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Lessons from 2016 The old joke is that Year Aheads are frequently out of date by the end of year they are written in. There is a real danger of that this year given the speed which things have moved since Brexit and more recently the US election. The two charts below show that Financials and Cyclicals have clawed back around 2/3 of their underperformance vs Defensives. Of course it depends how you frame the question since we have included Utilities and Telecoms in the defensive basket. But when we downgraded Banks 10 days or so ago they had outperformed Food and Beverage by ~50% since the lows of early July. Whichever way you cut it some of these moves have been extreme. Chart 7: The moves since Brexit in both Financials... Chart 8: ...and Cyclicals relative to Defensives has been dramatic 0.85 1.45 0.80 1.35 0.70 1.15 0.65 1.05 0.60 0.95 mee =———(Cyclicals vs Defensives relative 0.50 0.85 === Financials vs Defensives relative 0.45 0.75 0110 «6011 O12 0130114 OMS 0116 01/10 «= 011 O12 013 0114 = O15 01/16 Source: Bloomberg Source: Bloomberg Moreover, in 2016 we doubt that even if investors had known the results of key events that they would necessarily have got the reaction in markets right. As we joked in our Cross Asset year ahead you needed not so much a crystal ball as a time machine to have got things completely right this year. Aside from Brexit and Donald Trump winning the US election it is easy to forget that in February we were worrying about a US recession and deflation. US 5Y5Y forward breakeven inflation rates actually troughed at 1.8% at that point. Four months later we were worrying about the deflationary impact of Brexit. Now we are thinking about the reflation under a Trump Presidency. Chart 9: US 5Y5Y forward inflation troughed in February Chart 10: At the same time as Basic Resources 3.3 17 34 45 —— Stoxx Basic Resources Price Relative 29 1.3 27 25 14 23 0.9 2.1 — 07 19 oa US Syoy fwd inflation swap 0.5 17 NO oO © © + T+ T TL WH HW oO oO oO Wd DG DB DB F BW 6 GS LS SRERaSRERSERERS EES RY yy ow vy ow ow cow =s = 5s =s =s SVP GM VW VV Ww Wt yw vw S a ae oe @ Source: Bloomberg Source: Bloomberg The panic in markets in early February actually presented a perfect buying opportunity for reflationary assets. Miners was a sector truly loathed by investors of all colours at the start of the year with many thinking that some of the big players might even go bust. If there is one key conclusion from all of this it is do not tie yourself to a view. We ; Bankot America 4 European Equity Strategy | 01 December 2016 Merrill Lynch HOUSE_OVERSIGHT_014463