The Bank of Japan can’t let goThis week financial markets were dominated by central banks policy decisions. While the Federal Reserve (Fed) and Bank of England (BOE) kept rates on hold, the policy board of the Bank of Japan (BOJ) decided to further increase the flexibility in its yield curve control policy.
The BOJ previously set a strict cap of 1.0% for the 10-year Japanese Government Bond (JGB) yield. But it has now decided that 1% should be a “reference” (not a strict cap), which effectively allows the yield to rise above 1% when the BOJ thinks it is appropriate. The upper bound of 1% appears to be a level they can’t let go of. By doing so, the BOJ is choosing an exit path that gives them the maximum flexibility but minimum volatility around the Yen. We view this as a dovish move as consensus expectations were for the BOJ to move the cap to 1.25% rather than 1%.
Japan’s remains on a narrow path
One of the reasons holding back the BOJ from normalisation of policy rates, is they still believe Japan’s recovery since the re-opening in October 2022 remains on a narrow path as it relies heavily on tourism, while the broader services sectors have yet to pick up significantly and manufacturing activity has been hampered by soft exports. Japan’s flash PMI readings for October showed us a bifurcated economy where the services sector is stronger than the manufacturing sector. Manufacturing PMI clocked in at 47.6, which is in contraction territory. Services PMI was 51.1, which is down from last month’s reading of 53.8 but is still in expansion territory, no doubt helped by fiscal stimulus and the accommodative monetary policy environment.
BOJ on the lookout for an intensified virtuous cycle between wages and prices
BOJ governor Ueda indicated that the BoJ will be monitoring the upcoming spring union-employer wage negotiations. A strong outcome could catalyse the earlier attainment of sustained inflation in Japan, but overall, Japan’s recovery isn’t strong enough yet for employers, especially small enterprises, to meaningful support wage hikes in the broad economy. While headline inflation bolted north of 4% in January 2023, it appears to have peaked and has begun receding. While core inflation remains around the 4% mark. The Producer Price Index (PPI) slowed to 2% annually in September suggesting a stabilization or even drop in CPI ahead.
The BOJ revised its outlook for core inflation (all items less fresh food and energy) to 3.8% in FY23, 1.9% for FY24 and 1.9% for FY25. The BoJ stated that the inflation uptick “needs to be accompanied by an intensified virtuous cycle between wages and prices”.
The Yen is unlikely to appreciate under BOJ’s policy change owing to the large gap in interest rates between the US and Japan. The direction of the Yen matters for Japanese equities owing to Japan high export tilt. The exporters stand to benefit amidst a weaker Yen.
Fire power abounds for Japanese equities
Japanese equities had a strong first half in 2023, attaining 33-year highs. Yet valuations at 15.7x price to earnings ratio (P/E), still trade at a 30% discount to its 15-year average providing room to catch up. More importantly, earnings revision estimates in Japan are currently the highest among the major economies. Earnings yield at 4.07% for the Nikkei 225 Index has been trending above bond yields 0.947% for 10 Year JGBs , keeping the well-known TINA (There is no Alternative) trade alive in favour of Japanese equities.
Tailwind from corporate governance reforms
Tokyo Stock Exchange’s (TSE) call for listed companies to focus on achieving sustainable growth and enhancing corporate value is beginning to bear fruit. The call was aimed at companies with a price to book (P/B) ratio below one. Those companies were asked to develop a plan for improvement, disclose and then implement and track its progress. The progress has been encouraging with 31% of companies on the prime market making a disclosure of their plan .
Large companies with a price to book ratio below one have been more proactive with disclosure. Historically cash-heavy Japanese companies face increasing pressure to improve their numbers, possibly by funnelling historically high excess cash reserves into increased buybacks or dividends.
Conclusion
Inflation has been missing in Japan for more than a decade. So now that it has arrived aided by the post pandemic pick up of the Japanese economy, policy makers are not in a rush to obliterate it. With wage growth lagging behind inflation, the Bank of Japan does not appear ready to wean itself from Yield Curve Control until a more intensified virtuous cycle is observed between wages and prices. The BOJ’s policy decision this week is unlikely to allow the appreciation of the Yen, which should continue to provide a competitive advantage to Japanese exporters.
This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
Tina
Soft landing calls for tough choices2023 has been a tough year for stock pickers. The gap between equity factor styles has been vast over H1. Growth, riskier in nature, posted the best performance up 24% year-to-date (YTD) followed closely behind by quality up 20% YTD1. The excitement around artificial intelligence (AI) reached a fever pitch in H1 2023, supporting growth-oriented technology stocks.
As we enter H2 2023, we remain constructive on select areas of global equity markets. The resilience of the US economy has defied all odds. The strength of the US consumer (accounting for 70% of GDP), alongside the fiscal impulse, has been the cornerstone of the US’ extraordinary resilience. While inflation has shown encouraging signs of decline in the US, strong economic momentum alongside a rebound in commodities raises the risk of a re-acceleration of inflation. In turn, rates could remain higher for longer, resulting in Federal Reserve (Fed) rate cuts being delayed until Q1 2024. In such an environment, an enhanced equity income approach could fit well. Even if the earnings outlook weakens in China, proactive policy support via rate cuts could support its stock multiples.
In Europe, where we are likely to witness a mild recession, we believe adopting a more cautious and defensive approach is warranted. Earnings revision ratios remain the strongest in Japan while they are the weakest in emerging markets.
US equities are the belle of the ball
It was the narrowest market in history, with just 25% of stocks outperforming the S&P 500. Expectations of cooling inflation aiding the Fed to end its current tightening cycle supported the performance of higher-duration growth stocks. For investors calling for a soft landing, rates are likely to remain at current levels or higher for a longer duration of time. A tight US labour market, with unemployment at historic lows and rising wages, is likely to slow the downward pricing momentum in the service sector. As the market regime transitions, it should provide a ripe opportunity for market breadth2 to improve. Markets may begin to favour value and dividend-paying stocks. History has shown us that breadth tends to improve as the economy recovers from a downturn.
Peak pessimism towards China
China’s reopening rebound has faded. The transition to a less debt-fuelled, less property-reliant and more consumer-driven economy is an important adjustment. We expect government stimulus policies to be aimed at enhancing the efficiency of the private sector. Further iterations of policy rate cuts by the People’s Bank of China (PBOC) are likely to follow; however, outright quantitative easing won’t be on the cards, as it is likely to further weaken the yuan, which the PBOC would like to avoid. With a low correlation to US equities (at 20x P/E)3 coupled with a high valuation discount, pockets of China continue to provide good investment prospects.
Pockets of opportunity in non-state-owned enterprises
Non-state-owned enterprises, particularly within the Technology, Communication Services and Health Care sectors, faced the brunt of China’s regulatory crackdown. These regulatory interventions stifled growth in key sectors such as e-commerce, mobile payment, ride-hailing, and online education. It also resulted in the suspension of initial public offerings (IPOs) and delisting of Chinese internet companies. Growing political frictions in supply chains are incentivising China to regain independence in the semiconductor and hardware space. Chinese technology companies are trading at a significant discount compared to US peers, offering plenty of room to catch up.
Prefer defensives over cyclicals as Europe runs out of steam
Nearly six months back, investors marvelled at how the euro-area economy had emerged from the energy crisis. That momentum appears to be fading as China’s recovery slows down, consumer confidence declines, and the impact of tighter monetary policy gains a stronghold on the economy. Higher inflation over the past year is holding back demand from households, which is hurting growth.
The monetary tightening over the past year not only triggered an increase in real rates, it also impacted borrowers’ credit metrics. Owing to this, eurozone banks have tightened their lending standards.4 Banks remain the primary source of corporate funding in Europe. The credit impulse—that is, the annual change in the growth of credit relative to GDP—in the euro area reached its lowest point since 2010.
TINA is alive in Japan
There is no alternative (TINA) to equities is still alive in Japan. This is evident from higher equity risk premiums of 2.97% for Japan compared to 0.41% in the US.5 While the rest of the world has been busy trying to quell the inflation fires, Japan has emerged from the COVID-19 lockdowns with a faster pace of growth and higher inflation. A combination of higher equity risk premiums, a weaker yen supportive of the Japanese export market, corporate reforms, and attractive valuations have been important catalysts for equities.
Policy shift still remains loose
The Bank of Japan (BOJ) took a significant step towards normalisation in July by announcing a further adjustment to its yield curve control (YCC) regime. The BOJ formally changing its course constitutes an acknowledgement that inflation is returning to the Japanese economy. Yet the BOJ lowered its (median) inflation forecast for fiscal year (FY) 2024 to +1.9% and left its FY 2025 projection unchanged at +1.6%, in effect justifying ongoing easing by the BOJ. With Japan’s nominal growth rising over the coming years, the revised policy by the BOJ still remains loose, supporting the case for Japanese equities. Historically, a weaker yen has benefitted the performance of Japanese exporters as it enhances their competitive advantage. Adopting a tilt towards dividend-paying Japanese equities is likely to reap the benefits of not only a weaker yen but also corporate governance reforms.
Conclusion
As we progress into year-end, the outlook remains more nuanced. In the US, we favour value and dividend stocks as equity market breadth improves. While China’s problems in the housing sector are likely to remain a drag on domestic demand, we do see pockets of opportunity in undervalued sectors – technology and healthcare. Given the strong manufacturing headwinds facing Europe, we expect weak growth in the eurozone for the remainder of 2023, potentially favouring a tilt towards defensive stocks.
Sources
1 Bloomberg as of 11 October 2023.
2 Breadth is measured by comparing the equal weighted performance versus the market cap-weighted performance of the US stocks listed on the S&P 500 Index.
3 P/E = price to earnings ratio.
4 Euro area Bank Lending Survey (BLS), April 2023.
5 Bloomberg, WisdomTree, as of 29 September 2023. Equity risk premium is the difference between the earnings yield and the respective 10-Year Government Bond Yield.
This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
Higher for LongerUS inflation data in July 2023 provided mixed signals. While Consumer Price Index (CPI) is moving in the right direction, producer price inflation suggest pipeline pressures are picking up. Core CPI, which excludes often-volatile food and energy costs, rose only 0.2% for a second month in a row . However, US producer prices picked up in July, owing to increases in certain service categories. This likely buys more time for the Federal Reserve (Fed) to deliberate on the future path of monetary policy.
The flows into bond exchange traded funds (ETFs) have been volatile. Over the past year, investors were starting to embrace duration. Investors were positioned for recession, inflation crash, and Fed cuts - evident from $31.7bn inflows to Treasury bond ETFs on pace for a record year2. However, investors are starting to pull out of the biggest bond ETFs devoted to Treasuries. More than $1.8 billion came out of the $39 billion iShares 20+ Year Treasury Bond ETF last week, the most since March 20203. Sentiment toward long-dated Treasuries has soured over the past month amid growing conviction that the Fed will keep interest rates at elevated levels for an extended period. We expect rates to remain higher for longer and are unlikely to see the Fed cut rates until the Q1 of next year amidst a stronger US economy.
Don’t celebrate on disinflation just yet
Overall, the US economy continues to show extraordinary resilience despite monetary constraints and credit tightening. While inflation has shown encouraging signs of decline, we caution that the level remains high. Strong July retail sales raise the risk of a re-acceleration in inflation. The four biggest categories of the ex-auto’s component saw outsized gains: non-store retailers, restaurants & bars, groceries, and general merchandise. Amidst a tight US labour market, with unemployment at historic lows and wages continuing to rise, the downward pricing momentum in the service sector is likely to be at a slower rate. Commodity prices are also beginning to rebound from the weakness seen in Q2 2023. Energy prices have been rising on the back of Organisation of Petroleum Exporting Countries and its allies (OPEC+) production cuts. If commodity prices extend their recent momentum, it could pose upside risks to inflation.
Fed Officials remain divided
Messaging on a somewhat mixed inflation outlook from the Fed Officials remains a mixed bag. One faction remains of the view that rates hikes over the past year and a half has done its job while another group contends that pausing too soon could risk inflation re-accelerating. Fed governor’s Michelle Bowman and Christopher Waller remain in the hawkish camp, hinting at more rate increases being needed to get inflation on a path down to the 2% target.
Futures markets are assigning about a 11% chance of a 25-basis-point rate hike when the Fed next meets on 19 and 20 September4. Additionally, rate cuts have now been completely taken off the table until perhaps later in the Q1 2024. The latest Fed minutes reveal commentary from officials, including the hawks, such as Neel Kashkari, suggest a willingness to pause again in September, but to leave the door open for further hikes at the upcoming meetings5.
Opportunity for a yield seeking investor
It’s been an impressive turnaround since the pandemic when negative real yields became the norm. TINA- ‘There Is No Alternative’ to equities, is over now that evidence of the shift to a 5% world appears stronger than ever. Today investors have the opportunity to lock in one of the highest yields in decades, with US two-year yields paying close to 5% exceeding the yields at longer maturities without the volatility witnessed in the 10-year sector. A resilient US economy is likely to keep interest rates and bond yields higher for longer.
Sources
1 Bureau of Labour Statistics as of 10 July 2023
2 BofA ETF Research, Bloomberg as of 9 August 2022 - 9 August 2023
3 Bloomberg as of 14 August 2023
4 Bloomberg as of 17 August 2023
5 federalreserve.gov as of 16 August 2023
This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
2% yield is coming--soonHello everyone,
I drew this pattern a few days ago when analyzing the SP500 behavior in recent weeks. I believe the market boogeyman is not gone and that today was just a taste of what he has in store. 2% yield will not be in July. It will be here in April or June... and as early as March 29th.
The yields are behaving extremely bullish lately. The blue lines represent an ascending channel that is consolidating at higher lows. In the past few days you can see that the pattern is returning to the center of this channel less and less. It's breaking out of the channel to former a sharper one. So we've got increasing curvature.
I believe the yields have a strong possibility of going parabolic unless the fed takes control. Given JPOWs speech, he is going to be reactionary and not prevent it. So it's definitely in the realm of possible and trending towards it. I believe this could have severe implications for the equities market. I've drawn a purple 2% yield line which is being eyed by the market as a whole as a possible 'catalyst' for a 20% correction. At 2%, the yield allows the bonds to break even by surpassing what JPOW says is inflation.
The bond market is not believing JPOW and the Fed. They seem to believe inflation is over 3% and as high as 4%. They also seem to believe that it is not transitory. The yield is also becoming suspicious. I believe there are a number of short sellers hitting the US10Y in an effort to push the fed to raise rates. I have no proof. Only a gut feeling based on observed price action.
Be careful. A parabolic yield could induce a panic leading to a possible limit down on the NASDAQ/SP500. You're welcome to view my forecast I made on March 12th. We are seeing some deviation but the overall pattern remains.
If I am trading right now I would be in cash or in puts. Please trade carefully. The market may experience extreme volatility as the TINA effect weakens. (There Is No Alternative -- meaning stocks have the best return possible and there is no competition)
Disclaimer: I am holding puts and have been for a few days. I am not a financial expert or advisor. Trade at your own risk.
Draghi Extacy works great :) How long DAX stay in heaven ?TINA is doing great for stocks . If you look to the past , never before the DAX get 2300 points in 3 months.
Never before MACD has reach this high.in positive area. Only the crash from 2009 and 2011 we seen this before in negative MACD area.
So we are waiting for Draghi next step. :)
How you rehab this junky the next months Mario :)