This month we make some changes to our regional and sector weightings:

  • We upgrade the Central and Eastern Europe, Middle East and Africa (CEEMEA) region to Neutral from Underweight as valuations have become more reasonable.   We downgraded CEEMEA to Underweight in June when premature optimism about the situation in Ukraine prompted a rebound in the Russian stock market.  However, the earnings outlook for CEEMEA has continued to deteriorate, suggesting that the region is unlikely to become attractive any time soon.  (Our previous regional recommendations were published in the June edition of The Cornerstone Journal of Sustainable Finance & Banking.)
  • We upgrade Health Care to Overweight from Neutral reflecting a relatively strong earnings outlook that outweighs the sector’s high valuation.  As discussed in Appendix 2: The Conceptual Framework, the sector model gives a heavier weighting to earnings (75%) than the regional model where valuation and earnings are equally weighted.  (Our previous sector recommendations were published in the Summer 2014 edition of The Cornerstone Journal of Sustainable Finance & Banking.)
Figure 1: Regional Rankings
Arrows Indicate Change vs. Last Month
Regional Rankings   Arrows Indicate Changes vs. Last Month
Figure 2: Sector Rankings
Arrows Indicate Change vs. Last Month
Sector Rankings Arrows Indicate Change vs. Last Month

Regional Strategy Update

We have updated the inputs to the Cornerstone Capital Regional Strategy Model in which we rank eight regions/major economies that are included in the MSCI All Country World Index (ACWI).

In terms of valuations, Figure 3 illustrates that the relative valuation of the CEEMEA region has improved.

Figure 3: Regional Valuations (50% of Aggregate Weight)
Arrows Indicate Change vs. Last Month (Up = More Expensive, Down = Less Expensive)
Figure 3 Regional Valuations

 

None of the relative valuation shifts of the other regions were material, with Japan (one of our Overweights) becoming even cheaper and Europe ex U.K. (one of our Underweights) getting more expensive.

Figure 4 illustrates that earnings momentum in the CEEMEA region continues to deteriorate, while Figure 5 illustrates that the earnings revisions trend in CEEMEA remains negative i.e., downgrades exceed upgrades.

Earnings momentum in Japan and Emerging Asia improved last month, while it worsened in Europe, excluding the U.K. and Latin America. Earnings revisions trends were also negative for Europe ex the U.K. and Latin America.

Figure 4: Earnings Momentum (33% of Earnings Weight) Arrows Indicate Change vs. Last Month
Figure 4: Earnings Momentum
Figure 5: Earnings Revisions (33% of Earnings Weight) Arrows Indicate Change vs. Last Month
Figure 5: Earnings Revisions

In addition, margins in CEEMEA are currently lower than in most other regions — Figure 6.

Figure 6: Margins (15-20% of Earnings Weight)
Sep14_Geraghty_Figure6

Another negative for CEEMEA is that share issuance remains very high — Figure 7. Given that corporate earnings are reported on a per share basis, a large amount of net share issuance is a drag on earnings per share growth in a region.

Figure 7: Net Share Issuance (15-20% of Earnings Weight) Arrows Indicate Change vs. Last Month
Figure 7: Net Share Issuance

Figure 8 summarizes the current regional recommendations and Figure 9 illustrates the dispersion of the regional scores.


Figure 8: Regional Recommendations
Figure 8: Regional Recommendations
Figure 9: Ranking by Weighting Valuation, Earnings and Governance Scores
Arrows Indicate Change vs. Last Month
Figure 9: Ranking Regions by Weighting Valuation, Earnings, and Governance Scores

Sector Strategy Update

We have updated the inputs to the Cornerstone Capital Sector Strategy Model in which we rank the ten GICs in the MSCI ACWI. In terms of valuations, Figure 10 illustrates that the Health Care sector is currently the most expensive, followed by our three Underweights: Materials, Utilities and Energy.

Figure 10: Sector Valuations (25% of Aggregate Weight)
Arrows Indicate Change vs. Last Month
Figure 10: Sector Valuations (25% of Aggregate Weight)

Figure 11 illustrates that earnings momentum in Information Technology improved again last month, while momentum in Health Care was relatively stable. Earnings momentum in the Utilities and Energy sectors weakened, while momentum in the Materials sector improved modestly after a long period of deterioration.

Figure 11: Earnings Momentum (33% of Earnings Weight)
Arrows Indicate Change vs. Last Month
Figure 11: Earnings Momentum

Figure 12 shows that all 10 GICS experienced more downward than upward earnings revisions last month, with Health Care being the least negative (i.e., downward revisions modestly exceeded upward revisions).

Figure 12: Earnings Revisions (25% of Earnings Weight) Arrows Indicate Change vs. Last Month
Figure 12: Earnings Revisions (25% of Earnings Weight)

Margins in Information Technology and Health Care — our two Overweights — are materially higher than in most other sectors (Figure 13).


Figure 13: Margins (25% of Earnings Weight)
Figure 13: Margins (25% of Earnings Weight)

Figure 14 illustrates that Utilities, one of our Underweights, has experienced a significant amount of share issuance over the last twelve months.

Figure 14: Net Share Issuance = 15-20% of Earnings Weight
Figure 14: Net Share Issuance = 15=2-% of Earnings Weight

Figure 15 summarizes the current sector recommendations.

Figure 15: Regional Recommendations
Fogire 15: Regional Recommendations

Figure 16 illustrates the dispersion of the sector scores.

Figure 16: Ranking Sectors by Weighting Valuation, Earnings and ESG Scores Arrows Indicate Change vs. Last Month
Figure 16: Regional Sectors by Weighting Valuation, Earnings and ESG Scores

Combining the Regional and Sector Models

Combining our sector and regional models, Figure 17 illustrates sector over- and under-weights by region.

  • We are overweight Health Care in the U.K., North America and Europe, ex U.K.
  • We are overweight Information Technology in Japan, Emerging Asia and North America.

We are underweight or neutral Energy, Materials and Utilities in the majority of regions.

Figure 17: Combining the Regional and Sector Model
Figure 17: Combining the Regional and Sector Model

Michael Geraghty is the Global Markets Strategist at Cornerstone Capital Inc. He has over three decades of experience in the financial services industry including working as an investment strategist at UBS and Citi.