The Terrible Twins

  • Trans-Atlantic equity values are approaching the upper end of their consolidation range. We doubt that the break-out will come until we have more clarity about economic activity in America.
  • Financial conditions in the trans-Atlantic space, in the EZ in particular, have become exceptionally calm and stable. The principal explanation is the price regime. Financial stability is encouraging valuation reconvergence within Europe.
  • We explain why we are upgrading the Italian market but we are not ready to upgrade the French market.

Recommended sector and market asset allocation

Over the last three months trans-Atlantic equity markets have defined a range of consolidation that marks the transition to more normal returns and more stable price multiples on Wall Street. A pattern of consolidation also continues in debt and forex markets. Through this transition our guiding principle is patience. We do not chase the market. We buy the setbacks. Equity values are approaching the upper end of their consolidation range. We doubt that they are yet ready to break out of the range. In America economic activity has weakened since the end of last year and no one is yet clear of the extent to which the exceptionally severe weather is the cause. We expect the spring to bring clarification and the break-out.

Financial conditions in the trans-Atlantic space, in the EZ in particular, have become exceptionally calm and stable. The principal explanation is the price regime. Financial stability amplifies valuation re-convergence within Europe, encouraging markets to adopt a longer horizon when pricing the return-to-more-normal of financial assets in the region. In this context we are upgrading the Italian market from N to OW. First, the context of disinflationary growth should ensure the complete valuation return–to-mean of Italian equity. Second, the Italian market’s high exposure to “domestic value” assets is no longer a handicap. Third, Italy’s political rejuvenation reduces the barriers to the redeployment of capital and labour. Italy has the greatest potential for recovery of the productivity and profitability of capital of any large European economy. The revival of corporate profitability is becoming visible. The redeployment of household savings and corporate capital implies a more active stock market.

We also explain why we are not ready to upgrade the French market. The EZ’s crisis has produced political change in Italy that has a plausible agenda, beginning with electoral reform. The realignment of economic policy in France is not yet decisive. The recovery of activity and profitability in France is lagging that of Europe in general because the French themselves do not yet believe in it. We will upgrade the French market when we see improvement of the remarkably depressed level of confidence among French consumers and businesses.

Weightings and asset allocation for the MSCI Europe Universe



14/02/2014 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 7
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 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 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)
  1.07    
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