The wounded and the dead

  • We conclude that the correction in trans-Atlantic equity markets is complete because the QE3-exit panic in fixed income markets has climaxed. Commodity values should now stabilise, allowing the bottoming of Europe’s most commodity-sensitive equity segments this month.
  • The first half of 2013 has brought discontinuity to the positive correlation between returns on equity and on fixed income assets that characterised the 20092012 period. This is a watershed. However, the decisive period of debt repricing may not take place for another 1218 months. The sovereign debt markets of the EZ periphery now present an attractive riskrewards profile.
  • The arbitrage of equity yield against equity growth favours Europe’s small and midcap universe, and smaller cap growth in particular.

Recommended sector and market asset allocation

We conclude that the QE3exit panic in fixed income markets climaxed at the beginning of last week. Accordingly, we presume that the correction in transAtlantic equity markets is complete. It was short but intense. We envisage the yield of the benchmark 10year Tnote trading between 2.252.80/90% through the year’s second half. We doubt that the recovery of the S&P500 will extend beyond the 16601700 area before yearend because we assume that its recent phase of multiple expansion is exhausted. · We also expect commodity values to stabilise. Investor sentiment has become excessively negative about these assets. In particular, we think the twoyear collapse of the relative price of Europe’s Basic Resources sector will end this month.

The first half of 2013 has brought discontinuity to the positive correlation between returns on equity and on fixed income assets that characterised the 20092012 period. This is a watershed. Although the Fed has achieved its immediate purpose, fundamental value has not been restored to the fixed income world if one accepts the diagnosis of the end of private sector deleveraging in America. However, the decisive period of debt repricing may not take place until the second half of 2014, or even early 2015. We argue that the sovereign debt markets of the EZ periphery now present a better riskrewards profile than many of their counterparts in the global US$ zone periphery.

The rediscovery of US$ interest rate risk emphasises that “equity yield” has become expensive relative to “equity growth”. The premium for equity growth in Europe has a fallen to its lowest level since 1995. The arbitrage of equity yield against equity growth from a longer term perspective favours the small and midcap universe. Above all, it favours small and midcap growth.

Weightings and asset allocation for the MSCI Europe Universe



28/06/2013 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 9.5 1.1 OW 14
Automobiles & Components 2.8 1.6 OW 4
Consumer Durables & Apparel 2.6 1.2 OW 3
Consumer Services 1.0 0.9 OW 2
Media 1.9 0.8 OW 3
Retailing 1.3 0.9 OW 2
Consumer Staples 14.8 0.5 OW 16
Food & Staples Retailing 1.6 0.7 OW 2
Fod Beverage & Tobacco 11.3 0.5 OW 12
Household & Personal Product 1.9 0.6 OW 2
Energy 9.7 1.0 N 10
Financials 20.8 1.4 OW 22
Banks 10.4 1.5 OW 11
Diversified Financials 3.8 1.6 N 4
Insurance 5.6 1.4 N 6
Real Estate 1.0 1.0 N 1
healthcare 13.2 0.6 UW 10
Healthcare Equipment & Services 1.2 0.5 UW 1
Pharmaceuticals & Biotechnology 12.0 0.6 UW 9
Industrials 11.3 1.2 UW 10
Capital Goods 8.7 1.2 UW 8
Commercial Services & Suppy 1.4 0.8 N 1
Transportation 1.2 1.0 UW 1
Information Technology 3.2 1.0 OW 4
Software & Services 1.5 0.9 OW 2
Technology & Hardware Equipment 0.9 1.1 OW 1
Semiconducors 0.8 1.1 OW 1
Materials 7.9 1.3 OW 9
Telecommunication services 5.6 0.7 UW 3
Utilities 4.0 0.9 UW 2
Exposure to risk
(beta value)
  1.03    
Lquidity ratio   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