From domestic America to domestic Europe

  • A truce in America’s political-culture war had always been expected by Mr Market but any definitive resolution is unlikely. What remains is the loss of the momentum of recovery of “domestic America”. The most significant beneficiary is “domestic Europe”.
  • We have been witnessing an acceleration of valuation re-convergence within Europe which is now producing significant movements of larger cap stocks in the EZ periphery.
  • We are downgrading the entire Nordic region from N to UW, whilst maintaining the same intra-Nordic distribution. We are upgrading Telecoms from N to OW because the return of external capital to distressed Europe is benefiting the most out-of-favour, larger cap bellwether stocks of these markets.

Recommended sector and market asset allocation

A truce in America’s political-culture war had always been expected by Mr Market, if only because the Republican Party put itself in such an untenable position. For this reason secure fixed income assets have derived little benefit from the latest episode of deadlock. The US$ has weakened only modestly. Higher risk stocks have not lost their leadership within trans- Atlantic equity markets. However, we do not imagine that there will be a resolution of the budgetary conflict in Washington in any definitive sense. What remains, therefore, is the loss of the momentum of recovery of “domestic America”. Portfolio capital has been moving out of America because the theme of domestic recovery has faded even as global growth has strengthened. Emerging markets are reviving. There is a more significant beneficiary: the return of “domestic Europe”. A political truce in Washington should allow Europe’s markets to resume their ascension, whose potential is implied by the continued out-performance of the risk-value combination. More important, the context is allowing an acceleration of the revival of the cheaper assets in the region.

We have been witnessing an acceleration of valuation re-convergence within the European equity space as measured by two major, complementary investment perspectives: value versus growth and domestic versus global. The current, second wave of valuation re-convergence is producing some quite dramatic movements of larger cap stocks in the markets of the EZ periphery. We expect this wave to reach a crescendo through the weeks ahead, breaking into year-end profit-taking.

We have two small adjustments to our recommended asset allocation. We are downgrading the entire Nordic region from N to UW, whilst maintaining the same intra-Nordic distribution (UW in Denmark & Norway and N/OW in Sweden & Finland). We are upgrading the Telecoms sector from neutral to OW because the return of external capital to equity in distressed Europe will be most manifest, in this initial stage, in the behaviour of the most out-of-favour, large cap bellwether stocks of these markets. The smaller cap universe will follow.

Weightings and asset allocation for the MSCI Europe Universe



11/10/2013 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 9
Food & Staples Retailing 1.7 0.8 N 2
Fod Beverage & Tobacco 10.7 0.5 UW 6
Household & Personal Product 1.8 0.5 UW 1
Energy 9.4 1.0 N 9
Financials 21.6 1.5 OW 25
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 7
Healthcare Equipment & Services 1.2 0.4 UW 1
Pharmaceuticals & Biotechnology 11.5 0.5 UW 6
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 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 OW (N) 7
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