The De-Rating of Global Cyclical Growth

  • Our assumption that “the money stays in equity markets” is being put to the test in Europe. We expect the EuroStoxx 50 to hold above the 3000 area, from where a recovery should be able to build.
  • Our interpretation is that we are witnessing a de-rating of the global cyclical (non-commodity) growth theme. The pressure has extended from industrial cyclicals to the global consumer cyclicals. Europe’s problem is that the relative contribution of global growth to the profitability of its companies has been more important than in any other region in recent years.
  • Our credo is the re-convergence of equity valuations and of corporate profitability within Europe. We are downgrading the German market and the more globally-exposed compartments of the Consumer Discretionary segment: Autos (to N) and Consumer Durables (to UW). We are upgrading the Insurance sector because it has become a clear value play.
Please note that the next EIN is scheduled to be published on August 18th

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.

Our assumption that “the money stays in equity markets” – that capitulation selling does not occur – is being put to the test in Europe. The behaviour of the US Treasury market suggests that the S&P500 should not trade below the 1890-1900 level at this time. The July payroll report relieved the immediate pressure upon the short end of the Treasury curve. Accordingly, we expect the DJ ES50 – a better benchmark for Europe’s markets than the Dax or CAC40 at this time – to hold above the 3000 area, from where a recovery should be able to build. We should know quite soon if our assumption is correct.

We are downgrading the more globally-exposed compartments of the Consumer Discretionary segment: Autos (to N) and Consumer Durables (to UW). We also want to downgrade Germany from N to UW. There is a common theme here. Europe’s equity correction since mid-June has been concentrated upon the cyclical universe, especially in the euro zone. The selling has extended from industrial cyclicals to the global consumer cyclicals. Our understanding is that global, non-commodity, cyclical growth is being de-rated. It is becoming more difficult for European companies operating in global markets to maintain margins and profitability that are high by historic standards due to exacerbated competition from America and the emerging world. Moreover, geo-political risk amplifies the decline in the world trade multiplier. Europe’s global cyclical growth stocks are converging upon the valuation discount that is already apparent in America. The message concerns future investment risk.

We want to continue to apply our belief in the re-convergence of the valuation and the profitability of global and domestic assets within Europe. The argument is the return-to-mean of the excess profitability of the global growth investment theme in an endcycle context in which the premium for equity growth is under pressure. The context leads us to upgrade the Insurance sector from neutral to over-weight because it has become a clear value play. No other sector in Europe with such consistent relative strength of profit growth is so cheap. The performance of Insurers remains positively correlated with that of the Banks. But, precisely, the derating is in the cyclical universe. The reporting season is producing a stabilisation of Europe’s banks.

Weightings and asset allocation for the MSCI Europe Universe



04/08/2014 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 9.9 1.1 UW (OW) 9
Automobiles & Components 3.2 1.5 N (OW) 3
Consumer Durables & Apparel 2.4 1.1 UW (OW) 2
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 1.3 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 OW (N) 24
Banks 11.9 1.3 N 12
Diversified Financials 3.6 1.4 N 3
Insurance 5.8 1.2 N 7
Real Estate 1.1 0.9 OW 2
healthcare 13.0 0.7 N 13
Healthcare Equipment & Services 1.1 0.6 N 1
Pharmaceuticals & Biotechnology 11.9 0.8 N 12
Industrials 11.1 1.1 UW 9
Capital Goods 8.4 1.1 UW 6
Commercial Services & Suppy 1.3 0.8 UW 1
Transportation 1.4 1.0 OW 2
Information Technology 3.3 1.1 UW 2
Software & Services 1.5 0.9 UW 1
Technology & Hardware Equipment 1.0 1.3 UW 0
Semiconducors 0.8 1.1 UW 0
Materials 8.2 1.2 N 8
Telecommunication services 5.0 0.9 OW 6
Utilities 4.3 0.8 N 4
Exposure to risk
(beta value)
  1.00    
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