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the margin outlook into 2017-18, given Capex to depreciation for the Market Ex-
Financials in 2015 hit its lowest level since 2003 and had been declining for 3-years.
Finally, we note that FX may provide a modest tailwind to European EPS again in 2017.
Our FX team's $/€ forecasts trough at $1.02 in mid-2017, implying a rate of
depreciation for the euro that peaks at 10%.

Chart 31: Stronger dollar would be a tailwind for EPS
YoY change in $/€ actual and implied by BofAML FX forecasts
[Graph showing currency fluctuations]
$/€ 3m avg YoY
---- 3m YoY (at BAML forecast)
01/01 01/03 01/05 01/07 01/09 01/11 01/13 01/15 01/17
Source: BofA Merrill Lynch Global Research, Datastream

Chart 32: Change in consensus EPS (%) vs annual market returns:
downgrades are the norm and average -10%
[Bar chart showing data from 2000 to 2016]
EPS change Dec pre to March post
Cal year return
Source: BofA Merrill Lynch Global Research, Datastream, IBES

Consensus downgrades in our base case – but less than average
Our base case 7% EPS growth assumption is below the current bottom up consensus of
+14%. Hence, for now we don't see the prospect of a sustained upgrade cycle.
Consensus downgrades are the norm however. 2010 was the last year that consensus
forecasts started the year too low. In fact, consensus was too high in 12 of the last 17
years. Moreover, our estimate of 7% EPS growth in 2017 implies less downgrades than
usual (10% is the average). It's also worth noting that over the past 17 years annual
consensus downgrades of less than 10% have never been accompanied by negative
equity returns for the same calendar year.

Sector EPS growth prospects
Correlation analysis of sector earnings growth against global GDP suggests that Banks are
the sector that may be most sensitive to improvements in global economy. Interest rate
developments are likely the key to earnings but they in turn should reflect the nominal
growth environment. Real economic growth would also have some effect on credit volumes
and collateral valuations though, reinforcing the link from the economy to Bank earnings.

Cyclicals unsurprisingly dominate the other sectors with EPS growth geared to global
growth. Basic Resources, Chemicals, Tech and Industrials all exhibit a correlation above
70%. Some other cyclicals including Autos and Construction have been had much less
correlated EPS growth to global GDP in recent years. In part that reflects that significant
earnings volatility in the period analysed. What's notable for both groups is that
expectations already look high for both sectors. Consensus estimates also factor in a
rebound in Resources sector EPS growth – but both these sectors have seen the largest
earnings declines over the past five years. Forecasts look more restrained in Industrials,
Chemicals, Tech – implying mid to high single digit growth in the coming three years.

Among Defensives expectations look highest in Telecoms – suggesting 10% average
EPS growth in 2016-18 despite the weak trend rate for sector earnings in recent years.
Consensus forecasts imply a more modest improvement for Utilities – with just 1% EPS
CAGR for 2016-18. Staples and Healthcare are forecast to have high single digit EPS
growth in the coming 3 years, implying 2-3pp improvements in the annual growth rate
relative the trailing 5-year average for Staples and +6pp for Healthcare.

Bank of America
Merrill Lynch
European Equity Strategy | 01 December 2016 13
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