Investors en masse certainly seem to have been caught on the wrong foot since the start of the New Year as global stock markets have been both volatile and in a sustained downtrend ever since 2014 kicked off. In fact, stats out showing that retail investors in the U.S pulled the most out of equity markets since records began (see below) shows just how jumpy they are and again, sadly how the masses are always wrong given that they really only became enthusiastic about equities last year – 4 years into the bull run.
With the first quarter almost wrapped up and equity markets globally down (some more than others), it is appropriate to reassess the investment landscape from a macro perspective to see what opportunities have been thrown up and indeed if one should change their stance.
With the US Federal Reserve continuing to cut back on its asset purchases, now at the $65billion level per month from $85bn previously, investors it seems are looking for an alternative reason to justify holding equities. Unfortunately, the state of the world economy just isn’t encouraging enough for a stock market that has almost tripled in value since the peak of the crisis 6 years ago and investors fear that without the help of central banks, financial markets will reassert themselves with gravity again as multiple expansion is difficult to justify from here.
Ironically, given the extension of QE relative to other markets around the globe, Japanese equities have been under intense fire in 2014 with the Nikkei losing almost 13% in the short YTD period – the largest of all developed markets as the table below shows (NOTE: TO END FEB). But while market routs deplete the wealth of panicked equity owners, they also create good opportunities for buyers. Is this a good opportunity to enter Japan again then, or should we stay away?
Japanese equities have in fact been through a really tough period for almost generation now – a true secular bear market with the index still down almost two thirds from its bubble high at the end of 1989 near, amazingly, 40,000. The Japanese economy has been experiencing deflation for more than 25 years and as this deflation ravaged companies and the Yen soared to new highs, the index was pushed down to a shade over 7,000 in 2009 – over 80% down from its all time high – an almost unprecedented fall in recent times. Equities were veritably trashed, to say the least, and one Japanese leader after another was condemned to the political scrap heap, seemingly unable to restore any confidence in the economy. It thus seemed that equity prices were condemned to stay flat for an eternity…
Enter stage left one Shinzo Abe – a second time Prime Minister, having previously stepped down due to ill health and who swept back to power in 2012 with a bold promise to reflate the country and recover the lost economy. Abe immediately set about pressing the BOJ to engage in a policy that mirrored the FED’s approach in recent years. That is injecting a large amount of money over a short period time in the hope that (a) the Money multiplier effect would kick in and (b) weakening the Yen materially to add a double whammy to exporters.
In January 2013 the BOJ announced a new inflation target of 2% and an asset purchase program of ultimately 60-70 trillion yen per annum. Not surprising then that given this magnitude of liquidity injection that it lit the match under the Japanese equity market. With many global investors underweight and caught on the hop, the Nikkei rose 43% and the JPY lost 22% during 2013 as a direct consequence of the new program as investors chased the market higher. We flagged this to our readers literally days before take-off here – http://www.spreadbetmagazine.com/blog/japanese-equities-dont-miss-the-train.html
The shakeout seen in recent weeks however have reminded investors just how fragile the Japanese economy still is and how interdependent, like the rest of the world, the country is on what happens with US monetary policy. If what happens in Vegas stays in Vegas, we could also say that what happens in the US surely doesn’t stay in the US! And that means that what the FED does is even more import than the BoJ for Japan.
We had a warning last year when Bernanke set of the so called “taper tantrum”. In the summer the Nikkei crashed by a shade over 20% peak to trough in a little over 4 weeks and the hot money flew away to, irony of ironies, the “safety of the dollar”. This year the same thing happened again. At first it seemed that markets shrugged off the initial tapering that started in December but when a mix of negative news coming from the US, China and the emerging markets hit the street, the hot money quickly flew away once more from Japan as the charts below depicts.
What we have learnt here at Titan over many years is that investors en bloc are typically always wrong and that “babies do get thrown out with the bath water”. This last week we began building exposure again to the Japanese market towards the lows, reasoning that if the hot money is out, the market is dramatically oversold and the reflation story is still full steam ahead with Japanese officials likely staying resolute in their economic reform plans, that this is a good recipe to be involved with.
From a pure valuation metrics basis Japanese equities are cheaper than US equities, particularly on a price to book basis and as the chart below shows the rout this last month actually took the market back to touch the top of the flag formation breakout last year. Technically with the weekly RSI back at 47, in a bull market, this can prove a good level to get long again as each of the circles on the chart illustrate.
Our and our client monies is now in part on a resumption of the bull market in Japan while the 14,000 level holds on a weekly closing basis. One thing we are watching closely however is the potential head and shoulders formation too and should the index break this key psychological level decisively, it would tell us that our view is wrong and that the Abenomics experiment is beginning to breakdown.
One way to hedge this bull play at present would be to sell S&P Call options as the VIX has spiked higher in recent days and so made premium worth taking. The gap between the S&P 500 & the Nikkei this year, as shown below, we expect to close.
If you’d like to invest alongside us in our Global Macro fund which to 7th March was up 49.25% YTD against our MSCI World Index benchmark of 1.21% (in constant dollars) then click the banner below for more details.
You should not take this piece as an advocation to trade in any of the instruments mentioned and should always take professional advice in relation to your own personal circumstances. Past Performance is not necessarily a guide to the future.
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