What Worked Japan - 03 Mar 2017 - Value did not work for the first time since last December

What Worked

Value, particularly PBR, was hurt this week. This is really the first week since last December that low PBR names have not done well. Low PBR names that were down included Ogaki Kyoritsu Bank (8361) down 10%, Showa Denko (4004) down 8% and Inpex (1605) down 5%.

High Beta names were also down this week. As with Value, this is the first week this year that high Beta names were hurt. Toshiba (6502) is down 5%, Taiyo Yuden (6976) is down 5% and Ibiden (4062) is also down 5%. With Value and Beta down, there was a slight move into high ROIC names. Morinaga (2201) is up 7%, Unipres Corp (5949) is up 6% and Nippon Paint Holdings (4612) is up 6%.

Who Moved

Only 25 names moved on volume this week. On the positive side, Mitsui Mining and Smelting (5706) is up 11%, Morinaga (2201) is up 7% and Morinaga Milk Industry is up 6%. On the other side, Ogaki Kyoritsu Bank (8361) is down 10%, Pola Orbis Holdings (4927) is down 7% and Park24 (4666) is down 6%.

Summary

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What Worked Australia - 03 Mar 2017 - PE comes off, and drags low beta names along with it

What Worked

PER finally took a week off, and came in quite negative this week with a very large down-swing in the cheapest names in the market. The lowest PER names (i.e. highest earnings yield) dropped almost -4% against the benchmark, while the more expensive names remained relatively flat. Some of the worst hit included Resolute Mining (RSG, -15.9%), Spotless Group Holdings (SPO, -14.4%) and Retail Food Group Limited (RFG, -10.6%). While 12 month momentum appeared to show positive results this week, the top and tail of 12 month momentum names both lost out to the benchmark, and the IC was in large part driven by middle three quintiles. 12 month momentum, either if you are for or against it, is not playing nicely for anyone focusing on this signal, and has not been a team player for close to three months.

Beta was a good mover this week, however like 12 month momentum, the IC was largely driven by the middle ground. That being said, low Beta names took a big hit this week, with the sharp drop in the last quintile (lowest beta) names looking about a sharp as drop in low PE names. Newcrest Mining (NCM, -7.6%), St. Barbara Limited (SBM, -7.4%) and Macquarie Atlas Roads (MQA, -1.8%) are among the lowest Beta names in the Australian market, and all off this week. On the other side, high beta names as a group also dropped against the benchmark, albeit not as heavily.

Who Moved

Volumes are still looking strong with 42 names from the benchmark moving this week on higher than normal volumes. Among the winners, Worelyparsons (WOR, +29.7%), Breville Group (BRG, +11.7%) and South32 Limited (S32, +10.6%) all finished the week higher with higher than normal volumes. On the other side, Orocobre (ORE, -17.6%), Healthscope Limited (HSO, -3.9%), Harvey Norman Holdings (HVN, -3.8%) and Cromwell Property Group (CMW, -3.5%) all ended weaker.

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Summary

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What Worked Asia - 24 Feb 2017 - Low PBR and short-term momentum names did well this week in Asia

What Worked

Value and high Beta names dominated in China this week. Both PBR and Beta were the strongest factors in China over the last month. Low PBR names that did well were Greenland Hong Kong up 12% and Sunac China Holdings up 9%. As with China, low PBR names continue to do well in Hong Kong. In Hong Kong, PBR is the strongest factor over the last 3 months. HNA Holdings Group is up 22% and Esprit Holding is up 19%.

High dividend yield names did well in Singapore this week. Sembcorp Marine is up 12%. In South Korea, Value and high Beta names were hurt this week. ViroMed is down 8% and LG International is down 6%. Large-cap names dominated in Indonesia. Bank Rakya Indonesia Agroniaga is up 18% and Indo Tambangraya Megah is up 13%. In the Philippines, positive momentum names did very well this week. Premium Leisure is up 11% and Belle Corp is up 5%.

Who Moved

291 names moved on volume this week. A good number of the names came in the Financial and Electronic Technology sector.  At the country level, HK/China made up one third of the volume spikes. On the positive side, Jindal Steel and Power is up 26%, HNA Holding Group is up 22% and AEON (Malaysia) is up 24%. On the other side, Sun Art Retail is down 19%, GeniuS Electronic Optical is down 13% and Season Pacific Holdings is down 13%.

Summary

Asia ex Japan Factor Performance

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Chart of the Day: JPY Forecast Model in the Money

The Model

Custom Products Research uses 5 regression models to forecast fair value for the USDJPY exchange rate. As of January 25, 2017 the fair value for USDJPY was ¥112.65, based on our main 3-Equation model (3EQ).  We had also forecast ¥114.51 based on the US-Japan 2-Yr 1 YR forward spread differential (2Y1YF) and ¥111.03 based on the inflation expectation-adjusted 2 YR US-Japan real rate spreads (IA2YS). The 5 regression models all have very high R2 with the 3 equation model at 89%, R= .944 and t-stat 121 over the last 7 years.  The inflation expectation adjusted 2 yr yield gap R2 is 90.8% over 5 years, R95% and t-stat 60.2. While the 2-Yr 1 YR forward spread has an R2 of 87% and R93% with t-stat 25.7 over last 2 years, but this falls over a longer timeframe. (for further details see January 31 report, ‘Exchange Rate Forecast…..’)

As of 1AM GMT February 24, 2017,  both  2Y1YF and 1A2YS indicated USDJPY fair value ¥112.90, which happened to be exactly the spot rate. While our 3-equation model stood at ¥111.92.

What has Changed?

Over the last month, 2-Yr yield spreads have remained unchanged at 145bps, while 2 and 3-YR inflation adjusted spreads have become more negative (-60bps to -100bps), implying a stronger Yen. Real adjusted 10-Yr rate spreads have also declined, from 0.6% to 0.09%, also implying a stronger Yen. Meanwhile inflation expectation-adjusted short-term yields have been flat. Similarly, the 2 YR 1-YR Forward rate differential has been flat at 1.9%, after having risen from 1.4% in October. 

The Outlook

We still expect the Yen to weaken towards year end, based on 4 quarter-point hikes by the Fed. (see January 1 report ‘Central Bank Policy: Fed Still Behind the Curve). Q1 GDP growth should be between 2.4-2.5%, Hourly wage growth is also 2.5% and the Bloomberg Economic Diffusion Index continues at a high level. January CPI was 2.3%, with continued upward pressure from oil and China producer pricing, supporting our ‘inflation surprise shock’ scenario. 

Unfortunately, as the BOJ is content with 1% real GDP growth and USDJPY above ¥110, no further rate cuts are expected from the BOJ (see February 17, 2017 report ‘Central Bank Policy – Why 2018 is Looking a Lot Like 2006 for the BOJ’)

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What Worked Japan - 24 Feb 2017 - Most factors insignificant, short-term momentum names hurt

What Worked

Interesting week. With TOPIX basically flat, none of the Value or Growth factors stood out this week. There was a slight selloff in high ROIC names. Nissan Chemical Industries (4021) was down 7%, Tokuyama Corp (4043) was down 6% and Taiheiyo Cement Corp (5233) was down 6%.

Momentum, particularly short-term momentum, names also did not do well this week. Daifuku (6383) was down 4%, Mitsui Mining and Smelting (5706) was down 5% and Daido Steel (5471) was down 4%. All other factors were insignificant this week.

Who Moved

42 names moved on volume this week. The volume spikes look to be spread across all sectors. On the positive side, Toyo Tire & Rubber is up 25%, Mitsui Mining and Smelting is up 19% and MinebeaMitsumi is up 19%. On the other side, Iida Group (3291)is down 11%, Nikon is down 10% and Asics Corp (7936) is down 9%.

Summary

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What Worked Australia - 24 Feb 2017 - Dividends strong with ROIC, 12M Momentum still off

What Worked

While Trailing PER managed to stay in the positive this week, Forward PER just ticked over into the positive, but still provided +2.5% on a long/short basis, compared to the market being down -1.2%. Looking at the individual quintiles for forward PER, the top and bottom went in the direction a value investor would hope they would – cheaper names going up, more expensive names down. The lack of IC strength this week was primarily driven by the middle ground of PER, throwing off the correlations. At midday today, there was not a lot of factor driven direction in the market, however a pick up into the end of the day saw the emergence of some clarity.

Forward Dividend Yield and ROIC (Trailing PER just made it…) were the only signal this week to push into our “worth looking at” territory of ±10.0%. It was a pretty even-sided bet this week in the Dividend yield space, with lower yielding names under-performing almost as much as the higher yielding names out-performed. Higher yielding names doing well this week included Nine Entertainment (NEC, +6.2%), Crown Resorts (CWN, +6.7%) and Asaleo Care (AHY, +10.4%). Lower yielding names were punished, among them Aconex (ACX, -10.8%), Australian Agricultural Company (AAC, -3.3%) and Galaxy Resources (GXY, -3.7%). The numbers for ROIC were being largely driven by the middle ground, although the top and tail did show an uptick in the higher return names, it was the low ROIC names that really drove the numbers.

Who Moved

Volumes still getting stronger around reporting in the Aussie market, with 36 names from the benchmark moving on significantly higher than normal volumes. Those closing the week lower included iSentia Group (ISD, -39.9%), Ardent Leisure Group (AAD, -22.8%) and WorleyParsons (WOR, -18.7%). On the other side, Seven Group Holdings (SVW, +10.4%), Monadelphous Group (MND, +10.0%) and Tassal Group (TGR, +9.5%) all finished the week in the positive and well outperforming the index.

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Summary

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Exchange Rate Forecast - USDJPY Fundamental Drivers, Technicals & Dervatives

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Looking Back at 2016

At the beginning of 2016, Custom Products forecast USDJPY of between ¥109.0 (2 equation model) and ¥114.4 (3 equation model) by December 31, 2016 (Compared to ¥120.2 at the beginning of 2016).  Our forecast differed from actual year-end USDJPY  ¥116.96 due to: 1) we had expected 2 quarter-point hikes from the FRB instead of only one, 2) we had expected the BOJ to cut its policy rate on deposits further from -0.1% to   -0.3% by December, 3) the Brexit shock which caused the GBP to depreciate 16.5% against the dollar lead to a ¥3.8 appreciation (3.45%) of the yen and 4) oil prices closed the year at $53/bbl  (10% higher than our forecast adding 1.35% to yen appreciation). Having said this, based on our 2 and 3 equation models; we would have expected the USDJPY to end 2016 between 106.7 and 113.4 with perfect hindsight.

Why has the Dollar Strengthened Since the US Election?

Since the US election, the yen has weakened from ¥104.5 to ¥115 (overshooting to 118.6). This is best understood in terms of

  1. Short-term rates,
  2. Growth expectations, and
  3. Inflation expectations.

Clearly the path for US rates has been ratcheted up since the US election. This has come from higher long-term growth expectations and increased inflation expectations from oil and a tighter labour market, lifting US real rates vis-à-vis Japan. US-Japan 10-yr yield spread, which was recovering from a September low of 1.55%, rose from 1.85% on November 7 to 2.35% by January 24. Interestingly, Japan 5-yr forward inflation expectations (FWISJ55) have risen from 0.11% to 0.62%, greater than the US increase from 2.22% to 2.55%, making the Japanese yen less attractive with increasing negative real interest rates. Similarly US 2-yr treasury rates have nudged up from .82% to 1.15% while Japanese rates have held flat at -0.24%. Finally, the 10-yr ‘real’ interest rate differential has widened from 0.32% to 0.62%.

Net-net, Custom Products would have expected a ¥7.4 depreciation from the pre-election rate of ¥104.5 from inflation-expectation adjusted short-term yields, a Y2.8 depreciation based on the real long-term yield differential and a depreciation to ¥118.1 based on the relative money supply growth (otherwise known as the Soros Chart). Each equation has been weighted by the R2 bringing our current fair value USDJPY estimate to ¥112.65 (Chart 1 dark blue line).

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Central Bank Policy…2017 Outlook: Fed Still Behind the Curve

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By some measures, the Fed has been behind the curve since mid-2014, in not gradually raising its policy rate.1 Granted the Fed chose to delay initiating its hikes until unemployment fell below its 5% target in Q42015, while maintaining concerns over historically low core inflation. Despite a second quarter-point hike now after a one year pause, the Fed finds itself even further behind the curve than at this time last year. Even under an accommodative rules-based policy rate, December’s rate should be closer to 2-2 1/4 and not 0.75%. As it stands, real policy rates (minus core inflation) are -1%, when full employment and 2% GDP growth would imply a 0.6% neutral real rate as a minimum. If real GDP growth continues above 2.5% as Q4 is trending, then the neutral rate would approach 1%, still significantly below the 2.1% neutral rate average in the 20-yr period up until the GFC.


We think that neutral Fed real rates (FF rate minus PCE deflator) should hover between 0.6% and 1.2% (1stdev of 15 year trend where natural rate r =1.3x g and g has fallen 0.5% over last 10 years) over the next few years. If core inflation creeps up to 2.0% over the next year, from 1.65% now, then the Taylor-rule FF rate target would rise to 2.50%. In addition, CPI is likely to reach 2.3% next year from 1.7% currently, with crude oil alone adding 40bps at current prices. As CPI exceeds core inflation, neutral real rates would likely increase from 0.6% to 1.2% bringing the target FF rate to 3.1% by December 2018. Clearly the risk is on the upside!


Though long-term real rates were negative as recently as Q3CY16, they are now 80bps and should reach 110bps by the end of 2017.2 Should the CPI exceed core inflation by more than 50bps, then we expect term premia to rise from 22 bps now to 100bps+, pushing 10 year treasuries to as high as 4.2% by the end of 2018 (see Chart p.12). In fact, ‘Greenspan’s conundrum’ could very easily end up becoming ‘Yellen’s conundrum’ (if reappointed to a second term), as the market, being significantly ahead of the fed would likely push 10 yr yields to 4% long before the fed finishes ratcheting up its hike path through 2019, ending the current recovery.


Finally, if the Fed drains off $2trn in excess liquidity over the next 4 years (contrary to its current stated intention), real long term rates could rise an additional 60-120bps. However, attractive swap rates (Chart 6) should ensure that overseas demand limits the rise, while demographics will continue to favour strong demand.

Implications

  • The Fed has been leading the central banks’ rate cut race to the bottom and must begin to redress policy rate misalignment (Charts 12, 14)
  • Confusing and contradictory FOMC guidance may call for implementation of rules-based policy rates (p.10)
  • Inflation is likely to pick up faster than current Fed path indicates, leading to a ratcheting up in rate hike forecasts. Expect four quarter-point hikes in 2017 and 2018 (Charts 8, 9)
  • The Fed is likely to see significant intervention from Congress should it not begin draining excess liquidity over the next four years (p.3)
  • Though real long-term rates and term premia should rise over the next few years, demographics and overseas demand to limit the slope (Chart 7)
  • Chair Yellen’s allusions to a return to Greenspan’s ‘high pressure economy’ are misplaced (p.20)
  • Policy rates are like lighter fluid or kindle for a fire; they will help start the fire but this does not provide long-term growth. If anything, excessively low short-term rates
    encourage business to increase leverage and thus volatility as ROA peaks (Chart 15).

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What Worked Asia - 17 Feb 2017 - More than 400 names moved on Volume in Asia this week

What Worked Large-cap names and Value did well in China this week as low Debt to Equity names were hurt. Hisense Kelon Electrical Holdings is up 17% and Beijing Enterprises Clean Energy is up 15%. Nothing stood out in Hong Kong.  Names down over the last month bounced up in South Korea. EO Technics is up 12% and Hankook Tire is up 8%. In Taiwan there was a slight selloff in Size and Quality names. Win Semiconductors is up 24% and General Interface Solution is up 13%.

In India there was a slight move into Size and away from high Beta names. Tata Motors is down 11% and Advanced Enzyme Technologies is down 12%. Growth names were hurt in Singapore this week. Hutchison Port Holdings is down 13% and Japfa is down 4% this week. Low PBR and Momentum names did well in the Philippines this week.

Who Moved – A very high 404 names moved on volume this week. All the volume spikes were spread across the region. However a quarter of the volume spikes came in the Financial Sector. On the positive side, PT Medco Energi Internassional is up 64%, Goldin Financial Holdings is up 50% and Formosa Sumco Technology is up 40%. On the other side, Luen Wong Group is down 28%, PChome Online is down 15% and Season Pacific Holding is down 18%.

Summary

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What Worked Japan - 17 Feb 2017 - Low PE did well this week, Large-cap continues to underperform

What Worked – After not really working since the end of last November, low PE name did well this week. Toyo Tire & Rubber (5105) is up 25%, MinebeaMitsumi (6479) is up 19% and DMG MORI (6141) is up 14%. High Dividend Yield names also did well this week. DIC Corp (4631) is up 7%, NSK (6471) is up 6% and Toda (1860) is up 6%. Large-cap names continued to underperform and have been beaten up since last June.

There have really only been three weeks since last June when large-cap name have outperformed. Large-cap names that were down this week were Toshiba (6502) down 23%, Iida Group (3291) down 11% and Nikon (7731) down 10%. There was also a slight move into high Beta names. High Beta names have quietly been outperforming since the beginning of the year. Mitsui Mining and Smelting (5706) is up 19% and Tokio Marine Holdings (8766) is up 5%.

Who Moved – 42 names moved on volume this week. The volume spikes look to be spread across all sectors. On the positive side, Toyo Tire & Rubber is up 25%, Mitsui Mining and Smelting is up 19% and MinebeaMitsumi is up 19%. On the other side, Iida Group (3291)is down 11%, Nikon is down 10% and Asics Corp (7936) is down 9%.

Summary

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