No blue skies for the Nikkei stock market this summer
DESPITE the bearish fundamentals plaguing the Japanese currency, the yen has proved remarkably resilient over recent months, boosted first by safe-haven inflows as a consequence of the European sovereign debt crisis and then from the deterioration in the US recovery.
This strength in the yen has had a detrimental effect on the health of Japanese firms and
therefore on the Nikkei 225. The Japanese index had fallen in line with other major indices since the end of April but has not picked up as strongly as the others since the start of this month. For example, the FTSE 100 is up 8 per cent month-to-date and the S&P 500 has risen 6.7 per cent but the Nikkei has only added 2.3 per cent since 1 July.
Given its relatively poor performance over the past few weeks you might be tempted to view the Nikkei as cheap. Indeed, nearly a third of independent financial advisers (IFAs) are tipping Japanese equities as a good bet over the summer months, according to research published last week by Ignis Asset Management. Ignis found that Japanese stocks were the fourth most favoured asset class, behind emerging markets, US equities and commodities.
So should contracts for difference (CFDs) traders also be considering trading Japanese stocks this summer? If you’re brave and a bit of a night owl, then the Nikkei 225 could be an ideal bet. For a start, its volatility is attractive – the index has seen monthly gains or losses of at least 10 per cent six times since January 2008 and State Street, an asset management and custody firm, expects this to last for years.
However, the vast majority of the events that determine the index’s daily movements happen when Europe is asleep. Unless you are prepared to stay up into the early hours or rise early, you need to be particularly rigorous about setting stop losses and limit orders – otherwise you could easily get burnt and miss out on any important moves.
But given how strong the yen is, should you be going long or short the Nikkei and its constituents? It is clear that many asset managers are starting to become more positive on Japan: Schroders is optimistic about Japanese stocks, arguing that they are undervalued and should benefit from a broadening of the export-led recovery. Over a long-term horizon, they are almost certainly correct – we will see a weakening of the yen eventually, which should help to stimulate the economy and exporters.
But in the short-term, fears of a US double-dip and risk aversion will probably keep the yen strong against the US dollar over the summer. This is not the only reason that CFD traders should be shorting Japanese equities either. Credit Suisse’s equity strategy team, led by Andrew Garthwaite, has downgraded Japan to benchmark from overweight for three key reasons. First, the team argues that this stage in the economic cycle is historically bad for Japan – the country’s stock market tends to peak about four months after the peak in the OECD global lead indicator, which was in April. Its exporters are also dependent on continued economic momentum in emerging Asia – 57 per cent of its exports go to the region and 19 per cent to China alone.
Second, Credit Suisse believes that “tightening fiscal policy and not engaging in QE in a period of deflation is a policy mistake” and highlights the likely lack of reform given the legislative deadlock that is prevailing. Third, the strategists reckon that Japan is no longer obviously oversold. Japan is no longer trading at a sharp discount to its Asian neighbours. It is also not obviously cheap relative to other global equities on a 12-month forward price-to-earnings ratio. “We struggle to understand why international investors would pay a p/e premium (19 per cent on forward earnings) or have such a low free cash flow yield relative to other regions (3.1 per cent in Japan compared with 6.7 per cent in the US and 6.3 per cent in Europe) for a market where long term growth looks to be slower than that of the US, Europe or the UK and corporate governance has proved to be a lot worse.”
With equity markets having come off so much in recent months, it is probably worth waiting for any rebounds in the Nikkei to go short.