2015 Economic & Market Outlook December 2014

MARKET OUTLOOK – DIVERGENCE AND DISCRIMINATION

SCOTIAB

VINCENT DELISLE l PORTFOLIO STRATEGIST l 514-287-3628 l [email protected] Scotia Capital Inc. – Canada Hugo Ste-Marie, Small Cap Strategist Scotia Capital Inc. – Canada (514) 287-4992 [email protected]

Jean-Michel Gauthier, Associate Scotia Capital Inc. – Canada (514) 287-3661 [email protected]

Pricing as at November 28, 2014, unless otherwise stated. All currencies in Canadian dollars unless otherwise stated. For Reg AC Certification and important disclosures see Appendix A of this report. Analysts employed by non-U.S. affiliates are not registered/qualified as research analysts with FINRA in the U.S.

2014 Market – Recap • Resource “users” outperforming “producers”. 2014 Recap - YTD Equity Indices & Currencies* -50% -40% -30% -20% -10% 0%

10% 20% 30% 40% 50%

Brazil (Bovespa) U.K. (FTSE)

Underperformers

Mexico (Mexbol) Russia (Micex)

Canada (TSX) Germany (Dax)

Currency YTD

Equity Index 2014 YTD

Japan (Topix) U.S. (S&P 500)

Outperformers

Turkey (Borsa Istanbul) India (Sensex)

China (Shanghai) -50% -40% -30% -20% -10% 0% *As at December 10th, 2014 Source: Scotiabank GBM Portf olio Strategy, Bloomberg.

2 Vincent Delisle | Portfolio Strategist

10% 20% 30% 40% 50%

Changes in P/E and Earnings Estimates • S&P 500 only index with P/E expansion AND positive revisions in 2014. Change in P/E & Fwd EPS - YTD (As at Dec. 10, 2014) 15%

U.S. Sectors - Change in P/E & Fwd EPS - YTD (As at Dec. 10, 2014) 15%

25%

25%

20%

20%

15%

15%

10%

10%

5%

5%

0%

0%

Change in Fwd P/E (%) 10%

Change in Fwd EPS estimates (%)

5%

10%

5%

0%

0%

-5%

-5%

-5%

-10% -10%

-10%

Change in Fwd P/E (%) Change in Fwd EPS estimates (%)

-15% -15%

-15% S&P 500 Dev. Europe China Japan (Yen) TSX (C$) MSCI LatAm (US$) (US$) (Renminbi) (US$)

Source: Scotiabank GBM Portfolio Strategy, Bloomberg, Thomson Financial. 3 Vincent Delisle | Portfolio Strategist

Source: Scotiabank GBM Portfolio Strategy, Bloomberg, Thomson Financial.

-5%

-10% -15%

Oil & U.S. GDP Growth • “Supply-driven” WTI decline tends to support positive LEI trend. • Gasoline a tailwind to retail sales. U.S. Leading Economic Indicators & WTI Crude Oil Prices

U.S. Retail Sales - Total and Ex-Gasoline Sales

100%

25% 9%

WTI - 6 months % - LHS 80%

20%

LEI - 6 months % - RHS

300

Low Gas Prices Stimulating Overall Consumption

6%

200

60%

15%

40%

10%

3%

100

20%

5%

0%

0

0%

0%

Spread (bp) - RHS

-3%

-60%

-15%

-80%

-20%

Source: Scotiabank GBM Portfolio Strategy, Bloomberg 4 Vincent Delisle | Portfolio Strategist

-9%

Source: Scotiabank GBM Portfolio Strategy, Bloomberg.

Jan-12

Jan-11

Jan-10

Jan-09

Jan-08

Jan-07

-12%

-300

High Gas Prices Hindering Overall Consumption Jan-06

Jan-15

Jul-13

Jan-12

Jul-10

Jan-09

Jul-07

Jan-06

Jul-04

Jan-03

Jul-01

Jan-00

Jul-98

Jan-97

Jul-95

Jan-94

Jul-92

Jan-91

Jul-89

-6%

Jan-16

-10%

Jan-15

-40%

U.S. Retail Sales YoY LHS -200 U.S. Retail Sales ExGasoline Sales YoY - LHS

Jan-14

-5%

Jan-13

-20%

-100

-400

Canadian Dollar Weakness Expected to Continue • Loonie downtrend triggered by U.S. economic outperformance and declining commodities. Canadian Dollar and Unemployment Rate Differential (1976-2014) 1.10

U.S. UR more than CAN UR

USDCAD - LHS

1.05

4

3

U.R. Differential (U.S. minus CDA - %) - RHS

1.00

2

0.95

1

0.90

0

0.85

-1

0.80

-2

0.75

-3

0.70

-4

Source: Scotiabank GBM Portfolio Strategy, Bloomberg. 5 Vincent Delisle | Portfolio Strategist

-5

Jan-16

Jan-14

Jan-12

Jan-08

Jan-06

Jan-04

Jan-02

Jan-00

Jan-98

Jan-96

Jan-94

Jan-92

Jan-90

Jan-88

Jan-86

Jan-84

Jan-82

Jan-80

Jan-78

Jan-76

0.60

Jan-10

U.S. UR less than CAN UR

0.65

-6

China GDP Growth Moderating • China policy targeting slower growth, “demand” factor not supporting CRB. Commodity Prices and China GDP Growth (1994-2014) 60%

13%

Forecasts

12% 40%

11% 10%

20%

9% 0%

8% 7%

-20%

6% 5%

-40%

CRB Index YoY - LHS 4%

China Real GDP YoY - RHS

Source: Scotiabank GBM Portfolio Strategy, Bloomberg. 6 Vincent Delisle | Portfolio Strategist

Dec-16

Dec-14

Dec-12

Dec-10

Dec-08

Dec-06

Dec-04

Dec-02

Dec-00

Dec-98

Dec-96

3% Dec-94

-60%

TSX versus S&P 500 • TSX leadership usually happens when world GDP is >4%.

7 Vincent Delisle | Portfolio Strategist

Global Macro Momentum • U.S. economy has been outpacing the rest of the world since 2010. ISM/PMI Trends: U.S., Europe, China, & Japan (2007-2014) 58

58 12-M Moving Average

56

56

54

54

52

52

50

50

48

48

46

46 U.S.

44

44

Europe

China*

42

42

Japan

*China PMI: Average of Government PMI and HSBC PMI Source: Scotiabank GBM Portfolio Strategy, Bloomberg 8 Vincent Delisle | Portfolio Strategist

Dec-14

Jun-14

Dec-13

Jun-13

Dec-12

Jun-12

Dec-11

Jun-11

Dec-10

Jun-10

Dec-09

Jun-09

Dec-08

Jun-08

38

Dec-07

38

Jun-07

40

Dec-06

40

Global Earnings Trend • Wide divergence, with S&P 500 and Japan leading. Forward Earnings Normalized (2011-2014) 150

150

Normalized at 100 on Jan. 2011

140

140

130

130

120

120

110

110

100

100

90

90

TSX

80

80

S&P 500

MSCI AC Europe

70

70

MSCI EM 60

Source: Scotiabank GBM Portfolio Strategy, Thomson Financial. 9 Vincent Delisle | Portfolio Strategist

Jan-15

Oct-14

Jul-14

Apr-14

Jan-14

Oct-13

Jul-13

Apr-13

Jan-13

Oct-12

Jul-12

Apr-12

Jan-12

Oct-11

Jul-11

Apr-11

MSCI LatAm Jan-11

50

60

MSCI Japan

50

U.S. Earnings Cycle Not Over • We expect S&P 500 EPS growth of 5%-7% in 2015. U.S. S&P 500 EPS Expansion Cycles & ISM Manufacturing Since 1948 40%

70

30%

65

20%

60

10%

55

0%

50

-10%

45

EPS Contraction Period

-20%

40

S&P 500 12M Trailing EPS YoY - LHS

Source: Scotiabank GBM Portfolio Strategy, Bloomberg, Shiller, Thomson Financial. 10 Vincent Delisle | Portfolio Strategist

Dec-16

Dec-12

Dec-08

Dec-04

Dec-00

Dec-96

Dec-92

35

Dec-88

Dec-84

Dec-80

Dec-76

Dec-72

Dec-68

Dec-64

Dec-60

Dec-52

Dec-48

Dec-56

ISM Manufacturing 12M Average - RHS

-30%

TSX Earnings Decline in 2015 • TSX EPS heading back below $900 ($920 in 2014). TSX 12-M Trailing EPS & WTI in C$ 1,100

150 TSX 12M Trailing EPS - LHS

1,000

WTI Oil Price (C$) - RHS

130

900 110 800

700

90

600

70

500 50 400 30

300

Source: Scotiabank GBM Portfolio Strategy, Thomson Financial, Bloomberg. 11 Vincent Delisle | Portfolio Strategist

Dec-16

Dec-14

Dec-12

Dec-10

Dec-08

Dec-06

Dec-04

Dec-02

Dec-00

Dec-98

Dec-96

10

Dec-94

200

TSX Discount Is Back • Discount near 10-year low, tracking Canadian-dollar depreciation. S&P/TSX vs. S&P 500 - 12-M Forward Relative P/E and C$ 1.30

1.10

S&P/TSX @ Prem ium

1.05

TSX/S&P 500 P/E Ratio - LHS

1.20

1.00 US$ per C$ - RHS 0.95

1.10

0.90

+1 St. Dev.

1.00

0.85 0.80

0.90

0.75 -1 St. Dev.

0.70

0.80

0.65 S&P/TSX @ Discount

Source: Scotiabank GBM Portfolio Strategy, Thomson Financial. 12 Vincent Delisle | Portfolio Strategist

Jan-17

Jan-15

Jan-13

Jan-11

Jan-09

Jan-07

Jan-05

Jan-03

Jan-01

Jan-99

Jan-97

Jan-95

Jan-93

Jan-91

Jan-89

0.60

Jan-87

0.70

Fed Rate Hikes in 2015 •

Fed cannot stay behind the curve forever (Taylor Rule at 2.42% versus Fed Funds still at 0.25%).

•

U.S. 10-year trend dictated by low EU yields; monitor technicals for upward reversion confirmation. Taylor Rule Target with U6 and U3 Unemployment Rate vs Fed Funds Rate 8 % Taylor Rule U3

%

Taylor Rule U6

6

3.50

3.50

3.00

3.00

2.50

2.50

6

Fed Rate 4

4

2

2

0

0

Original Taylor Rule Fed funds at 2.42% U-6 Taylor Rule version at 0.72% Fed Funds currently at 0.25%

-2

U.S. 10-Yr Yields & 50-d/200-d MA (2012-2014)

8

2.00

200-d MA

-2

1.50

1.50

50-d MA

Source: Scotiabank GBM Portfolio Strategy, Bloomberg. 13 Vincent Delisle | Portfolio Strategist

Source: Scotiabank GBM Portfolio Strategy, Bloomberg.

Dec-14

1.00 Sep-14

Jun-14

Mar-14

Dec-13

Mar-13

-6

Dec-12

Jan-15

Jan-14

Jan-13

Jan-12

Jan-11

Jan-10

Jan-09

Jan-08

Jan-07

Jan-06

Jan-05

Jan-04

Jan-03

Jan-02

Jan-01

Jan-00

Jan-99

Jan-98

Jan-97

Jan-96

Jan-95

Jan-94

1.00

Sep-13

-4 Jun-13

-4

-6

2.00

US 10-Yr Yield

2015 Strategy Highlights •

U.S. monetary normalization will continue with Fed rate hikes starting in Q2.

•

U.S.-dollar gains likely to persist on policy divergence with BoJ/ECB.

•

Yields should move higher with slopes flattening.

•

The broader global economy could benefit from lower oil prices as users edge producers.

•

TSX earnings revisions risks will linger in a sub-US$70 WTI world. Scotiabank GBM Asset Mix - December 2014 Update

Equities Canada (TSX) U.S. (S&P 500) Western Europe Pacific (Japan/Australia) EM Asia LatAm

Bonds Governm ent Corporate

Cash (91-D Tbills)

Asset Mix Benchmark Recommended 60% 65% 5% 22% 14% 10% 6% 3%

6% 28% 8.5% 12% 8% 2.5%

40%

30%

30% 10%

19% 11%

0%

5%

Source: Scotiabank GBM Portf olio Strategy estimates.

14 Vincent Delisle | Portfolio Strategist

Change From Last

U.S. versus Canada • Global Screen (SAGE): Still U.S. over Canada. SAGE - Canada/U.S. Barometer 150% Max Overw eight Canada Canada

30% Canada/U.S. Barometer - LHS

100%

20%

MSCI Canada less MSCI U.S. 3M Rolling Rel. Return (US$) RHS

50%

10%

0% Neutral

0%

-50%

-10%

-100%

-20%

Max U.S. -150%

Overw eight U.S.

Source: Scotiabank GBM Portfolio Strategy.

15 Vincent Delisle | Portfolio Strategist

Dec-15

Dec-14

Dec-13

Dec-12

Dec-11

Dec-10

Dec-09

Dec-08

Dec-07

Dec-06

Dec-05

Dec-04

Dec-03

Dec-02

-30%

Sector Strategy

December 2014 U.S. Sector Recommendation SQoRE TSX Sector Signals - December 2014

Underweight

Overweight As at Nov. 28, 2014

Technology

2.0%

Financials

2.0%

Industrials

1.0%

Energy

0.0%

Materials

0.0%

Health Care

0.0%

Telecom

0.0%

Staples

-1.0%

Utilities -2.0% Energy -2.0% -2.5% -2.0% -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% Source: Scotiabank GBM Portfolio Strategy.

UW

Services

UW

Integrated

OW

E&P, Uranium

UW

Pipelines

Discretionary

Signal

Materials Chemicals Metals & Mining

Neutral

UW Neutral UW

Gold & Precious Metals

Large UW

Paper, Lumber, Packaging

Large OW

Industrials

OW

Capital Goods

Neutral

Transportation

Large OW

Discretionary Staples Health Care Financials Banks Div. Financials Insurance REITs

Technology Telecom Utilities

OW OW OW Large OW Large OW OW Large OW OW

OW OW Neutral

Source: Scotiabank GBM Portfolio Strategy.

16 Vincent Delisle | Portfolio Strategist

Appendix A: Important Disclosures Company

Ticker

Disclosures (see legend below)*

The following analysts certify that (1) the views expressed in this report in connection with securities or issuers they analyze accurately reflect their personal views and (2) no part of their compensation was, is, or will be directly or indirectly, related to the specific recommendations or views expressed by them in this report: Vincent Delisle, and Hugo Ste-Marie This research report was prepared by employees of Scotia Capital Inc. and/or its affiliates who have the title of Analyst. All pricing of securities in reports is based on the closing price of the securities’ principal marketplace on the night before the publication date, unless otherwise explicitly stated. All Equity Research Analysts report to the Head of Equity Research. The Head of Equity Research reports to the Managing Director, Head of Institutional Equity Sales, Trading and Research, who is not and does not report to the Head of the Investment Banking Department. Scotiabank, Global Banking and Markets has policies that are reasonably designed to prevent or control the sharing of material non-public information across internal information barriers, such as between Investment Banking and Research. The compensation of the research analyst who prepared this report is based on several factors, including but not limited to, the overall profitability of Scotiabank, Global Banking and Markets and the revenues generated from its various departments, including investment banking. Furthermore, the research analyst's compensation is charged as an expense to various Scotiabank, Global Banking and Markets departments, including investment banking. Research Analysts may not receive compensation from the companies they cover. Non-U.S. analysts may not be associated persons of Scotia Capital (USA) Inc. and therefore may not be subject to FINRA Rule 2711 restrictions on communications with subject company, public appearances and trading securities held by the analysts. For Scotiabank, Global Banking and Markets Research analyst standards and disclosure policies, please visit http://www.gbm.scotiabank.com/disclosures Scotiabank, Global Banking and Markets Research, 40 King Street West, 33rd Floor, Toronto, Ontario, M5H 1H1. *

Legend

General Disclosures This report has been prepared by analysts who are employed by the Research Department of Scotiabank, Global Banking and Markets. Scotiabank, together with “Global Banking and Markets”, is a marketing name for the global corporate and investment banking and capital markets businesses of The Bank of Nova Scotia and certain of its affiliates in the countries where they operate, including Scotia Capital Inc. All other trademarks are acknowledged as belonging to their respective owners and the display of such trademarks is for informational use only. Scotiabank, Global Banking and Markets Research produces research reports under a single marketing identity referred to as “Globally-branded research” under U.S. rules. This research is produced on a single global research platform with one set of rules which meet the most stringent standards set by regulators in the various jurisdictions in which the research reports are produced. In addition, the analysts who produce the research reports, regardless of location, are subject to one set of policies designed to meet the most stringent rules established by regulators in the various jurisdictions where the research reports are produced. Scotia Capital Inc. or an affiliate thereof owns or controls an equity interest in TMX Group Limited and in excess of 1% of the issued and outstanding equity securities thereof. In addition, an affiliate of Scotia Capital Inc. is a lender to TMX Group Limited under its credit facilities. As such, Scotia Capital Inc. may be considered to have an economic interest in TMX Group Limited. This report is provided to you for informational purposes only. This report is not, and is not to be construed as, an offer to sell or solicitation of an offer to buy any securities and/or commodity futures contracts. The securities mentioned in this report may neither be suitable for all investors nor eligible for sale in some jurisdictions where the report is distributed. The information and opinions contained herein have been compiled or arrived at from sources believed reliable, however, Scotiabank, Global Banking and Markets makes no representation or warranty, express or implied, as to their accuracy or completeness. Scotiabank, Global Banking and Markets has policies designed to make best efforts to ensure that the information contained in this report is current as of the date of this report, unless otherwise specified. Any prices that are stated in this report are for informational purposes only. Scotiabank, Global Banking and Markets makes no representation that any transaction may be or could have been effected at those prices. Any opinions expressed herein are those of the author(s) and are subject to change without notice and may differ or be contrary from the opinions expressed by other departments of Scotiabank, Global Banking and Markets or any of its affiliates. Neither Scotiabank, Global Banking and Markets nor its affiliates accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or its contents. Equity research reports published by Scotiabank, Global Banking and Markets are available electronically via: Bloomberg, Thomson Financial/First Call - Research Direct, Reuters, Capital IQ, and FactSet. Institutional clients with questions regarding distribution of equity research should contact us at 1-800-208-7666. This report and all the information, opinions, and conclusions contained in it are protected by copyright. This report may not be reproduced in whole or in part, or referred to in any manner whatsoever, nor may the information, opinions, and conclusions contained in it be referred to without the prior express consent of Scotiabank, Global Banking and Markets.

Additional Disclosures Canada: This report is distributed by Scotia Capital Inc., a subsidiary of The Bank of Nova Scotia. Scotia Capital Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. Chile: This report is distributed by Scotia Corredora de Bolsa Chile S.A., a subsidiary of The Bank of Nova Scotia. Hong Kong: This report is distributed by The Bank of Nova Scotia Hong Kong Branch, which is authorized by the Securities and Future Commission to conduct Type 1, Type 4 and Type 6 regulated activities and regulated by the Hong Kong Monetary Authority. Mexico: This report is distributed by Scotia Inverlat Casa de Bolsa S.A. de C.V., a subsidiary of the Bank of Nova Scotia. Peru: This report is distributed by Scotia Sociedad Agente de Bolsa S.A., a subsidiary of The Bank of Nova Scotia. Singapore: This report is distributed by The Bank of Nova Scotia Asia Limited, a subsidiary of The Bank of Nova Scotia. The Bank of Nova Scotia Asia Limited is authorised and regulated by the Monetary Authority of Singapore, and exempted under Section 99(1)(a),and (b), (c) and (d) of the Securities and Futures Act to conduct regulated activities. United Kingdom and the rest of Europe: Except as otherwise specified herein, this report is distributed by Scotiabank Europe plc, a subsidiary of The Bank of Nova Scotia. Scotiabank Europe plc is authorized by the Prudential Regulation Authority (PRA) and regulated by the PRA and the Financial Conduct Authority (FCA). Scotiabank Europe plc complies with all FCA requirements concerning research and the associated disclosures and these are indicated on the research where applicable. United States: This report is distributed by Scotia Capital (USA) Inc., a subsidiary of Scotia Capital Inc., and a registered U.S. broker-dealer. All transactions by a U.S. investor of securities mentioned in this report must be effected through Scotia Capital (USA) Inc. Non-U.S. investors wishing to effect a transaction in the securities discussed in this report should contact a Scotiabank, Global Banking and Markets entity in their local jurisdiction unless governing law permits otherwise.

Definition of Scotiabank, Global Banking and Markets Equity Research Ratings & Risk Rankings We have a four-tiered rating system, with ratings of Focus Stock, Sector Outperform, Sector Perform, and Sector Underperform. Each analyst assigns a rating that is relative to his or her coverage universe or an index identified by the analyst that includes, but is not limited to, stocks covered by the analyst. Our risk ranking system provides transparency as to the underlying financial and operational risk of each stock covered. Statistical and judgmental factors considered are: historical financial results, share price volatility, liquidity of the shares, credit ratings, analyst forecasts, consistency and predictability of earnings, EPS growth, dividends, cash flow from operations, and strength of balance sheet. The Director of Research and the Supervisory Analyst jointly make the final determination of all risk rankings. The rating assigned to each security covered in this report is based on the Scotiabank, Global Banking and Markets research analyst’s 12-month view on the security. Analysts may sometimes express to traders, salespeople and certain clients their shorter-term views on these securities that differ from their 12-month view due to several factors, including but not limited to the inherent volatility of the marketplace. Ratings

Risk Rankings

Focus Stock (FS) The stock represents an analyst’s best idea(s); stocks in this category are expected to significantly outperform the average 12-month total return of the analyst’s coverage universe or an index identified by the analyst that includes, but is not limited to, stocks covered by the analyst. Sector Outperform (SO) The stock is expected to outperform the average 12-month total return of the analyst’s coverage universe or an index identified by the analyst that includes, but is not limited to, stocks covered by the analyst. Sector Perform (SP) The stock is expected to perform approximately in line with the average 12-month total return of the analyst’s coverage universe or an index identified by the analyst that includes, but is not limited to, stocks covered by the analyst. Sector Underperform (SU) The stock is expected to underperform the average 12-month total return of the analyst’s coverage universe or an index identified by the analyst that includes, but is not limited to, stocks covered by the analyst. Other Ratings Tender – Investors are guided to tender to the terms of the takeover offer. Under Review – The rating has been temporarily placed under review, until sufficient information has been received and assessed by the analyst.

Low Low financial and operational risk, high predictability of financial results, low stock volatility. Medium Moderate financial and operational risk, moderate predictability of financial results, moderate stock volatility. High High financial and/or operational risk, low predictability of financial results, high stock volatility. Speculative Exceptionally high financial and/or operational risk, exceptionally low predictability of financial results, exceptionally high stock volatility. For risk-tolerant investors only.

Scotiabank, Global Banking and Markets Equity Research Ratings Distribution*

Distribution by Ratings and Equity and Equity-Related Financings* Percentage of companies covered by Scotiabank, Global Banking and Markets Equity Research within each rating category. Percentage of companies within each rating category for which Scotiabank, Global Banking and Markets has undertaken an underwriting liability or has provided advice for a fee within the last 12 months.

Source: Scotiabank GBM.

For the purposes of the ratings distribution disclosure FINRA requires members who use a ratings system with terms different than “buy,” “hold/neutral” and “sell,” to equate their own ratings into these categories. Our Focus Stock, Sector Outperform, Sector Perform, and Sector Underperform ratings are based on the criteria above, but for this purpose could be equated to strong buy, buy, neutral and sell ratings, respectively.

www.gbm.scotiabank.com TM

Trademark of The Bank of Nova Scotia. Used under license, where applicable. Scotiabank, together with “Global Banking and Markets”, is a marketing name for the global corporate and investment banking and capital markets businesses of The Bank of Nova Scotia and certain of its affiliates in the countries where they operate, including Scotia Capital Inc. Scotia Capital Inc. is a Member of the Canadian Investor Protection Fund.