The hand that feeds you

  • The ECB’s policy break-through is the catalyst for EZ equity break-out. We are reducing our portfolio liquidity ratio. We see a further 10-15% appreciation for pan-EZ equity benchmarks this year. We are raising our international European rating to OW, on a par with US equity, to the detriment of Japan.
  • Global equity has not broken out of its consolidation pattern, signalling the persistence of investor caution and uncertainty. Although we expect the EZ to deliver a growth surprise this year, some patience is required. We need first to see the bottom for IG bond yields and the price of oil. Accordingly, the changes to our recommended portfolio are minor as yet, upgrading Italy and the EZ Industrial sector.

Recommended sector and market asset allocation

EZ equity markets have broken out of their erratic phase of correction of the previous six months. We consider that there is potential for another 10-15% appreciation for pan-EZ equity benchmarks this year measured from the level of last week’s close. To salute the break-out we are reducing the liquidity ratio of our recommended portfolio from 6% to 4%.

The ECB’s QE will not by itself shift the global investment climate decisively. The investment environment at this time is still characterised by investor caution and uncertainty. The disturbance created by the election in Greece is just the most immediately apparent aspect of this context. It is not the most significant to our way of thinking. The inevitable re-negotiation of Greek debt is another consequence of the emergence of deflation risk in the region. Excluding the EZ, the global equity class has not broken out of the phase of consolidation that prevails since the middle of last year. Deflation anxiety remains high. The global output cycle is not yet ascending. Yields of IG bonds continue to decline in major markets. Defensive investment strategies are still out-performing.

We consider that upside potential for US equity is very limited at this point. The positive momentum in European equity resulting from the ECB’s announcements will probably be exhausted by the end of this week-month. We would use the opportunity provided by profit-taking in equity through February to reduce further the liquidity ratio of our recommended portfolio.

We expect the EZ to deliver a positive growth surprise this year due to the combined effects of the triple shock from energy, currency and credit. However, some patience is required. Although the perception of deflation risk attached to the EZ has declined the improvement in expectations of nominal growth in the euro system is small, as yet. Consequently, the initial response to the ECB’s QEinfinity is a further reduction in nominal and real yields of long duration IG EZ debt, especially in the EZ periphery. Moreover, we have no signal yet that commodity values, that of crude oil especially, have bottomed. Accordingly, we are not in a hurry to move our recommended portfolio into higher risk value stocks in the cyclical-financial space. We have no clear signal yet to sell bond proxies or reduce exposure to high quality growth stocks. In particular, we remain under-weight the banking sector.

At this point we have only one small adjustment to make to our sector asset allocation. We are raising the Industrial sector in the EZ to OW, largely as the consequences of currency devaluation. However, for the same reason we maintain the sector in Europe ex-EZ at UW. For Europe overall, the sector goes to Neutral from UW.

We expect fund flows into European equity, that of the EZ in particular, to rise significantly this year, both from within and outside Europe. However, we conduct our international asset allocation in common currency terms. The rule is that forex adjusts more rapidly than the equity space. Within European equity our only immediate adjustment is to raise our rating of the Italian market to Neutral at the detriment of the Nordic area, through Denmark.

We are raising our overall international European rating to OW, on a par with US equity, to the detriment of Japan. We consider that there is more scope for positive surprises from Europe this year than from Japan.

Weightings and asset allocation for the MSCI Europe Universe

26/01/2014 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 3.5 1.4 OW 5
Consumer Durables & Apparel 2.5 1.0 N 2
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 17
Food & Staples Retailing 1.3 1.1 OW 2
Fod Beverage & Tobacco 11.1 0.8 OW 13
Household & Personal Product 1.8 0.7 OW 2
Energy 7.6 1.1 N 7
Financials 22.3 1.1 UW 18
Banks 11.6 1.2 UW 8
Diversified Financials 3.1 1.2 UW 2
Insurance 6.2 1.1 N 6
Real Estate 1.4 0.9 OW 3
healthcare 13.8 0.8 OW 16
Healthcare Equipment & Services 1.3 0.7 OW 2
Pharmaceuticals & Biotechnology 12.6 0.8 OW 14
Industrials 11.1 1.1 N  (UW) 11
Capital Goods 8.4 1.1 UW 7
Commercial Services & Suppy 1.2 0.9 N (UW) 1
Transportation 1.5 1.0 OW 2
Information Technology 3.4 1.0 OW 4
Software & Services 1.4 0.9 UW 1
Technology & Hardware Equipment 1.0 1.1 OW 2
Semiconducors 0.9 1.1 OW 2
Materials 7.4 1.1 UW
Telecommunication services 5.3 1.0 OW 6
Utilities 4.1 0.9 UW 2
Exposure to risk
(beta value)
Lquidity ratio   4% (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