Higher rates come with high fund inflows into equities, even Japan’s
Although spiking long-term rates in the US have jolted markets, from our perspective it has mainly impacted sector allocations rather than hurting appetite for equities which are reportedly seeing near record US inflows. Even Japan equities have recently seen highest inflows in weeks from US investors. Although there is some concern for economic policy errors that have helped led rates higher, we don’t think their normalisation towards pre-pandemic levels is menacing for stocks, especially value names within the cyclical segments which now looks almost certain to continue outperforming the market, up or down, at least for the next quarter.
The above scenario keeps us fairly bullish on our market in Japan which is one of the most economic sensitive stock markets among developed ones. We continue to expect Topix to be trading around 2K by the end of this quarter, and certainly above that sometime during the next one. This is especially so as rising US rates look to have led to a trend reversal in the ¥$ rate with weakening yen coming at a good time for firms given that Japan’s export volumes are surging.
The end to the pandemic is starting to look real
As we have hoped, Covid-related conditions are generally improving, and rapidly as infections and fatalities continue to decline. This is especially so in developed countries as number of vaccines administered continue to get ramped up. With J&J’s one-shot jab also having just been approved in the US, and the one from Novavax likely to follow in March, we think the combination of an end to the winter season, rising inoculations, types of vaccines being made available, and antibodies developed naturally from those already infected, all spell the end to the Covid pandemic by summer, as surreal as this call still may sound.
Obviously, we are not talking about eradicating the virus, nor its variants which are certain to linger on and prove problematic. But we think we would have tamed the virus enough to see the end to lockdowns and start learning to live alongside Covid. However, it is hopeful to hear that mRNA platforms which are proving revolutionary and could help us eliminate cancers in the near future, are seeing their vaccines already being re-sequenced for Covid variants with fast FDA approvals sounding likely.
When to buy back tech names, at least in Japan
Sharp climb in US long term rates have also brought with it heavy headwinds for growth stocks. Although our suggested long/shorts have been well positioned for this trend reversal, we thought it would be more useful this week to ponder a short-term playbook for tech stocks, rather than to just reiterate our buy calls on cyclicals and other re-opening plays, not to mention, shorting video game developers. Suffice to say, we think normalisation positioning in equity funds have much further to go.
To be sure, in any traditional up-cycle, techs usually lead the way. But with tech stocks having been on a tear and on a separate secular growth trend for so long, not to mention, the pandemic adding some significant positive earnings distortion for some, we feel that whole space is likely to continue to get derated for the time being as the prevailing wisdom is that higher rates are not good for growth stocks. However, at this stage we do suspect that at some point early next quarter, before the next earnings season, techs could become poised for a notable bounce as these macro headwinds would have passed, at least temporarily, and markets would begin thinking earnings again.
As always, some caution is warranted given that from the market point of view, earnings multiple of tech stocks could dive much lower as their earnings continue to climb up but funds are forced to reduce their sector overweight positions in favour of cheaper, more operationally leveraged normalcy plays. In Japan, semiconductor equipment, materials and handset components which make up the bulk of tech stocks are looking highly likely to see the benefits of continued rapid order growth with semiconductor capex entering what can be best described as a super-cycle. As adoption of EUV manufacturing tools become even more crucial to stay cost competitive, there is more to this spending cycle than the obvious need to address the current capacity shortages.