HOUSE_OVERSIGHT_030841.jpg

market thoughts Our core macro view remains that the global economy continues to muddle through. We see U.S. growth between +1.5% and 2.0%, Europe continuing to work its way out of recession, and emerging economies growing +4%-5%, led by China as growth moves to a more sustainable trend-like +7%-8%. Global growth next year should be somewhere between +2.5% and 3%. China has just gone through a major political transition. We expect the new Government to focus on reform initiatives and inward investment. As my team in Hong Kong continues to remind me, 7% growth feels pretty good. There simply isn’t the sense of concern or urgency in China as there has been outside the country around a Chinese hard landing. !t’s a domestic economy that is maturing, which is exactly what we expect to see ahead. With the U.S. election behind us, we believe there should be little doubt across markets that until inflation becomes a meaningful concern, central banks will continue to make holding cash and core bonds frustrating for investors—slowly pushing investors to take on incremental risk across markets. But like deleveraging, increased risk taking needs to be a process, not an event. Fundamentals matter I’m a pragmatist in life and as an investor, especially when measuring and trying to understand risk. My team is very much macro driven, and | believe in fundamentals (as a parent, | have to). | like to have a view on both the upside and downside of an investment. My favorite investment ratio is 2:1, when thinking about the potential upside- relative-to-downside, and those investments are hard to find. Credit has been one of them. | recently challenged our quantitative research and analytics team to help me think about the benefits and the risk in portfolio diversification. We continue to have significant investment tilts across our portfolios, and | wanted to make sure we weren't taking on additional risk because of a lack of diversification. My intuition is that there is far less benefit today than there has been traditionally in a set-it and forget-it approach to asset allocation (something we don’t practice). Let me also add that there is a tremendous difference between an investor who is less diversified and one who is out of the market, which continues to be painful for many investors still on the sidelines. The team looked back to 1991 at the correlation between assets across world equity, bond, commodity and foreign exchange markets. What we found is that correlation across risk assets has been particularly high since the 2008 financial crisis. You get less benefit owning a little bit of everything and a great deal more reward for being disciplined and investing only where you see the most value. What was even more interesting is that while some of this is obviously cyclical, there appears to be a structural pattern here as well. Correlation across risk assets has risen 0.80 0.70 a 0.60 0.50 0.40 0.30 0.20 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 Source: J.P. Morgan Private Bank, Bloomberg. Data as of November 2012. Why is this relevant? Because it helps explain why we’ve been comfortable barbelling the risk we’ve taken across portfolios this year with a significant overweight to credit markets; it’s allowed us to own less equities for similar returns. Effectively, we’ve been able to take normal levels of risk in portfolios but focus on the higher certainty of those returns coming from yield rather than more volatile equity price appreciation. We still see fundamental value in our credit allocations, but the return ahead is going to be driven by yield or the coupon, not by bond price appreciation. I’m going to argue that it places us right where we should be in the deleveraging and global recovery cycle. It’s time to revisit the balance of how we are taking risk in portfolios. If we want to achieve similar portfolio returns next year, we'll need to take more directional risk where we see value across global markets. The end of “easy money” Index 2012 YTD Annualized _ Realized Return Return Volatility* Global Equities (MSCI World) 8.6% 10.8% 19.1% J.P. Morgan Developed High 5 é 5 Yield Bonds 12.7% 22.4% 9.4% Investment Grade (JULlexEM) 9.9% 11.9% 4.9% Emerging Market Debt 6 6 6 (J.P. Morgan EMBI) 16.1% 16.5% 6.9% Source: Bloomberg. Data from January 2009 through November 14, 2012. * Data from January 2009 through October 2012. It is not possible to invest directly in an index. HOUSE_OVERSIGHT_030841