28 November 2013

Macro Strategy Update

Japan: Bullish Perspectives

We have been bullish on Japanese equities since early June, after the Nikkei sold off 20% from its May peak. Since then, Japanese equities have been consolidating with an upward bias, notching lower highs but higher lows. In recent days, the Japanese market is springing back to life. Our patience is beginning to pay off.

Purely from a technical perspective, when the Nikkei broke out of the resistance formed over the past five months, a new trend has emerged. This was aided by the action of the Japanese yen. In a similar fashion, the yen was consolidating since mid-May, making a series of higher lows and lower highs. Now the yen is done consolidating and the next move appears to be headed lower. We have long argued that a weaker yen would boost corporate profitability and hence drive Japanese equities higher. This is likely to play out in the months ahead as the yen continues to weaken.

Image courtesy of Stockcharts.com

Image courtesy of Stockcharts.com


In the longer term, the continued rise in the Nikkei could mark the end of the 23-year bear market for Japan. The Nikkei would need to break out of the resistance established since 1996, and when that happens, we could possibly see a secular bull market in Japanese equities. This is likely a 2014 event for the Japanese market, where the yen has further potential to fall to pre-2008 levels.

Resolving the technical picture with fundamentals, it remains crucial that monetary policy remains accommodative in the short term, and meaningful reforms occur in the longer term. The odds are high that renewed monetary easing could occur as higher sales tax kicks in next year. Comments from Bank of Japan (BOJ) officials show a bias towards downside risk to the economy . It is likely that the BOJ will err on the side of caution by providing more monetary stimulus should the domestic economy1 starts to soften in anticipation of the higher sales tax.

Image courtesy of Stockcharts.com

Image courtesy of Stockcharts.com


Beyond monetary policy, for the Nikkei to embark on a long term bull market, reforms need to kick in. So far, the pace of reforms is proceeding at glacial speeds. The only change is the removal of rice subsidies as Japan prepares to join the Trans Pacific Partnership free trade agreement. While this is not a huge move by PM Abe, it is significant since rice farmers are supporters of the ruling Liberal Democratic Party. The removal of a 40-year old subsidy is significant as it shows the commitment to change Japan. Still, observers are looking for corporate tax changes and labour reforms as keys to unlocking Japan’s growth potential. Perhaps we could see some of these changes in 2014, which would then form the basis of a stronger Japanese economy and a higher Nikkei.

For the time being, as long as the yen trades weaker, Japanese equities are likely to rally. A break above May’s high would turn some skeptics into buyers. The next leg of the Japanese rally has begun.

Portfolio Positions

We have made some decent profits so far on our Japan play. However as per our last update, we are monitoring the global markets and may take some profits off the table toward the end of this year or the beginning of next year. For now we see overall market momentum as still strong and will remain invested.



References
1. BOJ Shirai Open to Further Easing Action. 27 November 2013. WSJ.com.

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