Big PE compression of growth stocks looking likely; Short NT ratio call revisited

As we mentioned last week, with wage inflation running red hot, a breakout of the US 10-yr treasury yield above its technically crucial 200-wk moving average looked inevitable in the near term. With January’s US employment data proving much stronger than consensus projections despite the surge in Omicron and indeed hourly earnings running nearly 6% higher than last term, there was no other direction for long term rates to go but up.

We think this only adds more pressure on the Federal Reserve to raise rates by more than 25bps in March, a call we had outlined back in late December as being one of the big surprises for early this year. It is worth noting that ECB is also pivoting towards a tighter monetary policy as inflationary pressures in the region are mounting, especially with energy prices climbing further as spectre of Russian invasion of Ukraine is looming large. 

We think all of the above global factors will be forcing BOJ to allow the yield curve in Japan to steepen further. Indeed, as we also predicted last week, Japan’s long-term rates are also breaking out with the 10-yr JGB last week hitting its highest yield since 2015 and testing its technically crucial 0.2% level. 

These developments also reinforce our top-down Japan stock market strategy of remaining over-weight cyclicals, financials and value stocks while suggesting shorting richly valued growth names. The heart wrenching ride in FANG stocks after earnings results last week which also dictated the direction of growth names in Japan provides vital clues to the unhealthy state of this market segment which we firmly believe is facing a notable earnings multiple compression.

This brings us to another of our major predictions but one dating back to December 2020 when we were looking at some of the big surprises for last year. One of these was for Nikkei/Topix (NT) ratio which had been climbing for almost 15 years and was accentuated by BOJ’s heavy-handed purchases of Nikkei ETFs until early last year, will reverse course.

Although initially this bet was based on our negative stance on some big components of the Nikkei, namely Fast Retailing and Softbank (which remains on top of our short sell list), we believe this highly correlated pair is also an elegant bet on value outperforming growth in Japan. Since its peak in February last year, Topix has outperformed Nikkei by over 10% and we see much more scope for this trend to continue.