* Our Asset Allocation Team reduce their Equities Overweight
Today our Asset Allocation team reduce their Overweight in Global Equities (see - "We
are worried. We reduce risk – for now" by Stephane Deo & Ramin Nakisa). In the nearterm,
they see some deterioration in the risk/return trade off, following a large re-rating
in equity markets. However, the context is that they are coming from their largest ever
Overweight in Equities and that it still remains their favoured asset class (with European
Equities as an Overweight).
* What are the implications for European Equities?
European Equity returns have also been driven by multiple re-rating rather than
earnings growth (Figure 1). Whilst this is normal for the early stage of the cycle, after 3
years in a row of earnings downgrades – investors are (understandably) running out of
patience. We see a recovery in European earnings in 2014 (+10%) and find ourselves in
the strange position of now actually being above consensus. But there is a near-term
risk to equities as we wait for the earnings to materialise (delayed by FX headwinds).
* Heightened risk in the periphery
The fall in Sovereign risk (measured by the sovereign CDS) has driven a re-rating of the
P/E multiple from c.9x to 13.9x (Figure 2). We see recent concerns over Portuguese
banks as a specific issue rather than a wider contagion risk for the periphery. Since
2012 the ECB has put in place the OMT, fundamental macro imbalances (current
accounts, deficits) are smaller, and the Global recovery is more mature. Nevertheless, it
reminds us just how far periphery Government Bonds have moved.
* Longer term investment case for Europe remains intact
Our longer term investment case for Europe is based on it being a late cycle play on the
global recovery and the depressed level of delivered earnings - still some 25% below
their 2007 peak in contrast to the US. There is also significantly higher Operational
Leverage and now some tentative signs of profit margins rising in Europe.