Technical Outlook 2013

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    Technical Outlook January 10, 2013

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    Long-Term (Secular) View

    Dow Jones Industrial Average

    10

    100

    1000

    10000

    100000

    '09

    '14

    '19

    '24

    '29

    '34

    '39

    '44

    '49

    '54

    '59

    '64

    '69

    '74

    '79

    '84

    '89

    '94

    '99

    '04

    '09

    Source: Bloomberg Finance L.P. As of December 20, 2012

    log scale

    We are strong believers that equities trade in long-term (secular) bull and bear cycles. Examples of previous long-term bear markets include 1905 to the

    1920s, 1930s, and 1960s to 1982 (seen in red boxes in chart). In our view, the S&P 500 has been in one of these secular bear market trading ranges since

    2000. Historically, these trading ranges have lasted roughly 14-15 years. With the current bear market in its 13th year, we believe we are getting closer to the

    end of the current bear cycle, and closer to the beginning of the next secular bull cycle. As we see it, we are in the 7th

    inning stretch of this drawn-out

    ballgame. We believe the catalysts to break out of this current bear cycle could be: 1) a successful resolution of the high sovereign deficits and debt seen in

    much of the developed world, and/or 2) a major asset allocation shift from bonds and into equities.

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    S&P 500 Index

    With the recovery entering its 5th year and the fact that the 4-year business cycle is projected to hit in the summer of 2014, we should be on the watch for a

    maturing cyclical bull market. That said, the S&P 500 remains in a long-term uptrend, which is supported by its rising 50-week moving average.

    Given our belief that U.S. equity markets remain in a secular sideways trading range, we believe the S&P 500 will be capped on the upside at 1,550-1,575,

    which represents the all-time highs of December 2007 and 2000. On the downside, we believe the S&P 500 could find support at 1,265-1,275, which

    represents the June 2012 lows and a 50% retracement of the advance from the October 2011 lows. Key levels to watch on the downside include 1,380-

    1,390 (intersection of the long-term uptrend and 50-week moving average), and 1,343 (November 2012 lows).

    Overall, we expect an increase in volatility in H1/13 as investors refocus their attention on U.S. politics, with U.S. lawmakers having to address the debt limit

    and sequestration (spending cuts) in February/March. Improving seasonality and increased clarity around these issues could lead to a stronger second halfof the year, resulting in modest gains for U.S. equities in 2013.

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    U.S. Sectors Favoured

    S&P 500 Health Care Index

    The U.S. Health Care sector is one of the few S&P 500 sectors that has made a

    new all-time high during this recovery.

    The sector remains in a long-term uptrend and is currently trading at short-term

    technical resistance around 475.

    With the sector showing continued strong relative strength versus the S&P 500, webelieve the Health Care sector will break above this 475 resistance level and make

    new all-time highs in 2013.

    The Health Care sector remains one of our favourite U.S. sectors given its strong

    technical profile. Our preferred industries include Pharmaceuticals and Biotech.

    S&P 500 Financials Index

    The U.S. Financial sector was the stand-out sector in 2012, rising over 20%. The

    gain in Financials was driven by an improving U.S. housing market, better than

    expected earnings, and declining financial stress across the globe.

    The S&P 500 Financials Index has been in a clear uptrend since October 2011,and recently broke above short-term resistance of 220. The sector continues to

    outperform the broader market, as seen by the confirming relative strength

    breakout (green circle).

    The sector is now at a key technical resistance level around 230, which was

    resistance in April 2010 and May 2011. If the sector is able to break above this 230

    level, we believe more upside is possible for 2013.

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    U.S. Sectors At Risk

    S&P 500 Telecommunications Index

    The S&P 500 Telecommunications sector remains in an uptrend, however we are

    seeing some concerning technical developments. First, on a relative basis, the

    sector has underperformed since peaking in August 2012. Second, we note that a

    head and shoulders top pattern is beginning to form, which would be confirmed on

    a price break below the neckline around 145.

    Admittedly, the Telecommunications sector plays well into our long-held bullish

    view of dividend paying stocks with its current dividend yield of 4.7%; however, the

    weaker technicals make us cautious on the sector.

    S&P 500 Energy Index

    The S&P 500 Energy sector was a significant underperformer in 2012, posting a

    modest gain of 2% compared to 13% for the S&P 500. As seen in the chart, the

    sector continues to trade range bound between 460 and 565. On a relative basis,

    the sector has underperformed the S&P 500 since May 2011.

    While we see the potential for some short-term outperformance in the Energy

    sector in 2013, possibly during the seasonally strong February through May period,

    the technicals remain negative in our view, hence our cautious view of the sector.

    To become more constructive on the sector we would like to see the S&P 500

    Energy Index break above 570 on improving relative strength.

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    Intermarket Picture

    I. Interest Rates

    In our view, the key to the equity markets this year will be what unfolds in the bond market. Following the release of the December Fed minutes, whichhinted that QE could end in 2013, the 10-year U.S. Treasury yield surged by roughly 20 basis points (bps) to 1.91%, resulting in the benchmark bond

    breaking above its long-term downtrend and its trading range since June 2012 (1.40-1.83%). While important technically, and bullish for equities (at least up to 4% before higher yields start to negatively pressure equity valuations), we should be

    mindful that we are entering the seasonally weak period for bonds (January to April), and the back up in yields may be transitory.

    The reason we believe the bond market will be an important driver for equities is the potential for a major asset allocation rotation from bonds and into

    equities. As seen in the accompanying chart, since 2007, U.S. investors have withdrawn over US$450 billion in equities and added US$1.2 trillion into

    bonds. Some are predicting this will reverse in 2013, which if it were to occur, would be a significant positive driver for equities.

    We believe the 10-year Treasury yield will continue to trade range bound between 1.60% and 2.40% through 2013. However, if the highly anticipatedreallocation into equities were to occur, then we could see the 10-year Treasury yield go as high as 3.50%. We assign a low probability to this event

    occurring in 2013.

    U.S. Mutual Fund Flows

    -$600,000

    -$400,000

    -$200,000

    $0

    $200,000

    $400,000

    $600,000

    $800,000

    $1,000,000

    $1,200,000

    $1,400,000

    Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

    Total Equity Flows

    Total Bond Flows

    Source: Investment Company Institute. As of January 4, 2013

    (in millions)

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    II. Currencies

    U.S. Dollar Index In our view, the outlook for the U.S. dollar is largely dependent on what happens

    with the U.S. 10-year Treasury yield and the Feds QE policies. Sustained asset

    purchases by the Fed through 2013 could lead to a further debasement of the U.S.

    dollar. In this scenario we could see the U.S. Dollar Index decline, possibly downto the 74 level. Interestingly, we note there is a head and shoulders top forming on

    the U.S. Dollar Index, which if the neckline were to be broken at 78.50, would have

    a measuring implication to the 73-74 level.

    As we intimated earlier in the report, we see the potential for an increase involatility heading into the February/March period, as U.S. lawmakers look to

    address the debt limit and spending cuts. If we saw the worst of politics being

    played out over these issues, and the credit rating agencies follow through with a

    U.S. debt rating downgrade, we could see a flight to safety in the U.S. dollar, with

    our upside target of 84 under this scenario. Intuitively one would think the opposite

    (i.e., U.S. dollar falls on debt downgrade), however, following the U.S. debt

    downgrade from Standard & Poors in August 2011, the U.S. Dollar Index rose by

    6%, three months after the downgrade.

    Canadian Dollar

    The Canadian dollar rose modestly in 2012, but traded fairly range bound for most

    of the year. We see a similar trading pattern unfolding for 2013, with the Canadian

    dollar trading between US$1.03 and US$0.96.

    We see upside being capped due to slower global growth and continued lowinterest rates in Canada.

    Should we see a U.S. debt downgrade and a flight to safety for the U.S. dollar, wecould see the Canadian dollar revisit the lows of $0.96.

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    III. Commodities

    Reuters/Jefferies CRB Commodity Index

    Given our expectations for modest U.S. and global growth in 2013, we believe

    commodity prices will remain range bound, with the Reuters/Jefferies CRB

    Commodity Index trading between 320 and 270.

    On a relative basis, the Reuters/Jefferies CRB Commodity Index continues to

    underperform versus the S&P 500, which we expect to continue in 2013.

    West Texas Intermediate (WTI) Oil Similarly, we see WTI oil trading in a range of US$80/barrel and

    US$100/barrel, with it possibly hitting both levels during 2013. Typically, we

    see oil prices strengthen in the early Spring ahead of the U.S. driving season,

    and weaken into the Fall, as demand wanes. We believe this seasonal pattern

    could play out once again in 2013.

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    IV. Gold

    Gold has been in a short-term downtrend since hitting an important technical resistance level of roughly US$1,800/oz. in September 2012. This level has

    proved to be stiff resistance for the metal, as it has peaked three times at this level since October 2011. We attribute some of the recent weakness to the December Fed minutes which captured an increasing concern from some Fed officials over its asset

    purchases: Several (officials) thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013, citing concerns aboutfinancial stability or the size of the balance sheet." A reduction or cessation of further asset purchases by the Fed would likely result in higher U.S. Treasury

    yields and U.S. dollar, which would negatively impact gold prices.

    Despite this, our outlook for gold remains bullish and we see the recent trading action as a consolidation pattern, ahead of another surge higher.

    Consolidations, as seen in 2006/07 and 2008/09, are normal and healthy.

    We remain bullish on gold prices given: 1) while the Fed always has some hawkish members, the doves clearly outweigh the hawks, making a pullback in

    asset purchases unlikely in 2013, 2) we expect real interest rates to remain low, as this is needed to help the funding arithmetic for the U.S. government,

    and 3) other central banks (i.e., ECB, BOJ, and BOE) appear committed to further balance sheet expansion. As seen in the accompanying chart, there is a

    plurality of central banks expanding their balance sheets, which we expect to continue in 2013. Overall, we believe gold will make another attempt at the US$1,800/oz. level in 2013, and possibly return to the all-time high of US$1,900/oz. that was

    reached in August 2011.

    Major Central Bank Balance Sheets

    0

    2000

    4000

    6000

    8000

    10000

    12000

    14000

    Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11

    US$billions

    Swiss National Bank

    Bank of Japan

    China

    ECB

    Federal Reserve

    Source: Bloomberg Finance L.P. As of December 20, 2012

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    S&P/TSX Composite Index

    The S&P/TSX Composite Index (S&P/TSX) is fast approaching a critical technical level of 12,750. This level acted as support in June 2011, and then

    became resistance in September 2011 and again in March 2012. When support becomes resistance, we call this a change of polarity, and it is a very

    important technical concept. If the S&P/TSX can manage to break above this level, we would target upside for the S&P/TSX at 13,500, and expect this

    resistance level to hold over the course of the year. On the downside, we believe the S&P/TSX would hold technical support at 11,250, should we see a

    market pullback sometime over the year, as we expect.

    Overall, given our modest growth expectations and range-bound trading for commodity prices, we see the resource-heavy S&P/TSX trading in a technical

    range of 13,500-11,250, with the index posting a modest gain for the year.

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    Canadian Sectors Favoured

    S&P/TSX Industrials Index In Canada, the S&P/TSX Industrials Index looks set to continue its outperformance

    from 2012.

    Industrials recently broke above an important technical resistance level of 120.Additionally, on a relative basis, it also broke above resistance, thus confirming the

    absolute price breakout.

    The sector is currently overbought with a Relative Strength Indicator (RSI) readingof 77.31, so we would not be surprised to see some profit taking in the near term.We would use the weakness to accumulate shares in the sector, as we see

    industrials performing well in 2013.

    S&P/TSX Consumer Staples Index

    On the defensive side, we believe the S&P/TSX Consumer Staples sector also

    looks poised to outperform in 2013.

    Similar to the Industrials, the S&P/TSX Consumer Staples Index recently broke

    above a short-term technical resistance level of 235, making a new all-time high.

    Its relative strength is also strong, helping to confirm the breakout.

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    Canadian Sectors At Risk

    S&P/TSX Utilities Index

    Despite the recent bounce in the Utilities sector, the outlook for the sector remains

    neutral.

    The sector continues to face stiff technical resistance at the important 230 level,

    which has held since early 2011.

    On relative basis, the sector continues to trade sideways versus the S&P/TSX.

    S&P/TSX Health Care Index

    In contrast to the U.S. Health Care sector, the Canadian Health Care sector is

    looking weak, in our view.

    Since peaking in July 2012, the sectors relative strength has been weak, as

    illustrated by the downtrend. In addition, the sector faces stiff resistance at the 70level.

    For Health Care we recommend investors look south of the border where the

    technicals look better, and it offers more breadth.

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    U.S. Stock Recommendations

    Ford Motor Co. (F-N) Ford Motor Co. recently broke out of its base ($9-$13) on heavy volume.

    The price breakout was confirmed by its relative breakout (green circle).

    The measuring implications of the breakout is $17, however we are targeting a

    more conservative $15.50, which was resistance in March-April 2011.

    Pfizer Inc. (PFE-N) Pfizer Inc. has been in a clear upward channel since bottoming in July 2010 and is

    showing strong relative strength.

    Large cap U.S. Pharmaceuticals is one of our favoured Health Care industries.

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    Qualcomm Inc. (QCOM-N)

    Qualcomm Inc. remains one of our favourite U.S. technology names.

    In 2012, the stock found resistance at the $57.50 level. In early 2012 the stock

    broke above this level, and it became support in Q4/12. We believe QCOM is now

    in a new higher trading range.

    If QCOM can break above short-term resistance of $65, we see it making another

    attempt at the $69 high seen in March 2012, and possibly breaking out to a new

    high in 2013.

    Norfolk Southern Corp. (NSC-N) Norfolk Southern Corp. underperformed significantly in H2/12, as weak coal

    markets hurt operating results.

    However, the stock has recently bounced back as seen by its improving relative

    strength and it is trading back above an important resistance level of $62.50.

    Following the rally, the stock has become overbought technically, however we

    would be buyers on weakness.

    We see the stock getting back to technical resistance in the $74-$75 range.

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    Canadian Stock Recommendations

    Precision Drilling Corp. (PD-T) Precision Drilling Corp. significantly underperformed since peaking in July 2011.

    However, we believe things are looking up for the driller.

    First, we note that the stock has broken above its long-term downtrend.

    Additionally, its relative strength against the S&P/TSX has started to turn higher.

    If PD can break above its current resistance around $9 we could see the stock

    trading up to next resistance around the $12 level.

    Franco-Nevada Corp. (FNV-T) Franco-Nevada Corp. has been a strong outperformer since 2011, as seen by its

    strong relative strength.

    Following a breakout above resistance of $45 in June 2012, FNV has been

    consolidating in a range of $55-$60.

    If FNV can break of this range, we believe the stock could make new highs in

    2013.

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    Alimentation Couche Tard (ATD.B-T)

    Following a breakout for Alimentation Couche Tard in Q1/12, the stock has been

    trading in a tight range of $45-$50.

    Over this time, ATD.Bs relative strength has continued to hold up against the

    S&P/TSX.

    ATD.B appears to be consolidating following its large gains, and appears poised to

    possibly break above current resistance of $50.

    Goldcorp Inc. (G-T)

    Admittedly, Goldcorp Inc.s technical profile leaves much to be desired, given its

    weak relative strength, and range bound trading pattern.

    However, the stock is coming up to technical support of $33, which given our

    constructive outlook for the price of gold prices, should hold.

    We would be buyers in the $33-$34 range, and sellers up at resistance around the$44-$45 range.

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