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Exhibit 67: Japanese Profit Margins Near-peak profit margins could be a headwind for Japanese equities. Trailing 12-Month Net Income (% of Sales} 6 24 1980 1985 1980 1995 2000 2005 2010 2015 Data through November 30, 2016. Source: Investment Strategy Group, Datastream. Exhibit 68: Japanese Equity Valuations Valuations are near the median level of Japan's deflationary period since 1999. Percentile 80 70 Average: 52% 50 47 43 40 38 30 20 10 0 Price to 10-Year — Price-to-Peak Price-to-Book Priceto 10-Year —_ Price-to-Peak Average Earnings Earnings Value Average Cash Cash Flow Flow Data as of December 31, 2016. Note: Based on data since 1999. Source: Investment Strategy Group, Datastream, MSCI. interplay of these inputs should still lead to positive earnings growth of 6% in 2017. The direction of valuation multiples is equally important. As shown in Exhibit 68, Japanese valuations are middling based on their history since 1999, which we believe is the relevant evaluation period given the deflationary headwinds that emerged thereafter. For equity multiples to move significantly higher from here would require sustainable above-trend earnings growth or a sizable increase in direct equity purchases by the Japanese central bank. But with the BOJ already holding a remarkable 60% of Japanese ETF market assets!” and profit margins near their peak levels, neither of these upside catalysts seems probable. In fact, P/E multiples are forecast to contract in our base case, as the 6% earnings growth we expect will likely disappoint current market expectations of 12%. Putting these pieces together, we expect neither a boom nor a bust for Japanese equities. Instead, the combination of mid-single-digit earnings growth, slight compression in valuation multiples and a 1.9% dividend yield should generate a 5% total return. While this return is attractive from an absolute standpoint, it also comes with significant downside risks given the country’s poor demographics, declining labor force and high government debt load. Consequently, we are tactically neutral on Japanese equities currently. Emerging Market Equities: Finally in Gear, but Potholes Ahead Emerging market equities as a whole finally moved forward in 2016 after three years in reverse: multiples expanded, earnings estimates improved and currencies appreciated, generating a 12% total return. Politics and commodity prices were key performance differentiators among emerging markets last year, leading Brazil and Russia to the winners’ podium while leaving Turkey and Mexico in last place. We expect emerging market equities to remain on track in 2017. Our central case calls for earnings growth of 5% in US dollar terms, driven by faster nominal GDP growth and the lagged impact of easier financial conditions and higher commodity prices. But with multiples already at post-crisis highs in an environment of rising global rates and heightened risks, we see little scope for further expansion. Combining these two inputs with a dividend yield of 2.6%, our forecast implies a total return of about 7% this year. However, the uncertainty around this forecast is quite large, as emerging market equities face several potential potholes on the road ahead. Chief among these is the ultimate policy agenda of the incoming US administration. On the one hand, a policy mix that favors US growth over trade restrictions would support emerging market exports and boost profits and equity returns. Outlook | Investment Strategy Group 59 HOUSE_OVERSIGHT_014592