By Bryce Coward, CFA - Gavekal Capital Blog
The nearly 20% appreciation in the yen vs. the USD that has taken place over the last year and pushed the pair from 125 to 101.8 may seem extreme, especially when considering the BOJ's relentless purchase of an ever expanding array of financial assets. Yet, from a purchasing power parity (PPP) perspective, the yen has just moved from extremely undervalued to just undervalued. Indeed, according to our PPP model, which takes into account relative price of the consumer baskets in the two countries, the yen was 31% undervalued a year ago (the most undervalued the yen has ever been according to our model) and now remains 17% undervalued (still one of the most extreme undervalued readings going back 25 years).
With this backdrop in mind, equity investors may be well suited by allocating to Japanese equities that substantially benefit from the continuation of this year-long trend of yen appreciation, namely stocks in defensive sectors. As chart 3 below shows, those sectors are the best-performing areas of the global equity universe today, and have also been among the top performers over the last 1, 3, 6 and 12 months.