Premature Birth

  • The renewed collapse of European equity last week is the continuation of the unstable behaviour we have been witnessing since mid-year. It emphasises why we have been so unhappy with the bullish sell-side consensus that characterises this year-end.
  • The reverse oil shock has rendered obsolete the debate about GB-QE in the EZ. The latter is virtually discounted. The controversy concerns its effectiveness. Leading indicators for nominal GDP and EPS growth in the euro area are not yet signalling improvement. We do not think that the period of market disturbance is complete. Optimism about European equity is premature. Capital preservation remains our credo. We are benefiting from the premium for quality and the out-performance of nonglobal growth and the consumer universe.

Recommended sector and market asset allocation

Last week registered the largest fall in the value of European equity since the summer of 2011. It was not an aberration. It was the continuation of behaviour we have been witnessing for some time. There has been a patent absence of investor confidence in European equity since mid-year. Investor sentiment is chronically unstable. It explains why we have been so unhappy with the bullish sell-side consensus that prevails at this time: “no risk because Mario is going to save us”. So much for all that nonsense.

The reverse oil shock has amplified the monetary divergence between America and the euro zone. It renders obsolete the debate about GB-QE in the EZ. The latter is virtually discounted. The controversy concerns the effectiveness of EZ-QE. European equity suffers from deficient profit growth and declining profitability relative to America. There are reasons for optimism in the medium term about the outlook for equity, including European equity. However, leading indicators for nominal GDP and EPS growth in the euro area are not yet signalling improvement. Earnings revisions remain negative, excluding energy. We are not yet at the point of inflexion. We do not think that the period of market disturbance is complete. Optimism about European equity is premature. Capital preservation remains our credo.

There is no strong market message at this point because major regional indices are just falling below the middle of the range of fluctuation defined since mid-year. We suspect that stocks will fall further this week before an attempt to stage a year-end rally. However, it is really “too late to sell, too early to buy.” There is no change in our recommended portfolio. It is delivering good out-performance by benefiting from the premium for quality and the out-performance of non-global growth and the consumer universe. The scale of the valuation discount of Europe’s energy sector is so enormous that we suspect a major trough will be in place by year-end, at relative price levels close to those recorded in the crisis period of 1998-2000.

Weightings and asset allocation for the MSCI Europe Universe



15/12/2014 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 10.5 1.1 OW 13
Automobiles & Components 3.3 1.4 N 3
Consumer Durables & Apparel 2.5 1.0 N 3
Consumer Services 1.0 1.0 OW 2
Media 2.2 0.9 OW 3
Retailing 1.5 0.9 OW 2
Consumer Staples 13.6 0.8 OW 16
Food & Staples Retailing 1.2 1.0 UW 0
Fod Beverage & Tobacco 10.7 0.8 OW 14
Household & Personal Product 1.8 0.7 OW 2
Energy 7.5 1.0 N 7
Financials 23.0 1.2 UW 20
Banks 12.3 1.2 UW 10
Diversified Financials 3.2 1.3 UW 2
Insurance 6.2 1.1 N 6
Real Estate 1.3 0.9 OW 3
healthcare 13.9 0.8 OW 17
Healthcare Equipment & Services 1.2 0.7 OW 2
Pharmaceuticals & Biotechnology 12.7 0.8 OW 15
Industrials 11.0 1.1 UW 8
Capital Goods 8.3 1.1 UW 5
Commercial Services & Suppy 1.2 0.9 UW 1
Transportation 1.5 1.1 OW 2
Information Technology 3.5 1.0 OW 5
Software & Services 1.5 0.9 UW 1
Technology & Hardware Equipment 1.0 1.2 OW 2
Semiconducors 0.9 1.1 OW 1
Materials 7.4 1.1 UW 4
Telecommunication services 5.3 1.0 OW 7
Utilities 4.3 0.9 N 4
Exposure to risk
(beta value)
  0.98    
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