Active Thinking

At GAM Investments’ latest Active Thinking forum, David Dowsett discusses the emergence of the first signs of market stabilisation and Ernst Glanzmann shares his optimistic outlook for Japanese companies and opportunities in robotics.

23 May 2022

David Dowsett – Global Head of Investments

Most of the pressure on markets continues to focus on speculative growth stocks and crypto. We are seeing risk assets being repriced in association with higher nominal and real interest rates. The sell off would become even more serious, in our view, if we experience an event such as an imminent payment crisis associated with the losses currently being experienced in tech and crypto. Our view is that this will not be the case and that this is a repricing of risk assets and not a credit crunch. While we believe it is appropriate to be vigilant about the risk of an immediate and serious market event, as it would have a significant impact on repricing, we do not currently see it in price action, the behaviour of banks or counterparty risk as it is measured.

As difficult as it can be to look through some of the day-to-day volatility, we believe we are seeing the first signs of market stabilisation, most of which are in the fixed income space. Core government bond markets have seen some stabilisation of yields. Treasury yields were 20 basis points (bps) lower week-on-week. We are not looking too much into this as we believe stabilisation is the key consideration. Associated with that, we may also be starting to see the first signs of stabilisation in high grade and high yield spreads, although this is not conclusive yet. Currently, in lower grade sections of the credit market, we are at yield levels that have historically been associated with good breakeven analysis and good entry points. This sentiment is beginning to spread through financial markets, with investment banks publishing more buy recommendations on higher yielding credit markets. Before the stabilisation can spread to other risk assets, we first need to see it conclusively in fixed income.

Over the summer months, we are expecting a bear market rally before we grapple with how embedded inflation is within the system later in the year.

Ernst Glanzmann – Japanese equities

We have just reached the end of Q1 results season in Japan. Overall, the top line looks solid, in our view, with average top line growth year-on-year at around 10% for the constituents of the TOPIX index. These results confirmed the monthly micro data releases and therefore did not surprise too much. More challenging for Japanese companies is the operating level or net income level, where we see pressures in terms of the rising costs of materials, production, and transportation. This is especially pronounced in the manufacturing sector. Unlike the US or Europe, Japanese companies are cautious about passing on rising production costs to consumers, though we expect this to improve over the next few quarters.

The end of March marked the financial year end in Japan, at which time many firms announce their financial outlook for 2022/23. We noticed a marked increase in the amount of capital expenditure plans, sizeable new share buyback programmes and dividend increases for the year ahead compared to 2021/22. This suggests to us that many companies still have healthy order books, are optimistic and thereby willing to invest in facilities. With that said, it is clear that companies are hyperaware of risks in relation to supply chains, as well as the challenges they face related to costs.

More broadly, we continue to see robotics orders track upwards in Japan, although there have been some gyrations from month to month. We are also seeing a pronounced increase in building of factories and power plants in Japan, which corresponds with the aforementioned increase in companies’ capital expenditure plans.

The Japanese equity market has underperformed strategically for many years and we believe an evident peak in inflation in the US could trigger a turnaround. We are currently seeing energy and commodities prices flattening out at high levels. If we were to see this stabilisation persist, or even see prices decreasing going forward, this would be a positive development. Further, if the Fed was to slow down, or even stop hiking rates, this would be very positive for the equity market in Japan, as well as many other markets, in our view. In the short term, we do, however, need to pay very close attention to the current economic setback in China brought about by strict lockdowns, which are likely to impact raw materials prices. Indeed, one of the most challenging risk factors, in our view, remains China’s zero Covid policy, which has an impact on procurement, production and creates delivery bottlenecks all over Asia, as well as for many companies in the US and Europe.

The Japanese equity market is at a 10-year low in terms of its price-to-earnings (P/E) ratio, while the dividend yield is looking healthy, particularly compared to the Japanese bond market, where there is some expectation that the Bank of Japan may be forced to raise rates at some point. One of the big themes in the market currently is the outperformance of large-cap, more liquid stocks versus small-/mid-cap stocks, as well as value outperforming growth.

In terms of investment opportunities, in the capital goods sector, the Covid-19 pandemic and the war in Ukraine are expected to lead to increased demand for the modernisation and renewal of production machinery that contributes to environmental protection, fuel efficiency, decarbonisation and productivity. At the same time, automation and unmanned operation of production lines, logistics and warehouses continues to proliferate, and the customer base for semiconductors, machine tools and industrial robots is expanding.

GAM is an independent, global provider of asset management services operating in three principal fields: investment management, wealth management and third-party fund management services. Across all areas of our business we are committed to the pursuit of highly differentiated strategies, having long recognised that results beyond the ordinary are best achieved by thinking beyond the obvious.