Global investors continue to invest in equities with their toe on the accelerator and their heel over the brake. Investor confidence has generally recovered from September 2006, while confidence in Asia has soared. Because of the “heel-and-toe” approach, investors everywhere continue to prefer large- over small-cap stocks.
While sentiment regarding Asia is high, Japan and Asia ex-Japan march to the beat of different drummers regarding their correlation with S&P sectors. Asia ex-Japan is highly correlated to the S&P 500 financials, while Japan (and the emerging markets) is more correlated to the S&P 500 materials sector.
The Bank of Japan appeared to “wimp-out” in passing on a widely expected rate hike, which the Bank itself is guilty of fostering. However we believe that traders and investors have still got it wrong in expecting multiple rate hikes from the BOJ and multiple cuts in rates by the Fed this year. The two scenarios are just not compatible, in our book.
Thus, a) the yen will not be as strong as some hope, and b) the Japanese bank stock rally could well be nipped in the bud, as both scenarios hinge upon multiple BOJ rate hikes.
On the other hand, rates on hold is generally good for stock prices, and successive corporate scandals in Japan have not seriously dented the rally, as there are plenty of investors (both domestically and overseas) willing to take large positions in Japan’s fallen angels (such as Nikko Cordial (OTC:NIKOY) and Fujiya). Meanwhile investor, and even government, pressure is forcing companies like Japan Airlines (OTC:JALSY) into a revitalization that should have taken place five years ago.
Indeed, these corporate “scandals” may have been the best thing to happen to shareholders in these companies in years, as it is forcing long-overdue restructuring and revitalization.
We therefore see renewed disappointment about the megabanks being offset by increased forced restructuring and active “survival” M&A for mature, domestic industries, which will boost productivity and shareholder returns.
Disclosure: Author is long EWJ.