USA
Review and Preview
Aug 07, 2006

Ted Wieseman (New York) and David Greenlaw (New York)

After some stronger economic data through the first part of the week had led the market to raise the odds of rate hike next week to about 40% – which would have been the most uncertain outcome for an FOMC meeting in nearly a decade – Friday’s weak employment report left little doubt about the likelihood of a pause at 5.25%, which the market now also sees as the peak. Even while the market had been previously ramping up the amount of expected near-term tightening, though, the amount of easing expected next year reached new highs on a daily basis, and this continued even after the market switched to pricing the end of the tightening cycle at 5.25% instead of 5.50%. This expectation of increasing medium-term easing, and probably a lot of bad positioning also, helped the curve flatten, with the week’s gains among the benchmark issues led by the 10-year (though much of the upside was futures led, with the bond and 10-year contracts and associated off-the-run issues performing very strongly), as the eurodollar futures market started to move towards pricing in the possibility of a cut in the funds target to 4.75% by the end of 2007.

Economic data released the past week were sharply mixed. Clearly the soft headline results from the employment report, both the fourth straight sluggish payroll gain and the uptick in the unemployment report off the cycle low of the prior two months, ultimately dominated market attention. But other data released through the week and some underlying details of the employment report were more positive. The ISM survey depicted stronger than expected factory sector activity in July, and this was confirmed by a robust advance in manufacturing hours worked in the employment report that should translate into another strong industrial production report in July. Strong auto sales and better than expected chain store sales results also pointed to a robust July retail sales report. And significantly stronger than expected results from the construction spending report and much higher than expected inventory numbers in the factory orders report implied a significant upward revision to the initially reported sluggish gain in Q2 GDP. Clearly the Fed seems very likely to keep rates unchanged on Tuesday. But with core inflation already near the top of their full year forecast, some incoming growth data looking more positive, and a significant earnings gain in the employment report further highlighting a sharp acceleration in labor costs – which is likely to be dramatically illustrated by some ugly unit labor cost numbers on Tuesday – we expect that Tuesday’s FOMC statement will leave open the prospect for more tightening down the road and certainly not hint at the quick about-face towards rate cutting the market currently expects. And we still think there will be more Fed rate action at some point down the road as second-half growth picks up and inflation continues to drift gradually higher.

Benchmark Treasury yields fell 7 to 9 bp the past week, with the belly of the curve outperforming as the 10-year yield fell 9 bp to 4.90% and the 5-year 8 bp to 4.83%, while the 2-year yield fell 7 bp to 4.91% and the 3-year and long bond yields each fell 7.5 bp to 4.86% and 4.99%, respectively. The 10-year and bond contracts also performed very strongly, with the 10-year contract and associated off-the-runs outperforming and the bond contract and associated off-the run bonds matching the on-the-run 10-year’s performance. TIPS put in an extremely strong performance, actually outperforming significantly in the rally, with the benchmark 5-year breakeven inflation spread widening 5 bp on the week to 2.59% and the 10-year spread 3 bp to 2.61%, leaving the 5-year/5-year forward breakeven the Fed focuses on unchanged at a relatively elevated 2.63%. Through the first four days of the week, the market had moved to price in a rising risk of a rate hike Tuesday and a higher likelihood of an eventual move to 5.50% by October if not Tuesday, while at the same time significantly increasing the amount of rate cutting expected next year. At Thursday’s close, the August fed funds contract was pricing in about a 40% chance of a rate hike Tuesday, the November contract was pricing in a 67% of a move to 5.50% by the October FOMC meeting, and the Dec 06 to Dec 07 eurodollar spread was inverted by a record 34 bp. After Friday’s employment report, of course, the amount of near-term rate hikes was sharply scaled back, but surprisingly the amount of easing expected next year barely budged. On the week, the August fed funds contract gained 2 bp to 5.29%, cutting the odds of a rate hike next week to (a somewhat surprisingly high) 20%.

The peak rate November contract rallied 1.5 bp to 5.35%, reducing the odds of a final move to 5.50% to 40%. In the eurodollar futures market the max one-year inverted Dec 06 to Dec 07 spread fell 7 bp to -33.5 bp (steepening just 0.5 bp Friday from Thursday’s all-time low), with the former rallying 2.5 bp to 5.425% and the latter 9.5 bp to 5.09%, a level that is starting to move towards pricing a 4.75% rather than 5% funds target by the end of next year.

Main data focus the past week was, of course, on the employment report.   Nonfarm payrolls rose a less than expected 113,000 in July, a fourth straight relatively sluggish gain over which time payroll growth has averaged 112,000, down from the 171,000 average from 2004 through March.

Weakness in July was seen in manufacturing (-15,000), retail (unchanged), temps (-2,000), and government (unchanged). Other details of the report were mixed. A pullback in recently stronger employment growth in the household survey (though a gap still exists, with population adjusted household survey employment up 1.6% year/year in July overall and 1.5% adjusted for definitional and coverage differences with the establishment survey versus nonfarm payroll growth of 1.3%) led the unemployment rate to rise to 4.8% from the cycle low 4.6% seen the prior two months. The average workweek held unchanged at a five-year high of 33.9 hours, leading aggregate hours worked to tick up 0.1%. With average hourly earnings up a strong 0.4%, aggregate weekly payrolls (a proxy for wage and salary income) gained a solid 0.5%.

Other key data released prior to the employment report were more positive. The manufacturing sector still appears to be posting robust growth, with very strong export gains likely offsetting some moderation in domestic demand. The ISM composite index posted a surprising increase to a three-month high of 54.7 in July from 53.8 in June, contrasting with softer results from the key regional surveys. The components were somewhat mixed with a pullback in the key orders index (56.1 v. 57.9) being more than offset by gains in the production (57.6 v. 55.1), employment (50.7 v. 48.7), and inventory (50.5 v. 46.9) gauges. Growth was less broadly based this month than has been seen recently, with 12 of 20 industries reporting expansion in July, compared with 14 in June, 13 in May, and 15 in March and April. The prices paid index (78.5 v.

76.5) rose to its second highest reading in the past two years, as a variety of energy, metal, and other products were again reported to be up in price. This upside in factory activity in July was confirmed by the employment report, in which the expansion of the average workweek to a level that hasn’t been matched in over six years and hasn’t been exceeded in over eight offset a decline in payrolls to lead to a strong advance in manufacturing hours worked. Largely based on this upside, we look for overall industrial production to surge 0.8% in July and the key manufacturing gauge 0.7%.

Consumer spending also appears to have been robust in July. Motor vehicle sales jumped to a 17.2 million unit annual pace in July, a six-month high, from 16.2 million in June. And chain store sales reports overall came in better than expected, which along with some likely price-related upside in gas station sales pointed to solid ex auto retail sales. We forecast a 1.2% surge in overall retail sales in July and a 0.5% gain ex autos.

While the early signs on growth at the start of Q3 were thus mixed – soft employment but apparent strength in factory output and consumer spending – data that filled in some of the missing gaps in Q2 suggested that the BEA was too conservative in its assumptions for missing data in preparing the disappointing +2.5% advance growth estimate, with upside surprises in construction spending and factory inventories. Construction spending posted a surprising 0.3% rise in June and both May (0.0% v. -0.4%) and April (+0.2% v. -0.2%) were revised higher. In June a pullback in the residential category (-1.0%) that was in line with a decline in housing starts was offset by the largest gain in private nonresidential spending (+2.7%) in nearly a year and a solid rise in government spending (+0.8%). Upside in nonresidential activity was broadly based, with good gains in hotels, office buildings, commercial real estate, power plants, and factories. The upside in June construction combined with upward revisions to prior months pointed to a two tenths upward revision to the advance Q2 GDP growth estimate.

Meanwhile, factory inventories posted a robust 0.8% gain in June on top of a sharply upwardly revised increase in May (+0.7% v. 0.0%). These figures by our calculations should add another four-tenths to Q2 growth.

So combining the construction and inventory data, we now see Q2 growth being revised up to +3.1% from +2.5%. A number of additional reports bearing directly on Q2 GDP will be released in the coming week, including wholesale inventories, international trade, and retail sales and inventories.

Meanwhile, the incoming inflation news continued to worsen. The core PCE price index rose 0.24% in June, bringing the year/year rate to +2.4%, matching the high since 1995. So far this year, the core PCE price index has risen at a 2.7% annual rate, and with only 0.1% gains in July and August 2005 the recent trajectory should continue to feed through into higher year/year numbers in the near term. Indeed, barring a significant near-term deceleration, core inflation seems likely already to break through the top of the Fed’s full year 2 1/4% to 2 1/2% forecast over the next two months. One of the reasons that Chairman Bernanke gave in his monetary policy testimony for being sanguine about the inflation outlook, moderate wage gains and corresponding muted gains in unit labor costs, has also swung massively in the other direction with the recent revisions to income growth. The monthly pattern of the big quarterly revisions reported with the Q2 GDP report was provided in the past week’s personal income report. Wage and salary income jumped 0.6% in June, bringing the year/year rise to +6.9% – the largest gain in nearly six years. And despite the overall weakness in the employment report, the earnings numbers remained robust, with an average hourly earnings jump of 0.4% combined with a 0.1% rise in hours worked combining for a solid 0.5% rise in aggregate payrolls in July, a proxy for wage and salary income growth. The much stronger than previously reported recent growth in compensation is likely to lead to both a sharp upward adjustment to Q2 and a further acceleration in Q3 unit labor costs in Tuesday’s productivity report.

Focus this week will clearly be on Tuesday’s FOMC meeting, though the actual outcome of the meeting is no longer in any significant doubt. The Fed is very likely to keep the funds target at 5.25%, so focus will be on the statement issued after the meeting. With the recent upside in actual incoming inflation data and some indications of further upside risks going forward, as seen in a recent modest uptick in inflation expectations, renewed upside in energy prices, and a sharp acceleration in labor costs – all factors Chairman Bernanke pointed to last month as reasons at the time to be sanguine on inflation risks – a pause at this point is still a bit risky in our view, and thus we expect the FOMC to signal in its statement that another tightening is still a good deal more likely than any near-term ease. Indeed, the key language from last month’s statement, which obviously ended up being consistent with a pause this month, would not appear to us to need much change – “Although the moderation in the growth of aggregate demand should help to limit inflation pressures over time, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.”

Aside from the FOMC, there are a number of key data releases and the refunding auctions (3-year Monday, 10-year Wednesday, 30-year Thursday) for investors to focus on in the coming week. After announcing a much bigger cut in its Q3 borrowing estimate than we had expected (to just +$30 billion from the +$89 billion estimated in May), Treasury surprised us by keeping the 3-year and 10-year sizes unchanged at $21 billion and $13 billion, respectively. It looks like the rapidly shrinking bill sector is going to keep getting smaller in Q3, as unchanged coupon sizes with the Treasury’s borrowing estimate would imply about a $25 billion bill paydown in Q3 on top of the $125 billion paydown in Q2. Meanwhile, the $10 billion bond reopening was as expected, but Treasury further surprised us by announcing a move to quarterly issuance in 2007. A 30-year bond will be auctioned in February and reopened in May, and then a 29-3/4 year bond will be auctioned in August and reopened in November.

Treasury said that the total amount of bond issuance next year would rise only “slightly” from this year’s $24 billion despite the addition of two extra auctions. So our initial thinking is for something around $9 billion new issue sizes and $5 billion reopenings for next year’s two issues.

Key data releases due out in the coming week include productivity and unit labor costs Tuesday, trade and the Treasury budget Thursday, and retail sales Friday:

* We forecast second quarter nonfarm business labor productivity growth of 0.5% and unit labor costs of +4.3%. The disappointing GDP results for Q2 point to a moderation in productivity growth and accompanying pickup in the pace of increase in unit labor costs. In fact, the most significant aspect of this report is likely to be a sizeable upward revision to unit labor costs in recent quarters. Based on the revised figures for compensation growth seen in the GDP report, we look for the yr/yr growth in unit labor costs in Q1 to be revised up by nearly two full percentage points – from +0.3% to +2.2%. And the expected result in

Q2 points to a further jump in the yr/yr growth rate – to +3.4%. While prior spikes in unit labor costs over the course of recent years were seen as temporary because they were apparently triggered by the exercise of stock options, there is no such indication that the latest move will prove short-lived. In sum, it's getting hard to be sanguine about the inflation outlook with unit labor costs now running well in excess of both core PCE and core CPI.

* We look for the trade deficit to widen by $1.7 billion in June to $65.5 billion, with exports down 0.6% and imports up 0.6%. On the export side, based on industry figures almost all of the downside should be accounted for by a correction in aircraft exports after last month's surge to a near record high. Otherwise, factory shipment figures point to little change in any other major category. On the import side, Energy Department figures suggest petroleum products should hold about unchanged after surging to a record high last month, while port data point to modest upside in other goods imports. Note that our deficit estimate is right in line with what BEA assumed in preparing the advance estimate of Q2 GDP.

* We expect the federal government to report a July budget deficit of $36 billion, $17 billion smaller than the same month a year ago. We now see the deficit running a bit lower than our latest estimate of $275 billion. Indeed, even though the Office of Management and Budget published an official deficit estimate of $296 billion only a few weeks ago, figures recently released by the Treasury Department imply that the Administration currently projects that the FY2006 deficit will be close to $260 billion.

* We look for a 1.2% jump in overall July retail sales and a 0.5% gain ex autos. A sharp jump in the auto dealer category and another price-related advance in the service station component account for the bulk of the anticipated gain in July retail sales. Excluding autos and gas stations, sales are expected to post a modest 0.3% gain. Although the chain store reports for discounters and general merchandisers were somewhat stronger than anticipated, we see continued softness in the apparel category and a slowdown in restaurant dining as likely drags this month.

 

Important Disclosure Information at the end of this Forum

Japan
Production Momentum and Stock Prices
Aug 07, 2006

Robert Alan Feldman (Tokyo)

What’s new

The recent strong production figures have revived the debate on the relationship between production momentum and equity prices.

ConclusionI: Equity prices will continue to receive support from production momentum. This conclusion remains true even if production flattens after the expected jump over the next two months.

ConclusionII: Forecasts depend on the sample period of estimation. Forecasts based on the last five years are more optimistic than those based on the last ten. Forecasts based on 50 years of data (including the high-growth era) are the most optimistic.

 

Implications

Domestic risks in the stock market are tilted upward. An end to support from production momentum would require huge undershoots of METI’s production forecasts.

Risks

Of course, production momentum is only one possible method of linking fundamentals to equity prices. Other models may show different results.

Summary and conclusions

This piece presents a recalculation of the relationship between production momentum and stock prices. Simple correlations of future stock prices with known changes of production have poor forecasting power. However, correlations of future stock prices with known production momentum have some forecasting power. The conclusions from this technical exercise agree with those of my colleague Naoki Kamiyama, who sees TOPIX heading back toward 1700 by year-end.

Indicators and stock prices:  Time and form

There are several fundamental problems in using economic indicators to forecast equity prices. First, economic data are usually old by the time they are announced. For example, industrial production data in Japan are announced at the end of the month, for the previous month. In the most recent case, data for June were announced at the end of July. In this sense, most economic data are old news.

Second, past data are useful only to the extent that they tell us about the future. Hence, one needs to calculate the forecasting power of economic statistics available at a given point, relative to market movements to the future of that point. For example, a one-month forward forecast of equity prices from industrial production is useless. Why? Because June data on production are only announced at the end of July, so a forecast for July based on June data can be calculated only after the July movement of equity prices is over. In this sense, economists often close the barn door after the horses have bolted.

Moreover, the message from indicators may not be easy to decipher, both due to timing and form. On timing, for example, say one is located at time t=0. The latest industrial production data refer to time t-1. We want to know the level of stock prices at, say, t+3. Thus, we have to use calculations based on production at t-1 to predict stock prices at t+3. On the question of form, the relationship between production and stock prices may not be simple. Indeed, a simple regression of stock prices at t+3 on industrial production at t-1 yields no statistically reliable forecasting power.

Thus, when using economic indicators to aid in the prediction of stock prices, much care is needed about timing and form. One must pay careful attention to the schedule of announcements relative to the horizon of the forecast. One must also pay careful attention to the structure of the relationship between the indicator and the market outcome.

Measuring momentum

Since direct correlations of the levels of industrial production and stock prices work poorly as predictors, one is tempted to correlate changes of production to changes of stock prices. Unfortunately, such first order relationships do not work well either.

Thus, we must move to the second difference, or momentum. One way to measure momentum of production is through the curvature of a time trend over the last year of data. The quadratic production time trend is calculated with the equation y = a + bt + ct², where t is time. For the year through June 2006, for example, the momentum was slightly negative, indicated by the inverted-U shape of the quadratic time trend. (A normal U-shape would indicate positive momentum.)

Does momentum matter?

The next issue is whether momentum has forecasting power versus equity prices. The first question is where momentum has been. When a time series of momentum is calculated, momentum is seen to swing up and down rather frequently. Most recently, production momentum has been negative. Indeed, in the year to June, production momentum was about 1 standard deviation below the normal level (the latter being almost exactly 0).

The next question is how the past values of production momentum are related to future values of stock prices. An examination of the data reveals that the answer is somewhat complex:  Say we are at month-end of time t. There is a statistically stable relationship between the change of momentum at a time t-1, which is the most recent available momentum calculation, and the percentage change of equity prices from the month-end at time t to a point two months hence, t+2. For example, at the end of July, one can use the change of momentum between May and June to predict the percentage change of TOPIX between July and September. Other potential lag structures yield lower forecasting power. This one, however, seems to be stable in different sample periods, although the actual forecast of stock prices itself depends of which sample period is used for estimation.

Main result:  Equities likely to rise

The main input is a forecast path for industrial production. The assumption here is that industrial production in July and August follows the path forecast by the METI survey, with one important adjustment. Because the METI survey is consistently biased to the upside, the production path used for the TOPIX forecast here corrects for these errors. For example, in the most recent 12 months, the 1-month ahead survey over-estimates the growth rate (month to month, seasonally adjusted) of production by an average of 1.7%-pts. Hence this amount was deducted from the METI figure for July when the assumed path of production was set. The same procedure was used for the 2-month ahead forecast, although in this case the accuracy of the 2-month ahead forecast has improved greatly. For the months beyond the METI survey, I assume that production remains flat. (Thus, the TOPIX forecast from this approach is probably too low, if we are correct that production will continue rising.) The final assumed path for production under these assumptions takes the index of industrial production (seasonally adjusted) from 105.7 in June 2006 to 110.2 in August.

Inserting the changes of industrial production momentum implied by this path of the production index to the forecasting relationship described above, a forecast path for TOPIX can be derived. Under the assumptions mentioned above, TOPIX is projected to rise to nearly 1700 in January 2007, close to the level and timing that my colleague, Naoki Kamiyama, has forecast.

It is important to note that this calculation is an equation-based projection, based on a single input variable. The qualitative message is probably more important than the quantitative one. The qualitative message is that, if the input variable evolves as projected, then there is likely to be upward pressure on stock prices.

Which sample period?

The quantitative message needs a bit more consideration. One problem with any statistical forecast is that the result may be sensitive to the sample period from which behavioral equations are estimated and forecasts are derived. As I said above, the existence of a relationship between equity price changes over a two-month forward period and the change of production momentum in the previous period is robust. However, when this relationship is estimated for different sample periods, the sensitivity of equity price movements to momentum changes, and hence the forecasts of equity price movements change as well.

In fact, the equity market forecast from this method is sensitive to the sample period of estimation. I calculated estimates for TOPIX based on three different sample periods, 1956-2006, 1996-2006 and 2001-2006. The exact forecasts range between 1600 and 1700 for early 2007.

The message from the differences of sample period is encouraging. The 1956-2006 sample includes Japan’s heady years of high growth. Whatever structural factors from the 1950s-70s that kept momentum strong and stock prices rising have probably faded by now. In contrast, the 1996-2006 period included eight years of structural pain (1996-2003) and only three years of recovery. No wonder that the equity forecast based on such a sample period is weak. The most recent five years, however, are about equally divided between times of trouble (2001-03/spring) and times of improvement (2003/summer - present). Since the 2001-06 sample shows a better TOPIX forecast that the 1996-06 sample, is seems fair to conclude that a structural change in the economy and the stock market is reviving the sensitivity of stock prices to production momentum.

Conclusion

The vagaries of econometric modelling suggest that no single forecast of equity prices should be taken as the whole truth. However, the qualitative message is clear:  Economic fundamentals suggest that Japanese equity prices are more likely to rise than to fall over the next 6-9 months.

Important Disclosure Information at the end of this Forum

Middle East and North Africa
Stay Tuned to the Weather Channel
Aug 07, 2006

Serhan Cevik (London)

Who has the worst record in forecasting — economists or meteorologists? Interesting question, and it would be a fascinating comparative analysis, but now we want to focus on the effect of climatic conditions on macroeconomic variables and to see whether ‘anomalies’ can turn into trends. With growing concerns about global warming, changes in weather systems are fast becoming an important factor not just for agriculture-based economies but for all countries around the world. Beyond the impact of output fluctuations on income growth, the immediate threat is on the inflation front. Take, for example, the Turkish case. Food prices increased by 12.1% in the last year, accounting for 28.5% of the rise in the consumer price index. Especially, the widening divergence between processed and unprocessed food prices (5.4% versus 21.8%) that we have highlighted continues to be out of sync with seasonal patterns and put upward pressure on headline inflation (see The Mysterious Vegetarian Demand Bubble, June 19, 2006). Therefore, the risk we need to assess is whether climatic shifts are becoming yet another source of supply-side shocks and consequently leading to an acute increase in food prices.

The rise in unprocessed food prices is almost a worldwide phenomenon. The global economy and particularly countries with an excessive dependence on imported sources of energy have already been struggling with an oil shock, and now they face emerging disruptions in the agriculture sector. The rise in food prices is almost a global phenomenon, affecting an increasing number of countries around the world. The European data show that annual food price inflation increased from 0.2% in the first half of 2005 to 4.7% this year. This is indeed a curious development, since food prices, unlike the petroleum market, are not homogenous across countries. Therefore, there must be an overpowering factor that could explain such price movements at a regional level. In our view, climatic shifts present a reasonable theory to focus on.

Global warming is an indisputable fact, not a figment of the imagination. According to the data compiled by NASA’s Goddard Institute for Space Studies, ‘anomalies’ in global weather conditions are clearly getting worse. For example, the average surface temperature in the northern hemisphere in the last 18 months deviated from the 1951-1980 mean by 0.97˚C. If you think this is a miniscule change, think again. Not only are we now in the ‘hottest’ period in recorded history, but also the degree of deviation from the long-term mean has surged from an average of 0.52˚C in the 1990s and 0.11˚C in the preceding two decades. As a result, the current wave of global warming that started in the 1980s is the worst episode, adding more than 0.2˚C a decade to global surface temperature. Not surprisingly, this anomaly has ‘coincided’ with the boom in human-made greenhouse gas emissions, and therefore it indicates a fundamental shift in climatic conditions, in our view. Indeed, climatologists have long warned that temperatures will keep increasing and global weather conditions will become even more volatile. From an economic point of view, unpredictability is like a Pandora’s box — never knowing what would come out of it — and presents serious challenges to policymakers.

With limited water supplies and cultivatable land, the Middle East faces a major threat. For some countries, the increase in agricultural prices can present an opportunity, since soft commodities have lagged behind the breathtaking increase in oil and metal prices. But the overall effect of global warming on production dynamics is not encouraging. Moreover, even if we assume a benign scenario, unlike the discovery of new oil fields, increasing the supply of agricultural commodities is significantly cheaper and easier over the medium term. That said, there is a case for higher soft commodity prices, especially now with prices and inventories at the lowest level in decades. However, even though some countries with productive farming sectors may benefit from such a trend, there are not many countries in the Middle East and North Africa fitting that description. Indeed, most of the region is a net food importer and therefore would suffer from higher prices on the income front and struggle with inflationary pressures.

Important Disclosure Information at the end of this Forum

Disclosure Statement

The information and opinions in this report were prepared or are disseminated by Morgan Stanley & Co. Incorporated and/or Morgan Stanley & Co. International Limited and/or Morgan Stanley Japan Securities Co., Ltd. and/or Morgan Stanley Dean Witter Asia Limited and/or Morgan Stanley Dean Witter Asia (Singapore) Pte. (Registration number 199206298Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H) and/or Morgan Stanley & Co. International Limited, Taipei Branch and/or Morgan Stanley & Co International Limited, Seoul Branch, and/or Morgan Stanley Dean Witter Australia Limited (A.B.N. 67 003 734 576, holder of Australian financial services licence No. 233742, which accepts responsibility for its contents), and/or JM Morgan Stanley Securities Private Limited and their affiliates (collectively, "Morgan Stanley").

Global Research Conflict Management Policy

This research observes our conflict management policy, available at www.morganstanley.com/institutional/research/conflictpolicies.

Important Disclosures

This report does not provide individually tailored investment advice. It has been prepared without regard to the circumstances and objectives of those who receive it. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages them to seek a financial adviser's advice. The appropriateness of an investment or strategy will depend on an investor's circumstances and objectives. This report is not an offer to buy or sell any security or to participate in any trading strategy. The value of and income from your investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized.

With the exception of information regarding Morgan Stanley, reports prepared by Morgan Stanley research personnel are based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we do not represent that it is accurate or complete. We have no obligation to tell you when opinions or information in this report change apart from when we intend to discontinue research coverage of a company. Facts and views in this report have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel.

To our readers in Taiwan: This publication is distributed by Morgan Stanley & Co. International Limited, Taipei Branch; it may not be distributed to or quoted or used by the public media without the express written consent of Morgan Stanley. To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Dean Witter Asia Limited as part of its regulated activities in Hong Kong; if you have any queries concerning it, contact our Hong Kong sales representatives.

This publication is disseminated in Japan by Morgan Stanley Japan Securities Co., Ltd.; in Canada by Morgan Stanley Canada Limited, which has approved of, and has agreed to take responsibility for, the contents of this publication in Canada; in Germany by Morgan Stanley Bank AG, Frankfurt am Main, regulated by Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin); in Spain by Morgan Stanley, S.V., S.A., a Morgan Stanley group company, which is supervised by the Spanish Securities Markets Commission (CNMV) and states that this document has been written and distributed in accordance with the rules of conduct applicable to financial research as established under Spanish regulations; in the United States by Morgan Stanley & Co. Incorporated and Morgan Stanley DW Inc., which accept responsibility for its contents. Morgan Stanley & Co. International Limited, authorized and regulated by Financial Services Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. Private U.K. investors should obtain the advice of their Morgan Stanley & Co. International Limited representative about the investments concerned. In Australia, this report, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act.

Trademarks and service marks herein are their owners' property. Third-party data providers make no warranties or representations of the accuracy, completeness, or timeliness of their data and shall not have liability for any damages relating to such data. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and S&P. Morgan Stanley bases projections, opinions, forecasts and trading strategies regarding the MSCI Country Index Series solely on public information. MSCI has not reviewed, approved or endorsed these projections, opinions, forecasts and trading strategies. Morgan Stanley has no influence on or control over MSCI's index compilation decisions. This report or portions of it may not be reprinted, sold or redistributed without the written consent of Morgan Stanley. Morgan Stanley research is disseminated and available primarily electronically, and, in some cases, in printed form. Additional information on recommended securities is available on request.