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Europe’s ERP on our model is 6.9% — down from the post-Brexit highs at 7.5% but still at a 70bp premium to the 3 and 5 year average for the ERP. That in turn implies a ~11% valuation haircut relative to 5-year average levels. These numbers also show that the recent rise in bond yields is modest relative to where cost of equity or ERP sits. We're quite far away from the level that bond yields would make ERP look expensive. Even with bund yields at 75bp (ie +50bp from here) it would only shift the ERP back to average levels (all else equal). Bond yields need to rise 150- 200bp to get to the expensive end of the range of last 6 years on ERP. Chart 21: Implied cost of equity (CoE) on our model in Europe is 6.9%, a Chart 22: Implied equity risk premium remains elevated: 6.7% ERP to little below the average since 1988 (7.2%) and last 10 years (8.4%). bund yields vs 10-year average of 6.2% and recent high of 7.3%. 16 12 14 10 12 8 10 8 6 8 4 4 —— Equity Risk Premium (vs 10y Bund) 3 ——|mplied cost of equity (%) 2 0 01/88 01/91 01/94 01/97 01/00 01/03 01/06 01/09 01/2 01/15 10/06 09/08 08/10 08/12 07/14 06/16 Source: BofA Merrill Lynch Global Research, Datastream, MSCI, IBES Source: BofA Merrill Lynch Global Research, Datastream, MSCl, IBES Europe cost of equity higher than long-run average compared to US. Europe also compares favourably on a relative basis against the US equity market in this framework. The implied CoE for the S&P500 on an equivalent model is 5.64%, which is now at an 11-year low and 130bp below the 10-year average. The implied ERP on that basis at 3.3% is also below average and not far off the lows from the past 10 years. Admittedly Europe did get significantly cheaper relative to the US during the GFC and the sovereign debt crisis. The cost of equity premium for MSCI Europe vs the S&P is 1.21%. That is a premium to the 30-year average of 0.72%. However it is below the average of the past 10 years — the spread peaked at over 4% in 2008 and at 2.7% in 2011 / 2012. Chart 23: Implied equity risk premium near 9-year lows in the US Chart 24: Europe vs US implied cost of equity spread —— Cost of equity spread Europe vs S&P 9 8 7 6 5 4 3 2 === 8P Equity Risk Premium (vs 10y UST) 0 -2 10/06 09/08 08/10 08/12 07/14 06/16 01/90 01/93 01/96 01/99 01/02 01/05 01/08 01/11 01/14 Source: BofA Merrill Lynch Global Research, Datastream, MSCI, IBES Source: BofA Merrill Lynch Global Research, Datastream, MSCl, IBES 10 European Equity Strategy | 01 December 2016 Bankof America Merrill Lynch HOUSE_OVERSIGHT_014469