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A modest pick-up in European GDP growth, the Euro at 1.20 and operational leverage should be enough

to drive 10% earnings growth in 2015 and 9% in 2016. Our fair value P/E multiple is 14.5x – just 7%

above the long-run average, but clearly on depressed earnings. This points to a fair value of 380 on the

Stoxx 600 by end-2015: some 13% upside. We launch an Interactive model with inputs for the macro

drivers and FX impact on earnings. If investors disagree with our inputs, they can change them.

"Goldilocks" is a surprise pick-up in European growth and acceleration in the US. But investors are

focusing on downside risks: a significant shock could push Europe into a "Triple-Dip Recession". We

view this as unlikely but in this scenario we see European equities down 30%. Our Quant team looks at

historical volatility to show implied price range. The "Triple-Dip" scenario is close to a 2-standarddeviation

event.

We upgrade Commercial Services to Overweight from Underweight as the sector's P/E relatives are close

to 10-year lows, the dividend yield relative is just coming off 10-year highs and earnings momentum has

turned. We take General Retail up to Neutral as a beneficiary of low rates and low oil. Our other

Overweight sectors: Banks, Luxury Goods, Tech Hardware, Media and Cap Goods. Favoured stocks

include ING, Soc Gen, Alstom, Richemont, Adecco, Marks & Spencer, Fresenius Medical, BSkyB, ITV and

Alcatel-Lucent (full table on page 5).

We take Pharma down to Underweight after significant outperformance (55% relative since 2012 and

the best performer YTD). The vast bulk of this has come from re-rating rather than earnings, which has

left relative valuations looking stretched: the P/E relative is at a 6-year high, the dividend yield at a c20%

discount to the market, and Pharma is now the most expensive major sector on PEG. The high inverse

correlation to the PMIs suggests underperformance if there is any macro recovery.

1. The real yield gap today (bonds vs equities) is 90% of its crisis peak; 2. Cyclical performance is c. 5%

away from the 09 lows; 3. US has outperformed Europe by 45% since 07 and is valued at a 30 year

record premium to Europe; 4. US & European profit gap still at record high (fig 1); and 5. Troubled

sectors in Europe are still near trough (to history & many US peers). We think Europe gets back to its

2007 profits by end 2016 (c. 10% a year) and if so it trades on 10.5x PE. See roadmap for this: page 27.

1. Banks: AQR done, balance sheets better by > €200bn and TLTRO offers a MIN €400bn at 15bps for 4

years contingent on lending; 2. ECB credit survey best in 7 years; 3. Lower oil: Eurozone wins & real

wage growth at 5 year high; 4. A weaker Euro supports revenues; and 5. Margins are starting to turn

up. Five Changes: page 19.

We are 50% behind the US in the race back to (or beyond!) last cycle's peak profits. Sadly only 30% of

the gap to the US is due to sector composition (more Tech in US); 70% is due to lower ROE for European

Sectors vs US peers, Euro, etc. Some SECTORS responsible: Technology, Transport, Food Retail, Telecoms,

Autos, Media, Utilities, Energy, Diversified Financial, Real-estate & more. If we put Europe & US earnings

both back to 07 profits (closely aligned in past): European PE sits on 10.5x and US on 20.5x.

Profits down and no one believes in growth. So buy 1) where ROE still depressed & cheaper than

local/US peers (fig 2) includes: TOTAL, BBVA, Randstad, M&S, SocGen; and 2) Cyclicals with dividends:

Swedbank, CRH, HSBC, M&S, Amec, Michelin & more.

The UBS strategy team downgrades Pharma to underweight based on (1) the large outperformance of

Pharma in the last 3 years, (2) significant multiple expansion, (3) high valuation – especially the 20-30%

premium to the market and a dividend yield now at a discount to the market, (4) high inverse correlation

to the macro cycle (detailed rationale included in this note). We agree with all those points, especially the

last point. It seems very clear that in case of a significant recovery, the Pharma sector should most likely

underperform.

Our bottom up fundamental view on the sector remains constructive: specifically, we expect several

companies to return to (near) double digit earnings growth, driven by a new innovation cycle, but also

smart restructuring & acquisitions. Valuations seem high looking at recent years, though a 5-6 year

horizon may be insufficient to gauge Pharma relative valuation to the overall market. The current market

premium of the sector is finally back to the period prior to 2009, before the sector moved towards the

patent cliff. Despite significant earnings downgrades for some companies (especially GSK, Sanofi) our

average projected earnings growth for the sector overall has increased from 7% to 8% since January

2014, with potential further upside from pipelines.

During 2014, we have a big divergence in earnings growth expectations within the large cap sector. In

January, we projected (near) double digit earnings growth for Novo and Bayer, and mid-single digit for

the remaining universe. Since then, Novartis and Roche have joined the (near-) double digit club,

whereas GSK and Sanofi's earnings growth prospect have dropped to a low single digit level with

uncertainty to the downside. This divergence is still not reflected in the multiples.

In case of a recovery, we would keep the stars and preferentially reduce the companies with low and

uncertain earnings outlook.