Key points
- Cyclicals and Financials stocks have been widely sold during the course last few years and so far in 2018.
- Based on the potential for upside in global long-term interest rates and relaxation in BOJ’s yield curve control measures, Financials stocks seem likely to return back into action in the remaining part of 2018.
- After a long bearish cycle, the supply demand for crude oil is impacting prices, now reaching levels unseen since 2014 (WTI Crude).
- Information Technology and Robotics have been seen there valuations reflecting an important shift in investors tolerance for fast growing but also highly valued stocks.
- Most managers sticking to a “Value” style are now getting more exposed to the old economy sectors.
- Following the financial crisis, frustration deepens for Value investors as Growth style wins big.
In this paper, we will take a closer look at what could be the drivers or catalysts for value stocks to come back into favour.
We see three broad themes that could result in a rerating scenario for Value names which have been disregarded by the market and left undervalued:
- End of “goldilocks” market
- Cool off in earnings momentum for tech-focused sectors
- Weak FY18 earnings guidance on FX assumptions likely to weigh on sentiment among export-centric companies.
As an auxiliary support factor for the value style, foreign investors are returning to Japanese stocks after having been net sellers by a wide margin of 8.7 trillion JPY. This net selling was particularly strong in the futures market and we interpret this to have temporarily widened due to the volatility spike and protectionism fears.
“Goldilocks” market to come to end
The underlying theme throughout 2017 was short-term earnings momentum, as the year saw a quintessentially “Goldilocks” market, complete with a mix of strong growth, decent corporate earnings, low volatility, and a gradual drift higher in bond yields.
However, going forward it seems things are likely to play out differently. This is thanks to the emergence of a fusion of sudden rises in US interest rates, stronger than expected US CPI, and rising commodities and WTI prices, augmented with likelihood for a widening deficit due to expansionary fiscal policy in the form of tax cuts and infrastructure spending.
On the central banking front, in Japan, although we expect that the BOJ will maintain its negative interest rate policy for the short-term rate to avoid extreme yen appreciation, we think there is likelihood that the BOJ will tweak its yield curve control policy by raising its 10-year interest rate target sometime in the second half of 2018. Meanwhile, the ECB has also committed to winding back monthly asset purchases with a tapering program which began in January, with many believing the bank could cease QE by next year if we see a further pick-up in Eurozone area inflation. Value stocks have been significantly undershooting in view of an established correlation with long-term interest rates, and we believe that under such circumstances, value stocks stand a chance of outperforming in 2018.
Earnings momentum of hi-tech/machinery companies slowing in FY2018 likely to trigger sector rotation.
During 2017, the rapid jump in stock prices of FANG and other similar names on profit growth hopes in the US market also translated into buying of strong profit growth stocks in Japan. As a result of this, the valuation gap of companies in the economically sensitive electric appliances and transport equipment sectors also widened. In addition to structural tailwinds such as hardware upgrades (e.g. dual lens camera adoption within smartphones), cyclical tailwinds led to higher memory prices, therefore boosting earnings of semiconductor related firms. In Japan, stock prices in the appliances sector topped pre Lehman shock highs, with relative PBRs above IT bubble era levels.
Cédric Le Berre
Fund Analyst, Japanese Equities and Emerging Markets