Download Country equity allocation

January 10 2013
Country equity allocation: methodology
note
Introduction
The objective is to present an analytical framework to support the geographic allocation of
the equity markets. Our goal is to present a dynamic, objective overview that captures the
main driving forces of the markets so that we can ask the right questions. Our approach
breaks down into two parts. The first mapping captures cyclical (short term) forces. The
second puts so-called "secular" (long term) forces into perspective. The two approaches are
independent and complementary.
Main driving forces of the markets: momentum and valuation
The behaviour of the equity markets may be stylised as follows (see graph):
The idea is to capture the main driving forces of
the equity markets: momentum and valuation.
The first mapping captures cyclical forces: In this
case, momentum is analysed from both a profit
and a market perspective.
Since the market anticipates profits, that
suggests market rotation in our cyclical mapping.
The mapping may be read dynamically, over
several months, or depth-wise, by style or by
region.
i: Outflows and downward profit revisions become excessive and the market is undervalued
ii: The market begins to anticipate an improvement in profits
iii: Profits and flows recover and support a bull market
iv: The market becomes overpriced, while inflows and upward profit revisions are excessive
The second mapping refers to a longer term
horizon, which erases the profit cycle with regard
to both momentum and valuation.
v: The market begins to anticipate a decline in profits
vi: Profits and flows slow down and maintain a bear market.
Stylised behaviour of the equity markets
A version of this mapping is adapted to the
developed markets and to the emerging markets.
Without providing definitive answers, pairing the
“cyclical” and “secular" dimensions helps to
reinforce convictions in decision-making.
Source: Amundi Strategy
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January 10 2013
“CYCLICAL MAPPING”
Source: Amundi Strategy
1
The cyclical approach, or how to integrate these
factors to differentiate between markets
Example of relative momentum: the German
market in relation to the world index
9
In a cyclical approach, the notion of momentum
should be separated into two pieces: profits
and the market. Consequently, we use three
dimensions that are represented in our first
mapping (see above): market momentum, profit
momentum and valuation. To highlight the
trend, profit momentum is represented on the
horizontal axis and market momentum appears
on the vertical axis.
“
8
In a cyclical approach,
there are two aspects of
the momentum effect:
profits and the market
”
Since the markets anticipate profit trends, this suggests that the markets normally follow a
rotation on the map, in the direction of the arrows. In addition, the size of the circles
corresponds to valuation. Lastly, the colours differentiate among regions. Note that all the
indices are shown relative to the MSCI World and are expressed in the same currency, in
this case, in US dollars.
How are the markets positioned on the map?
1. Relative market momentum (vertical axis of the map)
We use two indicators: the index ratio (market index/MSCI World) compared to its 200-day
average is the main indicator (first graph on the right). It aims to capture the relative market
trend. The flow analysis (cumulative flows over 12 weeks, compared to their 10-year
average) is complementary (second graph on the right). It aims to anticipate turnarounds.
So, we are interested in extreme situations regarding flows and their potential to return to
the average. In the end, the more bullish the relative market momentum, the higher the
circle is positioned on the map.
2. Profit momentum (horizontal axis of the map)
Here we also use two indicators: the relative profit index (source: IBES) compared to its
200-day average is the main indicator. It aims to capture the relative profit trend. The
analysis of profit revisions by analysts is complementary. It aims to anticipate turnarounds.
So, we are interested in extreme situations regarding profit revisions and their potential to
return to the average. In the end, the more positive the profit momentum, the more the circle
is positioned to the right on the map.
7
6
5
4
3
02 03
04 05 06
07 08 09
10 11
DAX Index/M SCI Wo rld
M o ving average (200days)
Source: Dat astream, Amundi Strategy
Example of a flow analysis:
the German market
4
3
2
1
0
-1
-2
-3
-4
-5
02
03
04
05
06
07
08
09
10
11
Flo ws
M ean
M ean + 1standard deviatio n
M ean - 1standard deviatio n
Source: EPFR, Amundi St rat egy
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January 10 2013
3. Relative valuation (three circle sizes)
We use two very traditional criteria: PER and P/BV estimated over the next 12 months
(source: IBES). These ratios are read relative to the market (e.g.: PER of the market/PER of
the MSCI World) in relation to their average over the last 10 years (see first graph on the
right). The more overpriced the market, the larger the circle on the map.
Example of a valuation criterion: relative
PER of the German market
1,00
0,95
0,90
How to read our cyclical map
To make our mapping easier to read, we have named its four parts: “Star”, “Doubt”, “Repair"
and "Challenger". At first glance, there is a favourable bias for “Challengers” capable of
rallying in terms of profits and “Stars” that are not too overpriced. We avoid the “Doubts”.
There is a somewhat unfavourable bias for “Repairs” as long as the market is not “really
underpriced”.
0,85
0,80
0,75
0,70
02 03 04 05 06 07 08 09 10 11
Comments on the map example from the preceding page (from 16 October 2012):
STAR: The US market (S&P 500) outperforms the MSCI World both with regard to the
market index and the profit index. This market is a “Star”. But, it is expensive compared to
the rest of the world. The market would therefore be vulnerable if profit momentum should
weaken.
P ER
10 Y mean
10 Y mean + 1standard deviatio n
10 y mean - 1standard deviatio n
Source : Dat ast ream, Amundi St rat eg y
DOUBT: The Japanese market underperforms the MSCI World, but its relative profit trend is
neutral. The market is not expensive. It is still in the “Doubt” period, but is about to enter the
“Repair” zone. If the market is right, profits will end by weakening and the market will
actually re-enter the "Repair" zone. Or, profits will hold firm and the market will emerge a
“Star”.
Trajectory of the German market on the
cyclical mapping
REPAIR: The UK market underperforms the MSCI World. Likewise, its relative profit trend is
negative. Its relative valuation is neutral. It is in “Repair” mode but is not a good enough deal
to anticipate a rebound.
CHALLENGER: The Australian market is beginning to outperform the MSCI World, but the
profit trend is not yet sustaining this upward movement. Its valuation is neutral. This market
is a “Challenger”. Profits need to accelerate in order to sustain its trend and become a
“Star”.
The mapping may be read dynamically, over time, or depth-wise, by style and by region:
“
It is wise to analyse the trajectory of a market in
order to better understand its dynamics by
The consistency of the
reviewing its position on the map, for example,
whole allows convictions
for six months (second graph). We can also
to emerge
analyse a market by investment style (third
graph) and zoom in on a region such as
Europe (first graph on the following page) or the emerging countries (second graph on the
following page). The consistency of the whole allows convictions to emerge.
”
Source: Amundi Strategy
Reading of the markets by style
Relative Market Trend (vs World)
2
Europe Mid
USA Large
1
Europe Small
Europe Large
USA Mid
USA Small
0
-2
-1
0
1
2
-1
Japan Small
Japan Mid Japan Large
-2
Relative EPS Momentum (vs World)
Source: Amundi Strategy
3
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January 10 2013
2
A complement to the cyclical reading:
the “secular” approach
Focus on cyclical mapping for Europe
2
Relative Market technical Trend (vs
World)
Considering markets with another time horizon further improves our understanding of them.
With the “secular" approach, we refer to a long-term horizon that erases the profit cycle. So,
now we use only two dimensions for our second mapping: market momentum (vertical axis)
and valuation (horizontal axis).
For market momentum, we use two criteria:
- The absolute return of the market compared to its 10-year, 4-year and 1-year averages.
- Flows, but this time accumulated over 3 years (in order to capture positions more than
movements) compared to the history over the last 10 years.
The markets are graded 0, 50 or 100 depending on whether they are bear, neutral or bull
markets. The indicator on flows is centred and reduced on a scale from 0 to 100. The
position on the vertical axis corresponds to the average of the two. In order to appear in the
upper portion, for example, the market must be on secular bullish trend. Then, the more the
market is bought, the higher it is positioned on the vertical axis.
Germany
Belgium
Switzerland
1
Norway
Denmark
UK
Spain
Austria
Sweden
0
France
Portugal
Greece
-2
-1
0
1
2
Italy Netherlands
-1
Ireland
-2
Relative EPS Momentum (vs World)
For the valuation, we use four non-cyclical criteria which inform the models with regard to
long-term trends:
Source: Amundi Strategy
Focus on cyclical mapping for emerging
countries
- The adjusted PER of the cycle, often called the Shiller PE ratio
- An average of more traditional indicators (PER, PBV, DY)
2
Relative Market technical Trend (vs World)
- The risk premium (1/PE - real long-term yields)
- The level of real long-term yields (to take into account the fact that the lower the real yields,
the higher the equilibrium risk premium)
The current levels are compared to very long historical levels (1970s) then centred and
reduced. Their average is finally reported on a scale of 0 to 100 on the horizontal axis. The
more the market is positioned to the right, the more expensive it is.
Below is the “secular" mapping for the developed countries. The same is available for the
emerging countries.
We see four key problems emerging over the long term:
- Are investors too optimistic?
- Some markets are “fallen angels”. We will avoid them.
- Others may be "value traps”.
India
Philippines
1
Indonesia
-2
STRONG
Thailand
Korea
0
Colombia
Peru
Chile
Russia -1
Brazil China
1
2
Malaysia
Argentina
-2
Relative EPS Momentum (vs World)
Source: Amundi Strategy
“SECULAR” MAPPING
100
OPPORTUNITIES ?
90
POTENTIAL
EXCESSIVE
OPTIMISM ?
USA
ositive Bias
80
LONG TERM MOMENTUM
Hungary
Taiwan
Czech
0
Republic
-1
- Others are still opportunities. This is clearly where we want to look for buy ideas.
Germany
Canada
70
Norway
60
UK
Sweden
Hong Kong
Ireland
Denmark
Singapore
50
40
Australia
Belgium
Austria
30
20
POTENTIAL
VALUE
TRAPS ?
10
WEAK
Mexico
Poland
Italy
To be
avoided
Switzerland
France
Japan
Greece
Spain
FALLING
Portugal
Netherlands
ANGELS ?
Finland
0
0
CHEAP
10
20
30
40
50
VALUATION
60
70
80
90
EXPENSIVE
100
Source: Amundi Strategy
4
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January 10 2013
Conclusion
Without providing definitive answers, pairing the “cyclical” and “secular" dimensions helps to
reinforce convictions in decision-making. The table below illustrates a few examples.
United States
Star
The S&P 500 is outperforming, which is
evidenced by a profit index that is also
outperforming.
But
the
market
is
overpriced relative to the last 10 years. Be
cautious.
Excessive
optimism?
The S&P 500 is on a positive secular
trend, but it is also overbought. In
addition, the valuation suggests low er
long-term returns than the average in
other markets.
Germany
Star
The DAX is outperforming, which is
evidenced by a profit index that is also
outperforming. In addition, the market is
neither overpriced nor underpriced
relative to the last 10 years. Favourable.
Opportunity?
The DAX is on a positive secular trend.
It is clearly somewhat overbought, but
its valuation suggests higher long-term
returns than the average in other
markets.
Japan
Doubt /
Repair
The Nikkei is
underperforming, as
evidenced by profits that are only just able
to compete with the global average. But, the
market is not overpriced. Should w e
revisit Japan?
Potential
“value trap”
The Nikkei’s valuation suggests higher
long-term returns than the average in
other markets. But, its secular trend is
negative. And the market may not be
underbought by accident.
United Kingdom
Repair
The FTSE 100 is underperforming, which is
evidenced by a profit index that is also
underperforming. In addition, the FTSE 100
is not underpriced, but it is not overpriced
either. Not attractive enough yet.
Excessive
optimism?
The FTSE 100 is on a positive secular
trend and is slightly overbought. The
valuation suggests long-term returns
close to the average in other markets.
Positive
Neutral
Negative
5
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Valuation (LT)
Secular Map
Momentum (LT)
EPS
Index
Cyclical Map
Valuation (10Y)
A FEW EXAMPLES
January 10 2013
Contributor
Editor
Philippe Ithurbide - Head of Research, Analysis
and Strategy - Paris
+33 1 76 33 46 57
Contributors
Eric Mijot – Deputy Head of Strategy and
Economic Research – Paris
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Chief editor: Pascal Blanqué
Editor: Philippe Ithurbide
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