Bill O’Neill – Chief Investment OfficerMerrill Lynch Wealth Management, Europe, Middle East and Africa

Year Ahead 2012

Riders on the Storm:the rocky road to recovery in 2012

CIO View – key points for 2012

2

Global growth and profits weaker in 2012

Deleveraging – the contraction of debt held- to persist as key influence in developed economies

Opposing this trend will be policy loosening or stimulus- its extent and timing are crucial

Quantitative easing (money printing) will become a global phenomenon

China will have a ‘soft landing’ in 2012 – again the key development is when policy eases

• Look for portfolio diversification, focus on a strategic framework to respond to the ‘New Normal’

Equity outperformance versus corporate debt will be modest

On equities, prefer U.S. and U.K. over Japan and Europe; stress theme of yield - quality - growth

Little value in core sovereign bonds

We shall see a weaker euro into 2012 especially if ECB buys government debt

Upside on gold above $2000 p/oz.; oil price flat for first half, moving higher as demand improves

Key points

Source: Bloomberg. Data as of 30 December 2011. 3

2011 asset class performance

%

The pressing need for mature economies to contain debt burdens has taken us to the edge of a second global recession in less than 3 years

Overview

Eurozone sovereign crisis is also a banking crisis

Source: Bloomberg. Data as of November 2011. *European sovereigns average is a simple average of French and Italian government debt credit default swaps (CDS)

4

Cost of protection for European banks and sovereigns

Basis points

0

100

200

300

400

2007 2008 2009 2010 2011

European banks European sovereigns average*

Overview

-1

0

1

2

3

4

5

6

7

1987 1992 1997 2002 2007

Japan U.S. (start and end dates shown)

Source: Bloomberg. Data as of November 2011. *U.S .10-year bond yield superimposed over Japan, with a lead . U.S. data from November 2000 to November 2011 5

Japan and superimposed U.S. 10 year real bond yield, 13 years later (%)*

%

U.S. bonds following Japan’s example sofar, only this time real rates likely to remain low

2000

2011

Overview

The U.S. recovery in the ‘New Normal’ is very subdued compared to history

Source: Bureau of Economic Research, National Bureau of Economic Research, TrendMacro calculations. Data as of September 2011.

The Zarnowitz Law, looking at strength of recovery against peak-to trough fall in business cycle

20011970 1990

1960

1980

1953

1981

1973

1957

2008 - where we were

2008 - where we should have been

0%

2%

4%

6%

8%

10%

12%

14%

16%

-6%-5%-4%-3%-2%-1%0%

Loss from peak - to - trough (%)

8 quarter gain from recession trough (%)

6

8.7% difference

Economics

Reluctance of businesses to investrisks persistently higher structural unemployment

Source: Absolute Strategy Research, Bloomberg. Data as of November 2011.

U.S. average number of weeks unemployed and business investment as % of GDP

% of total

7

% of GDPThe Federal Reserve will respond to high unemployment with direct support to housing. No rate hike until at least 2014

Economics

Optimistic growth forecasts still markthe path to debt stabilisation in the eurozone

Source: Factset, Bloomberg, BofA Merrill Lynch Global Research. Data as at November 2011.

Differing expectations for real GDP growth rates in several eurozone nations in 2012

8

-4

-3

-2

-1

0

1

2

3

4

Germany Ireland Greece France Italy

Government trend growth assumptions Bank of America Merrill Lynch 2012 forecast

%

Economics

European debt deleveraging has a large banking component

Source: BofA Merrill Lynch Rates and Currency Research. Created 15 December 2011. Data as at Q1 2011, except French household (2010). *Eurozone countries = Germany, France, Italy, Spain, Greece, Portugal, Ireland, Belgium, Netherlands & Slovakia** Latest data available given lack of data from Greece, inter alia, since start of 2011.

Eurozone* and U.S. total debt to GDP as of Q1 2011**, with sectoral breakdown

9

15

3329

23

Eurozone*

Households Financial Non-financial General government

Economics

27

2821

24

U.S.

Households Financial Non-financial General government

China’s next 5-year plan to focus on supporting consumption following 2009 fiscal expansion

Source: Absolute Strategy Research. Data as of October 2011.

Chinese exports, fixed asset investment and retail sales as a percentage of GDP

%

10

Policy

Debt reduction options

Solution Explanation Examples Feasibility

11

Policy

Growth

Fiscal Adjustment and Austerity

Sovereign Default/Debt Restructuring

Currency Devaluation

Inflation

Financial Repression – measures taken by governments to force investors to hold more assets with lower returns and higher risk, than otherwise desired

Higher growth leads to lower government debt

Fiscal support weakens

South Korea High household/financial debt likely to weigh on activity

Governments adopt strict fiscal austerity

adopted alongside economic reform

Eurozone (especially periphery), U.K., not the U.S.

Unpopular with voters and correct spending/tax mix challenging

Governments write off their debts A restructure involves an adjustment

in the terms of existing debt

Default: Russia, Argentina, possibly Greece

Would lead to inability to access capital markets for funding, adverse effects on banking sector

Devaluing the currency of issue makes debt easier to repay

Hungary, Finland, Iceland U.S. QE2 (quantitative

easing)

Risk is higher inflation / social upheaval Cannot work for all but needs to happen to

G7 vs. emerging markets esp. China

A rise in domestic price level reduces the real burden of domestic denominated debt

United Kingdom Would be attempted via printing money to pay off debt – QE

2.3%

11.5%

16.8%

19.3%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

Eurozone U.S. U.K. Japan

ECB’s QE* response tiny compared to other central banks, will have to change in 2012

Source: Bank of England, Bank of Japan, European Central Bank, U.S. Federal Reserve, Bloomberg. Data as of 15 December 2011 *QE = quantitative easing

Central banks’ holdings of their nation’s government bonds, as a percentage of relevant GDP

12

% of GDP

Policy

€1 trillion more would take ECB action to same size as Fed’s response

Divergence in bond yield spreads suggests ECB already confronted with Euro disintegration

Source: Bloomberg. Data as of 24 November 2011. *arithmetic average of France, Austria, Netherlands and Finland ** arithmetic average of Spain, Italy and Portugal 13

Cash spreads of selected European 2 year bonds over Germany

Spread over Germany (basis

points)

-100

0

100

200

300

400

500

600

700

800

900

1000

1100

2005 2006 2007 2008 2009 2010 2011

Triple AAA* Peripheral ex Greece**

Potential risks

German export story vulnerableto an investment slowdown in China

Source: Bloomberg. Data as of November 2011.

German exports to China and German capital goods orders, in millions of euros

€ m

14

€ mChina should experience a soft landing next year. Lower inflation will see policy focus on growth again. The risk is that the shift in stance fails to head off a sharp slowdown in investment spending

Potential risks

Softer Chinese residential property activity maysignal weaker investment in 2012

Source: Gavekal. 3 month moving average data, as of 14 December 201115

Chinese residential investment growth and sales growth (year-on-year)

Growth rate

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

2005 2006 2007 2008 2009 2010 2011

Sales growth Investment growth

Potential risks

Higher inflation remains the key area of vulnerability for emerging economiesInflation across developed and developing economies

Source: International Monetary Fund. Data as of September 2011.16

%, year-on-year

0

3

6

9

12

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Developed economies Emerging and developing economies

Projection

Good news is that consumers’ purchasing power will be supported by easing inflation, but limited to mature economies

Potential risks

-4

-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Consumption Investment Net exports GDP growth ()%

Israeli GDP growth should be resilient in 2012, despite weakening net exports

Source: BofA ML Global Economic Research. Data as of 3 January 2012.

Israel GDP growth, decomposed into consumption, investment and net exports

17

%

Israel economics

Solid domestic consumption should cushion GDP in 2012 amid external headwinds from the eurozone

Estimates

Forecast updateNo global recession in 2012 but G5

growth sluggish and China below 9% growth

18

Source: BofA Merrill Lynch Economics Research. Data as of 1 December 2011. *G5 refers to the Group of 5, namely Eurozone, Canada, Japan, the United Kingdom and the United States .

2011 Forecast (%) 2012 Forecast (%)

Global 3.8 3.5

G5* 1.4 1.1

United States 1.8 1.9

Eurozone 1.5 -0.6

Germany 2.7 -0.5

France 1.5 -0.6

Japan -0.3 2.3

Italy 0.6 -0.7

United Kingdom 0.9 0.3

Israel 3.9 3.5

Brazil 3.1 3.4

Russia 4.0 3.6

China 9.2 8.6

India 7.0 6.8

Growth forecasts 2011-2012

Macro summary

19

We expect a worldwide slump to be avoided in 2012 but the scene is set for a fragile expansion, with U.S. growth at only 2% and emerging economies again the mainstay of the advance

A persistent failure to address the systematic issue in the Euro debt crisis - risk of default - means Europe will see a contraction in activity in 2012

The dominant policy story in 2012 will be stabilising the euro zone and a global pattern of monetary stimulus involving monetisation in the developed world

We do expect US to avoid a recession but weak recovery in business spending will limit pace of expansion

China’s GDP growth rate should bottom out at around 8% per annum. Easy money stimulus will come sooner than expected but the price will be persistent higher inflation

A weak consumer and ripples from the eurozone sovereign debt crisis should push the Bank of England into further quantitative easing (QE) - this should limit the rise in sterling through 2012

We expect the euro to weaken as ECB offers a back stop to euro bonds and U.S. consumer gains from lower inflation

Global coordinated response is crucial to re-balance the global economy, as political differences pose ongoing threats to the recovery

Risks in 2012: Positive: Rebound in business spending/ ECB support/ stronger U.S. housing/ China pro -growthNegative: Euro disintegration/ government defaults/ bank runs/ currency wars/ excess austerity

CIO View - macro summary for 2012

Household equity holdings look set to continue shrinking despite better value, earnings growth

Source: U.S. Federal Reserve, BofA Merrill Lynch Global Research. Data as of December 2011. 20

Households’ direct holdings of listed equities as a % of total financial assets

%

10

15

20

25

30

35

1987 1990 1993 1996 1999 2002 2005 2008 2011

U.S. U.K.

Investors are deeply sceptical about the recovery, worried about the risks of even greater disappointment

Strategy

More assets performing in the same way -a huge challenge for true diversification

Source: Bloomberg, HSBC. Data as of November 2011

Correlation heat maps for 2005 and 2011

21

2005 2011

Strategy

A strategic framework for navigating the ‘New Normal’

22

2012 may be characterised by low returns, high risk and a polarised environment

Source: CIO, EMEA Merrill Lynch Wealth Management

Low returns

Overpriced safe-haven assets

Risky assets suffering from uncertainty

Strategy: sector selection (high dividends, high

quality stocks)Polarised environment

Shift between “risk-on” and “risk-off” environments

Deeply divided currencies, industries and countries

/regions

Strategy: separating markets and currency management (funds of

currencies)

High risk

More frequent high volatility bubbles

Increasing correlations

Strategy: macro/CTA hedge funds

Strategy

Optimism on earnings growth fades, especially in Europe – any improvement modest in 2012

Source: Factset. Data as of November 2011.23

U.S. (S&P 500) and European (Stoxx 600) 2012 earnings per share (EPS) forecasts

$ per share

24

25

26

27

28

29

30

102

104

106

108

110

112

114

Jan-10 Jul-10 Jan-11 Jul-11 Jan-12

U.S. Europe

€ per share

Equities

Market valuation discounts a 10-20% decline in profits

Source: Factset. Data as of 17 November 2011.

12 month forward price to earnings ratio for the MSCI AC World equity market

%

24

10% reduction

in earnings

Valuation of equities and positioning reflect the multiple dangers ahead. Upside limited by level of profits’ growth slowdown

Equities

Relative to developed, emerging equity markets are at cheapest valuations since 2009

Source: Factset. Data as at 17 November 2011. * relative to the MSCI World Index

12 month forward relative price to earnings ratio for the MSCI Emerging Markets Index*

25

Ratio

Prefer U.S., U.K. equities over Japanese and European stocks

Equities

Tech, consumer staples and discretionary stand out – focus on yield, quality and growth

26

Source: BofA Merrill Lynch Global Research. Data as of November 2011. *Sector position (overweight/neutral/underweight) reflects the sector weighting of BofA-ML US Equity Strategy Research.**Price momentum ranked by 3 month change in the sector’s relative price versus the S&P500; Estimate revisions ranked by 3 month change in relative next 12 month’s consensus earnings estimates versus S&P 500; Valuation ranked by the ratio of current relative Price/Earnings ratio of the sector compared to its long-term average relative P/E. Combined rank is the equal weighted average of individual ranks.

Source: BofA Merrill Lynch Global Research. Data as of November 2011. *Sector position (overweight/neutral/underweight) reflects the sector weighting of BofA-ML US Equity Strategy Research.**Price momentum ranked by 3 month change in the sector’s relative price versus the S&P500; Estimate revisions ranked by 3 month change in relative next 12 month’s consensus earnings estimates versus S&P 500; Valuation ranked by the ratio of current relative Price/Earnings ratio of the sector compared to its long-term average relative P/E. Combined rank is the equal weighted average of individual ranks.

BofA-ML Research Position*

Combined Ranks

Price Momentum

Rank**

Estimate Revisions Ranks**

Valuations Rank**

Information Technology Overweight 9.3 9 9 10

Consumer Staples Overweight 8.0 8 10 6

Healthcare Neutral 6.7 6 5 9

Consumer Discretionary Neutral 5.3 5 8 3

Industrials Neutral 5.0 4 6 5

Utilities Neutral 5.0 10 4 1

Energy Neutral 4.3 3 2 8

Materials Underweight 4.0 2 3 7

Financials Underweight 4.0 1 7 4

Telecommunications Neutral 3.3 7 1 2

U.S. S&P 500 sector ranking model

Equities

Large-cap stocks favoured styles for next year, favouring high quality

Source: Bloomberg. Data as of 17 November 2011. *MSCI US Growth total return vs. MSCI US Value total return indices** S&P 500 total return vs. Russell 2000 total return indices, 3 month moving average

Growth versus value* relative performance and large versus small ** cap stocks in the U.S.

27

Relative Performance

Relative Performance

Growth outperforms value

Equities

In periods of decelerating profit, continue with dividend yield theme in the U.S.

Source: Factset, Bloomberg., BofA Merrill Lynch Global Research. Data as of October 2011.

Performance of dividend yield and dividend growth in different profit environments for S&P 500

28

11%

-9%

6%

-1%

-12%

-8%

-4%

0%

4%

8%

12%

Profits Decelerations Profits Accelerations

High Dividend Yield High Dividend Growth

Equities

U.S. high yield debt in favour, as long as defaults remain low

Source: Bloomberg. Data as of November 2011.

High yield price index and default rate for the U.S.

%

29

Index level

Estimates

Fixed income

Extending duration will not pay in 2012 unless deflation fears rise or Fed is aggressive with QE3*

Source: Bloomberg. Data as of 17 November 2011. *QE3 = third round of quantitative easing

U.S. Treasury real yield curves for January and November 2011

30

%

Core sovereign bonds unattractive in all scenarios other than a global recession

Fixed income

Unless there is another global recession in 2012, copper prices look unusually cheap

Source: Bloomberg. Data as of November 2011.Source: Bloomberg. Data as of November 2011.31

Ratio of gold price to copper price (average shown by dotted line)

Ratio

0.0

0.1

0.2

0.3

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

Commodities

Rebound in industrial metals in coming months, with energy prices following in second half of 2012

32Source: BofA Merrill Lynch Global Commodity Research estimates. Data as of 5 January 2012. * WTI = West Texas IntermediateSource: BofA Merrill Lynch Global Commodity Research estimates. Data as of 5 January 2012. * WTI = West Texas Intermediate

Commodity SpotJune 2012(Forecast)

December 2012(Forecast)

Brent Crude Oil ($/barrel) 113.41 104.00 116.00

WTI* Crude Oil ($/barrel) 102.64 96.00 110.00

Aluminium ($/metric tonne) 2,065 2,250 2,500

Copper ($/metric tonne) 7,540 8,000 8,500

Lead ($/metric tonne) 2,060 2,000 2,200

Nickel ($/metric tonne) 18,795 18,500 18,000

Zinc ($/metric tonne) 1,869 2,100 2,300

Gold ($/oz) 1,613 1,750 2,000

Oil, base and precious metal forecasts into 2012

Commodities

3.0

3.5

4.0

4.5

5.0

90

100

110

120

130

140

2005 2006 2007 2008 2009 2010 2011

ILS real effective exchange rate ILS per USD (right hand scale)

Although interest rates will likely fall in 2012, the shekel should remain supported by fundamentals

Source: BofA ML Global Economic Research. Data as of 3 January 2012.

Israeli shekel (ILS) per U.S. dollar (USD) exchange rate and real effective exchange rate

33

Index

Currencies - Israel

We expect modest shekel appreciation versus the U.S. dollar by end of 2012, with USD-ILS at 3.65 from around 3.85 currently.

ILS per USD

A good first six months for the dollar - renminbi appreciation to continue

3434Source: BofA Merrill Lynch Global Research. Data as of 12 December 2011Source: BofA Merrill Lynch Global Research. Data as of 12 December 2011

Currency SpotJune 2012(Forecast)

December 2012(Forecast)

EUR – USD 1.32 1.25 1.30

USD – JPY 78 73 76

EUR – GBP 0.85 0.82 0.85

GBP – USD 1.56 1.52 1.53

USD – CHF 0.93 0.99 0.97

USD – BRL 1.83 1.90 1.85

USD – RUB 31.63 32.00 30.00

USD – INR 52.84 53.00 49.00

USD – CNY 6.36 6.35 6.20

Developed majors

BRIC (Brazil, Russia, India and China) group

34

Currencies

CIO View - market outlook for 2012

35

The task of ensuring diversification across investment portfolios is complicated by a shrinking set of ‘safe havens’

We continue to stress the need for a strategic framework to deal with ‘New Normal’ (sluggish growth, higher risks), including managing for scenarios involving big losses (drawdown); volatility bubbles and constant switching between ‘risk on /risk off’

Equity outperformance relative to higher risk corporate debt will be modest

We stress yield, quality and growth in selecting equities, supporting:

Within fixed income, bias to investment grade credit, particularly the U.S., persists.

Tight control of supply and inventories limits a possible fall in the crude oil price.

Copper would benefit from China’s easing. Upside to gold price above $2,000

Risks in 2012

+ Positive: Better performance for U.S. banks, M&A pick up, recovery in U.S. housing and cyclical stocks− Negative: Profits contraction, tax raids on corporates, financial repression, protectionism

Large caps Dividend growth

U.S. and U.K. equities M&A and corporate cash flow

Secular themes such as the emerging market consumer and infrastructure

Too early for financials and Europe and we await China’s policy easing to add to emerging markets

Market outlook

Questions and answers

36

37

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