CIO REPORTS

The Weekly LetterOffice of the CIO • MARCH 10, 2015

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Nasdaq 5000—Version 2.0 Fifteen years to the month after the Nasdaq Composite Index hit

an all-time high of 5,048, it finally crossed the 5,000 mark again

last week. The outperformance of the Nasdaq over the past two

years has been driven by the same sector of the market that

caused it to crash at the turn of the century – Technology.

We continue to hold a positive view on equities over bonds, and

Technology remains one of our preferred sectors on the basis

of strong cash flows and balance sheets and relatively attractive

valuations (see Exhibit 1). Additionally, the recent upsurge of

connected devices creates several opportunities within certain

segments of the industry.

Solid balance sheets supported by strong cash flowsTechnology companies on average have some of the strongest balance sheets in the U.S. Many are flush with

cash, allowing them to buy back stock to bolster share prices,

acquire companies to benefit from synergies and boost earnings,

and pay out dividends to shareholders. In fact, Tech is the only

sector with more cash than debt on company balance sheets.

The sector has a dividend yield of roughly 1.5%, compared to

nearly zero in 2000. In addition to solid balance sheets, the

Technology companies of today generally have strong cash

flows. The combination of high cash levels and low payout

ratios puts them in the best position to grow dividends or other

outlays beneficial to investors.

Valuations are not extendedAfter a 60% run for the tech-heavy Nasdaq over the past two

years, in which it outperformed the S&P 500 by over 15%,

valuation multiples for the Technology sector have risen. However,

at roughly 16.8 times the 2015 earnings forecast by BofA Merrill

Lynch (BofAML) Global Research’s equity strategy team, Tech stocks are nowhere near the lofty valuations of 2000.

Nasdaq 5000—Version 2.0: Last week, the technology-heavy Nasdaq composite index crossed the 5,000 level. This came 15 years after its dot-com era peak of 5,048. In contrast to the bubble in 2000, the Technology sector today presents several attractive opportunities, in our opinion. We favor “old tech” companies with healthy balance sheets and stable cash flows, and find that semiconductor and communication equipment companies stand to benefit from the growth of connected devices.

Markets In Review: Equities declined last week, with the S&P 500 down 1.5%. The MSCI EAFE Index fell 1.9%, although European and Japanese equities were higher in local currency terms. Treasury yields spiked following a stronger than expected employment report, with the 10-year at 2.24% from 1.99% the prior week. A sharply stronger U.S. dollar weighed on commodities, as WTI crude oil fell 0.3% to $49.61 per barrel and gold fell 3.8% to $1,167 per ounce, breaking the $1,200 support level.

Looking Ahead: On Thursday, U.S. retail sales for February are expected to be up after a series of soft numbers, while consumer confidence is expected to be down slightly for March. In Europe, industrial production is expected to be up for January.

Exhibit 1: The Technology sector of today is less expensive and higher-yielding than in the “dot-com” era

Adjusted Positive Price to Earnings (Left) Dividend Yield (Right)

2000

2001

2002

2003

2004

20

05

2006

2007

2008

2009

2010

20

11

2012

2013

2014

20

15 0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

10

20

30

40

50

60

70

80

Source: Bloomberg, MLWM Investment Management & Guidance. Data as of March 9, 2015. Technology sector represented by S&P 500 Information Technology GICS Sector Level 1. Price to earnings adjusts all negative earnings to zero.

The current pace of earnings growth supports our bullish view of Technology. It has one of the most positive earnings

trends among sectors in the U.S., with the highest ratio of

analysts raising estimates to those cutting them, according to

the BofAML Global Research U.S. Equity Strategy Team. They

note it is also the only sector with operating margins well above

average, which is attributed largely to structural changes within

the industry.

There are segments of the Tech sector that trade at lofty

valuations, such as some internet services stocks. Fundamentals

based on earnings growth, cash flow generation and quality

of balance sheets can be vastly different for such companies.

Some hold the potential for attractive long-term returns, but

investors need to be selective and understand the volatility that

comes with owning such names.

Innovation propels growthThe U.S. accounts for almost a third of global spending on

research and development (R&D), according to the U.S. equity

strategists at BofAML Global Research. Technology vendors are

among the biggest contributors to that spending. Historically,

companies across industries that invest in R&D have tended

to outperform those that don’t (see Exhibit 2). As a result, their

competitors are being pushed to invest and innovate, to the

benefit of technology suppliers.

What do we like?In general, we favor “old tech” companies due to their ability to generate steady cash flows and consistent earnings growth. Many are paying healthy dividends, which

add to their appeal.

One of the biggest trends within Tech is rising connectivity

among billions of “smart” devices. These extend beyond

computers and cell phones to household devices, industrial

robots and more. Communication equipment companies will play a key role in upgrading networks to accommodate the rising traffic and bandwidth demands.

Semiconductor companies should benefit too from the rapid growth of connected devices, as it is expected to

generate strong demand for equipment that can provide

efficient power management and connectivity. The investment

case for semiconductor stocks is supported by the fact that

they’re trading at reasonable valuations and have exhibited

robust profit growth. They generally have healthy balance

sheets and some of the highest dividend yields in the sector.

One downside to this digital revolution has been the surge

in cyber crime. The demand for cybersecurity solutions has

skyrocketed as companies invest to bolster their network

infrastructure and protect their customers’ data. Select

software and services companies should continue to benefit

from this trend.

Portfolio Strategy: We feel several factors differentiate

the Nasdaq of today from its past peak, and maintain

our positive outlook for equities over bonds, with

Technology remaining one of our favored sectors. In

general, we prefer “old tech” companies that tend to be

in more mature businesses, generate stable and healthy

cash flows, maintain solid balance sheets and pay

dividends to shareholders.

One of the biggest developments within the industry in

recent years has been the rise in connectivity of “smart”

devices. Communication equipment and semiconductor

companies should be the biggest beneficiaries of

this trend. Cybersecurity is also emerging as a major

opportunity due to increased demand for network

infrastructure and data protection.

CIO REPORTS • The Weekly Letter 2

Exhibit 2: Tech companies are the biggest spenders on R&D, which has been shown to lead to outperformance

Top 4 Sectors by R&D to Sales1 Year Outperformance of Companieswith R&D Expenses to Those Without

Ratio of R&D Expenses to Sales

-4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0%

10.0%

Technology Health Care Industrials Materials

Source: BofAML Global Research, MLWM Investment Management & Guidance. Data as of February 28, 2015. Sectors represented by S&P 500 GICS sectors, performance range 1990-2014.

CIO REPORTS • The Weekly Letter 3

Markets in ReviewTrailing Economic Releases

n Total vehicle sales in the U.S. for February were less than forecasted, falling slightly to 16.2 million from 16.6 million the previous month. Sales have been volatile due to inclement weather, but the trend has been positive, and auto sales should continue to rise in 2015 supported by continued gains in consumer confidence and an improving labor market.

n Euro-area fourth-quarter GDP was unrevised from flash estimates, up 0.3% quarter-over-quarter. Growth in Germany has been leading the region higher, but strength in periphery countries such as Italy and Spain has contributed as well. The European Central Bank has revised its growth forecasts higher for the next several years, although inflation forecasts shifted lower, with expectations of no inflation for 2015.

n U.S. nonfarm payrolls for February significantly beat expectations, rising by 295,000. This followed a downward-revised 239,000 gain in January. Partly as a result of a decline in the labor force participation rate, the unemployment rate fell further than expected to 5.5%. Average hourly earnings disappointed, rising only 0.1% from January. This implies 2% annual wage growth, below expectations that it would remain at 2.2%.

Looking AheadOn Thursday, U.S. retail sales for February are expected to be up after a series of soft numbers, while consumer confidence is expected to be down slightly for March. In Europe, industrial production is expected to be up for January.

BofA Merrill Lynch Global Research Key Year-End ForecastsS&P Outlook 2015 E

S&P 500 Target 2,200

EPS $119.50

Real Gross Domestic Product 2015 E

Global 3.4%

U.S. 3.1%

Euro Area 1.4%

Emerging Markets 4.2%

U.S. Interest Rates 2015 E

Fed Funds 0.50-0.75%

10-Year T-Note 2.35%

Commodities 2015 E

Gold 1,238

WTI Crude Oil $57

All data as of last Friday’s close.

Upcoming Economic Releases

n On Thursday, U.S. retail sales are forecast to rise 0.4% for February, after a series of disappointing months, including a reading of -0.8% in January. The BofAML Global Research U.S. Economics team expects harsh winter weather to be a drag on sales, with expectations of significant improvement in underlying spending trends to emerge in the spring.

n On Thursday, euro-area Industrial Production for January is expected to be up 0.8% year over year after declining 0.2% in December. The BofAML Global Research European Economics team is more positive on the region as Quantitative Easing by the European Central Bank is set to start this month, with 60 billion euros per month in asset purchases.

n On Friday, the University of Michigan Consumer Sentiment Index Flash Survey for March is expected to show a slight decline to 95.0 following the reading of 95.4 in February. A post-recession high of 98.1 was reached in January. Continued cold weather and slightly higher oil prices may be dragging on the index, although strong employment growth and equity prices continue to buoy consumer sentiment.

EquitiesTotal Return in USD (%)

Level WTD MTD YTDDJIA 17,856.8 -1.5 -1.5 0.7

Nasdaq 4,927.4 -0.7 -0.7 4.3

S&P 500 2,071.3 -1.5 -1.5 1.0

S&P 400 Mid Cap 1,486.6 -1.3 -1.3 2.6

Russell 2000 1,217.5 -1.3 -1.3 1.2

MSCI World 1,742.0 -1.7 -1.7 2.2

MSCI EAFE 1,848.6 -1.9 -1.9 4.5

MSCI Emerging Mkts 971.2 -1.9 -1.9 1.8

Fixed IncomeTotal Return in USD (%)

Yield (%) WTD MTD YTDML U.S. Broad Market 2.20 -1.0 -1.0 0.1

U.S. 10-Year Treasury 2.24 -2.1 -2.1 -0.3

ML Muni Master 2.39 -0.6 -0.6 0.2

ML U.S. Corp Master 3.14 -1.2 -1.2 0.6

ML High Yield 6.16 -0.4 -0.4 2.6

Commodities & CurrenciesTotal Return in USD (%)

Level WTD MTD YTDBloomberg Commodity 203.0 -2.6 -2.6 -3.4

Gold Spot1 1,167.2 -3.8 -3.8 -1.5

WTI Crude $/Barrel1 49.6 -0.3 -0.3 -6.9

Level CurrentPrior

Week EndPrior

Month End2014

Year EndEUR/USD 1.08 1.12 1.12 1.21

USD/JPY 120.8 119.6 119.6 119.8

Source: Bloomberg. 1Spot Price Returns. All data as of last Friday’s close. Past performance is no guarantee of future results.

S&P 500 Sector Returns (as of last Friday’s market close)

-4.1% -2.7%

-2.0% -1.4%

-1.8% -1.1%

-0.5% -2.9%

-2.5% -0.8%

-5.0% 0.0% 5.0%Prior Week

Telecom Materials

Information Technology Industrials Healthcare Financials

Energy Consumer Staples

Consumer Discretionary

Utilities

GWM Investment Management & Guidance (IMG) provides investment solutions, portfolio construction advice and wealth management guidance.

The opinions expressed are those of IMG only and are subject to change. While some of the information included draws upon research published by BofA Merrill Lynch Global Research, this information is neither reviewed nor approved by BofA ML Research. This information and any discussion should not be construed as a personalized and individual recommendation, which should be based on your investment objectives, risk tolerance, and financial situation and needs. This information and any discussion also is not intended as a specific offer by Merrill Lynch, its affiliates, or any related entity to sell or provide, or a specific invitation for a consumer to apply for, any particular retail financial product or service. Investments and opinions are subject to change due to market conditions and the opinions and guidance may not be profitable or realized. Any information presented in connection with BofA Merrill Lynch Global Research is general in nature and is not intended to provide personal investment advice. The information does not take into account the specific investment objectives, financial situation and particular needs of any specific person who may receive it. Investors should understand that statements regarding future prospects may not be realized.

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Asset allocation and diversification do not assure a profit or protect against a loss during declining markets.

Neither Merrill Lynch nor any of its affiliates or financial advisors provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions. The investments discussed have varying degrees of risk. Some of the risks involved with equities include the possibility that the value of the stocks may fluctuate in response to events specific to the companies or markets, as well as economic, political or social events in the U.S. or abroad. Bonds are subject to interest rate, inflation and credit risks. Investments in high-yield bonds may be subject to greater market fluctuations and risk of loss of income and principal than securities in higher rated categories. Investments in foreign securities involve special risks, including foreign currency risk and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are magnified for investments made in emerging markets. Investments in a certain industry or sector may pose additional risk due to lack of diversification and sector concentration. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates, and risk related to renting properties, such as rental defaults. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Income from investing in municipal bonds is generally exempt from federal and state taxes for residents of the issuing state. While the interest income is tax exempt, any capital gains distributed are taxable to the investor. Income for some investors may be subject to the federal alternative minimum tax (AMT).

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Mary Ann Bartels CIO, Portfolio Solutions, U.S. Wealth Management

Christopher J. Wolfe CIO, Portfolio Solutions,

PBIG & Institutional

Ashvin B. ChhabraChief Investment Officer, Merrill Lynch Wealth Management

Head of Investment Management & Guidance

Office Of the ciO

Hany Boutros

Vice President

Emmanuel D. “Manos” Hatzakis

Director

Niladri “Neel” Mukherjee

Managing Director

AdonVanwoerden

Asst. Vice President

JohnVeit

Vice President