Disease of the heart

  • The recent decline of real bond yields does not represent a “growth scare” of the usual kind. The explanation relates to the mediocrity of the longer term outlook for growth. At this time the growth correction in trans- Atlantic equity markets is exhausted. The shift into defensive stocks since March has not been sustained. A balanced portfolio is appropriate.
  • We discuss the deflation risk premium attached to the core debt of the EZ. Only parts of Europe are in trouble. France is the most troublesome case due to the country’s political paralysis. The EZ has to accommodate the French depression at this time. There should be little surprise attached to the ECB’s initiatives this week. We would stay with reflation plays in Europe even though it may be a while before the market verdict becomes clear.

Recommended sector and market asset allocation

The persistent strength of the most secure debt markets this year does not represent a “growth scare” of the usual kind. The decline of real bond yields is taking place without financial stress or immediate anxiety about the growth of output. The explanation relates to the mediocrity of the longer term outlook for growth. Moreover, the downward movement of yields registered in markets outside the USA has exerted a significant influence upon US$-denominated debt. We assume that although the major bond markets will stay well bid at this time their upside potential is practically exhausted. The growth correction in trans-Atlantic equity markets is complete, at least for the moment. The shift into defensive stocks since March has not been sustained. A balanced portfolio is appropriate.

We discuss the deflation risk premium attached to the core government debt of the EZ. “Europe” is no longer in trouble. The prospects for many European economies appear to be good. Only parts of Europe are in trouble. France is the most troublesome case. The EZ’s debt crisis did not give rise to structural reform and real adjustment in France. The competitiveness of the French economy has not been restored. Although prices are not falling in France a deflationary psychology is gaining ground whose fundamental origins are political paralysis. The debate about the reform of the EU is to a significant extent the question of reform in France. Although we think that France will ultimately follow the example of its neighbours we cannot say how or when the change will take place. The EZ has to accommodate the French depression at this time. There should not be much surprise attached to what the ECB will announce on Thursday. We would stay with reflation plays in Europe, which includes financials, even though it may be another week or two before the market verdict becomes clear. We would increase our commitment to equity if markets weaken significantly after the ECB’s announcements.

Weightings and asset allocation for the MSCI Europe Universe



26/05/2014 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 N 2
Retailing 1.3 0.9 N 1
Consumer Staples 14.1 0.5 UW 12
Food & Staples Retailing 1.7 0.8 UW 1
Fod Beverage & Tobacco 10.7 0.5 N 10
Household & Personal Product 1.8 0.5 UW 1
Energy 9.4 1.0 N 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 UW 10
Capital Goods 9.0 1.2 UW 7
Commercial Services & Suppy 1.4 0.8 UW 1
Transportation 1.2 1.0 OW 2
Information Technology 3.1 1.0 UW 2
Software & Services 1.4 0.9 UW 1
Technology & Hardware Equipment 0.9 1.2 UW 0
Semiconducors 0.9 1.0 UW 0
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)
  1.05    
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