Equity strategy

Europe Equity Research 18 October 2010

Equity Strategy

Remain OW Discretionary - Autos&Retail in particular - lagging UK Retail names offer an opportunity

European Equity Strategy

Mislav Matejka, CFAAC

(44-20) 7325-5242 [email protected]

Emmanuel Cau, CFA (44-20) 7325-1684 [email protected]

J.P. Morgan Securities Ltd.

See page 24 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

European Autos EV/EBITDA

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5.0x

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7.0x

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Europe Autos EV/EBITDA av erage

Source: J.P. Morgan Equity research

CBI retail survey vs. UK retail perf relative

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

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CBI Retail surv ey ch oy a UK retail relativ e (RHS,%y oy )

Source: Datastream, MSCI

UK vs Europe ex-UK Retail 12m Fwd P/E

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

UK vs Europe ex-UK Retail 12m Fwd P/E average +1stdev -1stdev

Source: IBES

• The Discretionary sector (OW) is performing strongly this year and we think there is more to go from Autos (OW) and Retailing (OW) in particular.

• Autos screen well on an "excess cash" basis, still have attractive valuations at 50% discount to historical averages on EV/EBITDA, and benefit from potential volume pickup and stronger profit margins than in the past. Retailing is leveraged to improving consumer confidence, stabilizing labour market and potential bottoming out in consumer loan growth.

• Within Retail however all the outperformance is coming from continental retail. UK retailing stocks are flat on the year (vs Europe ex UK names which are up 27% ytd). The pushbacks on the UK subsector range from incoming fiscal drag to potential for continued consumer deleveraging.

• We think there is an opportunity in domestic UK cyclical names as well. The valuation gap with the continental stocks is extreme. UK Retail trades on a 40% P/E discount to the continent and a 21% discount to historical relatives. The CBI retail survey is well correlated to Retail stocks, its last print is at 6 year highs, opening up a gap with Retail sector performance.

• Admittedly, the UK consumer outlook is mixed, with a recent deceleration in private job creation and a renewed slowing in UK house prices. However, in certain areas we find perhaps too much cautiousness. The pessimism regarding fiscal drag might be overplayed in the near term, where the public sector job cuts for example are largely weighted to the second half of parliament.

• Private sector job growth remains the key and here corporates are in a good position. The UK is unlikely to decouple from global trends, where we are seeing recent signs of stabilization. The projected public job shedding over the next 3 years of 180k is one half of what the private sector job creation was in just the 3 months to June, of 300k. Near term headline newsflow is likely to be poor, but we would use any potential weakness as a good entry point.

• Within Autos we believe some domestic OEMs, Peugeot in particular, are attractive in addition to our continued positive view on German names (Daimler). Among Retail stocks our analyst has Next, Kingfisher, Inchcape, WH Smith and Game Group as top UK picks.

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Mislav Matejka, CFA (44-20) 7325-5242 [email protected]

Table of Contents Remain OW Discretionary –Autos&Retail in particular – lagging Retail UK names offer an opportunity.......................3 Appendix I – UK sectors geographical sales exposure ......13 Appendix II – UK sectors performance and valuation.........14 European Equity Strategy Key Calls and Drivers ................15 Top Picks ................................................................................16 Technical Indicators...............................................................17 Performance ...........................................................................18 Earnings ..................................................................................19 Valuations ...............................................................................20 Sector, Regional and Asset Class Allocations ....................23

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Remain OW Discretionary –Autos&Retail in particular – lagging Retail UK names offer an opportunity European Discretionary stocks have done very well this year, outperforming the overall market by 19%.

Table 1: Ytd performance of Consumer Discretionary subsectors Ytd perf JPM stance

Europe 2% Discretionary 21% OW Automobile 27% OW Consumer Durables 38% N Hot,Rest&Leisure 12% OW Media 8% OW Retailing 18% OW Source: Datastream, MSCI

We remain positive on most subcomponents of the sector, in particular on Autos and Retail, which we focus on in this report.

The only Discretionary subsector which we are not OW anymore is Luxury, having recently downgraded it from OW to N (see our report dated 13th Sept).

OW Autos - Strong performance ytd but still undervalued

We think many investors started the year with a cautious view on the Auto sector given difficult base effects, as "cash for clunkers" incentives were rolling off in 2010, and the weak prospect for the European consumer.

Consequently, we think many were caught by surprise by the run of European Autos, and we think there is more to go for the following reasons:

1 – Strong profitability

Figure 1: Ytd revisions in ‘10 and ‘11 Autos EPS estimates

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Jan Feb Mar Apr May Jun Jul Aug Sep Oct

7.5

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2010e Autos EPS 2011e Autos EPS (rhs) Source: IBES

Out of the 24 level 2 sectors, the European Auto sector has enjoyed the second highest EPS upgrades ytd. IBES has revised up 2010e and 2011e EPS estimates by 103% and 32% respectively.

Figure 2: Global auto sales (million units, saar)

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00 01 02 03 04 05 06 07 08 09 10 11

Global Auto Sales, Mn Units, saar Source: J.P. Morgan

Global car sales have been surprisingly robust ytd, driven by strong EM demand but also resilient DM sales, despite the end of government incentives.

Figure 3: Days auto supply inventory

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06 07 08 09 10

US Light Vehicles Av g PSA, Renault, Ford Europe Source: J.P. Morgan Equity Research

https://mm.jpmorgan.com/PubServlet?action=open&doc=GPS-470960-0.pdf

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In addition to strong volume delivery, pricing has held up better than expected due to tight inventory discipline. Autos inventories are currently lower than their levels in 2006-2008, in both Europe and the US.

Figure 4: European Autos EBIT/Sales

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99 00 01 02 03 04 05 06 07 08 09 10 11 12

Europe Autos EBIT/Sales IBES forecasts Source: Worldscope, IBES

Profit margins have almost recovered their drop during 2007-08, highlighting the improved ability of management teams to operate in a weak macro environment. We expect auto margins to improve further, driving robust EPS delivery in ’11 and’12.

Figure 5: European Autos Net Debt / EBITDA

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00 01 02 03 04 05 06 07 08 09 10E 11E 12E

Europe Autos, Net Debt to EBITDA Source: Datastream, Worldscope, IBES

European car makers’ balance sheets are strong, cash rich and in a much better position than during '00-'04.

Putting top-line, margins and capital structure together and assuming WE SAAR rises to 14MM in 2012, toward their pre-crisis level, vs. 12.8MM in ’10, our sector analyst Ranjit Unnithan sees a potential 116% EPS increase across the sector (ex-Fiat) by 2012 (see “European Autos – Earnings growth will not be all cyclical, dated 06 October 2010). This compares to consensus estimates of 75% EPS growth between 2010 and 2012.

2. “Excess cash potential”

Figure 6: European Autos Free cash Flow yield estimates

6.0%5.6%

4.1%

2.8%

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2010e 2011e

FCF y ield pre-div idend FCF y ield post-div idend Source: IBES

We think the auto sector is also offering a significant cash return potential, which is currently underestimated by the market. Even after dividend payments as expected by consensus, the sector is still offering 4.1% FCF yield for 2010 and 2.8% for 2011.

Figure 7: European Autos dividend payout ratio consensus estimates

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Europe Autos div idend pay out ratio IBES estimates 2004-07 av erage Source: IBES

IBES dividend estimates imply a lower payout ratio than during the previous cycle for the Auto sector. If the payout ratio of 26% forecasted for 2011 returns to its 32% average of 2004-‘07,’11 dividend estimates would have to be raised by 25%.

3. Valuations are still cheap



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Figure 8: European Autos EV/Sales

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90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Europe Autos EV/Sales av erage Source: J.P. Morgan Equity Research

Even though the auto sector has performed strongly ytd, we find its valuations still attractive and not fully reflecting the positives mentioned above. The sector trades currently on 20% EV/sales vs LT average of 28%, a 25% discount.

Figure 9: European Autos EV/EBITDA

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90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Europe Autos EV/EBITDA av erage Source: J.P. Morgan Equity research

On EV/EBITDA, the sector trades on 1.6x currently vs. 3.2x on average, a 50% discount.

Table 2: European Auto stocks performance, valuation and sales exposure to Europe Ytd EV/ EV/ FCF ND/ %Europe

perf P/E Sales EBITDA yield Equ salesBMW 57% 10.4 39% 2.3 9% -33% 56%DAIMLER 29% 10.8 40% 3.4 2% -24% 46%FIAT 16% 15.2 33% 3.6 -2% 52% 51%PEUGEOT 9% 5.9 14% 1.6 12% 11% 79%RENAULT 9% 7.3 18% 1.8 16% 14% 76%VOLKSWAGEN 39% 11.3 22% 1.9 7% -88% 71%Source: Datastream, MSCI, IBES, Worldscope

At the stock level, we are looking for some rotation toward lagging domestic OEMs, and not purely at German export names, given their strong outperformance ytd and increasing FX headwinds.

OW Retail

Retailing stocks have performed well ytd in Eurozone and we think they remain good plays on stabilizing labor market, improving consumer confidence and potential bottoming out in consumer credit growth.

Figure 10: Eurozone PMI composite employment

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42

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

EMU PMI composite - employ ment Source: Markit

Eurozone labour market is clearly stabilizing, as evidenced by the PMI composite employment intentions which are stronger today than at any point in ’03, ’04 or ’05, basically stronger than at any point in the first 3 years of the past recovery.

Figure 11: Eurozone consumer confidence

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85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

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US Conference Board index - consumer confidenceEU surv ey - consumer confidence indicator (rhs)

Source: European Commission

Consumer sentiment has also recovered sharply from its depressed level of last year. In contrast to the US, where consumer confidence has been ranging for the last 6 months, it is moving higher in Eurozone.

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Figure 12: Eurozone consumer loan growth

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04 05 06 07 08 09 10

Loans to Households, %oy a Source: ECB

There are also signs that accommodative ECB monetary policy is gradually gaining traction. Loans to households have been expanding for over a year now, providing additional support to consumer spending.

UK Retail has lagged - offers an opportunity

Figure 13: UK Retail Rel to Europe Ex UK Retail ytd

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Jan-10 Mar-10 May -10 Jul-10 Sep-10

UK retail rel to Europe Ex UK Retail Source: Datastream, MSCI, re-based to 100 on 1st Jan, 2010

Even though the overall European retail sector has outperformed ytd, we highlight that UK retailing has performed rather poorly, flat on the year so far vs 27% up for non UK stocks.

Table 3: Ytd performance of UK domestic consumer plays Ytd perf % Domestic sales Restaurants&Pubs 19% 99% Food&Drug Retail 5% 82% Retailing 0% 76% Gambling -1% 79% Source: Worldscope, Datastream, MSCI

UK Discretionary Retailing has also performed badly compared to other domestic consumer plays, Pubs and Food&Drug Retailing.

Figure 14: UK Retail price relative

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Jan-09 Jul-09 Jan-10 Jul-10

UK retail relativ e Source: Datastream, MSCI, re*based to 100 on 1st January 2009

In fact, UK Discretionary Retail peaked as early as May ’09 and has been losing ground ever since. We see a good risk-reward here and scope for UK retailers to catch up with their continental peers.

Valuation gap between UK and non-UK retailing has opened up

Figure 15: UK and Europe retail 12m Fwd P/E relative

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

UK Retail 12m Fw d P/E rel Europe Retail 12mFw d P/E rel Source: IBES

Historically UK and continental retailers tended to trade broadly together. However, a valuation gap has opened up between the two groups.

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Figure 16: UK rel to Europe ex-UK retail 12m Fwd P/E

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UK v s Europe ex -UK Retail 12m Fw d P/E av erage +1stdev -1stdev Source: IBES

The UK retailing sector is currently trading on 10.2x 12m Fwd P/E vs. 17x for Europe ex-UK retailing, giving a 40% discount.

Figure 17: UK vs. Europe ex-UK Retailing EV/EBITDA

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Nov -06 May -07 Nov -07 May -08 Nov -08 May -09 Nov -09 May -10

UK v s non-UK Retail 12m Fw d EV/EBITDA av erage Source: IBES

UK retailing also looks cheap on EV/EBITDA, trading on 5.3x 12m Fwd vs.10x for the Europe ex-UK sector.

Earnings revisions have turned positive in Q3, driven by stronger top-line

Figure 18: Ytd move in '10 and '11 IBES EPS estimates for UK retailers relative to the market

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2010e UK Retail EPS relativ e 2011e UK Retail EPS relativ e Source: IBES

UK retailing EPS estimates were revised down sharply during H1. They appear to have bottomed out in June, with ‘10 and '11 consensus EPS forecasts having been revised up by 5% and 5.5% respectively since then, relative to the overall market. Excluding the negative BP effect on the market EPS estimates, forecasts for UK retailers have been revised up by 3% for both ’10 and ’11 relative. At the same time, UK retailing stocks actually underperformed the broader market by 1.5%.

Figure 19: Ytd move in '10 and '11 IBES sales estimates for UK retailers relative to the market

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2010e UK Retail Sales relativ e 2011e UK Retail Sales relativ e Source: IBES

Importantly, the main source of EPS upgrades came from top-line. IBES revised up ’10 and ’11 Retail revenues estimates by 8% and 9% respectively since June relative to the overall market.

UK consumer data is mixed – but not all poor

Table 4: Indicators of household spending momentum

Apr May Jun Jul AugSe

pCBI Retail Survey Vols., % bal 13 -18 -5 33 35 49BRC Retail Survey %oya -2.3 0.8 1.2 0.5 1.0 0.5GFK Survey Cons Conf, %bal -16 -18 -19 -22 -18 -20GFK Survey Major Purchases, %bal -20 -21 -24 -16 -20 -15Retail Sales Vols., %3m/6m -0.6 -0.9 -0.2 3.3 4.8Private Car Reg’s %3m/6m -29 -50 -61 -59 -60Mortgage Apps. New Purchases, 000s 49.7 49.6 48.4 48.3 47.4

Source: JP Morgan Economics Research

In the table above we present a set up metrics associated with UK consumer spend. They show a mixed bag.

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Figure 20: CBI retail survey

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

CBI retail trades surv ey - v olume of sales Source: Datastream

While the UK CBI Retail survey tends to be volatile, the latest reading showed a marked pickup, printing a 6 year high.

Figure 21: CBI retail survey vs. UK Retail performance relative

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CBI Retail surv ey ch oy a UK retail relativ e (RHS,%y oy ) Source: Datastream, MSCI

This indicator showed a good correlation with the relative performance of UK Discretionary Retail stocks.

Figure 22: UK nominal consumption spending – yoy%

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UK nominal household spending %y oy Source: Bloomberg

We also highlight that UK consumer nominal value of spending has been growing strongly recently, at 7% annualised rate between Q3'09 and Q2’10. This is much better than most commentators expected, and ahead of disposable income growth, which run at 2-3% rate. Only a small portion of this was due to VAT increase.

Figure 23: UK car registrations

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UK New car registrations, sa ('000) Source: SMMT, J.P. Morgan

UK monthly car sales also appear resilient. While the scrappage scheme ended in March ’10, the volumes appear to have stabilized at a level above that witnessed before the introduction of incentives.

The headwinds from fiscal consolidation are important, but perhaps might not be dominant

While recent consumer spending pattern has been remarkably robust, investors are skeptical regarding its future delivery.

Part of the bearishness on the UK consumer outlook has to do with the incoming fiscal consolidation. The Government target is for a balanced structural budget in five years time, as well as the falling debt to GDP ratio by the end of this parliament in 2015-16.

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Table 5: UK fiscal thrust, private final sales and inventory contribution

qoq%, saar

Real GDP

Fiscal Thrust

Underlying Private

Final Sales Inventory

Contribution 09Q1 -9.0% 0.1% -9.1% 0.1% 09Q2 -2.5% -0.9% -3.3% 1.8% 09Q3 -0.9% 1.9% -1.0% -1.8% 09Q4 1.6% 0.6% -0.9% 1.9% 10Q1 1.2% 2.2% -2.1% 1.2% 10Q2 4.8% 0.1% 2.5% 2.2% 10Q3e 3.1% -0.2% 1.7% 1.6% 10Q4e 1.5% -0.4% 1.7% 0.1% 11Q1e 1.0% -0.7% 1.8% -0.1% 11Q2e 2.5% -0.7% 2.5% 0.7% 11Q3e 3.0% -0.5% 3.3% 0.1% 11Q4e 3.0% -0.4% 3.8% -0.5% Source: J.P. Morgan Economic Research

This is undoubtedly a negative force, where JPM projects fiscal drag to have started in Q3 ’10 and will continue over the forecastable time horizon.

On Oct 20th the UK Chancellor will lay out the departmental spending allocation up to 2014-15. More detail on changes to the welfare system should be forthcoming with the scrapping of Child Benefit payments to those paying the higher rate of income tax.

Table 6: OBR Public finance projections

09-10 10-11

11-12

12-13

13-14

14-15

15-16

Overall Deficit(£bn) 155 149 116 89 60 38 20Overall Deficit 11.0 10.1 7.5 5.5 3.5 2.1 1.1Primary deficit 9.0 7.4 4.9 2.7 0.6 -0.9 -1.9 Cycl adjusted 6.8 4.7 2.4 0.6 -1.1 -2.2 -2.7 Change 2.8 -2.0 -2.3 -1.8 -1.7 -1.0 -0.5Net debt (PSND ex) 53.5 61.9 67.2 69.8 70.3 69.4 67.4 Nominal Spending(% oya) 6.3 4.1 0.4 1.6 1.5 2.1 2.7Nominal Revenue(%oya) -3.6 6.4 6.7 6.5 6.4 5.8 5.3 Real GDP, %oya -3.7 1.8 2.4 2.9 2.8 2.7 2.7

Source: OBR, % of GDP unless stated

The projection is for 25% reduction in real terms on around 40% of total spending. Our economists point out that the aggregate government expenditure is still forecast to rise in nominal terms, and the losses in public sector employment associated with fiscal retrenchment are heavily back loaded.

Figure 24: UK public sector employment

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99 00 01 02 03 04 05 06 07 08 09 10

UK Public Sector Employ ment (% total employ ment) Source: ONS

The public sector employs 21% of UK workforce, and 600k job cuts are projected, moving from 6.1mn public workers to 5.5mn over the course of the parliament.

While this is a concern, we suggest that it might not be the dominant driver of consumer spend going forward.

Figure 25: UK private sector job additions (QoQ)

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99 00 01 02 03 04 05 06 07 08 09 10

UK Priv ate Sector Employ ment Change, thousands sa Source: ONS

We point out that in the 3 months to June the UK private sector added nearly 300k jobs, almost double the 180k public jobs expected to be lost in the first 3 years of the parliament.

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Figure 26: UK composite PMI employment

37383940414243444546474849505152535455

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

UK PMI composite employ ment Source: Markit

We believe private sector labor outlook will remain the key to UK consumer fortunes over the medium term. The latest UK composite PMI employment survey is just above the 50 threshold.

Figure 27: UK monthly claimant count

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Monthly change in claimant count unempploy ment Source: Datastream

The September UK monthly claimant count has moved marginally into positive territory, at 5.3k. We note that this measure was running close to 100k on monthly frequency in the past recession. Also, during the last expansion, between ’03 and ’07 it frequently tended to be marginally in positive territory.

Figure 28: UK Global Composite PMI: Output

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

UK Composite PMI Global Composite PMI Source: Markit, JP Morgan

UK economy remains extremely well correlated to global activity. Recent signs of stabilization in global economic momentum in addition to robust corporate sector profitability leaves us constructive on this front.

Other drivers of UK consumer outlook – wage growth soft but positive – inflation to slow

Figure 29: UK nominal wage growth

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UK nominal w age grow th %y oy Source: ONS

Our economists believe wage growth of around 2% is reasonable over the next 12 months, along with total employment growth of 0.5%. This gives pretax nominal income growth of 3%.

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Figure 30: UK CPI, with JPM projections

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UK CPI, all items %oy a Forecast Source: Datastream, J.P. Morgan estimates

The drags are inflation, which our economists project to average 2.1% in 2011. This includes the January VAT hike, which effectively adds 1%. Other tax changes are not likely to produce a meaningful impact in our view. This would leave post tax real income running at 0.5% into next year.

QE2 to provide additional support

Figure 31: UK HH interest expense as a share of disposable income

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UK household interest pay ments as a% of dispoable income Source: NSO

Against the negative impact from fiscal tightening, record low interest rates are providing some positive offset to household disposable income. The recent heightened expectations for an additional wave of QE are positive for household balance sheets and asset reflation more generally.

We acknowledge the drags from recent renewed softening in the housing market and further deleveraging potential

Figure 32: Nationwide house price index, sa %oya

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-5%0%5%

10%15%20%25%30%

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Nationw ide house price index , sa (%y oy ) Source: Nationwide

UK house prices have softened again.

Figure 33: RICS Survey, Stocks of homes on books

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RICS housing surv ey - stocks of homes on books Source: RICS

While this is concerning we caution against too aggressive negative extrapolation as the RICS survey stocks of housing for sale are not elevated. Also, the new buyer enquiries reading has moved up from -17 to -2, the highest in four months.

Figure 34: UK consumer leverage

8090

100110120130140150160170180

87 90 93 96 99 02 05 08

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HH Debt % of gross disposable income HH Financial Balance % of gross disposable income Source: Datastream

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The starting point of elevated consumer leverage is still a difficult one, where over time further balance sheet repair is needed. The latest prints on household savings rate and financial position have showed a deterioration, with deleveraging drive stalling. However, our economists point out that these datasets are typically the most revision prone.

Table 7: UK Retail stocks performance and valuation Ytd perf 12m Fwd P/E 10/09e EPS 11/10e EPS

JD SPORTS FASHION 60.4% 7.47 15.7% 4.5%SPORTS DIRECT 51.5% 9.66 24.8% 4.0%DUNELM GROUP 32.7% 14.18 11.5% 10.8%TED BAKER 24.4% 15.47 24.1% 9.5%LOOKERS 22.4% 9.28 -17.3% 9.6%INCHCAPE 13.8% 10.61 23.8% 10.1%BROWN (N) GROUP 12.9% 10.31 5.0% 7.2%KESA ELECTRICALS 10.6% 12.71 21.5% 18.3%DIGNITY 9.1% 12.28 2.3% 9.3%NEXT 7.1% 9.94 19.8% 6.8%KINGFISHER 4.6% 11.16 18.3% 14.4%HALFORDS 4.5% 8.73 15.7% 8.9%MARKS & SPENCER 2.4% 12.49 -1.5% 6.9%WH SMITH -2.8% 9.87 5.7% 4.0%PENDRAGON -5.4% 6.69 - 36.5%DEBENHAMS -9.0% 7.39 -19.4% 11.7%CARPETRIGHT -17.2% 20.19 10.3% 23.9%HOME RETAIL -21.9% 10.02 -7.4% 0.4%DIXONS RETAIL -23.0% 9.6 60.7% 33.6%MOTHERCARE -26.4% 12.71 15.6% 19.4%TOPPS TILES -27.5% 9.1 -8.8% 8.4%GAME GROUP -30.4% 6.64 -45.9% 15.4%HMV GROUP -48.3% 4.02 -8.3% 1.9%Average 1.9% 10.5 7.6% 12.0%Median 4.5% 9.9 10.9% 9.5%Source: Datastream, IBES

At the stock level, we highlight Next, Kingfisher, Inchcape, WH Smith and Game Group all rated OW by our analysts, as attractive plays in the UK retailing space.

As of recently more cautious on Luxury goods

While we remain positive on the overall Discretionary sector, we downgraded Luxury goods to N from OW recently (see our report dated 13th Sept).

Figure 35: Luxury goods 12m Fwd P/E relative

0.7

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1.5

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1.9

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

Consumer Durables 12mth Fw d P/E rel av erage +1stdev -1stdev

Source: IBES

Luxury goods have performed strongly over the past 18 months, but appear stretched now. The sector trades on 18x 12m Fwd P/E, a 62% premium to long term relative average.

Figure 36: Luxury goods performance relative vs. Japanese consumer confidence

-80%

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

-50%

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Lux ury Goods rel to Europe (%y oy ) Japanese consumer sentiment (%y oy ,RHS)

Source: Datastream, MSCI

While the sector is undoubtedly a beneficiary of increasing EM demand, we note that other drivers of its performance are showing signs of moderation. In particular, a rollover in Japanese consumer sentiment was historically a negative for the Luxury space.

Figure 37: Trade-weighted euro

260

265

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275

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285

290

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300


Trade Weighted Euro Source: Bloomberg

Heading into Q4 where comps are getting tougher, the recent Euro strengthening is an additional source of risk in our view.


13



Appendix I – UK sectors geographical sales exposure Table 8: UK sectors revenues exposure Sector % Ex UK Sales Health Care 92% Metals & Mining 90% Automobiles & Components 87% Technology Hardware & Equipment 78% Software & Services 70% Insurance 69% Energy 68% Capital Goods 66% Hotels Restaurants & Leisure 65% Media 63% Telecommunication Services 62% Food Beverage & Tobacco 62% Chemicals 61% UK 58% Semiconductors & Semiconductor Equipment 57% Household & Personal Products 56% Diversified Financials 45% Transportation 43% Banks 32% Utilities 26% Consumer Durables & Apparel 25% Retailing 24% Real Estate 23% Food & Staples Retailing 18% Source: Datastream, Worldscope bottom up

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Appendix II – UK sectors performance and valuation Table 9: UK sectors performance breakdown Mkt Cap % of %ch %ch %ch, qtd %ch %ch %ch Current vs 12 Mth (Bn £) All-Share 2010 2009 Q4'10 Q3'10 Q2'10 Q1'10 High LowFTSE All Share ASX Index 1,824 100.0 7.2 25.0 3.2 12.7 -12.6 5.4 -1.1 19.4FTSE 100 UKX Index 1,585 86.9 5.8 22.1 3.2 12.8 -13.4 4.9 -1.8 19.6FTSE 250 MCX Index 212 11.6 16.9 46.3 3.3 12.4 -7.9 9.2 -0.7 25.1All Share Ex Financials 1,421 77.9 All Share Ex Resources 1,263 69.2 Ex Resources & Financials 860 47.2 Oil & Gas FTRSRC Index 289 15.8 -5.8 14.5 2.7 19.4 -25.2 2.8 -12.5 24.8Oil & Gas Producers FAOILG Index 275 15.1 -7.0 13.3 2.6 19.2 -25.9 2.6 -13.4 24.4Oil Equipment & Svs FXOESDE Index 13 0.7 40.5 86.5 4.3 26.1 -3.8 11.1 0.0 51.5Basic Materials FTBASI Index 272 14.9 15.6 106.3 9.5 19.5 -21.1 11.8 -0.9 41.8Chemicals FACHEM Index 8 0.4 45.4 48.0 4.7 26.7 -3.7 13.8 0.0 56.2Mining FAMNG Index 258 14.2 14.2 108.1 9.8 19.1 -21.6 11.4 -1.8 41.1Industrials FTGENI Index 131 7.2 21.4 26.5 4.5 11.4 -5.5 10.3 0.0 29.9Construction FACONS Index 5 0.3 6.2 6.2 3.4 12.1 -15.1 8.0 -5.2 19.3Aerospace & Defence FAAERO Index 33 1.8 11.8 15.9 5.2 6.5 -9.4 10.2 -1.6 24.2General Industrials FADIND Index 11 0.6 32.5 23.7 5.3 19.8 -6.6 12.4 -0.1 47.8Electronics FAELTR Index 6 0.3 68.7 22.5 5.7 27.6 11.9 11.8 0.0 83.6Engineering FAENGN Index 14 0.7 58.9 79.8 8.3 23.7 -1.5 20.5 -0.9 73.2Industrial Transport FATRAN Index 3 0.2 20.7 53.8 2.0 6.7 -2.4 13.6 0.0 24.3Support Services FASUPP Index 59 3.2 16.2 29.0 3.2 8.9 -4.5 8.1 0.0 24.4Consumer Goods FTCONS Index 212 11.6 8.2 23.2 0.9 8.3 -6.6 6.1 -0.5 17.4Autos FAAUTO Index 3 0.2 53.5 78.7 6.0 45.7 -15.7 17.9 -0.5 76.1Beverages FABEVG Index 63 3.5 9.1 28.9 2.8 5.4 -3.1 3.9 -0.3 23.1Food Producers FAFOOD Index 37 2.0 -0.8 25.5 -0.1 2.9 -6.1 2.8 -5.7 7.4Housebuilders FXHOUGE Index 31 1.7 -2.5 31.5 -1.9 11.2 -15.3 5.5 -10.0 12.2Personal Goods FAPERC Index 9 0.5 57.1 105.8 -3.1 35.8 7.0 11.7 -3.1 82.6Tobacco FATOBC Index 68 3.7 12.4 9.9 1.5 8.0 -6.1 9.3 -1.1 23.4Health Care FTNCYC Index 133 7.3 4.9 6.0 3.3 5.6 -3.0 -0.8 -0.6 15.8Health Care & Equipment FAHLTH Index 6 0.3 -13.9 44.4 -4.7 -6.9 -4.3 1.4 -20.2 3.1Pharmaceuticals FAPHRM Index 127 7.0 5.9 4.4 3.6 6.3 -2.9 -1.0 -0.6 17.1Consumer Services FTCYCS Index 182 10.0 9.4 27.6 2.3 10.2 -9.7 7.4 -3.3 16.7Food Retailers FAFDRT Index 52 2.9 4.4 12.5 1.5 12.7 -10.7 2.3 -2.2 15.4General Retailers FARETG Index 30 1.6 -0.7 73.1 4.6 10.0 -10.3 -3.7 -5.1 17.3Media FAMEDA Index 51 2.8 16.3 29.2 1.5 9.6 -6.1 11.3 -1.5 25.4Travel & Leisure FALEIS Index 49 2.7 15.9 23.3 2.8 8.4 -11.6 17.7 -6.3 26.9Telecommunications FTNCYS Index 108 5.9 12.8 3.8 4.9 10.6 -6.7 4.2 0.0 24.5Fixed Telecoms FATELE Index 17 1.0 2.5 -0.8 1.0 3.3 2.7 -4.4 -5.0 19.8Mobile Telecoms FXMOBTE Index 90 5.0 14.9 4.6 5.6 12.0 -8.3 5.9 0.0 26.8Utilities FTUTIL Index 66 3.6 7.3 -0.7 3.0 8.8 -4.1 -0.2 -1.8 22.6Electricity FAELEC Index 18 1.0 5.4 -1.0 1.3 8.3 -0.7 -3.3 -3.0 20.1Gas, Water & Multi-utilities FAUTLO Index 48 2.6 8.1 -0.6 3.7 9.1 -5.4 1.0 -1.4 26.4Financials FTFINC Index 403 22.1 5.9 25.1 1.5 12.3 -10.8 4.2 -2.7 17.3Banks FABANK Index 264 14.5 4.1 23.8 0.1 10.7 -11.9 6.7 -7.5 14.4Non-life Insurance FAINSU Index 18 1.0 17.7 -1.9 1.1 8.5 0.0 7.3 -0.2 24.1Life Insurance FALIFE Index 53 2.9 5.0 26.8 0.2 25.9 -13.0 -4.4 -1.4 29.5Real Estate Investment & Services FAREISV Index 5 0.3 -8.0 - 3.0 4.1 -12.7 -1.7 -10.4 11.1Real Estate Investment Trusts FAREITS Index 23 1.3 1.7 7.6 6.7 12.6 -13.7 -2.0 0.0 22.6Financial Services FAOTHR Index 40 2.2 8.7 40.6 6.9 12.0 -8.5 -0.8 -1.1 25.3Technology FTSEIT Index 30 1.7 26.2 75.9 -2.0 18.0 -4.8 14.6 -3.9 36.1IT Software FASOFT Index 21 1.2 16.1 64.5 -3.0 13.6 -7.5 13.9 -5.0 24.3IT Hardware FAINFT Index 9 0.5 58.9 130.8 0.5 30.0 3.8 17.1 -2.5 76.2Source: Bloomberg

15



European Equity Strategy Key Calls and Drivers We find the backdrop for stocks still constructive: manufacturing momentum has peaked and clear evidence of labour market recovery remains elusive, but record low credit yields and functioning markets are a support, delinquencies continue to move lower and bank lending standards are easing, earnings remain on an uptrend, inflation backdrop is favourable, yield curve is steep, etc. We favour Cyclicals while in general we remain cautious on Defensives.

Table 10: J.P. Morgan Equity Strategy — Factors driving our medium-term views Driver Impact Our Core Working Assumptions Recent Developments Global Growth Neutral Recovery to prove sustainable beyond manufacturing peak Mixed US housing and labour readings European Growth Positive Eurozone growth to remain at trend Soft September PMI readings but strong IFO Inflation Positive Low inflation backdrop to remain Mkt increasingly fearing Deflation Monetary Policy Positive All key central banks in maximum dovish mode New rounds of monetary support Currency Neutral Rangebound Euro and start of Renminbi revaluation Recent Euro strengthening Earnings Positive Earnings uptrend to continue Look for supportive Q3 earnings delivery Valuations Positive Equities attractively valued vs bonds and history Europe on 10.5x Fwd P/E, 30% below LT average Technicals Neutral Better seasonality in Q4 Source: J.P. Morgan estimates.

Table 11: J.P. Morgan Equity Strategy — Scenarios: Base Case and Risks Scenario Macro environment in 2010E

Upside scenario - Goldilocks Strong growth recovery without near-term policy tightening. Earnings surprise on the upside. Equities rerate significantly. Cyclical and Financial sectors continue to outperform strongly.

Base-case scenario – Recovery has legs Recovery proves sustainable. Central banks remain accommodative. Beta outperforms

Downside scenario – Double dip Final demand rebound fails to follow restocking. World falls into deflationary trap, consumers undergo a significant and protracted process of balance sheet repair. Cash is king, only the defensive sectors outperform, but even they fall significantly in absolute terms.

Source: J.P. Morgan estimates

Table 12: J.P. Morgan Equity Strategy — Key sector calls*

Sector Recommendations Key Drivers The view could be expressed through these ETFs hedged by SXXPIEX GY

Mining Overweight China policy turnaround, RMB appreciation XPPS GR Autos Overweight Cheap, strong profitability, volume upside Utilities Underweight Pricing weakness, regulatory risk X6PS GR Pharma Underweight Structural risks remain, overowned XDPS GR Source: J.P. Morgan estimates. * Please see the last page for the full list of our calls and sector allocation.

Table 13: J.P. Morgan Equity Strategy — Key regional calls Region Recommendations J.P. Morgan Views ETFs Global OW Europe vs. US Europe cheaper, underowned, resilient activity long SDJE50 GR vs IVV US Global OW EM vs DM EM to be supported by inflows, turn in China policy stance Source: J.P. Morgan estimates

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Top Picks Table 14: J.P. Morgan European Strategy: Top European picks

IBES consensus estimates Performance

Name Price Ticker JPM Rating

Analyst Name Sector

10/09e EPS 10e P/E

10e Div Yield 10 ytd -3m -12m

BP 429.7 £ BP/ LN OW Fred Lucas Energy 44.2% 6.5 1.8% -28.4% 7.2% -23.1%BG Group 1174.0 £ BG/ LN OW Fred Lucas Energy 11.8% 15.7 1.1% 4.6% 8.5% 2.6%Statoil 127.0 NK STL NO N Nitin Sharma Energy 14.8% 9.2 5.0% -12.3% -1.9% -7.2%TOTAL 38.9 E FP FP N Nitin Sharma Energy 34.2% 8.3 6.0% -13.6% -0.3% -7.2%ArcelorMittal 25.2 E MT NA OW Alessandro Abate Materials 2733.3% 14.8 2.2% -21.8% 5.8% -7.2%Rio Tinto 4134.5 £ RIO LN OW David Butler Materials 88.6% 9.8 1.5% 22.0% 31.9% 37.9%Xstrata 1342.0 £ XTA LN OW David Butler Materials 75.3% 11.9 0.8% 19.7% 42.4% 30.2%Anglo American 2863.5 £ AAL LN OW David Butler Materials 102.1% 11.4 1.0% 5.6% 18.5% 23.9%Siemens 80.5 E SIE GR OW Andreas Willi Industrials 124.0% 13.7 2.2% 25.4% 5.5% 16.7%Schneider 101.2 E SU FP OW Andreas Willi Industrials 36.3% 15.9 2.8% 23.7% 13.8% 33.0%BAE Systems 366.5 £ BA/ LN OW John Middleton Industrials 4.3% 8.7 4.6% 1.9% 14.9% 15.0%Man 81.0 E MAN GR OW Nico Dil Industrials 159.9% 21.2 1.3% 48.8% 8.8% 38.9%Philips 24.1 E PHIA NA N Andreas Willi Industrials 144.6% 13.3 3.1% 16.7% -8.0% 27.6%Daimler 47.4 E DAI GR OW Ranjit A Unnithan Discretionary - 12.5 2.7% 27.3% 8.9% 35.0%LVMH 111.5 E MC FP OW Melanie A Flouquet Discretionary 36.8% 22.0 1.8% 42.2% 22.1% 53.3%Intercontinental Holels 1161.0 £ IHG LN OW Tim Barrett Discretionary -8.5% 20.3 2.3% 30.0% 0.1% 38.1%ITV 63.0 £ ITV LN OW Filippo Pietro Lo Franco Discretionary 150.0% 14.4 0.0% 20.2% 20.1% 23.1%JCDecaux 20.3 E DEC FP OW Filippo Pietro Lo Franco Discretionary 545.5% 28.5 0.6% 19.0% -1.0% 32.9%Inbev 45.0 E ABI BB OW Mike J Gibbs Staples 27.8% 20.0 1.0% 23.6% 6.5% 36.0%Carrefour 40.1 E CA FP OW Matthew Truman Staples 18.2% 17.1 2.9% 19.6% 13.7% 28.8%BAT 2416.5 £ BATS LN OW Rae Maile Staples 14.4% 13.8 4.7% 19.8% 6.6% 22.4%Givaudan 1010.0 SF GIVN VX OW Celine Pannuti, CFA Staples 48.4% 18.6 2.3% 22.2% 7.3% 29.5%Nestle 52.4 SF NESN VX OW Polly Barclay Staples 11.1% 16.2 3.4% 4.3% -1.9% 20.1%Roche 138.4 SF ROG VX OW Alexandra Hauber Health Care 16.3% 10.5 4.9% -21.3% -7.9% -18.3%Novartis 56.8 SF NOVN VX OW Alexandra Hauber Health Care 36.6% 11.8 3.8% 0.4% 5.6% 9.9%Astrazeneca 3337.5 £ AZN LN N Alexandra Hauber Health Care 2.0% 8.3 4.6% 14.7% 2.0% 19.8%Credit Suisse 42.6 SF CSGN VX OW Kian Abouhossein Financials -2.1% 8.5 4.7% -16.7% -6.1% -29.4%BNP Paribas 52.3 E BNP FP OW Kian Abouhossein Financials 22.9% 8.2 3.7% -6.5% 3.1% -6.5%UniCredit 1.9 E UCG IM OW Ignacio Cerezo Financials 11.1% 18.7 2.1% -16.6% -9.6% -29.1%Societe Generale 41.7 E GLE FP OW Kian Abouhossein Financials 412.0% 8.9 3.5% -14.8% 7.9% -13.3%BBVA 9.8 E BBVA SM N Ignacio Cerezo Financials -12.9% 8.0 4.4% -23.3% -0.2% -21.6%HSBC 662.3 £ HSBA LN OW Carla Antunes da Silva Financials 133.3% 13.4 3.5% -6.6% 3.5% -8.4%Swiss Re 47.7 SF RUKN VX OW Michael Huttner, CFA Financials 215.5% 10.2 4.2% -4.5% -1.4% -3.5%Ageas 2.3 E AGS BB OW Duncan Russell, CFA Financials -52.1% 9.9 3.5% -13.5% 15.5% -32.0%Barclays 280.0 £ BARC LN N Carla Antunes da Silva Financials 30.8% 9.4 1.9% 1.4% -10.7% -27.0%Alcatel Lucent 2.6 E ALU FP OW Rod Hall, CFA IT - -37.3 0.0% 9.7% 18.6% -20.4%ASML 23.0 E ASML NA OW Sandeep S Deshpande IT - 10.9 1.2% -4.1% -8.5% 10.5%SAP 37.9 E SAP GR OW Stacy Pollard IT 16.2% 17.6 1.5% 14.7% 0.7% 8.3%Vodafone 166.5 £ VOD LN OW Paul Howard Telecoms - - 5.3% 15.9% 14.0% 22.9%KPN 11.4 E KPN NA OW Akhil Dattani Telecoms 28.9% 9.8 7.0% -3.7% 5.5% -5.4%Telenor 89.8 NK TEL NO OW Akhil Dattani Telecoms 19.4% 13.9 3.8% 10.7% -1.0% 24.5%Centrica 327.7 £ CNA LN OW Edmund Reid Utilities 16.7% 13.3 4.3% 16.6% 4.7% 33.9%Source: Datastream, MSCI, IBES, J.P. Morgan, Prices and Valuations as of COB 14th October, 2010 Please see the most recent company-specific research published by J.P. Morgan for an analysis of valuation methodology and risks on companies recommended in this report. Research is available at http://www.morganmarkets.com, or you can contact the covering analyst or your J.P. Morgan representative.

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Technical Indicators Figure 38: AAII Bulls vs. Bears

-60%

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Europe 6m fw d av erage return

Source: Datastream, Bloomberg, J.P. Morgan

Figure 39: Put Call ratios

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04 05 06 07 08 09 10S&P Put Call ratio

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Figure 40: Skew

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Europe 6m fw d av erage return


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Performance Table 15: Sector Index Performances — MSCI Europe (%change) Local currency Industry Group 4week 12m 10YTDEurope 2.5 3.2 2.2Energy 4.5 (3.4) (6.7)Materials 8.8 15.5 6.7 Chemicals 6.3 22.4 12.4 Construction Materials (1.2) (29.0) (27.5) Metals & Mining 12.1 20.5 8.7Industrials 5.2 12.7 12.5 Capital Goods 5.3 13.2 13.8 Transport 4.9 7.9 6.9Consumer Discretionary 4.4 22.0 21.1 Automobile 6.1 19.9 27.0 Consumer Durables 9.8 46.7 38.3 Media 1.3 11.0 8.0 Retailing 0.5 20.4 17.5 Hotels,Restaurants&Leisure 2.4 13.4 12.3Consumer Staples 1.5 18.1 7.3 Food & Drug Retailing 1.4 19.7 8.6 Food Beverage & Tobacco 1.4 17.6 7.1 Household Products 2.4 19.5 6.2Healthcare 1.4 5.1 (0.8)Financials (1.2) (12.0) (4.0) Banks (2.7) (13.6) (6.3) Diversified Financials (1.8) (14.6) (1.2) Insurance 2.2 (8.7) (1.8) Real Estate 5.8 6.7 7.3Information Technology 2.6 (2.2) 6.6 Software and Services 2.2 7.0 14.6 Technology Hardware 0.8 (15.0) (2.5) Semicon & Semicon Equip 7.9 21.5 15.5Telecommunications Services 2.6 7.1 4.3Utilities 0.5 (5.9) (10.6)Source: MSCI, Datastream, as at COB 14th October, 2010.

Table 16: Country and Region Index Performances (%change) Local Currency US$ Country Index 4week 12m 10YTD 4week 12m 10YTDAustria ATX 6.9 (1.7) 7.5 14.9 (7.1) 5.6Belgium BEL 20 3.0 3.0 6.0 10.7 (2.6) 4.1Denmark KFX 2.5 24.3 25.8 10.1 17.3 23.3Finland HEX 20 4.8 13.7 13.5 12.7 7.5 11.4France CAC 40 2.2 (1.6) (3.0) 9.9 (7.0) (4.8)Germany DAX 3.3 10.3 8.4 11.0 4.2 6.4Greece ASE General 0.4 (46.8) (29.8) 7.9 (49.7) (31.1)Ireland ISEQ (1.9) (18.9) (9.4) 5.5 (23.3) (11.1)Italy FTSE MIB 2.0 (13.4) (9.3) 9.6 (18.1) (10.9)Japan Topix (0.9) (6.4) (7.8) 4.3 2.7 5.4Netherlands AEX 2.0 4.9 1.8 9.6 (0.9) (0.1)Norway OBX 5.8 12.8 3.5 12.4 9.3 4.2Portugal BVL GEN 4.0 (8.9) (5.5) 11.8 (13.9) (7.2)Spain IBEX 35 1.2 (8.6) (9.1) 8.8 (13.6) (10.8)Sweden OMX 1.9 18.3 15.4 9.8 24.7 25.8Switzerland SMI 0.3 0.5 (1.6) 6.6 7.3 6.7United States S&P 500 4.4 7.5 5.3 4.4 7.5 5.3United States NASDAQ 5.7 12.1 7.3 5.7 12.1 7.3United Kingdom FTSE 100 3.4 9.0 5.8 5.9 9.4 4.9EMU MSCI EMU 2.5 (1.5) (0.8) 10.2 (6.9) (2.6)Europe MSCI Europe 2.5 3.2 2.2 8.3 1.4 2.4Global MSCI AC World 3.3 4.3 2.6 6.0 5.5 4.9Source: MSCI, Datastream, as at COB 14th October, 2010.

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Earnings Table 17: IBES Consensus EPS Sector Forecasts — MSCI Europe EPS Growth (%) 2009E 2010E 2011E 2012E Europe (16.7) 35.4 16.0 12.5 Energy (47.3) 39.1 14.0 12.6 Materials (58.1) 78.4 28.8 12.4 Chemicals (27.2) 35.7 10.9 10.7 Construction Materials (46.9) (9.9) 30.5 26.2 Metals & Mining (72.4) 147.3 38.6 11.7 Industrials (32.1) 43.5 17.4 14.8 Capital Goods (31.4) 35.2 17.5 14.0 Transport (62.7) 242.4 20.2 19.7 Discretionary (51.2) 133.6 19.4 16.8 Automobile (175.6) - 37.8 27.6 Consumer Durables (19.7) 42.6 15.7 12.3 Media (12.7) 11.0 8.9 8.3 Retailing 7.1 16.2 9.7 12.4 Hotels,Restaurants&Leisure (3.0) (2.8) 12.8 12.9 Staples 3.8 9.8 10.7 10.9 Food & Drug Retailing (2.5) 14.2 14.1 12.5 Food Beverage & Tobacco 6.5 7.7 10.3 10.6 Household Products (4.1) 18.6 6.5 9.7 Healthcare 10.3 10.6 6.7 4.1 Financials 63.2 58.4 23.7 17.3 Banks (59.8) 142.6 34.8 22.8 Diversified Financials - 31.4 16.5 13.6 Insurance 41.7 9.4 10.5 8.7 Real Estate - 7.4 2.5 6.0 IT (47.1) 56.7 25.0 11.6 Software and Services (2.3) 11.8 15.7 12.9 Technology Hardware (43.7) (3.8) 35.2 13.4 Semicon & Semicon Equip (293.8) - 18.9 4.8 Telecoms (0.4) 1.0 3.9 4.2 Utilities (7.3) (3.7) 0.8 7.5 Source: IBES, MSCI, Datastream. As at COB 14th October, 2010

Table 18: IBES Consensus EPS Country Forecasts EPS Growth (%) Country Index 2009E 2010E 2011E 2012E Austria ATX (40.1) 31.7 32.2 20.4Belgium BEL 20 489.4 33.1 5.4 10.2Denmark Denmark KFX (24.2) 26.9 32.8 19.3Finland MSCI Finland (46.0) 25.3 18.5 11.3France CAC 40 (33.5) 39.2 14.4 12.3Germany DAX (7.4) 59.4 10.6 13.6Greece MSCI Greece (32.4) (42.9) 36.4 34.9Ireland MSCI Ireland (50.9) - - 129.6Italy MSCI Italy (39.0) 7.1 25.2 16.9Netherlands AEX (53.0) 86.0 21.5 14.1Norway MSCI Norway (38.5) 35.1 23.2 12.3Portugal MSCI Portugal 2.6 0.3 14.6 16.7Spain IBEX 35 (22.8) 0.3 11.6 12.7Sweden OMX (26.1) 35.8 16.6 11.9Switzerland SMI 604.6 36.1 11.0 9.4United Kingdom FTSE 100 (39.2) 56.6 19.3 11.6EMU MSCI EMU (18.0) 33.5 15.8 14.1Europe ex UK MSCI Europe ex UK (3.7) 33.6 15.6 13.4Europe MSCI Europe (16.7) 35.4 16.0 12.5United States S&P 500 4.4 39.5 14.0 14.1Japan Topix - 91.5 18.3 13.1Emerging Market MSCI EM 13.9 36.1 14.9 11.0Global MSCI AC World 0.6 34.6 15.6 12.9Source: IBES, MSCI, Datastream. As at COB 14th October, 2010** Japan refers to the period from March in the year stated to March in the following year – EPS post-goodwill.

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Valuations Table 19: IBES Consensus European Sector Valuations P/E Dividend Yields EV/EBITDA Price to Book 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E Europe 12.0 10.3 9.2 3.4% 3.9% 4.3% 6.5 5.9 5.3 1.6 1.5 1.3 Energy 9.5 8.3 7.4 4.1% 5.0% 5.2% 4.1 3.6 3.3 1.5 1.4 1.3 Materials 13.0 10.1 9.0 2.1% 2.5% 2.8% 6.8 5.6 4.9 1.7 1.5 1.4 Chemicals 14.5 13.1 11.8 2.7% 3.0% 3.3% 7.3 6.7 6.1 2.3 2.1 1.9 Construction Materials 14.3 11.0 8.7 3.3% 3.8% 4.4% 7.7 6.7 5.8 0.9 0.8 0.8 Metals & Mining 12.0 8.7 7.8 1.6% 2.1% 2.3% 6.4 5.0 4.3 1.8 1.6 1.4 Industrials 14.8 12.6 11.0 2.6% 3.0% 3.4% 7.6 6.6 5.8 2.2 2.0 1.8 Capital Goods 14.5 12.4 10.8 2.7% 3.1% 3.5% 7.7 6.7 5.9 2.1 1.9 1.7 Transport 14.9 12.4 10.4 2.5% 2.9% 3.3% 6.7 5.9 5.1 1.8 1.7 1.5 Discretionary 14.7 12.3 10.6 2.6% 3.0% 3.5% 6.4 5.7 4.9 2.0 1.9 1.7 Automobile 12.9 9.4 7.3 1.8% 2.6% 3.4% 3.7 3.1 2.3 1.2 1.1 1.0 Consumer Durables 19.9 17.2 15.3 1.6% 1.8% 2.1% 10.4 8.9 8.2 3.4 3.0 2.7 Media 12.6 11.5 10.7 4.1% 4.4% 4.8% 7.3 6.8 6.2 2.2 2.1 1.9 Retailing 16.3 14.9 13.2 3.0% 3.5% 3.9% 9.4 8.9 7.9 3.4 3.1 2.9 Hotels, Restaurants & Leisure 15.0 13.3 11.8 3.0% 3.4% 3.8% 8.0 7.2 6.6 2.1 2.0 1.8 Staples 15.4 13.9 12.5 2.8% 3.1% 3.4% 9.1 8.3 7.6 2.8 2.6 2.3 Food & Drug Retailing 13.9 12.2 10.9 2.9% 3.2% 3.6% 7.1 6.4 5.8 2.1 1.9 1.8 Food Beverage & Tobacco 15.5 14.1 12.7 2.9% 3.2% 3.5% 9.6 8.8 8.0 3.0 2.7 2.4 Household Products 17.6 16.5 15.0 2.3% 2.5% 2.7% 10.6 9.6 8.6 3.6 3.2 2.9 Healthcare 11.1 10.4 10.0 3.6% 3.9% 4.2% 7.8 7.0 6.5 2.7 2.4 2.2 Financials 10.8 8.7 7.4 3.3% 4.0% 4.8% - - - 1.0 0.9 0.8 Banks 12.2 9.0 7.4 3.0% 3.8% 4.8% - - - 0.9 0.9 0.8 Diversified Financials 9.5 8.1 7.2 2.5% 3.1% 4.0% - - - 1.1 0.9 0.9 Insurance 8.5 7.7 7.1 4.8% 5.3% 5.8% - - - 1.0 0.9 0.8 Real Estate 17.2 16.8 15.8 4.9% 4.7% 4.9% - - - 1.0 1.0 0.9 IT 16.3 13.1 11.7 2.3% 2.6% 2.8% 8.0 6.5 5.8 2.4 2.2 2.0 Software and Services 17.5 15.1 13.4 1.6% 1.9% 2.1% 9.7 8.1 7.2 3.2 2.8 2.5 Technology Hardware 16.3 12.1 10.6 3.6% 3.8% 4.2% 6.9 5.5 4.9 2.0 1.8 1.7 Semicon & Semicon Equip 14.5 12.2 11.6 1.2% 1.6% 1.7% 7.2 5.8 5.2 2.1 1.8 1.6 Telecoms 10.5 10.1 9.7 6.1% 6.5% 6.9% 5.3 5.3 5.1 1.7 1.6 1.5 Utilities 10.4 10.3 9.6 5.5% 5.6% 5.9% 7.3 7.1 6.8 1.3 1.3 1.2 Source: IBES, MSCI, Datastream. As at COB 14th October, 2010

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Table 20: IBES Consensus P/E and 12-Month Forward Dividend Yields — Country Forecasts P/E Dividend Yield Country Index 12-Mth Fwd 2010E 2011E 2012E 12-Month Forward Austria ATX 11.0 13.3 10.1 8.4 2.7% Belgium BEL 20 12.6 12.8 12.2 11.0 3.3% Denmark Denmark KFX 14.3 17.7 13.3 11.2 0.9% Finland MSCI Finland 12.9 14.5 12.3 11.0 4.2% France CAC 40 10.2 11.1 9.7 8.7 5.4% Germany DAX 10.6 11.2 10.1 8.9 3.1% Greece MSCI Greece 9.1 11.4 8.4 6.2 3.1% Ireland MSCI Ireland 37.6 - 23.1 10.1 3.5% Italy MSCI Italy 9.9 11.6 9.3 8.0 4.1% Netherlands AEX 10.1 11.6 9.5 8.4 3.5% Norway MSCI Norway 10.1 11.7 9.5 8.5 2.6% Portugal MSCI Portugal 12.6 13.9 12.2 10.4 4.3% Spain IBEX 35 10.2 10.9 9.8 8.7 5.6% Sweden OMX 13.3 15.0 12.9 11.5 2.5% Switzerland SMI 11.6 12.4 11.1 10.2 3.2% United Kingdom FTSE 100 10.5 12.0 10.1 9.0 4.0% EMU MSCI EMU 10.6 11.7 10.1 8.8 4.2% Europe ex UK MSCI Europe ex UK 11.2 12.2 10.5 9.3 3.7% Europe MSCI Europe 10.9 12.0 10.3 9.2 3.9% United States S&P 500 12.7 14.0 12.3 10.8 2.4% Japan Topix 13.2 14.5 12.3 10.9 2.0% Emerging Market MSCI EM 11.3 12.8 11.1 9.5 2.3% Global MSCI AC World 11.9 13.5 11.7 10.3 2.8% Source: IBES, MSCI, Datastream. As at COB 14th October, 2010; ** Japan refers to the period from March in the year stated to March in the following year – P/E post goodwill

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Economic, Interest Rate and Exchange Rate Outlook Table 21: Economic Outlook in Summary Real GDP Real GDP Consumer prices % oya % oqa, saar % oya

2009E 2010E 2011E 1Q10E 2Q10E 3Q10E 4Q10E 1Q11E 2Q11E 3Q11E 2Q10E 4Q10E 2Q11E 4Q11EUnited States -2.6 2.6 2.4 3.7 1.7 1.5 2.0 2.5 2.5 3.0 1.8 0.9 1.2 1.1Eurozone -4.0 1.7 1.5 1.4 3.9 2.0 1.0 1.0 1.0 1.8 1.5 1.7 1.1 1.0United Kingdom -4.9 1.7 2.2 1.3 4.9 2.5 1.5 1.0 2.5 3.0 3.5 2.6 1.9 2.1Switzerland -1.9 2.9 2.0 4.2 3.5 2.5 2.0 1.5 1.5 2.3 1.0 0.4 0.1 0.7Japan -5.2 2.9 0.9 5.0 1.5 2.5 -1.5 0.5 1.5 1.8 -0.9 -0.8 -0.2 -0.3Emerging markets 1.3 6.9 5.6 7.7 7.1 3.8 5.0 6.0 6.4 5.9 5.2 5.3 5.2 5.1Global -2.2 3.6 2.9 4.2 3.9 2.5 2.2 2.8 3.1 3.4 2.5 2.3 2.3 2.1Source: J.P. Morgan economic research, J.P. Morgan estimates, as of COB 14th October, 2010.

Table 22: Official Rates Outlook % Forecast Forecast for Official interest rate Current Last change (bp) next change (bp) Dec 10 Mar 11 Jun 11 Sep 11 Dec 11

United States Federal funds rate 0.125 16 Dec 08 (-87.5bp) On Hold 0.125 0.125 0.125 0.125 0.125Eurozone Refi rate 1.00 7 May 09 (-25bp) On Hold 1.00 1.00 1.00 1.00 1.00United Kingdom Repo rate 0.50 5 Mar 09 (-50bp) On Hold 0.50 0.50 0.50 0.50 0.50Switzerland 3-month Swiss Libor 0.25 12 Mar 09 (-25bp) June 11 (+25bp) 0.25 0.25 0.50 0.75 1.00Japan Overnight call rate 0.05 5 Oct 10 On Hold 0.05 0.05 0.05 0.05 0.05Source: J.P. Morgan estimates, Datastream, as of COB 14th October, 2010.

Table 23: 10-Year Government Bond Yield Forecasts % Forecast for end of 14-Oct-10 Dec 10E Mar 11E Jun 11E Sep 11EUnited States 2.43 2.25 2.25 2.25 2.25Eurozone 2.30 2.30 2.20 2.30 2.40United Kingdom 2.98 3.00 3.00 3.10 3.25Japan 0.87 0.80 0.80 0.90 0.95Source: J.P. Morgan estimates, Datastream, as of COB 14th October, 2010.

Table 24: Exchange Rate Forecasts vs. US Dollar Forecast for end of 14-Oct-10 Dec 10E Mar 11E June 11E Sep 11E Dec 11EEUR 1.41 1.30 1.30 1.30 1.30 1.25GBP 1.60 1.49 1.48 1.48 1.49 1.47CHF 0.95 0.99 0.98 0.96 0.96 1.00JPY 81 79 81 83 85 88Source: J.P. Morgan estimates, Datastream, forecasts as of COB 14th October, 2010.

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Sector, Regional and Asset Class Allocations Table 25: J.P. Morgan Equity Strategy — European Sector Allocations

MSCI Europe Weights J.P. Morgan Allocations Deviation From MSCI J.P. Morgan

RecommendationEnergy 10.1% 11% 0.9% OverweightMaterials 9.9% 11% 1.1% Overweight Chemicals = Construction Materials = Metals & Mining +Industrials 10.6% 10% -0.6% Neutral Capital Goods = Transport =Consumer Discretionary 8.6% 9% 0.4% Overweight Automobile + Consumer Durables = Media + Retailing + Hotels, Restaurants & Leisure +Consumer Staples 12.3% 12% -0.3% Underweight Food & Drug Retailing = Food Beverage & Tobacco - Household Products -Healthcare 10.1% 9% -1.1% UnderweightFinancials 23.1% 24% 0.9% Overweight Banks + Diversified Financials = Insurance = Real Estate =Information Technology 2.9% 4% 1.1% Overweight Software and Services + Technology Hardware = Semicon & Semicon Equip +Telecoms 6.9% 7% 0.1% NeutralUtilities 5.4% 3% -2.4% Underweight 100% 100% 0% BalancedSource: MSCI, Datastream, J.P. Morgan

Table 26: J.P. Morgan Equity Strategy — European Regional Allocations

MSCI Europe Weights J.P. Morgan Allocations Deviation From MSCI J.P. Morgan

RecommendationEurozone 50% 53% 3% OverweightUnited Kingdom 33% 30% -3% UnderweightOthers* 17% 17% 0% Neutral

100% 100% 0% BalancedSource: MSCI, J.P. Morgan estimates * Switzerland, Sweden, Norway and Denmark.

Table 27: J.P. Morgan Equity Strategy — European Asset Class Allocations

Benchmark Weightings J.P. Morgan Allocations Deviation From MSCI J.P. Morgan

RecommendationEquities 60% 70% 10% OverweightBonds 30% 25% -5% UnderweightCash 10% 5% -5% Underweight 100% 100% 0% BalancedSource: J.P. Morgan. Note: We use the MSCI Europe Developed index as the benchmark against which to determine our sector and regional allocations. Our Overweight/Underweight recommendations reflect our belief that the relevant sector/region will out- / underperform the index in the next 6 to 12 months

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Companies Recommended in This Report (all prices in this report as of market close on 14 October 2010) Game Group (GMG.L/74p/Overweight), Inchcape (INCH.L/340p/Overweight), Kingfisher Plc (KGF.L/240p/Overweight), Next Plc (NXT.L/2,231p/Overweight), WH Smith (SMWH.L/480p/Overweight)

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