In this briefing:
1. 🇯🇵 JAPAN: Winter Results & Revisions Scores – Market Composite & Sector Review – Chilling
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CHILLING – A winter chill has descended over the Japanese equity market. As we covered in our Insight on market aggregate earnings Japan: Winter Results & Revisions Flash the net income of corporate Japan peaked on 26th December, However, reported earnings are a lagging indicator, and in this instance, the ‘lag’ was almost one year, with the Total Market Capitalisation (excluding REITs) peaking on 23rd January 2018. Our preferred, and often leading, indicators are the All-Market Composite Results Score – a measure of the trend and momentum in quarterly corporate earnings the All-Market Composite Forecast/Revision Score – which measures the trend and rate of change in company initial forecasts and revisions. The Results Score peaked on 1st February 2018, seven trading days after the market peak and is now one year into an extended period of decline. The Forecast/Revision Score is slowing peaked out on 27th October 2017, three months ahead of the market and the Results Score – demonstrating the reliability of company forecasts, as opposed to ‘consensus’, as a leading indicator of future earnings. Revisions have continued to ‘lead’ on the way down and 0.55 points ‘ahead’. Â
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TURNING NEGATIVE? – Subtracting the Forecast/Revision Score from the Results Score shows the extent of the lag in the latter. The relationship has been relatively stable of over one year; however, as we ‘roll’ into the next fiscal year’s forecasts in May, we can expect the difference to move closer to zero as both scores turn negative. As the cycle bottoms out, the revisions will recover ahead of results, and the difference will also become negative, setting the stage for the next upswing in later 2019 or early 2020. Â
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On each of the three occasions since 2006 when the Results Score has fallen below ‘4’, it has subsequently fallen below zero. In 2012, the decline was muted by the advent of the Bank of Japan (BOJ)’s policy of weakening the currency. The current score of 2.14 suggests we are continuing on a path to zero and below. Failing a currency move through Â¥115 (see below), the Results Score should turn negative by the time the full-year results are announced next May. We also expect a high degree of caution in forecasting, especially on the Auto sector which is overshadowed by the prospect of US tariffs. The announcement of the closer of Honda Motor (7267 JP)‘s car plant in Swindon in the UK is not a good portent. Â
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BEAR MARKETÂ RALLYÂ & THE YENÂ – Total Market Value has recovered by 13.8% since Christmas Day and is currently at the same level as when we published our Autumn review –Â SloMo Slowdown. With earnings and revisions heading lower, the implied expectation is for some or all of – a further central bank easing, a resolution of current trade tensions, and a weakening of the Yen. The last has been the ‘get-out-of-jail’ card for Japanese equities. Our chart compares the year-on-year percentage change in the US$/Â¥ exchange rate with a lag of six months to the Combined Results and Revision Score (with each sore being equally-weighted). The last eight turning points for the rate of change of the cross rate, have coincided with directional changes in earnings and revisions momentum. The recent weakness in the currency suggests a more stable market – at least until the late spring.Â
RECOMMENDATION – Although current valuations are attractive, we believe the market is correctly anticipating further declines in earnings momentum over the next few quarters. We would stay underweight Japanese equities by 20% (i.e. 5.5% v. 7%) with a bias towards domestic sectors, notably, Information Technology, Telecommunications, Media, Healthcare & Commercial Services. We would not hedge the currency.
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