Evolving Markets

Our Global Investment Committee always seems to meet in the middle of great volatility, and this time was no exception, with the investment world facing all sorts of new challenges.

In our view, the LDP coalition's maintenance of a strong two-thirds majority in this election will greatly help Prime Minister Abe and his party's reform efforts, while likely bolstering Yen weakness to some degree.

The three main points from our prior report on this topic have not changed; however, there are a few more anomalies in the data this time.

The Japanese equity market for the most part maintained a strong tone in 2014, with the Nikkei Stock Average at one point in December rising intra-day above JPY18,000 - a level it had not seen since July 2007.

Equity investors should not fret too much about weak macro data, as Japanese companies have been able to overcome such for nearly a decade through rationalization and improved corporate governance.

Moody's downgrade of Japan to A1 will likely have very little effect on bond yields, the economy or risk-asset psychology. The major reason why is due to its odd premise of predicting too much success of Abenomics, while most market observers are not so optimistic.

Three important things to know about the recently announced Japanese GDP statistics that indicated that the country was in a recession.

We examined the relationship between a country's working age population and its listed company corporate earnings for ten nations, and found that the relationship is ambiguous at best, with correlations ranging from positive to strongly negative.

Although there are potential flashpoints, there are some areas where the US President may be more willing to cooperate with the new Congress — such as being awarded the authority to fast track trade agreements, particularly the Trans Pacific Partnership (TPP)

We have long reported on the role of the wealth effect, as its importance is vastly underestimated by local and foreign investors. The 2Q data for net financial assets shows a QoQ increase to a new historical high.

Update on Japan’s “Show me the Money” corporate governance — the dividend paid by TOPIX continues to rise towards its historic high, but the payout ratio has been stagnant for the past few months, as earnings continue to rally equally well.

Our house view is that non-economic factors played the largest role in the recent market turbulence. We discuss these below and forecast their future development.

Much as we expected, China’s economy has continued to slow faster than consensus, but does not appear to be in a hard landing.

Improving the number of independent directors and other governance issues are very important in the intermediate term for Japan, but it is crucial for investors to understand that much of the profitability message has already been understood by Japanese corporate for nearly a decade.

Japan’s pipeline inflation, which we measure using the recently renamed Producer Price Index’s Finished Consumer Goods for Domestic Demand sub-component continued to be quite depressed in August.

Japan’s 2Q GDP growth, at -7.1% QoQ SAAR, was far below June’s consensus of -3.1% (and our -2.5% estimate) and we need to reduce our CY14 forecast, but not by much and we remain more optimistic than consensus.

Although not a Goldilocks scenario, our forecasted macro-backdrop is quite positive for global equities.

G-3 bond yields rose less than we predicted, mostly due to continued ECB aggressiveness, worries about the Chinese economy and the decline in oil prices.

Sentiment about Fed policy remains very volatile, but Yellen has remained remarkably stable in her outlook and bond prices have remained under control during the transition away from ultra-accommodative levels.

Nikko AM’s Global Investment Committee met on September 26th and updated our house view on the global economic backdrop, financial markets and investment strategy advice. In sum, there certainly are some worrisome issues, as always, but we find none of them convincing enough to halt the upward momentum in equity prices.

Domestically produced goods and imported finished consumer goods both rose mildly MoM. This must be causing much doubt at the BOJ about achieving the 2% Core CPI target.

As for the entire Eurozone, its trade surplus in goods and services remains near record highs, but it is not increasing further, so it is no longer supportive of GDP growth.

Regarding our long-standing theme of rebalancing in the Eurozone, recent trends have been more negative, so we offer this summary with some relevant charts.

Last month we described Japan’s “Show me the Money” corporate governance as regards the sharp rise in corporate profit margins to new highs. This theme is paralleled by the trend in dividend payments.