Tuesday, November 17th, 2015

More Cherries

There are no great trends at work in asset allocation at the moment. Equity and bond indices are stuck in a narrow range and our equity vs bonds indicators have hardly moved in a month. Equities continue to offer poor returns on a risk-adjusted basis. But some countries are better than others, so this week we concentrate on two which have been in the headlines for all the wrong reasons and which may offer interesting opportunities.

Japanese equities had a poor end to Q3 and start to Q4. We believe this was due to the Post Bank IPOs which started trading two weeks ago. The strain of underwriting and attracting buyers for such a large privatisation should not be under-estimated. One way of measuring this is to look at what happened once the strain was removed. Last week Japanese equities were the only major asset class to go up in dollar terms. Every other equity region and fixed income category fell, as did commodities and REITs.

This week the headlines scream that Japan has fallen back into technical recession but the equity market has hardly moved. This is not because poor GDP data will lead to another round of QE as in the Eurozone. It’s because the case for Japanese equities has never really revolved around Japanese GDP. It is about the improved returns of Japanese companies as a result of corporate governance reforms, and the switch out of government bonds and into higher-yielding equities by some of the most influential pension schemes in the country. We think that both trends have further to go. We may even see greater interest from domestic retail investors as a result of the recent IPOs.

The other country is France. Before the tragedy in Paris, we had noticed that it was second in our Eurozone equity ranking and third in our Eurozone bond model. A bit like Japan, French equities suffer from the bad rap of being associated with a poorly performing economy, but they have more than their fair share of international companies which are global payers in their industries. Groups such as Accor, Air Liquide, Axa, BNP, Carrefour, Danone, L’Oreal, LVMH, Renault, Sanofi, Total and Vinci have long since outgrown their French roots. The French equity market is the largest in the Eurozone, about 20% larger than Germany, and it has a broad spread of capitalisation by sector. If investors can justify US equity performance by reference to global growth, the same logic can apply to the French index. Unlike the UK it does not have too much exposure to commodities and energy, or the scandal-hit auto sector like Germany.

Our next point may seem slightly contradictory, but French companies would be best placed to benefit if there were an acceleration in the French economy. We think this is possible for two reasons. First, May 2017 is the date of the next Presidential elections, which means that 2016 should be the year for pork barrel politics. Second, the bombings have already led to calls for increased military and security spending. Regardless of whether the policy will work, the economic implications should be positive, especially as France has a substantial defence industry (Airbus, Dassault, Safran, Thales, Zodiac). This could turn into an important budgetary stimulus. So there is the message. France and Japan are among the handful of developed markets which have produced positive returns in dollar terms YTD. Both could continue to surprise the sceptics.

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