Frustration prolonged

  • The failure of the investment consensus to anticipate the shift in market behaviour of the last few months is producing unease. “Growth” is not the problem. The principal explanation is provided by the disinflation shock in the major economies. It has allowed developed credit to take over from developed equity as the leadership asset category of the last six months.
  • The good news is that trans-Atlantic equity assets have demonstrated resilience. Our perception is that there is rather less downside risk attached to them than in Q1. The bad news is that the pattern of market behaviour that has prevailed since last November has not yet been broken. Still, the message is patience. The equity bull market will only be in real trouble when the cost of debt must rise, beginning in America. The stalemate in markets should be broken before the end of this quarter.

Recommended sector and market asset allocation

The failure of the investment consensus to anticipate the shift in market behaviour of the last few months is producing unease. “Growth” is not the problem. The principal explanation is provided by the inflation surprise – the disinflation shock - in the major economies. It is primarily global in origin, corresponding to an improvement in the terms of trade for the developed world. The structural forces at work are those of over-investment, over-capacity and declining corporate profitability in the post-boom emerging economies. The disinflation shock is associated with downward pressure upon the profitability of companies operating in global markets. Its ambiguous effects are causing confusion. It has facilitated the maintenance of a super-low cost of debt throughout the developed world. It has allowed developed credit to take over from developed equity as the leadership asset category of the last six months. It is not coincidental that Japanese equity has become the outstanding under-performing asset from an international perspective whilst consistent out-performance has been delivered by the financial assets of the EZ periphery. The assumption that the disinflation shock will fade from this time is doubtless the most significant source of macro-economic uncertainty affecting the pricing of financial assets.

The good news is that trans-Atlantic equity assets have demonstrated resilience. They have absorbed the disturbances produced by the weakness of momentum stocks without experiencing a significant setback. Our perception is that there is rather less downside risk attached to trans-Atlantic equity markets than there was in the first quarter. The bad news is that the pattern of market behaviour that has prevailed since last November has not yet been broken, notably by reference to the most secure debt markets and the major currency parities. Since we never shared the consensus view of the beginning of the year we are not tempted to change our narrative. The message is patience not panic. Our equity bull market is in real trouble when the cost of debt must rise, beginning in America. Clearly, we have not reached that point. We still expect that the stalemate in markets will be broken before the end of this quarter. Higher multiple, high EPS stocks remain vulnerable in this quarter. We are backing off from the Technology sector.

Weightings and asset allocation for the MSCI Europe Universe



28/04/2014 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 9.9 1.1 OW 12
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 2
Retailing 1.3 0.9 N 1
Consumer Staples 14.1 0.5 UW 9
Food & Staples Retailing 1.7 0.8 UW 1
Fod Beverage & Tobacco 10.7 0.5 UW 7
Household & Personal Product 1.8 0.5 UW 1
Energy 9.4 1.0 UW 8
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 6
Real Estate 1.0 1.1 OW 2
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 N 12
Capital Goods 9.0 1.2 N 9
Commercial Services & Suppy 1.4 0.8 UW 1
Transportation 1.2 1.0 OW 2
Information Technology 3.1 1.0 N (OW) 3
Software & Services 1.4 0.9 UW 1
Technology & Hardware Equipment 0.9 1.2 N (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 N 4
Exposure to risk
(beta value)
  1.06    
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