In 2021, this year’s sector leaders should hugely under-perform the market

Despite bleak short-term outlook, end of pandemic is in sight
We go into 2021 similarly optimistic about Japanese stock market as we were this time last year. We obviously had no idea what was to transpire in regards to the pandemic. However, by end of January it was all but evident to us that 2020 was going to be a very tough year, tainted by human tragedy as Covid-19 became the dominant subject of our weeklies starting with this one: {}

Early on, we recognised that our bullish stance on technology which was carried over from 2019 was going to pay dividends as stay-at-home and work-from-home regimes were only going to increase data traffic and would leave tech names well positioned in lock-downs that followed. However, even we had not anticipated the sheer pace of the rebound in technology shares which by August we felt looked over-extended and with huge number of vaccines in the works, we felt the time had come to switch to more undervalued cyclicals. By early November, we went a step further, suggesting to start buying more travel-related names as we believe the pent-up demand for overseas travel will leave airlines, hotels and resorts, fully booked up from the second half of 2021. 

To be sure, we had hoped that the contagion would be better contained by now, especially in the West. Although the new Covid variants which are said to be more contagious have provided yet more short-term speed bumps towards normalisation, the good news is that the virus seems not to have mutated to a deadlier form and the vaccines that have been approved thus far are likely to be equally as effective on blocking these new strains. As far as the new lockdown regimes from record number of infections and hospitalisations are concerned, we suspect these events will only speed up vaccination plans and with number of new Covid vaccines likely to prove effective in their trial runs by early January, even more drugs will be on their way which we think will end this pandemic by summer of 2021. 

2021 could be more challenging than it currently appears 
Although January could still prove volatile for markets as the outgoing US president is doing his utmost to prove disruptive as we have been largely predicting, we suspect we will enter calmer markets by late January as the Biden administration takes helm. Moreover, with two Republican senators in Georgia looking to be struggling to hold on to their seats in early January run-offs, the balance of power could tip leftwards in the US senate which will undoubtedly leave more generous fiscal stimulus measures on the cards. In such a scenario, US stocks could have one big push led by cyclicals and public works plays, even before Trump leaves office. 

Having surged to record highs of nearly $4.8trn by May, AUM in US money market funds have been on a gradually downtrend, and have most recently taken a big dip to an eight-month low to below $4.3trn. With so much money on the side-lines and institutional investors remaining largely underweight Japanese equities which this year have outperformed most developed markets outside of the US, especially in dollar terms, it is difficult not to be very bullish about our own market. We are targeting ¥2K level (+12%) for Topix by the first quarter of next year and as we have repeatedly highlighted, Japan is not only highly cyclical in its nature, but it is strongly geared to the fast-recovering Chinese economy and command much more modest valuation premiums than most other markets. 

On the other hand, we think work-from home, stay-at-home beneficiaries are likely to see a rapid deceleration in their earnings growth in 2021 from this year’s massive positive distortions as vaccination programs start to gain more traction by early spring, when we think schools and offices will open up and holiday makers make summer plans to rush out of their respective countries for a much-deserved break. We, thus, suspect that this segment of the market which led the way up for much of this year will be coming under intense selling pressure by the second half of 2021 at the latest. Although shorting any segment of the market in this bull run has proved highly challenging and frustrating this year, we see very fertile grounds for short selling some key areas of technology, and more specifically the video games segment which we will be attacking again in 2021.