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Sector Trades Table 7: European Sectors — Summary of investment case and risks a Lon Stance oe Summary of view (Ticker) [Weight % (bp) Laggard despite Republican clean sweep reducing legislative risks, valuations close to 2010-12 lows at trough of patent cliff but sector team 12.5 o/w #150 — expect 11% EPS CAGR 2018-2021 supporting 17/18x PE (currently on 13x 2018), catalysts from new products set to be announced in 2017. Risks: rising bond yields continues, pipelines fail to realise, strong growth leads to risk-on rally led by value/ rotation out of quality. HealthCare (SXDP Index) Forecast Brent to average ~$61/bbl in 2017 on supportive demand backdrop (EM), OPEC reduction, supply destruction causing rebalance 4.6 ow -150 Oil team modeling 8%-17% upside from crude rally meaning FCF covers ~6% DY and EPS to improve (revisions 2nd best in market) Risks: OPEC fails to cut supply pushing rebalancing out, strong dollar and protectionism curtail global demand and EM growth. Oil & Gas (SXEP Index) Media Market laggard and de-rated presenting favourable entry points, optionality to improving EU consumer confidence even if UK consumer set to (SXMP 2.6 OW +100 be squeezed next year, historically outperforms when dollar’ PMIs/ inflation rising, positioning now underweight in FMS. Index) Risks: UK growth/ EU consumer confidence drop quickly, investors prefer cheaper cyclicals if we see another leg to risk-on rally. sr Big underperformer in reflation rotation given defensive yield characteristics now oversold, consistent underweight in FMS but fundamental Utilities pe . a . ; : ~. 3.9 OW +100 —_ putlook positive with cyclical/ earnings improvement from higher power prices/ CSPP/ changing sector composition. SX6P Index : ; a ; arr : “ef a ce Risks: lack of differentiation from investors in rising yields continues, commodity prices roll, regulatory risk increases. Autos & Parts 32 Mw 0 Bull case: Margins supported by strong EU/ China sales, lease growth in US, valuations at multi-year lows, positioning neutral, cyclical beta SXAP Index , Bear case: Future car raises questions over terminal value, US/UK markets peaked, Truck market has turned, China tax cut fo end Banks 104 MAW 0 Bull case: global yields and inflation continue to rise as global growth pushes higher, Italian banks successfully recap and earnings improve. SX7P Index ‘ Bear case: LT profitability challenges persists (ECB monetary policy), UK large caps underperform, rates move unwinds. Baie Bull case: Investors still uw, Trump delivers on fiscal not trade, DXY capped so EM recovery / China cycle continues, higher metals lifts FCF. Resources 3 MW 0 ; oe : : . : ; SXPP Index Bear case: Protectionism rises, China cycle slows, hawkish Fed hurts EM rally, metals prices fail to sustain recovery. Chemicals 5 MW 0 Bull case: Cheap on relative PE/ DY, M&A pick-up, cyclically geared to improving EM growth, higher quality characteristics vs other cyclicals. SX4P Index Bear case: OPEC deal fails hurting oil, industrial cycle potentially at risk from protectionism, margins unsustainable given at highest since 2004 Const & Mats 3 MW 0 Bull case: geared to expected increase in fiscal spending (esp US), EU mfg and construction PMls solid, US ISM / housing market strong SXOP Index Bear case: Most expensive sector on relative basis, re-rated on fiscal expectations but EPS hasn't followed, exposure to softening UK market Fin Srvs 19 MW 0 Bull case: High proportion of dollar earnings/ sterling reporters, geared to pick up stronger markets, potential M&A targets SXFP Index ; ear case: less attractive valuations and not as levered into better growth/ rising bond yields than other financials (e.g. Banks). Ind Gd&Svs 419 MW 0 ull case: US mfg ISM strong, EU OECD lead indicator improving, expect fiscal spending in US, high RoE and consistent earnings SXNP Index ; Bear case: valuations stretched on PBV, big outperformance driven by re-rating more than eps growth, Q3 earnings season has been weak. Insurance 64 MW 0 Bull case: beneficiary of rising yields, strong balance sheets, cheap on PBV/ PE and attractive, growing and covered DY. Positioning still light. (SXIP Index) : Bear case: lower beta and longer cycle than Banks, vulnerable to any rally in bond prices from Italy risks, higher DY in more cyclical sectors. Persnl & Bull case: luxury stocks delivering growth, tobacco structural outperformer, has de-rated following Brexit rally but earnings outlook decent. HHG 88 M/W 0 ; . : i” vy. : : ti Bear case: margins at 10y peak, stiff competition from digital innovation, EM consumer demand volatile, vulnerable to rising rates. (SXQP Index) Real Estate ; . a 7 . Bull case: oversold on CTI, at 10y lows on relative PE and bottom quintile on PBV, UK market held up post-Brexit, yield attractive if bonds rally (SX86P 1.9 MAW 0 ree . oo ; . Index) Bear case: positioning o/w vs history, REITs vulnerable to rising yields backdrop, rental yields under pressure fall if UK/ EU growth slumps. Bull case: strong FCFY and improving balance sheets, valuations not expensive, positioning has unwound, beneficiary of CSPP, major Telecomm SXKP Index 3.8 M/W 0 aggard. ear case: structural challenges to monetising data, consolidation not set to play out, vulnerable to further outflows in rising yield environment. Technology 44 MW 0 Bull case: valuations less stretched, semis cycle proving resilient, higher "quality" cyclical, positioning neutral, structural growth SX8P Index ‘ Bear case: vulnerable to rotation into value sectors in a risk-on market, margins close to peak, structural challenges for Nokia/ Ericsson. Food & Bev 59 uw A50 Highest correlation to rising yields/ bond proxy, valuations still not cheap on a range of metrics (esp vs Healthcare), falling earnings revisions. SX8P Index , Risks: Oversold vs history in rotation move, sector has de-rated enough if bond yields capped/ CB don’t hike/ growth disappoints. Travel & Leisr 18 uw 450 Airlines in structural decline, negatively correlated to higher oil, vulnerable to weaker UK and returns at peaks levels, valuations not cheap SXTP Index , . Risks: Oil rally takes longer to materialise if OPEC fails to cut, European/ global growth picks up and UK gdp surprises to upside. Retail 34 uw 200 Most vulnerable to consumer squeeze in UK, margins in structural decline, supermarkets have had their relief rally, expensive on PE/ PBV/DY SXRP Index , . Risks: modest inflation provides pricing power, Eurozone growth boosts consumer demand, positioning light, strong x-mas season. Source: BofA Merrill Lynch Global Research BankofAmerica <2” 30 European Equity Strategy | 01 December 2016 Merrill Lynch HOUSE_OVERSIGHT_014489