Deflation Anxiety and Profitability Re-distribution

  • We shall be attending our German Conference in Frankfurt over the next few days. This has been a big week for all financial markets. There are doubtless more weeks of this kind still to come. We set out briefly our thoughts and initial conclusions in this flash note.
  • We are moving from Over-Weight to Neutral in Switzerland. We will not move to Under-Weight in Switzerland until we are ready to downgrade the sectors of higher quality growth. The counterpart is to raise our exposure to the neighbouring core markets of the EZ - Germany and France - moving from Under-Weight to Neutral. The combined influence of lower energy costs and the forex influence should begin to have a positive effect upon corporate profits in EZ markets from this time.
  • We are increasing our exposure to the consumer universe in both the Staples and Discretionary space. We are moving the “problem child” segment of Food & Staples Retailing to Over-Weight. As a consequence, our rating of the broader Retail sector of the DJ Stoxx universe moves from Neutral to Over-Weight. We are also moving from Neutral to Over- Weight in the Automobile sector.

Recommended sector and market asset allocation

We expect to see the major Swiss equity indices catch up quickly with the realignment of CHF/Euro. We anticipate a fall of at least 15% for the major Swiss benchmarks as the CHF rises towards parity with the euro. The immediate protection afforded to international equity investors in Switzerland by currency appreciation should soon be exhausted. Accordingly, we are reducing our allocation to the Swiss market from this time, to the benefit of EZ markets. We are moving to Neutral in Switzerland. We will not move to UW in Switzerland until we are ready to downgrade the sectors of higher quality growth.

The counterpart is to raise our exposure to the neighbouring core markets of the EZ - Germany and France - moving from UW to Neutral. The combined influence of lower energy costs and the forex influence should begin to have a positive effect upon corporate profits in EZ markets from this time.

The context of a reverse oil shock and fund exit from the commodity space is exceptionally favourable for the relative performance of consumer stocks, especially those with domestic exposure and low expectations for profitability improvement. We are increasing our exposure to the consumer universe in both the Staples and Discretionary space. We are moving the “problem child” segment of Food & Staples Retailing to OW. As a consequence, our rating of the broader Retail sector of the DJ Stoxx universe moves from Neutral to OW. We are also moving from neutral to OW in the Automobile sector. We expect the European region and most other major developed markets to deliver positive surprises for car sales this year.

Weightings and asset allocation for the MSCI Europe Universe



16/01/2014 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 10.7 1.1 OW 15
Automobiles & Components 3.4 1.4 OW (N) 4
Consumer Durables & Apparel 2.5 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 14.2 0.8 OW 18
Food & Staples Retailing 1.3 1.1 OW (UW) 2
Fod Beverage & Tobacco 11.1 0.8 OW 13
Household & Personal Product 1.9 0.7 OW 3
Energy 7.4 1.1 N 7
Financials 22.2 1.2 UW 19
Banks 11.6 1.2 UW 8
Diversified Financials 3.1 1.3 UW 2
Insurance 6.2 1.1 N 6
Real Estate 1.4 0.9 OW 3
healthcare 14.2 0.8 OW 17
Healthcare Equipment & Services 1.3 0.7 OW 2
Pharmaceuticals & Biotechnology 12.9 0.8 OW 15
Industrials 11.1 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 1.1 OW 4
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
Telecommunication services 5.2 1.0 OW 6
Utilities 4.1 0.9 UW 2
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