Asia Pacic ex-Japan, Australia, China, Taiwan and Thailand were the markets that offered both decent yields and growth. Sector-wise, the technology hardware and consumer discretionary sectors in Asia also provided a combination of yield and growth.

Global Dividend Income

Equities

Asia Pacific ex-Japan offered both decent dividend yields and good earnings growth over the past three years.

Equity Dividend Yield

6%

10-year government bond yield

Dividend Yield vs. EPS Growth

3-year average
5%
Asia Pacific countries Other EM countries Regions Taiwan

4.5%

4%
2.7%

3.6%

3.7%

3.5% 2.9% 2.6% 2.1% 1.8%

3.4%

Poland

Australia

2%

4%

Europe

Brazil

0%

AP ex-Jp

Divi idend Yield

3%

Thailand China EM Indonesia US

Hong Kong Russia

Malaysia Turkey Philippines

South Africa

REIT Dividend Yields

6%
4.7% 4.8% 4.5% 3.6%

10-year government bond yield

5.7% 5.3% 5.6% 4.0% 3.2%

2%

4% 2% 0%

4.1%

Mexico Korea India

1%

0% 0% 5% 10% 15% EPS growth 20% 25%

Source: FactSet, NAREIT, Standard & Poors, Ibbotson, J.P. Morgan Asset Management Guide to the Markets Asia. (Top Left) Yields shown are for the appropriate MSCI index. (Bottom Left) Yields shown are for the appropriate FTSE NAREIT REIT index, which excludes property development companies. (Right) Yield and EPS growth are average values over the last 3 years from respective MSCI indices and S&P 500.

46

Data reflect most recently available as of 30/6/13.

Guide to the Markets Asia, page 46

Is Asia in a dividend sweet-spot? With strong cash ows and low gearing, we believe Asian companies can continue to grow dividends. Compared to other regions in the world, Asia Pacic ex-Japan has shown the highest annualised dividend per share (DPS) growth during the past decade (9.3%). Among individual markets in the region, China had the strongest DPS growth, followed by Singapore and Australia. Europes DPS growth (6.3% annualised) has been the slowest, as companies hoarded cash in the wake of the Global Financial Crisis. In contrast, as shown in the chart on the next page, US dividend payouts have been catching up very quickly since bottoming in 2009.

3Q | 2013

Regional Dividend Income

Regional DPS
Index, rebased 2003 = 100
280 260 240 10x
Asia Pacific ex-Japan EM Europe US

Median 12-month Forward P/E by Style*

MSCI AC World Index
20x
Growth AC World High Dividend Value

15x

Equities

220 200 180 5x '07 '09 '11 '13

Asia Pacific ex-Japan and emerging markets have shown an annualised DPS growth of 7-9% over the past 10 years.

Median 12-month Forward P/E by Region

160 140 120 100 9x 80 '03 '05 '07 '09 '11 '13 7x
MSCI AC World MSCI US MSCI Europe MSCI AC APxJ MSCI EM

PE comparison of high dividend stocks by region**

17x 15x 13x 11x 13.1 12 2 12.2 14.6 13.5 11.4 10.9

6-yr. range 6-yr. average Latest

12.9 12 2 12.2

11 7 11.7 11.1

Source: MSCI, FactSet, J.P. Morgan Economics, J.P. Morgan Asset Management Guide to the Markets Asia. *Value is defined as bottom 2 quintiles (bottom 40%) of low forward PE stocks within the MSCI AC World index. Growth is defined as the top 2 quintiles (top 40%) of high forward EPS growth stocks within the MSCI AC World index. **High dividend stocks are defined as top 2 quintiles of dividend-paying stocks within the index.

47

Data reflect most recently available as of 30/6/13.

Guide to the Markets Asia, page 47

Are Asian dividend stocks expensive? Given strong support by investors, high dividend equities in Asia have performed well. It is therefore reasonable to question whether their valuations are expensive. We believe they are not. The median 12-month forward PE for the MSCI AC Asia Pacic ex-Japan Indexs high dividend stocks1 is 12.9x, slightly above their long-term average of 12.2x, but below the median PE of 13.7x for the broad index and the median PE of 13.1x for MSCI AC World high dividend stocks1 . Certain defensive sectors, such as REITs, health care and consumer staples, are expensive, while there are still some sectors or markets, such as China and Korea, which offer sustainable dividend income at reasonable valuations. Furthermore, the recent sell-off in high dividend sectors, triggered mainly by the Feds tapering concerns, have provided good buying opportunities for cheaper high dividend stocks in the region.

Investment implications We believe investing in Asian dividend stocks is not purely a defensive strategy for bear markets. It is an all-weather investment theme that has not only provided a rising income stream, but has also delivered consistent outperformance in the longer term. As such, it should be considered as a staple part of an investors asset allocation.

Quintile 1 and quintile 2 dividend stocks of the respective index.

MARKET

INSIGHTS

Quarterly Perspectives

Abenomics third arrow of structural reforms

Overview The Japanese stock market, after impressive gains following the introduction of Abenomics, has seen a sharp correction since late May. This correction could be explained by a) the signicant overbought position following the 60% rally in TOPIX since December 2012, b) investor concerns over the tapering of quantitative easing by the US Federal Reserve and c) disappointment over Prime Minister Abes structural reform plans. We believe Abe deserves more patience from the market, as we think he will push ahead with more aggressive structural reforms, offering Japan the best chance of economic revival in the past 10 years.

Japanese public reaction to rst two arrows Abenomics has been a good demonstration of the role of expectations in nancial markets and in the real economy. First of all, it called for aggressive monetary easing, which led to a signicant depreciation of the Japanese yen. This weaker yen fostered expectations of higher corporate earnings that, in turn, drove up stock prices. Higher stock prices and the possibility of higher personal income, in wages and bonuses, have made households feel wealthier and led to a surge in department store sales. Besides, rising ination expectations prompted people to buy houses and to lock in xed income mortgages. Furthermore, rising business expectations should contribute to corporate capital investments.

Japan: Economic Snapshot

Real GDP Growth and CPI Inflation Department Store Sales
Year-over-year % change, 3-month moving average
GDP

Regional and Local Economy y

Year-over-year % change
8% 4%
Consumption Tax Hike (f (from 3% to t 5%, 5% Apr A 97)

Higher stock prices and expectations of higher household income are stimulating consumer spending.

15%

Consumption Tax Hike (f (from 3% to t 5%, 5% A Apr 97)

5%

Nationwide

0%
Inflation

-4% 4% -8% '95 '97 '99 '01

-5%
Tokyo Area

PM Koizumi Era (Apr 01 Sep 06)

-15%

'03

'05

'07

'09

'11

'13

'95

'97

'99

'01

'03

'05

'07

'09

'11

'13

Bank of Japan Tankan Business Confidence Survey

Index
40 20 0
-20 -40 -60 '95 '97 '99 '01 '03 '05 '07 '09 '11 '13
Non-manufacturing Index 6/2013: 4 (Forecast) 9/2013: 10 Manufacturing Index (Forecast) 9/2013: 12 6/2013: 12

Monthly Cash Earnings by Employees

Year over year % change Year-over-year change, 3 3-month month moving average
4%
Real

2% 0% -2% -4% -6% '95 '97 '99 '01 '03 '05 '07 '09 '11 '13
Nominal

17

Source: Japanese Cabinet Office, Ministry of Internal Affairs and Communications, Japan Department Stores Association, The Bank of Japan, Ministry of Health, Labor and Welfare, FactSet, J.P. Morgan Asset Management Guide to the Markets Asia. (Top Left) Japans 1Q 2009 GDP growth reached a trough of -9.4% and is cut off to maintain a more reasonable scale. (Bottom Left) Forecast for September 2013 from Bank of Japan Tankan Short-Term Economic Survey of Enterprises in Japan. Data reflect most recently available as of 1/7/13.

Guide to the Markets Asia, page 17

10

3Q | 2013
Reforms critical to sustained recovery, but likely to be gradual On June 14 the cabinet approved the structural reform plan Japan Revitalisation Strategy, which aims to improve the countrys long-term economic potential. Some investors were disappointed at the plan, as it did not include a lower corporate tax rate or liberalisation of the labour market. It also failed to challenge the vested interests of the powerful agricultural cooperatives and doctors association or to address the falling population.

Japan: Structural Trends

Regional and Local Economy y
OECD Indicators of Market Regulations*
Index relative to Japan (Japan rebased = 100)
200
Labor Market Trade and Investments

Labor Productivity Growth by Sector

% annualized between 2006 to 2010
4% 3% 2%
3.6%

150 100

1% 50 0
Japan France Germany Australia UK Canada US

1.1%

0% -1%
Total Manufacturing

0 6% 0.6% -0.2%
Agriculture Construction

-0.2%
Service

-0.3%
Financials

Corporate Tax Rate (2013)

40% 30% 20%
40%

Population Forecast
Millions
160 120

0 14 15 64 65+

Working Age Ratio**

2012 2030 2060 63% 58% 51%

Increasing productivity in both the agriculture and service sectors is considered important.

38%

33%

80
30% 24% 23% 17%

10% 0%
US Japan France Germany

17%

40 0 2010

Korea

UK

Singapore

HK

2016

2022

2028

2034

2040

2046

2052

2058

Source: National Institute of Population Japan Japan, OECD OECD, Japan Productivity Centre Centre, KPMG KPMG, FactSet FactSet, J J.P. P Morgan Asset Management Guide Guide to the Markets Asia. Asia * OECD has developed a range of indicators at both the economy-wide and sector levels. All of these indicators measure the extent to which policy settings promote or inhibit competition in areas of the product market where competition is viable. In general, the higher the value, the more restrictive the country is towards that particular criteria. ** Working age ratio is the ratio of the working age population (aged 15-64) to the total population. Data reflect most recently available as of 30/6/13.

20

Guide to the Markets Asia, page 20

However, one of the important lessons learnt by Prime Minister Abe as former Prime Minister Koizumis Chief Cabinet Secretary is that reforms that could face resistance from various lobbying groups can only proceed in a gradual manner. The best strategy is to make haste slowly. In this sense, the recommendation to set up special economic districts is key. Success in these zones could reinforce public support for the experiment to be extended to the whole nation. While economic reforms take time to implement, consumer and business expectations of higher productivity and income in the future following the reforms could induce present consumption and capital investment.

Investment implications After the market rally in response to phase 1 of Abenomics, a sustained rally will be contingent upon the economic reform measures and strategy. The good news is that the Japanese public are already showing signs of buying-in to Prime Minister Abes plan and this could attract more strategic investors to build long-term positions in Japanese equities.

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Quarterly Perspectives Asia | 3Q 2013

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