The Rehabilitation of Europe

  • Europe’s exit from recession has produced a growth surprise. The dispersion of activity within the EZ continues to decline. This period marks a turning point for regional growth expectations. The return of growth confirms the rehabilitation of Europe among professional equity investors.
  • Although Europe’s rehabilitation allows its markets a new phase of out-performance it does not change our interpretation that a period of consolidation is required at this time. “Take profits in August, buy back in September-October”. The opportunity is provided by the uncertainty associated with the September FOMC and Germany’s election.

Recommended sector and market asset allocation

Europe’s exit from recession has produced a growth surprise: it is sooner and stronger than the consensus expected whilst the degree of dispersion of activity within the euro area continues to decline. This period marks a turning point for regional growth expectations. We can envisage recovery over an extended period, albeit slowly. The return of growth also confirms the rehabilitation of Europe by the investment consensus. Europe now benefits from a bullish consensus among professional equity investors. The value argument is acknowledged. Retail inflows into equity should increase. We do not want to change the interpretation that the cheaper deflation risk premium markets of Europe and Japan should deliver international equity out-performance through the second half of this cycle.

Although Europe’s rehabilitation is allowing a new phase of out-performance of the American reference it does not change our interpretation that a period of market consolidation is required at this time. “Take profits in August, buy back in September-October”. The opportunity is provided by the uncertainty that is associated with the September FOMC and Germany’s election. We are not expecting the current pull-back on the S&P500 to go beyond the 1550-1600 area. However, the behaviour of Wall Street is consistent with our view that the return of an interest rate constraint marks the end of the recent period of multiple expansion.

The recovery of European value can only be a gradual affair, if only because radical policy change in the euro zone is not on offer. Hence our recommendation of a balanced portfolio for 2013. We explain why the next step in our gradual return-to-mean within Europe will doubtless be to upgrade the markets of the euro zone to over-weight at the expense of that of the UK.

Weightings and asset allocation for the MSCI Europe Universe



26/08/2013 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 9.9 1.1 OW 15
Automobiles & Components 3.0 1.6 OW 4
Consumer Durables & Apparel 2.7 1.2 OW 4
Consumer Services 0.9 0.9 OW 2
Media 1.9 0.8 OW 3
Retailing 1.3 0.9 OW 2
Consumer Staples 14.1 0.5 OW 15
Food & Staples Retailing 1.7 0.8 OW 2
Fod Beverage & Tobacco 10.7 0.5 OW 1 2
Household & Personal Product 1.98 0.5 OW 2
Energy 9.4 1.0 N 9
Financials 21.6 1.5 OW 24
Banks 11.0 1.5 OW 12
Diversified Financials 4.0 1.6 OW 5
Insurance 5.6 1.4 N 6
Real Estate 1.0 1.1 N 1
healthcare 12.7 0.5 UW 9
Healthcare Equipment & Services 1.2 0.4 UW 1
Pharmaceuticals & Biotechnology 11.5 0.5 UW 8
Industrials 11.6 1.1 UW 10
Capital Goods 9.0 1.2 UW 8
Commercial Services & Suppy 1.4 0.8 N 1
Transportation 1.2 1.0 UW 1
Information Technology 3.1 1.0 OW 4
Software & Services 1.4 0.9 OW 2
Technology & Hardware Equipment 0.9 1.2 OW 1
Semiconducors 0.9 1.0 OW 1
Materials 8.1 1.3 N 8
Telecommunication services 5.5 0.8 N 5
Utilities 3.9 0.9 UW 2
Exposure to risk
(beta value)
  1.06    
Lquidity ratio   4%    
* The exposure to risk is measured by the weighted average of 2-y betas.
We manage the liquidity ratio within a 0-10% rank.
Source: Kepler Cheuvreux