Size segment matters when it comes to sector allocation

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 14. 11251663

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 2013. 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

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 2009. 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 5.1 4.6 4.1 3.6 3.1 2.6 2.1 1.6 1.1 0.6 0.1 Consumer Discretionary Three-Month Mov ing Av erage Rev ision Ratio Small Caps Jobless claims (inverted) 0 100 200 300 400 500 600 700 450 375 300 225 150 75 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-12 00 01 02 03 04 05 06 07 08 09 10 11 12 13 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

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 2013. 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 2013. 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 1979 42.8 27.6-10.6 1980 38.6 33.4-3.7 1982 24.9 52.5 22.1 1983 29.1 44.4 11.9 1985 31.0 52.9 16.7 1988 24.9 36.2 9.0 1991 46.0 27.2-12.9 1995 28.4 18.1-8.1 1997 22.4 41.7 15.8 1999 21.3-21.5-35.3 2003 47.3 28.2-12.9 2009 27.2 20.1-5.6 2010 26.8 17.3-7.6 Average 31.6 29.1-1.6 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. 1981 to Dec. 2012, except from Telecom which is based on data since Dec. 1995 Source: Compustat, I/B/E/S, BofA Merrill Lynch US Equity & US Quant Strategy 4

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% 150 30.5 130 110 90 70 50 Correlation=0.94 25.5 20.5 15.5 10.5 40% 20% 30 10 Jan-86 Jan-90 Jan-94 Jan-98 Jan-02 Jan-06 Jan-10 Source: FactSet Research Systems; BofA Merrill Lynch Small Cap Research 5.5 0.5 0% 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

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. 2013 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= -0.81 120 100 80 60 40 20 0 Jan-79 Jan-82 Jan-85 Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06 Jan-09 Jan-12 15.0 13.0 11.0 9.0 7.0 5.0 3.0 1.0 1.2x 1.1x 1.0x 0.9x 0.8x 0.7x 0.6x 0.5x 86 88 90 92 94 96 98 00 02 04 06 08 10 12 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

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 21 19.3 175 11.2 Consumer Staples 3 2.8 45 2.9 Energy 4 3.7 67 4.3 Financials 20 18.3 430 27.5 Health Care 21 19.3 214 13.7 Industrials 9 8.3 162 10.4 Information Technology 25 22.9 357 22.9 Materials 2 1.8 34 2.2 Telecommunication Services 2 1.8 41 2.6 Utilities 2 1.8 37 2.4 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 109 100 1,562 100 ** Historical average is based on data going back to 1994. Source: Mergerstat; FactSet Research Systems; BofA Merrill Lynch Small Cap Research Source: BofA Merrill Lynch US Equity & US Quant Strategy 7

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 200.00 150.00 100.00 50.00 0.00-50.00-100.00 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 80 60 40 20 0-20 -40-60 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 500 62% 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

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 1996 60 Percentage of Tech companies Pay ing Div idends Buy ing Back Stock 2.2x 2.0x 50 1.8x 40 1.6x 30 1.4x 20 10 0 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-12 1.2x 1.0x 0.8x 86 88 90 92 94 96 98 00 02 04 06 08 10 12 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

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) 7.7 2.1 Correlation= 0.82 6.7 1.9 1.7 5.7 1.5 4.7 1.3 3.7 1.1 2.7 0.9 1.7 0.7 0.7 0.5 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 16 14 12 10 8 6 Technology Energy Consumer Discretionary Industrials Materials 1.0 1.1 1.2 1.3 1.4 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

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 1979 42.8 26.0-11.7 1980 38.6 16.4-16.0 1982 24.9 29.2 3.4 1983 29.1 26.8-1.8 1985 31.0 44.3 10.1 1988 24.9 29.8 3.9 1991 46.0 28.4-12.1 1995 28.4 23.4-3.9 1997 22.4 35.3 10.5 1999 21.3 38.5 14.3 2003 47.3 33.0-9.7 2009 27.2 10.2-13.4 2010 26.8 15.2-9.1 Average 31.6 27.4-2.7 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 86 88 90 92 94 96 98 00 02 04 06 08 10 12 Utilities Relativ e Fw d. P/E Source: FactSet/I/B/E/S, BofA Merrill Lynch US Equity & US Quant Strategy Av erage 11

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. 1981 to Dec. 2012, except from Telecom which is based on data since December 1995 Source: BofA ML US Equity & Quant Strategy 12

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 3.79 2.73-28% 11.55 9.05-22% 15.88 16.26 2% Consumer Staples 3.98 5.04 26% 12.94 13.07 1% 15.54 16.51 6% Energy 1.92 2.62 36% 7.18 7.88 10% 11.95 14.89 25% Financials 1.11 1.90 70% N/A N/A N/A 12.06 11.51-5% Health Care 2.79 5.27 89% 11.85 17.91 51% 13.24 17.25 30% Industrials 2.88 2.96 3% 10.44 10.01-4% 13.77 15.19 10% Information Technology 3.32 4.16 25% 10.11 15.24 51% 12.08 19.39 60% Materials 2.66 2.37-11% 10.71 8.91-17% 13.37 14.79 11% Telecommunication Services 2.23 2.63 18% 4.77 6.79 42% 17.22 15.65-9% Utilities 1.54 1.65 8% 6.28 6.42 2% 14.85 12.53-16% 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 2.3 2.1-8% 9.2 10.1 10% 16.2 15.2-6% Consumer Staples 2.3 2.0-12% 11.7 9.9-16% 17.8 15.8-11% Energy 1.8 2.0 12% 8.1 8.2 1% 16.9 16.6-2% Financials 1.2 1.5 32% 8.6 10.1 17% 13.3 12.9-3% Health Care 2.8 2.9 4% 11.5 15.3 33% 16.2 18.9 17% Industrials 2.2 2.0-7% 11.5 10.4-10% 15.7 15.6-1% Information Technology 2.5 2.7 6% 12.3 16.5 34% 16.6 19.7 19% Materials 2.0 1.8-9% 9.1 8.9-2% 15.7 14.1-10% Utilities 1.6 1.6 3% 6.1 7.0 15% 16.2 14.1-13% 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 1.66 0.99-41% 1.19 0.90-24% 1.19 1.08-10% Consumer Staples 1.75 1.75 0% 1.33 1.30-2% 1.17 1.11-5% Energy 0.84 0.91 8% 0.74 0.76 4% 0.90 1.00 11% Financials 0.49 0.65 32% N/A N/A N/A 0.91 0.77-15% Health Care 1.22 1.82 48% 1.22 1.74 43% 0.99 1.14 14% Industrials 1.26 1.04-18% 1.07 0.99-8% 1.03 1.01-2% Information Technology 1.46 1.37-6% 1.04 1.39 34% 0.91 1.23 36% Materials 1.16 0.87-25% 1.10 0.89-19% 1.00 0.99-1% Telecommunication Services 0.98 0.92-6% 0.49 0.66 34% 1.29 1.04-19% Utilities 0.67 0.60-10% 0.64 0.64 0% 1.12 0.85-23% 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 1.1 1.0-8% 0.9 0.9 5% 1.0 1.0-4% Consumer Staples 1.1 1.0-11% 1.2 0.9-19% 1.1 1.0-9% Energy 0.9 1.0 12% 0.8 0.8-3% 1.1 1.1 2% Financials 0.6 0.8 32% 0.8 0.9 11% 0.8 0.8-1% Health Care 1.4 1.4 5% 1.1 1.4 28% 1.0 1.2 20% Industrials 1.1 1.0-7% 1.1 1.0-14% 1.0 1.0 2% Information Technology 1.3 1.3 5% 1.2 1.5 27% 1.1 1.3 22% Materials 1.0 0.9-8% 0.9 0.8-5% 1.0 0.9-7% Utilities 0.8 0.8 5% 0.6 0.7 11% 1.0 0.9-10% Note: Trailing and forward P/E are based on Thomson estimates. Source: FactSet Research Systems; Thomson Financial; BofA Merrill Lynch Small Cap Research 13

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 11.5 22.1 5.8 7.6 15.2 15.0 1.6 0.9 20.5 13.5 22.5 35.9 Consumer Staples 9.0 11.4 4.7 5.3 8.7 14.8 2.8 1.1 23.8 10.9 21.6 38.3 Energy 4.5 46.9-2.2 8.5 7.4 11.0 2.1 0.6 16.6 6.0 24.7 38.6 Financials 14.3 14.1 0.0 5.8 10.7 8.5 1.8 3.1 8.9 8.1 143.3 30.0 Health Care 0.1 12.6 3.6 9.7 8.3 15.6 2.0 0.2 21.7 10.0 21.6 25.4 Industrials 8.5 19.3 3.8 6.5 11.2 15.0 2.4 0.9 20.7 12.4 51.9 29.7 Information Technology 6.2 21.2 6.5 7.4 11.8 15.0 1.7 0.4 27.4 9.6 8.7 12.6 Materials 18.1 39.6 4.4 6.1 7.6 14.0 2.6 0.8 18.2 10.9 27.4 33.0 Telecom 23.4 2.3 8.3 4.7 10.4 49.9 Utilities 0.1 6.4 11.8 3.4 3.5 5.0 4.2 3.5 11.2 9.2 92.9 47.6 Benchmark 8.2 19.4 3.3 7.0 10.2 13.5 2.2 1.3 16.7 10.0 46.8 28.7 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 25.7 17.1 Consumer Staples 29.5 16.4 Energy 46.7 23.0 Financials 21.0 6.4 Health Care 21.2 9.5 Industrials 39.7 21.3 Information Technology 58.2 39.4 Materials 48.5 31.4 Telecom 0.3 - Utilities 6.3 5.3 Benchmark 32.8 19.9 Source: FactSet Research Systems; BofA Merrill Lynch Research Small Cap Research Link to Definitions Macro Click here for definitions of commonly used terms. 14

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. 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