Sit and Stay

  • We consider why this year is so difficult for active equity FMs, especially in Europe. The entire trans-Atlantic investment space is currently approaching the end of the cycle of monetary super-stimulus, led by America. Certain components of the bull market are already exhausted, notably the out-performance of smaller caps. A new phase of economic expansion is struggling to emerge in Europe. The established patterns of profit growth and of relative profitability within the region are breaking down but the new are not yet apparent. The consequence is valuation return-to-mean.
  • September trading is dominated by the shift in investors’ perception of the status of the US$. Investor caution in Europe encourages us to think that there is more upside for equity values through the weeks ahead. Our “balanced” portfolio is still “fully invested”. However, we designate Q4 for profit-taking.

Recommended sector and market asset allocation

We consider why this year is so difficult for active equity FMs, in Europe in particular. Europe is experiencing a double transition. The entire trans-Atlantic investment space is currently approaching the end of the cycle of monetary super-stimulus, led by America. Certain components of the bull market are already exhausted, notably the out-performance of smaller caps. The transition that is specific to Europe is the consequence of the upheavals of the period since 2007. A new phase of economic expansion is struggling to emerge with different patterns of relative economic performance that do not conform to investor pre-conceptions. The defining feature of the transition to the new Europe is valuation re-convergence and return-to-mean. The established trends of profit growth and of relative profitability within the region are breaking down. It is too early to discern the new hierarchies of profitability. Accordingly, the market is wiping the slate clean, systematically re-setting valuations at long-term trend levels. Competition is the principal motor of profitability return-to-mean, which translates into changes in corporate pricing power and relative prices. In this respect we have emphasised the displacement of Europe’s deflation risk from domestic assets to global product markets.

September trading is dominated by the shift in investors’ perception of the status of the US$, which is another barometer of America’s end-cycle. It has brought commodity weakness which has spilled over into under-performance by emerging markets. We suspect the US$ will consolidate its recent gains through October. However, the longer term message should be clear.

In European equity investors remain reluctant to leave the perceived safety of large cap defensive stocks even though higher risk stocks have ceased to under-perform since July. Financials continue to out-perform in both America and Europe. However, industrial cyclicals are still not out-performing in Europe despite forex adjustment. Investor caution encourages us to think that there is more upside for equity values through the weeks ahead, and probably more in Europe than in America. Our “balanced” portfolio is still “fully invested”, with a liquidity ratio of just 2%. However, we designate Q4 for profit-taking.

Weightings and asset allocation for the MSCI Europe Universe



15/09/2014 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 9.8 1.1 N 9
Automobiles & Components 3.1 1.5 N 3
Consumer Durables & Apparel 2.3 1.0 UW 1
Consumer Services 0.9 0.9 OW 2
Media 2.1 0.9 N 2
Retailing 1.4 0.9 UW 1
Consumer Staples 13.3 0.7 N 13
Food & Staples Retailing 1.2 1.0 UW 1
Fod Beverage & Tobacco 10.3 0.7 N 10
Household & Personal Product 1.7 0.7 OW 2
Energy 9.2 0.9 UW 7
Financials 22.8 1.2 OW 26
Banks 12.7 1.3 N 13
Diversified Financials 3.1 1.4 N 3
Insurance 5.9 1.1 OW 7
Real Estate 1.1 0.9 OW 2
healthcare 13.6 0.8 OW 16
Healthcare Equipment & Services 1.2 0.6 OW 2
Pharmaceuticals & Biotechnology 12.4 0.8 OW 14
Industrials 11.0 1.1 UW 9
Capital Goods 8.3 1.1 UW 6
Commercial Services & Suppy 1.2 0.8 UW 1
Transportation 1.5 1.0 OW 2
Information Technology 3.3 1.1 OW 4
Software & Services 1.4 0.9 UW 1
Technology & Hardware Equipment 1.0 1.3 OW 2
Semiconducors 0.9 1.1 OW 2
Materials 7.8 1.2 N 7
Telecommunication services 4.9 0.9 N 5
Utilities 4.3 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