Interpreting the Malaise

  • The frustration continues. Still, we doubt that equities are vulnerable to a significant pullback at this point. The problem is not the growth of employment, spending and output in the trans-Atlantic economies. We do not expect to see US$ bond yields decline further.
  • The context benefits Europe’s larger cap value stocks. Europe’s Energy sector has finally revived, marking a major valuation bottom. We are removing our long-standing UW position here. We are also moving from N to UW in the Technology sector
  • We examine the problem with the equity growth style. The “take-off” metaphor for the US economy has lost credibility. It seems to us that it is too late in this investment cycle for there to occur a significant increase in the premium for equity growth.

Recommended sector and market asset allocation

The frustration continues. We are not convinced that the selling pressure is yet exhausted among growth stocks and in the smaller cap universe. Europe’s larger cap value stocks have benefitted. Smaller cap growth has become the most vulnerable of Europe’s equity compartments. Still, we doubt very much that equities are vulnerable to a significant pullback at this point. Equity markets are absorbing the pressure upon higher multiple growth stocks without serious damage because growth-duration and purely cyclical assets are in no trouble. The problem is not the growth of employment, spending and output in the trans-Atlantic economies. Accordingly, we do not expect to see US$ bond yields decline further. However, upside potential for equities is limited and the bias in favour of more defensive stocks that has emerged since March will probably remain this quarter. In this context Europe’s Energy sector has finally revived, marking a major valuation bottom. We are removing our long-standing UW position. We are also moving from N to UW in the Technology sector because the sector contains many smaller cap, higher multiple, higher EPS growth stocks.

The influence of the Ukraine can only provide a partial explanation for the frustration. In last week’s note we explained the influence of the disinflation shock. This week we examine the problem with the equity growth style. What has changed recently concerns the probability of an acceleration of growth in America. The rise in the confidence about growth prospects that was perceptible in 2013 has stalled. The “take-off” metaphor has lost credibility. Fewer think that US growth on average through 2015 will be above 3%. It is beginning to be realised that the potential, non-inflationary growth rate of the US economy is probably much closer to 2% than to 3% and that the Fed has become more aware of the potential costs of providing more monetary stimulus. Our hypothesis is that it is too late in this investment cycle for there to occur a significant increase in the premium for equity growth.

Weightings and asset allocation for the MSCI Europe Universe



05/05/2014 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 10
Food & Staples Retailing 1.7 0.8 UW 1
Fod Beverage & Tobacco 10.7 0.5 UW 8
Household & Personal Product 1.8 0.5 UW 1
Energy 9.4 1.0 N (UW) 9
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 11
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 UW (N) 2
Software & Services 1.4 0.9 UW 1
Technology & Hardware Equipment 0.9 1.2 UW (N) 0
Semiconducors 0.9 1.0 UW (N) 0
Materials 8.1 1.3 N 8
Telecommunication services 5.5 0.8 OW 7
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