Hubris of the Pax Germanica

  • The conflict with Russia represents a significant shock to the European region, amplifying the trans-Atlantic divergence of economic policy and performance. It should provide the catalyst for policy reformulation in the EZ. It has emphasised the vulnerability of Germany. Early 2014 marked the zenith of the perception of the economic supremacy of the German economy within Europe.
  • The summer has delivered a text book case of a bear trap in Europe’s equity space. At this point our understanding is that the phase of short squeeze is at an end. Consolidation now follows, below the threshold of 3200 for the DJ ES50. However, we do not think that the recovery of European equity is complete because the bull market in both US equity and in European debt should extend through the weeks ahead.
  • We want to increase exposure to equity that will benefit from currency adjustment whilst maintaining the principle of the “balanced portfolio”. We are upgrading the Healthcare sector to OW and downgrading Telecoms to N.

Recommended sector and market asset allocation

The conflict with Russia represents a significant economic and political shock to the European region which has amplified the trans- Atlantic divergence of economic policy and performance. The Ukraine has become a metaphor for the vulnerability of Europe, and of the German economy in particular. It is clear to us that early 2014 marks the zenith of the perception of the economic supremacy of Germany within Europe. The confrontation with Russia should provide the catalyst for policy reformulation. Without more growth-friendly policies in the EZ there will be renewed political crisis. However, Germany has a peculiar inability to cope with deflation anxiety. Largely as a consequence, Germany’s influence upon economic policy in the region has begun to fade. Markets are implementing a de facto QE programme without waiting for policy announcements.

The summer has delivered a text book case of a bear trap in Europe’s equity space. At this point our understanding is that the phase of short squeeze is at an end. We expect consolidation to characterise this end-of-summer re-entry period, below the threshold of 3200 for the DJ EuroStoxx50. Investors are waiting to see Russia’s next move. Beyond this phase of consolidation, our perception is that the recovery of European equity is not complete because the bull market in both US equity and in European debt should extend through the weeks ahead.

We want to increase exposure to equity that will benefit from currency adjustment whilst maintaining the principle of the “balanced portfolio”, balanced in terms of exposure to growth and value and to security and risk. A bias to more secure stocks over the last few months has been unavoidable but we have refused to move into an excessively defensive posture for reasons that have been demonstrated over the last few weeks. We are moving from N to OW in the Healthcare sector at the expense of the Telecoms sector which we are downgrading to N. Healthcare should continue to attract funds, including from corporates themselves, in current circumstances whilst there is less scope for earnings upgrades in Telecoms.

Weightings and asset allocation for the MSCI Europe Universe



01/09/2014 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 9.9 1.1 UW 9
Automobiles & Components 3.1 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 10.4 0.6 N 10
Household & Personal Product 1.7 0.7 OW 2
Energy 9.5 0.9 OW 11
Financials 22.5 1.3 OW 24
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 13.2 0.8 OW (N) 15
Healthcare Equipment & Services 1.1 0.6 OW (N) 2
Pharmaceuticals & Biotechnology 12.0 0.8 OW (N) 13
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 2
Software & Services 1.5 0.9 UW 1
Technology & Hardware Equipment 1.0 1.3 N 1
Semiconducors 0.9 1.1 N 1
Materials 8.0 1.2 N 8
Telecommunication services 4.9 0.9 N (OW) 5
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