A game of patience

  • The year-end consolidation in equity markets has been defined: of the perfect variety in America; imperfect in Europe. We counsel patience. We expect QE3-exit disruption in early 2014 to provide the next opportunity to reset value-risk trades.
  • We demonstrate that the recovery of the stocks most exposed to domestic markets is one of the outstanding features of Europe’s equity year. The reciprocal has been the under-performance of companies with the highest dependency upon Asian markets.
  • We talk about the new investment year ahead. We explain why we are no longer more optimistic than the investment consensus about year-ahead equity returns. Although we do not consider that the end of the current equity bull market is imminent we do think that 2014 will be its last full year.

Recommended sector and market asset allocation

We said that investors in European equity should take their profits for this year rather earlier than usual. For European equity the investment year ended in November. If markets in the region move back to their November highs through to year-end we will raise further the liquidity ratio of our recommended portfolio. In the US equity market the “perfect” label applies to the year-end consolidation, defined as the 1770/80 – 1820/40 area on the S&P500.

We demonstrate that the recovery of the stocks most exposed to domestic markets is one of the outstanding features of Europe’s equity year, reversing a trend that began in 2007. The reciprocal has been the under-performance of companies with the highest dependency upon Asian markets. In this sense the European economy – in the form of anticipation of economic recovery – has become a source of strength rather than a handicap. Europe’s fragility at this time – which explains to a large extent the stop-go nature of the performance of European equity from an international perspective - is the company factor: few companies are yet validating the expectations implicit in the recovery of equity valuations.

We provide our own contribution to the year-end ritual of sell-side summaries of the investment outlook for the New Year to come. We explain why, for the first time since this cycle began, we are no longer more optimistic than the investment consensus about year-ahead equity returns. We are witnessing late-cycle optimism among investors that always tends to be excessive, if only because it fails to recognise the maturity of the current investment cycle. 2014 should mark the beginning of the withdrawal of the exceptional monetary stimulus that has characterised the American response to the deflationary repercussions of the great crash. The counterpart is the assumption that the US economy in 2014 should finally register above-trend growth of the 3% variety. To be sure, we do not consider that the end of the current equity bull market is imminent. However, we do think that 2014 will be its last full year.

Although growth in Europe should return to trend in 2014 the return-to-mean theme within the region’s equity markets has already established its supremacy since late-2012. We are referring to the re-convergence of equity valuations and returns that has constituted the predominant influence upon the behaviour of stocks in the area since the price of investment security climaxed in the summer of 2012. The recovery of equity value in the region should occur in successive waves whose strength will determine the extent to which the European region is capable of delivering a degree of international equity out-performance. The last wave of value recovery peaked in October. We expect the QE3-exit market disruption of early 2014 to provide the next opportunity to reset value-risk trades in the region. Until then we counsel patience.

Weightings and asset allocation for the MSCI Europe Universe



06/12/2013 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 9.9 1.1 OW 14
Automobiles & Components 3.0 1.6 OW 4
Consumer Durables & Apparel 2.7 1.2 OW 3
Consumer Services 0.9 0.9 OW 1
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 23
Banks 11.0 1.5 N 11
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 N 12
Healthcare Equipment & Services 1.2 0.4 N 1
Pharmaceuticals & Biotechnology 11.5 0.5 N 11
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 6
Utilities 3.9 0.9 UW 2
Exposure to risk
(beta value)
  1.06    
Lquidity ratio   5%    
* 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