Japanese Equities Awaken

At Macro Ops we like trades where a confluence of positive tailwinds intersect with a thematic that has a long runway. Opportunities where attractive valuations spawned by negative to neutral sentiment combined with improving fundamentals and accelerating momentum are what we look for.

One of our current holdings checks all these boxes. I’m talking about Japanese equities. A theme we’re playing using futures on the Nikkei (DXJ is the ETF alternative).

The Nikkei has had a good run since it first popped up on our radar back in September.

But this move is only getting started. Here’s why it’s time to be long Japan.

On a valuation basis, Japan is one of the cheapest developed markets. Trading at a forward PE of 15x it’s well below the global PE average of 17X and the US’s lofty forward PE ratio of 18.6X,

While the US and European markets have been getting all of the attention. The Nikkei has quietly made new multi-decade highs.

And after underperforming relative to the rest of the world (ROW) for decades, the Japanese market has been rising faster than global stocks as a whole since 2013.

Relative momentum is an important factor. It makes plainly visible the large trends created from global capital flows. These trends, once started, have a tendency to persist for years.

Behind this improving tape is one of the best looking fundamental backdrops of any advanced economy.

Japan had the fastest increase in earnings growth of all the major stock markets in 17’. Net profits for Topix companies increased 35% Y/Y in the first half of fiscal year 18’.

And the market continues to be overly pessimistic on earnings estimates. This is resulting in forecasts having to be continuously revised higher.

It’s steady positive surprises like these that drive bull markets (the market climbing the proverbial wall of worry). Here’s the same chart along with FTSE Japan on a Y/Y basis, showing earnings surprises (both positive and negative) leading stock returns.

We expect this positive fundamental momentum to accelerate in the year ahead.

After years of stagnation, Japan is finally seeing its nominal GDP make new highs (chart via Morgan Stanley).

Its Leading Composite index (LCI), a composite of 12 indices measuring the country’s economic and financial health, has been strongly trending higher since 2015. This signals robust economic momentum that should continue into the foreseeable future.

We can see this improving economic momentum across the board. The Tankan business conditions survey recently saw its most positive results in over 20+ years.

Employers are on a hiring binge.

The labor market is the strongest it has been in 23 years.

In addition to this great trifecta of low valuations, negative to neutral sentiment, and improving fundamental backdrop, there are a number of catalysts that are set to drive this trend onwards and upwards.

In December, the Japanese ruling coalition approved a draft for a significant tax package (surprisingly, it’s received little attention in the press).

The aim of this tax proposal is to incentivize corporates to raise wages and increase capex spending.

If passed, it would lower the effective corporate tax rate to as low as 20%, down from 30% where it currently sits. The law would allow large corporates to reduce their effective corporate tax rates to 25% if they raise wages by more than 3% as well as expand investment.

The 25% rate could be reduced further, to the minimum 20%, if companies invest into new technologies that are related to the Internet of Things (IoT).

If this proposal gets passed into law (we think it will be, albeit with some minor changes), it will take effect this fiscal year and run for three years.

This would be huge… Japanese public companies have a lot of cash (estimates put it at close to 120tn yen) sitting on their balance sheets. That’s a lot of cash that could potentially be put to work in the real economy.

There’s also a number of positive macro tailwinds, such as a likely fiscal/infrastructure boost in spending as Japan prepares for the coming 2020 Tokyo Summer Olympics. Not to mention, accelerating economic/business ties between Japan and mainland China. China is seeing rising labor costs and so is turning to Japan for robots, amongst many other high-value items.

If you don’t own any Japanese stocks, you might want to rethink that.

In a follow on piece, I’ll talk about a few Japanese stocks we’re tracking which have large upside potential.

PS — If you’d like more of this type of research, then check out the Macro Intelligence Report (MIR) here.

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Brandon Beylo

Value Investor

Brandon has been a professional investor focusing on value for over 13 years, spending his time in small to micro-cap companies, spin-offs, SPACs, and deep value liquidation situations. Over time, he’s developed a deeper understanding for what deep-value investing actually means, and refined his philosophy to include any business trading at a wild discount to what he thinks its worth in 3-5 years.

Brandon has a tenacious passion for investing, broad-based learning, and business. He previously worked for several leading investment firms before joining the team at Macro Ops. He lives by the famous Munger mantra of trying to get a little smarter each day.


Investing & Personal Finance

AK is the founder of Macro Ops and the host of Fallible.

He started out in corporate economics for a Fortune 50 company before moving to a long/short equity investment firm.

With Macro Ops focused primarily on institutional clients, AK moved to servicing new investors just starting their journey. He takes the professional research and education produced at Macro Ops and breaks it down for beginners. The goal is to help clients find the best solution for their investing needs through effective education.

Tyler Kling

Volatility & Options Trader

Former trade desk manager at $100+ million family office where he oversaw multiple traders and helped develop cutting edge quantitative strategies in the derivatives market.

He worked as a consultant to the family office’s in-house fund of funds in the areas of portfolio manager evaluation and capital allocation.

Certified in Quantitative Finance from the Fitch Learning Center in London, England where he studied under famous quants such as Paul Wilmott.

Alex Barrow

Macro Trader

Founder and head macro trader at Macro Ops. Alex joined the US Marine Corps on his 18th birthday just one month after the 9/11 terrorist attacks. He subsequently spent a decade in the military. Serving in various capacities from scout sniper to interrogator and counterintelligence specialist. Following his military service, he worked as a contract intelligence professional for a number of US agencies (from the DIA to FBI) with a focus on counterintelligence and terrorist financing. He also spent time consulting for a tech company that specialized in building analytic software for finance and intelligence analysis.

After leaving the field of intelligence he went to work at a global macro hedge fund. He’s been professionally involved in markets since 2005, has consulted with a number of the leading names in the hedge fund space, and now manages his own family office while running Macro Ops. He’s published over 300 white papers on complex financial and macroeconomic topics, writes regularly about investment/market trends, and frequently speaks at conferences on trading and investing.

Macro Ops is a market research firm geared toward professional and experienced retail traders and investors. Macro Ops’ research has been featured in Forbes, Marketwatch, Business Insider, and Real Vision as well as a number of other leading publications.

You can find out more about Alex on his LinkedIn account here and also find him on Twitter where he frequently shares his market research.