turning analysis into action february 2013 portfolio strategies desk market outlook mark hebeka, cfa...

Turning Analysis into Action

February 2013

Portfolio Strategies Desk

Market Outlook

Mark Hebeka, CFAHead of Portfolio Strategies Desk

2

Important Information

The opinions expressed in this material are strictly those of Merrill Lynch, are made as of the date of this material and are subject to change without notice. Other affiliates may have opinions that are different from and/or inconsistent with the opinions expressed herein and may have banking, lending, and/or commercial relationships with the companies that are mentioned here.

This material was prepared by the Investment Management & Guidance Group (IMG) and is not a publication of BofA Merrill Lynch Global Research. The views expressed are those of IMG only and are subject to change. This information should not be construed as investment advice. It is presented for information purposes only and is not intended to be either a specific offer by any Merrill Lynch entity to sell or provide, or a specific invitation for a consumer to apply for, any particular retail financial product or service that may be available through the Merrill Lynch Family of companies.

Merrill Lynch does not provide tax, accounting, or legal advice. Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local tax penalties. Please have your clients consult their advisor as to any tax, accounting or legal statements made herein.

The investments discussed have varying degrees of risk. Some of the risks involved with equities include the possibility that the value of the stocks may fluctuate in response to events specific to the companies or markets, as well as economic, political or social events in the U.S. or abroad. Bonds are subject to interest rate, inflation and credit risks. Investments in foreign securities involve special risks, including foreign currency risk and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are magnified for investments made in emerging markets.

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Investment products:

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© 2013 Bank of America Corporation. All rights reserved

Are Not FDIC Insured May Lose Value Are Not Bank Guaranteed

3

-10%-5%0%5%

10%15%20%25%30%

Financials Industrials Materials Cons Disc HealthcareCons

Staples Energy Utilities Info Tech Telecom

Q4 2012

2012

-10%-5%0%5%

10%15%20%25%30%



Q4 2012

2012

-10%-5%0%5%

10%15%20%25%30%



Q4 2012

2012

-10%-5%0%5%

10%15%20%25%30%



Q4 2012

2012

DJ-UBS TR

Global NAREIT Gold

HFRX Global

HF

Russell 1000

Growth

Russell 1000 Value

Russell 2000

Growth

Russell 2000 Value

Russell Midcap Growth

Russell Midcap Value

S&P500

US Broad Market Treasury TIPS

Municipal Corp.

High Yield

Non-US IG

Emerging

MarketsMortgag

eAsset-Backed

IG Preferred–Fixed

IG Preferre

d–Floating

As of 12.31.12 Quarterly % Chg YTD % ChgDJIA 13,104.1 -1.7% 10.2%NASDAQ 3,019.5 -2.7% 17.5%S&P 500 1,426.2 -0.4% 16.0%S&P 400 Mid Cap 1020.4 3.6% 17.9%Russell 2000 849.4 1.9% 16.3%MSCI World 1,338.5 2.6% 16.5%MSCI EAFE 1,604.0 6.6% 17.9%MSCI Emerging Mkts 1,055.2 5.6% 18.6%

S&P 500 SECTOR RETURNS

BOND MARKET RETURNS

As of 12.31.12 Quarterly % Chg YTD % ChgML US Broad Market Master

261.9 0.3% 4.5%

ML US Treasury Master 1490.8 -0.1% 2.2%ML Agency Master 179.4 0.2% 2.5%ML Muni Master 475.1 0.5% 7.3%ML US Corp Master 2449.6 1.2% 10.4%ML High Yield 952.0 3.2% 15.6%

As of 12.31.12 Quarterly % Chg YTD % ChgDJ-UBS Total Return 279.8 -6.3% -1.1%Gold Spot* 1675.4 -5.5% 7.1%Silver Spot* 30.2 -12.7% 8.2%Copper Spot* 365.3 -2.8% 6.3%WTI Crude $/Barrel* 91.8 -0.4% -7.1%

As of 12.31.12 Quarterly % Chg YTD % ChgGlobal NAREIT 2007.6 5.8% 28.7%US NAREIT 2,379.9 2.4% 18.2%Alerian MLP 385.1 -3.4% 4.8%HFRX Global Hedge Fund

1,148.3 0.8% 3.5%

As of 12.31.12 Quarterly % Chg YTD % ChgEUR/USD 1.3193 2.6% 1.8%USD/JPY 86.75 11.3% 12.8%GBP/USD 1.6255 0.5% 4.6%USD/CHF 0.9154 -2.6% -2.4%

BONDS

COMMODITIES

CURRENCIES*

ALTERNATIVES

CROSS ASSET RETURNS

Returns calculated are total returns unless otherwise stated (*indicates spot returns). All bond indexes represented by BofA Merrill Lynch Global Bond Indexes.

STOCKSWORLD BY REGION

S&P 500 MSCI WORLD MSCI EAFE MSCI EUROPEMSCI EMERGING

MARKETS MSCI PACIFIC

-5%

0%

5%

10%

15%

20%

25%

Financials Industrials Materials Cons DiscHealthcare

Cons Staples Energy Utilities Info Tech Telecom

-10%-5%0%5%

10%15%20%25%30%

-5%

0%

5%

10%

15%

20%

25%

-10%-5%0%5%

10%15%20%25%30%

Markets Review

4

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

US Economy Continues to Heal

The US economy continues to show signs of improvement with the FED committing to low interest rates and asset purchases (QE3) on the order of $40 billion per month in an effort to reduce unemployment rate, currently at 7.9%. Inflation concerns remain muted as consumer confidence and various retail metrics showing signs of stabilization. On the investment front, capex spending is set to rise after years of underinvestment. In addition, housing recovery shows continued momentum.

Source: BofA-ML Global Research, Investment Management & Guidance (IMG)

1970 1976 1982 1988 1994 2000 2006 2012-2%0%2%4%6%8%

10%12%14%16%18%

6.5%

RecessionUnemployment RateHistorical AverageBroader Unemployment Rate (U-6)

UNEMPLOYMENT RATE ABOVE HISTORICAL AVERAGE

1990 1992 1995 1997 2000 2002 2005 2007 2010 2012

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

Fed Assets Headline CPICore CPI

INFLATION RATE REMAINS MUTED DESPITE QE RETAIL SALES CONTINUE TO STABILIZE (YoY %)

1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012

-15%

-10%

-5%

0%

5%

10%

15%

20%

Recession Retail Sales, YoY %

Average

US REAL GDP GROWTH IN 2013

BofA ML Forecasts: 1Q 2013:

1.0% 2Q 2013:

1.5% 3Q 2013:

2.2% 4Q 2013:

2.5%Historical Average

5



2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

US REAL GDP GROWTH IN 2013

BofA ML Forecasts: 1Q 2013: 1.0% 2Q 2013: 1.5% 3Q 2013: 2.2% 4Q 2013: 2.5%

Historical Average

6



1970 1976 1982 1988 1994 2000 2006 2012-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

6.5%

Recession Unemployment RateHistorical Average Broader Unemployment Rate (U-6)Historical U-6 Average FED Target Unemployment

UNEMPLOYMENT RATE ABOVE HISTORICAL AVERAGE

7



RETAIL SALES CONTINUE TO STABILIZE (YoY %)

1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012-15%

-10%

-5%

0%

5%

10%

15%

20%

Recession Retail Sales, YoY % Average

8

Housing Recovery

Source: Federal Housing Finance Agency, S&P, Haver Analytics, National Association of Realtors, Census Bureau, BofA Global Research, IMG

Various housing fundamentals such as household formation, home prices, housing starts, housing inventory, etc. point to an improvement in the sector. Existing home sales increased 5.9% in November from the previous month, representing an annual rate of 5 million units. Home prices are projected to increase 5% year over year in 2012 compared to 3.7% decline in 2011. Residential homebuilding is expected to contribute 0.3 percentage point to US GDP growth in 2012 and 0.4 percentage points in 2013.

HOME PRICES TRENDING UPWARD

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

100

110

120

130

140

150

160

170

180

Ind

exe

d t

o 2

00

2=

10

0 Case-Shiller 20 City, +5% in 2012

Case-Shiller National, Up 5% in 2012

FHFA House Price Index, +4% in 2012

19992000200120022003200420052006200720082009201020112012

1,000K

2,000K

3,000K

4,000K

5,000K

6,000K

7,000K

8,000K

0

2

4

6

8

10

12

14

Supply in Months Total Existing Home Sales

Housing Inventory

EXISTING HOME SALES AND INVENTORY

Market Peak: 3.6 months of

supply

Months of supply of existing homes

Existing Homes SalesExisting Home Inventory

CONSTRUCTION JOBS LAG HOUSING STARTS

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

400K

600K

800K

1,000K

1,200K

1,400K

1,600K

1,800K

2,000K

2,200K

2,400K

3.2%

3.4%

3.6%

3.8%

4.0%

4.2%

4.4%

4.6%

4.8%

5.0%

5.2%

Housing Starts Lagged 5 Qs (LHS)Construction jobs as % of Labor Force (RHS)

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

0K

500K

1,000K

1,500K

2,000K

2,500K

Average 1,352K

HOUSING STARTS FORECASTED TO AVERAGE 975k in 2013

According to BofA Research, housing starts are forecasted to add 0.4 (pp) to GDP in 2013.

9

Housing Recovery


HOME PRICES TRENDING UPWARD

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012100

110

120

130

140

150

160

170

180

Ind

exe

d t

o 2

00

2=

10

0

Case-Shiller 20 City, +5% in 2012

Case-Shiller National, Up 5% in 2012

FHFA House Price Index, +4% in 2012

10

Housing Recovery


1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20121,000K

2,000K

3,000K

4,000K

5,000K

6,000K

7,000K

8,000K

0

2

4

6

8

10

12

14

Supply in Months Total Existing Home Sales Housing Inventory

EXISTING HOME SALES AND INVENTORY

Market Peak: 3.6 months of supply

Months of supply of existing homes

Existing Homes SalesExisting Home Inventory

11

Housing Recovery


1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 20120K

500K

1,000K

1,500K

2,000K

2,500K

Average 1,352K

HOUSING STARTS FORECASTED TO AVERAGE 975k in 2013

According to BofA Research, housing starts are forecasted to add 0.4 (pp) to GDP in 2013.

12

Housing Recovery


CONSTRUCTION JOBS LAG HOUSING STARTS

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013400K

600K

800K

1,000K

1,200K

1,400K

1,600K

1,800K

2,000K

2,200K

2,400K

3.2%

3.4%

3.6%

3.8%

4.0%

4.2%

4.4%

4.6%

4.8%

5.0%

5.2%

Housing Starts Lagged 5 Qs (LHS)

13

US Energy Independence

US OIL SUPPLIES FORECASTED TO RISE ~15% BY 2016…

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

15

17

19

21

23

25

27

29

31

33

100

150

200

250

300

350

Oil (billion barrels) Natural gas (trillion cubic feet)

TECHNOLOGY ADVANCEMENT BOOSTS US PROVED RESERVES

Mexico

Norway

UK

Russia

India

Columbia

Biofuels

Canada

Brazil

United States

-1,000 -500 0 500 1,000 1,500 2,000

US TO SUPPLY A LARGE PORTION OF NON-OPEC SUPPLY GROWTH BETWEEN 2011-2016

Advancement in technology has boosted US energy production over the past 5 years. US is on track to supply a large portion of Non-OPEC supply growth in the near future. Harnessing these reserves gives the US a significant competitive advantage that will grow in years to come, with Commodity Strategist Francisco Blanch estimating that the US enjoys a $700mn per day “energy carry” relative advantage.

ENERGY COSTS AS % OF TOTAL OPERATING COSTS (2010)

Source: BofA-ML Global Research, IMG

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

4.0

5.0

6.0

7.0

8.0

9.0

10.0

18.0

19.0

20.0

21.0

22.0

23.0

24.0

Total US Oil Supplies Total US Oil Demand

Su

pp

ly (

bil

lio

ns

of

Ba

rre

ls)

De

ma

nd

(b

illi

on

s o

f b

arr

els

)…While U.S. demand is ex-pected to decline by 3%

14


1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

15

17

19

21

23

25

27

29

31

33

100

150

200

250

300

350

Oil (billion barrels) Natural gas (trillion cubic feet)

TECHNOLOGY ADVANCEMENT BOOSTS US PROVED RESERVES


15



US OIL SUPPLIES FORECASTED TO RISE ~15% BY 2016…

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 20164.0

5.0

6.0

7.0

8.0

9.0

10.0

18.0

19.0

20.0

21.0

22.0

23.0

24.0

Total US Oil Supplies Total US Oil Demand

Su

pp

ly (

bill

ion

s o

f B

arr

els

)

De

ma

nd

(b

illio

ns

of

ba

rre

ls)

…While U.S. demand is ex-pected to decline by 3%

16


ENERGY COSTS AS % OF TOTAL OPERATING COSTS (2010)


17

Pent Up Demand

1998

1998

1999

2000

2000

2001

2002

2002

2003

2004

2004

2005

2006

2006

2007

2008

2008

2009

2010

2010

2011

2012

$0

$20

$40

$60

$80

$100

$120

$140

$160

$180

$15

$17

$19

$21

$23

$25

$27

$29

$31

Share Buybacks (in $billions, LHS)

Dividends per Share (12 Months, RHS)

USE OF CASH: SHARE BUYBACKS AND DIVIDENDS AMONG S&P 500 COMPANIES

While US GDP growth remains tepid, US corporate profits have soared allowing companies to build cash on their balance sheets. However, capex has not kept pace after years of underinvestment. Mergers and acquisitions activity can also rise given strong balance sheets, low interest rates, and attractive equity valuations. In lieu of M&A, idle cash has resulted in increased dividend payouts and share buybacks.

CORPORATE PROFITS SOAR

1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012

3%

4%

5%

6%

7%

8%

9%

10%

11%

Recession Corporate Profits*

Average

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

M&A Transactions (in $bilions)

M&A ACTIVITY LOWEST SINCE 2002

CAPEX SPENDING HAS NOT KEPT PACE

Dec-93 Dec-95 Dec-97 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Dec-11

-40%

-30%

-20%

-10%

0%

10%

20%

30%

New Orders: Non-defense capital goods ex. Aircraft, YoY%Average


18

Pent Up Demand

CORPORATE PROFITS SOAR

1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 20123%

4%

5%

6%

7%

8%

9%

10%

11%

Recession Corporate Profits* Average


19

Pent Up Demand

CAPEX SPENDING HAS NOT KEPT PACE

Dec-93 Dec-95 Dec-97 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Dec-11-40%

-30%

-20%

-10%

0%

10%

20%

30%

New Orders: Non-defense capital goods ex. Aircraft, YoY% Average


20

Pent Up Demand

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

M&A Transactions (in $bilions)

M&A ACTIVITY LOWEST SINCE 2002


21

Pent Up Demand

1998

1998

1999

1999

2000

2001

2001

2002

2002

2003

2004

2004

2005

2005

2006

2006

2007

2008

2008

2009

2009

2010

2011

2011

2012

$0

$20

$40

$60

$80

$100

$120

$140

$160

$180

$15

$17

$19

$21

$23

$25

$27

$29

$31

Share Buybacks (in $billions, LHS)

USE OF CASH: SHARE BUYBACKS AND DIVIDENDS AMONG S&P 500 COMPANIES


22

International Markets Also Improving

Source: BofA-ML Global Research, International Monetary Fund, Bloomberg, IMG

Economic conditions around the world are also improving. BofA-ML’s Economic Conditions Index (ECI), a broad measure of business conditions around the world, has been trending up steadily and uniformly across regions. The world economy, outside of the U.S., is expected to grow around 4% annually between now and 2014. Stress in financial markets is now at the lowest levels since 2007.

BUSINESS CONDITIONS GLOBALLY TICKING UP

Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12

-5

-4

-3

-2

-1

0

1

2

GLOBALcycle DMcycle GEMcycle

z-sc

ore

s

BofA-ML Economic Conditions In-dex (ECI)

2011 2012 2013 2014

-1%

0%

1%

2%

3%

4%

5%

6%

7%

Global xU.S. Euro Area

Japan Emerging Markets

GROWTH OUTSIDE U.S. TO RISE IN 2013 AND 2014

Forecasts

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

0

50

100

150

200

250

300

350

400

450

GFS

In

dex

MS

CI A

C W

orl

d In

de

x

GLOBAL FINANCIAL STRESS INDEX AT LOWEST SINCE 2007

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

0%

2%

4%

6%

8%

World

Advanced economies

EM and Developing economies

Infl

ati

on

Ra

te (

Yo

Y%

)

Fore-casts

GLOBALLY INFLATION IS UNDER CONTROL

23



BUSINESS CONDITIONS GLOBALLY TICKING UP

Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12-5

-4

-3

-2

-1

0

1

2

GLOBALcycle DMcycle GEMcycle

z-sc

ore

s

BofA-ML Economic Conditions Index (ECI)

24



2011 2012 2013 2014-1%

0%

1%

2%

3%

4%

5%

6%

7%

Global xU.S. Euro Area Japan Emerging Markets

GROWTH OUTSIDE U.S. TO RISE IN 2013 AND 2014

Forecasts

25



Dec-0

6

Apr-0

7

Jul-0

7

Oct-0

7

Jan-

08

May

-08

Aug-0

8

Nov-0

8

Feb-

09

May

-09

Sep-

09

Dec-0

9

Mar

-10

Jun-

10

Oct-1

0

Jan-

11

Apr-1

1

Jul-1

1

Oct-1

1

Feb-

12

May

-12

Aug-1

2

Nov-1

2-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

0

50

100

150

200

250

300

350

400

450

GFS

Ind

ex

MS

CI A

C W

orl

d In

de

x

GLOBAL FINANCIAL STRESS INDEX AT LOWEST SINCE 2007

26

Equity Fundamentals & the Great Rotation

Source: BofA-ML Global Research, ICI, http://www.econ.yale.edu/~shiller/data.htm, IMG

STOCKS ATTRACTIVELY PRICED RELATIVE TO BONDS

1976 1981 1986 1991 1996 2001 2006 2011

-6%

-4%

-2%

0%

2%

4%

6% Equity risk premium

+1 std deviation

Tech bubble peak

RECORD INVESTOR FLOWS INTO BONDS FUND SINCE 2007

2007 2008 2009 2010 2011 2012

-300000

-200000

-100000

0

100000

200000

300000

400000

500000

Equities Bonds

Ne

t Fl

ow

s (b

illio

ns,

$)

One of the major themes of Research is the coming “Great Rotation” from bonds to stocks. Play this theme by emphasizing bonds that act like stocks and favor intermediate maturities over longer-term maturities

S&P 500 FORWARD PRICE-EARNING (PE) RATIO BELOW HISTORICAL AVERAGE

1986 1990 1994 1998 2002 2006 2010

5.0x

10.0x

15.0x

20.0x

25.0x

30.0x

Forward P/E

Average= 15.1x

S&P 500 EARNINGS PER SHARE FORECASTED TO GROW

2005 2006 2007 2008 2009 2010 2011 2012E 2013E

$0

$20

$40

$60

$80

$100

$120

BofA-ML Strategy EPS estimates vs Consensus 2012: $102.75 vs $102.74 | 2013: $110.0 vs $106.59

http://www.econ.yale.edu/~shiller/data.htm

27



RECORD INVESTOR FLOWS INTO BONDS FUND SINCE 2007

2007 2008 2009 2010 2011 2012-300000

-200000

-100000

0

100000

200000

300000

400000

500000

Equities Bonds

Ne

t Fl

ow

s (b

illio

ns,

$)


28



STOCKS ATTRACTIVELY PRICED RELATIVE TO BONDS

1976 1981 1986 1991 1996 2001 2006 2011-6%

-4%

-2%

0%

2%

4%

6% Equity risk premium

+1 std deviation

Tech bubble peak


29



S&P 500 EARNINGS PER SHARE FORECASTED TO GROW

2005 2006 2007 2008 2009 2010 2011 2012E 2013E$0

$20

$40

$60

$80

$100

$120

BofA-ML Strategy EPS estimates vs Consensus 2012: $102.75 vs $102.74 | 2013: $110.0 vs $106.59


30



S&P 500 FORWARD PRICE-EARNING (PE) RATIO BELOW HISTORICAL AVERAGE

1986 1990 1994 1998 2002 2006 20105.0x

10.0x

15.0x

20.0x

25.0x

30.0x

Forward P/E Average

Average= 15.1x


31

Key Implementation Themes

• Globalize Equity Portfolios: Move beyond the U.S.

• Housing: Banks key beneficiaries

• Dividend Growth Over Dividend Yield

• Fixed Income Positioning:• Credit risk over duration risk

32

International Developed Markets: Receding Risks & Attractive Valuations

Source: BofA-ML Research, Bloomberg, IMG

EUROPEAN VOLATILTY AT MULTI-YEAR LOWS

Receding tail risks associated with the European Central Bank ‘s (ECB) actions has led to lower volatility, declining bond yields and rising equity markets in the Euro area. BofA Research’s base case calls for Europe to further stabilize in 2013 with most growth coming in 2H13. Risks to continued European recovery include: contagion effects associated with Spain seeking entry into OMT program amid intense market pressure, potential Greek exit, inability to resolve the US fiscal cliff, and escalation of Mid-East tensions leading to a spike in oil prices. The pro-stimulus policies of Japan’s new government is supportive of equities.

JAPANESE EQUITIES: ALSO ATTRACTIVE VALUATIONS

EUROPEAN EQUITY MARKETS: ATTRACTIVE VALUATIONS

1996 1998 2000 2002 2004 2006 2008 2010 2012

0.6

0.7

0.8

0.9

0.70

Average=0.74

+1 Standard Deviation

-1 Standard Deviation

MSCI Europe relative to MSCI US - Price to Book

Average

1899

1907

1915

1923

1931

1939

1947

1955

1963

1971

1979

1987

1995

2003

2011

0

10

20

30

40

50

60

0%

5%

10%

15%

20%

25%

30%

35%

40%

Euro Stoxx 50 Volatility Index Greek 10 Yr Bond Spreads

Eu

ro S

tox

x 5

0 V

ola

tilit

y In

de

x

10

Yr

Bo

nd

Yie

lds

1996 1998 2000 2002 2004 2006 2008 2010 2012

0.3

0.4

0.5

0.6

0.7

0.8

Average=0.54

0.455813953488372

MSCI Japan relative to MSCI US - Price to Book

Average

YEN’S WEAKESS INCREASES JAPANESE COMPETITIVENESS

2002

2003

2004

2004

2005

2005

2006

2006

2007

2007

2008

2008

2009

2009

2010

2010

2011

2011

2012

2012

70

80

90

100

110

120

130

JPYUSD 200-day MA

33

China Rebounding with Emerging Markets Leading Global Growth

Source: BofA-ML Research, Bloomberg, Haver Analytics, National Bureau of Statistics of China, IMG. *For 2012

ESTIMATED CONTRIBUTION TO GLOBAL GROWTH BY REGION*

2007 2008 2009 2010 2011 2012 2013

0%

2%

4%

6%

8%

10%

12%

14%

BofA ML Forecasts: 4Q 2012:

7.8% 1Q 2012:

8.3% 2Q 2013:

8.3% 3Q 2013:

8.0% 4Q 2013:

8.0%

CHINA REAL GDP FORECASTS (%, YoY)

EM economies are expected to lead global growth. In particular, the risk of a Chinese hard landing have eased with 4Q GDP growth forecasted at 7.8% vs 7.4% in 3Q (lowest since 1Q 2009). Exports are expected to remain flat in 2013 (forecasted to grow at 7.5%) on weakness of EU, US, and Japan. With inflation subdued, accommodate pro-growth policy remains in effect. Other metrics such as industrial production (+10%, YoY), fixed asset investment (+21%, YoY), credit growth (+16%), Purchase Mangers Index (50.6), retail sales (+15%, YoY) remain healthy.

CHINA EXPORTS TO REMAIN FLAT IN 2013(%, YoY)

2005 2006 2007 2008 2009 2010 2011 2012

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

-$30

-$20

-$10

$0

$10

$20

$30

$40

$50

Trade Surplus in $ billions, RHS Export Growth (%, YoY), LHS

U.S.; 12%

EU; -1%Japan; 4%

DM Others; 9%

China; 40%

India; 12%

Brazil; 3%Russia; 3%

EM Other, 18%

CONSUMPTION EXPECTED TO LEAD CHINESE GROWTH

2006 2007 2008 2009 2010 2011

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

5.4%

4.8%

-0.4%

Net ExportsInvestmentsConsumption

Consumption as component of GDP growth exceeded investments in 2011

34

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

0

50

100

150

200

250

300

350

400

80

90

100

110

120

130

140

150

160

S&P Homebuilders Idx S&P Home Improv IdxBKX Index S&P/Case-Shiller C20

Housing and the Banks

Source: BofA-ML Research, Bloomberg, IMG

BANKS HAVE LAGGED OTHER HOUSING SENSITIVE SECTORS (3Q2011-2012)RALLY IN HOUSING STOCKS SINCE 3Q 2011

Housing starts were up 25% and home prices increased 5% in 2012. BofA-ML Research forecasts the recovery will continue in 2013, with another 25% rise in housing starts and 3% increase in home prices in 2013.Homebuilders and other direct sectors have already rallied substantially. Financials is our preferred way to play the continued rebound in housing is through the Financials, particularly the large banks.

REGIONALS OUTPERFORMED MONEY CENTERS IN 2012 THE MONEY CENTERS-REGIONALS VALUATION GAP

S&P Home-

builders Idx

S&P Home Improv Idx

KBW Bank Idx S&P 500

0%

25%

50%

75%

100%

125%

150%

175%

200%

Dec-11 Mar-12 May-12 Jul-12 Sep-12 Nov-12

80

100

120

140

160

180

JPM C RF

35

Dividend Growth Investing

Source: BofA-ML Research, Oppenheimer, http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html, IMG

DIVIDEND GROWERS HAVE OUTPERFORMED OVER TIME…DIVIDEND GROWTH AT MOST DISCOUNT TO YIELD SINCE 1990

Stocks with the highest dividend growth have been one of the most consistent strategies. In fact, over the long-run dividend growth accounts for a majority of the total return on stocks. The low interest rate environment and high demand for income from retiring baby boomers supports the secular case for dividends.

…AND WITH LESS RISK HIGHEST YIELDING STOCKS NOT THE OPTIMAL SOLUTION

1 2 3 4 5 6 7 8 9 104%

6%

8%

10%

12%

14%

16%

18%

12%

14%

16%

18%

20%

22%

24%

26%

Annualized Return

Decile (1=lowest D/Y, 10=highest D/Y)

An

nu

al R

etu

rns

Ris

k (

Sta

nd

ard

Devia

tion

)

High-est Re-turns

Lowest Volatility

Lower re-turns,

higher volatility

10% 12% 14% 16% 18% 20% 22% 24% 26% 28%

-2%

0%

2%

4%

6%

8%

10%

Risk (Annualized Standard Deviation)

An

nu

aliz

ed

Re

turn

s

Dividend Growers (16.4%, 9.4%)

Dividend Payers w/ No Change (18.5%, 7.0%)

Non-Dividend Payers (25.7%, 1.35%)

Dividend Cut-ters (25.7%, -0.89%)

All Dividend Payers (17.2%, 8.6%)

-40%

-20%

0%

20%

40%

60%

80%

100%

Dividend Growth More Expen-sive

Dividend Yield More Expen-sive

http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

36

Fixed Income Solutions

Source: BofA-ML Global Research, http://www.econ.yale.edu/~shiller/data.htm, Bloomberg, IMG

The yield on the 10-year Treasury is currently lower than the dividend yield on the S&P 500. That has not happened on a sustained basis since the 1950s. Low yields present a problem for bond holders (duration risk). While our base case calls for still positive credit returns in 2013 , the era of equity like returns in fixed income has likely come to an end. The key will be higher-yield, lower quality credit markets.

HY SPREADS HAVE ROOM TO NARROW FURTHEREM DEBT ONE OF THE BEST PERFORMING BOND SECTORS (2007-2012)

S&P DIVIDEND YIELD VS 10-YEAR TREASURIES YIELDS ACROSS THE FIXED INCOME MARKET (Dec 2012)

U.S. T

reas

urie

s

DM S

over

eign

s (x

U.S.)

Mor

tgag

es

Mun

is

IG C

orpo

rate

s

EM S

over

eign

s

IG Pre

ferred

s

EM LCL

Cur

renc

y

HY Co

rpor

ates

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%Higher yielders have lower duration risk

1996 1998 2000 2002 2004 2006 2008 2010 2012

0

500

1000

1500

2000

2500

2007 2008 2009 2010 2011 2012

70

80

90

100

110

120

130

140

150

160

170

EM Sovereigns EM Local Debt

DM Sovereigns U.S. Treasuries

1950195519601965197019751980198519901995200020052010

0%

2%

4%

6%

8%

10%

12%

14%

16%

S&P Dividend Yield 10-Yr Tsy Yield


37

Appendix

38

APPENDIX 1: Rotation Scenarios

Source: BofAML Research, ML GWM Investment Management & Guidance

BofA ML Forecast

• Federal funds rate increase mid-2015 (same timeframe outlined by Federal Reserve)• 10-year U.S. Treasury target for year-end 2013 • 30-year U.S. Treasury target for year-end 2013 • GDP forecast 2013• CPI ex Food & Energy 2013• Private Payrolls (Avg MoM change) 2013• Housing Starts (Thous. SAAR) 2013

2.0%3.25%1.4%1.8%94,000897

Orderly Rotation Disorderly Rotation

• Attractive equity returns over a longer period combined with less attractive bond returns

• 2.5% tailwind becomes 2.5% headwind• Slowly rising interest rates – 10-year Treasury

yields can move above 3% without causing alarm• Employment and GDP data continue to improve

but at a sluggish pace

• Employment, GDP and housing data continue to improve at an accelerating pace

• 10-year Treasury moves a second leg higher toward 4% in a matter of months

• Flows abruptly change

39

Metric Current Level Trending Goal

Unemployment Rate 7.7 6.9

GDP (Annual Growth Rate) 2.0 < 3.0

Retail Sales 3.8 4.7

Consumer Confidence 73.7 85.0

CPI 1.9 < 2.5

S&P/Case-Shiller Home Price Index

146.2 160.0

ISM Manufacturing 49.5 55.0

What concerns us (scored 1-10 with 10 being the most worrisome) and how is it trending

> Weight of Fiscal cliff – Higher taxes and austerity measures (6) - flat

> European debt crisis – Spain asking for debt relief and Elections in Italy (7) - improving

> China - Economic outlook and new leadership (4) - flat

> Mid-East unrest – Syria, Egypt, Palestine and Israel (5) – flat

APPENDIX 2: Checklist / Worry List

Source: Bloomberg, BofAML Global Research, Portfolio Strategies Desk Research

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