Despondency and the Bear Trap

  • Our interpretation of the revival of volatility in both the bond and currency space is that the US currency is crossing the threshold from “neutrality” to strength. The implications are considerable.
  • A policy reformulation in the euro area is underway. The bull market in fixed income assets throughout the euro system is extending. In reality, the US$ promises to be the principal motor of the euro zone’s reflation.
  • We have witnessed the operation of a bear trap in European equity this summer: the losses of the last couple of months should be recovered. The recovery is proceeding rapidly. The initial phase is led by the category of cyclical growth stocks whose weakness has been most pronounced since Q1.

Recommended sector and market asset allocation

The disparity this summer between the messages delivered by financial markets on either side of the Atlantic is extraordinary. In America the bull market in risk assets has extended. The S&P500 is trading at the 2000 threshold. In the euro zone the bull market in secure fixed income assets has extended. The interventions by Janet Yellen and Mario Draghi at Jackson Hole tell the story. Our interpretation of the revival of volatility in both the bond and currency space is that the US currency is crossing the threshold from “neutrality” to strength. The implications are considerable.

A policy reformulation in the euro area is underway. The ECB has reiterated its role as anti-deflation backstop. There will be a compromise between France and Germany. German will accept a relaxation of budgetary constraints. France will reaffirm its commitment to structural reform. In reality, the US$ promises to be the principal motor of the euro zone’s reflation. There is no return to credit-financial crisis in the euro zone. The dichotomy between the EZ centre and periphery is gone. The message of economic and strategic vulnerability also concerns Germany. We are witnessing an extension of the bull market in fixed income assets throughout the euro system.

The post-2008 equity bull market in Europe has always been a derivative of America‘s equity bull market and of the bull market in the region’s debt markets. Both these bull markets are manifestly intact. In fact, both these bull markets have extended further than we initially expected this year. Consequently, the bull market in European equity cannot yet be at an end. We have witnessed the operation of a bear trap in European equity this summer: the losses of the last couple of months should be recovered. The recovery is proceeding rapidly. The initial phase is led by the category of cyclical growth stocks whose weakness has been most pronounced since Q1. To mark the change we are removing our under-weight positions in the two segments of the Tech sector that epitomise “cyclical growth” sensitive to the value of the US$: semiconductors and technology hardware.

Weightings and asset allocation for the MSCI Europe Universe



25/08/2014 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 10.0 1.1 UW 9
Automobiles & Components 3.2 1.5 N 3
Consumer Durables & Apparel 2.4 1.1 UW 2
Consumer Services 0.9 0.9 OW 2
Media 2.0 0.9 UW 1
Retailing 1.4 0.9 UW 1
Consumer Staples 13.4 0.7 N 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 2
Energy 9.4 0.9 OW 10
Financials 22.4 1.3 OW 25
Banks 11.8 1.3 N 12
Diversified Financials 3.7 1.4 N 4
Insurance 5.8 1.1 N 7
Real Estate 1.1 0.9 OW 2
healthcare 13.0 0.8 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 N (UW) 3
Software & Services 1.5 0.9 UW 1
Technology & Hardware Equipment 1.0 1.3 N (UW) 1
Semiconducors 0.8 1.1 N (UW) 1
Materials 8.1 1.2 N 8
Telecommunication services 4.9 0.9 OW 6
Utilities 4.3 0.9 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