Dust to Dust (QED)

  • Investor over-enthusiasm has been removed. The sources of market disturbance are not substantial. The under-performance of emerging assets is an old story with much further to run. We are reducing our portfolio liquidity ratio to 4%.
  • The market setback has provided a practical demonstration of the argument that the sources of equity risk are changing. If investors are disturbed they are not disturbed in the same ways as in the past.
  • We are making an adjustment to our recommended portfolio that marks our conviction about the nature of this investment year. We are upgrading the Banking sector from N to OW and reducing the Energy sector from N to UW.

Recommended sector and market asset allocation

The over-enthusiasm for our bull-market-without-apparent-risk has been removed. A more cautious mood now prevails. This is the point at which we begin to feel positive again. Although it may be some weeks before equity markets are able to sustain an advance to higher ground we want to accumulate stocks on any weakness from this time. The sources of market disturbance are not substantial. We raised our portfolio liquidity ratio from 3% to 5% last November 18th. We are moving back towards a “fully invested” position by reducing it to 4%.

The market setback has provided a practical demonstration of the argument that the sources of equity risk are changing. High beta sectors and stocks have not notably under-performed in the setback. Equity quality is no longer the default defensive option. The distribution of returns by equity style has not followed the familiar patterns. Smaller caps have not under-performed. Earnings momentum does not work. If investors are disturbed they are not disturbed in the same ways as in the past. QED.

Following more than three years of under-performance the relative global price of emerging equity has almost returned to its mean of the last 25 years. The relative profitability of emerging equity peaked more than five years ago. Price follows profitability. The idea that the problem is “Fed tapering” is simplistic nonsense. The emerging world has lost its financial stability. Without stability its boom is unsustainable. It is not our perception that 2014 is 1997 for the emerging world. However, it might be 1996.

We are making an adjustment to our recommended portfolio that marks our conviction about the nature of this investment year. We are upgrading the Banking sector from N to OW and reducing the Energy sector from N to UW. The Banks remain the barometer of the revival of the European economy in general and of domestic value assets in particular. The longer term perspective emphasises that there is still scope for both valuation and profitability recovery. The label of “global value” for the Energy sector is incontestable. However, there is no indication that the relative decline of profit growth and profitability in the sector is decelerating, still less reversing.

Weightings and asset allocation for the MSCI Europe Universe



31/01/2014 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 2
Media 1.9 0.8 OW 3
Retailing 1.3 0.9 OW 2
Consumer Staples 14.1 0.5 UW 8
Food & Staples Retailing 1.7 0.8 UW 1
Fod Beverage & Tobacco 10.7 0.5 UW 6
Household & Personal Product 1.8 0.5 UW 1
Energy 9.4 1.0 UW (N) 8
Financials 21.6 1.5 OW 24
Banks 11.0 1.5 OW (N) 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 N 13
Healthcare Equipment & Services 1.2 0.4 N 1
Pharmaceuticals & Biotechnology 11.5 0.5 N 12
Industrials 11.6 1.1 OW 13
Capital Goods 9.0 1.2 OW 10
Commercial Services & Suppy 1.4 0.8 N 1
Transportation 1.2 1.0 OW 2
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 3
Exposure to risk
(beta value)
  1.07    
Lquidity ratio   4% (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