Cheap Yen & Low P/E To Deliver Immense Bargains in NikkeiBuying financial assets in dips provides an inbuilt margin of safety. Enriching that trade is a currency that is hovering at its near lowest in a decade.
Expected equity gains compounded with Yen that is anticipated to strengthen will strongly propel alpha from the proposed trade setup in Japanese equities.
The P/E ratio based on next 12-months earnings in Japan is 13x and cheaper relative to 18x for the S&P500 and 27x for the Nasdaq.
The Yen is near its lowest on average based on real-effective exchange rate. It is 2.3x standard deviations below the average over the last decade.
For investors looking to hedge their yen exposure, its term structure delivers a positive basis (forward value minus spot price) that can be harvested through hedging.
A long position in CME Nikkei/Yen Futures combined with a full currency hedge delivers a 1.9x reward to risk ratio with entry at 29065 and target of 31295 hedged by a stop at 27900.
DEMYSTIFYING THE NIKKEI 225 INDEX (“NIKKEI”)
The Nikkei index lists 225 largest Japanese firms. Given Japan’s heft, the index is an indicator of Asian market sentiments.
The Japanese stock index was previously called Nikkei Dow Jones Stock Average from 1975 to 1985. The name was later changed to Nihon Keizai Shimbun or Japan Economic Newspaper which is commonly referred to as Nikkei.
The Nikkei is a price-weighted index with an adjustment factor for each stock. The summation of the adjusted prices is divided by a divisor (29.508) to maintain index continuity.
The 225 firms are spread across thirty-five industries. Top fifteen industries form 93% of the index. Top ten firms represent 38% of the Nikkei.
Technology, Consumer Goods, Materials, and Capital Goods represent 95% of the index.
JAPANESE EQUITIES HAVE BEEN RESILIENT THIS YEAR
Japanese equities have delivered 13% gains so far this year with resilience across all sectors. Thanks to Apple and Microsoft, Nasdaq has returned 22% this year as investors seek shelter from ongoing crisis in US banking sector. “Stealth” QE partly explains the outsized gains in Nasdaq.
In sharp contrast, S&P500 is up 9%, Dow is up 3%, Russell 2000 is up merely 1% while Chinese equities are down 3%.
Positive performance in Nikkei is evident across all sectors and names. Broad based recovery in Japan makes Nikkei far more resilient relative to US equities where superior performance is restricted to no more than a dozen quality names.
JAPANESE EQUITIES ARE PRIMED FOR GROWTH
Japanese shares continue to inch higher with the Nikkei trading near its highest level in eight months led by earnings optimism and expanded government subsidies for chip production.
The prospect of chip makers looks bright after Industry Minister Yasutoshi Nishimura said Japan plans to provide additional subsidies to chipmakers.
The P/E based on next 12-months earnings in Japan is around ~13x and cheaper relative to ~18x in the US. For every dollar of earnings, only USD 13 is required to be invested in Nikkei compared to USD 18 in the S&P500 & USD 27 in Nasdaq.
Japanese stocks not only trade on low P/E but pay healthy dividends. Nikkei has a yield of 2.13% compared to Dow Jones at 2.09%, S&P 500 at 1.67% and Nasdaq-100 at merely 0.86%.
THE YEN IS EXPECTED TO REGAIN ITS HAVEN STATUS
The yen is expected to regain its status as a haven currency after years of dollar dominance with the BOJ expected to normalise its monetary policy.
The BOJ is anticipated to discard its yield-curve control policy in coming months and that should help strengthen the Yen. Barclays analysts expect the yen to appreciate to 123 per dollar by this time next year.
The yen has faced headwinds from higher energy prices and a worsening rate differential as global central banks hiked rates to contain inflation. As energy prices ease and the rate hiking cycles pause, selling pressure on the Yen will soften.
If the Fed stops raising rates after a final increase this week, that might lead to inflation-adjusted yield differentials to stop widening in favour of USD.
Majority of forecasts have the yen strengthening to levels beyond that implied by the forward market. Analysts are one way on the direction of the dollar-yen. Japanese yen forecast for end-2023 was 125 as of last week, compared to FX forward rate at 129.
Analysts at RBC fear that these crowded expectations underplay the impact of recession. US recession spreading to global markets could send the Yen plunging to 150 to the dollar as per RBC.
COT REPORTS POINT TO BULLISH SENTIMENTS FOR JAPANESE EQUITIES
The CFTC’s Commitment of Traders report (COT) shows positioning by professional investors in Nikkei futures.
The report shows open interest segmented into four buckets, namely, (a) Asset Managers (pension funds, mutual funds, & institutional asset managers), (b) Leveraged Funds (hedge funds & money managers), (c) Other Reportables (traders using derivatives to hedge business risk), and (d) Non-Reportables (small speculators).
Asset Managers have increased their net long positioning by 278% in Yen denominated futures.
Leverage funds have reduced net shorts on Dollar-denominated futures.
TRADE SET UP
Low P/E ratios, Cheap Yen, Resurgence as a Haven, are among the drivers favouring the Nikkei. A long position in CME Nikkei/Yen Futures with currency fully hedged will deliver a 1.9x reward to risk ratio with entry at 29250 and target of 31295 hedged by a stop at 27900.
Every tick represents five index points corresponding to a change of JPY 2,500 per lot.
● Entry: 29065
● Target: 31295
● Stop: 27900
● Profit at target: JPY 1,115,000
● Loss at stop: JPY 582,500
● FX hedging gains with CME Micro USD/JPY Futures (Dec 23 contract): JPY 37,200
● Reward-to-risk: 1.9x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
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