Meek inheriting the Earth

  • Investor over-enthusiasm and over-commitment to equity allowed us to buy stocks cheaper. There may be further opportunities to buy weakness later this month. However, we see no discontinuity in the equity world. Our characteristic investment themes are extending their outperformance. Market weakness is concentred in large cap, globallyexposed stocks, especially in the more defensive names.
  • The change in the fortunes of domestic relative to global assets since 2012 reflects the reversal of the sources of disinflation. Deflationary forces within the developed economies are fading. Non-orthodox monetary policy has not succeeded in raising inflation expectations because the emerging world and the commodity space have become a source of disinflation. Domestic assets are benefiting from the prolonged reflation that disinflationary growth is allowing.

Recommended sector and market asset allocation

The year began with investor over-enthusiasm and over-commitment to equity which allowed us to buy stocks cheaper at the beginning of February. Consensus thinking is now in disarray. We expect investors to reposition as markets recover, which implies further opportunities to buy stocks on weakness later this month. From our perspective there is no discontinuity in the equity world at the beginning of 2014. There is confirmation of the messages that emerged from 2012-2013. The context is defined by what it is not: the problem in European equity is not financial stress and the economy. Our characteristic investment themes - the out-performance of higher risk smaller caps, of domestically-oriented companies and of those with comparatively high exposure to European markets - are extending their out-performance. Market weakness is concentred in large cap, globally-exposed stocks, especially in the more defensive names. We did emphasise that the re-convergence of valuations within Europe’s markets would ultimately be determined more by the de-rating of the winners of the 2007-2012 period than by the recovery of the losers.

The change in the fortunes of domestic relative to global assets since 2012 reflects the reversal of the sources of disinflation. Deflationary forces within the developed economies are fading. Nonetheless, non-orthodox monetary policy has not succeeded in raising inflation expectations, largely because the emerging world and the commodity space have become a source of disinflation. The end of the decline of real long-term interest rates in the trans-Atlantic economies reflects the improvement in the expected profitability of domestic assets and the better trade-off between the growth of output and inflation. In this sense, “growth” is not the cause but the consequence.

We are downgrading the Technology software compartment to neutral because it is dominated by a stock that epitomises the category of secure, global growth assets which continues to be de-rated. We are upgrading the small compartment of Real Estate stocks because it represents the kind of domestic asset that benefits from the prolonged reflation in Euroland that disinflationary growth is allowing.

Weightings and asset allocation for the MSCI Europe Universe



07/02/2014 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 7
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 N (UW) 1
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 N (OW) 1
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)
  1.08    
Lquidity ratio   4%    
* 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