The Elephant Moves

  • An important week for markets. The re-pricing of US$ interest rate risk is the motor of market turmoil. Equity markets require stabilisation of US$ debt markets before any kind of recovery can be sustained.
  • We expect the current wave of adjustment in debt markets to be exhausted by the end of this month because the re-pricing is proceeding so rapidly. Intervention of the Fed and PBoC will come if dislocation extends.
  • We reiterate a number of strategic principles. The principal message for equity portfolios is that equity growth is cheap relative to equity yield. The re-pricing of capital has begun due to the recovery of private investment in America. Still, this process is just beginning: it is not yet critical.

Recommended sector and market asset allocation

This promises to be an important, stressful week for markets. The re-pricing of US$ interest rate risk is the motor of market turmoil. The investment world has misread the Fed because it has under-estimated the evidence that de-leveraging in the US private sector has come to an end and has been over-impressed by the “helicopter Ben” stereotypes. Equally, the Fed has misread markets. The reversal in the fixed income space is of enormous significance. Investors should now be familiar with the assets that are most vulnerable, beginning with precious metals and extending through the range of emerging assets. The perception of risk in China is approaching a psychosis. The pullback in Europe’s equity markets has become full correction.

Equity markets require stabilisation of US$ debt markets before any kind of recovery can be sustained. Forward markets are now discounting a profile for US$ rates through 2016 that is compatible with a further strengthening of growth in the US economy. Central Banks would not want the adjustment to extend further at this time: the intervention of the Fed and PBoC will come if dislocation extends. A degree of debt overshooting seems inevitable. We could see the 10-year T-note yield spike to the 2.75% level. Still, we would expect the current wave of adjustment in debt markets to be exhausted by the end of this month because the re-pricing is proceeding so rapidly. The S&P500 is testing support in the 1550-70 area. Extreme risk is to the 1500-1520 area.

We set out separately a number of strategic principles. The principal strategic message for equity portfolios is that equity growth is cheap relative to equity yield. We have always assumed that the loss of cheap capital will bring an end to the current equity bull market because cheap capital is its organising principle, defining its leadership theme; that of secure growth. The re-pricing of capital has begun due to the recovery of private investment in America. However, our interpretation is that this process will become critical when yields on 10- year Treasuries are trading above 3%, moving towards 4%. We are not expecting to see this occur this year.

Weightings and asset allocation for the MSCI Europe Universe



14/06/2013 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 9.4 1.1 OW 14
Automobiles & Components 2.7 1.6 OW 4
Consumer Durables & Apparel 2.6 1.2 OW 3
Consumer Services 0.9 0.9 OW 2
Media 1.9 0.8 OW 3
Retailing 1.3 0.9 OW 2
Consumer Staples 14.8 0.5 OW 16
Food & Staples Retailing 1.7 0.7 OW 2
Fod Beverage & Tobacco 11.3 0.5 OW 12
Household & Personal Product 1.9 0.6 OW 2
Energy 9.8 1.0 N 10
Financials 20.9 1.5 OW 22
Banks 10.5 1.5 OW 12
Diversified Financials 3.8 1.6 N 4
Insurance 5.6 1.4 N 6
Real Estate 1.0 1.0 N 1
healthcare 13.0 0.6 UW 10
Healthcare Equipment & Services 1.2 0.5 UW 1
Pharmaceuticals & Biotechnology 11.7 0.6 UW 9
Industrials 11.4 1.2 UW 10
Capital Goods 8.8 1.2 UW 8
Commercial Services & Suppy 1.4 0.8 N 1
Transportation 1.2 1.0 UW 1
Information Technology 3.2 1.0 OW 4
Software & Services 1.5 0.9 OW 2
Technology & Hardware Equipment 0.9 1.1 OW 1
Semiconducors 0.8 1.1 OW 1
Materials 8.1 1.3 OW 9
Telecommunication services 5.5 0.7 UW 3
Utilities 4.0 0.9 UW 2
Exposure to risk
(beta value)
  1.03    
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