Japanese Equities: Is a Growth vs Value shift coming?
Dan Carter and Mitesh Patel describe the ‘growth vs value’ situation in Japanese equities, and ask whether a shift in momentum is around the corner.
In the last two years, the stylistic preference of equity markets – which for so long had been for highly priced, asset-light growth companies, hence the headlines above – has done a one-eighty. Value investors, with their fondness for slower growing and asset-intensive but lowly-valued businesses are the heroes. Growth investors are the ones under the cosh. This stylistic see-saw, and the inevitable realisation that no investment style is ever really dead, has some investors questioning when market leadership might change again. For those with an interest in Japanese equities, this piece aims to be of some help.
Source: Bloomberg, to 31.10.2023
When the boot was on the other foot, value managers were full of analogies including stretched rubber bands or over-wound springs. Clichéd as they are, these comparisons highlighted well that a stylistic turnaround was on the cards, but they did little to suggest precisely when it should happen because markets are apt to overshoot. The same is true now. For sure, the rubber band has relaxed, the spring unwound, but eyeballing the chart above suggests only that it is right to consider the next shift in market leadership, it helps little in predicting its timing.
Next, let’s turn to valuations. If the appeal of so-called value stocks is their low valuations, surely their outperformance over growthier peers diminishes their attraction and at some point, investors will be right to refocus their attentions? Indeed, if you look at the differential in the earnings yield between the MSCI Japan growth and value indices, you can see that the gap has come down significantly over the past 12-18 months. This normalisation suggests that much of the easy money has been made in Japanese value stocks. That said, it also seems too early to call loudly for a shift in stylistic leadership back to growth names.
Perhaps we can get a steer from global markets? Here, the picture is more supportive of the idea that the resurrection of the growth factor is near in Japan, or at least nearer than it is in other regions. The chart below shows the ratios of growth and value indices (each one indexed back to a decade ago) in Japan and other major developed markets. The orange line, representing Japan, suggests that the pre-pandemic growth market was milder than elsewhere and the subsequent value rally stronger. On this basis at least, investors in the Japanese market seem justified in considering a shift growthwards, at least as a priority ahead of their other global allocations.
Source: Bloomberg, to 31.10.2023
Our final and perhaps most important factor to consider when pondering the renaissance of growth stocks is the monetary environment. As interest – or discount – rates rise, the current value of any firm’s future earnings declines. For companies with potentially much larger profits in the future or with an especially long runway of steady growth, the effect is especially severe. As rates decline, the same mechanism works in reverse. Might bond markets predict a shift in stylistic preference in equities?
Source: Bloomberg, to 31.10.2023. All series indexed to October 2013.
In the chart above, the blue line shows the relative performance of Japan’s style indices. As it rises, growth is outperforming value and as it falls the reverse is true. Inflexions – marked by the vertical red and green lines – seem to coincide with changes in monetary conditions, as modelled here by the yield on ten-year Japanese government debt. Financial theory appears to work, but not perfectly. Big moves in bond markets, such as in late 2019 did not touch the equity market’s stylistic balance. Still, it seems sensible to assume that for the equity market baton will be passed only when the trajectory of Japanese rates changes. Simple! So, will it?
This question requires a whole article of its own, luckily we’ve already written it: Inflation in Japan: threat or opportunity? – Jupiter Asset Management (jupiteram.com) The tentative conclusion in our summer piece was that the Bank of Japan would likely use the currently elevated levels of inflation to normalise monetary policy, that is to allow yields to rise. With its miniscule shift in stance in October, the Bank of Japan edged ever so slightly in that direction. Survey data shows that most economists think a further move will be made before next summer.
Given what we know about interest rates and equity market preferences, the implications of a shift in policy stance by the Bank of Japan should be clear – it would further favour value over growth. However, a shift in BoJ policy could also strengthen the Yen, the weakness of which has been a boon to many export focused sectors so far in 2023. We think that banks and other interest rate sensitives are the clearer beneficiaries if this final value blow-off comes about. More importantly though, our belief is that this eventuality – a final spike in value outperformance – could be what is needed to finally shift the other indicators discussed here, of mean-reversion and valuation, to the levels required for a rotation in leadership back to growthier stocks.
Past performance is no guide to the future. Source: Jupiter, NAV to NAV for Jupiter Japan Income I GBP Acc, gross income reinvested, net of fees, as at 30.09.23 over five -year rolling periods. Topix Income and Topix Growth are not the fund’s Target indices and are used here for illustrative purposes only.
We appreciate though, that many clients will adjust their allocations to try to catch the fair wind of stylistic leadership and for those, we hope that what we have presented here is helpful. It seems to us that the answer to when growth stock will catch a break is likely “not now, but soon”. Mean reversion and valuation indicators suggest that much of the easy money in value has been made, but that does not mean that a little more cannot be made still. Further tightening from the Bank of Japan – widely expected in the next half-year, and likely to favour banks over Yen sensitives – could be the catalyst for the final melt-up in value stocks needed to finally push valuations and mean reversion over the edge. Investment styles never die, but they do hibernate and after the winter it could be time again for growth stocks to rouse.
Performance
Past performance is no guide to the future. Returns may increase or decrease as a result of currency fluctuations.
Source: Morningstar, NAV to NAV, gross income reinvested, net of fees, in GBP, to 30.09.23. Target Benchmark: TSE TOPIX. Comparator: IA Japan.
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