Are we at peak global, and do markets care?​

Trade wars are in the headlines again, as Trump and Xi exchange threats.  For investors the big question has to be whether these will lead to a reverse of globalisation.  One commentator points out that there are parallels but also big differences with the US-Japan friction of the 1980s.  China, unlike Japan then, is an important part of the US supply chain and hiking tariffs will simply hurt US producers.  Secondly, the US has no big stick to use against China, because it doesn’t provide any form of defence shield as it did for Japan.  Thirdly, China has broader military ambitions which may create additional causes of friction. The base case has to be that Trump’s comma-head advisors head him off actually implementing his threats.  They’ve done a good job over the past 15 months but that’s no guarantee it will happen again.  I say that is the base case because it’s so clearly in everyone’s interest.  Even if this goes in a different direction, it is likely to take time to play out and increased military spending will certainly have a positive impact on some parts of the stockmarket, in Japan, the US or China.  We may indeed have reached ‘Peak Global’, but at least in the short-term trade friction is more likely to be used as the post hoc excuse for a market setback than actually be the primary cause.​

Where to find value in markets today?

Value depends first and foremost on your time horizon - how long are you prepared to wait to get your returns?  Having said that there are pockets of value even in today’s extended stockmarkets.  You can choose to pay 30x for a ‘safe’ dividend earner or a high-flying tech giant, or you can look at some of the following.  None of them are risk free and most are unpopular, but that’s what value is all about – looking where the herd isn’t.  I hasten to add that I do put my money where my mouth is and may well have positions in stocks in these areas.   Quoted infrastructure – under threat from McDonnell’s pronouncements and dented by the Carillion collapse, but trading at discounts to NAV of up to 10% and offering inflation-correlated yields of 5% or more.  That’s a real yield of 7% more than index-linked gilts.  What’s not to like? Quoted private equity - trading at discounts to NAV of up to 15% and in a good position to pick up smaller and mid-size quoted companies where MIFID2 will have the unintended consequence of reducing, even eliminating, research on them resulting in their becoming extremely cheap.  Of course, you could simply buy the companies but that requires significant analysis and I expect them to become a lot cheaper first. Woodford Patient Capital Trust - Neil Woodford is under the cosh at the moment but if you read the commentary on his exemplary website you will see that a lot is going right as well as a few high-profile things going wrong.  His portfolio is heavy on bio-tech, where most trusts trade at a premium rather than a 10% discount to NAV.  But the clue is in the name – you do need to be patient. Japan - I am not a huge bull of the Japanese equity market but to my mind it is exposed to a lot of the right dynamics at the moment: the domestic economy recovering after 25 years, China’s economy reaccelerating, higher military spending in the region etc.  It’s also still a highly inefficient market and in this respect may foreshadow European markets now that MIFID2 is  eviscerating research.  See my comment about private equity above, which equally applies in Japan. If current market trends continue, the first three could all get cheaper in the short term as the lemmings gallop over the cliff.  But at Linchpin we think that they offer a lower risk way of generating returns when the next bear market, as it undoubtedly will, descends on us. Feel free to email or pick up the phone to discuss any of them in more detail.

After a 50% rise in 18 months, William Bourne looks at the future for Japanese equities

In September last year I came off the fence on the side of the bulls in Japan.  I pointed to the likelihood of another four years of Abenomics to wear down any opposition at the Ministry of Finance, the revival of the Chinese economy and a change in monetary policy to target the yuan rather than the US$. Four months later, the market is up around 50% in yen terms since mid-2016, and the very smallest companies in the JASDAQ index by much more.  It is time to review how much further Japanese equities might rise. It is clearly one of the cheaper of the developed markets, with an average TOPIX price to book of around 1.4x (half the US S&P 500 index at 2.8x), but that alone is not sufficient.  Value has had a rough near decade in the QE environment and while that trend may have ended it has not obviously reversed. There are some encouraging signs domestically.  I have written before about the gradual renormalisation of risk-taking - call it the return of animal spirits if you like.  That seems to have spread to the financial markets, with domestic investors once again raising equity weightings.  The Deputy Governor of the Bank of Japan in November 2017 called for ‘fair remuneration for financial intermediation services’, which is banking to you and me, to prevent a collapse of the financial system. I would suggest that the two largest influences, however, are outside Japan.  The first has to be China.  Japan’s relationship with China is multi-dimensional: on the one hand it is deeply connected economically as an investor and as a supplier of intermediate goods; on the other is the stand-off between the first and second regional powers, typified by the dispute over the Senkaku/Diaoyu islands.  I would argue that both are positive for Japan’s corporates: on the one hand Japan will share from the Chinese recovery; on the other defence spending is rising steeply. The second is the path of global interest rates.  This is more nuanced but if the trend to higher rates rises we can expect investors’ appetite for duration, whether in bonds or equities, to fall.  In such a case, Japan’s low valuations will be more attractive relative to other markets.  I accept that does not necessarily mean a higher market level and it may simply mean that Japanese equities fall by less than other markets.  However it almost certainly does mean a swing back to value at the same time and that is where Japanese equities score highly.  So I remain on the front foot. To find out more about Linchpin's advice and support in Japan click here.​

Why the TOPIX index might finally make new highs after 25 years

Peter Tasker's article reflects on what is going right in Japan and why after 25 years the TOPIX index might finally break upwards through the 1800 barrier. At the very least, it should be food for thought for those who are still bearish on Japan's future.

Colour coded queues

Back from six days in Japan, I never cease to wonder at how central Tokyo functions so efficiently.   Imagine Shinagawa Keihin Kyukoo (ie. Tokyo Yokohama express) station, where one of the Haneda airport shuttles departs from.  Trains depart from each platform every three minutes and passengers queue in one of four colour coded areas on the platform at each door, with a separate area for those exiting the trains.  When the train comes in, the appropriately coloured queue streams on board.  The station announcer sits on a dais a few feet higher so he can see what’s going on.  I did notice green coloured ‘walkways’ on the Victoria line platform at King’s Cross on my return but they were broadly ignored by Londoners.  It is two years since I last visited Japan.  There’s no doubt more of a spring in their feet: the crane count is up, employment is close to full in real terms and there is more appetite for risk taking at the individual level.  But there is a greater realism that Japan’s future depends largely on what the US and China decide and, as elsewhere in the world, the millennial generation is choosing not to make large purchases, which makes it more difficult for companies to incentivise them. Out in the boondocks, it looks much more subdued.  We drove down empty motorways and stayed at onsen (hot spring resorts) which had as many foreigners as Japanese staying.  Local town centres continue to hollow out and the number of uncultivated paddyfields - unthinkable ten years ago because of the tax advantages of being a ‘farmer’ – continue to grow.  When a mountain road was closed for repairs, there was a female (again, that would not have been thinkable ten years ago) construction worker there to tell us which way to go, despite there being a map as well.  You can read that as hidden unemployment or as a sign of Japanese attention to detail.It is also not a revelation that Japan is much better at dealing with its elderly population.  My mother-in-law, who suffers from a mild form of dementia, lives with my sister-in-law and husband. Both have jobs, so she is picked up from home every day by carers and taken to a day care home, where she can have a bath, is able to do a range of activities and, above all, can socialise.  In the evening she is delivered back home just before my sister-in-law returns.  The cost is below £50 a day.   It must be a kinder way of dealing with the problem than what happens here in the UK. Whither Japan?  In my last blog, I came off the fence on the side of the bulls, mainly because I believe Japan is so connected to the recovering Chinese behemoth.  My visit confirms that the recent encouraging macro-economic domestic data is consistent with what is happening on the ground.  However, demographics and a less than entirely functional financial system – even after many bank mergers – may hold it back. To find out more about Linchpin's advice and support in Japan click here.​

November update on global liquidity

As regular readers of the Linchpin blog will know, I am presently upbeat about China’s prospects and consequently for other economies in Southeast Asia.  Our friends at CrossBorder Capital have released end October data on money and credit flows, which corroborates this picture.  While global liquidity is still about neutral (48 on a scale of 0 to 100), and China’s a bit higher than average, capital flows are heavily skewed towards China and Southeast Asia.  We think this is safe haven money which fled in 2015/6, and is now being invested into these economies as returns on investments improve again.  The combination of adequate liquidity and strong capital flows is quite bullish for these equity markets, at least for the time being. Other trends remain in place: the Eurozone and the UK are at the top of the liquidity cycle while the US looks very late in the cycle.  Given domestic Japanese liquidity remains low, the strength of the Japanese stockmarket seems to be because it is increasingly in the Chinese orbit.  However, we are less positive about the Japanese market than some commentators right now, particularly after its post-election rise. If you would like to read CrossBorder’s update, which represents the most timely macro-economic data available, it is available for purchase here. ​

Investors, watch the People's Bank of China!

At 31 trillion renminbi the People’s Bank of China (PBOC) is now the largest central bank in the world by some margin.  It also operates differently to other banks in one crucial respect - it sets domestic banks overnight reserve targets rather than operating through reserve maintenance windows which allow some flexibility.  This gives it more direct control over domestic credit, as can be seen by the fact that over the last 40 years the credit multiplier (ie. the ratio between the total pool of credit, including shadow banks, and the PBOC’s balance sheet) has remained almost unchanged at about five times.  In contrast, both the US and the Eurozone’s equivalent numbers have varied by about 400%, demonstrating that the Federal and the Reserve and the ECB have more limited control over their economies. An important consequence of this is that interest rates and bond yields, which we have always seen as the ‘price’ of money’ rather than a policy tool anyway, do not give any signals about the PBOC’s policy stance.  The clearest signal of domestic monetary policy is given simply by the size of the balance sheet. In 2015, there was a 15% tightening, both in order to ensure the Chinese currency was included in the IMF’s SDR basket and also as part of an anti-corruption drive.  This resulted in a sharp contraction in the economic growth rate, capital outflows, and sharp falls in equity markets both in China and other Emerging Markets.    Today the balance sheet is growing at a 12% annualised rate.  In our view, this is clear evidence of easier monetary policy, which will in turn lead to a faster growing Chinese economy.  As well as Chinese markets, other Emerging Markets and Japan and commodity prices can be expected to benefit.   Some commentators are misled by rising bond yields, currently 4%, believing this is a signal of tighter monetary policy and a faltering economy.  In contrast, we see this simply as a higher ‘price’ of money as economic confidence returns and appetite for safe assets declines. It is not all good news: if the PBOC has more control over its domestic economy than western banks, it has the ability to turn the taps off as well as on.  The next major financial crisis may well emanate from this source.  That is why we say all investors need to watch the Chinese central bank. Our data comes from our friends at CrossBorder Capital, who have published a more detailed analysis on this subject and have for many years kept a careful eye on Chinese monetary policy.  If you would like to purchase their report, please email us on ​

Japan - coming off the fence on the side of the bulls

I wrote an update a few weeks ago on Japan (‘Japan - Glass Half Full? Or Empty?') arguing that the market is being pulled between positive and negative factors.  At that time, I sat on the fence which way it would fall but things have, as is their wont, moved on. Most obviously, Prime Minister Abe now looks likely to call an election this autumn on the back of a disorganised opposition and North Korea’s provocation.  He may still look at the spectre of Theresa May and draw back, but it is probable that he will win a mandate out to 2021.  This would give him another four years to wear down the bureaucrats, particularly in the Ministry of Finance, who form the stoutest opposition to Abenomics. It is also becoming clearer that the Chinese economy has weathered the travails of 2015 and is on its way back up.  The evidence is in the capital flowing back into China, as much as the headline data. This is important to Japan, which since the war has developed from being an outsourced manufacturing offshoot of the US economy (I exaggerate, of course) to a producer of high-end goods for the world.  They now find themselves primarily as an intermediate goods producing satellite of greater China’s: for example, consumer goods imports from China are very roughly equivalent to exports of intermediate goods back there, in considerable contrast to Japan’s trade surplus with the US.  At a simplistic level, a stronger Chinese economy can only be good for Japan. There is also the suggestion from our friends at CrossBorder ('Japanese Monetary Policy in a Chinese-Dominated World') that that as their economy has become more linked to China’s, Japanese monetary policy has shifted too.  Historically their focus has been on preventing extreme yen strength against the US dollar but it looks as if it is turning to a more pro-cyclical one of aiming for currency stability against a basket of Asian currencies.  It may be a symptom of this change that, whereas historically a strong yen/dollar exchange rate has tended to mean a weak Japanese equity market, over the past couple of years we have seen periods of market strength at the same time as the yen has strengthened.  What does this mean for the Japanese equity market?  I will come off the fence and suggest it is probably positive overall, mainly because a renewed Abe term reduces uncertainty and it appears that Japan has found an economic model to replace the post-war one based on the US.  But I’m not as bullish as some: the scope for policy error remains, foreign investors are no longer underweight and Japanese corporate cashflow remains subdued, albeit slowly improving.​