Japanese equities could be one of the best trades for 2019, but it's not yet time to buy, according to NN Investment Partners. In fact, the Dutch asset management firm has recently removed its overweight to the asset class, despite its positive views on valuation.
If 2017 was a ‘Goldilocks’ environment for economic, and earnings, growth – all major regions participated in a synchronised upswing – 2018 has thus far been a year of divergence.
While the US economy was ramped up by President Donald Trump’s tax cuts, the head of steam built up by the likes of Europe, Japan and emerging markets petered out amid trade concerns and data disappointments.
But Valentijn van Nieuwenhuijzen, chief investment officer at NN IP, reckons 2019 will see a re-convergence of economic growth within developed markets. This will mainly be due to the effect of the US’s recent fiscal boost fading, allowing Europe and Japan to catch up.
As well as economic growth converging, earnings growth and equity markets will, too, and Ewout van Schiak, head of multi asset, thinks investors should look to play this trend in portfolios.
“Of course, we know the US had a remarkable year in terms of earnings growth,” van Schiak explains. “It will be very difficult to show further improvement and earnings growth numbers in the US will probably be lower than they have in the last year.
“In the rest of the world – Europe and Japan – we think earnings growth can stabilise, or even improve a bit from what we saw last year. If you compare from a valuation perspective, Europe and Japan are a lot more attractive than the US. We do think this convergence will soon start.”
Investors Need Clarity - and Better Data
But what will be the trigger for this? Clearly, proof of better growth numbers in both Europe and Japan would be needed. Clarity on the political risks in Europe, such as in Italy, and on global trade would also be helpful.
“Clearly, if these things do not materialise these areas will probably not work and the current trend of US outperformance would continue,” van Schiak adds.
Japan in particular is a wait-and-see game for the team “because lately the earnings numbers have been a bit disappointing”. “We do expect growth to pick up slowly, but consistently.”
The main catalysts van Schiak will be looking for here would be a sizeable pick up in wage growth, which would give people more money to spend and, thus, improve domestic consumer confidence.
Meanwhile, Japan also has the best opportunities for productivity increases helped by corporates investing more in labour-saving investments. “That can be an important stimulus for corporate earnings.”
However, counters van Schiak: “I have to admit we don’t see it at the moment and on a more short-term view we actually removed our Japanese equities overweight.”
Prefer Financials Over Bond Proxies
Bond yields are on the rise, and have been for quite a while now. Normally, that would spell good news for financials. However, during this cycle, this has not played out and financial stocks have lagged rates.
But van Schiak expects this to change in 2019: “On the back of the continued stabilisation in global growth and the convergence we expect, we are relatively constructive on financials.”
But rising bond yields are, of course, negative for ‘bond proxy’ stocks, which are investments seen as safe dividend payers that can substitute fixed income products while rates are low.
Now yields in the US are firmly above 3% and valuations of these stocks have been bid up significantly, “we do think it’s a year to stay away from utilities, staples and telecom”.
However, like Japan, this is a trade that doesn’t work yet in markets. “When I look at our portfolios, we haven’t implemented it yet – these are really true 2019 ideas for which we still need to find the trigger and the right time to implement.”
No Recession on the Horizon
While many have been calling for a recession in the US recently, the firm do not see this on the cards, despite their views that growth will slowdown across the pond.
Firstly, van Nieuwenhuijzen points out that just because the current expansion is long in the tooth does not mean a reversal is imminent.
“Please remember Australia has not had a recession in 30 years – there are not fixed rules in economics; there’s no necessity for a recession to materialise just because the cycle has been long,” he says.
A trigger is needed, but the team sees no signs of any big showstoppers bringing the cycle down. “Tight labour markets that really drive wages and inflation can be one trigger, because central banks have to tighten policy much sharper than markets are now pricing.
“We really do not see that happening; we only see a modest uptick in inflation and wages in the US, but nothing dramatic and well below the growth rates we saw before the crisis and not something that would trigger the Fed into a really restrictive policy stance.”
Other potential recession indicators like central banks being behind the curve on inflation; excessive investments combined with low profitability; and excessive private leverage also look benign currently.
