Friday, September 10th, 2021

Three Quick Ideas

There are two times of the year when we tend to be cautious about the recommendations that come out of our models: the first week of the New Year and the week after Labor Day in the US. We try not to make any major calls without additional confirmation. This week’s note is therefore just a quick summary of three ideas which have come up during our normal review process. The most important is a change of view on Japanese equities, the other two are warnings about extreme overweight positions in US equities and in European industrials.

First, Japan has just generated an important technical buy signal, which is uncannily like the one it produced at the beginning of the Abenomics rally in 2012. When a region has been out of favour for a long time, we pay great attention when our recommended weight crosses back up through its 26-week MAV, particularly if this happens deep in underweight territory and we also have a high-conviction positive lead indicator. All these conditions are met in Japan at the moment. It has crossed the MAV at almost exactly the same level and with the same gradient as it did in December 2012, when Shinzo Abe was appointed Prime Minister for the second time and launched the Abenomics reform programme. This may be a coincidence, but we would follow the technical signal in any case.

The signal actually happened three weeks ago, before Mr Suga announced his resignation, and has since been confirmed twice. Of course, the reform story may subsequently be disproved by events, but that’s not the point. The point is that investors are prepared to give Japan the benefit of the doubt. Alongside the “pull” story, there is also a “push” story. Those US investors who still believe in international diversification are under pressure to reduce their exposure to the US, because of its recent strong performance. They already own Europe and have done well, but they need to divert the money they were putting into China somewhere else. No other Emerging Market is large enough to absorb these flows, which leaves Japan as the only other viable destination.

Our other two observations are more tentative. We mentioned that US investors are under pressure to reduce their exposure to the US. Our recommended weight for the US relative to the World ex US is just below its 10-year high, which occurred in September 2018. The only other time it was close to this level was in January 2015. On both previous cases, the recommended weight stayed at this level for 4-6 weeks and then fell sharply. Last week was the second week at this peak level. We are not aware of any catalyst which would force the US to underperform other regions, but given where we are, we don’t really need one. An absence of buyers would be enough.

One possible catalyst could be a series of GDP downgrades for 2021 due to Delta variant. US Industrials have begun to respond to this risk and we are now slightly underweight at -6%. However, European Industrials have seen their relative weight rise throughout the summer and the sector is now ranked #2, as opposed to #6 in the US. The difference between their relative weights in the US and European model is also just below a 10-year high. Given that most European majors also have significant exposure to the US economy, we don’t think such a large gap is sustainable.

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