The Profitability Frontier

  • The evidence of stabilisation of the commodity-emerging space is already compelling, if not yet conclusive.
  • From this point our Summer promises to become more tedious. Having erased the setback of May-June, the upside potential on Wall Street should now be limited. The relative performance of European equity should now improve.
  • The global growth theme is no longer supreme. The main global counterpart of the current rise of the EZ’s external surpluses is to be found in Asia. We explain why the Consumer Discretionary sector represents the profitability frontier of this cycle.

Recommended sector and market asset allocation

Having assumed that the first substantial episode of re-pricing of US$ debt is done we have expected this month of July to be characterised by the stabilisation of the commodity-emerging space. The evidence is already compelling, if not yet conclusive. Our interpretation is that China risk is adequately discounted at this time. We reiterate our principal currency rule for this year: Euro-US$ should not move far from the US$1.30 level. We must, however, expect that anxiety about QE3-exit will return. It is plausible to think that the approach of the September FOMC meeting will trigger another market setback.

From this point our Summer promises to become more tedious. Having erased the setback of May-June, the upside potential on Wall Street should now be limited. We expect that profit-taking will be the predominant response to the usual procession of somewhat better than expected earnings. Although the recovery of European stocks sensitive to credit influences is still constrained, notably in the EZ periphery, Europe’s markets will be advantaged by the stabilisation of its numerous commodity-emerging stocks. European equity is less vulnerable to the uncertainty affecting debt markets because the economic environment is improving.

We show that the external competitive effects of the EZ’s crisis are similar to that of the S. Asian crisis in the late 90s. The main global counterpart of the current rise of the euro zone’s external balance of payments surplus is to be found in the emerging world, in Asia in particular. This factor contributes to the end of the period of supremacy of the global growth theme. We explain why the Consumer Discretionary sector represents the profitability frontier of this cycle. There is profit and profitability out-performance here that is combined with valuations that are recovering from comparatively low levels.

Weightings and asset allocation for the MSCI Europe Universe



12/07/2013 Neutral weight in MSCI (%) 2-yr beta values
(vs MSCI)
Tactical sector rating Recommended allocation (%)
Consumer Discretionary 9.6 1.1 OW 15
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 1.7 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 21.1 1.4 OW 22
Banks 10.6 1.5 OW 11
Diversified Financials 3.8 1.5 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 1.4 0.9 OW 2
Technology & Hardware Equipment 0.9 1.1 OW 1
Semiconducors 0.8 1.1 OW 1
Materials 7.7 1.3 OW 9
Telecommunication services 5.6 0.7 UW 3
Utilities 3.9 0.9 UW 2
Exposure to risk
(beta value)
  1.04    
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