A Ja­panese Goldilocks?

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

Ever since the Ja­panese bull mar­ket kicked off in late 2012, global as­set al­lo­ca­tors have been able to put the mar­ket on the back burner as eq­uity gains have been eroded by yen weak­ness. De­spite two years of ag­gres­sive mon­e­tary eas­ing and a 70% rally in stocks, Ja­panese stocks still only matched global bench­marks (MSCI Ja­pan ver­sus MSCI AC World in US dollar terms). How­ever, there are good rea­sons to think that this neg­a­tive cor­re­la­tion be­tween stocks and the yen could be break­ing down. As a re­sult, con­tin­u­ing to ig­nore Ja­pan could prove painful.

So far this year MSCI Ja­pan has jumped 8%, beat­ing ma­jor de­vel­oped mar­ket peers. The rally also oc­curred de­spite the yen strength­en­ing against the euro. This is a de­ci­sive shift that ap­pears to break the in­verse yen-eq­ui­ties cor­re­la­tion which has broadly ap­plied for more than a decade. This shift looks to be partly a func­tion of Ja­pan’s ro­ta­tion from bonds to eq­ui­ties; the Bank of Ja­pan’s bond buy­ing pro­gramme will have di­rected funds into risk as­sets and so too will the Gov­ern­ment Pen­sion In­vest­ment Fund’s in­creased weight­ing in eq­ui­ties. The new fac­tor is the height­ened par­tic­i­pa­tion of do­mes­tic in­vestors, whose more the­mat­i­cally driven in­vest­ment ap­proach of­fers a counter point to the on/off style of for­eign in­vestors, based on cur­rency move­ments. Granted, do­mes­tic in­ter­est in Ja­pan can prove fleet­ing (the con­se­quence of a 20 year struc­tural bear mar­ket), while the macroe­co­nomic out­look is hardly out­right bullish. Still, the US ex­pe­ri­ence of the last five years has shown that a “Goldilocks” sce­nario for eq­uity in­vestors can re­sult from an econ­omy that is gen­er­at­ing growth, but is not so hot as to disturb cen­tral bank eas­ing poli­cies or cause a richly val­ued bond mar­ket to suf­fer desta­bil­is­ing volatil­ity.

Such a Goldilocks sce­nario can prove durable so long as cor­po­rates con­tinue to de­liver earn­ings growth. In­deed, Ja­pan is among the few ma­jor mar­kets that are see­ing earn­ings up­grades, with in­vestors ex­pect­ing for­ward EPS growth of 10%. This pos­i­tive out­look should con­tinue to be sup­ported by a com­pet­i­tive yen, the col­lapse in com­mod­ity in­put costs and a se­quen­tial im­prove­ment in real wages that feeds into firmer do­mes­tic de­mand. Even the Ja­panese elec­tric­ity gen­er­a­tors, which have suf­fered due to their re­liance on im­ported fuel, are now op­er­at­ing close to breakeven lev­els, and have seen a leap in their earn­ings ex­pec­ta­tions.

In­vestors are also get­ting more cash back from their Ja­panese eq­ui­ties as a gen­uine shift in the cor­po­rate gov­er­nance cli­mate forces, at long last, a greater fo­cus on share­holder value. It is no longer un­usual for Ja­panese firms to raise div­i­dends and make share buy­backs; ag­gre­gate buy­backs (so far an­nounced) have risen 49% YoY in the half year fi­nan­cial pe­riod end­ing on March 31. Ag­gre­gate div­i­dends paid to in­vestors records were started.

Ja­panese com­pa­nies have plenty of scope to ex­pand this re­turn of cash as tril­lions of yen are squir­reled in bank de­posits. With the up­side for bonds and money mar­ket prod­ucts be­ing limited by record low yields, we would ex­pect this “not too hot, not too cold” sce­nario to re­sult in do­mes­tic in­vestors tak­ing on a more “nor­mal” eq­uity ex­po­sure.

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