Japan Is Back

Weekly Commentary

Market Recap

• Equity markets held firm this week, with little in the way of major market-moving data.
• The S&P 500 gained 0.4%, led by consumer discretionary stocks, while technology dipped.
• Meantime, the TSX slipped 0.7% as health care, consumer staples and industrials lagged.

Japan

Japan’s Nikkei index has seen strong performance so far this year, with stocks reaching highs that haven’t been approached in decades. What’s driving this resurgence, and is the trend sustainable? Our house view is slightly bullish on Japan, and we have a position in those equities in the International (EAFE) sleeve of our portfolios. In our view, there are a few factors at play. First is that over the past few years, we’ve seen Japanese companies refocus on things investors like. Up and down the Japanese market, companies have tended to trade at low price-to-earnings and price-to-book ratios; now, that’s starting to change. On top of that, executives are focusing more and more on capital efficiency, which wasn’t always the case a decade ago. And they’re also realizing the importance of raising dividends—we’ve seen both dividend increases and share repurchases popping up lately. It’s a playbook borrowed from North American markets, and that’s given investors greater confidence. The rebound may also be buoyed by investors pivoting from other regions as a result of rising tensions and political risks in North America and Emerging Markets. Japan enables investors to essentially sidestep those potential headwinds, and despite declines over the past year, the Yen remains a strong, stable currency.

Bottom Line: In a challenging economic environment, Japan may offer investors the attractive valuations and yields they’re looking for.

Energy

Oil and Energy markets are in an interesting and complicated situation. In terms of short-term outlook, there are a couple of considerations. One is OPEC cutting production, which is theoretically good for prices because it limits supply. But this move also tells you that demand has underwhelmed expectations. The production cut is intended to establish a floor for prices above the $70-per-barrel level, but it’s not necessarily going to move prices significantly higher. So, the logical follow-up question is—why is demand not meeting expectations? In our view, it comes down to China. Though its economic reopening is underway, the growth effect is not at the pace investors expected. The property sector has not been strong, and in general, the Chinese consumer is a bit tighter with their spending than their U.S. counterpart. This has lowered energy demand expectations and put further pressure on oil prices. Over the longer term, we do think that oil prices should continue to be in the $80-90 per barrel range. But in the short term, we don’t see a meaningful catalyst for growth.

Bottom Line: An underwhelming reopening in China has reduced the demand for oil, and there’s no obvious imminent catalyst that could cause prices to surge beyond $90 per barrel in the near term.

Gold

Given recent market volatility and the likelihood of a recession down the road, is now the time for gold? Overall, we still have a slightly bullish view on gold despite the fact that, with Technology outperforming, it hasn’t done particularly well of late. In the longer term, however, we still like gold’s upside. If prices can climb past the $2,000-per-ounce mark again, that momentum is likely to carry it even higher. But even at its current sub-$2,000 range, it’s not unattractive, and we believe it could go a little lower in the short term. If that happens, we’ll be buyers.

Bottom Line: We already have a slight overweight to gold, and we’re prepared to buy on the dips.

Positioning

We remain positioned for an extended recession. The expected downturn has already been pushed down the road, and the risk, in our view, is that it will be pushed out even further. Given that uncertainty, we prefer to stay relatively neutral and let the various scenarios play out. We’re still waiting to see strong evidence of a slowdown; so far this year, we’ve only seen slight evidence, and markets have effectively shrugged it off. One could make the argument that only about six of the biggest names have driven the market’s success, and while that’s true to an extent, other companies have started to do well over the past week. It goes back to the question investors have been asking about the S&P 500’s recent bifurcation—will the top six names fall off, or will the other 494 catch up? So far, the top six aren’t losing massive ground, but everyone else does seem to be gaining. That’s the case even in the Financials sector, which had been hit hard after the Silicon Valley Bank debacle. With these questions still sorting themselves out, we believe a neutral position to be the most prudent course of action.

BMO’S “FIVE LENSES” STRATEGY

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Originally Posted June 12, 2023 – Japan Is Back