Insights

The US presidential election in November continues to cast a long shadow, and as the race between the 45th (Donald Trump) and 46th (incumbent Joe Biden) presidents quickens, divisions have only widened. The investment world is no exception, and one particularly troubling battleground is the growing regulatory divide regarding ESG reporting.

This month we analyse why the influence of capex and wages on spending behaviour are key to gauging whether an inflationary mindset is taking hold among households; amid an adjustment by Japanese stocks from record highs, we also look for growth narratives to sustain a long term uptrend.

Naomi Fink recently joined Nikko Asset Management as a Global Strategist based in Tokyo. We sat down with Naomi to discuss her personal relationship with Japan, and to hear her views on arguably the most talked-about investment region in the world at present.

Dreams have a place in the world. However, in stock markets, cashflows often serve as gravity when share prices display dream-like behaviour. Fortunately, our Future Quality philosophy, coupled with our consistent process of reviewing the portfolio and ranking stocks, will help us separate dreams from reality. As a result, the portfolio is performing well, especially due to stock selection outside of AI and across all sectors.

The Bank of Japan kept interest rates steady as expected while upping its CPI forecast, paving the way for future rate hikes. Any further hawkish stance by the BOJ may depend on the persistence of positive real wages and inflation's impact on consumer purchasing power.

Inflation uncertainty seems increasingly entrenched, which is less kind to developed market sovereign bonds. The US fiscal deficit is very large, and the Federal Reserve (Fed) is now in the challenging position of deciding when to cut rates. Energy remains a good hedge in this environment, and gold is increasingly being recognised as a store of value.

The Chinese economy and its equity market continue to be significant focal points in broader Asia. Additional support measures, combined with a recalibration of market expectations, have helped Chinese equities recover from the panic selling witnessed towards the end of 2023 and into January. As a result, fundamental strengths are being recognised in certain areas.

We maintain a positive outlook for Asian local government bonds, particularly those from India, Indonesia and the Philippines. In our view, the disinflation trends in these countries should provide their central banks with the flexibility to shift towards rate cuts later in the year.

We highlight the importance of making decisions based on probabilities and the best expected outcomes, assessing relevant information and acting ahead in constantly changing market conditions.

The Bank of Japan (BOJ) lifted interest rates for the first time in 17 years in March, making a historic departure from negative interest rates. We provide an overall evaluation of its decision, discuss how long accommodative monetary conditions could still last, analyse the yen’s potential policy impact and assess the BOJ’s options after halting ETF purchases.

The Global Investment Committee sees robust corporate earnings, firm employment and expectations for rate cuts keeping markets more buoyant than anticipated by average consensus estimates.

We remain very strong supporters of the healthcare sector. In addition to the well-known demographic drivers, innovation is enabling structural changes in healthcare delivery and in our view these changes will confer years of strong organic growth opportunities if we choose the right companies.

Japanese households, long under-invested in financial markets, are expected to play a significant part in the country’s “virtuous circle” of reflation as they seek returns capable of keeping up with inflation.

The stage is now set for a Biden versus Trump rematch in November. So, what does this mean for sustainable bonds?

Improving economic dynamics defy conventional logic of what one would expect from one of the most aggressive tightening cycles in history. However, if one considers the magnitude of the 2020 expansion in money supply, there is still significant excess liquidity, perhaps transmitting to resilient demand and cash flow that so far exceeds the headwinds of higher rates.

We think that there could be some short-term rebound in China as valuations are in extreme oversold territory. However, for the rally to be more sustainable, we are monitoring for a few drivers, including supply-side measures that can resolve China’s main housing issues.

We maintain a positive outlook for Asian local government bonds, particularly India, Indonesia and Philippine bonds. In our view, the disinflation trends in these countries should provide the Reserve Bank of India, Bank Indonesia and Bangko Sentral ng Pilipinas with the flexibility to shift towards rate cuts later in the year.

The Asian REIT market is the second-largest REIT market globally, but there is still plenty of room for growth. As REIT regulations and listing processes become increasingly market-friendly in newer REIT markets, we expect more asset owners to securitise their real estate into REIT products, driving greater investor interest.

The “trial balloons” of media announcements in advance of today’s interest rate hike by the Bank of Japan —its first in 17 years—apparently did their job, as the end of its negative interest rate policy, yield curve control and ETF purchases were smoothly digested by markets.

The green bond market has experienced tremendous growth since 2007, but despite its rapid success, there are still barriers to overcome. In particular, assessing the impact of green bonds continues to be a contentious topic.

Japan equity was the best-performing asset class in 2023, but despite the Nikkei reaching all-time highs in 2024, Japan also recently experienced economic contraction. Against that backdrop, Japan Equity Investment Director Junichi Takayama offers five reasons why Japan’s economic resurgence still has ample runway.

We visited Vietnam in February and found that business and economic prospects have turned around completely for the better from a year ago. Interest rates have normalised, and mortgage terms are the most favourable that we have ever seen in Vietnam.

This month we focus on the prospect of Japanese stocks sustaining their upward trajectory after reaching record highs; we also assess how the country’s Q4 GDP contraction sharpens the focus on consumption and wages in 2024.

One of Japan’s more recent economic releases made us sit up and take notice. Within the very resilient Q4 capital expenditure figures released this week was one important reinforcing indicator of Japan’s structural recovery, or in the Bank of Japan’s language, its “virtuous circle” of reflation. One near-term positive development for Japan is the very real possibility that the “technical recession” in Japan Q4 GDP (down 0.4% quarter-on-quarter) could be, thanks to unexpectedly strong Q4 capex, revised away.

This is the “swan song” of this report, which comes at an appropriate time because it was always meant to prove to readers that corporate governance, and the overall case for investing in Japanese equities, was sound. Now that the market’s performance and global enthusiasm for Japan has swelled, there is less need for the report, although it is useful to note the continuance of its impressive trend.

We explain how reflationary dynamics underpin the foundations of Japan’s incipient structural recovery and illustrate why we believe the country’s equity comeback should not be written off as another flash-in-the-pan cyclical upturn headed for an eventual return to deflationary dynamics.

The seemingly impossible soft landing on the back of one of the most aggressive monetary tightening cycles in history is looking not just possible, but increasingly probable. US data is coming in stronger and global demand is generally steady with increasing channels of potential upside.

Our economic system is based on a model of take, make and waste that consistently over-utilises and fails to replenish Earth’s valuable, but dwindling resources. The need to transform how we interact with nature creates a major opportunity for the green bond universe. So far, issuers have successfully embraced funding the transition toward carbon neutrality, but far fewer are looking at regenerative biodiversity projects or initiatives that seek to protect our ecosystems from loss.

Our Future Quality investment philosophy revolves around identifying companies that have pricing power, possess management teams that invest will appropriately, boast strong balance sheets and offer opportunities that are not yet priced in by the market. This approach will remain constant in 2024 although we are also acutely aware of the significant impact energy security will have on global decarbonisation efforts.

The Indian market remains attractive. It has the highest earnings growth in the Asian region, valuations that are in the middle of its historic range and an economy that is growing strongly with inflation under control.

We expect an anticipated decrease in developed market bond yields, coupled with enhanced foreign inflows, to bolster demand for Asian bonds. We see Asia credit remaining well supported with subdued net new supply as issuers continue to access cheaper onshore funding.

The emergence of AI has dramatically shifted the future pathway for the technology sector, and our research has found that this emerging structural trend chimes with our Future Quality principles.

While fixed income issuance has become a standard mechanism for governments and companies to raise finance, it often lacks a defined purpose. However, the growing trend of responsible investing is changing that. The need to tackle our planet’s many climate, environmental and societal challenges is reuniting fixed income with its sense of purpose.

This month we discuss how emerging growth narratives such as semiconductors may come into focus in 2024; we also assess the slightly hawkish turn the BOJ took at its January policy meeting.

Last year, global investors turned their attention firmly towards Japan as a way of increasing their Asia exposure while avoiding perceived geopolitical and regulatory risks linked to China, and amid the high inflation environment dominating western economies. But this year, Japan’s success is more based on its own merits.

The US economy continues to look robust, so we have stayed constructive on growth assets and short maturity global credit where yields are attractive. We still believe that the path to 2% inflation in the US is relatively unclear. If anything, our conviction on this point has increased because easier financial conditions may ultimately pave the way for the return of sticky inflation.

The peaking of interest rates and potentially the US dollar could be a boon for broader markets—particularly those more sensitive to liquidity, countries with more room to ease rates and areas where positive fundamental changes have been overlooked. China’s economy is undergoing a major transition into one that promotes advanced manufacturing, technology, self-sufficiency and higher-end overseas growth. These are areas of our focus.

We expect macro and corporate credit fundamentals across Asia ex-China to stay resilient due to fiscal buffers although slower economic growth seems to loom over the horizon.

This month we discuss why the equity market is relatively unaffected by the political scandal shaking Japan’s ruling party; we also assess how 2024 could become an inflection point in the country’s “savings to investments” drive.

Although we believe that the prospects for the economy remain mostly unchanged, the outlook is softer at the margins, perhaps reflecting the tightening of financial conditions seen during the recent months. Over the past month, however, financial conditions have eased considerably on the assumption of impending rate cuts.

Given the volume of quality defensive companies with relatively high dividend yields, higher for longer interest rates are a significant headwind for New Zealand’s equity markets. Alongside these, the country’s globally-focused export companies will be looking for the global growth story to play out positively, but for the meantime will at least be enjoying a relatively weak New Zealand dollar.

Japan may not be known for quick, sweeping reforms. However, developments in the country’s corporate governance over the last 10 years suggest that once changes are set in motion, they can have a deep and lasting impact, raising the value of its companies and creating investment opportunities along the way.

We expect poor 1Q24 returns for MSCI World after the 4Q23 surge, but a more positive trend for the rest of 2024. Regionally, we much prefer Japan in the year ahead. Our view on global bonds for USD-based investors is that they are preferred during much of the 1H, but only marginally attractive in the 2H.

We expect sentiment toward Asia’s bond markets to turn increasingly positive in 2024. We also expect macro and corporate credit fundamentals across Asia ex-China to stay resilient on the back of fiscal buffers, although slower economic growth appears to loom over the horizon.

Despite short-term negatives, we believe that China continues to offer ample long-term growth opportunities as the country pivots towards advanced manufacturing and technology. Elsewhere, some of the best growth stories globally could be found in India and Indonesia, while Taiwan and South Korea are expected to continue benefitting from a modest upcycle as the semiconductor industry recovers.

We discuss how a bullish year for Japan equities has brought what was previously out of sight into view and analyse focal points for the market as we head into 2024; we also assess how focusing on efficiency and growth could be the way forward for Japan given its projected drop in the GDP rankings.

Our investment themes for 2024 focus on key features of a world in transition. They include higher-for-longer rates, production shortages in natural resources and the search for new sources of productivity. Transitions are never easy, and features of the old world accustomed to low rates may not make it. We believe that some of these old-world features could pose systemic risks as “creative destruction” does not always run smoothly.

We are heading into a changing world, where the more recent past can no longer be relied on to guide our path forward. But we are not blindfolded. There are tools we can use to provide a greater degree of certainty. Our Future Quality approach is designed to help us identify franchises that are set to endure.

We present our 2024 outlook for sustainable fixed income, core markets and credit markets.

We expect 2024 to be a year of domestic consolidation and long-term reform measures, where markets are driven more by Japan-specific events than by global factors. After decades of deflation, we see Japan as finally breaking out of this cycle in 2024, as it enters a virtuous cycle of price increases and wage hikes.