investment viewpoints

All roads lead to Japanese equities

All roads lead to Japanese equities
Sui Kai Wong - Portfolio Manager

Sui Kai Wong

Portfolio Manager
Florian Ielpo, PhD - Head of Macro, Multi asset

Florian Ielpo, PhD

Head of Macro, Multi asset

 

 

Need to know:

  • Japanese equities have recently hit all-time high valuations, prompting some investors to reconsider them as a core portfolio component 
  • The country's unique economic response to global inflation positions Japanese equities favourably for continued inclusion in our long-term investment strategies
  • Our All Roads multi-asset strategy has increased its allocation to Japanese equities due to advantageous macroeconomic and financial trends

 

An opportune time to boost exposure

Over the past two quarters, Japanese equities have been in the spotlight, achieving all-time high valuations and sparking discussion: is it an opportune time to reintegrate Japanese equities as a fundamental component of portfolio construction? 

Designed with a long-term perspective, our All Roads strategy has always included Japanese equities and our flexible process has enabled us to increase our exposure over recent months. Our nowcasting indicators and trend signals currently find Japan an attractive market – with inflation at a satisfactory level , the economy continues to experience robust growth cycles, supported by an accommodative central bank. These factors have strengthened trend signals, eventually driving the increase in our exposure to Japanese equities. 
 

Welcome inflation

The Japanese response to the recent surge in global inflation is distinct from that of other G10 economies. Unlike peers that struggled with the negative impacts of inflation, the Bank of Japan (BoJ) has long faced a different predicament: actively seeking to stoke inflation after decades of deflationary pressures. This fundamental divergence is key to understanding both the economic and market dynamics currently at play in Japan. Moreover, Japan's unique restraint in fiscal spending during the pandemic allowed it to preserve the benefits of 15 years of quantitative easing, without needing to take drastic monetary policy measures.
 
While other G10 nations have responded to the aftermath of surging inflation with significant rate hikes, thereby slowing economic growth, the BoJ initially loosened its yield-curve control mechanism. Later, after considerable deliberation, it opted to move away from negative interest rates. 

Presently, Japan maintains the lowest short- and long-term interest rates in the developed world – these rates are markedly below those of counterparts. In turn, the JPY was driven to multi-decade weakness, which created two by-products: domestic deflationary pressure eased with imported inflation, and immense capital flowed into Japan, revitalising the economy and equity market. With the central bank not overburdening the economy by tightening, Japan has enjoyed robust GDP growth. As inflation recedes with global economic adjustments, Japan’s monetary policy, which is the least hawkish in the G10, provides a buffer, mitigating potential negative impacts and sustaining its economic trajectory.


Our nowcasting signals agree

Our novel Japan nowcasting indicators (see figure 1) vividly illustrate the current economic dynamics in the country. By juxtaposing our nowcasting indicator with the corresponding economic phenomena, each chart clarifies Japan’s economic conditions:

  • Regarding growth, our indicator remains consistently above 50%, reflecting the robust conditions that have prevailed throughout 2023 and are expected to last into 2024. This is in stark contrast to the economic downturns in the eurozone and China 
  • Meanwhile, inflation pressures, which notably intensified during 2021-2022, have since receded without significant intervention from the BoJ
  • Currently, our data advocates for the persistence of this Japanese economic equilibrium; our monetary policy nowcasting signal hovers at 50%, the critical threshold delineating the need for hawkish (above 50%) versus dovish (below 50%) policy shifts 


The phase of welcome inflation is now transitioning into a period of above-trend growth coupled with normalised inflation, in turn prompting the BoJ to continue its longstanding strategy of bolstering the economy through low interest rates. Such a backdrop is inherently beneficial for equity trends, underpinning a positive outlook for Japanese markets.

FIG 1. LOIM Japanese nowcasters vs growth, inflation and BoJ target rate


Source:  Bloomberg, LOIM. For illustrative purposes. Data as at June 2024.
 

An allocation that responds to change 

These factors have significantly shaped our multi-asset strategies, as demonstrated in figure 2, which details the recent trajectory of the Japanese equities allocation within our All Roads balanced strategy. The chart illustrates both the absolute and relative changes within our total equities exposure. Notably, both metrics showed a lower positioning in 2021, followed by an increase, initially in relative terms and subsequently in absolute terms. 

The shift in allocation directly reflects how risk assessments and trend analyses influence the adjustments to our strategy. The favourable macroeconomic environment in Japan, which has propelled Japanese equities into an uptrend, has been instrumental to increasing the weighting. 

Importantly, the augmented allocation depends on both global and local equity contexts, with our  process responding dynamically to the evolving trends and overarching economic conditions. 

Currently, approximately 15% of our equity investments are directed towards Japanese stocks (compared to a 5-6% weight in a passive MSCI World allocation, for example)1. This positioning has been a performance-driver for our solutions in the first quarter of this year.

FIG 2. All Roads balanced strategy’s allocation to Japanese equities, December 2018 - May 2024

Source:  Bloomberg, LOIM. Allocation is subject to change without notice. For illustrative purposes only. Data as at 31 May 2024.
 

Simply put, the Japanese economy benefited from the inflation context more than any other country – this has been a factor supporting the domestic equities market.

To learn more about our risk-based approach to multi-asset investing, click here.

Macro/nowcasting corner

The most recent evolution of our proprietary nowcasting indicators for global growth, global inflation surprises, and global monetary policy surprises is designed to track the recent progression of macroeconomic factors driving the markets.

Our nowcasting indicators currently show:

  • In contrast to last week, our growth nowcaster has fallen, particularly in the US, but not in China, where financial conditions have pushed the indicator higher
  • After a few weeks of a rising inflation nowcaster, there has been no movement this week in our inflation indicator
  • Our monetary policy nowcaster saw a minor decline in the US and a slight increase in China. The signal of status quo for monetary policy remains firmly in place as shown in the chart

  

World growth nowcaster: long-term (left) and recent evolution (right)

World inflation nowcaster: long-term (left) and recent evolution (right)

World monetary policy nowcaster: long-term (left) and recent evolution (right)

 

Reading note: LOIM’s nowcasting indicators gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).
 

source:

1  As of the time of writing at end-May 2024. Allocations are subject to change.

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