France Can’t, Germany Won’t

  • The American shield has protected Europe this year. We expect the S&P500 to reach the 2050 level this week, to be followed by profit-taking from the end of the reporting season.
  • A new message is emerging from the October panic-disturbance in European equity. The cyclical universe is rather less vulnerable. The consumer universe of stocks is behaving better, reminding us that lower inflation can be good for growth. However, Europe’s banks are coming under pressure, especially those of the EZ, due to an increase in the premium for financial quality. Investors are impatient for a policy reformulation in the euro area that is not happening at this time. Germany and France are not moving. Consequently, the pressure upon the ECB is rising. Mr Draghi cannot deliver on the unrealistic expectations that are now invested in him, at least not soon. Capital preservation remains our priority.
  • Accordingly, we are downgrading the banking sector from N to UW. We are moving from OW to N in Spain and moving Italy from N to UW because the re-appearance of a financial risk premium affects the markets of the EZ periphery disproportionately. The counterpart is an upgrade of the Nordic area, largely by removing the UW in Sweden.

Recommended sector and market asset allocation

Our investment year-end is shaped by three assumptions. First, we expect profit-taking to prevail on Wall Street from the end of the current reporting season. We expect the S&P500 to reach the 2050 level this week. However, we do not expect that the advance will be sustained beyond. The growth leaders of the bull market are showing signs of fatigue again. The retail world is over-enthusiastic. Second, the recognition of a stronger US$ tells us to expect disturbances in the emerging world. However, the idea that global growth is slowing is a misperception. Weaker commodity values does not mean slower world growth. Third, and most important from our perspective, the policy reformulation in the euro zone is not going well. Germany and France are not moving. Consequently, the pressure upon the ECB is rising. Mr Draghi cannot deliver on the unrealistic expectations that are now invested in him, at least not soon. The sources of the market disturbances of the last few months have not disappeared. Capital preservation remains our priority. We think that the sellers will prevail in the area of 3100-3200 for the DJ EuroStoxx50. We expect that there will be better opportunities ahead.

A new message is emerging from the panic-disturbance of October. Europe’s cyclical universe is rather less vulnerable. We are doubtless seeing here the effect of forex depreciation and lower producer costs, notably of energy. We also suspect that investors are realising that “global growth” is not disappearing. In particular, the consumer universe of stocks is behaving better, reminding us that lower inflation can be good for growth. However, Europe’s banks are coming under pressure, especially those of the EZ. It is not coincidental that the equity markets of the euro zone periphery are losing ground.

Investors have begun to think that the EZ’s deflationary environment is a chronic condition. The consequence is an increase in the premium for financial quality in the system. To this extent, a financial risk premium is returning. It is largely a function of the perception of the EZ’s policy response. Investors are impatient for a policy reformulation in the euro area that is not happening at this time. There is little progress where it is most important. Both the German and French governments are abdicating economic responsibility to the ECB. Most investors assume that the absence of inflation will allow Draghi to lead the ECB down the path identified by the Fed and BoE. However, Draghi is not in a position to introduce government bond-QE at this time. The ECB’s GC will not sanction GB-QE until the alternatives are seen to be insufficient. Accordingly, we are downgrading the banking sector from N to UW. The re-appearance of a financial risk premium within the euro system affects the markets of the EZ periphery disproportionately. Accordingly, we are moving from OW to N in Spain. We are moving Italy from N to UW because Italy’s financials are more vulnerable than those of Spain. The counterpart is an upgrade of the Nordic area, largely by removing the UW position in Sweden.

Weightings and asset allocation for the MSCI Europe Universe



10/11/2014 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 10.1 1.1 N 10
Automobiles & Components 3.1 1.4 N 3
Consumer Durables & Apparel 2.4 1.0 UW 1
Consumer Services 1.0 1.0 OW 2
Media 2.2 0.9 OW (N) 3
Retailing 1.4 0.9 UW 1
Consumer Staples 13.6 0.7 OW 15
Food & Staples Retailing 1.2 1.0 UW 1
Fod Beverage & Tobacco 10.7 0.7 OW 12
Household & Personal Product 1.7 0.7 OW 2
Energy 8.8 0.9 N 9
Financials 22.6 1.2 UW (OW) 22
Banks 12.3 1.2 UW (N) 11
Diversified Financials 3.2 1.3 UW (N) 2
Insurance 6.0 1.1 OW 7
Real Estate 1.2 0.9 OW 2
healthcare 13.6 0.8 OW 16
Healthcare Equipment & Services 1.2 0.7 OW 2
Pharmaceuticals & Biotechnology 12.4 0.8 OW 14
Industrials 11.0 1.1 UW 9
Capital Goods 8.4 1.1 UW 6
Commercial Services & Suppy 1.2 0.8 UW 1
Transportation 1.5 1.1 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 1.2 OW 1
Materials 7.7 1.1 UW (N) 6
Telecommunication services 5.1 0.9 N 5
Utilities 4.3 0.8 N 4
Exposure to risk
(beta value)
  0.99    
Lquidity ratio   6%    
* 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