Eye on the Market I June 27. 2011 J.P.Morgan It's that time of year again (Final Exam); the IEA's release of strategic petroleum reserves; the D-word (derivatives) As we wrote a few weeks ago, this is the kind of market we expected this year: a tug of war between private sector profits and public sector problems. The chart below shows how some things (profits, capital spending, high end retail sales, credit spreads) improved over the last two years in the US, recovering most of what was lost during the recession. Other things haven't (almost anything having to do with employment, compensation or housing). Financial markets usually lead the economy in a recovery, but these gaps are too wide. One thing this chart does not capture: a doubling of net Federal debt/GDP since June 2007. Share of peak-to-trough decline recovered in the US since 2007 Percen 100'Y, 90% 80% 70% 60% 50% 40% 30% 20% - 10% 0% 1 Sources: Standard &Poors, Bureau of Economic Analysis, Deutsche Boerse, Federal Reserve Bank, US Can sus Bureau. Bureau of Labor Statistics. Real Capital An alytics, J.P. Morgan Securities LLC, J.P. Morgan Private Bank. Empirical Research Partners. IIE High end S&P500 Corp. Inv.Grade Small SW500 US CBD row•End Stale Tax Agg. Sperdng on Nonfarm Unem• Avg. HrV. Retail Earnings Capex Spreads Business index Industrial Office Cap Retail Revenue Work durables/ Payrolls ployment Earnings Income Production Rates Week homes rate Growth In January, we laid out a view that entails a single digit return year for stocks and other risky assets, with a lot of volatility. To get an understanding of why, please take the following closed-book exam. The answers appear at the end of the note. On the United States We expect a modest rebound from Q2 weakness, given the recent decline in energy prices, and the end of Japanese supply chain disruptions. However, issues related to government debt, weak labor markets and the fact that cr