Size segment matters when it comes to sector allocation

Transcription

1 Size segment matters when it comes to sector allocation Revisiting large & small cap sector allocations Given that both the large-cap and small-cap US equity strategy teams have recently made changes to their respective sector allocation, we look at where size matters in terms of differences and similarities by sector according to qualitative and quantitative signals. We also look at a variety of fundamental and risk metrics, including valuation, revision trends, foreign exposure, balance sheet strength and earnings growth expectations. Where we differ There are four sectors for which we see divergent forces between large caps and small caps: Health Care (overweight in small, market weight in large), Consumer Staples (underweight in small, market weight in large), and Energy and Industrials (market weight in small, overweight in large). Higher foreign exposure, more global GDP sensitivity and large cash balances make us more positive on Energy and Industrials in the large cap space, thus our overweight position. But while large cap Health Care is certainly undervalued, we see continuing government risk for Health Care, warranting a market weight. For small caps, we are more sanguine on Health Care due to its stronger secular as well as near-term earnings growth potential, and the expected pick-up in M&A activity in the space could bolster the smaller names. For large caps, while Consumer Staples defensive aspects suggest that the sector could lag the market if we continue to see upside, its better dividend growth potential, still reasonable valuations for many subsectors, and global, high quality bias warrants a market weight in large, compared to underweight in small. And where we are the same Five of the ten sectors share the same weight in our large and small cap sector allocations. We are overweight Technology across both size segments, as attractive valuations, clean balance sheets, cash deployment and foreign exposure make Tech one of our favorite sectors. On the other end of the spectrum, we advise underweighting Utilities in both the large and small cap universes as this sector is expensive, purely domestic, and likely to lag in a cyclical recovery. We are Market Weight Consumer Discretionary, Financials, and Materials across small and large. Small Cap US Equity Strategy/Small Cap Research United States 26 February 2013 Steven G. DeSanctis, CFA Small-Cap Strategist MLPF&S Savita Subramanian Equity & Quant Strategist MLPF&S Jill Carey Equity Strategist MLPF&S Christina Giannini, CFA Small-Cap Strategist MLPF&S Alex Makedon Quantitative Strategist MLPF&S Dan Suzuki, CFA Equity Strategist MLPF&S Matthew Trapp, CFA Small-Cap Strategist MLPF&S Table 1: Sector allocation large and small Rating GICS Sector Large Caps Small Caps Consumer Discretionary M M Consumer Staples M U Energy O M Financials M M Health Care M O Industrials O M Information Technology O O Materials M M Telecommunication Services U Utilities U U Rating: M=Marketweight; O=Overweight; U=Underweight Source: BofA Merrill Lynch Small Cap Research c58da9b710df662c BofA Merrill Lynch does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Refer to important disclosures on page 15 to 17. Link to Definitions on page

2 Table 2: Sector comparison by size segments BofAML Weight Comments GICS Sector Large Caps Small Caps Large Small Homebuilders & home improvement stores are beneficiaries of housing recovery, Consumer Discretionary M M but likely already priced in Best revision ratio, estimates holding up thanks to housing. Valuations stretched Valuations are not attractive. Continued high unemployment, higher taxes, and still weak balance sheets relative to history could depress consumer spend Impact of slow US economy and higher taxes. Consumer Staples M U High quality, dividend yield, and dividend growth potential Recently moved rating to Underweight from Market Weight. Higher foreign exposure and less govt. risk than other defensive sectors One of the most expensive sectors in small caps. Risks: inflation, upside surprise to profits growth Sector lags when market rallies. Energy O M Attractive valuations (across P/B, P/CF, Fwd P/E) Valuations are attractive. Benefits from US domestic energy advantage Oil and Natural Gas price forecasts little upside. Cyclical recovery play, high foreign exposure Street expects big jump in earnings, weak revision trend. Financials M M Benefits from US cyclical recovery / housing recovery Posting strong earnings on back of improving housing market. Attractive on relative P/B but expensive vs. history on relative forward P/E Valuations are not as attractive as other sectors. Old leadership rarely becomes new leadership; high beta; regulatory/litigation risk Higher interest rates hurt this sector's performance. Health Care M O Attractive valuations (across P/B, P/CF, Fwd P/E) Attractive valuations clean balance sheets, ripe for M&A activity. Large cap pharma is our preferred dividend yield play (inexpensive & underowned) We think estimates are conservative for Most government spending exposure of any sector Debt ceiling and its impact on company earnings. Industrials O M Closet quality play: largest percentage of high quality stocks Good global exposure and better China and ISM boost performance. GDP-sensitive, global exposure, capex exposure Not attractive on valuations. Defense stocks at risk from govt. spending cuts Has been a strong performer of late. Information Technology O O Historically cheap on forward P/E, cash (dividend/buyback/capex potential) Valuations are very attractive and cash rich. Highest foreign exposure, secular & cyclical growth, lower EPS vol. vs. history Companies paying dividends, buying back stock, potential for M&A. Risks: consensus overweight; govt. spending exposure Good global exposure and revisions have been turning around. Materials M M Poor risk-reward vs. other non-financial cyclicals (high beta but low LTG) Recently moved up rating to Market Weight. Risk: Highly leveraged to China growth Lots of global exposure and better global demand boost sector. Expensive sector and commodity prices falling not rising. Telecom Services U Very expensive vs. history on relative fwd. P/E Combined with Utilities. Little room to raise dividends (high payout ratios) Defensive/domestic Utilities U U Most expensive sector vs. history on relative fwd. P/E Too defensive and expensive. Little room to raise dividends (high payout ratios) Higher interest rates hurt sector performance. Defensive, purely domestic Great rotation leaves this sector behind. Rating: M=Marketweight; O=Overweight; U=Underweight Source: BofA Merrill Lynch Small Cap Research 2

3 26 February 2013 We are currently Market Weight the sector in both large caps and small caps. Consumer Discretionary M/W Large and Small In both large caps and small caps we are Market Weight the sector, having made no change to this weighting in either or our recent sector allocation changes. Our views on growth, valuation, and the impact of the macro backdrop are similar: 2013 earnings and sales growth for both size segments are expected to come in above the universe average, and interestingly, the long-term forecasted growth rate (three to five years) is higher for large than for small Consumer Discretionary has been the best-performing sector in large and the second-best performing sector in small since the market low in Valuations reflect the strong performance, as the sector is the most broadly overvalued within large caps, and overvalued on both P/B and forward P/E within small caps. Exposure to improving housing market with Household Durables (large and small) and Specialty Retail (large home improvement stores) Small cap consensus earnings growth of 22%, however, seems awfully high but trend in revision ratio has outpaced that of the overall size segment. Continued high unemployment, consumer deleveraging, and higher taxes also pose risk to the sector across both large and small. Chart 1: Revision trend for small-cap Consumer Discretionary has been better than overall universe Chart 2: The relationship between S&P 500 Consumer Discretionary and jobless claims suggests further upside may be limited Consumer Discretionary Three-Month Mov ing Av erage Rev ision Ratio Small Caps Jobless claims (inverted) Consumer Discretionary index Feb-90 Aug-91 Feb-93 Aug-94 Feb-96 Aug-97 Feb-99 Aug-00 Feb-02 Aug-03 Feb-05 Aug-06 Feb-08 Aug-09 Feb-11 Aug Source: FactSet Research Systems; Thomson Financial; I/B/E/S, BofAML Small Cap Strategy, BofAML US Equity & Quant Strategy Initial jobless claims (thous.), 4 w k. av g. (inv erted) Source: Bloomberg, BofA Merrill Lynch US Equity & US Quant Strategy Consumer Discretionary index 3

4 We are currently Market Weight the group in large caps, but Underweight the group in small caps. Consumer Staples M/W in Large, U/W in Small We have a mixed rating on Consumer Staples, as we are Market Weight the group in large caps (downgraded from Overweight in November 2012), but recently went to an Underweight in small caps from a previous Market Weight. Our recent downgrades were based on our views of the economic backdrop for We forecast small caps will gain over 20% this year, outperforming our S&P 500 forecast return of 12%, amid a re-acceleration in economic growth. We also expect profit growth to reaccelerate. Defensives sectors tend to lag in this type of environment, and thus Consumer Staples may be left behind. However, reasons for being Market Weight in large caps as opposed to Underweight in small include the following: Dividends: The dividend yield of small cap Staples is less than that of the overall Russell 2000, while within the S&P 500, it is more attractive than the benchmark. Large cap Consumer Staples also offer more opportunity for dividend growth. Valuation: The sector is one of the most-expensive groups in small caps, with all absolute and relative measures well above their long-term averages, while in large caps, it looks more fairly valued. Quality: The return on equity is higher for large cap Consumer Staples than for small, and within the large cap universe, Consumer Staples is the second highest quality sector after Industrials based on S&P Common Stock Ranks. Balance sheets: Debt to market equity is higher for small cap Staples than for large, at 38% vs. 21%. Foreign exposure: 30% of large cap Consumer Staples sales come from overseas, compared to just 16% for small. Foreign exposure is one of our favorite themes for Good risk-reward in large caps: Within the S&P 500, Consumer Staples has historically offered the highest average 12-month return and lowest volatility of returns of all 10 GICS sectors. Table 3: In strong years, Consumer Staples tends to get left behind Russell 2000 Consumer Staples Excess Average Source: BofA Merrill Lynch Small Cap Research; Russell Investment Group Chart 3: S&P 500 Consumer Staples offers the highest avg. 12-month return and the lowest volatility of all ten GICS sectors Average 12-month return 14% 12% 10% 8% 6% 4% Cons. Staples Energy Health Care Cons. Disc. Industrials Materials Financials Telecom 17% 19% 21% 23% 25% 27% 29% Volatility (standard deviation) of 12-mth returns Tech Note: Based on data from Feb to Dec. 2012, except from Telecom which is based on data since Dec Source: Compustat, I/B/E/S, BofA Merrill Lynch US Equity & US Quant Strategy 4

5 In Energy, we are Overweight the sector in large caps, but Market Weight in small caps. Energy O/W in Large, M/W in Small On Energy, we are also mixed with an Overweight in large caps and a Market Weight for small caps. BofAML oil and gas forecasts are close to where the commodities are trading at today and performance of the sector has a strong correlation with commodity prices. In small caps, we think much of the profits for the sector comes from Natural Gas, and thus with the easy comparisons to last year s level, earnings growth is expected to spike substantially down cap. While earnings growth expectations are lower in large, our commodity strategists expect Brent-WTI spreads to remain wide, a positive for the refiners. Valuations are attractive across both the large and small cap spectrum, though perhaps even more so in large. Energy is the most broadly undervalued sector besides Health Care within the S&P 500 on all three relative valuation metrics we track. For small caps, Energy trades below average on relative Price/Book, while relative P/CF and P/E are close to their norms. Other reasons for being Overweight in large caps vs. Market Weight in small caps include: Balance sheets: Large caps have cleaner balance sheets, a higher ROE and higher dividend yield than small caps. Foreign exposure: Large cap Energy has a substantially higher proportion of its sales coming from overseas, and we expect the multinationals in the S&P to outperform in 2013 as global growth outpaces US growth. Chart 4: Oil prices drives small-cap Energy s performance. Chart 5: Energy has among the highest global exposure in the S&P 500, and should benefit from global growth outpacing US growth Oil (Left Scale) Small-Cap Energy (Right Scale) 60% Correlation= % 20% Jan-86 Jan-90 Jan-94 Jan-98 Jan-02 Jan-06 Jan-10 Source: FactSet Research Systems; BofA Merrill Lynch Small Cap Research % Tech Energy Materials Industrials Cons. Staples Cons. Disc. Health Care Financials Utilities Telecom S&P 500 S&P ex. Fin. Source: Company reports, BofA Merrill Lynch US Equity & US Quant Strategy 5

6 Financials M/W for both Large and Small In both large caps and small caps, we are Market Weight Financials for the following reasons: In both large caps and small caps we are Market Weight this sector. Financials has substantial exposure to the improving housing market. This is likely an even larger benefit for small caps, where we estimate over 70% of the sector s profits come from housing related industries consensus earnings growth is about the same in both size segments (~14% YoY). Small caps have a higher dividend yield due to their large exposure to REITS, but large caps have high dividend growth and continued dividend growth potential. Earnings have continued to come in strong, but valuations may be getting ahead of themselves. Small caps look fairly valued based on relative forward P/E, while large caps actually look overvalued on this metric. Net interest margins are still under pressure due to low interest rates. Risks: if we see a Great Rotation back to equities and out of fixed income, a surge in interest rates is possible, which would hurt performance. Chart 6: If interest rates rise substantially thanks to Great Rotation, could pose a threat to small-cap Financials performance Chart 7: Large cap Financials look expensive vs. history on relative forward P/E, even though they look attractive on P/B Financials (Left Scale) 10-Year Treasury Yield (Right Scale) Correlation= Jan-79 Jan-82 Jan-85 Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06 Jan-09 Jan x 1.1x 1.0x 0.9x 0.8x 0.7x 0.6x 0.5x Financials Relative Fw d. P/E Av erage Source: FactSet Research Systems; BofA Merrill Lynch Small Cap Research; Russell Investment Group Source: FactSet/I/B/E/S, BofA Merrill Lynch US Equity & US Quant Strategy 6

7 26 February 2013 We are Overweight Health Care in small caps but Market Weight the group in large caps. Health Care M/W Large, O/W Small This is another group in which we have a difference of opinion, with the sector Overweight in small caps and Market Weight in large caps. Across both size segments, we like Health Care for its attractive valuations all absolute and relative measures are trading below their long-term averages. Pharma is our preferred yield play in the large cap space, as this industry is both inexpensive and underowned. Bot Table 4: Small-cap Health Care saw its fair share of deals in 2012 and we think this will pick up in 2013 Historical 2012 Average** GICS Sector Number Percent Number Percent Consumer Discretionary Consumer Staples Energy Financials Health Care Industrials Information Technology Materials Telecommunication Services Utilities However, reasons for being Overweight in small but Market Weight in large include: M&A: Very good balance sheets could lead to a pick up of M&A activity in the small cap space as well as capital deployment, which bodes well for performance. Secular growth: Small cap Health Care fits the secular growth theme well, and these names should outperform in a slow US economy. For large caps, Health Care is more of a defensive sector with lower long-term growth. Government exposure: While a risk for both sectors, the S&P 500 has very high government sales exposure. In addition to risk from entitlement reform, industries which receive government/academic funding (such as medical technology) are at risk from sequestration. Earnings: Consensus expects little to no earnings growth for large caps in 2013, compared to low-teens growth for small caps. Chart 8: Health Care makes up the largest portion of S&P 500 US government sales exposure Tech, Industrials, Energy / Utilities & Other 25% Defense 35% Health Care 40% Total , ** Historical average is based on data going back to Source: Mergerstat; FactSet Research Systems; BofA Merrill Lynch Small Cap Research Source: BofA Merrill Lynch US Equity & US Quant Strategy 7

8 Industrials is another sector in which our ratings are different across market cap. We are Overweight the sector in large caps and Market Weight the group in small caps. Industrials O/W Large, M/W Small This is another sector in which we have different ratings, as we are Overweight for large caps and Market Weight for small caps. Across both size segments, the sector looks fairly valued on relative forward P/E, and we like the sector for its exposure to an improving global economic backdrop. The ISM has recently started to turn up, and capex guidance has improved both positives for Industrials. Within large caps, we remain cautious on defense stocks due to the impending sequestration. Other reasons for our Overweight in large vs. Market Weight in small include: Quality: Large caps have a higher than average ROE and dividend yield, and within the S&P 500 Industrials actually has the highest proportion of high quality stocks of any sector. Foreign exposure: While a positive for both size segments, this is even more of a benefit to large, where 40% of sales from overseas, than for small (where 21% of sales come from overseas). Chart 9: For small-cap Industrials to perform well, we need to see an improving ISM Correlation = 0.25 ISM (Left Scale) Industrials (Right Scale) Dec-90 Dec-92 Dec-94 Dec-96 Dec-98 Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12 Source: FactSet Research Systems; Federal Reserve Board; BofA Merrill Lynch Small Cap Research Table 5: Industrials has the highest proportion of high quality stocks in the S&P 500 Cap-Weighted Proportion of B+or Better Stocks Percentage of Companies ranked B+ or Better Industrials 85% 77% Consumer Staples 79% 69% Information Technology 68% 44% Health Care 67% 63% S&P % 53% Materials 60% 50% Financials 57% 42% Consumer Discretionary 53% 51% Energy 51% 42% Utilities 38% 55% Telecom Services 8% 13% Note: Based on S&P Common Stock Ranks (High quality = B+ or Better, Low Quality = B or Worse) Source: S&P, BofA Merrill Lynch US Equity & US Quant Strategy 8

9 In both large caps and small caps, we are Overweight Information Technology. Information Technology O/W Large and Small We are Overweight Tech in both size segments. Although some characteristics are different, including better earnings and sales growth rates down the cap spectrum, reasons for our Overweight in large and small include: Tech has very clean balance sheets. Within large caps, Tech is the only sector with more cash that debt. Within small caps, balance sheets are the best in the size segment. Companies have been returning capital to shareholders via dividends and buybacks, and we think this theme will continue. Cash deployment for small caps has been higher than average, which tends to boost performance. Within small caps, given last year s underperformance, the sector is one of the most attractive based on valuations with all metrics trading substantially below average. Within large caps, the sector offers the most implied upside on relative forward P/E of any sector. M&A activity is one of our themes in 2013 and we think much of the action will take place in small cap Tech. Tech offers both secular and cyclical growth opportunity. Tech has the highest foreign exposure of all of the sectors for both large and small caps, and thus a rebound in the global economy will help this group. Revision trends for Tech remain below average, but have been improving across both large and small. Chart 10: Small-cap Tech companies have been buying back stock and/or paying dividends, which can boost performance Chart 11: Large cap Tech is trading at a discount to the S&P 500 for the first time since Percentage of Tech companies Pay ing Div idends Buy ing Back Stock 2.2x 2.0x x x x Jan-88 Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan x 1.0x 0.8x Tech Relative Fwd. P/E Av erage ex. Tech Bubble Source: FactSet Research Systems; BofA Merrill Lynch Small Cap Research Source: FactSet/I/B/E/S, BofA Merrill Lynch US Equity & US Quant Strategy 9

10 We are Market Weight Materials in both the large caps and small caps. Materials M/W for both Large and Small Both the large cap and small cap teams recently moved up their weighting on this sector from Underweight to Market Weight. There are some differences in characteristics among size segments, as large caps offer a higher dividend yield and better balance sheets, while small caps offer a higher projected long-term growth rate. Similarities across both sectors, however, underlie our Market Weight: Foreign exposure small cap Materials derives nearly one third of its sales from outside of the US, while large cap Materials derives nearly half of its sales from overseas. China growth is particularly important for large cap Materials, which can be a risk if growth does not bottom. Commodity prices drive performance and if they do head higher thanks to better global demand, this will help the sector. In both the large and small cap space, the sector also has exposure to improvement in the US housing market. Valuations are not as attractive as other groups for both large and small caps, relative P/B, P/CF and forward P/E multiples are above their historical averages. Chart 12: If commodity prices do improve, this will help boost Materials in small caps Chart 13: Poor risk/reward: Materials has the highest beta but among the lowest LTG expectations for the S&P 500 Non-Financial cyclicals Materials (Left Scale) CRB Index (Right Scale) Correlation= Dec-88 Jun-90 Dec-91 Jun-93 Dec-94 Jun-96 Dec-97 Jun-99 Dec-00 Jun-02 Dec-03 Jun-05 Dec-06 Jun-08 Dec-09 Jun-11 Dec-12 Reward = Projected LTG Rates Technology Energy Consumer Discretionary Industrials Materials Risk = 5-Yr Beta Source: FactSet Research Systems; Federal Reserve Board; BofA Merrill Lynch Small Cap Research Source: FactSet/Compustat, I/B/E/S, BofA Merrill Lynch US Equity & US Quant Strategy 10

11 In both small caps and large caps we rate Utilities as Underweight. Utilities U/W for both Large and Small Both in large caps and small caps we view Utilities as a sector investors should be Underweight for the following reasons: Long-term growth rates are the worst of any group across both size segments, and balance sheets are also weaker than most other sectors. Dividend yields are high, but as payout ratios are also high we see little room for the sector to raise dividends. With the expected pick-up in US GDP growth and better global growth, we expect this defensive and very domestic sector to lag. And if we are correct with our market call that small caps post a strong 2013, this sector will get left behind. If interest rates head higher, the group will trail as it is inversely correlated with the 10 year Treasury. The sector sports some of the highest valuations in both the large and small cap space despite weak growth prospects. Table 6: Utilities perform even worse than Staples if small caps have a big year Russell 2000 Utilities Excess Average Source: BofA Merrill Lynch Small Cap Research; Russell Investment Group Chart 14: Large cap Utilities are still trading near all time highs on relative forward P/E 1.4x 1.2x 1.0x 0.8x 0.6x 0.4x Utilities Relativ e Fw d. P/E Source: FactSet/I/B/E/S, BofA Merrill Lynch US Equity & US Quant Strategy Av erage 11

12 We combine Telecomm Services with Utilities in small caps, but rate the group Underweight in large caps. Telecomm Services Underweight in Large Caps Given its very low weighting, we combine the group with Utilities in small caps. As for large caps, we are Underweight the group for the following reasons: Valuations are stretched the relative forward P/E for Telecom remains near all-time highest despite coming down slightly over the past few months. Telecom typically lags in cyclical recoveries, and has little foreign sales exposure. The earnings revision ratio has been deteriorating for Telecom since late last year. Risk-reward is the most unfavorable for Telecom of all ten GICS sectors it has the lowest historical average returns but highest probability of loss. Telecom is the highest dividend yielding sector in the S&P 500, but has little room to raise dividends given its high payout ratio. Telecom has the lowest proportion of high quality stocks of all ten sectors. Chart 15: Worst risk-reward: Telecom has the lowest avg. 12mth returns but the highest probability of loss of all ten sectors 15% Average 12-month return 13% 11% 9% 7% 5% Cons. Staples Tech Health Care Industrials Cons. Disc. Energy Financials Materials Utilities Telecom 3% 20% 25% 30% 35% 40% Probability of Loss (% of negative 12-mth returns) Note: Based on data from Feb to Dec. 2012, except from Telecom which is based on data since December 1995 Source: BofA ML US Equity & Quant Strategy 12

13 26 February 2013 Valuation data: Small caps vs. large caps Table 7: Absolute valuations for large caps Price to Book Price to Operating Cash Flow Forward P/E (Consensus) Sector Current Average Implied upside Current Average Implied upside Current Average Implied upside Consumer Discretionary % % % Consumer Staples % % % Energy % % % Financials % N/A N/A N/A % Health Care % % % Industrials % % % Information Technology % % % Materials % % % Telecommunication Services % % % Utilities % % % Source: FactSet Research Systems/Compustat; I/B/E/S BofA Merrill Lynch US Equity & US Quant Strategy Table 8: Absolute valuations for small caps Price to Book Price to Cash Flow Forward P/E (Consensus) Sector Current Average Implied upside Current Average Implied upside Current Average Implied upside Consumer Discretionary % % % Consumer Staples % % % Energy % % % Financials % % % Health Care % % % Industrials % % % Information Technology % % % Materials % % % Utilities % % % Source: FactSet Research Systems; Thomson Financial; BofA Merrill Lynch Small Cap Research Table 9: Relative valuations for large caps Price to Book Price to Operating Cash Flow Forward P/E (Consensus) Sector Current Average Implied upside Current Average Implied upside Current Average Implied upside Consumer Discretionary % % % Consumer Staples % % % Energy % % % Financials % N/A N/A N/A % Health Care % % % Industrials % % % Information Technology % % % Materials % % % Telecommunication Services % % % Utilities % % % Source: FactSet Research Systems/Compustat; I/B/E/S BofA Merrill Lynch US Equity & US Quant Strategy Table 10: Relative valuations for small caps Price to Book Price to Cash Flow Forward P/E (Consensus) Sector Current Average Implied upside Current Average Implied upside Current Average Implied upside Consumer Discretionary % % % Consumer Staples % % % Energy % % % Financials % % % Health Care % % % Industrials % % % Information Technology % % % Materials % % % Utilities % % % Note: Trailing and forward P/E are based on Thomson estimates. Source: FactSet Research Systems; Thomson Financial; BofA Merrill Lynch Small Cap Research 13

14 26 February 2013 Characteristics: Large vs. small Table 11: Characteristics by sector for large caps and small caps 2013 EPS Growth 2013 Sales Growth Long-Term Earnings Growth Dividend Yield Return On Equity Debt To Capital Sector Large Caps Small Caps Large Caps Small Caps Large Caps Small Caps Large Caps Small Caps Large Caps Small Caps Large Caps Small Caps Consumer Discretionary Consumer Staples Energy Financials Health Care Industrials Information Technology Materials Telecom Utilities Benchmark Source: FactSet Research Systems; Thomson Financial; BofA Merrill Lynch Small Cap Research Table 12: Foreign exposure by sector for large caps and small caps Foreign Sales GICS Sector/Index Large Caps Small Caps Consumer Discretionary Consumer Staples Energy Financials Health Care Industrials Information Technology Materials Telecom Utilities Benchmark Source: FactSet Research Systems; BofA Merrill Lynch Research Small Cap Research Link to Definitions Macro Click here for definitions of commonly used terms. 14

15 26 February 2013 Important Disclosures FUNDAMENTAL EQUITY OPINION KEY: Opinions include a Volatility Risk Rating, an Investment Rating and an Income Rating. VOLATILITY RISK RATINGS, indicators of potential price fluctuation, are: A - Low, B - Medium and C - High. INVESTMENT RATINGS reflect the analyst s assessment of a stock s: (i) absolute total return potential and (ii) attractiveness for investment relative to other stocks within its Coverage Cluster (defined below). There are three investment ratings: 1 - Buy stocks are expected to have a total return of at least 10% and are the most attractive stocks in the coverage cluster; 2 - Neutral stocks are expected to remain flat or increase in value and are less attractive than Buy rated stocks and 3 - Underperform stocks are the least attractive stocks in a coverage cluster. Analysts assign investment ratings considering, among other things, the 0-12 month total return expectation for a stock and the firm s guidelines for ratings dispersions (shown in the table below). The current price objective for a stock should be referenced to better understand the total return expectation at any given time. The price objective reflects the analyst s view of the potential price appreciation (depreciation). Investment rating Total return expectation (within 12-month period of date of initial rating) Ratings dispersion guidelines for coverage cluster* Buy 10% 70% Neutral 0% 30% Underperform N/A 20% * Ratings dispersions may vary from time to time where BofA Merrill Lynch Research believes it better reflects the investment prospects of stocks in a Coverage Cluster. INCOME RATINGS, indicators of potential cash dividends, are: 7 - same/higher (dividend considered to be secure), 8 - same/lower (dividend not considered to be secure) and 9 - pays no cash dividend. Coverage Cluster is comprised of stocks covered by a single analyst or two or more analysts sharing a common industry, sector, region or other classification(s). A stock s coverage cluster is included in the most recent BofA Merrill Lynch Comment referencing the stock. BofA Merrill Lynch Research personnel (including the analyst(s) responsible for this report) receive compensation based upon, among other factors, the overall profitability of Bank of America Corporation, including profits derived from investment banking revenues. Other Important Disclosures Officers of MLPF&S or one or more of its affiliates (other than research analysts) may have a financial interest in securities of the issuer(s) or in related investments. BofA Merrill Lynch Global Research policies relating to conflicts of interest are described at "BofA Merrill Lynch" includes Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S") and its affiliates. Investors should contact their BofA Merrill Lynch representative or Merrill Lynch Global Wealth Management financial advisor if they have questions concerning this report. "BofA Merrill Lynch" and "Merrill Lynch" are each global brands for BofA Merrill Lynch Global Research. Information relating to Non-US affiliates of BofA Merrill Lynch and Distribution of Affiliate Research Reports: MLPF&S distributes, or may in the future distribute, research reports of the following non-us affiliates in the US (short name: legal name): Merrill Lynch (France): Merrill Lynch Capital Markets (France) SAS; Merrill Lynch (Frankfurt): Merrill Lynch International Bank Ltd., Frankfurt Branch; Merrill Lynch (South Africa): Merrill Lynch South Africa (Pty) Ltd.; Merrill Lynch (Milan): Merrill Lynch International Bank Limited; MLI (UK): Merrill Lynch International; Merrill Lynch (Australia): Merrill Lynch Equities (Australia) Limited; Merrill Lynch (Hong Kong): Merrill Lynch (Asia Pacific) Limited; Merrill Lynch (Singapore): Merrill Lynch (Singapore) Pte Ltd.; Merrill Lynch (Canada): Merrill Lynch Canada Inc; Merrill Lynch (Mexico): Merrill Lynch Mexico, SA de CV, Casa de Bolsa; Merrill Lynch (Argentina): Merrill Lynch Argentina SA; Merrill Lynch (Japan): Merrill Lynch Japan Securities Co., Ltd.; Merrill Lynch (Seoul): Merrill Lynch International Incorporated (Seoul Branch); Merrill Lynch (Taiwan): Merrill Lynch Securities (Taiwan) Ltd.; DSP Merrill Lynch (India): DSP Merrill Lynch Limited; PT Merrill Lynch (Indonesia): PT Merrill Lynch Indonesia; Merrill Lynch (Israel): Merrill Lynch Israel Limited; Merrill Lynch (Russia): OOO Merrill Lynch Securities, Moscow; Merrill Lynch (Turkey I.B.): Merrill Lynch Yatirim Bank A.S.; Merrill Lynch (Turkey Broker): Merrill Lynch Menkul Değerler A.Ş.; Merrill Lynch (Dubai): Merrill Lynch International, Dubai Branch; MLPF&S (Zurich rep. office): MLPF&S Incorporated Zurich representative office; Merrill Lynch (Spain): Merrill Lynch Capital Markets Espana, S.A.S.V.; Merrill Lynch (Brazil): Bank of America Merrill Lynch Banco Multiplo S.A.; Merrill Lynch KSA Company, Merrill Lynch Kingdom of Saudi Arabia Company. This research report has been approved for publication and is distributed in the United Kingdom to professional clients and eligible counterparties (as each is defined in the rules of the Financial Services Authority) by Merrill Lynch International and Banc of America Securities Limited (BASL), which are authorized and regulated by the Financial Services Authority and has been approved for publication and is distributed in the United Kingdom to retail clients (as defined in the rules of the Financial Services Authority) by Merrill Lynch International Bank Limited, London Branch, which is authorized by the Central Bank of Ireland and is subject to limited regulation by the Financial Services Authority details about the extent of its regulation by the Financial Services Authority are available from it on request; has been considered and distributed in Japan by Merrill Lynch Japan Securities Co., Ltd., a registered securities dealer under the Financial Instruments and Exchange Act in Japan; is distributed in Hong Kong by Merrill Lynch (Asia Pacific) Limited, which is regulated by the Hong Kong SFC and the Hong Kong Monetary Authority; is issued and distributed in Taiwan by Merrill Lynch Securities (Taiwan) Ltd.; is issued and distributed in India by DSP Merrill Lynch Limited; and is issued and distributed in Singapore by Merrill Lynch International Bank Limited (Merchant Bank) and Merrill Lynch (Singapore) Pte Ltd. (Company Registration No. s F 06872E and D respectively) and Bank of America Singapore Limited (Merchant Bank). Merrill Lynch International Bank Limited (Merchant Bank) and Merrill Lynch (Singapore) Pte Ltd. are regulated by the Monetary Authority of Singapore. Bank of America N.A., Australian Branch (ARBN ), AFS License (BANA Australia) and Merrill Lynch Equities (Australia) Limited (ABN ), AFS License (MLEA) distributes this report in Australia only to 'Wholesale' clients as defined by s.761g of the Corporations Act With the exception of BANA Australia, neither MLEA nor any of its affiliates involved in preparing this research report is an Authorised Deposit-Taking Institution under the Banking Act 1959 nor regulated by the Australian Prudential Regulation Authority. No approval is required for publication or distribution of this report in Brazil and its local distribution is made by Bank of America Merrill Lynch Banco Múltiplo S.A. in accordance with applicable regulations. Merrill Lynch (Dubai) is authorized and regulated by the Dubai Financial Services Authority (DFSA). Research reports prepared and issued by Merrill Lynch (Dubai) are prepared and issued in accordance with the requirements of the DFSA conduct of business rules. Merrill Lynch (Frankfurt) distributes this report in Germany. Merrill Lynch (Frankfurt) is regulated by BaFin. 15

16 This research report has been prepared and issued by MLPF&S and/or one or more of its non-us affiliates. MLPF&S is the distributor of this research report in the US and accepts full responsibility for research reports of its non-us affiliates distributed to MLPF&S clients in the US. Any US person receiving this research report and wishing to effect any transaction in any security discussed in the report should do so through MLPF&S and not such foreign affiliates. General Investment Related Disclosures: This research report provides general information only. Neither the information nor any opinion expressed constitutes an offer or an invitation to make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for differences). This report is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person. Investors should seek financial advice regarding the appropriateness of investing in financial instruments and implementing investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Any decision to purchase or subscribe for securities in any offering must be based solely on existing public information on such security or the information in the prospectus or other offering document issued in connection with such offering, and not on this report. Securities and other financial instruments discussed in this report, or recommended, offered or sold by Merrill Lynch, are not insured by the Federal Deposit Insurance Corporation and are not deposits or other obligations of any insured depository institution (including, Bank of America, N.A.). Investments in general and, derivatives, in particular, involve numerous risks, including, among others, market risk, counterparty default risk and liquidity risk. No security, financial instrument or derivative is suitable for all investors. In some cases, securities and other financial instruments may be difficult to value or sell and reliable information about the value or risks related to the security or financial instrument may be difficult to obtain. Investors should note that income from such securities and other financial instruments, if any, may fluctuate and that price or value of such securities and instruments may rise or fall and, in some cases, investors may lose their entire principal investment. Past performance is not necessarily a guide to future performance. Levels and basis for taxation may change. This report may contain a short-term trading idea or recommendation, which highlights a specific near-term catalyst or event impacting the company or the market that is anticipated to have a short-term price impact on the equity securities of the company. Short-term trading ideas and recommendations are different from and do not affect a stock's fundamental equity rating, which reflects both a longer term total return expectation and attractiveness for investment relative to other stocks within its Coverage Cluster. Short-term trading ideas and recommendations may be more or less positive than a stock's fundamental equity rating. BofA Merrill Lynch is aware that the implementation of the ideas expressed in this report may depend upon an investor's ability to "short" securities or other financial instruments and that such action may be limited by regulations prohibiting or restricting "shortselling" in many jurisdictions. Investors are urged to seek advice regarding the applicability of such regulations prior to executing any short idea contained in this report. Foreign currency rates of exchange may adversely affect the value, price or income of any security or financial instrument mentioned in this report. Investors in such securities and instruments, including ADRs, effectively assume currency risk. UK Readers: The protections provided by the U.K. regulatory regime, including the Financial Services Scheme, do not apply in general to business coordinated by BofA Merrill Lynch entities located outside of the United Kingdom. BofA Merrill Lynch Global Research policies relating to conflicts of interest are described at Officers of MLPF&S or one or more of its affiliates (other than research analysts) may have a financial interest in securities of the issuer(s) or in related investments. MLPF&S or one of its affiliates is a regular issuer of traded financial instruments linked to securities that may have been recommended in this report. MLPF&S or one of its affiliates may, at any time, hold a trading position (long or short) in the securities and financial instruments discussed in this report. BofA Merrill Lynch, through business units other than BofA Merrill Lynch Global Research, may have issued and may in the future issue trading ideas or recommendations that are inconsistent with, and reach different conclusions from, the information presented in this report. Such ideas or recommendations reflect the different time frames, assumptions, views and analytical methods of the persons who prepared them, and BofA Merrill Lynch is under no obligation to ensure that such other trading ideas or recommendations are brought to the attention of any recipient of this report. In the event that the recipient received this report pursuant to a contract between the recipient and MLPF&S for the provision of research services for a separate fee, and in connection therewith MLPF&S may be deemed to be acting as an investment adviser, such status relates, if at all, solely to the person with whom MLPF&S has contracted directly and does not extend beyond the delivery of this report (unless otherwise agreed specifically in writing by MLPF&S). MLPF&S is and continues to act solely as a broker-dealer in connection with the execution of any transactions, including transactions in any securities mentioned in this report. Copyright and General Information regarding Research Reports: Copyright 2013 Merrill Lynch, Pierce, Fenner & Smith Incorporated. All rights reserved. iqmethod, iqmethod 2.0, iqprofile, iqtoolkit, iqworks are service marks of Merrill Lynch & Co., Inc. iqanalytics, iqcustom, iqdatabase are registered service marks of Merrill Lynch & Co., Inc. This research report is prepared for the use of BofA Merrill Lynch clients and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of BofA Merrill Lynch. BofA Merrill Lynch Global Research reports are distributed simultaneously to internal and client websites and other portals by BofA Merrill Lynch and are not publicly-available materials. Any unauthorized use or disclosure is prohibited. Receipt and review of this research report constitutes your agreement not to redistribute, retransmit, or disclose to others the contents, opinions, conclusion, or information contained in this report (including any investment recommendations, estimates or price targets) without first obtaining expressed permission from an authorized officer of BofA Merrill Lynch. Materials prepared by BofA Merrill Lynch Global Research personnel are based on public information. Facts and views presented in this material have not been reviewed by, and may not reflect information known to, professionals in other business areas of BofA Merrill Lynch, including investment banking personnel. BofA Merrill Lynch has established information barriers between BofA Merrill Lynch Global Research and certain business groups. As a result, BofA Merrill Lynch does not disclose certain client relationships with, or compensation received from, such companies in research reports. To the extent this report discusses any legal proceeding or issues, it has not been prepared as nor is it intended to express any legal conclusion, opinion or advice. Investors should consult their own legal advisers as to issues of law relating to the subject matter of this report. BofA Merrill Lynch Global Research personnel s knowledge of legal proceedings in which any BofA Merrill Lynch entity and/or its directors, officers and employees may be plaintiffs, defendants, co-defendants or co-plaintiffs with or involving companies mentioned in this report is based on public information. Facts and views presented in this material that relate to any such proceedings have not been reviewed by, discussed with, and may not reflect information known to, professionals in other business areas of BofA Merrill Lynch in connection with the legal proceedings or matters relevant to such proceedings. This report has been prepared independently of any issuer of securities mentioned herein and not in connection with any proposed offering of securities or as agent of any issuer of any securities. None of MLPF&S, any of its affiliates or their research analysts has any authority whatsoever to make any representation or warranty on behalf of the issuer(s). BofA Merrill Lynch Global Research policy prohibits research personnel from disclosing a recommendation, investment rating, or investment thesis for review by an issuer prior to the publication of a research report containing such rating, recommendation or investment thesis. Any information relating to the tax status of financial instruments discussed herein is not intended to provide tax advice or to be used by anyone to provide tax advice. Investors are urged to seek tax advice based on their particular circumstances from an independent tax professional. The information herein (other than disclosure information relating to BofA Merrill Lynch and its affiliates) was obtained from various sources and we do not guarantee its accuracy. This report may contain links to third-party websites. BofA Merrill Lynch is not responsible for the content of any third-party website or any linked content contained in a third-party website. Content contained on such third-party websites is not part of this report and is not incorporated by reference into this report. The inclusion of a link in this report does not imply any endorsement by or any affiliation with BofA Merrill Lynch. Access to any third-party website is at your own risk, and you should always review the terms and privacy policies at third-party websites before submitting any personal information to them. BofA Merrill Lynch is not responsible for such terms and privacy policies and expressly disclaims any liability for them. 16

17 Certain outstanding reports may contain discussions and/or investment opinions relating to securities, financial instruments and/or issuers that are no longer current. Always refer to the most recent research report relating to a company or issuer prior to making an investment decision. In some cases, a company or issuer may be classified as Restricted or may be Under Review or Extended Review. In each case, investors should consider any investment opinion relating to such company or issuer (or its security and/or financial instruments) to be suspended or withdrawn and should not rely on the analyses and investment opinion(s) pertaining to such issuer (or its securities and/or financial instruments) nor should the analyses or opinion(s) be considered a solicitation of any kind. Sales persons and financial advisors affiliated with MLPF&S or any of its affiliates may not solicit purchases of securities or financial instruments that are Restricted or Under Review and may only solicit securities under Extended Review in accordance with firm policies. Neither BofA Merrill Lynch nor any officer or employee of BofA Merrill Lynch accepts any liability whatsoever for any direct, indirect or consequential damages or losses arising from any use of this report or its contents. 17