Bear Market Rules : don’t panic

  • The “don’t panic” market message concerns the next few weeks. The “sell the rallies” portfolio message relates to the next few months.
  • Trans-Atlantic equity has entered an extended period of correction. First, Europe, then America. We expect the period of difficulty for investors in risk assets to extend through to at least the spring of next year. For this reason there should be no traumatic market break-down because the correction will be extended in time. We think that there is a good probability that US equity will stabilise this week. The influence of the reporting season should be beneficial. We are not expecting to see the SPX trade below the 1900 area at this time.
  • We continue to implement our strategy of capital preservation, ignoring market gyrations. We are upgrading large cap consumer staples and Switzerland at the expense of the EZ. The policy disarray in the EZ implies under-performance. The pax germanica has broken down. It will take time to reformulate a policy consensus for the EZ.

Recommended sector and market asset allocation

The “don’t panic” market message of today’s note concerns the next few weeks. The “sell the rallies” portfolio message relates to the next few months. European equity has become an acknowledged danger zone. The new element is that confidence in American equity is ebbing. There are more and more signs of trouble for the US equity bull market. The problem is the dependency upon monetary drugs. There is withdrawal of monetary support and controversy about the next, big step. The unease is represented by the return of the narrative that explains that it’s OK to buy bonds because the Fed will never raise rates, or at least not next year.

Our interpretation is that trans-Atlantic equity has entered an extended period of correction. First, Europe, then America. We expect the period of difficulty for investors in risk assets to extend through to at least the spring of next year. For this reason there should be no traumatic market break-down because the correction will be extended in time. The risk of market collapse is low because there is little financial stress, as indicated by the behaviour of financial stocks. This understanding applies to the immediate position. We think that there is a good probability that US equity will stabilise this week. The influence of the reporting season should be beneficial. We are not expecting to see the S&P500 trade below the 1900 area at this time. Another consideration is the commodity space. The US$’s appreciation has lost momentum. Accordingly, we expect commodity values to stabilise at current levels, assisting commodity-sensitive stocks, led by Basic Resources.

In this difficult context we will continue to implement our strategy of capital preservation, ignoring market gyrations, as we said we would. Our portfolio liquidity ratio goes to 5%. We are raising exposure to consumer stocks through the Food & Beverages sector because super-low inflation and improved terms of trade for the trans-Atlantic economies provide support to consumers. We are moving the small Financial Services sector of the DJ Stoxx universe to UW in recognition of the under-performance of smaller cap stocks, which we expect to continue through the winter. Construction goes to N, with a mea cupla. Accordingly, the Swiss market also goes to OW from N. The counterpart is the euro zone. We are downgrading the French market to UW from N and the Italian market from OW to N. The message here is not about France or Italy. It is about the consequences of the policy disarray in the EZ. The pax germanica has broken down. It will take time to reformulate a policy consensus for the EZ. However, this is not a replay of 2010-2012 because this is not a financial crisis.

Weightings and asset allocation for the MSCI Europe Universe



13/10/2014 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 2.9 1.5 N 3
Consumer Durables & Apparel 2.3 1.0 UW 1
Consumer Services 0.9 1.0 OW 2
Media 2.1 0.9 N 2
Retailing 1.4 0.9 UW 1
Consumer Staples 13.6 0.7 OW (N) 14
Food & Staples Retailing 1.2 1.0 UW 0
Fod Beverage & Tobacco 10.6 0.7 N 12
Household & Personal Product 1.8 0.7 OW 2
Energy 8.9 0.9 UW 7
Financials 23.0 1.2 OW 26
Banks 12.8 1.2 N 13
Diversified Financials 3.1 1.3 N 3
Insurance 6.0 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 12.6 0.8 OW 15
Industrials 10.7 1.1 UW 9
Capital Goods 8.1 1.1 UW 6
Commercial Services & Suppy 1.2 0.8 UW 1
Transportation 1.4 1.1 OW 2
Information Technology 3.3 1.1 OW 4
Software & Services 1.5 0.9 UW 1
Technology & Hardware Equipment 1.0 1.3 OW 2
Semiconducors 0.8 1.2 OW 2
Materials 7.6 1.2 N 7
Telecommunication services 5.0 0.9 N 5
Utilities 4.4 0.8 N 4
Exposure to risk
(beta value)
  1.00    
Lquidity ratio   5% (4%)    
* 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