Tuesday, November 12th, 2013

Bits and Pieces

The ECB surprised almost everyone, including us, with a rate cut last week, so we start this note by quoting the final sentences of last week’s note. “If the ECB looks as though it may cut rates in December, the currency play which has boosted euro equities will go into reverse. Either way, it is time for US investors to think about what to buy when the Eurozone rally fades.”

Our US asset allocation model has already reduced its exposure to Eurozone equities by one percentage point. Ordinarily, we would dismiss this as a random fluctuation (as might still be the case) but it feels more significant than that. There is scope for the euro to fall by 5% against the US dollar without breaching the recent range, and several commentators expect the ECB to introduce further liquidity support for the banking system as we approach the year end. More euros probably means cheaper euros. If the currency does depreciate further, we would expect US investors to look for a better entry point into Eurozone equities and / or to top slice some of their current position.

Because the ECB rate cut came earlier than we expected, details of the China reform package are not as widely disseminated as we thought they would be when the Eurozone equity story peaked. Without this information, it is hard to commit to a major move into Emerging Market equities, which means that the UK emerges as an interesting idea for a short term trade. The economy is growing well; the currency is stable; there looks to be no rate hike in the short term. What’s not to like? Our only comment is that the UK index has the highest exposure to global companies of any of the major indices (and the least exposure to its domestic economy) which means that it is unlikely to outperform the rest of the world for very long. That said, it is a perfectly sensible place to park liquidity while waiting for a better idea to develop.

The other important development this week is the downgrade to US Financials from Overweight to Neutral. The US sector model has been reducing exposure for several weeks, but the process clearly accelerated in the middle of October. Investors appear to be concerned that the sector will face simultaneous tightening by US regulatory and monetary authorities starting soon and running for several quarters. This is a view that we share, even though we find it difficult to make precise forecasts about the timing of the taper and the new legal framework for the US banking system.

The US is the only region where we have formally changed our recommendation on Financials, but we have also reduced our exposure to the sector in the UK, the Pan-Europe and Japan. We may find that our models increase exposure to Eurozone Financials, if the ECB does provides a significant boost to liquidity, but apart from that the outlook for the sector is weak in most regions.

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