HSBC, SocGen take contrarian view of Japan’s blistering market

JAPAN, Asia’s most popular market, also has its detractors.

Investor enthusiasm for Japanese equities dominates the region, with 59 per cent of Asia’s fund managers overweight on the country, according to a Bank of America survey this month with India a distant second at 18 per cent. The optimism is based on the country’s Nikkei 225 and Topix indexes reaching their highest levels in 34 years, coupled with a weak yen and the return of inflation.

That popularity has convinced strategists at HSBC Holdings and Societe Generale (SocGen) that the market has risen too far and investors should start taking profits. The yen’s volatility has become another concern. The currency’s weakness has been driven by the country’s negative rates and traders have been whipsawed as speculation picks up that the Bank of Japan will finally end the policy this year.

“I will be careful in this market,” said Herald van der Linde, head of Asia equity strategy at HSBC in Hong Kong. “Everybody’s well positioned for it, everybody’s bought into it,” he said, adding that much of the good news have been priced in. The brokerage has an underweight rating for Japan stocks.

Some technical indicators support that view. The Topix is showing signs of overheating as its relative strength index recently reached the highest since May. The last time it breached the overbought threshold in September, the market fell around 9 per cent. Some market watchers say Japanese stocks risk becoming a crowded trade.

HSBC forecasts that the Topix will end the year at 2,460, which would be a 1.3 per cent decline from current levels. Societe Generale expects the Nikkei 225 to fall to 32,500 by the end of June, a decline of about 8 per cent

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“A lot’s already been priced in the near term,” said Michael Dyer, investment director for multi-asset strategies at M&G Investments in Hong Kong. “We’ve lightened up a little bit. We took some profits. It’s become more and more again a consensus trade.”

His view is echoed by Kelvin Leung, a portfolio manager at Robeco Hong Kong. The “recent rally is still quite momentum driven and quite overheated in my opinion”, he said. “If you observe the market breadth, it’s driven by large cap, tech and auto. I would say it’s quite narrow still.”

If and when Japan does raise rates, it will likely be moving in the opposite direction of the Federal Reserve. Lower rates in the US would weaken the US dollar’s strength vis-a-vis the yen.

This factored into Societe Generale’s decision to slash its Japanese stocks allocation to 8 per cent from 15 per cent in November as the yen’s excessive movement to either side of the dollar “makes the risk-reward a little bit less attractive”, according to Frank Benzimra, head of Asia equity strategy at the French firm.

“We have to recognise some risk at the time where the Fed is expected to ease and the Bank of Japan is expected to tighten,” said Hong Kong-based Benzimra.

An appreciation of the yen is also being closely monitored by JPMorgan Private Bank as a risk to their investments.

“A big part of the upside that we have seen has been yen depreciation. Of course, it doesn’t account for all of it, but it is a key driver,” said Alexander Wolf, head of Asia investment strategy. “And we do expect the yen to appreciate, though not massively, given how cheap it is relative to the dollar.”

Bullish long term

Still, the overwhelming sentiment is for further gains. The Nikkei could rise to between 42,000 and 43,000 this year, according to Toshio Morita, chairman of the Japan Securities Dealers Association. The country’s financial institutions have been adding staff, with an emphasis on traders who have experience in an environment with rising interest rates.

Bullish investors point to policies aimed at improving corporate valuations, namely the capital improvement directive by the Tokyo Stock Exchange on companies trading below book value. Efforts to beat that metric have helped companies such as Daiwa Securities Group, which traded above book value this week for the first time in six years.

At the same time, more than a quarter of investors surveyed by Bank of America in January expect double-digit returns in the next 12 months, an increase from one-sixth in the previous survey in December.

Mitsubishi UFJ Asset Management’s chief fund manager, Kiyoshi Ishigane, said that while he has pared his exposure, he continues to be optimistic for the future.

“I reduced the weight of Japanese stocks and took a bit of profit,” he said. “I also expect the yield on the 10-year Treasury will increase again, potentially dragging stocks down going forward. That said, the fundamentals of Japanese stocks haven’t changed much, so I remain bullish long term.” BLOOMBERG