The rewards for political co-operation

  • Another week of frustration before we have exit from the deadlock in Washington? Markets assume that the disruption will not escalate into a form of default beyond this week. The context is different from that of the summer of 2011. In this case the S&P500 should recover from the 1625- 75 area. Crisis requires the market to move through this support.
  • The paralysis in Washington is encouraging capital to move out of America. The risk-value combination continues to out-perform in Europe’s equity markets. Italy demonstrates how the return of private capital to distressed Europe is raising the rewards for political cooperation. We are upgrading Italy and downgrading the Swiss market.

Recommended sector and market asset allocation

Another week of frustration before we have a more-or-less unsatisfactory exit from the deadlock in Washington? Market behaviour is informed by the assumption that it would be suicidal for the Republican Party to escalate the disruption beyond this week by provoking a form of government default. We do not disagree. The context is different from that of the summer of 2011. The economy is stronger, as is the position of Obama. We suspect that the political landscape in both America and Europe is just beginning to be reshaped by the shift in the economic climate, reducing the returns on political intransigence and separatism. In this case the S&P500 should recover from the 1625-75 area. The US currency should recover against the Euro from the US$1.36-1.38 area. Crisis requires markets to move through these levels.

The paralysis in Washington is encouraging capital to move out of America. Growth perceptions almost everywhere are improving in a context in which the Federal Reserve cannot entertain the removal of monetary stimulus. Despite the negative influence from America, the process of valuation re-convergence in Europe is extending. We are not just witnessing the revival of the domestic value universe. The investment risk attached to secure growth assets has risen.

The return of private investment capital to distressed Europe is raising the rewards for political co-operation. Mr Berlusconi’s failure to de-stabilise the Letta government is a demonstration of the consequences. We have the political signal to upgrade the Italian market, the region’s primary representative of domestic value. The counterpart is the downgrading of Switzerland, the exemplar of the secure growth of global corporate franchises. However, value recovery does not mean value leadership. What has changed is the end of the out-performance of secure, larger cap growth stocks. The context has become more favourable to lower quality, cheaper, more cyclical growth. And to the universe of small and mid-cap stocks in general, whose multiple winning style combinations we identify in the latest edition of “Hit Seeker”.

Weightings and asset allocation for the MSCI Europe Universe



04/10/2013 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 10
Food & Staples Retailing 1.7 0.8 N 2
Fod Beverage & Tobacco 10.7 0.5 UW 7
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 8
Healthcare Equipment & Services 1.2 0.4 UW 1
Pharmaceuticals & Biotechnology 11.5 0.5 UW 7
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 3
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