Bonfire of the Analysts?

  • The Q3 growth surprise is complete. The wave of investor enthusiasm in Europe’s equity markets is beginning to fade. There is no corresponding profit surprise from European companies but there is a displacement of investment risk.
  • We think that investors should hold their nerve at this point. We also explain why we are not impressed by the new investment consensus about Europe.

Recommended sector and market asset allocation

We have seen the first indications that the wave of investor enthusiasm that has characterised the last three months in Europe’s equity markets is beginning to fade. The growth surprise delivered by economic data through Q3 is complete: we have entered the period of growth consolidation. The growth surprise is not yet translating into a corresponding profit surprise. However, there is a displacement of investment risk: there are fewer disappointments from companies most dependent upon domestic markets and comparatively more from those with greater exposure to markets outside the region.

There is no change to our recommended portfolio. We think that investors should hold their nerve at this point. It remains our perception that an equity market correction of significance is unlikely to occur until the reporting season in America draws to a close later in November. If investors remain confident that domestic demand in the US will pick up then we should not see the US$ weaken beyond the 1.38-1.40 area to the Euro. Similarly, the yield on the 10-year Treasury note should not decline below the 2.4-2.5% window. We expect more authentic market correction to come around the turn of the year, in all probability with the realisation that the withdrawal of QE3 remains on the agenda for 2014.

The new consensus about Europe says that investment risk has returned to normal but that growth will not. We explain why we are not impressed. What remains cheap in Europe is the price of potential profits and of future profitability within the region. There remains huge potential for Europe’s return-to-mean over an extended horizon precisely because the experience of the last five years has been so exceptionally bad.

Weightings and asset allocation for the MSCI Europe Universe

25/10/2013 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 7
Utilities 3.9 0.9 UW 3
Exposure to risk
(beta value)
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