Q4 Exit Strategy

  • We explain our exit strategy for this “last quarter of the last year of the bull market of monetary super-stimulus”.
  • We are assuming that this equity investment year will come to an end in profit-taking in November. Credit and currencies have provided the expected signals. We intend to raise our portfolio liquidity ratio progressively through October into November. We will then move towards a portfolio position that we think will best protect equity capital in Europe through the dangerous period of the first half of next year. A conventional defensive-only approach is not going to be sufficient.

Recommended sector and market asset allocation

We explain our exit strategy for this “last quarter of the last year of the bull market of monetary super-stimulus”. The process of discounting the withdrawal of America’s hyper-reflation began almost eighteen months ago. It is less and less controversial to think that the Fed should be ready to begin the process of raising US$ rates by Q2 of next year. According to our investment principles, it is not possible to change an investment environment without a degree of disruption. The day of the announcement that “the Fed raises rates” the transition should be virtually complete. For equity values the several months that proceed this date should be the most difficult. We are assuming that this equity investment year will come to an end in profit-taking in November, as is habitually the case. Credit and currencies have provided the expected signals. This time, however, we doubt that funds will return to produce the usual year-end equity rally that spills over into January. We have already seen the end of the rise of equity price multiples and a decline in market breadth on Wall Street. The final stage should be the fall of major equity price indices to an extent that is “significant but not traumatic”. We think that this means a correction of the order of 10-20% for major US benchmarks.

Week after week through October and November our intention is to raise the liquidity ratio of our portfolio, from the bottom of the range that we allow ourselves to the top. We began last week. This week we go to 4%, close to our long-term average. We do not want to make a precipitous call in response to market behaviour. We will gradually move towards a portfolio position that we think will best protect equity capital in Europe through the dangerous period of the first half of next year. The difficulty is that a conventional defensive-only approach is not going to be sufficient due to the flight to greater security that has characterised the last six months in Europe. We think that equity values will probably rally into November. However, many investors – like us – will use such a movement to reduce their exposure. The continuation of Europe’s equity resurgence in a more authentic sense will have to wait for the period beyond the turbulence that we expect to be produced by the approach of America’s monetary return-tomore- normal.

Weightings and asset allocation for the MSCI Europe Universe



06/10/2014 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 1.0 0.9 OW 2
Media 2.1 0.9 N 2
Retailing 1.4 1.0 UW 1
Consumer Staples 13.2 0.7 N 13
Food & Staples Retailing 1.1 1.1 UW 0
Fod Beverage & Tobacco 10.4 0.7 N 10
Household & Personal Product 1.7 0.7 OW 2
Energy 9.1 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 13.9 0.8 OW 17
Healthcare Equipment & Services 1.2 0.6 OW 2
Pharmaceuticals & Biotechnology 12.7 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 7.5 1.2 N 7
Telecommunication services 5.0 0.9 N 5
Utilities 4.4 0.8 N 4
Exposure to risk
(beta value)
  1.01    
Lquidity ratio   4% (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