The bear trap, and bigger themes

  • A “bear trap” characterises our interpretation that European equity will recover from July through to the autumn. Exchange rate adjustment is the catalyst. Europe’s economic recovery is not compromised.
  • We suspect that the most significant development in July is the reversal in the high yield market, which we view as the leading indicator of the second phase of adjustment of the US$ debt space. We think that corporate credit spreads are establishing multi-year floors. The profittaking in corporate credit should extend to sovereign spreads and emerging debt.
  • In a more general sense financial markets are already anticipating monetary adjustment in America. The loss of smaller cap leadership and the climax of the valuation of America’s growth universe announce the end of the investment cycle.

Recommended sector and market asset allocation

We recapitulate three strategic themes. The bear trap in European equity has been our focus in July. We think that profit-taking in the credit space is the predominant story of this third quarter. The transition to lower returns on financial risk assets is the major theme of 2014.

A “bear trap” characterises our interpretation that European equity will recover from July through to the autumn. We have emphasised the significance of the US$1.35 threshold for the euro, beyond which earnings relief for European corporates begins to be anticipated. Exchange rate adjustment implies the stabilisation of inflation expectations in the euro zone and the end of the under-performance of European equity relative to the US benchmark. Europe’s economic recovery is not compromised. Deflationary forces of domestic origin continue to fade in almost all economies of the region. We expect Europe’s banks to perform better in the year’s second half.

We suspect that the most significant development in July is the reversal in the high yield market, which we view as the leading indicator of the second phase of adjustment of the US$ debt space. We are assuming that Europe’s benchmark credit indices are establishing a multi-year floor. We expect the profit-taking in corporate credit to extend to sovereign spreads and emerging debt by September.

In a more general sense financial markets are already anticipating monetary adjustment in America. In the US equity space the stabilisation of price multiples signals the end of the rise of the valuation of America’s growth universe of stocks. The loss of smaller cap leadership is an advance indicator of the end of the investment cycle. From the perspective of market leadership it could be said that the bear market for the active fund management industry has already begun.

Weightings and asset allocation for the MSCI Europe Universe



28/07/2014 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 10.0 1.1 OW 11
Automobiles & Components 3.3 1.5 OW 4
Consumer Durables & Apparel 2.4 1.1 OW 3
Consumer Services 0.9 0.9 OW 2
Media 2.0 0.9 UW 1
Retailing 1.3 0.9 UW 1
Consumer Staples 13.3 0.7 N (UW) 13
Food & Staples Retailing 1.4 1.0 UW 1
Fod Beverage & Tobacco 10.3 0.6 N 10
Household & Personal Product 1.7 0.7 OW (N) 2
Energy 9.6 0.9 OW 11
Financials 22.4 1.3 N 23
Banks 11.8 1.3 N 11
Diversified Financials 3.7 1.4 N 4
Insurance 5.8 1.2 N 6
Real Estate 1.1 0.9 OW 2
healthcare 12.7 0.8 N 13
Healthcare Equipment & Services 1.1 0.6 N 1
Pharmaceuticals & Biotechnology 11.6 0.8 N 12
Industrials 11.1 1.1 UW 9
Capital Goods 8.5 1.1 UW 7
Commercial Services & Suppy 1.3 0.8 UW 1
Transportation 1.4 1.0 OW 2
Information Technology 3.2 1.1 UW 2
Software & Services 1.5 0.9 UW 1
Technology & Hardware Equipment 1.0 1.3 UW 0
Semiconducors 0.8 1.2 UW 0
Materials 8.3 1.2 N 8
Telecommunication services 4.9 0.9 OW 6
Utilities 4.4 0.8 N 4
Exposure to risk
(beta value)
  1.01    
Lquidity ratio   2%    
* 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