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Exhibit 63: Relative Performance of "Stable” and “Volatile” EAFE Stocks Investors have recently shifted toward firms more exposed to the business cycle. Relative Return (%) 8 5 wStable = Volatile 6 4 Last 3 2016-to-Date 5 Years 10 Years 1987-2007 = Since 1987 Months Annualized Returns Data as of October 31, 2016. Note: Equally weighted USD-hedged returns relative to the developed markets (ex-US). Stable and volatile stocks are drawn from the large-cap universe. Stability is measured using a model based on return on equity, earnings growth, financial leverage and beta. Source: Investment Strategy Group, Empirical Research Partners. po Exhibit 64: Spain 5-Year Credit Default Swap and Relative Equity Performance The dramatic reduction in Spanish default risks suggests equity valuations have scope for upside. Price Ratio (July 24, 2012 = 100) Basis Points 50 4 0 40 + ¥ 30 5 , * fo ides i 100 te 200 | 300 20 4 - 400 500 00 - + 600 90 = MSCI Spain vs. MSCI EMU (Sector-Adjusted) L 700 =— — — — Spanish CDS Spread (Right, Inverted) 80 L g00 2009 =. 2010 2011 2012 = 2013 2014 = 2015 2016 Data through December 31, 2016. Source: Investment Strategy Group, MSCI, Datastream. has both hobbled bank profits—which represent a third of EuroStoxx 50 earnings—and boosted equity valuations. But with ECB policy unlikely to become any more accommodative, additional valuation expansion can no longer be taken for granted. Instead, the onus for Eurozone equity upside now rests with earnings. Here, the prospects are favorable for several reasons. First, above-trend Eurozone GDP growth is likely to lead to boosted domestic sales and reduced economic slack, both of which have lifted Eurozone earnings in the past. Second, the broader pickup in global GDP growth we expect should benefit the 45% of the EuroStoxx 50’s sales that are generated outside Europe. Higher revenue is particularly beneficial to these EuroStoxx firms given their operating leverage, as small improvements in sales spread over their sizable fixed costs also push profit margins higher. Finally, financial sector earnings stand to benefit from the higher interest rates we foresee. Against this backdrop, we expect earnings to expand 5% in 2017. Meanwhile, valuation multiples are likely to contract slightly as interest rates normalize higher and investor focus shifts toward eventual ECB tapering late this year. Combining these elements with a 3.6% dividend yield implies EuroStoxx 50 total returns of 3% in 2017. The risks to our base case are skewed mildly to the upside. After underperforming most equity markets in 2016, Eurozone equities have room to play catch-up. Moreover, the passing of long-feared French and German elections could compress today’s elevated equity risk premium, although political uncertainty is likely to remain high in the interim. Finally, investors’ recent shift toward firms more exposed to the business cycle should benefit Eurozone firms given their greater operating leverage (see Exhibit 63). Within the Eurozone, we are overweight Spanish equities. Here, we are drawn to attractive valuations (see Exhibit 64), domestic growth momentum and embedded overweight to banks. UK Equities: Scaling the Wall of Worry While the Brexit vote was surprising, the subsequent performance of the UK stock market was even more so. Despite the tremendous political and social uncertainty engendered by the referendum’s outcome, UK equities generated one of the strongest returns of any major equity market last year in local currency terms. Several factors at the root of this outperformance should continue to work in favor of UK equities in 2017. First, FTSE 100’s global Outlook | Investment Strategy Group 57 HOUSE_OVERSIGHT_014590