The elephant in the room

  • We are assuming that the recent pullback in equity markets is complete. Equity values should be able to resume their upward movement.
  • It is becoming clearer that Q2 2013 is the beginning of the bear market in US$-denominated credit. A different kind of credit risk has emerged which at this initial stage relates to investor repositioning in a context of steepening of yield curves.
  • We conclude that we should not expect equity price multiples to rise much further on Wall Street. We expect a period of consolidation of equity values beyond July-August.

Recommended sector and market asset allocation

We are assuming that the recent pullback in equity markets is complete, including that of the Japanese market. Equity values should be able to resume their upward movement into the summer.

In this week’s note we focus upon developments in US$ credit markets. It is becoming clearer that Q2 2013 is the beginning of the bear market in US$-denominated credit, validating the diagnosis that Q3 2012 marked a turning point for the pricing of the world’s most secure government debt. The commodity-emerging capitulation of April is linked to the turmoil in US$ credit funds by the rise in “real” yields of Treasuries through May. The link is the transfer of investor allegiance from “global growth led by China” to “American revival”.

Even small shifts in investor perceptions of our investment future have the potential to cause huge disturbances in the fixed income world because there is over-valuation and investor over-exposure in this space. Indeed, it is the perception among investors that interest rate risk is negligible that has created the investment risk.

We expect the pressure upon US$ bonds to continue through the weeks ahead. A different kind of credit risk has emerged which at this initial stage relates to investor re-positioning in a context of steepening of yield curves, which should favour cyclical assets, as long as adjustment is not disruptive. If US$ credit markets can now envisage the return of interest rate risk, albeit in the unfamiliar shape of discussion of QE3, then we conclude that we should not expect equity price multiples to rise much further on Wall Street. From this summer we are assuming that earnings growth – at a trend long-term rate of 5-10% - will become the only motor of the rise of equity values in America. This view is consistent with the interpretation of a period of consolidation in equity markets beyond July-August.

Weightings and asset allocation for the MSCI Europe Universe



07/06/2013 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 9.4 1.1 OW 14
Automobiles & Components 2.8 1.5 OW 4
Consumer Durables & Apparel 2.4 1.1 OW 3
Consumer Services 0.9 0.9 OW 2
Media 1.8 0.8 OW 3
Retailing 1.5 0.9 OW 2
Consumer Staples 14.6 0.5 OW 16
Food & Staples Retailing 1.6 0.7 OW 2
Fod Beverage & Tobacco 11.2 0.5 OW 12
Household & Personal Product 1.8 0.6 OW 3
Energy 9.7 1.0 N 10
Financials 21.3 1.5 OW 22
Banks 10.8 1.5 OW 12
Diversified Financials 3.8 1.6 N 4
Insurance 5.6 1.4 N 6
Real Estate 1.0 1.0 N 1
healthcare 12.8 0.6 UW 10
Healthcare Equipment & Services 1.2 0.5 UW 1
Pharmaceuticals & Biotechnology 11.6 0.6 UW 9
Industrials 11.3 1.2 UW 10
Capital Goods 8.8 1.2 UW 8
Commercial Services & Suppy 1.4 0.8 N 1
Transportation 1.2 1.0 UW 1
Information Technology 3.1 1.0 OW 4
Software & Services 1.5 0.9 OW 2
Technology & Hardware Equipment 0.8 1.2 OW 1
Semiconducors 0.8 1.1 OW 1
Materials 8.2 1.3 OW 10
Telecommunication services 5.5 0.7 UW 3
Utilities 4.0 0.9 UW 2
Exposure to risk
(beta value)
  1.04    
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