Crisis and Continuity

  • We begin 2015 with continuity of diagnosis and of portfolio positioning. GB-QE in the EZ is discounted. The controversy concerns the effectiveness of EZ-QE. We do not think that the period of market disturbance is complete. We are not yet at the point of inflexion. Our only change is to downgrade the Utilities sector from N to UW because we believe that its valuation re-rating is complete and we do not anticipate an improvement in its relative profit growth.
  • The defensive bias in stock behaviour in Europe is still apparent. Capital preservation remains our credo, referring to a portfolio positioning that emphasises the premium for quality and for liquidity in both the credit and equity space.
  • 2015 has begun as 2014 ended, with pronounced weakness in European large cap value. There is a link between the under-performance of the banks and of energy stocks. A collapse in the value of an asset as strategically important as oil produces the expectation of credit stress in the commodity-emerging space which translates into a banking risk premium. We cannot yet say that the price of oil has bottomed.

Recommended sector and market asset allocation

We begin 2015 with continuity of diagnosis and of portfolio positioning. EZ equity has continued to under-perform US equity and EZ IG debt. Our only change is to downgrade the Utilities sector from N to UW because we believe that its valuation re-rating is complete and we do not anticipate an improvement in its relative profit growth. We can reprint our conclusion of mid-December: “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. Capital preservation remains our credo.”

Capital preservation refers to portfolio positioning. There is not great downside risk attached to major European equity indices. Industrial cyclical sectors and smaller caps are no longer under-performing. The commodity-sensitive segments appear to be bottoming. However, the defensive bias in stock behaviour is still very apparent. Higher quality equity continues to out-perform. Stocks with high sensitivity to credit continue to under-perform. We emphasise the premium for quality and for liquidity in both the credit and equity space. 2015 has begun as 2014 ended, with pronounced weakness in the most vulnerable, lower quality compartment of European equity: that of large cap value, in which we find a large number of Banks and Energy stocks, in the EZ especially. The under-performance of large cap value in Europe identifies a crucial weakness of the bullish consensus. There is a link between the under-performance of the banks and of energy stocks. A collapse in the value of an asset as strategically important as oil produces the expectation of credit stress in the commodity-emerging space which translates into a risk premium for the banking system. We cannot yet say that the price of oil has bottomed. We remain highly exposed to the consumer universe (30% of total portfolio).

Weightings and asset allocation for the MSCI Europe Universe



12/01/2014 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 10.8 1.1 OW 14
Automobiles & Components 3.3 1.4 N 3
Consumer Durables & Apparel 2.6 1.0 N 3
Consumer Services 1.1 1.0 OW 2
Media 2.3 0.9 OW 4
Retailing 1.5 0.9 OW 2
Consumer Staples 13.8 0.8 OW 16
Food & Staples Retailing 1.2 1.1 UW 1
Fod Beverage & Tobacco 10.8 0.8 OW 13
Household & Personal Product 1.8 0.7 OW 3
Energy 7.6 1.1 N 7
Financials 22.2 1.2 UW 19
Banks 11.6 1.2 UW 8
Diversified Financials 3.2 1.3 UW 2
Insurance 6.2 1.1 N 6
Real Estate 1.3 0.9 OW 3
healthcare 14.0 0.8 OW 18
Healthcare Equipment & Services 1.3 0.7 OW 2
Pharmaceuticals & Biotechnology 12.7 0.8 OW 16
Industrials 11.2 1.1 UW 8
Capital Goods 8.4 1.1 UW 5
Commercial Services & Suppy 1.2 0.9 UW 1
Transportation 1.5 1.1 OW 2
Information Technology 3.5 1.1 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 7.6 1.1 UW
Telecommunication services 5.2 1.0 OW 6
Utilities 4.2 0.9 UW (N) 3
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