Markets entering a regime change which looks very bullish for Japan equities
Growth stocks derating should continue but markets look well supported
As we have previously noted, we think this trend in growth stocks derating should continue in global stock markets, at least until we get closer to the next earnings season, when earnings start to matter again. Generally, we think earnings multiples that growth stocks currently demand still seem too high relative to the much higher rate of earnings rebound we are seeing in cyclicals which trade at much more modest valuations. For this reason alone, we think there is some bottom-up logic to this top-down view that equates higher rates to a sell signal for growth stocks.
We suspect the ten-year US treasury yield will be testing the pre-pandemic highs of 2% in the near-term as the end to Covid health crisis comes closer in sight. We think rising long term rates have brought a major market regime change that could further push down earnings multiples of growth stocks, at least towards their bottom-line growth rates which are typically in their mid-teens. In fact, the old ‘peg ratio’ might be a useful yardstick for investors to measure that relationship.
What is interesting is that during this growth stock sell-off, VIX index or the fear gauge had actually receded close to its 12-month lows of 20. This is suggesting perhaps that this rotation out of tech and other growth stocks to post-pandemic normalcy plays is not really disrupting the general bullish mood as hopes are high that lockdowns and travel restrictions come to an end by this summer.
On the other hand, AUMs in US money market funds are surging back up, pointing to likely asset allocations, out of fixed income funds and into everything else. There is also more liquidity coming in from Fed and US Treasury Department squaring up their books for discontinuation of some relief programs and untapped loans provisions. Come what may, given where we are at this early stage of the cyclical rebound, we think stock markets will remain well supported and share prices of recent market leaders are unlikely to reverse course anytime soon.
Japan stocks looking fantastically placed, especially for L/S funds
We want to reiterate our view that this month could prove pivotal to 2021 performance of equity funds and those with L/S mandates are looking particularly well placed to take advantage of this two-way market. Questions is, will they? We have not sensed much shorting taking place as investors are generally wary of a big rebound in growth stocks which materialised last week but quickly faded. Although technical support levels seem to have held up thus far, another selling assault, particularly in Japan tech names will push them below their 200-day moving average and off the cliff.
Moving on to our own market, one thing we wanted to get off our chest, having spoken with a few readers that manage global money is that although our bullish outlook about Japan might sound self-serving, we are always fairly agnostic about market’s direction and our bullish strategic stance was only adopted last September. Our focus remains on generating ideas that generate alpha while one of our key remits will always be looking for short ideas. We be just as happy to call our market down and feeling very much at home with it.
Nevertheless, the picture for Japanese equities looks outstanding for the next few quarters and given the market’s cyclical gearing, it could prove to be one of the best performing among the majors. In Japan, not only valuations look relatively modest, but its capital markets are deep, allowing borrow for shorting most stocks at reasonable rates. We also think this sudden tailwind from weaker yen will only add to the earnings growth momentum of cyclical exporters. We are also positive about the growing trend in share buyback programs which are usually followed by shares retirements, making these real buybacks that positively impacts EPS. This backdrop makes Japan one of the more attractive stock markets for global funds.
