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November 16, 2010 global debates playbook shifting to neutral on more balanced risks 1

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    November 16, 2010 global debates playbook shifting to neutral on more balanced risks 1 November 16, 2010 global debates playbook shifting to neutral on more balanced risks 1 Presentation Transcript

    • MORGAN STANLEY RESEARCH November 16, 2010 Global Cross-Asset Strategy Group Global Debates Playbook Morgan Stanley & Co. Inc. Gregory Peters greg.peters@morganstanley.com Shifting to Neutral on More Balanced Risks +1 212 761-1488 Jason Draho We move from full ‘risk-on’ to a more balanced Asset Class Views jason.draho@morganstanley.com risk on / off view. All three of our market pillars — – + +1 212 761-7893 US growth, Europe sovereign risk, and the China GBP ● ‘Goldilocks’ scenario — were flashing green for risk- on a few weeks ago. The constructive view was EM credit ● Please see page 2 for full list of members driven by the mantra “don’t fight the Fed.” That hasn’t EM currencies ● changed for the US. But the high likelihood that Subscribe to the Global Debates Playbook, Ireland will go to the EFSF fund and the contagion risk Oil ● the latest investor debates and high- that this poses for the euro periphery is a risk-off Commodities ● conviction trades from Morgan Stanley’s signal, in our view. And China is less supportive for risk-on, as rising inflation will trigger policy tightening. EM equities ● Global Cross-Asset Strategy Group Recent price action suggests US growth may be Europe equities ● better than expected, countering the downside Gold ● risks. The sharp rise in US Treasuries over the past two weeks — the 10Y is up over 40bps — is due US credit ● entirely to real rates; inflation expectations have EUR ● Morgan Stanley does and seeks to do declined. Add to that the US dollar rally, and the market may be expecting stronger real growth, a view US Treasuries ● business with companies covered in Morgan Stanley Research. As a result, shared by our economists. This may also indicate that USD ● investors should be aware that the firm growth has taken over from QE as the main market driver. In our view, this upside risk is enough to Europe credit ● may have a conflict of interest that could affect the objectivity of Morgan balance out the increased downside risks elsewhere. German Bunds ● Stanley Research. Investors should While we’ve dialed back our constructive view on JPY ● consider Morgan Stanley Research as risky assets considerably, we still see near-term only a single factor in making their upside. The probability and magnitude of a correction investment decision. has increased because of the rise in European For analyst certification and other sovereign and EM inflation risks. Yet we view these important disclosures, refer to the as downside risks, not the base case. The EM over Disclosure Section, located at the DM gap should shrink in a risk neutral environment, but we don’t expect a performance reversal in the end of this report. += Analysts employed by non-U.S. affiliates are not registered near term. with FINRA, may not be associated persons of the member and may not be subject to NASD/NYSE restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account.
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Table of Contents Global Cross-Asset Strategy Group Global Cross-Asset Strategy Economics Market Commentary 3 Joachim Fels3 +44 (0)20 7425 6138 Global Cross-Asset Strategy Overview 7 Dick Berner1 +1 212 761 3398 Investor Debates 8 Elga Bartsch3 +44 (0)20 7425 5434 Asset Class Base Case Views 10 Robert Feldman7 +81 3 5424 5285 Risk-Reward Views: Economics Takehiro Sato7 +81 3 5424 5367 Global Economics 14 Qing Wang5 +852 2848 5220 US 15 Chetan Ahya5 +65 6834 6738 Europe 16 Gray Newman1 +1 212 761 6510 Japan 17 China 18 Strategy Asia ex-Japan 19 Jim Caron1 +1 212 761 1905 Brazil / Latam 20 Laurence Mutkin3+ +44 (0)20 7677 4029 India 21 Rashique Rahman3+ +44 (0)20 7677 7259 Russia 22 Stephen Hull3+ +44 (0)20 7425 1330 Risk-Reward Views: Strategy Gerard Minack6+ +612 9770 1529 US Rates 23 Graham Secker3+ +44 (0)20 7425 6188 Europe Rates 24 Alex Kinmont7+ +81 3 5424 5334 UK Rates 25 Jonathan Garner3+ +44 (0)20 7425 9237 EM Fixed Income 26 Jerry Lou5+ +852 2239 1588 FX 27 Greg Peters1 +1 212 761 1488 Developed Market Equities 28 Vishy Tirupattur1 +1 212 761 1043 Europe Equities 29 Hussein Allidina1 +1 212 761 4150 Japan Equities 30 Sivan Mahadevan1 +1 212 761 1349 Asia / GEMs Equities 31 China (and Hong Kong) Equities 32 Global Corporate Credit 33 Securitized Credit 34 Commodities: Oil 35 Global Equity Derivatives 36 Global Credit Derivatives 37 Volatility Across Asset Classes 38 1 Morgan Stanley & Co. Incorporated 2 Morgan Stanley C.T.V.M. S.A. 3 Morgan Stanley & Co. International plc 4 Morgan Stanley India Company Private Limited 5 Morgan Stanley Asia Limited 6 Morgan Stanley Australia Ltd 7 Morgan Stanley MUFG Securities 8 Morgan Stanley Taiwan Ltd + Analysts employed by non-U.S. affiliates are not registered with FINRA, may not be associated persons of the member and may not be subject to NASD/NYSE restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. 2
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Shifting to Neutral as Increased Downside Risks Balance the Upside from QE and Growth We move from full ‘risk-on’ to a more balanced risk on / off view. We’ve Exhibit 1: Two of our three market pillars have moved toward risk off… based our risk-reward assessment on three pillars: (1) US growth; (2) European sovereign risk; and (3) the China ‘Goldilocks’ scenario (see Exhibit 1). All three Theme Where Do Things Stand? Risk On / Off? were flashing green for risk-on a few weeks ago, though our view was driven by the mantra: “don’t fight the Fed.” That hasn’t changed as we assess the US • “Don’t fight the Fed” — growth gets a outlook. But the growing likelihood that Ireland will go the EFSF fund and the US Growth pass for a little longer Risk on contagion risk that this poses for the euro periphery is a risk-off signal, in our view. The third pillar, China and EM, is also less supportive for risk-on, as rising inflation will trigger policy tightening. But the real risk is a replay of 2008, in Sovereign  Ireland going to the EFSF appears Risk off which overheating could lead to a hard landing. Debt Crisis imminent, contagion looms Increased volatility is likely as markets digest news on sovereign risk and EM inflation, particularly on the policy front. The uncertainty about the fate  China ‘Goldilocks’ scenario nearing an of Ireland and the rest of the euro periphery leaves markets susceptible to large China / EM Risk neutral end swings on any news or rumors. The same is true as investors assess the magnitude of inflation in EM and the risk of overheating. In both cases, policy is a major market driver. In Europe, containing sovereign risk depends on euro Exhibit 2: …but the sharp rise in real rates may be a signal of better growth periphery governments taking tough fiscal actions and the EFSF serving as a “circuit breaker” for systemic risk. In EM, policy-makers have to walk a fine line 10Y Inflation Expectations (lhs) 2.2% 1.2% between tightening too little and too much. Given all this, the risk of a policy 10Y Real Rates (rhs) error is high, and that adds to both volatility and downside risk. 2.1% 1.0% Recent price action suggests the market may be anticipating better US 2.0% growth, countering the downside risks. The sharp rise in US Treasuries in 0.8% the past two weeks — the 10Y is up over 40bps — after the Fed’s announce- 1.9% ment on QE has caught many investors by surprise. What’s most noteworthy is 1.8% 0.6% that rise in yields has been entirely in real rates; inflation expectations have declined (Exhibit 2). Add to that the US dollar rally, and the market may be 1.7% expecting stronger real growth, not higher inflation, a view shared by our 0.4% economists (see Trade Tailwinds: Coming Strongly in Q4, November 1.6% 5). Moreover, the nearly 20bps rise in the 2Y suggests a marginal change in the 1.5% 0.2% view that the Fed will be on hold indefinitely. Position unwinding likely accounts for some of the rate move post-announcement. But the markets may be 2-Aug 6-Sep 11-Oct 15-Nov transitioning from QE to growth as the main market driver. In our view, this Source: Bloomberg, Morgan Stanley Research upside risk is enough to balance out the increased downside risks elsewhere. 3 Greg Peters, (212) 761-1488, Greg.Peters@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 If, or When, Ireland Goes to the EFSF Is Not Sufficient to Eliminate Contagion Risk Ireland is likely to go to the EFSF stability fund very soon… Pressure on Exhibit 3: Euro periphery banks disproportionately access ECB liquidity Ireland from Germany and other eurozone governments to restructure is 70% mounting, driven by fears of contagion spreading through the bond markets. Likewise, the ECB is pushing Ireland to go to the EFSF because Irish banks 60% have lost access to market funding and now rely on emergency lending support 50% from the ECB. If Ireland resists — it’s funded until next summer and has a cash buffer — or it reaches an agreement that does not include a credible bank 40% recapitalization plan, risk-off sentiment will continue to weigh on markets. 30% …but that still leaves uncertainty in the credit markets and contagion risk. 20% The ideal solution, outlined by our colleague Joachim Fels, is for Ireland to go to the EFSF, where it could borrow at a subsidized interest rate of 4-5% and 10% use the loan proceeds to recapitalize and restructure the banking system (see 0% Morgan Stanley Strategy Forum, November 15). But even in this situation, it’s D ec-08 M ar-09 Jun-09 S ep-09 D ec-09 M ar-10 Jun-10 S ep-10 not clear if the markets will fund Portugal and Spain, who don’t have similar cash buffers. In fact, banks in the euro periphery already rely heavily on lending E C B total liq uidity provision: G IP S bank s / eurozone bank s Source: BIS,T otal bank assets: G IP S / E urozone Morgan Stanley Research support from the ECB (Exhibit 3). Source: ECB, Morgan Stanley Research Plans to install a permanent crisis resolution mechanism to replace the EFSF in 2013 is another market headwind. The CRM would include a Exhibit 4: Sovereign risk signposts to watch government bailout facility similar to the EFSF. But the crucial difference is that it would share the burden with private creditors in a crisis, in the form of Category Event Date voluntary maturity extension, interest-rate holidays or even haircuts. The possibility of the latter, which is apparently off the table for now, is adding to • By-election for a seat in Parliament • Nov. 25 investor anxiety about lending, even now. Ireland • Presentation of detailed 2011 budget • Nov. 28 The EFSF buys time, but the structural problems still must be addressed. • Budget vote • Dec. 7 Lending to the euro periphery now is designed to support fiscal adjustment, structural reform, and the recapitalization of banks. The dual goals are to put Eurozone • Eurozone finance ministers meeting • Nov. 16 public sector debt on a sustainable path and to enable the country to return to finances • EU finance ministers meeting • Nov. 17 private sector funding at a reasonable cost. Failure to meet these objectives in the next few years may result in a further extension of loans, but eventually the Crisis • German proposal on future CRM • mid-Nov political will for doing so won’t be there. More drastic outcomes then become Resolution likely. In the near term, Exhibit 4 lists a number of events that can either Mechanism • EU Commission takes up the proposal • mid-Dec mitigate or exacerbate sovereign risk, and with it risk-on sentiment. 4 Greg Peters, (212) 761-1488, Greg.Peters@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Inflation Risk in Emerging Markets and the Policy Response Could Trigger a Replay of 2008 There are inflation parallels to 2008, but also differences. QE is the target Exhibit 5: The CRB commodity index is above pre-crisis high of much criticism, particularly in Asia, which is awash in inflation fears. By 500 148 some measures, commodity prices are higher than their peak in 2008 (Exhibit W T I US$ Per Barrel (RS) 5). This risks repeating the experience of 1H08, when abundant liquidity, good CR B Food Index (LS) 436 125 fundamentals, and surging commodity prices led to huge inflationary pressures CR B Com m odity (LS) in EMs. In response, policy-makers were tightening aggressively going into the 102 global recession triggered by Lehman’s bankruptcy. The difference for EM 372 policy-makers today is that any tightening will occur while the Fed is starting a 79 new round of QE, which presents additional challenges. 308 56 The form, not just the magnitude, of policy tightening matters, in China. Our China economist Qing Wang believes that if China relies on rate hikes or 244 33 currency appreciation, it should be fine. But if the authorities are reluctant to allow a rapid rise in either, as has been their preference in the past, they would 180 10 need to cut back on the supply of new credit. Given the magnitude of monetary Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 overhang (Exhibit 6), this would require a drastic cut to make a meaningful Source: Bloomberg, Morgan Stanley Research difference in inflation expectations, which have risen with QE. That is the risk: inflation in China tends to be tamed only after drastic credit controls, which Exhibit 6: Until M1 growth returns to trend, inflation pressure will persist cause more harm to the real economy than either rate hikes or CNY 15% % D eviation of M 1 from the trend (lhs) 12% appreciation. C P I % YoY (rhs) 10% Forecast The markets may react more to what the PBoC does next than the Fed. Investors are debating whether policy tightening in EM could be the trigger to 8% end the risk-on trade. We don’t believe that will be the case, given the still 5% ample liquidity globally. However, as now one of the main engines of global growth, China tightening could cause a market correction, even if it helps to 0% 4% avoid overheating. Markets have often paused or modestly corrected following the initial Fed rate hike at the beginning of a tightening cycle, but performed -5% well starting in about 6 months. The PBoC may take on that role now in this 0% cycle. -10% -15% -4% M ar-97 M ar-99 M ar-01 M ar-03 M ar-05 M ar-07 M ar-09 M ar-11 Source: CEIC, Morgan Stanley Research 5 Greg Peters, (212) 761-1488, Greg.Peters@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Our Asset Class Views Reflect the Move to Risk Neutral We’ve dialed back our constructive view on risky assets considerably but Adjustments to our asset class views reflect the balanced risk on/off still see near-term upside. The probability and magnitude of a correction has skew. We continue to favor equities over bonds generally. There is low upside increased because of the rise in European sovereign and EM inflation risks. to bonds, despite QE, and the sell-off in Treasuries last week while equities Yet we view these as downside risks, not part of our base case. The also fell is a reminder that bonds are far from risk-free. The main changes to combination of QE and signs of improving US growth should continue to our views over the past month, aside from a general scaling back of risk, are: provide risky assets with a tailwind, but the risk-reward is more modest than a month ago. • USD and EUR both moved to neutral from extreme negative and positive, respectively. QE remains a headwind for the USD, whereas rising The EM over DM gap shrinks in a risk neutral environment. Investors are sovereign risk reinforces its safe-haven status, while weakening the EUR. starting to ask whether DM can finally outperform EM, especially with the start of policy tightening in China. We expect the performance gap to shrink as risk • Commodities, while still attractive on tightening supplies, are reduced a is dialed back, but no performance reversal in the near term. However, it is notch on USD strength and potential EM overheating risk. important to differentiate between EM equities and fixed income. Our EM equity strategist Jonathan Garner recently scaled back his overweight, roughly analogous to “sell into strength” (see Start to Scale Back OW Equities, October 18). In contrast, our EM fixed income colleagues upgraded their view to neutral/bullish, looking effectively to “buy on dips” (see Global EM Investor: Credit, Rates & Currencies, November 10). Investor positioning and strategic behavior could be a near term technical headwind. Many investors are positioned with the same risk-on QE trades: short the USD and long commodities and the belly of the Treasury curve. With sovereign and inflation risks back on the table, investors are asking when the risk-on trade will end. Proactively repositioning for this outcome could itself trigger ‘risk off’ market moves. For instance, some of the recent moves in Treasury rates reflects repositioning post-QE. 6 Greg Peters, (212) 761-1488, Greg.Peters@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Global Cross-Asset Strategy – Overview Base Case: The risk-reward outlook is balanced between risk on/off; cautiously positive on risky assets Risk On/Off Skew: Neutral to negative bias • QE is forcing investors out on the risk spectrum, providing support for risky assets. We expect this to continue into 2011. However, QE provides a cyclical floor rather than a cyclical lift for the economy. R is k O n • For markets to continue grinding higher into 1Q11, growth will become more important. The US growth outlook continues to improve to a sustainable level; 3.5% GDP in 4Q. • Inflation rather than deflation is more likely in the US, due to better growth (good inflation) and partly N e u tra l from DM importing higher inflation from EM (bad inflation) – the latter being a consequence of QE spilling over into EM and higher commodity prices. T h is M o n th R is k O ff L a s t M o n th • An improving growth outlook and rising inflation expectations will favor equities over bonds, generally • QE is likely to affect policy in other countries, but in different forms. Only Japan and possibly the UK are likely to engage in actual QE; other countries in DM and EM will be slow in raising nominal rates, Strategic Asset Class Views keeping real rates low. Global liquidity stays abundant well into 2011. – + • Sovereign risks in Europe remain elevated until Ireland goes to the EFSF and has a credible plan for GBP ● recapitalizing and restructuring its banking system to limit contagion risk. Portugal is likely to follow Ireland. Focus returns to Spain, which will have to address its banking problems. EM credit ● • EM growth stays strong, but rising inflation and commodity prices increase the risk of overheating and EM currencies ● odds of sharp policy tightening, repeating 2008. Capital inflows continue to provide strong technical Oil ● support for EM assets. Rising commodity prices could differentiate between EM winners and losers based on who’s a producer versus consumer. Commodities ● • Continue to favor EM over DM, although the gap shrinks in a risk neutral environment. No clear catalyst EM equities ● for a performance reversal in the near term. Europe equities ● Gold ● What’s Changed: Increased downside risks, and less near-term upside US credit ● • Global growth looks stronger than even a month ago and the global output gap is shrinking. This EUR ● positive development is offset by greater risk of EM overheating due to surging capital inflows and policy makers who may fall behind the curve in fighting inflation. This increases DM “bad inflation” risk. US Treasuries ● • Sovereign risk in Europe is back, with Ireland posing contagion risks to periphery bond markets USD ● because of an undercapitalized banking system. Portugal’s weakness due to structural problems Europe credit ● makes it likely to go to the EFSF as well. German Bunds ● • Rising currency tension is a downside risk if it constrains capital flows and trade, but EM currencies, if they continue to rise, are a counter to inflation risk and ultimately help global rebalancing. JPY ● 7 Greg Peters, (212) 761-1488, Greg.Peters@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Investor Debates Risk on or off?  What’s the catalyst to end the ‘risk on’ trade? When will ‘risk on’ end? Has that happened already?  Will ample liquidity continue to support markets or is asset reflation due to QE already priced?  Is evidence of improving growth enough to counter increased sovereign and EM overheating risks?  Can events in EM be the trigger for risk off even if DM growth is ok and liquidity is abundant? US outlook & QE  What impact will QE have on the economy?  Based on recent economic data, and the increase in rates, will growth be better than expected?  Will the Bush tax cuts be extended? Is the policy gridlock in Washington a positive for the markets?  Can the Fed tolerate higher inflation and risk asset bubbles, especially given international pressure?  How significant is the potential negative feedback loop from QE (e.g., importing inflation)?  How long will investors give growth a “free pass” before expecting to see benefits from QE? Sovereign debt  When and what will cause Ireland to go to the EFSF / IMF? crisis  How long will the ECB continue to support Irish banks before forcing a fiscal solution?  Will Portugal quickly follow Ireland’s lead in going to the EFSF?  If Ireland goes to the EFSF, will it be a ‘circuit breaker’ by recapitalizing its banks or trigger contagion?  What form and final impact will the proposed Crisis Resolution Mechanism have?  How extensively will contagion spread to Spain? To the euro core? China / EM  How at risk is China of overheating? Will tightening lead to a soft or hard landing? overheating & FX  How widespread is the risk of overheating across EM?  How serious will the currency war get? How likely are further capital controls?  Which countries will respond to QE by raising interest rates (and FX) and which will risk inflation?  Which countries will be the winners and losers from QE, stronger currencies, and higher commodity prices? 8 Greg Peters, (212) 761-1488, Greg.Peters@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Investor Debates by Asset Class Rates  Why have rates across the Treasury curve gone up since the Fed announced QE details?  Will rates decline, and by how much, once the Fed starts to purchase Treasuries?  Will euro-periphery spreads continue to widen on contagion fears?  What happens to spreads in the core if a periphery country taps the EFSF fund?  With rising inflation risk in EM and large capital inflows, what happens to credit spreads and local rates? FX  Will the USD continue to strengthen on better growth and ‘risk off’, or weaken again on QE?  Can the EUR strengthen despite sovereign risk problems?  Will China allow the CNY to appreciate faster to fight inflation and alleviate global pressure?  Which EM countries will try to keep their currencies from rising?  How will currency tensions be resolved? Will there be coordinated policies?  How long will the USD remain the main reserve currency? What are the alternatives to replacing it? Equities  Have equities fully priced in the benefits of QE? Can the rally only continue if growth improves?  Would Ireland going to the EFSF lead to a significant correction? Even if growth is still surprising to the upside?  Are EM equities at risk of a correction on tightening concerns?  Is DM more attractive than EM, given overheating concerns? Can high-beta EM fall while DM is rising?  Will multiples contract if growth doesn’t improve? Credit  What does QE mean for corporate credit with yields already so low?  What’s the risk to credit from companies doing shareholder-friendly activities (M&A, buybacks, dividends)?  What does Basel III mean for hybrids and Tier 1 capital?  How is bank debt / RMBS affected by the mortgage foreclosure crisis and mortgage put-back problem? Commodities  How much more will QE and lower USD drive up commodities?  With tightening supply and stronger EM growth, how high could commodities go?  Will gold continue going higher because it is an inflation hedge against QE and a risk-off hedge? 9 Greg Peters, (212) 761-1488, Greg.Peters@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Asset Classes Base Case Views Rates / Sovereign Credit Trades Views • Long front-end forward rates to benefit from rolldown – + • We see the 10Y trading in a range of 2.25% to 2.85% in the near term, with rates likely to fall once Fed purchases begin. and carry with the Fed likely on hold for a while US duration ● • Overweight the belly of the curve; the 5-10yr sector is EU volatility ● • Fed purchases will cause the belly to outperform further as the bulk of the purchases are in the 5-10y sector. We expect the 2s10s curve to flatten close to expected to outperform, boosted by Fed purchases US volatility ● 2.00 while the 10s30s could continue to steepen. • We now like being short volatility on 5s and prefer to US spreads ● • A headwind for lower rates is the negative feedback loop, driven by higher move our long variance trade to 30y tails EM spreads ● inflation in AxJ due to excess liquidity. Inflation could flow back to the US in the • Long low coupon vs. high coupon in Greece, Portugal, EU curve ● form of higher commodity prices, but also a decline in foreign ownership. Spain, UK (cheap insurance against contagion) EM local dur. ● • We expect interest rate volatility to increase further out on the curve (30y), and to • Long Italy, Spain, France and Belgium vs. short EM local curve ● fall in the belly. Portugal, Ireland, and Netherlands EU duration ● • Reversing our underweight of euro peripheral vs. core for 3 reasons: 1) tactical • 5s to underperform on the Bund curve, 10s to US curve ● trading model has its smallest underweight to peripherals for 5 quarters; 2) outperform EU spreads ● potential regulation of financials may support peripheral bonds; 3) downside risks • Gain exposure to EM growth through Argentina to peripherals are lower for investors measured against a pan-Europe index. warrants and O&G sector • In EM, we move our directional stance to neutral/bullish. Metrics reveal signs of • Favor high-beta (Central and Eastern European stability in EM macro-fundamental trends. This development supports the case for countries, Ukraine, Argentina) over low-beta credits building strategic long-side EM risk positions into 2011. EM risk market remains short-term overbought but valuation metrics suggest more compelling entry levels. . FX Trades Views • With improving global economic conditions contrasting with the Fed’s easing • Short EUR/CHF (1.28) – + move, there may be near-term upside risks for higher-beta currencies in the G10. CHF ● • Long EUR/USD (1.46) Our preferred currencies are CHF, GBP and SEK. GBP ● • Short EUR/SEK (8.88) SEK ● • We are now in the final stages of USD weakness and EUR is generally trading with the core. The key risks to this call are US economic data outperforming and • Long GBP/JPY (134.50) KRW ● German data underperforming. Unless peripheral concerns begin to have an • Short MS Dollar Index (65.00) CAD ● impact upon the core, we expect that peripheral issues will not have lasting • Long MS AxJ Index (120.00) SGD ● impacts upon EUR/USD, although they may increase volatility going forward. CNY ● • We take a cautious approach by looking for other European outperformance NOK ● against the EUR. We look for CHF to be the biggest beneficiary from any EUR ● concerns surrounding the Eurozone, while SEK should also benefit due to the strong fundamentals and dual surpluses of both currencies. USD ● NZD ● • We like GBP tactically as we believe QE expectations will continue to be priced out in the short-term leading to GBP benefit as it contrasts with the rest of the G4 AUD ● as GBP is not hampered by QE and the UK takes control of its fiscal problems. JPY ● 10 Greg Peters, (212) 761-1488, Greg.Peters@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Asset Classes Base Case Views Equities Trades Views Europe Europe – + • Tactically constructive on DM and EM equities, any pullback should be modest. • Post-QE announcement, US growth will be the main driver for equities moving • Add some beta – e.g., Financials & Commodities. Materials ● higher, while QE will continue to provide a cyclical floor to the market. • Superior EM growth – Energy and Materials offer Energy ● • Elevated sovereign risk and the potential for contagion in Europe is a headwind better value than Staples and Capital Goods. Financials ● for equities; this is likely to remain until there is some resolution with Ireland • Reliable growth stocks should be long-term winners, Telecom ● initially and then the rest of the euro periphery. however value stocks should outperform in the short- Industrials ● term if the market rallies. Tech ● • Rising inflation in China and other countries in AxJ, exacerbated by QE, could trigger significant tightening – otherwise risk overheating. We would look to reduce • Dividend strategies – we like high and secure Cons Staples ● an EM overweight given the potential for a corrective phase. dividend yielders; stocks where DY > credit yield; Healthcare ● index dividend swaps. • Longer-term, we expect DM equities to trade in a broad range for an extended Utilities ● period for 3 reasons: 1) that’s what usually happens after big bear markets; 2) Japan Cons Disc ● valuations point to low returns; and 3) we expect a sub-par macro cycle. • Buy domestic demand super-large caps: Large has • Near-term, DM equities have reasonable valuations and attractive yield, but underperformed small; super-large (Core 30) has investor sentiment is reaching elevated levels. underperformed large; within the Core 30 of Topix, EM – + domestic demand stocks have underperformed. • Valuations are fair, particularly in Europe – approx. 10.5x 2011 IBES P/E, China ● earnings growth leading indicator predicting 48% earnings growth NTM EM Malaysia ● • High dividend yields for the S&P 500 and MSCI Europe – comparable to the • Overweight consumer discretionary as a play on Russia ● 10Y Treasury yield – are supportive for prices as investors seek yield development of urban middle class and rising wages. Korea ● • Expect companies to start putting to work near-record cash holdings in • Overweight upstream Asia / EM energy Taiwan ● increased dividends and buybacks, and M&A, though more so in 2011 • Underweight telecoms, utilities and healthcare India ● • Earnings forecasts for 2011 are optimistic, but haven’t increased since the • In China, overweight high-beta sectors – properties, Brazil ● spring and significant downward revisions are less likely. material, banks, and insurance – and underweight Indonesia ● • Flows out of equities and into bonds are slowing and likely to reverse in 2011 transportation, consumers, auto, and technology. South Africa ● if rates start to rise, providing a technical tailwind for equities. Thematic Turkey ● • EM equities are increasingly less attractive after a 35% return to MSCI EM since • Long Large Cap Quality Mexico ● May and rising inflation and tightening risks. Valuations are in-line or slightly above long-run averages. • Long DM equities with high leverage to EM growth • Technical support from Asia / EM funds – 23 consecutive weeks of positive flows • Long Dividend Yield / Reliable Growth – but the markets are technically overbought and there is a big wave of secondary placements from corporates in the pipeline. 11 Greg Peters, (212) 761-1488, Greg.Peters@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Asset Classes Base Case Views Credit / Spread Product Trades Views • Overweight US & Asia, neutral Europe. – + • Generally constructive – a low growth, low return world should keep DM credit in a • Long Financials, and extend out the maturity curve. US HY ● relative “sweet spot,” with a lid on egregiously credit-unfriendly actions. Tier 1 in Europe and Asia remains a core overweight. CLO ● • Financials should lead the way with ongoing credit repair, especially in Europe, • Quality HY is cheap relative to low-quality IG in the Asia Financials ● and benefit as banks call/tender Tier 1 paper. However, the size, timing and scope of GSE MBS putbacks to US banks is a new headwind to credit valuations. US: overweight BBs vs. BBBs. The same applies to US Financials ● Asia. Buy 3s5s steepeners in selected US HY. Asia HY ● • Attractive valuations and strong corporate fundamentals in non-financials provide a margin of error against higher loss rates, but volatility is likely to remain high. • Long the HY ‘tails’ (CCCs) relative to high quality. RMBS ● • Put spread collars in iTraxx Main and Senior EU Financials ● • Headwinds for credit are (1) low Treasury and Bund yields that have driven corporate bond yields to historic lows, constraining further spread repair; and (2) Financials to play sovereign volatility. For large tail Asia IG ● with low yields on QE, we see a pickup in shareholder friendly activity (i.e., scenarios, put spreads in CDX IG and risk reversals in US IG ● moderate increase in LBOs) as likely. CDX HY. Europe IG ● • The front end of the credit curve is more attractive based on current stage in the • Long senior tranches of non-agency RMBS (subprime CMBS ● default cycle, spread per unit of duration, and roll down and carry. and alt-A). Europe HY ● • Net shrinkage in supply and fund flows are positive technicals; fully invested • Long CMBX.3 AM and short CMBX.3 A; expect to see investors and positive supply are near-term headwinds in Asia. substantial steepening here. • For non-agency RMBS, the market is pricing in much harsher outcomes than the • All CLO tranches are cheap compared to the collateral is currently and expected to perform. This provides a substantial positive underlying; particularly bullish on CLO mezz. convexity potential. For CMBS, the two most senior classes of the synthetic CMBX indices, AAAs and AMs, remain cheap to fair value, while the AJs and below are extremely rich Commodities Trades Views • With refinery maintenance having peaked, we anticipate further crude draws • Good risk/reward in being long crude, specifically – + ahead, which together with a still favorable macro environment should lift oil prices Dec’11 WTI, with prices very likely to move north of Agriculture ● higher into year-end. $90/bbl by year-end. Precious metals ● • Our updated analysis of crude oil’s supply-side fundamentals portends falling • Seek exposure to stockpiling ahead of China’s H1 Oil - WTI ● spare capacity, which will propel prices above $100/bbl in 2011 to ration demand. production/consumption cycle, (coal and iron ore). Gold ● • Agriculture prices have rallied and the corn balance is precariously tight. Prices Strong conviction on copper and nickel, avoid Bulk comm'd ● aluminium and zinc. will need to continue to move higher, to at least $6.00/bu for a sustained period, to Base Metals ● ration demand and add acreage. Weather is still a significant risk to wheat. • Add exposure to corn (Dec’ 11) but shy away from Natural Gas ● wheat as weather is the biggest driver. • The weakening of the US$ has been the major factor in the current metals rally, although the impact of the strengthening in the global manufacturing sector as • Add gold to the precious metals basket for protection evident in the latest PMIs should not be underestimated as a factor in the against a USD under pressure, palladium for a sustainable strength of metal and bulk raw material prices. greater risk appetite 12 Greg Peters, (212) 761-1488, Greg.Peters@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Risk-Reward Views 13 Greg Peters, (212) 761-1488, Greg.Peters@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Global Economics Risk-Reward View Investor Debates What’s in the price? Signposts  Equity and credit markets have rallied on the prospect of  QE2: will it work? Will other DM central banks follow the Fed? How will EM policymakers react? QE2, and, while the bond market is looking for the QE2- consistent level of yields, the dollar has weakened. After G20 summit  Global growth: merely moderating or double-dipping? Key focus on US and China trajectory in 2H 2010 and 2011.  Risky assets are pricing growth moderation, but no DD. US Tsy semi-annual currency report  QE2 has raised inflation expectations from low to more  Inflation or Deflation? What is more powerful – By 4Q moderate levels. deleveraging or massive monetary stimulus? PBoC to revise up 2010 target for new bank lending (currently RMB Base Case / Thesis 2011 Global GDP: 4.2%  Bull Case 2011 Global GDP: 5.4% 7.5trn) Just say no to the double-dip Cyclical momentum in the A stronger capex and inventory cycle could boost global December Euro Area and the UK is still strong, and we are looking for a output and trade. Commodity prices would skyrocket, fuelling Greece: 3rd disbursement of € 9Bn pickup in US growth next year. Fiscal tightening is less inflation concerns and leading to more aggressive monetary widespread than generally believed and may crowd in tightening. 2010-11 private spending. Importantly, with the Fed engaging in QE2, China currency manipulation bill to go global monetary policy remains super-easy.  Bear Case 2011 Global GDP: 3.0% before Senate Central banks: The Big Easy Fed, ECB, BoJ all remain Growth in China/Asia falters in response to monetary super-expansionary into 2011, and EM CBs’ ability to tighten tightening, aborting the strong global trade recovery, pushing is thus limited due to concerns about excessive currency commodity prices lower. Protectionism could also be a policy appreciation. China is even starting to relax credit policy. response. Fiscal positions would deteriorate further, making Sovereign risk concerns to spread into the European a large-scale sovereign risk crisis even more likely. core and, eventually, to migrate to the US as most governments lack resolve to tighten policy significantly. This raises the temptation to inflate away the debt. Key Indicators GDP Growth: Not Double-Dipping, Moderating 2010 2011 2012 2013–2017 6 G10 F o re c a s ts Bull 5.4 5.9 5.0 4 Global GDP Base 4.7 4.2 4.4 4.1 Bear 3.0 2.9 3.0 2 Bull 3.2 3.8 2.7 0 DM GDP Base 2.4 2.1 2.4 2.1 -2 Bear 0.9 0.9 1.4 -4 Bull 7.9 8.2 7.4 EM GDP Base 7.3 6.5 6.5 6.1 -6 Bear 5.2 4.9 4.5 -8 G 10 G DP Q oQ SAAR G 10 CPI YoY Bull 4.0 4.3 3.8 -1 0 Global G 1 0 P o licy R a te Base 3.3 3.2 3.2 3.1 M a r-0 0 M a r-0 2 M a r-0 4 M a r-0 6 M a r-0 8 M a r-1 0 M a r-1 2 Inflation (CPI) Bear 2.5 2.5 2.4 Source: Morgan Stanley Research 14 Joachim Fels, Manoj Pradhan, Spyros Andreopoulos (44 207) 425-6138, joachim.fels@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 US Economics Risk-Reward View Investor Debates What’s in the price? Signposts  Double-dip and deflation fears have eased, reflecting the onset of  Near term, our trading desk does not think that QE2 is fully in the November 15 QE2. But tail risks are not zero: Recent data have been mixed. price, and yields may decline to 2.3%. Equally, with monetary “Lame duck” session of Congress begins  Policy intractability: Fiscal policy appears gridlocked, although an policy driving yields, it is difficult to determine whether or not real extension of expiring tax cuts is likely at some point. The yields reflect market expectations for growth. But rising December 3 economic impact of additional easing likely will be modest. breakevens do reflect some longer-term upside for inflation,  Sovereign credit concerns: When will spotlight turn to the US? something the Fed welcomes. November employment situation December 14 Base Case / Thesis 2011 GDP: 2.7%  Bull Case 2011 GDP: 3.8% FOMC meeting Subpar growth, but consensus is too dour. Four factors will Improving income and another increase in mortgage refinancing sustain growth at 2-2½% in H2: (1) a rebound in net exports; (2) activity should bolster household cash flows and add to solid growth in personal income; (3) a modest refinancing wave; (4) discretionary spending power. Overall final demands look set to rising infrastructure spending. We still think that the US economy accelerate and historically low levels of business inventories (in remains on track for moderate, sustainable growth in 2011. relation to sales) point to production gains. A rebound in inflation expectations could prompt a much more rapid exit by the Fed than QE2. We expect the Fed to announce an initial commitment to buy is now priced in. Treasuries at around a $100 billion monthly clip for the next six months. Going forward, the Fed likely will adopt a flexible approach  Bear Case 2011 GDP: 1.6% to QE that can be scaled to economic and financial conditions. Nevertheless, the fractures in the monetary policy transmission Even larger home price declines, the “sunset” of the Bush tax cuts, mechanism mean that QE won’t yield much bang for buck. and continued moderation in job growth could weigh on growth. If QE2 will push nominal yields lower. We believe that the actual the economic recovery falters, the unemployment rate will climb start of the program will trigger further significant declines in significantly, credit-related losses will mount, and risk aversion will Treasury yields, especially if the Fed is as resolute as its prior predominate. These developments would reinforce deflation fears rhetoric. and compel the Fed to undertake more significant QE. Key Indicators Two Scenarios for Growth in 2011 4.0 2009 2010 2011 2012 US Real G D P G row th (Q uarterly % Change, SAAR ) Bull 3.0 3.8 4.8 GDP Base -2.6 2.7 2.7 3.2 3.5 M S Base Case (O ctober 2010) Bear 2.4 1.6 1.6 M S "Full Sunset" Scenario (O ctober 2010) 1.8 2.4 2.9 3.0 CPI -0.3 1.6 1.8 2.2 1.5 1.3 1.5 9.6 8.4 7.6 2.5 Unemployment 9.3 9.7 9.2 8.3 9.8 10.0 9.0 0.50 1.50 3.50 2.0 Policy Rates 0.125 0.125 0.125 2.50 (EOP) 0.125 0.125 1.00 1.5 1Q 10A 2Q 10A 3Q 10E 4Q 10E 1Q 11E 2Q 11E 3Q 11E 4Q 11E Source: Bureau of Economic Analysis, Morgan Stanley Research estimates 15 Richard Berner, (212) 761-3398, richard.berner@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Europe Economics Risk-Reward View Investor Debates What’s in the price? Signposts  Will Portugal/Ireland have to tap the EFSF? Will the crisis  GDP growth of 1.6% this year, around 1.4% next year. November 16 & 17 resolution mechanism replacing the EFSF in 2013 pave Subdued inflation pressures (5Y/5Y fwds at 2.14%). Eurogroup Meeting the way for a debt restructuring? – When/how will the ECB  ECB starting to gradually raise rates in H2 2011. Ecofin Council Meeting move towards the exit? Is the ECB done buying peripheral  Ten-year bund yields to continue to move higher. Consensus UK MPC Minutes government bonds? – Could Germany see a consumer forecasts are for 3% in late 2011. November 23 & 24 revival given its strong labour market performance? France INSEE Mfg survey Germany Ifo index Base Case / Thesis 2011 GDP: 1.4%  Bull Case 2011 GDP: 2.3% Late November Our base case is for growth momentum in the second half of Bold policy action would address the issues in the banking Troika to judge Greek progress this year to return to the trend range of the strong print in 2Q. system and force recapitalisation/restructuring. ECB keeps December 2 Incoming activity data point to upside risks to our official liquidity ample. Borrowing costs come down substantially, ECB Council Meeting & Press Conf forecasts for growth to return to trend in 2H 2010. The helped by credible fiscal consolidation. Global growth is even stronger led by EM and more expansionary policies globally. December 6 stronger than expected momentum is a welcome cushion Eurogroup Meeting against the impact of a stronger euro. Several factors  Bear Case 2011 GDP: 0.5% support our call for a slowdown between this and next year. Budget Ireland First, there will be additional fiscal tightening at the beginning Policy inaction and looming bank losses lead to full blown Ecofin Council Meeting of next year, notably in the large countries. Second, even credit crunch. Inventory and investment recovery reverts. December 9 though credit growth seems to have troughed the recovery Fiscal austerity forced by the market lacks credibility and the UK MPC Meeting remains creditless. Third, outside Germany, the euro area periphery marks new wides. Global growth peters out as no recovery still remains largely jobless. With both growth and one is stepping into the void left by the US consumer. A inflation being modest over the forecast horizon, we expect global inflation scare propels bond yields higher. the ECB to be on hold until early 2012. Key Indicators Bull, Base, and Bear Cases – ECB Refi Rate 2009 2010 2011 2011–2015 5 Bull 1.8 2.3 2.6 GDP Base -4.1 1.5 1.4 1.8 4 Bear 1.3 0.5 1.0 1.8 2.3 1.6 3 CPI 0.3 1.7 1.8 2.1 Refi rate 1.4 1.3 2.6 2.00 2 9.7 9.0 Base Case Unemployment 9.4 9.9 9.5 Rate (%) 1 1.00 10.2 10.7 1.00 2.00 0.10 Policy Rates 0 1.00 1.00 1.00 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 (EOP) 0.75 0.10 Source: Morgan Stanley Research 16 Elga Bartsch, (+44) 207 425 5434, elga.bartsch@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Japan Economics Risk-Reward View Investor Debates What’s in the price? Signposts  Will the yen weaken or strengthen?  Investors are reluctant to take short-horizon strong-yen Early November  Have JGB yields hit bottom? positions in yen/dollar, fearing intervention. JGB investors BoJ Law revision proposals  Will politics change fiscal policy ? are waiting to see the DPJ’s stance on budget issues such discussed by a group in the ruling as spending control, tax hikes, and civil service reform. party and by opposition parties; Reduced BoJ independence would likely be welcomed by pressure on BoJ continues. markets, and bring earlier yen weakness. End-November Production, inventory, employment Base Case / Thesis ¥93/US$ (end 2011)  Bull Case ¥110/US$ indicators announced late in the BoJ remains behind the Fed in aggressiveness of easing US growth surprises on the strong side, pushing Fed to a month; these will determine whether stance, spurring continued yen strength. Although weak stronger rate hike, while DPJ government pressures BoJ BoJ will be pushed toward increase of growth and continued deflation will spur more BoJ easing, toward more easing. JGB yields rise as capital flows abroad; special fund. we expect BoJ action to be slow and grudging, relative to domestic investors show weaker home bias. Global growth strong enough to raise earnings sharply. December other central banks. Only when deflation fears in US wane will we see reversal of yen strength Tax Debate  Bear Case ¥75/US$ Ruling party tax committee will We still see strong demand from duration matching needs will keep demand for JGBs strong. However, higher volatility US growth double-dips, Fed does QE3, while BoJ resists debate corporate tax cut, elimination has triggered “sell on strength” in JGBs, and put a floor policy change. China slowdown hurts exports, harming of special tax breaks, tax-loss carry- under yields at around 0.9% for the 10yr JGB. earnings growth. Intervention by Japanese authorities might forward extensions, etc. slow yen appreciation. Policy will drift as political disruptions continue. Credible direction will emerge only when politics settle, which could Budget finalization Cabinet must take several more months. approve draft budget for FY11 by end-December. Focal points: (a) Key Indicators Yen/US$: Breakout only in end-2011 whether new bond issuance will exceed the government’s declared 2010e 2011 2012 2013–2016 Y44 trl ceiling, (b) spending control, 115 115 Bull 3.4 2.2 3.1 2.0 Y en / U S $ F o r c d a te 29O CT10 (c ) Revenue projections. 110 110 GDP Base 3.0 1.0 1.7 1.0 105 105 Bear 2.7 -0.1 0.2 0.0 Bull -0.9 0.0 0.2 1.0 100 100 CPI Base -1.0 -0.3 -0.2 0.5 95 95 (Japan Core) Bear -1.1 -0.6 -0.5 0.0 90 90 Bull 5.1 4.7 3.9 3.0 Unemployment 85 85 Base 5.1 4.9 4.5 3.7 Rate 80 80 Bear 5.1 5.5 5.9 5.0 2 sd b a nd , b a se d o n 1 0 0 d m -sd ev . 7 5 Bull 0.05 0.25 0.50 1.5 75 Call Rate (EOP) Base 0.05 0.05 0.25 0.5 70 70 2008 2009 2010 2011 Bear 0.05 0.05 0.05 0.05 Source: Morgan Stanley Research 17 Robert Feldman, +81 3 5425-5385, Robert.Tokyo.Feldman@morganstanleymufg.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 China Economics Risk-Reward View Investor Debates What’s in the price? Signposts  Whether headline CPI inflation is peaking or would keep  A Goldilocks Scenario. rising through the year. In the latter case, the probability of December another interest rate hike will be rising. Early December, Central Economic  Whether property prices would correct before year end– Work Conference which will set the as supply comes on line–or resurge. In the latter case, the policy targets for 2011 risk of another wave of austere measures would be high. Base Case / Thesis 2010 GDP: 10%  Bull Case 2010 GDP: 11% 2010 – Goldilocks On Track: We expect headline CPI If a) external demand were to be substantially stronger than inflation to peak at 3.7-3.8%YoY in Oct-Nov 2010 before envisaged under our baseline scenario; and b) a major declining below 3.5%YoY in Dec 2010. We forecast GDP slowdown in private residential property construction would growth at 9.3% YoY (or 2.4% QoQ SAAR) in 4Q10 and not materialize while the social housing program would take 10.2% for the year as whole. Our calls include: a) no off, a full-blown overheating would become possible. additional rate hike through year-end; b) bank lending target is unlikely to be relaxed significantly beyond the original  Bear Case 2010 GDP: 9.0% target of Rmb7.5tn; and c) RMB appreciation against the USD to continue, reaching 6.60 by end-2010. The strong export growth in 1H10 may well turn out to be transitory, and the subsequent export growth over the course of the year would slow sharply. Austere policy measures against speculation in property market may weaken construction activity substantially, while the social housing program may fail to fill the slack in 2H10, resulting in a hard landing in FAI growth. Key Indicators China: Economy Regained Momentum 20 2009 2010 2011 2012–2016 GDP ( QoQ , %, SAAR) Regained Bull 11.0 11.0 9.5 16 15.1 Momentum GDP Base 9.6 10.0 9.5 8.0 12.7 12 Bear 9.0 8.0 6.5 9.8 10.0 9.2 9.5 11. 1 Bull 3.3 4.5 4.0 8 7 .5 7.1 8.3 CPI Base -0.6 2.8 3.0 3.0 2.8 Bear 2.3 2.0 2.0 4 Bull 3.3 3.5 3.0 0 Trade Balance Base 4.0 2.8 2.2 2.0 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 (% of GDP) Bear 2.3 1.5 1.5 Source: Morgan Stanley Research 18 Qing Wang, (852) 2848-5220, Qing.Wang@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 AxJ Economics Risk-Reward View Investor Debates/Themes What’s not in the price? Signposts  Will China’s current stabilization of domestic demand  We expect China's policy rate hike to be one-off and expect Nov 16 continue? Will policy makers signal softening in policy policy makers to signal softening in policy stance in Q4- BOK’s monetary policy meeting stance or continue with policy rate hikes? 2010, considering that the targeted moderation in demand  Will increasing food and commodity prices, strong growth appears to have been achieved. Nov 30 and delayed policy exit result in inflation risk in AXJ?  We continue to see upside risk of inflation on strong growth, delayed policy exit and higher commodity prices. India’s Quarterly GDP  Will regions’ policy makers respond with stringent capital control measures on rising capital inflows?  If capital inflows were to become unmanageably high, some countries may initiate measures to discourage debt capital inflows, but not equity capital inflows. Base Case / Thesis 2011 GDP: 8.2%  Bull Case 2011 GDP: 9.4% In 2011, we expect GDP growth to remain strong at 8.2% We believe the key driver that can influence our base case (close to the trailing five-year average), compared with 8.9% GDP growth forecasts positively would be an upside surprise in 2010 and 6.2% in 2009. We expect the region’s growth to in exports. Exports have already recovered above pre-crisis be driven by domestic demand. We expect private levels. consumption to continue to accelerate across the region. However, capex growth is likely to moderate in China as well  Bear Case 2011 GDP: 6.9% as AxJ ex-China. Reflecting the relative strength of domestic demand, we expect the region’s net exports (as a We think the key risk to our base case is any deterioration in percentage of GDP) to decline to 4.1% in 2011 from 4.3% in EU’s sovereign debt concerns and/or US growth outlook, 2010 and the peak of 6.8% in 2007. leading to a double-dip in the developed world. A double-dip in the developed world can pose downside risk to external demand and capital inflows. Key Indicators CRB Commodity Index Above Pre-Crisis High 2009A 2010E 2011e 2012e 2013–2017e 500 WTI US$ Per Barrel (RS) 148 Bull 9.4 9.6 8.7 CRB Food Index (LS) 125 436 GDP Base 6.2 8.9 8.2 8.0 7.6 CRB Commodity (LS) 102 Bear 6.9 6.4 5.8 372 79 Bull 4.8 4.6 4.3 308 CPI Base 2.4 4.8 4.0 3.6 3.5 56 Bear 3.3 2.8 2.3 244 33 Policy Rates (EOP) 4.5 5.0 5.7 5.8 180 10 5.3 3.4 2.9 2.8 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 CAB (% of GDP) Fiscal Balance (% of GDP) -3.7 -3.8 -3.2 -3.2 Source: Bloomberg, Morgan Stanley Research. 19 Chetan Ahya, +65 6834 6738, Chetan.Ahya@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Brazil / Latam Economics Risk-Reward View Investor Debates What’s in the price? Signposts November 16  While authorities have tightened exchange controls,  Brazil market is pricing in no more hikes this year and we agree, but we see another 175 bps of hikes in 2011 while the Chile – Monetary Policy Meeting raising the IOF tax on fixed income, equity fund, multi market fund and debentures capital inflows, BRL keeps market sees 150 bps of tightening at most;  Equity and credit markets are once again showing significant November 19 strengthening. Can the authorities fight the rally? strength and confidence that Brazil’s economy is likely to Colombia – Monetary Policy Meeting  Mid-cycle moderation or more worrisome sign? We believe Brazilian growth is strongly linked to global cycle. produce strong results this year and next. October 26 Base Case / Thesis 2010 GDP: 7.9%  Bull Case 2010 GDP: 8.7% Mexico —Monetary Policy Meeting Brazil’s economy is slowing. After posting GDP growth at Given lags between monetary tightening and the economy’s December 1 11.4% annualized pace in the first quarter, the economy response, more fiscal stimulus for longer and supportive global backdrop, Brazil’s growth rate in the second half Chile – Monetary Policy Minutes stalled in April through July—the stalling was hard to see Peru – CPI (November) given the momentum at the beginning of the second quarter bounces back after mid-year to pace similar to what was which kept the average for the second quarter up 5.1% on seen in the first fourth months of the year. annualized basis over first quarter. Part of the slowdown may December 3  Bear Case 2010 GDP: 7.2% Colombia – Monetary Policy Minutes be a mid-cycle moderation, especially after tax breaks accelerated consumption in the first quarter. But we suspect The bear case assumes the economy stalls in the second slowdown may also have been a reaction at the time to a half of 2010—even in that case, the strong statistical December 5 more cautious global outlook. The slowing allowed the carryover in early 2010 should produce a solid headline Colombia – CPI (November) central bank to slow the hiking pace in July and signal hikes average growth rate. It assumes that global conditions turn may have ended for the time being in September. less supportive, while domestic concerns on political December 8 developments increase. Although we have growth moving We suspect growth will be strong enough in 2011 to prompt Brazil—Monetary Policy Meeting back to 3% range in 2011, the headline annual GDP report the central bank to restart hikes under next administration. would likely post closer to 2%. Brazil – CPI (November) Key Indicators Brazil: Real GDP Growth December 7 (% change y-o-y) Chile – CPI (November) 2009 2010 2011 2011–2015 Bull -0.2 8.7 6.3 5.0 1 2 .0 % December 8 GDP Base -0.2 7.9 4.0 4.0 1 0 .0 % Mexico – CPI (November) 8 .0 % Bear -0.2 7.2 2.0 3.0 6 .0 % Bull 4.3 6.2 6.0 5.5 4 .0 % CPI Base 4.3 5.8 5.5 5.0 2 .0 % Bear 4.3 4.8 4.5 4.5 0 .0 % Bull 8.75 12.25 15.75 NA -2 .0 % Policy Rates Base 8.75 10.75 12.50 NA (EOP) -4 .0 % J u n -0 4 M a r -0 5 D e c -0 5 S e p -0 6 J u n -0 7 M a r-0 8 D e c -0 8 S e p -0 9 J u n -1 0 M a r-1 1 D e c -1 1 Bear 8.75 10.75 8.75 NA Source: Morgan Stanley Research 20 Gray Newman, (212) 761-6510, Gray.Newman@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 India Economics Risk-Reward View Investor Debates/Themes What’s not in the price? Signposts Near term  We remain bullish on India’s structural as well cyclical November 30  Is market underestimating inflation and trade deficit risks growth outlook. However, we believe accommodative GDP data for QE-September in India? monetary and loose fiscal policies have pushed growth Medium term higher than the near-term potential. Over the next 6-12 months, we believe that monetary policy and fiscal policy exit Next 6 Months  Infrastructure – India’s long-term structural challenge now Policy announcements on (1) will need to stay on course to manage the macro stability getting addressed, lifting sustainable growth rates. divestment of the government’s stake risks of a large trade deficit, rising inflation expectations and  Will India start outpacing China’s growth rates in 3-4 in SOEs; (2) infrastructure sector low deposit growth in the banking system. years’ time? including highways and electricity Base Case / Thesis 2010 GDP: 8.5%  Bull Case 2010 GDP: 9.0% Transitioning from policy-driven to private-sector- We see a bull-case scenario growth for India at 9% in 2010, driven growth in 2010: We expect GDP growth to rise to assuming acceleration in pace of structural reforms from the 8.5% in 2010 compared to 6.7% in 2009. In 2010, even as government and better than expected external demand. policymakers gradually withdraw the monetary and fiscal  Bear Case 2010 GDP: 8.0% policy support, we expect the growth momentum to be sustained. We think the key risk to our base case is a decline in global risk appetite and capital inflows in the country. Any spike in Sustaining 8% plus growth in 2011: We expect the commodity prices will stoke inflation pressures and push government to execute on several of the long-pending policy current account deficit wider to vulnerable level. changes, ensuring acceleration in the capex cycle (manufacturing as well as infrastructure) along with steady growth in private consumption. Key Indicators BRIC: Two-year Trailing Average GDP Growth 14% 2009 2010e 2011e 2012e 2013–17e 12% Bull 9.0 9.8 10.3 11.0 10% Base 6.7 8.5 8.7 9.0 9.5 8% GDP Bear 8.0 7.7 7.8 7.5 6% Bull 12.3 7.5 7.0 6.5 4% Base 10.8 12.0 6.5 5.6 5.0 2% CPI Bear 10.5 5.8 5.0 4.0 0% Policy Rates (EOP) 4.75 6.25 7.50 7.75 Braz il Rus s ia CAB (% of GDP) -2.2 -3.4 -2.3 -2.0 -2% India China Fiscal Balance -4% 2010E 2011E 2012E 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 (% of GDP) -9.8 -8.1 -7.3 -6.9 E = Morgan Stanley Research estimates; Source: CEIC, IMF, Morgan Stanley Research 21 Chetan Ahya, +65 6834 6738, Chetan.Ahya@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Russia Economics Risk-Reward View Investor Debates What’s in the price? Signposts  To what extent will the food prices and social transfers  Consensus sees GDP growth around 4.0% in 2010, and Nov-2010 accelerate the CPI inflation in 2011? 4.5% in 2011. We are slightly more optimistic on this year Final 2011-2013 Budget Law  When will the CBR start the rate hiking cycle? but we see risks of the weakening external demand.  What will the final privatisation plan and schedule look Dec-2010 like? The final privatisation plan from the government Base Case / Thesis 2010 GDP: 4.2%  Bull Case 2010 GDP: 5.0% We expect growth to reach 4.2% in 2010. We cut our Stronger commodity prices could boost short-term growth. previous forecast of 5.5% due to lower than expected 1Q  Bear Case 2010 GDP: 3.5% GDP growth as well as the slowdown in activity seen in the summer caused by extreme heat. We are positive on 2011 We see risks of the weakening external demand and more with our GDP forecast at 4.3%, thanks to a boost from negative contribution from net exports. Hidden bad debt may constrain domestic demand and credit, while an absence of investment. Also, the government plans to increase social reform may leave growth stagnant. spending prior to presidential elections in 2012. As a result, we are concerned about upside inflation risks next year, but are also optimistic on household consumption (+5.5%Y in 2011). We expect the CBR to stay on hold until the end of the year, and to start tightening only in 2011, when the recovery is on firmer grounds. Key Indicators Domestic Demand Takes Over as a Growth Engine 2009 2010 2011 2011–2015 40 % year on year MS Bull 5.0 6.5 6.0 30 forecast GDP Base -7.9 4.2 4.3 3.7 20 Bear 3.5 2.2 1.5 10 Bull 7.1 10.7 11.0 0 -10 CPI Base 11.7 6.7 9.0 8.1 Real GDP HH consumption -20 Bear 6.4 6.8 4.0 Export Fixed investment -30 Import Bull 8.25 12.00 NA -40 1Q- 1Q- 1Q- 1Q- 1Q- 1Q- 1Q- 1Q- 1Q- 1Q- 1Q- Policy Rate Base 8.75 7.75 8.50 NA 01 02 03 04 05 06 07 08 09 10 11 Bear 6.75 6.00 NA Source: Morgan Stanley Research 22 Alina Slyusarchuk, (44) 20 7677-6869, alina.slyusarchuk@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 US Rates Risk-Reward View Investor Debates What’s in the price? Trades  What will be the size of QE2?  The Fed is priced to be out of the market until late 2011. • We maintain our longs in front-end Thus front-end rates a re priced to be low and stable. The forward rates. This strategy that  Will QE2 work, if no then what? market is also pricing QE2 to be ~$1Tr over the next year. looks to take advantage of roll down  Will stimulus arise in the form of a streamlined refi wave? and carry has been our core UST 10yr could fall toward 2.25% as a result.  What will the impact of QE2 be on rate levels and the thematic trade. However, we are shape of the yield curve. now looking at longer dated forwards as well, Base Case / Thesis 10y Range: 2.25%-2.85%  Bull Case UST 10y 2.00% • We like owning the belly of the curve. In particular, we like owning We are taking a more tactical approach to the market. We If economic data weakens materially and the Fed decides to UST 10y vs. 2s and 30s. We want to see the near-term range for UST 10y to be 2.25% - 2.85%. launch a QE2 program whereby it purchases additional enter this position upon a back-up in assets, then yields could materially drop. yields. See chart. The exposure in the market is that investors are long USTs. The record pace of inflows into bond funds confirms this.  Bear Case UST 10y 3.25% • In volatility space, we like owning Real money is the main buyer as they were late to the bond variance swaps. Volatility is low but If the data surprises to the upside and removes the tail risk of 10y rates are making many double market rally. For many, the Fed’s decision to buy USTs was a faltering economy, thus the Fed may not engage in QE the game changer. Now with the details of the Fed’s QE digit daily moves; variance is a good causing yields to rise materially. Note that investors are long way to play this. Political uncertainty purchases of $500bn USTs, we believe this may cause the bonds and a liquidation/stop-out trade is a risk. 10y to drop to 2.25% and the UST 2s10s curve to flatten to and economic uncertainty are 175bps. expected make rates volatile over the coming months. A risk to ‘risk on’ trades is that low rates foster greater demand for higher returns and encourage investors to take on a larger duration exposure than they otherwise would. Gap in T 2s10s Curve & 10s30s to Narrow Catalysts Re-Shaping the Curve may What we're watching Market Inflection Points be a Key Source of Alpha Flow of Money Bond funds continue to have a record pace of inflows despite the fact that yields continue to fall. As long as the Fed engages in QE and Gap keeps yields low, then there is little risk. But if rates start to rise, then the risk is an exodus from interest rate and spread products. UST 10y Most investors believe that QE will take place at the Nov. 3 FOMC meeting. The expectation is for a sizeable program that drives yields lower toward 2.25% Yield Curve The part of the curve that we expect to perform best is the 5-10yr belly. We believe QE purchases of USTs will be biased toward this sector of the curve as it has the highest sensitivity to mortgage rates. Source: Bloomberg, Morgan Stanley Research 23 Jim Caron, (212) 761-1905, Jim.Caron@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Europe Rates Risk-Reward View Investor Debates What’s in the price? Trades  Peripherals: carry vs. potential event risk. Even those with  Rates: Decent sell-off in rates ahead of Fed QE Spreads: a bearish “end game” view are worried about the risk of announcement. Risk are two-way now but still with very little Long IT SP FR & BE vs. short PT IE underperformance. chance of ECB rate hikes priced for 2011-12 NL  If the EUR rallies on QE, what can the ECB do?  Peripheral CDS implies 5y cumulative probability of default Long low coupon vs. high coupon in for peripherals as follows (40% recovery): GR 52%, IE 35%, Greece, Ireland Portugal, Spain, PT 31%, SP 19%, IT 16%. (cheap insurance against contagion) Base Case / Thesis Italy, Spain & France to  Bull Case IT, SP tighten 30bp, FR by 10bp perform into year-end Rates: For a/cs benchmarked vs. broad EU indices, shorts in Three reasons to reverse underweight peripheral vs core: weighty peripherals (IT, SP) carry large underperformance Duration: back to flat after 35bp sell- risk, due to carry & contribution to index volatility. Same off 1. Our tactical trading model has its smallest underweight to argument applies to France vs. AAA-only index. peripherals for 5 quarters 2. Changes afoot in regulation of banks & insurance  Bear Case IT, SP widen 25bp, FR by 15bp Curve: 5s to underperform on the companies may support peripheral bonds curve, 10s to outperform Notwithstanding the bullish arguments, peripherals are 3. For investors measured against a pan-Europe index, the subject to event risk & sharp swings in sentiment: something balance of risks of owning peripherals, which was heavily of that nature could easily overwhelm the carry cushion of skewed to the downside earlier in the year, is less heavily Regulatory uncertainty adds volatility these peripherals. to 10/30: buy 5y 10/30 curve caps skewed now. Positioning is, we believe, underweight Spain & France; and carry is positive for both vs important indices. In the past month, spreads have moved in; but not by much. Peripherals still inside last month’s wides - just Catalysts What we're watching Why it matters EUR Trade-weighted EUR is +5% from summer levels. Another 7% would put it @ 2008-09 highs, raising possibility that ECB would have to be more accommodative Peripherals Politics, budgets: with many weak or minority governments in the EU, fiscal backsliding is a risk NL pensions A softening of ALM rules would see large steepening in 10/30 swap developments curve Source: Morgan Stanley Research 24 Laurence Mutkin +44-207-677-4029, laurence.mutkin@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 UK Rates Risk-Reward View Investor Debates What’s in the price? Trades  August Inflation Report was dove-ish, implying very low  Front end has rallied still further with 2s @ ~ funding +15bp: Long Gilts vs. swaps in 30-years rates for very long. But with CPI, RPI well over target: how running out of upside here. Long Gilts vs. Bunds moved in 10- long can BoE (a) keep rates on hold; (b) maintain  Gilts are trading tighter vs. Bunds despite the DBR flight-to- years & 5-years credibility? Sterling should be the first place to see erosion quality, but have further to tighten Maintain long 5s/20s steepener of credibility Base Case / Thesis Weak growth plus fiscal  Bull Case Gilts/Bunds narrows ~20bp to tightening means Gilts should outperform ~ +45bp Gilts yields have fallen on election producing fiscally Spread has finally moved in, helped by growing confidence hawkish coalition government, but room to rally further. in the UK governing coalition’s sustainability & by Bunds unwinding some of their flight-to-quality bid after the EUR banks stress tests. The spread has further to go before Gilts/Bunds has narrowed but has further to run, as Gilts are reaching our target. Ongoing ASW buying from UK pension still relatively too cheap & Bunds could cheapen further as funds and/or cheapening of Bunds on EMU fiscal concerns flight-to-safety bid unwinds after bank stress tests. spreading to core could sharply narrow Gilts/Bunds We expect ongoing UK 30y ASW buying will support 30y  Bear Case Gilts/Bunds widens to 100+bp Gilts. Further EMU flight-to-quality could see Gilts lag Gilts-Bunds can still narrow further Catalysts What we're watching Why it matters Sterling A weakening in GBP would be a sign that the BoE may be unable to “hold the line” in its dove-ish policy stance Source: Morgan Stanley Research 25 Laurence Mutkin +44-207-677-4029, laurence.mutkin@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 EM Fixed Income Risk-Reward View Investor Debates What’s in the price? Trades  Currency intervention – how far will it go?  Macro and market dynamics have improved, assisting short- Long local-currency bonds: Israel, term valuations for EM credit spreads and currencies relative South Africa nominal bonds and  The impact of rising inflation expectations and to fair value. Prevailing EM sovereign credit spreads suggest Korea linkers commodities prices on EM fixed income.  Will the inflows to EM asset markets continue? market pricing EM real GDP growth of 5-7%, within the Receive MXN 2y TIIE and 2y range of our economist forecasts. CLP/Camara TRY 2s5s CCS steepener Base Case / Thesis +220 bps  Bull Case +180 bps ZAR and PLN 2s10s flatteners Long TWD 1y5y swaption payer Our macro metrics show incipient signs of stability for macro- Sustained capital inflows, signs of re-acceleration in EM fundamental trends – and likely moving from deteriorating to growth and attractive long-term valuations argue for strong Pay INR 1-2y OIS on dips improving. This is the first time since 2Q this year; since that and steady gains for EM credit spreads (and currencies) Long MXN/ZAR time, EM risk markets have traded sideways to lower. This is through 1H11. For EM currencies, appreciation provides a an important development. It is likely to pave the way for means of tightening monetary conditions in the face of rising Favor high-beta (Central and Eastern more sustained EM asset price gains well into 2011. It inflation. European countries, Ukraine, Dubai, increases the likelihood of our bull case scenario. EM Argentina) over low-beta credits inflation is likely to rise into 2Q11 and with it EM rates to rise  Bear Case +380 bps Focus on idiosyncratic risks: CIS and EM currencies to appreciate. Near-term, currency Periphery Europe concerns may weigh on sentiment but we banks and CIS/Latam oil and gas intervention is likely to intensify as response to the US see no material prospect for contagion absent a seizing of (O&G) are attractive implicit ‘weak dollar’ policy – and as a result gains more DM funding markets. Signs of EM macro-fundamental limited, but EM currencies have scope to outperform 1H11 Gain exposure to EM growth through improvement may prove to be fleeting, leaving markets with Argentina warrants and O&G sector (vs EUR and USD basket) on the back of sustained capital limited upside. inflows, particularly into 2Q as inflation dynamics intensify. EM rates – lower for now, but higher into 2Q11 Catalysts EM composite 2y IRS – Actual versus MS Model Prediction 10.0 What we're watching Why it matters 9.0 Capital flows Steady and strong flows into EM, so far mostly portfolio equity and 8.0 fixed income likely to maintain upward pressure on EM asset prices and be met with policy response, which may lead to periods of 7.0 volatility. 6.0 Currency policy Post-QE2 announcement and G20 the scope for intervention or capital controls. CNY trade-weighted revaluation likely to mitigate EM central 5.0 banks weighing against strength in their currencies. 4.0 Monetary policy Inflation, likely to intensify in early 2011, ultimately requires a degree of Jun-05 Mar-06 Dec-06 Sep-07 Jun-08 Mar-09 Dec-09 Sep-10 Jun-11 policy tightening. Market may be uncomfortable with the prospect of Act Pred sustained tightening so early in the recovery. Source: Morgan Stanley Research, Bloomberg 26 Rashique Rahman, +44 207 677 7295, rashique.rahman@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 FX Risk-Reward View Investor Debates What’s in the price? Trades  How much QE is already in the price and thus how much  Forwards discount 1.39 in EUR/USD and 80.3 in USD/JPY Short EUR/CHF target 1.28 will it continue to drive the USD lower. by year-end, respectively, compared with MS forecasts for Long EUR/USD target 1.46  ECB is normalising policy and ongoing rebalancing flows 1.36 and 93. Short EUR/SEK target 8.88 are likely to keep it the strong G3 currency for now. Long GBP/JPY target 134.50  Currency tensions remain a theme, despite G20. Modest capital controls continue to creep in pushing G10 higher. Short MS Dollar Index target 65.00  Bull Case EUR/JPY +15% in 2010 Long MS AxJ Index target 120.00 Base Case / Thesis EUR/JPY +5% in 2010 The Fed’s move to QE will continue to weigh on the USD, While the prospect of the Fed implementing more QE is given the longer term implications for US inflation and the being priced in, implementing this policy in a larger size and uncertainty of success. It is also clear that US policy makers if it were open ended may result in greater demand for EUR. view USD weakness as part of the solution. Meanwhile, the Japanese follow up their initial intervention Until such time as EM takes on more appreciation, the axis with a credible easing policy and much larger, sustained of adjustment is likely to come via the EUR. This is intervention. particularly true whilst the ECB continues to see a passive  Bear Case EUR/JPY -10% in 2010 normalisation of policy. We believe there is greater upside before Euro area policy makers will lean against this The changes in the EU Treaty rules and concerns regarding strength. the ability of the periphery to implement fiscal tightening The JPY should be weaker, from a fundamental point of weigh on the EUR. At the same time, the BoJ does not view, although we may need to see more commitment to provide credible additional easing. In addition, the biggest easing and an inflation target before this is reflected in the surprise would be a concerted effort by EM to allow for JPY. meaningful appreciation, this would ease the appreciation pressure on the G10 and EUR in particular. EUR Rebalancing Demand Catalysts 8000 1 .7 E M T o t a l F lo w (m n US D) What we're watching Why it matters 6000 1 .6 EU R U S D S p o t The Federal Reserve The market has focused on the Fed’s QE but we are waiting for the specific 4000 1 .5 details on the objectives as a guide for the extent of QE, as well as duration of the purchases. Post the meeting, we are monitoring for Fed member’s conviction 2000 1 .4 regarding the effectiveness of the policy. 0 1 .3 US Inflation Given the increased focus on inflation for the FOMC and the part it is likely to play in driving QE, the inflation data is likely to be more important than usual. -2 0 0 0 1 .2 The surprise would be for greater than expected readings, strengthening USD. -4 0 0 0 1 .1 Global Rhetoric on FX While the G20 meeting were committed to addressing imbalances and co- operating in reducing tensions, we have seen more talk of capital controls post -6 0 0 0 1 the forum. As such, with the USD expected to moderate, we are watching for any Ja n -0 4 Ja n -0 5 Ja n -0 6 Ja n -0 7 Ja n -0 8 Ja n -0 9 Ja n -1 0 further action to counteract capital flows and EM appreciation. Source: Morgan Stanley Research; EPFR, Bloomberg 27 Stephen Hull, (44) 20 7425-1330, Stephen.Hull@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 DM Equities Risk-Reward View Investor Debates What’s in the price? Trades  Strength and sustainability of macro expansion  Sell-side earning forecasts are for sustained earnings Regional:  Significance of policy action on macro cycle and risk expansion: over 30% increase in EPS between 2010 and Buy EM over DM assets/resolution of debt super-cycle 2012 (both SPX and MSCI DM), after a sharp gain in 2010  Extent of margin uplift/profits from EM expansion  Buy-side arguably more cautious. Equities appear cheap if Sector: consensus earning forecasts are correct Long Europe Exporters Long US/Europe Industrials Base Case / Thesis  Bull Case Double-digit gains in 2011 Sustained macro expansion, ongoing low rates, and further Thematic: DM: Equities range bound SPX 950-1250 gains in margins and a QE2-inspired re-rating of risk assets. Earnings appear likely to meet consensus expectations for Buy Large Cap Quality Three reasons to expect range-bound equities: 1) that’s what usually happens after big bear markets; 2) valuations new record highs in 2011. Buy EM exposed DM stocks point to low returns; 3) we expect a sub-par macro cycle.  Bear Case Back to lows Buy Dividend Yield / Reliable Growth So far markets have broadly followed the script. We don’t Sovereign stress takes hold in the G7 and/or double-dip as expect equities to break the range until either the structural stimulus is withdrawn. DM markets would likely see a problems fade (upside risk) or recession looms (downside). serious deflation scare in this scenario. We think the latter is more likely, but not this year. QE2 is the new unknown. While we doubt it will be a macro game-changer, it may help risk assets independently of the impact on macro. We think the risk-reward on equities is becoming less favourable, but QE2 may see more upside. Equity Returns Follow Cycle Lead Catalysts EXC ESS EQUITY RETURNS AND OEC D LEADING INDEX 60 20 G L O BA L * O E C D G 7 L E I (RH S) What we're watching Why it matters 45 15 EQUITY-BOND RET 6M % 30 10 Leading indicators In a credit-less cycle, what moves equities is changes in earning expectations. Equities don’t worry about rates, they worry about 6M SAAR % 15 5 growth. If growth sentiment worsens, equities will weaken. 0 0 -15 -5 Margins Margins have surprised us, and we think forecasts for 2011 are too -30 -10 high. If productivity slows, margin forecasts look too high. -45 -15 * EQUITY LESS BOND RETURN (6 MONTH) MSCI Sovereign debt Sovereign stress is the sword of Damocles hanging over this DM LESS ML G7 GOVT BOND INDICES -60 -20 expansion. 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: IBES, DataStream 28 Gerard Minack, (61) 2 9770-1529, Gerard.Minack@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 European Equities Risk-Reward View Trades Investor Debates What’s in the price? OW equities, UW bonds  What is the outlook for growth in the global economy and  MSCI Europe trades on a consensus 12m forward PE of 10.8 compared to a long-run average of 14 and our Sectors: European corporate profits in 2011?  What are the implications of further QE on growth, inflation subjective ‘fair value’ range of 11-12 for this cycle. O/W – Insurance, Materials, Energy, and asset prices? Europe’s trailing dividend yield is 3.2%, the same as a Telecoms  With regulations increasingly encouraging institutional pan-European government bond. Our CVI suggests an U/W – Utilities, Cons Disc, investment in bonds who will buy equities in the future? 85% chance of up markets in the next 6 months. Healthcare, Div Fins & Real Estate Themes: Base Case / Thesis MSCI Europe: 1270  Bull Case MSCI Europe: 1420 1) Add some beta – e.g. Financials & We are overweight equities as we believe the market is too ‘Normal Cycle – albeit with lower growth and lower rates’ Commodities. pessimistic on economic and corporate profit growth, while (23% upside). Bond yields of 3.5%, short rates at 1.25%, CPI at 2.5% and 20% EPS growth in 2011. Using a CVI value of 2) Superior EM growth – Energy and valuations are reasonable and broad longer-term sentiment Materials offer better value than is weak. We assume 4%+ global GDP growth in 2011 will 0 (fair value) this implies a MSCI Europe target of 1420 and an implied 2011 PE of 13.1. Staples and Capital Goods. translate into double-digit EPS growth again next year. Our base case index target offers 10% upside and hence does  Bear Case MSCI Europe: 715 3) Reliable growth stocks should be not imply any re-rating of European stocks. In our base case long-term winners, however value we also assume that the European authorities manage to ‘Double-Dip’ (38% downside). Bond yields of 2%, 3M rates of stocks should outperform in the short- stabilise the outlook for eurozone sovereign debt, with yields 0.75% and headline CPI of 1.25%. EPS falls 20% in 2011. term if the market rallies. moving moderately higher due to a better growth Using a CVI value of -2, this implies a MSCI Europe target of 4) Dividend strategies – we like high environment. 715 and an implied 20011 PE of 9.8. In this scenario the and secure dividend yielders; stocks European Shiller PE would fall to 8.6. where DY > credit yield; index dividend swaps. Earnings Growth Leading Indicator (EGLI) Catalysts +60 Aug-11e YoY EPS = 44% What we're watching Why it matters +40 Growth indicators Evidence that the economic recovery is sustainable should provide +20 strong support for stocks. However weakness in lead indicators and job/wage data would raise fears in the market of a double-dip 0 Inflation and net flows Inflation expectations have risen in the US, UK and Europe over the -20 into equities last couple of months. Corroboration of this trend in the real economy -40 Predicted YoY EPS Growth % will raise pressure on asset allocators to consider switching from nominal to real assets. In-sample Out-of-Sample Actual YoY EPS Growth % forecasts forecasts -60 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 Corporate newsflow re Corporate newsflow has held up better than economic newsflow over Source: MSCI, S&P, IFO, OECD, GSCI, Haver, Datastream, Morgan earnings and M&A the last few months with companies’ maintaining confidence in their Stanley Research. For details see Upgrading European Earnings - Trough earnings outlook. With FCF yields at record highs and borrowing costs in 3Q09, 20% Growth in 2010, August 17, 2009. at record lows we expect to see an acceleration in M&A activity. 29 Graham Secker, + 44 20 7425-6188, Graham.Secker@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Japan Equities Risk-Reward View Investor Debates What’s in the price? Trades  Will the BoJ ease? Or will Japan acquiesce in yen  Potential double-dip in the US and global economies; Buy domestic demand super-large appreciation? widespread expectation of early, further material yen caps: Large has underperformed strength; suspicion BoJ will be reluctant to ease further; small; super-large (Core 30) has  Domestic or export focus? underperformed large; within the  Is Japan just a trade, or can there be any longer-term EPS of 60 for Topix Core 30 of Topix, domestic demand story? stocks have underperformed. Base Case / Thesis 2010 yr-end: Topix 1000  Bull Case 2010 yr-end: Topix 1100 Sector model recommends : Banks, Non-Bank Financials; Telecoms, The mid-cycle growth scare is passing out of the picture; BoJ eases more dramatically and further now that directional Marine Transport meanwhile policymakers have begun to creep towards shift towards loosening has been achieved; Market gets to easier settings. We maintain our end-2010 target at 1000. longer-run fair value quickly. Financials lead. Our bond-stock model continues to favour bonds, suggesting choppy conditions until that changes, but that switch could  Bear Case 2010 yr-end: Topix 800 occur quite soon if current trends are continued. BoJ does nothing further; fiscal policy tightens as programs The market trades at book value (2/3 of stocks below book); roll off; domestic recovery is interrupted and deflation firms are profitable; earnings have been better than expected resurgent. EPS rises but is a mild negative surprise vs. high for H1 F10 and expectations revised up for H2 F10; earnings expectations. Defensives lead as global investors “give up look as though they are now settling into roughly 20% annual on Japan.” growth. A 20% rally is possible. Yen weakness may prove elusive, but current strength is still the most likely trigger for further monetary loosening. We look for a stronger market and a stronger yen. Topix Scenarios – Base Case = Back to 2004 Catalysts 2000 What we're watching Why it matters 1800 1600 BoJ Any unexpectedly aggressive additional change in stance will spark a sharp rally, or alternatively, a move away from easing could trigger a 1400 sharp correction. 1200 1100 Global leading indicators Signs emerging that we are close to another inflection point as the high 1000 1000 frequency indicators begin to bottom out. 829.51 800 800 Inflation data Any indication of inflation, from whatever source, would be very 600 00 01 02 03 04 05 06 07 08 09 10 positive for equities. Source: Morgan Stanley Research 30 Alex Kinmont, (81) 3 5424-5337, Alexander.Kinmont@morganstanleymufg.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Asia / GEM Equities Risk-Reward View Investor Debates What’s in the price? Trades  Can Asia / GEM transition towards sustained domestic  Consensus earnings growth expectations for EM have risen We reduced our equities OW to 4% demand lend growth offsetting a weak industrialised world to 38% in 2010 from 30% at the start of the year. This is in- from 6% (proxy MXEF) and raised recovery and eurozone sovereign issues? line with our base case forecast made in November 2009. It our cash weighting, as well as  Has monetary policy easing in China in 2009 weakened is at 16% for 2011 currently. MSCI EM is trading at 13.9x on reduced beta in out stock focus list. the banking system and generated an asset price bubble 12m forward PER metric, this leaves the asset class priced Reasons for this call: standard in property and more widely in fixed investment? slightly above the 20-year average of 12.8x. valuations metrics are in-line or slightly above long-run averages; Base Case (55%) MXEF: 1120 (+2%)  Bull Case (30%) MXEF: 1650 (+50%) technically overbought market; The headwinds of monetary policy tightening in Asia and Economic growth is stronger and earnings growth is 50%. exceptionally strong fund inflows and parts of Latin America are offset by a second year of global Funds flows reach the extreme levels of 2Q and 3Q07, concerning macro-economic indicator economic and earnings recovery. Global growth remains prompting a valuation overshoot to trailing PER of 20.0x by suggesting higher risk for double dip. above 4.0% both this year and next. Commodity prices, firm year end (similar to end 2007). The payback would come in somewhat from end 2009 levels over the year as a whole. 2011. We are now overweight Asia and underweight Latin America, a region China engineers a successful soft landing in bank lending  Bear Case (15%) MXEF: 605 (-45%) which tends to underperform during growth and property prices. There are no major political risk An economic double-dip as eurozone sovereign risk issues / corrective phases of MSCI EM. events impeding global trade and the RMB post de-peg other negative catalysts impact consumer and corporate revalues steadily versus the US$ to 6.60 by year end. Our preferred markets are China, confidence. Earnings recession begins again in late 2010. Earnings growth is 40% in USD whilst the year-end 2010 China fails to achieve a soft landing. Earnings growth is Russia, Korea, Malaysia and Czech trailing PER ends at 16.0x, in line with the 20-year average. below 15% for the year as a whole with a year end trailing Republic PER of 10.5x (average trough last three cycles). Our sector overweights are Consumer Discretionary, Financials and Energy. We are underweight MSCI EM Trailing P/Book –Now 9% above Average Catalysts 4.0x Telecoms, Utilities and Healthcare 3.5x What we're watching Why it matters 3.0x +2 SD Asian inflation Outside of India inflationary pressures are moderating. This is allowing 2.5x +1 SD forward PER to re-rate consistent with our base case as it did in 2H 2.0x L-T Avg 2.1x 2004. -1 SD 1.5x Earnings Our base case of 40% EPS for MXEF would generate a 14% ROE and 1.0x -2 SD likely a tenth straight year of superior profitability to MXWO. 0.5x Funds Flow Dedicated EM equity funds reported positive inflows for 22 consecutive weeks, a record for 2010. EM funds reported cumulative inflows of 0.0x $56bn for this period. Our bull scenario envisages a euphoric phase Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 as in 2007 whilst to avoid the bear it is important that flows do not Source: Morgan Stanley Research reverse on a sustained basis as they did in 2008. 31 Jonathan Garner, +852 2848 7288, Jonathan.Garner@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 China (and Hong Kong) Equities Risk-Reward View Investor Debates What’s in the price? Trades  Has China entered into a rate hike and tightening cycle?  Skeptical about growth sustainability as China has entered Overweight high-beta sectors – into a rate hike cycle. banks, properties, insurance, and  Will the property sector double dip and drag everything  Double dip of a policy induced property market. materials. else down?  Will inflation hit China before it hits the developed markets?  Improved risk appetite thanks to QE2 demand contraction. Underweight transportation, consumers, auto, and technology. Base Case / Thesis  Bull Case We remain bullish on China and Hong Kong equities. China policies switch from tightening to loosening. New Despite the recent market recovery we remain bullish. We stimulus packages arrive as decelerating signs surface. think China is moderating growth to a more sustainable China accelerates while global cost of capital remains low. mode rather than hard landing after stimulus exit, with Property transaction volume rebounds sharply. greater focus on domestic demand. Property price will turn weaker but volume should recover. Policies will remain  Bear Case supportive amid quantitative easing globally and next rate Runaway inflation make regulators tighten aggressively, hike unlikely in the next 6 months. resulting in pessimistic growth prospects, and more severe Potential catalysts for market to rerate: 1) the peaking out of asset quality problems in the banking sector. CPI YoY comp due to base effect shall ease inflation and tightening concerns; 2) consistent appreciation of the Rmb against the US$ shall attract liquidity inflow to China assets including equities. Valuation remains Attractive Catalysts 30 MSCI China FY1 PE What we're watching Why it matters 25 Inflation risks QE2 has a danger to inflate energy and food price globally, which will FY1 PE Average +0.5 std -0.5 std force China to tighten prematurely. We are watching oil price closely to 20 +1 std -1 std manage China tightening risk (oil leads China PPI). 15 Rmb appreciation With the de-peg from US$, if Rmb consistently appreciates against the against the US$ US$ in the coming few months, although slowly, it could attract 10 additional liquidity into China equities. 5 Oct-97 Oct-99 Oct-01 Oct-03 Oct-05 Oct-07 Oct-09 Source: Morgan Stanley Research 32 Jerry Lou, (852) 2848-6511, Jerry.Lou@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Global Corporate Credit Risk-Reward View Investor Debates What’s in the price? Trades  Corporates and financials keep repairing balancing  IG credit spreads still imply a five-year default rate much Bullish on credit globally, although US sheets, and liquidity is strong. But is this strong enough to worse than any seen since 1980, but HY spreads now no & Asia to Outperform Europe. Strong offset unprecedented sovereign volatility? longer compensate for a “worse case” experience (although preference for High Yield over IG one much worse than average). Implied credit volatility is at credit in the US.  Will the positives of bank deleveraging (less issuance, better capital) outweigh the negatives (credit contraction). the low end of the YTD range, but the skew remains steep, Long financials, and extend out the  The “good spread / bad yield” conundrum on corp. bonds. indicating fears of large tail risks remain. maturity curve. Tier 1 in Europe and Asia remains a core overweight, we Base Case Keep Calm and Carry On  Bull Case 2003-04 Redux believe Basel III is an important catalyst that will support bond calls. Central banks stay on hold until mid-2011. Cash yields at 0% Credit valuations remain well supported in a lower growth, Positive basis means more value now keep money pouring into the asset class, and the ECB is lower return world. Choppy economic data keeps the M&A lies in CDS. Sell bonds, sell able to unlock coax European banks to deposit less there cycle more conservative (and sensible) despite the cheap protection, and take out dollar price and instead by sovereign supply. Similar to 2003-04, cost of debt capital. With our economists pushing back their companies remain adverse to increasing leverage. Quality High Yield remains cheap to rate hike expectations in both the US and eurozone, liquidity will remain ample for longer. Low-Quality IG in the US. Overweight  Bear Case Global Double-Dip BBs vs. BBBs. Europe muddles through with weak domestic growth, with a In Europe, the stress tests become a key missed opportunity weaker euro and pound helping to cushion the effects of Take default risk over spread risk. to break the cycle of bank & sovereign fears, as weaker Shorten in non-financial IG credit. greater fiscal austerity, and sovereign spreads stabilizing at growth on the back of a strengthening EUR leads to their higher levels. US and Asia credit outperform on a better Long mezzanine risk in IG tranches revival. In the US, low rates fail to motivate continued asset and US CLOs. Short senior/super- growth and extended liquidity, led by Financials. Expect inflows, and continued disappointing data re-ignites double- dispersion of performance by Region (Europe vs. Global), senior index tranches vs. Delta dip fears. For Asia, the “importing” of loose monetary policy Instrument (cash vs. CDS), and regional revenue exposure. abroad leads to an over-heating To hedge, we prefer buying payer spreads, rather than payers outright, given that the volatility skew in credit Credit still well off YTD Highs Catalysts options remains highly elevated. Levels: '10 Tights (LH), '10 Wides (RH), and Today 94 US IG CDS (bp) What we're watching Why it matters 76 130 $101 Fund Flows Fixed income markets have seen record flows out of equities, and into US HY CDS ($ Px) $101 $92 bonds, despite the lowest yields in generations. Are these inflows here 96 to stay, or are they just chasing returns? Strong recent performance in Euro. IG CDS (bp) 65 140 Equity markets will also challenge retail investor perceptions 450 Euro. HY CDS (bp) Issuance Patterns / Our base case is that the unusually uncertain macro outlook has a 382 630 Shareholder Friendly silver lining: it is keeping corporates much more conservative than they 6.9% Activity would otherwise be, given their all-in borrowing costs. Still, the longer € Tier 1 (YTC, %) 6.9% 10.0% this persists, the more comfortable companies may be with the new 107 normal. Expect share buybacks, dividend increases, and LBO activity Asia IG CDS (bp) 88 156 to pick up, although think 2003/04 (not 2006/07). If corporate thinking Source: Morgan Stanley Research, Bloomberg, iBoxx changes, we expect the US will lead Europe. 33 Greg Peters, (212) 761-1488, Greg.Peters@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Securitized Credit Risk-Reward View Investor Debates What’s in the price? Trades  Magnitude and timing of losses in mortgage pools, both  Severe outcomes for collateral performance, much harsher Long senior tranches of non-agency residential and commercial. than how the collateral is currently performing and expected RMBS (subprime and alt-A)  The scope and effectiveness of foreclosure mitigation. to perform going forward. For example, in typical subprime Credit steepeners in CMBS – (long  Re-emergence of new issuance beyond consumer ABS. RMBS, market pricing generally assumes that 80-90% of AAA, AM and AJ tranches versus currently performing loans will eventually default and there short AA and below tranches) will be no improvement in currently delinquent loans. Long AAA and AA tranches of US and European CLOs Base Case / Thesis  Bull Case In non-agency RMBS, market pricing solves for mid to high Foreclosure mitigation efforts succeed in reducing the Long A and BBB tranches of US single-digit returns assuming draconian outcomes for shadow inventory and strategic default incentives, leading to CLOs collateral performance. This provides a substantial positive significant improvement in RMBS collateral performance. convexity potential if the realized collateral performance Similarly, losses in CMBS pools turn out to be lower along turns out to be even slightly better than what is priced in. with uncertainty about remaining duration. In CLOs, the AAA mispricing corrects (tightening of 100 bps) and leveraged In CMBS, we expect collateral deterioration to continue but loan defaults remain in the 4-6% range. the uncertainty about future losses to subside such that the at the money point in losses would be around AA tranches,  Bear Case which leaves the AAA stack to be significantly underpriced. Foreclosure mitigation efforts do not succeed in reducing the In CLOs, the allocation of risk premium to senior tranches is shadow inventory and strategic default incentives, leading to extension of durations on non-agency RMBS. In CMBS as inconsistent with other risk remote tranches and the well, loan modifications lead to extension of duration beyond underlying loans. The at-the-money tranche has moved 3 years. Leveraged loan defaults spike to >12%. down to BBB or below. Shadow Inventory in US Housing Catalysts 12 Total Inventory What we're watching Why it matters 10 Progress on HAMP, The implementation and success of foreclosure mitigation has HAFA and 2MP significant impacts on the timing and amount of cash flows to investors Millions of Units 8 Yearly Home Sales 6 Put Back Potential Put backs are not currently being priced in, creating a free option in 4 senior RMBS tranches. The question is whether investors can gather 2 the requisite interest to clear the hurdles in the path of put backs. 0 Special Servicer Activity Refinancing and modifications of maturing loans are a crucial Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 in CRE Pools determinant of the magnitude and timing of CRE losses Source: Morgan Stanley Research 34 Vishwanath Tirupattur, (212) 761-1043, vishwanath.tirupattur@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Crude Oil Risk-Reward View Investor Debates What’s in the price? Trades  Non-OECD remains strong, but YoY comps will be tougher in Q4. OECD  Crude oil prices have broken through the range-bound ($70-$80/bbl) market Long deferred crude oil. WTI for demand though has started to improve, and together with robust non- we’ve seen for the most of the last year, continuing to trade at the whim of the OECD demand, global demand sits just shy of record highs (~1.3 mmb/d). macro though improved fundamentals have also lent support. Prices will, in delivery in December 2011 is Inventories, though drawing, remain lofty, but only because supply has surprised to the upside. Nonetheless, the ability to grow upstream our view, ultimately trade higher into year-end as refiners exit maintenance, trading near $87/bbl. If our production on a go-forward basis remains the biggest challenge facing the bolstering crude demand and tightening both inventories and spreads. energy market. As demand improves, spare capacity will fall, forcing prices Deferred prices are not reflecting the supply side reality and will need to estimates prove correct, prices higher to ration demand. increase markedly from current levels, in our view. will need to move markedly higher from current levels (targeting Base Case / Thesis YE 2010= $95/bbl  Bull Case YE 2010: $110/bbl $100/bbl average price for 2011) Better-than-expected demand, which would likely lift The biggest driver of crude pricing has been and continues to be the market’s risk appetite, and/or supply disruptions, would force to ration demand. appetite for risk. QE2 and inflation expectations will provide support for crude in the balances and spare capacity to tighten faster than coming months, however, improving fundamentals are now becoming a focus. we’ve modeled in our base case (1.7 mmb/d global demand growth). Last month, we highlighted that Demand is vibrant. Chinese industrial activity also points to higher demand comps as the latest PMI reading for October registered at 54.7. WTI spreads would likely come under pressure as refiners went Moving into 2011 and 2012, the market’s focus will again revert to the constraints down for maintenance. Spreads facing supply. With most of the low-hanging fruit on the demand side already  Bear Case YE 2010: $60/bbl actually tightened, which suggests picked, we anticipate that prices will need to move markedly higher to ration If we are wrong, and the economy falters materially a tighter-than-expected near-term demand and find equilibrium. Specifically, we spare capacity falling to 4.1mmb/d (read: risk off), oil demand growth is likely to disappoint, leaving spare capacity and inventories S/D. Spreads should tighten and 2.5 mmb/d respectively at year-end 2011 and 2012 as OPEC increases production to compensated for rapidly falling inventories. Our 2011/12 price more ample than we forecast in our base case. further in the coming weeks as However, lower prices should ultimately serve to help forecast of $100/bbl and $105/bbl, respectively, represents an oil burden of 4% – a demand growth while discouraging OPEC production. some 4-5 mmb/d is coming back level, historically, at which oil demand and economic growth have started to sputter. Net, any weakness is likely to be short-lived. online. Inventories Set to Draw Materially in 2011 Catalysts 2.85 1,250 2.80 What we're watching Why it matters 750 2.75 2.70 US/Euroil/China Provides relatively timely confirmation of demand developments in the 2.65 250 Fundamentals Data OECD – weekly for the US, monthly for Europe – as well as for China, the biggest delta on the margin – monthly data for China. 2.60 (250) 2.55 Physical Markets The structure of the forward curve, as well as prices of crude and 2.50 (750) products in the cash markets, provides color on what the fundamentals 2.45 are saying – little influence in these markets by specs. 2.40 2005 2006 2007 2008 2009 2010 2011 2012 (1,250) Economic data Positive data would continue to bolster equity markets, as well as OPEC Crude Prod MoM Δ - RHS OPEC Adds/Cuts providing confidence in demand. Stocks - LHS (bln bbls) MS Forecast - LHS (bln bbls) Inv. Path without OPEC Invervention Source: IEA, Morgan Stanley Research estimates 35 Hussein Allidina, (212) 761-4150, Hussein.Allidina@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 In the United States, portions of this report regarding non-US options Global Equity Derivatives Risk-Reward View are intended for Morgan Stanley’s Institutional Clients only. Investor Debates What’s in the price? US Trades  The likelihood of a double-dip, with impacts on the level of  A secular shift in risk from EM to DM, with emerging market Protection: Buy 3m S&P 500 OTM put volatility overall, as well as skew and term structure implied volatilities now trading below those of developed spreads. Buy S&P 500 puts knocking in markets, and with flatter skew on higher gold.  EM vs. DM risk profiles  Monetizing steep volatility term structures  Continued high correlation between single-stocks, and Upside: Buy 3m S&P 500 OTM calls  When will the macro fade and inter and intra-market persistent volatility for years into the future, largely reflective Yield: Sell 2y S&P 500 variance, buy correlation decline of risk aversion 2012/13 S&P dividends, and buy-write select single names Base Case / Thesis  Bull Case VIX in the low teens European Trades We believe a sustainable, if bumpy, global recovery will push A straight line recovery strong enough to grow out of Protection: Buy 3m SX5E OTM put volatility below current levels that are moderately stressed. financial and sovereign problems, with moderate inflation, spreads We expect DM volatility to normalize more than EM given the would drive volatility towards, but not all the way to, cyclical Upside: Buy 2012/13 SX5E dividends excess risks priced in. Given risk factors disproportionately lows. Yield: Sell Dec10 puts on select high impact DM markets, DM skew and term structure will likely  Bear Case VIX in the low 40s and secure dividend stocks remain steep. We believe intra-market correlation will fall, although sustained differentiation will take time to A double dip in developed markets, driven by a weak Asia and EM Trades materialize. recovery, over tightening in China, or European sovereign stress impacting fundamentals could drive volatility to Protection: Buy 3m KOSPI OTM puts; cyclical highs (excluding the depths of the financial crisis). buy 3m IBOV OTM put spreads; buy We wouldn’t buy volatility here, but we like entering into OTM puts on Indian, Australian banks; Contagion to core DM sovereigns would drive a more directional option trades while saving some budget for and sell OTM puts on China, HK banks; extreme volatility tail. cheaper levels. We would lean against skew to buy buy PSC’s over select Aussie stocks protection, with upside exposure worth buying as well. Upside: Buy OTM calls or worst-of-calls on basket of EM-driven indexes Volatility: Buy/sell 3m EM/DM straddles EM vol trading similar to DM Catalysts and put or call combos 100% Premium 90% EM 3m Avg Imp Vol 80% DM Avg 3m Imp Vol What we're watching Why it matters 70% 60% Steepness of volatility Due to uncertainty over growth, deflation, and the impact of 50% curves government stimulus and interest rate policy, uncertainty is high both 40% near and longer-term. 30% 20% Growth metrics in US, A double dip is the fundamental risk that is keeping volatility high; 10% China, and Europe improving data could be a catalyst for normalization. 0% Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 High correlation Cross-asset correlations have declined across the board, although Source: Morgan Stanley Research, MS Quantitative & Derivative Strategies between asset classes they remain high historically. has fallen Sivan Mahadevan, (212) 761-1349, sivan.mahadevan@morganstanley.com 36
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 In the United States, portions of this report regarding non-US options Global Credit Derivatives Risk-Reward View are intended for Morgan Stanley’s Institutional Clients only. Investor Debates What’s in the price? Trade Ideas  The likelihood of a double-dip, with impacts on the level of  Correlation has fallen in IG tranches, indicating that the TRANCHES: volatility overall, as well as skew and term structure market is pricing in more idiosyncratic risk today Long 5-year IG15 3-7% and 7-15%  M&A activity and the impact on junior tranches  In HY tranches, equity tranches are cheap, ignoring positive risk: Based on both relative and fundamentals in the short dated maturity absolute value measures, and  How to isolate credit risk from rates risk  Credit volatility is still rich, pricing in an expectation that expectations for flows into junior  How to position for year-end mezzanine in this part of the cycle. credit will continue to be volatile Long HY15 0-15% vs short 15-25% on Base Case / Thesis  Bull Case Correlation and volatility drop a relative basis: We like delta hedging an equity long with a mezzanine short in The strong rally in credit has taken us back to pre-sovereign Continued market recovery that causes idiosyncratic risk to the new HY15 tranches. crisis ranges, though we are still not back at the spread rise and default correlation to flatline and volatility to continue Short 5-year 15-100% risk: A good tights for the year. Much of this rally has been driven by to decline. large-tail scenario hedge. favorable global central bank policies as well as an OPTIONS: improving macro environment and growth story. However,  Bear Case Correlation and volatility rise Buy put spread collars to hedge credit options markets have not fully reset to pre-crisis levels spread widening on an overweight and implied volatility remains elevated. Skew remains steep, A double dip in developed markets, driven by a weak recovery, over tightening in China, or European sovereign portfolio. particularly in relation to equity skew. Given this, we are inclined to use volatility neutral or even short strategies in stress impacting fundamentals could drive volatility to Buy payer ladders to hedge spread this market. cyclical highs (excluding the depths of the financial crisis). widening on underweight positions. Contagion to core DM sovereigns would drive a more Buy receiver ladders to hedge a extreme volatility tail. spread tightening on an overweight In the face of continued healing we also expect implied portfolio. default correlation to flatline in IG. Buy receivers or receiver spread collars to hedge spread tightening on Credit vol trending lower Catalysts an underweight portfolio. 120% CDX IG 110% 3M Implied Vol What we're watching Why it matters 100% 5yr implied correlation 90% Growth metrics A double dip is the fundamental risk that is keeping volatility high; improving data could be a catalyst for normalization. 80% 70% 60% Mezzanine tranche As markets continue to heal, risk will shift out of the mezzanine tranche 50% performance and into other parts of the capital structure 40% 30% Volatility levels Peripheral European stress coupled with US growth uncertainty could 20% cause volatility to remain elevated Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Source: Morgan Stanley Research Sivan Mahadevan, (212) 761-1349, sivan.mahadevan@morganstanley.com 37
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Cross-Asset Volatility Volatility Heals Substantially, Tail Risks Still Somewhat Elevated Markets have normalized Since the 2010 peaks in volatility (in mid-May) markets have resolved some of the global macro-economic risks. European somewhat governments have policies in place to relieve banking and sovereign related stresses. However fears of a potential global economic slowdown remain prescient in investors’ minds. Volatility has fallen dramatically Among asset classes we consider, volatility has fallen across the board. We see the greatest drops in US and European credit and equities, as volatility here was the highest in May, and near-term fears have been pushed out further in the term structure. Entry points much more The fall in volatility with still moderate levels of skew in many markets makes the overall entry point for short-dated hedges attractive today attractive today compared to most of the 2nd and 3rd quarters of 2010. Long-dated hedges remain expensive in many markets. How to hedge today We take advantage of lower levels of volatility, still steep skew and some relative value to identify hedging strategies across the asset classes cover in this report. Our preferred strategies range from simple OTM puts, to put spreads, strangles and cross-asset “knock-in” hedges where high levels of correlation can reduce costs. Change in 3m Imp Change in Skew Change in Spot 2006-2007 since late-May 12m since late-May 12m Level since late-May Asset Class Asset Current Vol Average Peak Percentile Peak Percentile Peak Credit CDX IG 58% NA -30% 22% -1% 66% -17 bps iTraxx 69% NA -25% 38% 0% 70% -15 bps Equities KOSPI 18% 18% -8% 20% -4% 51% 17% IBOV 23% 35% -13% 5% -1% 64% 21% SPX 22% 13% -12% 48% -3% 62% 7% SX5E 25% 15% -13% 63% -5% 59% 6% Commodities Oil 31% 29% -9% 12% -1% 51% 10% Gold 18% 19% -6% 26% 0% 64% 10% Rates 1y US Swap Rates 40 bps 61 bps -23 bps 0% 20 bps 63% -38 bps 10y US Swap Rates 106 bps 67 bps -14 bps 41% 3 bps 25% -72 bps FX EURUSD 12% 7% -4% 70% 2% 92% 10% Note: Rate volatility is in normalized basis points, credit volatility is volatility of spreads, and all others are price return volatility * Pre-Crisis Average is the average level from 7/1/06 through 6/30/07 Source: Morgan Stanley Research, Morgan Stanley Quantitative and Derivative Strategies, Bloomberg Portions of this report regarding non-US options are not intended for US clients, other than Institutional Clients. Investing in options is not suitable for all investors. Please see the disclosures at the end of this report and discuss whether this or any particular options strategy is suitable with your Morgan Stanley representative. Please direct all market-specific questions to the coverage analyst and all options-specific questions to Sivan Mahadevan, Derivative Research Strategist. 38 Sivan Mahadevan, (212) 761-1349, sivan.mahadevan@morganstanley.com
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Option Strategy Risk Factors Calls: The maximum potential loss is the premium paid. Dividend Futures/Swaps: Investors long dividend futures/swaps participate 1:1 in movements on the underlying dividend levels. If Call Spreads: The maximum potential loss is the premium paid. the dividend index rises the position will show a profit and a loss if the index falls below the entry price. Overwriting (selling calls over long stock positions): At expiry the risk is that the stock rallies through the short call strike, with the Variance/Volatility Swaps: At expiry, an investor long/short a stock called away at the strike price, limiting participation in further variance/volatility swap will be paid the difference between the upside. volatility (squared for variance) and the strike price (or vice-versa for short variance positions) that is realized over the term of the Puts: Overlaid on a long stock position, the position is protected below contract. If realized volatility is above the strike price, there will be the strike at expiration. The maximum potential loss in isolation is a gain/loss, and if realized volatility is below the strike price, there the premium paid. will be a loss/gain. Prior to expiry, spot starting variance swaps have exposure to both implied and realized volatility, with the Put Spreads: Overlaid on a long stock position, the position is protected realized volatility exposure progressively accruing and the implied between the strikes (but not below) at expiration. The maximum volatility exposure decaying. potential loss in isolation is the premium paid. Underwriting (selling puts): The max loss is the strike less the premium. Above the strike investors keep the yield, but must be willing to miss out on any near-term upside as well. Put Spread Collars: Overlaid on a long stock position, the position is protected between the strikes at expiration. If the stock rallies through the short call strike, investors could be forced to sell their stock and upside will capped. The maximum loss on the option position alone is unlimited due to the short call. Call Spread Collars (Call Spread + Short Put): Overlaid on a short stock position, the position is protected between the strikes (but not above) at expiration, while profit is capped below the strike of the put sold. The maximum potential loss in isolation is the level of the put strike plus/minus the initial premium. Straddles and Strangles: The maximum potential loss on a long straddle or strangle is the premium paid. The maximum potential loss on a short straddle or strangle is unlimited. 39
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Options Disclosure Options are not for everyone. Before engaging in the purchasing or writing of options, investors should understand the nature and extent of their rights and obligations and be aware of the risks involved, including the risks pertaining to the business and financial condition of the issuer and the underlying stock. A secondary market may not exist for these securities. For customers of Morgan Stanley & Co. Incorporated who are purchasing or writing exchange-traded options, your attention is called to the publication “Characteristics and Risks of Standardized Options;” in particular, the statement entitled “Risks of Option Writers.” That publication, which you should have read and understood prior to investing in options, can be viewed on the Web at the following address: http://www.optionsclearing.com/about/publications/character-risks.jsp. Spreading may also entail substantial commissions, because it involves at least twice the number of contracts as a long or short position and because spreads are almost invariably closed out prior to expiration. Potential investors should be advised that the tax treatment applicable to spread transactions should be carefully reviewed prior to entering into any transaction. Also, it should be pointed out that while the investor who engages in spread transactions may be reducing risk, he is also reducing his profit potential. The risk/ reward ratio, hence, is an important consideration. The risk of exercise in a spread position is the same as that in a short position. Certain investors may be able to anticipate exercise and execute a "rollover" transaction. However, should exercise occur, it would clearly mark the end of the spread position and thereby change the risk/reward ratio. Due to early assignments of the short side of the spread, what appears to be a limited risk spread may have more risk than initially perceived. An investor with a spread position in index options that is assigned an exercise is at risk for any adverse movement in the current level between the time the settlement value is determined on the date when the exercise notice is filed with OCC and the time when such investor sells or exercises the long leg of the spread. Other multiple-option strategies involving cash settled options, including combinations and straddles, present similar risk. Important Information: • Examples within are indicative only, please call your local Morgan Stanley Sales representative for current levels. • By selling an option, the seller receives a premium from the option purchaser, and the purchase receives the right to exercise the option at the strike price. If the option purchaser elects to exercise the option, the option seller is obligated to deliver/purchase the underlying shares to/from the option buyer at the strike price. If the option seller does not own the underlying security while maintaining the short option position (naked), the option seller is exposed to unlimited market risk. • Spreading may entail substantial commissions, because it involves at least twice the number of contracts as a long or short position and because spreads are almost invariably closed out prior to expiration. Potential investors should carefully review tax treatment applicable to spread transactions prior to entering into any transactions. • Multi-legged strategies are only effective if all components of a suggested trade are implemented. • Investors in long option strategies are at risk of losing all of their option premiums. Investors in short option strategies are at risk of unlimited losses. • There are special risks associated with uncovered option writing which expose the investor to potentially significant loss. Therefore, this type of strategy may not be suitable for all customers approved for options transactions. The potential loss of uncovered call writing is unlimited. The writer of an uncovered call is in an extremely risky position, and may incur large losses if the value of the underlying instrument increases above the exercise price. • As with writing uncovered calls, the risk of writing uncovered put options is substantial. The writer of an uncovered put option bears a risk of loss if the value of the underlying instrument declines below the exercise price. Such loss could be substantial if there is a significant decline in the value of the underlying instrument. • Uncovered option writing is thus suitable only for the knowledgeable investor who understands the risks, has the financial capacity and willingness to incur potentially substantial losses, and has sufficient liquid assets to meet applicable margin requirements. In this regard, if the value of the underlying instrument moves against an uncovered writer’s options position, the investor’s broker may request significant additional margin payments. If an investor does not make such margin payments, the broker may liquidate stock or options positions in the investor’s account, with little or no prior notice in accordance with the investor’s margin agreement. • For combination writing, where the investor writes both a put and a call on the same underlying instrument, the potential risk is unlimited. • If a secondary market in options were to become unavailable, investors could not engage in closing transactions, and an option writer would remain obligated until expiration or assignment. • The writer of an American-style option is subject to being assigned an exercise at any time after he has written the option until the option expires. By contrast, the writer of a European-style option is subject to exercise assignment only during the exercise period. 40
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Disclosure Section The information and opinions in Morgan Stanley Research were prepared or are disseminated by Morgan Stanley & Co. Incorporated and/or Morgan Stanley C.T.V.M. S.A. and/or Morgan Stanley & Co. International plc and/or RMB Morgan Stanley (Proprietary) Limited and/or Morgan Stanley MUFG Securities, Co., Ltd. and/or Morgan Stanley Asia Limited and/or Morgan Stanley Asia (Singapore) Pte. (Registration number 199206298Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H) and/or Morgan Stanley Taiwan Limited and/or Morgan Stanley & Co International plc, Seoul Branch, and/or Morgan Stanley Australia Limited (A.B.N. 67 003 734 576, holder of Australian financial services license No. 233742, which accepts responsibility for its contents), and/or Morgan Stanley Smith Barney Australia Pty Ltd (A.B.N. 19 009 145 555, holder of Australian financial services license No. 240813, which accepts responsibility for its contents), and/or Morgan Stanley India Company Private Limited and their affiliates (collectively, "Morgan Stanley"). For important disclosures, stock price charts and equity rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Research Management), New York, NY, 10036 USA. Analyst Certification The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Gregory Peters, Jason Draho, Alina Slyusarchuk, Jim Caron, Laurence Mutkin, Rashique Rahman, Gerard Minack, Graham Secker, Alex Kinmont, Jonathan Garner, Jerry Lou, Vishwanath Tirupattur, Sivan Mahadevan. Unless otherwise stated, the individuals listed on the cover page of this report are research analysts. Global Research Conflict Management Policy Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at www.morganstanley.com/institutional/research/conflictpolicies. Important US Regulatory Disclosures on Subject Companies Within the last 12 months, Morgan Stanley managed or co-managed a public offering (or 144A offering) of securities of Greece, Portugal, Italy, United Kingdom, Ukraine. Within the last 12 months, Morgan Stanley has received compensation for investment banking services from Israel, United Mexican States, Dubai World (Dubai). In the next 3 months, Morgan Stanley expects to receive or intends to seek compensation for investment banking services from Hellenic Republic, Portugal, Spain, Italy, France, Belgium, Netherlands, Argentina, Ukraine, Israel, United Mexican States, Dubai World (Dubai). Within the last 12 months, Morgan Stanley has received compensation for products and services other than investment banking services from United Kingdom, Hellenic Republic, Italy, Netherlands, Belgium. Within the last 12 months, Morgan Stanley has provided or is providing investment banking services to, or has an investment banking client relationship with, the following company: Hellenic Republic, PORTUGAL, Spain, Italy, France, Belgium, Netherlands, Argentina, Ukraine, Israel, United Mexican States, Dubai World (Dubai). Within the last 12 months, Morgan Stanley has either provided or is providing non-investment banking, securities-related services to and/or in the past has entered into an agreement to provide services or has a client relationship with the following company: United Kingdom, Hellenic Republic, Italy, Netherlands, Belgium. The equity research analysts or strategists principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues. Morgan Stanley and its affiliates do business that relates to companies/instruments covered in Morgan Stanley Research, including market making, providing liquidity and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis. Morgan Stanley may have a position in the debt of the Company or instruments discussed in this report. Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions. 41
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Disclosure Section (Cont.) STOCK RATINGS Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight, Not-Rated or Underweight (see definitions below). Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold and sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Global Stock Ratings Distribution (as of October 31, 2010) For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal- weight, Not-Rated and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight and Not-Rated to hold and Underweight to sell recommendations, respectively. Coverage Universe Investment Banking Clients (IBC) Stock Rating Category Count % of Total Count % of Total IBC % of Rating Category Overweight/Buy 1122 40% 413 44% 37% Equal-weight/Hold 1158 41% 411 43% 35% Not-Rated/Hold 121 4% 22 2% 18% Underweight/Sell 393 14% 103 11% 26% Total 2,794 949 Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan Stanley received investment banking compensation in the last 12 months. Analyst Stock Ratings Overweight (O). The stock's total return is expected to exceed the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Equal-weight (E). The stock's total return is expected to be in line with the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Not-Rated (NR). Currently the analyst does not have adequate conviction about the stock's total return relative to the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Underweight (U). The stock's total return is expected to be below the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months. 42
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Disclosure Section (Cont.) Analyst Industry Views Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the relevant broad market benchmark, as indicated below. In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad market benchmark, as indicated below. Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad market benchmark, as indicated below. Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index. Important Disclosures for Morgan Stanley Smith Barney LLC Customers Citi Investment Research & Analysis (CIRA) research reports may be available about the companies or topics that are the subject of Morgan Stanley Research. Ask your Financial Advisor or use Research Center to view any available CIRA research reports in addition to Morgan Stanley research reports. Important disclosures regarding the relationship between the companies that are the subject of Morgan Stanley Research and Morgan Stanley Smith Barney LLC, Morgan Stanley and Citigroup Global Markets Inc. or any of their affiliates, are available on the Morgan Stanley Smith Barney disclosure website at www.morganstanleysmithbarney.com/researchdisclosures. For Morgan Stanley and Citigroup Global Markets, Inc. specific disclosures, you may refer to www.morganstanley.com/researchdisclosures and https://www.citigroupgeo.com/geopublic/Disclosures/index_a.html. Each Morgan Stanley Equity Research report is reviewed and approved on behalf of Morgan Stanley Smith Barney LLC. This review and approval is conducted by the same person who reviews the Equity Research report on behalf of Morgan Stanley. This could create a conflict of interest. Other Important Disclosures Morgan Stanley & Co. International PLC and its affiliates have a significant financial interest in the debt securities of Portugal, Spain, United Kingdom, Hellenic Republic, Italy, France, Ireland, Netherlands, Belgium, Argentina, Israel, South Africa, United Mexican States, Ukraine. Morgan Stanley produces an equity research product called a "Tactical Idea." Views contained in a "Tactical Idea" on a particular stock may be contrary to the recommendations or views expressed in research on the same stock. This may be the result of differing time horizons, methodologies, market events, or other factors. For all research available on a particular stock, please contact your sales representative or go to Client Link at www.morganstanley.com. Morgan Stanley Research does not provide individually tailored investment advice. Morgan Stanley Research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Research may not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them. The fixed income research analysts or strategists principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality, accuracy and value of research, firm profitability or revenues (which include fixed income trading and capital markets profitability or revenues), client feedback and competitive factors. Fixed Income Research analysts' or strategists' compensation is not linked to investment banking or capital markets transactions performed by Morgan Stanley or the profitability or revenues of particular trading desks. 43
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Disclosure Section (Cont.) Morgan Stanley Research is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. The "Important US Regulatory Disclosures on Subject Companies" section in Morgan Stanley Research lists all companies mentioned where Morgan Stanley owns 1% or more of a class of common equity securities of the companies. For all other companies mentioned in Morgan Stanley Research, Morgan Stanley may have an investment of less than 1% in securities/instruments or derivatives of securities/instruments of companies and may trade them in ways different from those discussed in Morgan Stanley Research. Employees of Morgan Stanley not involved in the preparation of Morgan Stanley Research may have investments in securities/instruments or derivatives of securities/instruments of companies mentioned and may trade them in ways different from those discussed in Morgan Stanley Research. Derivatives may be issued by Morgan Stanley or associated persons. With the exception of information regarding Morgan Stanley, Morgan Stanley Research is based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to tell you when opinions or information in Morgan Stanley Research change apart from when we intend to discontinue equity research coverage of a subject company. Facts and views presented in Morgan Stanley Research have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel. Morgan Stanley Research personnel may participate in company events such as site visits and are generally prohibited from accepting payment by the company of associated expenses unless pre-approved by authorized members of Research management. The value of and income from your investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates, securities/instruments prices, market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in securities/instruments transactions. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. If provided, and unless otherwise stated, the closing price on the cover page is that of the primary exchange for the subject company's securities/instruments. Morgan Stanley may make investment decisions or take proprietary positions that are inconsistent with the recommendations or views in this report. To our readers in Taiwan: Information on securities/instruments that trade in Taiwan is distributed by Morgan Stanley Taiwan Limited ("MSTL"). Such information is for your reference only. Information on any securities/instruments issued by a company owned by the government of or incorporated in the PRC and listed in on the Stock Exchange of Hong Kong ("SEHK"), namely the H-shares, including the component company stocks of the Stock Exchange of Hong Kong ("SEHK")'s Hang Seng China Enterprise Index; or any securities/instruments issued by a company that is 30% or more directly- or indirectly-owned by the government of or a company incorporated in the PRC and traded on an exchange in Hong Kong or Macau, namely SEHK's Red Chip shares, including the component company of the SEHK's China-affiliated Corp Index is distributed only to Taiwan Securities Investment Trust Enterprises ("SITE"). The reader should independently evaluate the investment risks and is solely responsible for their investment decisions. Morgan Stanley Research may not be distributed to the public media or quoted or used by the public media without the express written consent of Morgan Stanley. Information on securities/instruments that do not trade in Taiwan is for informational purposes only and is not to be construed as a recommendation or a solicitation to trade in such securities/instruments. MSTL may not execute transactions for clients in these securities/instruments. To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Asia Limited as part of its regulated activities in Hong Kong. If you have any queries concerning Morgan Stanley Research, please contact our Hong Kong sales representatives. 44
    • MORGAN STANLEY RESEARCH Global Debates Playbook November 16, 2010 Disclosure Section (Cont.) Morgan Stanley Research is disseminated in Japan by Morgan Stanley MUFG Securities, Co., Ltd.; in Hong Kong by Morgan Stanley Asia Limited (which accepts responsibility for its contents); in Singapore by Morgan Stanley Asia (Singapore) Pte. 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