The Return of Capital

  • The quarter is ending with anti-climax. As long as the political pullback on Wall Street is not characterised by selling pressure we do not expect to see the S&P500 below the 1675-1625 area.
  • EZ equity is displaying greater resilience, with little evidence of contagion from Italy, because the value-risk combination has continued to outperform.
  • We are witnessing valuation re-convergence within Europe led by larger caps, reflecting the low credit content of the region’s recovery. Our perception is that the divergence of smaller cap performance between Europe’s markets is now, finally, just beginning to reverse.

Recommended sector and market asset allocation

The quarter is ending with anti-climax. Although the political games in Washington may extend through to midmonth the assumption is that last-minute deals will avoid serious economic damage. As long as the pullback on Wall Street is not characterised by selling pressure we do not expect to see the S&P500 below the area between 1675 and 1625.

The value-risk combination has continued to out-perform within Europe’s markets. EZ equity is displaying greater resilience with little evidence of contagion from Italy at this time. We will remain UW the Italian market until we can see the way out of the uncertainties created by the election in February. Our OW position in the EZ is concentrated in the core markets.

This has been a cycle of smaller cap out-performance in trans-Atlantic markets, largely because the collapse of interest rates has lowered the risk of corporate default. However, the disparities of credit conditions within Europe have produced unprecedented divergence in the behaviour of the region’s smaller cap universe. The return of American portfolio capital to relatively cheap European assets is especially important at this time because there is a chronic deficiency of financing via the banks and the public sector. Inflows of external private capital must compensate for the low credit content of Europe’s recovery. One consequence is a pattern of valuation re-convergence led by larger caps. Valuation re-convergence is lagging within the smaller cap universe, largely because smaller caps in the EZ periphery have not yet participated. Our perception is that the divergence of smaller cap performance between Europe’s markets is now, finally, just beginning to reverse.

Weightings and asset allocation for the MSCI Europe Universe



30/09/2013 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 9.9 1.1 OW 16
Automobiles & Components 3.0 1.6 OW 5
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 UW 11
Food & Staples Retailing 1.7 0.8 N 2
Fod Beverage & Tobacco 10.7 0.5 UW 8
Household & Personal Product 1.8 0.5 UW 1
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 OW 7
Real Estate 1.0 1.1 UW 0
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 OW 12
Capital Goods 9.0 1.2 OW 10
Commercial Services & Suppy 1.4 0.8 N 1
Transportation 1.2 1.0 N 1
Information Technology 3.1 1.0 OW 5
Software & Services 1.4 0.9 OW 2
Technology & Hardware Equipment 0.9 1.2 OW 2
Semiconducors 0.9 1.0 OW 2
Materials 8.1 1.3 N 8
Telecommunication services 5.5 0.8 N 6
Utilities 3.9 0.9 UW 2
Exposure to risk
(beta value)
  1.09    
Lquidity ratio   3%    
* 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