Leaders and Lemmings

  • With the arrival of Q4 this week we focus upon the apparent paradox of this end-cycle period. Financial markets are focused upon America’s monetary transition. The process of discounting the change in the investment environment is advanced. However, this does not mean that market disruption will be avoided.
  • The most characteristic feature of the European equity space is the outperformance of financials, and the simultaneous under-performance of industrial cyclicals and commodity-sensitive stocks, despite currency adjustment. This is the reflation trade. The counterpart is despondency among European investors.
  • We are not surprised to see rising volatility among US growth stocks. The behaviour of credit and currencies in Q3 reinforces our interpretation that Q4 should be used to take profit in equity because America’s monetary return-to-more-normal is just over the horizon. We are beginning gradually to raise our portfolio liquidity ratio from its “fully invested” level from the beginning of October.

Recommended sector and market asset allocation

With the arrival of Q4 this week we focus upon the apparent paradox of this end-cycle period. Financial markets are focused upon America’s monetary transition. The process of discounting the change in the investment environment is advanced. This does not mean that market disruption will be avoided. Since the spring of 2013 we have been witnessing distribution in trans-Atlantic financial markets. The leading money has been selling gradually and methodically to the lagging money. The retail and the trading money will create the market disruption.

We have maintained our “fully invested, balanced portfolio” despite investor despondency about Europe, which is no surprise. The most characteristic feature of the European equity space at this time is the out-performance of financials, especially in the EZ, and the simultaneous under-performance of industrial cyclicals and commodity-sensitive stocks, despite accelerated currency adjustment. This is the reflation trade. The ECB is using the evidence that long-term inflation expectations are weakening to agitate for a more active policy response. The expectation of “do what it takes” prevents any significant deterioration in the EZ’s debt-credit space. We still think it probable that equity values will register upward surprises through October. Still, the bigger message is the theme of today’s note. The behaviour of credit and currencies in Q3 reinforces our interpretation that Q4 should be used to take profit in equity because America’s monetary return-to-more-normal is just over the horizon.

Accordingly, we are especially attentive to the behaviour of the US equity market at this time because we think that a market climax is approaching. Our focus is upon the leading segments of the leading market; America’s growth stocks. Is Nasdaq already peaking? Perhaps, but we doubt it. The QE3 programme is not yet at an end. It seems too early for yearend profit-taking. Still, we are not surprised to see rising volatility among US growth stocks. We are beginning gradually to raise our portfolio liquidity ratio from its “fully invested” level from the beginning of October, as we said we should.

Weightings and asset allocation for the MSCI Europe Universe



29/09/2014 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 9.7 1.1 N 9
Automobiles & Components 3.0 1.5 N 3
Consumer Durables & Apparel 2.3 1.1 UW 1
Consumer Services 0.9 0.9 OW 2
Media 2.0 0.9 N 2
Retailing 1.4 1.0 UW 1
Consumer Staples 13.2 0.7 N 13
Food & Staples Retailing 1.2 1.0 UW 0
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 22.9 1.2 OW 26
Banks 12.8 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 13.7 0.8 OW 17
Healthcare Equipment & Services 1.2 0.6 OW 2
Pharmaceuticals & Biotechnology 12.6 0.8 OW 15
Industrials 10.9 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 7.6 1.2 N 7
Telecommunication services 5.0 0.9 N 5
Utilities 4.3 0.8 N 4
Exposure to risk
(beta value)
  1.01    
Lquidity ratio   3% (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