Positioning for a seasonality boost:: Macquarie Research,

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Positioning for a seasonality boost
Event
 We update our equity risk premium estimates, the Macquarie Country Alpha
Model and the seasonal outlook for global equity markets.
Impact
 The US equity risk premium (ERP) at the end of August was 6.9%, up over
100 basis points over the last month, largely due to the fall in bond yields. The
ERP is now 2.37 standard deviations above the long-term average and the
last time it rose to similar levels was when Lehman collapsed in September
2008. In that case, the normalisation of the ERP began with a near 100 basis
point rise in bond yields, with equities bottoming in March 2009. Looking
forward, we therefore expect to see a strong rise in bond yields before a
sustained equity market rebound occurs.
 At an ERP of 6.9% we would expect Growth to outperform Value over the
next 12 months. Historically, the Russell 1000 Growth index tends to
outperform the Russell 1000 Value index when the risk premium is high. This
likely reflects the fact that many apparently cheap stocks are caught by the
“value trap” when economic conditions are weakening.
 Based on the historical patterns of seasonality, September and October tend
to be the best months to increase equity allocations, or to shift to cyclicals as
seasonal risk tends to peak in these months. Returns from November to April
tend to be higher on average, with a greater chance of positive returns
compared to the May to October period.
 Continuing a trend from last month, the Macquarie Country Alpha Model
shows the regions with the strongest momentum are North America and
Asia, while European markets tend to rank higher in terms of value.
 Among the top 10 equity markets, the Country Alpha Model favours UK,
China and France over Switzerland, Japan and Canada. Germany is no
longer a preferred country due to the significant loss of momentum in August.
Outside the major markets, and given the region’s high equity risk premium,
we favour Emerging Asia, with the top ranking countries in this region being
Korea and Indonesia. Despite the apparent value on offer, we remain
cautious on smaller European countries such as Spain and Italy.
Outlook
 We continue to believe that there will be a sell-off in US 10-year bonds in
the order of 50 to 100 basis points before there is sustained upward
momentum in global equities markets. That said, we recommend some
increase in equity exposure, and a slightly less defensive strategy, over
the next two months to position for the seasonal uplift in returns that
typically occurs between November and April.
 Given the weakening economic conditions and the high equity risk
premium, we still favour growth over value. While seasonality should
boost returns towards year end, it’s still important to own stocks with
greater earnings certainty, and to avoid the “value traps”.