european investment notes...economy & strategy 2 keplercheuvreux.com recommended sector and...

21st

July 2014

European Investment Notes

Cross Asset Research No. 207

Decision Time We recognise the significance of the conflict in the Ukraine. The controversy concerns European equity, not its American counterpart. There is no good reason to change the “buy the pullback” playbook for US equity.

Our interpretation has not changed. Although we cannot expect a recovery of European equity to be sustained at this point we do not think that this is a time to sell European equity. We have confirmation of the “slow sink” of the Euro. The reporting season is providing support, notably for financials.

We cannot remove the defensive bias to our portfolio until the most secure bond markets begin to weaken. We are reinforcing the consumer universe through the P & H sector. For similar reasons we are upgrading the UK market at the expense of the EZ.

Research team

Christopher Potts [email protected] +44 20 7621 6640

Nicolas Trémel [email protected] +44 20 7621 6642

Clément Genes [email protected] +33 1 53 65 36 41

Joakim Tabet [email protected] +44 20 7621 5122

IMPORTANT. Please refer to the last page of this report for “Important disclosures” and analyst(s) certifications

keplercheuvreux.com

Economy & Strategy

2 keplercheuvreux.com

Recommended sector and market asset allocation This is decision time for European equity. Deflation anxiety has been on the rise for some time. Over the last two

weeks investors have been reminded about both credit risk and geopolitical risk. We recognise the significance of

the conflict in the Ukraine. Its consequences are reduced commercial and financial ties between Russia and the West,

the reassessment of European energy policy and the weakening of the Russian economy to the point of recession

through 2015. The controversy concerns European equity, not its American counterpart. There is no good reason to

change the “buy the pullback” playbook for US equity. The reporting season in America is sending familiar,

reassuring signals. Our interpretation has not changed. We cannot expect a recovery of European equity to be

sustained at this point. However, we do not think that this is a time to sell European equity. There have been no signs

of panic in Europe’s markets. We have confirmation of the “slow sink” of the Euro against the US$. The reporting

season is also providing support for financials. Inflation in the region is stabilising. The forex market should bring

relief, albeit slowly. Earnings downgrades in the region should stabilise through the months ahead. America will tell

us when to sell equity assets, not Europe. America is not yet ready for the sell sign.

We cannot remove the defensive bias to our recommended portfolio until the most secure bond markets begin to

weaken. The category of European equity that should draw benefit from the current context is the consumer

universe, both Staples and Discretionary. We are upgrading the Personal & Household sector to OW because profit

leadership remains apparent here but its relative valuation has virtually completed its return to-mean. A similar

logic applies to the UK market, at the expense of the euro zone. The UK also has relatively high exposure to the

positive effects of a stronger US$. For similar reasons we are moving to over-weight from neutral in the global-

consumer Danish market to the expense of Finland.

Weightings and asset allocation for the MSCI Europe Universe

* The exposure to risk is measured by the weighted average of 2-y betas. We manage the liquidity ratio within a 0-10% rank. Source: Kepler Cheuvreux

21/07/2014Neutral weight in

MSCI (%)

2-yr beta values

(vs MSCI)

Tactical sector

rating

Recommended

allocation (%)

Consumer Discretionary 10.2 1.1 OW 11

Automobiles & Components 3.3 1.5 OW 4

Consumer Durables & Apparel 2.5 1.1 OW 3

Consumer Services 0.9 0.9 OW 2

Media 2.0 0.9 UW 1

Retailing 1.3 0.9 UW 1

Consumer Staples 13.5 0.7 N (UW) 14

Food & Staples Retailing 1.4 1.0 UW 1

Food Beverage & Tobacco 10.4 0.6 N 10

Household & Personal Product 1.7 0.7 OW (N) 3

Energy 9.6 0.9 OW 11

Financials 22.1 1.3 N 22

Banks 11.5 1.3 N 11

Diversified Financials 3.7 1.4 N 4

Insurance 5.8 1.2 N 6

Real Estate 1.1 0.9 OW 2

Healthcare 12.9 0.8 N 13

Healthcare Equipment & Services 1.1 0.6 N 1

Pharmaceuticals & Biotechnology 11.8 0.8 N 12

Industrials 11.1 1.1 UW 9

Capital Goods 8.4 1.1 UW 7

Commercial & Professional Services 1.2 0.8 UW 1

Transportation 1.4 1.0 OW 2

Information Technology 3.2 1.1 UW 2

Software & Services 1.5 0.9 UW 1

Technology & Hardware Equipment 0.9 1.3 UW 0

Semiconductors 0.8 1.2 UW 0

Materials 8.2 1.2 N 8

Telecommunication Services 4.9 0.9 OW 6

Utilities 4.3 0.8 N 4

Exposure to risk (beta value) 1.00

Liquidity ratio 2%

Economy & Strategy


21/07/2014 Neutral weight in Stoxx (%)2-year Beta Values

(vs DJ Stoxx)

Tactical

Sector rating Recommended Allocation (%)

Automobiles 3.0 1.5 OW 4

Banks 13.1 1.4 N 13

Basic Resources 3.1 1.4 N 3

Chemicals 4.5 1.0 UW 4

Construction & Mat. 2.3 1.3 OW 4

Financial Services 1.6 1.2 OW 2

Food & Beverages 8.1 0.6 N 8




Media 2.5 0.9 UW 2

Oil & Gas 7.3 0.9 OW 8

Personal & HG 5.8 0.8 OW (N) 7


Retail 3.0 1.0 UW 1

Technology 3.1 1.1 UW 2

Telecoms 4.3 0.9 OW 5

Travel 1.5 0.9 OW 2


21/07/2014Neutral weight

in DJ-EuroStoxx (%)

2-year Beta Values

(vs DJ Euro-Stoxx)Tactical Sector rating Recommended Allocation (%)

Automobiles 6.4 1.3 OW 7

Banks 13.8 1.6 N 14

Basic Resources 1.1 1.2 N 1

Chemicals 8.8 0.9 UW 7

Construction & Mat. 3.4 1.2 OW 4

Financial Services 0.9 0.9 OW 2

Food & Beverages 6.2 0.5 N 6




Media 2.8 0.7 UW 2

Oil & Gas 6.8 1.0 OW 8

Personal & HG 4.2 0.7 OW (N) 5


Retail 2.8 0.9 UW 1

Technology 5.2 0.9 UW 4

Telecoms 4.6 1.0 OW 6

Travel 1.1 0.7 OW 2


21/07/2014 Neutral weight in Stoxx (%)2-year Beta Values

(vs DJ Stoxx)Tactical Sector rating Recommended Allocation (%)

France 14.6 1.1 N (OW) 15

Germany 13.2 1.1 N 13

Italy 3.9 1.3 OW 5

Netherlands 6.2 0.9 N 6

Spain 5.4 1.3 OW 6

Switzerland 13.2 0.8 N 13

UK 30.9 0.9 N (UW) 31

Euroland 49.8 1.1 N (OW) 50

Nordic 9.4 1.0 N 9

Denmark 2.3 0.8 OW (N) 3

Finland 1.4 1.2 UW (N) 1

Sweden 4.4 1.1 UW 3

Norway 1.3 0.9 OW 2

Source: Kepler Cheuvreux

Weightings and asset allocation for the Europe's leading equity markets (DJ Stoxx)

Exposure to risk (beta value)

2%Liquidity ratio

Weightings and asset allocation for the DJ-Stoxx sectors

Liquidity ratio

1.02

1.03

Exposure to risk (beta value)

2%

Weightings and asset allocation for the DJ Euro-Stoxx sectors0000000000000000000

Economy & Strategy


Chart 1 –The Bond-Equity Relationship in America and Germany

Source: Datastream

Chart 2 – It Does Move: the Slow Break-Down in Euro-US$

Source: Bloomberg

60

80

100

120

140

160

180

200

220

2009 2010 2011 2012 2013 2014 2015

Equity / Bonds (total return indices). MSCI country index / to 10y benchmark bondIndex: Jan. 1st 2009=100

Germany

USAequity out-performance

1.20

1.25

1.30

1.35

1.40

1.45

1.50

2011 2012 2013 2014 2015

EUR / USD

EUR / USD 200-day moving average

$1.35threshold

The controversy concerns European equity, and the EZ in particular, not its American counterpart. There is no good reason to change the “buy the pullback” playbook for US equity. The reporting season in America is sending familiar, reassuring signals. We have confirmation of the “slow sink” of the Euro against the US$. The point is that the forex influence does not begin to be positive for the earnings of the euro zone corporate sector relative to trend and relative to expectations until the euro trades below the US$1.35 threshold with its momentum firmly established on a downward trajectory. We expect to see the euro near US$1.30 in Q4.

Economy & Strategy


Chart 3 – Nominal and Real, Inflation-Adjusted US-German Yield Spreads

Source: Datastream, Deutsche Bundesbank

Chart 4– Relative Unit Labour Costs and the Real, Effective Euro Exchange Rate

Source: ECB, Datastream

-600

-500

-400

-300

-200

-100

0

100

200

300

400

500

600

84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16

10Y real yield spread - Germany vs US

10Y nominal yield spread - Germany vs US

bp

lowestsince 1993

lowestsince 1989

75

80

85

90

95

100

105

110

115

120

125

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Index: Q1-1999 = 100

Euro ULC-based REER

Euro NEER

Relative ULCs

lower relative labour costs

The spread between nominal yields at the long end of the yield curve between the USA and Germany is at its widest since 1989. In real, inflation-adjusted terms the spread is at its largest since 1993. Unit labour costs in the euro area as a whole continue to fall relative to the external world. Exchange rate adjustment is not required to restore a loss of international competitiveness due to rising internal costs. It is required to improve a competitiveness that is threatened by a rising nominal exchange rate.

Economy & Strategy


Chart 5 – Consensus 12-Month Forward EPS Growth in Europe compared to France

Source: Thomson Reuters IBES, Datastream

Chart 6 – “Core” Consumer Price Inflation for Goods and Services in the Euro Zone

Source: Eurostat, Datastream

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

12-month forward EPS growth (% change y-o-y)MSCI Universe

Europe

France

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

HICP - Core

HICP - Core services

HICP - Core goods

% YOY, 3M average

stabilised

not yet stabilised

Earnings downgrades in the region should stabilise through the months ahead. Inflation in the region is stabilising. The forex market should bring relief, albeit slowly. Regional EPS growth will probably not be much more than 5% this year. However, it should not be much less. Prices of services in euroland have already stabilised. Prices of goods will also stabilise if we are correct in thinking that the external value of the Euro is sinking.

Economy & Strategy


Chart 7 – The K-C Observed Risk Ratio*

* Kepler-Cheuvreux Observed Risk Ratio (ORR) = Sector-neutral, equal-weighted portfolio of higher risk stocks (high beta, high EPS volatility and high

EPS uncertainty) vs lower risk stocks (low beta, low EPS volatility and low EPS uncertainty).

Source: Datastream, Kepler Cheuvreux

Chart 8 – Lower versus Higher Quality Stocks in the DJ Stoxx 600 Universe

“Higher-Quality” = low debt/EBITDA, high EBIT margin, low EPS uncertainty

“Lower-Quality” = high debt/EBITDA, low EBIT margin, high EPS uncertainty Source: FactSet, Kepler Cheuvreux

90

100

110

120

130

140

150

160

170

2009 2010 2011 2012 2013 2014 2015

EuropeObserved Risk Ratio. Index: Jan. 1st 2009 = 100

Outperformance of Risk

Q3-2012 turn

85

90

95

100

105

110

01/12 07/12 01/13 07/13 01/14 07/14 01/15

Lower-Quality vs Higher QualityIndex: Jan. 1st 2012 = 100

16/10/2013

consolidation

Out-performance ofLower-Quality vs Higher Quality

The defensive bias in European equity has become more and more apparent since Q1. The bias is now mature. There are few signs of investor panic.

Economy & Strategy


Chart 9 – The Participation Rate* in the Equity Markets of the USA and Europe (Market Breadth)

* Participation rate = Net Rises (weekly performances) as a % of total stocks Source: Datastream, Kepler Cheuvreux

Chart 10 – The Trans-Atlantic Differential in the Equity Participation Rate

* Participation rate = Net Rises (weekly performances) as a % of total stocks Source: Datastream, Kepler Cheuvreux

-15

-10

-5

0

5

10

15

2010 2011 2012 2013 2014 2015

Participation rate* (3-month moving average)

US

Europe

%

-10

-5

0

5

10

15

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

Participation rate* (3-month moving average)

Differential US - Europe

The contrast in trans-Atlantic market breadth has reached its widest since the ends of 1992, due largely to the continued reduction of investor exposure to Europe’s smaller cap universe.

Economy & Strategy


Chart 11 – Net Portfolio Capital Flows in the Euro Zone by Major Financial Asset

Source: ECB, Datastream, Kepler Cheuvreux

Chart 12 – Value versus Growth and the European Downgrade

Source: Datastream

-200

-100

0

100

200

300

400

500

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Net portfolio investment (inflows minus outflows)

Equities Bonds Money markets instruments Total

EURbn - 12-month cum.

65

70

75

80

85

90

95

100

105

2010 2011 2012 2013 2014 2015

Index: Jan. 1st 2010 = 100MSCI Universe

Europe: Value vs Growth

Europe vs US (local currency)

neutrality of growth / valuein Europe

European downgrade

The net inflows of portfolio capital to the EZ that have assisted the Euro since mid-2012 have begun to weaken. Our assumption is that European equity should no longer under-perform US equity in local currency terms once forex adjustment begins to be significant. We define the threshold of significance to be the level of US$1.35 for the euro.

Economy & Strategy


Chart 13 – The Manufacturing PMI for EZ and Non-EZ Economies

Europe excluding Eurozone = UK, Switzerland, Sweden Source: Bloomberg, Kepler Cheuvreux calculations

Chart 14 – The Manufacturing New Orders-Inventories Ratio in the USA and China

Source: Bloomberg

30

35

40

45

50

55

60

65

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

Manufacturing PMI

Eurozone

Europe excluding Eurozone

-3

-2

-1

0

1

2

3

4

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Manufacturing: New Orders / InventoriesStd dev. From long-term average (3m mov. av.)

China

US

The divergences between the indicators of the short-term growth of output within Europe have increased significantly this year. The indicators of the short-term outlook for the growth of output in America and China are positive.

Economy & Strategy


Decision Time

This is decision time for European equity. The pronounced under-performance of

Europe’s equity markets through Q2 relative to America and relative to credit has

emphasised the growth problem. In particular, it seems that everyone has understood by

now that the French economy is in deep trouble. Even growth in Germany this year is

disappointing. The consequence has been the return of the “I told you so, euro zone does

not work” narrative. Those who never believed the European recovery story have

returned to their negative comfort zone. They have sold or they are short. European

equity has already gone defensive over the last few months. If Europe is not a sell at this

time it is an opportunity.

We recognise the significance of the conflict in the Ukraine (see below). We cannot

expect a recovery of European equity to be sustained at this point. However, our

interpretation has not changed. We do not think that this is a time to sell European

equity. America will tell us when to sell equity assets, not Europe. America is not yet

ready for the sell sign.

Our ideas are best verified in conditions of adversity. From this point of view we would

say that last week was defined by what did not happen. European equity did not fall. It did

not under-perform the American benchmark. Europe’s banks did not under-perform. The

US$ price of gold did not rise.

The point is that investors have been provided with good excuses to sell European equity

this month. Deflation anxiety has been on the rise for some time. Over the last two weeks

investors have been reminded about both credit risk and geopolitical risk. The media tells

us that the world is dangerous. We prefer to the listen to the message of market

behaviour.

We observe that there have been no signs of panic in Europe’s markets. The sellers of

European equity have not proved to be stronger than the buyers. We have a kind of

stalemate between the two at this point.

Our argument is that the earnings downgrades in the region should stabilise through the

months ahead. Inflation in the region is stabilising (see chart 6). The forex market should

bring relief, albeit slowly (see chart 2). The banks should behave better (see charts 21-23).

The growth of output should not weaken in the year’s second half. Regional EPS growth

will probably not be much more than 5% this year. However, it should not be much less. In

this case, European equity should deliver positive returns from this month of July through

to the autumn, until America is ready for the sell sign.

The controversy concerns European equity, not its American counterpart. There is no

good reason to change the “buy the pullback” playbook for US equity. The reporting

season is sending familiar, reassuring signals. The absence of volume on the down days on

Wall Street indicates that there is no reduction of exposure to equity at this time. The

disinflation shock in the major economies – in America in particular – is fading. The short-

term outlook for the growth of output in America and China is good (see chart 14).

Investors know the nature of the enemy. Precisely, they know that the phase of monetary

danger has not yet arrived.

Economy & Strategy


The Ukraine and the German Question

In one sense the destruction of MH17 is already a turning point in the Ukrainian conflict.

It does mark the failure of the interpretation that conciliation and quiet diplomacy could

overcome Russian objections to a united Ukraine, even without the Crimea, under pro-EU

leadership. It was always our view that this interpretation was wishful thinking. By

supporting President Poroshenko the EU has closed the door to compromise with Russia

on the question of the territorial integrity of the Ukraine. At the same time the EU has

continued to pretend that the Ukrainian question is negotiable with Russia, if only to

placate the public opinion that is “neutralist” in its inclinations in large parts of Europe, in

Germany in particular.

Although the MH17 affair weakens Putin’s international position it is illusory to think that

Russia will relax its opposition to a pro-Western Ukraine. However, its tactics may

change. Within Europe those who have argued for conciliation are weakened. The

consequences of this conflict are reduced commercial and financial ties between Russia

and the West, the reassessment of European energy policy and the weakening of the

Russian economy to the point of recession through 2015.

A risk premium associated with the Ukrainian conflict is not new. We doubt that there will

be escalation of the conflict at this time because Putin’s diplomatic position has been

weakened. Nonetheless, the influence of this conflict is significant. It is not going away. It

creates a diffuse risk premium attached to all of Eastern Europe, including Germany. It

provides a part of the answer to the German enigma of 2014.

Germany’s economic and political leadership of Europe has never been more in evidence.

Angela Merkel appears to be unrivalled both within Germany and within Europe. Alone of

the major economies Germany has been able to eliminate the deficit of its public finances.

However, Germany is vulnerable. Its prosperity is excessively dependent upon external

markets. For this reason we think that a decade of out-performance within Europe by the

German stock market is coming to an end. Why is the German economy not stronger at

this time? Why are funds leaving German equity?

Last week provided evidence of two sources of support for European equity. In the first

place, the forex relief is arriving, albeit slowly. We have confirmation of the “slow sink” of

the Euro against the US$. We think that the resurgence of the perception of geopolitical

risk will take the euro through the US$1.35 threshold. Until now we had thought that a

significant depreciation of the Euro would not occur until we see higher yields of US

Treasuries. Risk of the geopolitical kind changes the equation. The point is that the forex

influence does not begin to be positive for the earnings of the euro zone corporate sector

relative to trend and relative to expectations until the euro trades below the US$1.35

threshold with its momentum firmly established on a downward trajectory (see chart 2).

We expect to see the euro near US$1.30 in Q4.

Economy & Strategy


Chart 15 – The Relative Performance of Secure Growth Stocks in the USA and Europe

Secure Growth = Low Beta 2y, Low EPS Uncertainty, Low Volatility of the profit growth, High EPS growth Source: FactSet, Kepler Cheuvreux

Chart 16 – The Performance of Europe’s Growth-Defensive versus Growth-Risk Stocks

Growth = high EPS for 2014-2015-2016

Risk = high beta, high EPS uncertainty, high EPS volatility

Defensive = low beta, low EPS uncertainty, low EPS volatility Source: FactSet, Kepler Cheuvreux

90

95

100

105

110

115

90

100

110

120

130

140

150

160

2009 2010 2011 2012 2013 2014 2015

Index: Jan. 1st 2009=100

Secure Growth Europe / Europe (lhs) Secure Growth US / US (rhs)

Out-performance of Secure-Growth

Q3-2012 peak

90

95

100

105

110

115

120

125

01/13 07/13 01/14 07/14 01/15

Growth-Defensive / Growth-RiskIndex: Jan. 1st 2013 = 100

out-performance of Growth-Defensive stocks

The disparity between the relative performances of secure growth stocks on either side of the Atlantic has been entirely closed this year. The universe of more defensive growth stocks has out-performed quite dramatically those companies with higher risk growth in recent weeks. This is major growth scare in Europe.

Economy & Strategy


Chart 17 – The K-C Reduced-Form Model of the Pricing of US Treasuries

The chart above compares the changes in the yield of the 10-year Treasury note over the last decade with that estimated by a simple model that

aggregates three conventional influences upon the pricing of government debt: the expected future level of Fed funds, long-term inflation expectations

and cyclical growth expectations as represented by the ISM business survey.

Source: Bloomberg, Kepler Cheuvreux

Chart 18 – The Relative Performance of Europe’s Domestic versus Global Stocks by Size Category

“Domestic” = high revenue exposure to Europe

“Global” = high revenue exposure to World excluding Europe Source: FactSet, Kepler Cheuvreux

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

US 10Y Treasury yield - Actual

US 10Y Treasury yield - Fitted

%

period of"growth psychosis"

discontinuity of 2008

60

70

80

90

100

110

120

130

140

2010 2011 2012 2013 2014 2015

Index: Jan. 1st 2010 = 100

Stoxx 600 Domestic / Stoxx 600 Global

SMID Domestic / SMID Global

SMID Domestic / Stoxx 600 Global

watershed

The conventional cyclical influences upon the pricing of US Treasuries have not validated the strength of longer-dates issues this year. The security premium that has emerged since Q1 is associated with the collapse of the cost of debt in Europe. Within the smaller cap universe there is little difference between the performance of domestic and globally-exposed stocks. However, the bid for defensive global stocks has strengthened decisively since Q1 in a context of smaller cap under-performance.

Economy & Strategy


In the second place, the reporting season is providing support for financials. Expectations

for US financials have been lowered too much, suggesting low earnings risk for major

international European banks. We have always thought that this investment cycle should

end with out-performance of US financials as credit growth accelerates (see chart 21).

We expect financials in both America and Europe to behave better in the year’s second

half.

We argued in last week’s note that the downward revision of expectations of nominal

growth in the euro zone is complete, largely because inflation in the region is stabilising.

Chart 6 shows that prices of services in euroland have already stabilised. Prices of goods

will also stabilise if we are correct in thinking that the external value of the Euro is sinking.

The barometer of nominal growth expectations is the pricing of the most secure debt in the

region. Accordingly, our presumption is that yields of longer-dated German bunds will not

fall below their historic lows of 2012-2013. This said, we recognise the significance of the

conflict in the Ukraine. It has already exerted a negative influence since the spring, notably

upon confidence in Germany and its hinterland. In current circumstances there will be few

sellers of these secure assets. However, we should point out that credit spreads within the

euro area are not widening at this time, either for corporate or sovereign debt. The effect of

the BES affair has been short-lived.

It is worth emphasising how extreme the trans-Atlantic divergence in the behaviour of

financial assets has become. The spread between nominal yields at the long end of the yield

curve between the USA and Germany is at its widest since 1989. In real, inflation-adjusted

terms the spread is at its largest since 1993 (see chart 3). Equity markets are showing

similar divergences. The contrast in trans-Atlantic market breadth has reached its widest

since the ends of 1992 (see charts 10 & 11). Our assumption is that European equity should

no longer under-perform US equity in local currency terms once forex adjustment begins to

be significant. We define the threshold of significance to be the level of US$1.35 for the

euro.

We are not suggesting that the equity market should suddenly begin to accord a premium

to stocks sensitive to a stronger US$. After all, a lower Euro-US$ exchange rate is

consensus. Our difference is that we think the movement will be more extended in time and

in scale than the consensus can conceive at the present time. We have already explained

the market response to the currency influence in previous notes. As demonstrated in chart

19, stocks sensitive to a stronger US$ with a lower risk profile, notably in the secure growth

category, have been out-performing strongly in recent weeks. Our portfolio of US$-

sensitive stocks excluding this lower risk compartment has registered a neutral

performance. It would seem that the US$’s influence has prevented the under-performance

of the more cyclical and financial stocks in this category.

Economy & Strategy


The point is that the correlation between the US$ exchange rate and the behaviour of

different categories of European equity should change from this time. The strengthening of

the euro against the US$ from mid-2012 to the spring of this year was associated with the

decline of credit-financial stress in the euro system and with strong net inflows of portfolio

capital into euro-denominated financial assets (see chart 11). This period demonstrates

why the performance of financial stocks, relative to regional benchmarks and relative to

their US counterparts, has been positively correlated with the Euro-US$ exchange rate. The

relationship is illustrated in chart 20.

For similar reasons the relative behaviour of lower risk, globally-exposed stocks has tended to

be negatively correlated with the Euro exchange rate. In recent years the Healthcare sector

has shown the highest degree of negative correlation with the Euro-US$ parity.

The currency-equity correlations of the last few years are testimony to the influence of

credit-financial stress upon the behaviour of all trans-Atlantic financial markets. Precisely,

the euro zone’s deflation anxiety is no longer linked so directly with credit-financial stress

thanks to the collapse of the cost of debt in the region. It is the absence of inflation in the

euro zone, due in large part to declining import prices, that indicates that exchange rate

adjustment is required.

To the extent that a lower Euro exchange rate will reduce deflation anxiety in the euro

system euro depreciation should reduce the pressure upon both cyclical industrials and

financials, if only by weakening the attraction of more defensive categories of equity. In this

respect it should be remembered that exchange rate adjustment is not required to restore a

loss of international competitiveness due to rising internal costs but to improve a

competitiveness that is threatened by a rising nominal exchange rate. Chart 4

demonstrates that unit labour costs in the euro area as a whole continue to fall relative to

the external world.

It is too early for us to envisage a return to Europe’s industrial cyclicals and a

reinforcement of our position in Europe’s financials. The forex influence is just beginning

to be positive. Earnings revisions in Europe are still predominantly negative. We note in

this respect that the under-performance of equity segments most exposed to

competitors in the emerging world – in the segments of Capital Goods, cyclical

technology goods and certain consumer durables – is common to both the US and

European markets. We cannot remove the defensive bias to our recommended portfolio

until the most secure bond markets begin to weaken.

The category of European equity that should draw benefit from the current context is the

consumer universe, both Staples and Discretionary. This is a US$-sensitive category of

equity. It retains profit leadership in Europe. It is less exposed to profitability risk than is

the global growth category of stocks. In this respect we have seen that the price of

internationally-traded crude oil has derived little benefit from the resurgence of

geopolitical risk.

Economy & Strategy


We want our recommended portfolio to respect the principle of valuation return-to-

mean within Europe at this time. We do not want to be increasing exposure to equity

compartments that are notably over-valued by reference to this criterion. Accordingly,

the consumer segment that has become more attractive is that of the cyclical and non-

cyclical lower risk consumer names grouped in the DJ Stoxx Personal & Household

sector. 1 Profit leadership remains apparent here but the overall valuation of this sector

has virtually completed its return to-mean within Europe, as indicated in chart 25. We are

prepared to give the sector the benefit of the doubt by moving it from neutral to over-

weight. In consequence, we are over-weight Europe’s consumer universe of stocks in

general, albeit modestly.

If we apply this same logic to Europe’s markets then the implication is that we should

remove our under-weight position in the UK. It is interesting that we see a configuration

for the UK market that is similar to that for the Personal & Household sector in the sense

that the valuation return-to-mean of the major UK indices is virtually complete. At the

same time the disadvantage of relatively slow earnings growth in the UK market has been

eliminated by the general slowdown in EPS growth in the region (see chart 24). And, of

course, the UK market has relatively high exposure to the positive effects of a stronger

US$. The upgrade to the UK market must be at the expense of the euro zone, which

means the “median” euro-market of France at this time. For similar reasons we are

moving to over-weight from neutral in the global-consumer Danish market to the

expense of Finland.

One last remark. An investment position long the US$ should be viewed as a natural

hedge against equity risk in general. We are moving into a context in which an

accentuation of the perception of global investment risk is likely to strengthen rather

than weaken the US$. An authentically stronger US$ would also expose the unresolved

structural problems in the emerging world. In this respect investors should be cautious

about what they wish for.

C.P./N.T./J.T./C.G.

1 Adidas, Amer Sports, Barratt Developments, Beiersdorf, Bellway, Berkeley Group Holdings, British American Tobacco,

Burberry, Christian Dior, Richemont, Electrolux, Henkel, Hermes, Hugo Boss, Husqvarna, Imperial Tobacco, L'Oreal, Luxottica, LVMH, OSRAM Licht, Pandora , Persimmon, Reckitt Benckiser, SEB, BIC, Svenska Cellulosa Aktiebolaget, Swatch, Swedish Match, Taylor Wimpey, Tod's

Economy & Strategy


Chart 19 – The Performance of Europe’s US$-Sensitive Stocks

Secure Growth stocks = Stocks with low beta 2y, low EPS uncertainty, low volatility of the profit growth, high EPS growth

US$ sensitive stocks = Stocks which exhibit the strongest negative correlation (weekly relative performance) with the EUR/USD exchange rate

Source: Datastream, FactSet, Kepler Cheuvreux

Table 1 – Secure Growth & US$ sensitive stocks (19 stocks)


Table 2 –US$ sensitive stocks (42 stocks)


90

95

100

105

110

115

120

125

130

135

140

01/13 04/13 07/13 10/13 01/14 04/14 07/14 10/14 01/15

Index: Jan. 1st 2013=100Stoxx 600 Europe Universe

Secure Growth & US$ sensitive stocks / Stoxx 600

US$ sensitive stocks / Stoxx 600 US$-sensitivesecurity out-performing

neutral

Aryzta AG Close Brothers Group plc Gerresheimer AG Ryanair Holdings Plc

Babcock International Group PLC Drax Group plc Hargreaves Lansdown plc Shire PLC

Booker Group PLC Electrocomponents plc InterContinental Hotels Group PLC Sports Direct International plc

Britvic plc Essentra plc Luxottica Group S.p.A. Telecity Group plc

Chr. Hansen Holding A/S G4S plc Rightmove plc

Admiral Group plc Diageo plc HSBC Holdings plc Sports Direct International plc

Airbus Group NV Direct Line Insurance Group Plc Inmarsat plc STMicroelectronics NV

ARM Holdings plc easyJet plc Lancashire Holdings Limited TalkTalk Telecom Group PLC

Aryzta AG Eutelsat Communications SA MTU Aero Engines AG Telecity Group plc

AstraZeneca PLC Experian PLC OCI NV Tesco PLC

BP p.l.c. Friends Life Group Limited Polyus Gold International Limited Ultra Electronics Holdings plc

Britvic plc Genel Energy PLC Rightmove plc Vodafone Group PLC

Capital & Counties Properties PLC Gerresheimer AG Rolls-Royce Holdings plc Wm Morrison Supermarkets plc

Catlin Group Limited GlaxoSmithKline plc Royal Mail plc WPP Plc

Coca-Cola HBC AG Hargreaves Lansdown plc Sage Group plc

Compass Group Plc Hikma Pharmaceuticals Plc Serco Group plc

The equity market has begun to anticipate a lower Euro-US$ exchange rate. Stocks sensitive to a stronger US$ with a lower risk profile have been out-performing since June.

Economy & Strategy


Chart 20 – Euro-US$ Parity and the Trans-Atlantic Banking Barometer

Source: Datastream

Chart 21 – Private Sector Credit Growth and the Relative Performance of US Financials

Source: Datastream

1.15

1.20

1.25

1.30

1.35

1.40

1.45

1.50

1.55

1.60

20

40

60

80

100

120

140

2009 2010 2011 2012 2013 2014

Banks Europe / Banks US (lhs. MSCI Universe. local currency)

EUR / USD (rhs)

Index: June 1st 2009 = 100

-14%

-10%

-6%

-2%

2%

6%

10%

14%

40

50

60

70

80

90

100

110

120

130

1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

US

Financials US / US (lhs)

Private Sector Credit Growth y-o-y (rhs)

Base 100 = Jan. 1st 1998 y-o-y % change

The correlation between the US$ exchange rate and the behaviour of different categories of European equity should change from this time. The currency-equity correlations of the last few years are testimony to the influence of credit-financial stress upon the behaviour of all trans-Atlantic financial markets. We have always thought that this investment cycle should end with out-performance of US financials as credit growth accelerates.

Economy & Strategy


Chart 22 – A Reduced-Form “Deflation Risk Premium” Model for the Pricing of the Banking

Sector

Model for EMU Banks = Rolling one-year linear regression model based on: JPM Global Composite PMI Index as Global Growth Expectations proxy,

Stoxx 600 Cyclicals relative to Defensives performance as cyclical barometer, and Kepler-Cheuvreux calculated Index for corporate default risk in

Europe as Europe "Deflation risk premium".

Source: Bloomberg, Datastream, Kepler Cheuvreux

Chart 23 – The Relative Composite Valuation of the Euro Zone Banks

Relative Composite Valuation = (Relative P/E + Relative P/B – Relative D/Y), number of standard deviations from the mean.

Source: FactSet, Kepler Cheuvreux

10

25

40

55

70

85

100

115

2007 2008 2009 2010 2011 2012 2013 2014 2015

Index = Jan. 1st 2007 = 100

Model for Eurozone Banks

MSCI Eurozone Banks

Banks not over-priced

-3

-2

-1

0

1

2

3

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Euro Stoxx BanksComposite Valuation relative to Euro StoxxZ-Scores = Standard Deviation from Mean

under-weight

neutral

over-weight

Std. deviations

Our model of Europe’s banks as a barometer of deflation risk does not suggest that the banking sector is expensive. The relative valuation of the euro zone‘s banks is becoming a source of support once again.

Economy & Strategy


Chart 24 – The Relative EPS Growth and Composite Valuation of the UK Market within Europe



Chart 25 – The Relative EPS Growth and Composite Valuation of the Personal & Household

Sector



60

65

70

75

80

85

90

95

100

105

-4

-3

-2

-1

0

1

2

3

4

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

United Kingdom / Stoxx 600

Relative Composite Valuation (lhs) Relative 12-month forward EPS (rhs)

Base 100 = Jan. 1st 1995

valuation return-to-trend almost complete

relative EPS stabilised

Std. deviations

-3

-2

-1

0

1

2

3

0

20

40

60

80

100

120

140

160

180

200

95 97 99 01 03 05 07 09 11 13 15 17

Personal & Household Goods / Stoxx 600

Rel. 12m fwd EPS (lhs)

Rel. Composite valuation (rhs)

Base 100 = Jan. 1st 1995 Standard Deviation from mean

The valuation return-to-mean of the major UK indices is virtually complete. At the same time the disadvantage of relatively slow earnings growth in the UK market has been eliminated. Profit leadership of the P & H sector remains very apparent whilst the overall valuation of the sector has virtually completed its return to-mean within Europe this year.

Economy & Strategy


The DJ Stoxx sector performance page

YTD performance DJ Stoxx (Level 2)

18/07/2014 1week 3 mos 12 mos

Utilities 0.0 2.3 12.2

Real Estate 0.4 4.3 2.0

Healthcare -0.6 6.5 3.7

Basic Resources 2.2 4.5 6.2

Oil & Gas -1.0 2.4 -1.3

Food & Beverage 0.2 2.8 -4.7

Construction -0.4 -6.0 9.9

Personal & HH -0.2 2.0 -5.2

Automobiles -1.1 -5.8 8.7

Travel 0.6 -0.9 -0.2

Financial Services 0.6 2.2 4.9

Insurance -0.1 1.0 1.9

Chemicals -0.4 1.8 -3.6

Telecom 0.3 -0.1 9.3

Banks 0.4 -6.5 -3.0

Technology 1.6 0.0 -2.9

Media 1.8 -1.2 -1.0

Industrial G&S -0.5 -4.3 -5.1

Retail 0.7 -1.2 -9.5

* Rank according to the YTD perf.

YTD performance: DJ Euro Stoxx (Level 2)

18/07/2014 1week 3 mos 12 mos

Utilities -0.3 1.6 21.6

Real Estate -0.3 5.1 -0.2

Oil & Gas -1.2 -1.2 3.8

Food & Beverage 0.1 1.9 -7.4

Construction -0.3 -8.6 12.0

Telecom -0.8 0.0 20.2

Automobiles -1.1 -5.9 9.3

Travel -0.2 -9.1 -5.2

Chemicals -0.8 2.9 -0.4

Banks -0.1 -9.7 19.6

Healthcare -0.5 0.9 -12.3

Financial Services 0.3 -3.4 3.9

Technology 0.9 1.4 0.3

Personal -0.4 -1.9 -11.5

Retail -0.4 -2.2 -5.7

Media 0.7 -5.2 -0.7

Insurance -0.7 -2.5 -1.1

Industrial G&S -1.0 -6.0 -2.2

Basic Resources 0.7 -1.9 2.9

* Rank according to the YTD perf.

Performance* relative to DJ Euro Stoxx (%)

Performance* relative to DJ Stoxx (%)

Source: Datastream

Source: Datastream

-3.6

-2.9

-2.8

-2.1

-2.0

-0.9

0.9

1.3

3.4

3.5

4.0

4.7

5.1

6.2

6.6

7.4

8.7

11.9

13.1

14.3

-20 -15 -10 -5 0 5 10 15 20

Retail

Industrial G&S

Media

Technology

Banks

Telecom

Chemicals

Insurance

Financial Services

DJ Stoxx

Travel

Automobiles

Personal & HH

Construction

Food & Beverage

Oil & Gas

Basic Resources

Healthcare

Real Estate

Utilities

-5.0

-4.5

-4.0

-3.3

-2.3

-1.9

-1.2

0.0

0.2

0.6

1.5

1.7

4.6

4.9

4.9

5.6

6.3

9.5

11.0

15.7

-25 -20 -15 -10 -5 0 5 10 15 20 25

Basic Resources

Industrial G&S

Insurance

Media

Retail

Personal & HH

Technology

Financial Services

Healthcare

Banks

Chemicals

DJ Euro-Stoxx

Travel

Automobiles

Telecom

Construction

Food & Beverage

Oil & Gas

Real Estate

Utilities

Economy & Strategy


The MSCI sector performance page

YTD performance MSCI Europe (Level 1)

18/07/2014 1week 3 mos 12 mos


Healthcare -0.7 5.9 3.5

Energy -1.0 3.4 0.3

Materials 0.7 2.0 2.6

Cons. Staples 0.1 2.3 -5.4

Cons. Discretionary 0.1 -1.8 -0.6

Financials 0.3 -3.4 -1.2

Telecoms Services 0.5 -0.9 8.8

Industrials -0.4 -5.0 -4.1

Information techno. 1.6 -0.7 -3.9

* Rank according to the YTD perf. Source: Datastream

YTD performance MSCI Europe (Level 2)

18/07/2014 1week 3 mos 12 mos


Real Estate 0.5 4.9 2.5

Pharma. & Biotech. -0.7 6.0 4.5

Energy -1.0 3.4 0.3

Consumer Services 0.4 7.4 6.6

Food Bev. & Tobacco 0.0 3.1 -3.5

Materials 0.7 2.0 2.6

Auto. & Compo. -1.0 -6.0 8.1

Transportation -0.7 -3.2 13.2

Healthcare Equipt & Serv. -0.4 4.4 -6.6

Insurance 0.0 1.3 1.0

Household & Personal Pdct 0.0 2.2 -4.9

Consumer Dur. & App. -0.1 -1.6 -11.7

Media 2.0 1.6 0.7

Banks 0.3 -5.6 -0.2

Techno. & Hard. Eqpmt 5.1 -0.3 9.5

Telecoms Services 0.5 -0.9 8.8

Commercial Serv. & Sup. -0.5 -3.9 -11.2

Capital Goods -0.4 -5.4 -5.3

Software & Services 1.9 -1.0 -5.8

Diversified Financials 0.9 -5.7 -7.8

Retailing 0.3 -2.4 -4.3

Semiconductors -2.8 -0.9 -13.1

Food & Staples Retailing 1.0 -3.1 -17.7

* Rank according to the YTD perf. Source: Datastream

Performance* relative to MSCI Europe (%)

Performance* relative to MSCI Europe (%)

-3.3

-2.3

-1.4

-0.1

1.2

3.6

5.6

6.4

9.1

10.0

15.1

-15 -10 -5 0 5 10 15 20 25

Information techno.

Industrials

Telecoms Services

Financials

Cons. Discretionary

Europe

Cons. Staples

Materials

Energy

Healthcare

Utilities

-6.4

-5.8

-5.2

-3.7

-3.3

-3.0

-2.7

-1.4

-1.1

-1.0

-0.6

-0.2

1.1

1.9

2.8

3.2

3.6

4.2

6.4

8.2

8.2

9.1

10.8

13.4

15.1

-15 -5 5 15 25

Food & Staples Retailing

Semiconductors

Retailing

Diversified Financials

Software & Services

Capital Goods

Commercial Serv. & Sup.

Telecoms Services

Techno. & Hard. Eqpmt

Banks

Media

Consumer Dur. & App.

Household & Personal Pdct

Insurance

Healthcare Equipt & Serv.

Transportation

Europe

Auto. & Compo.

Materials

Consumer Services

Food Bev. & Tobacco

Energy

Pharma. & Biotech.

Real Estate

Utilities

Economy & Strategy


Performances by market

YTD performance* (MSCI in %** ) Performance* (MSCI in %** )

18/07/2014 1week 3 mos 12 mos

World Dev. 0.6 4.6 13.7

World Em. 0.8 4.8 11.6

World AC 0.7 4.6 13.5

S&P 500 0.5 6.1 17.1

USA 0.5 6.1 17.4

Japan 0.7 7.4 2.2

DJ Stoxx 600 0.8 2.2 13.3

DJ Eurostoxx 0.4 -0.5 15.9

France 0.4 -2.1 11.9

Germany 0.6 1.0 13.2

Italy 0.5 -3.6 31.0

Netherlands -0.1 1.7 8.3

Spain -0.4 2.7 34.2

Sweden (EUR) 1.5 1.8 5.8

Switzerland (EUR) 0.6 2.0 10.8

UK (EUR) 1.4 5.6 10.9

* in Local currency

** Except otherwise indicated

Sector factor : excess return due to the singular sector composition of the country indexCountry factor : excess return due to company specific factors (in aggregate)Residual : excess return that can not be explained by sector and country factors

European "Country & Sector Factor": YTD performance

Source: Datastream

Source: Datastream

4.5

5.3

-0.2

6.9

1.4

11.2

-1.3

1.7

1.7

3.5

-3.8

7.0

7.0

4.7

5.1

4.7

-15 -5 5 15 25

DJ UK (€)

DJ Switzerland (€)

DJ Sweden (€)

DJ Spain

DJ Netherlands

DJ Italy

DJ Germany

DJ France

DJ Eurostoxx

DJ Stoxx 600

Japan

USA

S&P 500

World AC

World Em.

World Dev.

-5

0

5

10

15

France Germany Italy Netherlands Spain Sweden Switzerland UK

Country factor Sector Factor Residual (* including Currency Factor) Excess Return

Economy & Strategy


DJ Stoxx Size & Style Indices

YTD performance

18/07/2014 1week 3 mos 12 mos

Small 200 -0.3 -3.2 2.0

Mid 200 0.4 -0.5 3.7

Large 200 -0.1 0.3 -0.7

Blue Chips 50 -0.1 0.8 -2.4

Growth * 0.1 0.1 -3.7

Growth-Small * -0.3 -1.2 0.8

Growth-Mid * 0.5 -1.7 -1.5

Growth-Large * 0.0 0.8 -4.9

Value * -0.1 0.4 3.2

Value-Small * 0.0 -2.7 5.8

Value-Mid * 0.5 -0.5 5.4

Value-Large * -0.3 0.9 2.8

* DJ Stoxx TM Universe Source: Datastream

Performance relative to DJ Stoxx (%)

4.7

6.4

4.5

4.8

2.9

2.8

1.6

2.8

3.0

3.4

5.1

1.6

3.5

0 2 4 6 8 10 12

Value-Large *

Value-Mid *

Value-Small *

Value *

Growth-Large *

Growth-Mid *

Growth-Small *

Growth *

Blue Chips 50

Large 200

Mid 200

Small 200

DJ Stoxx 600

Economy & Strategy


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Economy & Strategy


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Italy: This document is issued by Kepler Capital Markets, Milan branch and Crédit Agricole Cheuvreux S.A., branch di Milano, authorised in France by the Autorité des Marchés Financiers (AMF) and the Autorité de Contrôle Prudentiel (ACP) and registered in Italy by the Commissione Nazionale per le Società e la Borsa (CONSOB) and is distributed by Kepler Capital Markets S.A and Crédit Agricole Cheuvreux, Société Anonyme (S.A.), authorised in France by the AMF and the ACP and registered in Italy by CONSOB. This document is for Eligible Counterparties or Professional Clients only as defined by the CONSOB Regulation 16190/2007 (art. 26 and art. 58).Other classes of persons should not rely on this document. Reports on issuers of financial instruments listed by Article 180, paragraph 1, letter a) of the Italian Consolidated Act on Financial Services (Legislative Decree No. 58 of 24/2/1998, as amended from time to time) must comply with the requirements envisaged by articles 69 to 69-novies of CONSOB Regulation 11971/1999. According to these provisions Kepler Capital Markets S.A and Crédit Agricole Cheuvreux, Société Anonyme (S.A.)warns on the significant interests of Kepler Capital Markets S.A and Crédit Agricole Cheuvreux, Société Anonyme (S.A.)indicated in Annex 1 hereof, confirms that there are not significant financial interests of Kepler Capital Markets S.A and Crédit Agricole Cheuvreux, Société Anonyme (S.A.)in relation to the securities object of this report as well as other circumstance or relationship with the issuer of the securities object of this report (including but not limited to conflict of interest, significant shareholdings held in or by the issuer and other significant interests held by Kepler Capital Markets S.A and Crédit Agricole Cheuvreux, Société Anonyme (S.A.)or other entities controlling or subject to control by Kepler Capital Markets S.A and Crédit Agricole Cheuvreux, Société Anonyme (S.A.)in relation to the issuer) which may affect the impartiality of t his document]. Equities discussed herein are covered on a continuous basis with regular reports at results release. Reports are released on the date shown on cover and distributed via print and email. Kepler Capital Markets, Milan branch and Crédit Agricole Cheuvreux S.A., branch di Milano analysts are not affiliated with any professional groups or organisations. All estimates are by Kepler Capital Markets S.A and Crédit Agricole Cheuvreux, Société Anonyme (S.A.) unless otherwise stated.

Spain: This document is only intended for persons who are Eligible Counterparties or Professional Clients within the meaning of Article 78bis and Article 78ter of the Spanish Securities Market Act. It is not intended to be distributed or passed on, directly or indirectly, to any other class of persons. This report has been issued by Kepler Capital Markets, Sucursal en España and Crédit Agricole Cheuvreux España S.V, registered in Spain by the Comisión Nacional del Mercado de Valores (CNMV) in the foreign investments firms registry and it has been distributed in Spain by it or by Kepler Capital Markets S.A and Crédit Agricole Cheuvreux, Société Anonyme (S.A.) authorised and regulated by both Autorité de Contrôle Prudentiel and Autorité des Marchés Financiers. There is no obligation to register neither file any report and any supplemental documentation or information with the CNMV. Neither verification nor authorisation or compliance revision by the CNMV regarding this document and related documentation or information needs to be fulfilled in accordance with the Spanish Securities Market Law (Ley del Mercado de Valores).

Switzerland: This publication is intended to be distributed to professional investors in circumstances such that there is no public offer. This publication does not constitute a prospectus within the meaning of Articles 652a and 1156 of the Swiss Code of Obligations.

Canada: The information provided in this publication is not intended to be distributed or circulated in any manner in Canada and therefore should not be construed as any kind of financial recommendation or advice provided within the meaning of Canadian securities laws.

Other countries: Laws and regulations of other countries may also restrict the distribution of this report. Persons in possession of this document should inform themselves about possible legal restrictions and observe them accordingly.THE DISTRIBUTION OF THIS DOCUMENT BY KEPLER CAPITAL MARKETS IN OTHER JURISDICTIONS MAY BE RESTRICTED BY LAW, AND PERSONS INTO WHOSE POSSESSION THIS DOCUMENT COMES SHOULD INFORM THEMSELVES ABOUT, AND OBSERVE, ANY SUCH RESTRICTIONS. BY ACCEPTING THIS REPORT YOU AGREE TO BE BOUND BY THE FOREGOING INSTRUCTIONS.

The MSCI indexes are the exclusive property of MSCI Inc. (“MSCI”). MSCI and the MSCI index names are service mark(s) of MSCI or its affiliates and have been licensed for use for certain purposes by KEPLER CHEUVREUX. The financial securities referred to herein are not sponsored, endorsed, or promoted by MSCI, and MSCI bears no liability with respect to any such financial securities. The Prospectus contains a more detailed description of the limited relationship MSCI has with KEPLER CHEUVREUX and any related financial securities. No purchaser, seller or holder of this product, or any other person or entity, should use or refer to any MSCI trade name, trademark or service mark to sponsor, endorse, market or promote this product without first contacting MSCI to determine whether MSCI’s permission is required. Under no circumstances may any person or entity claim any affiliation with MSCI without the prior written permission of MSCI.

The Dow Jones GCC IndexSM, or other applicable index, are calculated, distributed and marketed by Dow Jones & Company, Inc., a licensed trademark of CME Group Index Services LLC ("CME"), and have been licensed for use. All content of the Dow Jones IndexesSM © 2012 Dow Jones & Company, Inc.

No part of this report may be reproduced in any manner or redistributed without the prior written permission of Kepler Cheuvreux.

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