Investors are less positive on the trade. 30% of investors surveyed believe that the “macro trade has largely run its course.” The broad consensus remains that any continuation of the trend will remain centered on the long equity/short JPY trade, while very few are considering short JGB positions for now.
The key equity beneficiaries of the post-Abenomics rally have been in the large cap corporate sector, which tends to be more export-driven. The main sector beneficiaries have been Telecoms and Consumer discretionary, which capture the major Japanese exporters such as Autos, Consumer electronics, and IT.
Financials such as banks also performed well primarily benefitting from the boost in their equity portfolios. Figures 3 and 4 highlight the importance of the currency impact so far. Figure 3 plots the relative quarterly outperformance of Japanese large caps minus small caps versus the currency returns, showing that periods of currency weakness clearly support large cap outperformance – the correlation since 1998 has been more than 60%.
Figure 4 zooms into the post QQE period to date, here we see the recent outperformance of large caps has followed the yen depreciation very closely. However, as the yen settles into a range between 102 and 105, in line with our strategist forecasts for the coming year, it is not necessarily clear that the next stage of the trade (if there is one) would continue with this pattern. We should watch out for a potential rotation away from the large cap exporters in favour of the small cap domestically oriented firms.
We have seen initial signs of success of Abenomics, as headline inflation has risen even before the upcoming impact of the VAT hike. Figure 6 shows the history of inflation surprises across the major economies, with Japan the only country where forecasts have consistently underestimated upside inflation pressure. What could provide the trigger for the next stage of the “Japan trade”? The key events over the next few months seem to be the following:
· April 7-8 BoJ meeting. Our economists do not expect policy action on this date.
· April 30 BoJ meeting, in which our economists expect GDP forecasts to be revised lower as part of the semi-annual Outlook Report.
· July 15 BoJ meeting. Our economists expect BoJ to revise CPI forecasts lower, and consequently we expect further monetary easing including ETF purchases.
The key test is whether or not the BoJ will be responsive to any downside inflation risks. Without further policy stimulus to offset the fiscal drag from the VAT hike, the risk is that the “Japan trade” is indeed over. On the other hand, if Abenomics is truly successful, we can expect weaker JPY /Nikkei correlation.
Over the longer term, we can expect less dependence on foreign flows as domestic investors gradually shift asset allocation in favour of equities if the economy continues to reflate. This supports our strategic case to be short JGBs where the breakeven cost of shorting is currently very low (Global Outlook).
Thus, a second stage of the trade could imply:
· Less emphasis on short JPY.
· Potential outperformance of small cap domestic equities over the large caps.
· Strategic short JGBs.