December 17, 2013

Report prepared by: Ryan Lewenza, CFA, CMT North American Equity Strategist

2014 Equity Market Outlook

Highlights

2014 Year-End Forecast

Index S&P 500 Index S&P/TSX Composite Index EPS $115.50 $875 P/E 17.0 16.3 Price 1,960 14,250

We see global growth accelerating in 2014, providing the foundation for improved earnings growth and additional equity gains next year. While strong equity returns in 2013 have been driven by an expansion of valuation multiples, we believe the key factor to market performance in 2014 will be earnings growth. We estimate 2014 earnings to grow 7% to US$115.50 for the S&P 500 Index (S&P 500). Applying a 17x P/E target multiple to our US$115.50 estimate equates to a 2014 year-end price target of 1,960. Adding in a 2% dividend yield, we forecast a potential 10.5% total return for 2014. We forecast S&P/TSX earnings to rise 6% next year to $875, but are well below the consensus estimate of $956. Combining our $875 earnings estimate with a projected 16.3x P/E, we arrive at a 2014 year-end price target of 14,250 for the S&P/TSX. Adding in an estimated 3% dividend yield, we estimate a total return of 9% in 2014. The technical profile for the S&P 500 remains bullish longer term, but we see the potential for weakness in Q1/14, as the U.S. Federal Reserve (Fed) could begin to taper its asset purchases. The S&P/TSX has improved of late, but we expect it will underperform the S&P 500 again in 2014. We recommend a cyclical bias in equity portfolios based on expectations for improving economic growth. This includes an overweight in the industrials, financials, and information technology sectors. Among the defensive sectors we recommend an overweight in the U.S. health care sector, as it is well positioned for U.S. demographic trends and Obamacare. Given our expectations for interest rates to rise next year, we recommend an underweight in the interest-sensitive utilities and telecommunications sectors, along with the REIT industry. We remain underweight the materials sector, as the outlook for commodity prices remains lackluster, with Chinas GDP growth likely to moderate to around 7% in the coming years.

Sector Recommendations
Sector Financials Consumer Discretionary Industrials Information Technology Energy Materials Health Care Consumer Staples Utilities Telecom Services U.S. Over Under Over Over Market Under Over Market Under Under Canada Over Market Over Over Market Under Market Market Under Under Preference U.S. Canada U.S. U.S. Canada Canada U.S. Canada Canada Canada

Source: Portfolio Advice & Investment Research Over=Overweight Under=Underweight Market=Marketweight

This Document is for distribution to Canadian clients only. Please refer to Appendix A of this report for important disclosure information.

North American Equity Strategy

December 17, 2013

2014 Equity Market Outlook

As we prepare to close the books on 2013, many investors are hoping for a repeat performance in 2014. The S&P 500 and Dow Jones Industrials Average (DJIA) hit new all-time highs, up 26.8% and 20.1%, respectively, on a price return basis, as of December 13, 2013 (Exhibit 1). The S&P/TSX lagged the U.S. markets this year but was still up a respectable 7.1% year-todate, with most of the gains coming in Q4/13. We believe the strong performance in 2013 can be attributed to two interconnected factors: the liquidity driven by the Fed s stimulus program and an expansion of equity valuations. We believe 2014 could prove to be an inflection year for the equity markets with the Fed likely to begin tapering its asset purchases in Q1/14, and therefore the U.S. economy and stock market having to be supported by its own fundamentals, rather than the aid of intense Fed stimulus. The key question for 2014 is whether the economic recovery will finally be self-sustaining. Exhibit 1: Q4/13 Price Returns
Indices Q4 Return YTD Return

S&P 500 Dow Jones Industrials Small Cap (Russell 2000) Growth (Russell 1000) Value (Russell 1000) S&P/TSX Composite S&P/TSX Small Cap
YTD Sector Performance

7.5% 4.0% 5.2% 7.2% 7.2% 4.1% 3.0%

U.S. (S&P 500)

26.8% 20.1% 33.0% 27.9% 26.8% 7.1% 1.4%

Canada (S&P/TSX)

Financials Consumer Discretionary Industrials Information Technology Energy Materials Health Care Consumer Staples Utilities Telecom Services

28.2% 35.1% 30.3% 20.4% 17.4% 15.8% 34.1% 20.3% 6.6% 3.6%

17.0% 34.6% 32.1% 25.6% 6.8% -34.1% 30.3% 18.9% -10.6% 5.3%

Source: Baseline. As of December 13, 2013

On a sector basis, the S&P 500 cyclical sectors have outperformed year-to-date with consumer discretionary (35.1%), industrials (30.3%), financials (28.2%) and information technology (20.3%) leading the way. The defensive health care sector has also performed well year-to-date, up 34.1%, as of December 13, 2013. The interest-sensitive utilities and telecommunications services sector have lagged and are up 6.6% and 3.6%, respectively. In Canada, it has been a similar experience with the consumer discretionary (34.6%), industrials (32.1%), health care (30.3%) and information technology (25.6%) sectors outperforming. Materials and utilities were the big laggards year-to-date, down 34.1% and 10.6%, respectively. Washington in the First Half, Corporate Earnings in the Second We believe decisions made in Washington could have a significant impact on the U.S. economy and stock market in H1/14. The first of a number of important announcements was made last week when Congress agreed to pass its first budget since 1986. The two parties agreed to a deal that: 1) would reduce the planned sequestration spending cuts by US$63 billion; 2) increase discretionary spending modestly; and 3) reduce the deficit by US$23 billion as a result of savings and planned spending cuts in other areas. Congress still needs to increase the debt limit in February 2014, but last weeks budget deal is a significant step forward that ends the political brinkmanship for now, and provides a clear roadmap for government spending and taxes over the next two years. The ongoing stalemate in Congress has been crimping growth and confidence, and undermining the countrys recovery, in our opinion. This budget agreement should help alleviate this. The second major policy announcement could come in Q1/14, when the Fed is likely to announce a tapering of it asset purchases (i.e., Quantitative Easing (QE)). Exhibit 2 illustrates the high correlation (0.93) between the Feds expanding balance sheet and the trajectory of the S&P 500 . With the U.S. economy improving, we believe the Fed, soon to be chaired by Janet Yellen, will begin to moderate its asset purchases. When this occurs we expect shortterm volatility in the stock market, but it should prove to be transitory as we see corporate earnings improving in 2014, helping to drive share prices higher. Exhibit 2: Budget Deal Is a Start in Addressing Deficits and Debt; S&P 500 Correlates with Fed Balance Sheet
(in trillions)

U.S. Fiscal Status

%
4
2 0 -2
2000

$18
$16 $14

S&P 500 And Federal Reserve Balance Sheet

1800
1600 1400 QE2 Operation Twist & QE3

(in millions)

$4,500,000

QE1

$4,000,000 $3,500,000 $3,000,000

$12
$10 $8

-4
-6 -8
U.S. Budget To GDP (RHS) U.S. Total Government Public Debt (LHS)

1200 1000
S&P 500 (LHS)

$6
$4 $2

$2,500,000
$2,000,000
Federal Reserve Banks Total Assets (RHS)

-10

800
600 Jan-09

r = 0.93
Jan-10 Jan-11 Jan-12

$0
'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13
Source: Bloomberg Finance L.P. As of December 5, 2013

-12

$1,500,000

Jan-13

Source: Bloomberg Finance L.P. As of December 13, 2013

Page 2

North American Equity Strategy

December 17, 2013

Economic Update Our investment strategy framework always begins with our outlook for economic growth. On that front, we see global growth accelerating in 2014, providing the foundation for improved earnings growth and additional equity gains next year. TD Economics is forecasting global growth to reaccelerate from 2.9% in 2013, to 3.5% in 2014, on the back of improved growth in developed markets (Exhibit 3). The euro zone, which emerged from its recession in Q2/13, is expected to grow 1% in 2014. The Japanese economy, boosted by aggressive fiscal and monetary policies is forecast to grow 1.4%. In the U.S., we believe growth is set to reaccelerate following a challenging 2013. TD Economics is forecasting growth to increase to 2.7% in 2014, from 1.7% in 2013. Central to our view of stronger U.S. growth is the expectation for some of the headwinds present in 2013 to recede in 2014, while many tailwinds present this year continue in 2014. In particular, the fiscal drag (i.e., tax increases and spending cuts), is expected to be cut in half in 2014, from an estimated 1.5% in 2013 to 0.8% in 2014. In our opinion, this as a significant positive for 2014. Exhibit 3: Global Growth Set to Reaccelerate in 2014; U.S. Growth to Improve on Less Fiscal Drag
%
4.0 3.5 3.0 2.5 2.0 1.5
1.7 1.7
2.9 3.4 2.7 2.3

GDP Forecasts 2014

%
3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0

U.S. Fiscal Stimulus/Drag

2.2 1.4
Fiscal drag is expected to be cut in half next year, which should result in higher U.S. econommic growth.

1.0
0.5 0.0 2013 2014 2013 2014 2013 2014

-0.4

-0.3

-0.3

-0.7
-1.5 2013

-0.8 2014 2015

Global

U.S.

Canada

2008

2009

2010

2011

2012

Source: TD Econonics. As of December 6, 2013

Source: TD Economics. As of December 2, 2013

There has been a marked improvement in the U.S. manufacturing sector and labour market. The ISM Manufacturing index rose to 57.3 in November (Exhibit 4), which is well above the key 50 expansion/contraction level and stands at its highest level since April 2011. The subcomponents of the ISM report were strong, with new orders hitting 63.6 in November and the spread between new orders and inventories widening, which should support continued strong manufacturing activity in the coming months. Following a period of weakness during the Spring, the U.S, labour market has also improved. Monthly nonfarm payrolls have averaged 204,000 over the last four months, and 189,000 year-to-date. As a result, the unemployment rate declined from 7.9% in January to 7% in November. While the decline in the unemployment rate can in part be attributed to a lower U.S. participation rate (down to 63% from 66% in 2009), the monthly job gains have played a meaningful role in the decline. We expect continued healthy job gains, which should help drive the unemployment rate down to 6.5% in 2014. Additionally, we expect continued strength in the U.S. housing market, auto sales remaining strong, capital spending improving, and the energy and manufacturing renaissance picking up speed. All told, U.S. economic growth should improve next year, and we see little evidence of a recession on the horizon. Exhibit 4: ISM and Global PMIs Grinding Higher; U.S. Labour Market Showing Improved Strength
Global PMIs Global U.S. Canada Japan U.K. Euro zone Germany France Italy China Current 53.2 57.3 53.7 55.1 58.4 52.7 54.2 47.1 51.4 51.4 >= 52 1 Month Ago 52.1 56.4 62.8 54.2 56.5 51.6 52.7 48.4 50.7 51.4 52 to 50 3 Months Ago 51.6 55.7 51.0 52.2 57.1 51.1 51.1 49.8 51.3 51.0 <= 50 6 Months Ago 50.6 49 63.1 51.5 51.5 48.8 48.6 48.4 47.3 50.8
(in thousands)

U.S. Labour Market

332
Nonfarm Payrolls (LHS)
Unemployment Rate (RHS)

(%)

350
311

8.5

300
250

271

8
247
205 219 199 153 165 138 160 238 200203 7.5

200
150
112 125 87

176172
148

175

142
89

100
50

6.5

0
Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13

Source: Bloomberg Finance L.P. As of December 5, 2013

Source: Bloomberg Finance L.P. As of December 5, 2013

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North American Equity Strategy

December 17, 2013

In Canada, TD Economics is forecasting growth to accelerate from 1.7% in 2013 to 2.4% in 2014, but lag the U.S. economy next year. They see strength being driven by consumer and business spending, along with improved exports on a lower Canadian dollar. Given our expectations for stronger global and U.S. growth, and the ISM index trending higher, we believe export growth could ramp up from the 2% rate seen in recent months (Exhibit 5). Risks to the Canadian economy remain elevated consumer debt levels and the frothy Canadian housing market. National home prices are up 30% since the trough in 2009, which equates to annual growth of over 6%. We believe the continued ascent in home prices will moderate in 2014, but unlike the U.S. experience, TD Economics does not foresee a major housing correction. Exhibit 5: Canadian Exports Look Set to Improve; Canadian Housing Gains to Moderate in 2014
Canada Domestic Exports Total Y/Y
25% 20%

Teranet-National Bank Composite Home Price Index

180 160 20% 15% 10% 5% 100

15%
10% 5% 0% -5% -10% -15% -20% -25% '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13
Source: Bloomberg Finance L.P. As of December 5, 2013

140
120

80
60 40
Y/Y % Chg (RHS) Index (LHS)

0%

-5%
-10%

'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13
Source: Bloomberg Finance L.P. As of December 5, 2013

Key Point: Although U.S. and Canadian economic growth is expected to accelerate in 2014, it should remain low from a historical perspective and below-trend for next year. The U.S. economy is expected to outperform the Canadian economy, largely due to the view that developing nations will be challenged in 2014, which is likely to provide a headwind to resource-based economies like Canada.

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North American Equity Strategy

December 17, 2013

Fundamental Update 2013s strong equity gains have been driven by multiple expansion rather than earnings growth. Going forward, we see further upside in equity prices but with earnings growth acting as the key driver in 2014. We forecast S&P 500 earnings to rise 7% Y/Y to US$115.50, which is below consensus of US$122.57 (Exhibit 6). Our US$115.50 earnings forecast assumes revenues grow at 6%, net profit margins remain unchanged at 9.5%, and company share repurchases add 1.5% to earnings growth. Consensus estimates for 2014 imply further margin expansion, with net margins increasing to 10.5%. However, with net margins already at historical highs (Q3/13 net margins were 9.75% versus long-term average of 7.8%), we believe it will be difficult to achieve further margin expansion. Looking at valuations, P/Es have expanded markedly with the S&P 500 trailing P/E increasing from 14x in December 2012 to 17x currently, which is just above its long-term average of 16.5x. We believe the crosscurrents of less Fed stimulus and improving economic growth will help to offset each other, resulting in no change to the P/E multiple by the end of 2014. Applying a 17x P/E target multiple to our US$115.50 estimate equates to a year-end price target of 1,960. Adding in a 2% dividend yield, we forecast a potential 10.5% total return for 2014. Exhibit 6: S&P 500 Earnings Rise 7% Next Year on Stronger Economic Growth; S&P 500 is Fairly Valued at 17x
$125 $120 $115 $111.30 $110 $105 $100 2013
Source: Bloomberg Finance L.P. As of December 5, 2013

S&P 500 Earnings Forecast

$122.57
Up 7% Y/Y but below consensus.

35

S&P 500 Trailing P/E

30
$115.50

25

20
15
$108.00

10 5 0
2014

Long-term Average = 16.4x

54

59

64

69

74

79

84

89

94

99

04

09

Source: Bloomberg Finance L.P. As of December 5, 2013

Our four main forecasting models show a range of potential year-end levels for the S&P 500 of 1,550 to 1,960, with the average of our four models forecasting a year-end target of 1,775 (Exhibit 7). Given our belief that the U.S. economy will improve next year and equity markets will begin to trade more on fundamentals rather than liquidity, we ascribe the most weight to our macroeconomic regression model, which is targeting 1,960 on the S&P 500 for next year. After 2013s strong advance in U.S. equity markets, some investors are pointing to the potential for mean reversion, and therefore a decline in the stock market next year. However, based on historical experience, that may not be the case. Looking back at annual returns since 1929, the average and median annual gain for the S&P 500 in years following a rise of 20% or more were 6.5% and 8.8%, respectively. Additionally, the occurrence of a positive return following a strong year was 64%, which was in-line with the probability of a positive return for all years. Based on historical experience, a strong result for the S&P 500 in 2013 does not mean investors should expect a negative return in 2014. In fact, on average, the S&P 500 has advanced 6.5% following strong years. Exhibit 7: S&P 500 Year End Target is 1,960; S&P 500 Returns Following Strong Preceding Year

S&P 500 Forecast Model Macroeconomic Regression Dividend Discount Model Normalized Earnings Price Momentum

Type Fundamental/Economic Fundamental/Valuation Fundamental/Valuation Technical Average

Year-End Target Upside 1,960 1,680 1,550 1,910 1,775 9% -7% -14% 6% -1%

Average Year Gain Following 20%+ Return on the S&P 500

10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0%
8.8% 6.5%

Average
Source: Bloomberg Finance L.P. As of December 5, 2013

Median

Source: Portfolio Advice & Investment Research. As of December 5, 2013

Page 5

North American Equity Strategy

December 17, 2013

Earnings estimates for the S&P/TSX have been steadily declining this year, largely on the back of weak results from the materials sector. The weakness in the materials sector can be attributed to moderating economic growth in the emerging markets and China. In Exhibit 8 we chart the Y/Y price changes in the CRB Commodity Index with Chinas historical GDP growth, which given the high correlation between the two, captures the influence of Chinas growth on changes in commodity prices. Given our view that Chinas economic growth is likely to downshift to a more sustainable 7% level longer term, we see this as a headwind for commodity prices, and in turn, S&P/TSX earnings. We forecast S&P/TSX earnings to rise 6% next year to $875, but are well below the consensus estimate of $956. Our below consensus estimate assumes lower revenues on the back of moderating growth from the emerging markets and lower net margin assumptions. Similar to the U.S., Canadian equity valuations have expanded in 2013, with the trailing P/E increasing from 15.7x to 17.8x currently, which is 4% below its average of 18.5x since 1994. We characterize the Canadian equity market as fairly to moderately undervalued. Combining our $875 earnings estimate with a projected 16.3x P/E, we arrive at our year-end price target of 14,250 for the S&P/TSX. Adding in an estimated 3% dividend yield, we project a total return of 9% in 2014. Exhibit 8: Commodities Correlate with China GDP Growth; S&P/TSX 2014 Earnings Forecasts
50% 40% 30% 20% 10% 0% -10% -20% -30% -40% '96 '98 '01 '04 '06 '09 '12
Source: Bloomberg Finance L.P. As of December 5, 2013
CRB Commodity Index Y/Y % Chg (LHS)

Commodity Prices & China GDP Growth

13 12 11 10 9 8 7 6

$1,000 $950 $900 $850 $800 $750

S&P/TSX Composite Earnings Forecast

$956
Up 6% Y/Y but below consensus.

$875 $845 $825

China GDP Y/Y (RHS)

5 4

2013
Source: Bloomberg Finance L.P. As of December 5, 2013

2014

Key Point: We are forecasting high single-digit returns for North American equities in 2014, with earnings growth driving most of the potential gains. We believe the Canadian equity market will continue to lag its U.S. counterpart, though not by as wide a margin as in the past two years.

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North American Equity Strategy

December 17, 2013

Technical Considerations Our investment outlook is primarily based on our fundamental work; however, we do incorporate technical analysis as an overlay. Despite the strong gains in equity markets, and some investors proclaiming a potential peak, our technical work suggests there may be further upside. The S&P 500 remains in a strong upward channel, which has been in place since the 2009 lows, and is above its rising 50-week moving average (Exhibit 9). With the S&P 500 breaking above long-term resistance and all-time highs of 1,575, we believe it could be in a new, higher trading range and possibly the early stages of a secular bull market. Secondary technical indicators also point to a strong equity market with the NYSE Advance/Decline (A/D) line trending higher, and the Dow Transports and DJIA making new highs, thus providing a Dow Theory buy signal. While the technicals remain constructive, the markets are not without potential risks. Our biggest concern is the inevitable Fed taper of asset purchases, which we believe could begin in Q1/14. We believe the Feds asset purchases have supported the equity markets advance and therefore expect some short -term weakness around the taper. Historically, the S&P 500 declined 12.5% and 16.4%, peak-to-trough, when QE1 and QE2 ended, respectively. As such, equity markets could come under pressure in H1/14, possibly declining by 5-10%, but this volatility should prove to be transitory as fundamentals continue to improve, in our opinion. Exhibit 9: S&P 500 Remains Above its Rising 50-week MA; NYSE A/D Line Continues to Trend Higher
2,000 1,800

S&P 500 Index

80000
S&P 500's technical profile is bullish longer term, but with the S&P 500 at its upper channel line and overbought, we could see a pullback in Q1/14.

Bloomberg Cumulative NYSE A/D Line

70000
60000 50000 40000

1,600 1,400 1,200

1,000 800 600 Aug-06

30000
20000 10000
S&P 500 50-week MA

NYSE A/D line continues to trend higher, confirming new price highs on U.S. equity indices.

0
Aug-09 Aug-10 Aug-11 Aug-12

Aug-07

Aug-08

-10000 Jan-09 Aug-13

Oct-09

Jul-10

Apr-11

Jan-12

Oct-12

Jul-13

Source: Bloomberg Finance L.P. As of December 5, 2013

Source: Bloomberg Finance L.P. As of December 5, 2013

Unlike the S&P 500, which has moved to all-time highs, the S&P/TSX is roughly 10% below its 2008 peak. The S&P/TSX recently broke above key resistance of 12,900 and its technical profile has improved but it does have a number of resistance levels that it will encounter as it moves higher (Exhibit 10). Comparing the S&P/TSX to the S&P 500, we note that it has underperformed the S&P 500 since 2011, which we expect to continue in 2014. Overall, we continue to prefer the U.S. equity market over the S&P/TSX given: 1) more aggressive central bank stimulus; 2) slower economic growth in China, which should provide a headwind to commodity prices and in turn, Canadas resource -heavy economy; and 3) a more constructive technical profile for the U.S. equity market Exhibit 10: S&P/TSX Breaks Above 12,900 But Faces Resistance and Continues to Underperform the S&P 500
14,500

S&P/TSX Composite Index

12 11

S&P/TSX Composite Relative to S&P 500

13,500
10

S&P/TSX outperforming the S&P 500

12,500

9 8

11,500

S&P/TSX 200-day MA
7 6

S&P/TSX underperforming the S&P 500

10,500 Jan-10

Jan-11

Jan-12

Jan-13

'04

'05

'06

'07

'08

'09

'10

'11

'12

'13

Source: Bloomberg Finance L.P. As of December 5, 2013

Source: Bloomberg Finance L.P. As of December 5, 2013

Key Point: The technical profile for the S&P 500 remains bullish longer term, but there is potential for some weakness in Q1/14, as the Fed could begin to scale back its asset purchases. We expect the 50-week MA to hold on any weakness, and would view a pullback as an opportunity to add U.S. equity exposure. The S&P/TSX has improved of late, but we anticipate it underperforming relative to the S&P 500 again in 2014. Page 7

North American Equity Strategy

December 17, 2013

Sector Positioning We recommend a cyclical bias in equity portfolios based on expectations for improving economic growth. This includes an overweight in the industrials, financials, and information technology sectors. The industrials sector, which is our preferred sector, stands to benefit from an expected increase in capital spending, and a stronger U.S. and global economy. We believe increased clarity from Washington around the deficits and debt, could improve business confidence and spur corporate managers to begin spending the significant cash balances sitting on balance sheets. Exhibit 11 illustrates the strong relationship between the Philadelphia Fed Survey of future capex spending intentions and actual capex spending. The capex spending intentions survey has increased sharply in recent months, and as a leading indicator of actual capital spending points to strong corporate investment in 2014. Our bullish stance on the information technology sector is predicated on: 1) the information technology sector outperforming in past periods of rising interest rates (Exhibit 11); 2) the sectors attractive valuation at 14.3x forward earnings; 3) the sector has the strongest balance sheets within the S&P 500; and 4) information technology is a likely beneficiary of the expected increase in capex spending in 2014. We recommend an overweight in the financials sector based on: 1) attractive valuations with the S&P 500 financials sector trading at 1.3x P/B (the S&P/TSX financials sector is fairly valued on P/B basis but attractive on P/E basis); 2) a constructive macro environment with improving labour markets and interest rates likely to rise; and 3) positive earnings outlook for the sector. Exhibit 11: Capex Set to Increase in 2014; Information Technology Outperforms in a Rising Rate Environment
40 30 20 10 0 -10 -20 -30 Mar-90
Philly Fed Future Capex Spending Intentions Advanced (LHS)

U.S. Business Capex Spending

We expect capex to pick up in 2014.

25 20 15 10 5

0 -5 -10 -15 -20 -25

-30 Feb-12

Sector Performance S&P 500 ENERGY INDEX S&P 500 MATERIALS INDEX S&P 500 INFO TECH INDEX S&P 500 CONS DISCRET IDX S&P 500 INDUSTRIALS IDX S&P 500 HEALTH CARE IDX S&P 500 CONS STAPLES IDX S&P 500 UTILITIES INDEX S&P 500 TELECOM SERV IDX S&P 500 FINANCIALS INDEX

Average Sector Return in Periods of Rising Rates -1.9% 2.0% 29.2% 3.9% 0.2% -7.2% -7.8% -18.3% -8.2% -6.4%

Rank 5 3 1 2 4 7 8 10 9 6

U.S. Real Nonresidential Fixed Investment Q/Q (RHS)

Sep-95

Mar-01

Sep-06

Source: Bloomberg Finance L.P. As of December 5, 2013

Source: Bloomberg Finance L.P., PAIR. As of December 5, 2013 Note: Periods include 10/93-11/94, 1/96-6/96, 10/98-01/00, 6/03-06/04, 6/05-6/06, 12/08-6/09

Among the defensive sectors, we recommend an overweight in the U.S. health care sector, as it is well positioned for U.S. demographic trends and Obamacare (Exhibit 12). Based on our expectations for longer-term interest rates to rise next year, we recommend an underweight in the interest-sensitive utilities and telecommunications sectors, along with the REIT industry. Although we see the potential for long-dated bond yields to move moderately higher next year, it is important to emphasize that the Fed is not expected to increase the Fed funds rate until at least 2015. We remain underweight the materials sector, as the outlook for commodity prices remains lackluster, with Chinas GDP growth likely to moderate to around 7% in the coming years. Exhibit 13 outlines our specific sector recommendations for the Canadian and U.S. equity markets. Exhibit 12: U.S. Aging Demographics; The Interest Sensitive Utilities Continue to Underperform as Rates Rise
(in millions)

Number of U.S. Persons 65+

92 79.7

100 90 80 70 60 50 40 30 20 10 0

0.16 0.15

S&P 500 Utilites Relative Performance and Interest Rates

%
0.50 1.00 1.50 2.00

56 41.4

0.14 0.13

35
25.5 16.6 3.1 4.9 9

2.50 0.12 0.11 0.1 Jan-11

S&P 500 Utilities Rel to S&P 500 U.S. Gov't 10-Year Yield (Inverted)

3.00 3.50 4.00 Jul-13

1900 1920 1940 1960 1980 2000 2011 2020 2040 2060
Source: U.S. Census Bureau. As of December 5, 2013

Jul-11

Jan-12

Jul-12

Jan-13

Source: Bloomberg Finance L.P. As of December 10, 2013

Page 8

North American Equity Strategy Exhibit 13: U.S. and Canadian Sector Recommendations
Sector U.S. (S&P 500) Stance Overweight Rationale
Stronger labour and housing markets should support loan growth Preference is for U.S. financials given more attractive valuations and frothy Canadian housing market Lofty earnings expectations for 2014 Sector is expensive at 18.3x FP/E Play on improving global growth and Capex spending Strong technical trends Preference is for U.S. industrials given higher U.S. GDP growth expectations and cheaper valuations Attractive valuations at 14.3x FP/E Strong balance sheets and cash flow Preference is for U.S. technology given greater breadth

December 17, 2013

Canada (S&P/TSX Composite) Stance Overweight Rationale

Economic conditions should support steady EPS and dividend growth Attractively valued on P/E basis (12.1x FP/E) but fairly valued on P/B (1.8x) Attractively valued at 14.7x FP/E and strong technical trends Our preference is for Canadian discretionary given more attractive valuations Play on improving global growth Strong technical trends Sector could benefit from companies putting their cash hoard to work Improving technical trends Weak China growth to provide headwinds to commodity demand Valuations are at high-end at 17.2x FP/E Preference is for Canadian energy Weak commodity prices to provide headwinds to earnings outlook Very weak relative technical trends Preference is for Canadian materials Lack of breadth and depth in sector L ofty earnings expectations for 2014 Valuations are at high-end on P/E and P/B basis Solid technicals for the sector given new price highs and strong relative strength We prefer Canadian staples sector to U.S. given better technicals and cheaper valuations Premium valuation with low earnings growth Very weak technical trends on the back of slowly rising interest rates Prefer Canadian utilities Weak relative technical trends Prefer Canadian telco's given less competition and therefore higher wireless pricing from carriers

Financials

Consumer Discretionary

Underweight

Marketweight

Industrials

Overweight

Overweight

Information Technology

Overweight

Overweight

Energy

Marketweight

Earnings are under pressure and sector is facing negative revision trends Marketweight This is offset by reasonable valuations (12.9x FP/E) and strong cash flows Weak earnings and lofty 2014 earnings estimates Very weak relative technical trends Positive long-term trends with aging population Preference is for U.S. healthcare given greater breadth and higher percentage spent on health care costs as percentage of GDP

Materials

Underweight

Underweight

Health Care

Overweight

Marketweight

Consumer Staples

Marketweight

Sector is fairly valued at 17.2x FP/E Weak technical trends on the back of slowly rising interest Marketweight rates Premium valuation with low earnings growth Very weak technical trends on the back of slowly rising interest rates

Utilities

Underweight

Underweight

The sector trades at a high 2.4x P/B and unjustified P/E premium to the market Underweight Telecom Services Very weak technical trends on the back of slowly rising interest rates Source: Portfolio Advice & Investment Research. As December 5, 2013

Underweight

Key Point: Economic momentum is expected to improve in 2014, which should provide a supportive backdrop for cyclical sectors of the equity market. Our preferred sectors are industrials, financials and information technology. Given our view that interest rates will slowly grind higher as economic momentum improves, the interest-sensitive utilities and telecommunications sectors should underperform.

Conclusion Economic growth should slowly improve next year, which should support corporate earnings growth. While strong equity returns in 2013 were driven by an expansion of valuation multiples, we believe the key factor to market performance in 2014 will be earnings growth. The inevitable Fed taper could result in market volatility, but we believe that will be transitory, with growth in the economy and earnings offsetting this headwind. Overall, we see North American equity markets having the potential to gain 9-10% in 2014. We believe the Canadian equity market will continue to lag its U.S. counterpart, though not by as wide a margin as in the past two years.

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North American Equity Strategy

December 17, 2013

Appendix A Important Disclosures

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