Current investor skittishness is essentially based on the fact that we are in the late stage of this global economic expansion, and everyone is aware that the current deceleration in the US economy (and the more recent deterioration in Japanese business sentiment as evidenced by the most recent BOJ Tankan) could deteriorate into a recession.
Relative sector performance in the FTSE Global sector indices indicates that global economic fundamentals still favor corporate earnings in basic materials/energy, while utilities remain strong because investors suspect the next move in central bank rates will be down, which is being supported by declining long bond yields.
Underperformance of the banks, cyclicals and small caps also indicates we are late in this economic expansion, as all perform better in the early stages of an expansion. In Japan, The TOPIX sector performance generally mirrors that of the FTSE Global sector indices, i.e., the banking, automobiles, pulp/paper (cyclicals) and pharmaceuticals are the worst performing sectors month-to-date.
But rather than looking at the stock market from the top-down and basing buy/sell decisions on the latest wiggle in the economic data, we believe investors should be looking at the Japanese market as a market of individual stocks, and at the longer-term trends.
If investors had stepped back and looked at the longer-term picture of what is happening in Japan's stock market, they would have realized that Japan (in terms of the i shares MSCI Japan ETF) has been out-performing the S&P since early 2003 and remains in a secular bull market.
That said, increasing polarization means that this secular rally will not lift all Japanese boats. Examples are Nintendo (OTCPK:NTDOY) and Sanyo Electric (OTC:SANYY). As Nintendo's current Wii and DS product offerings are in the take-off stage, bottom-up growth is strong enough to offset top-down crosswinds such as a stronger yen and slower economic growth.
On the other hand, slower economic growth and a strong yen could seriously hinder Sanyo Electric's restructuring, as the company is already struggling to meet current restructuring targets despite favorable economic conditions and very supportive exchange rates. What Sanyo needs is a white knight, not a brighter outlook for the US or Japanese economies.
Disclosures: The author is long EWJ