Half-Way Back
Gary Dugan, Chadi Farah, Bill O'Neill
The Global CIO Office
- Markets recover 50% of their dips -equity indices, and bond yield lows.
- Economists debate if weather-related issues distorted the labour market data.
- A substantial part of the Yen carry trade is unwound
- Japanese equities have still to recover as much as global equities and have a following wind of better economic data.
- Bond yields drift from expensive to fully valued in the absence of a recession.
Global equites ended a 10-day rout, recovering almost half-way back to where they stood prior to the US employment report. Although Japan too has recovered around half of the losses, it is more substantially behind in percentage terms and probably offers a buying opportunity. Market sentiment has largely recovered although there will a legacy shock to the system which may make investors more discerning investors in crowded trades. We note the substantial outflows from non-investment grade bond funds and the tentative recovery in tech stocks.
Bond markets too, have seen the more extreme bond yield lows reversed again, recovering 50% of their yield drops.
Chart 1: Global Equities Recover Half of the Losses Since US Employment Report
Source: Bloomberg
US economic news maybe not as bad as it seemed
A slew of upbeat economic datapoints since the disappointing US labour market report has had us wondering if the July employment report exaggerated the overall economic weakness. Moreover, in recent days, economists have pointed to the potential distortions in the data from the poor weather in July. A record 461,000 people with full-time jobs said they were unable to work in July, significantly ahead of the long-term average of 50,000. In addition, 1.09 million full-time workers said they could only work part-time during the month.
The good news is that the weaker employment report acted as a trigger in encouraging the Federal Reserve to at least consider to kickstart the rate cutting cycle with a larger cut in September. Many in the market now believe that a 50-bp cut in September is a done deal, and do not rule out a further reduction of 50 bps in November.
Chart 2: Market Expectations for Year-End 2024 and December Interest Rate Cuts
Source: Bloomberg
With the equity markets in a bit of a fragile state, we recommend watching out for this week’s US inflation data. The market expects the headline rate to remain unchanged at 3.0%. We are also of the view that the strength in both food and energy prices should keep the headline rate unchanged.
Chart 3: US CPI Likely Stuck at 3% for Another Month
Source: Bloomberg
Japanese Equities: A Buying Opportunity
After all the market fallout and a settling-down period, Japanese equities are still down 10% from the levels before the onset of the mini-crisis with the Yen markedly appreciating. While investors remain concerned about the recent sharp strengthening in the JPY and the headwind that might affect Japanese corporate profit growth, we believe the setback in equities has thrown open a buying opportunity.
Let’s also address the carry trade. There was much speculation about the scale of the carry trade, which propelled the yen to some initial sharp weakness and some subsequent reversal. A growing consensus is that 75% of the carry trade has already been unwound (ref JPMorgan research). In any case, the yen has unwound a good amount of its most recent weakness, leaving it at a very competitive level relative to the average of the past five years.
Chart 4: Yen has Appreciated but Still at a Competitive Level
Source: Bloomberg
Thankfully, one data point kept the underlying Japan equity story on track. Real wage growth of 1.1% in June was significantly ahead of expectations and showed that there is still good momentum in the macroeconomic tale of an economy in transition to hopefully better things. It was the first real increase in wages in 27 months. Nominal wages grew by 4.5%, the fastest pace of growth since January 1997. Together with good summer bonuses, and likely further wage increases, households should be a far better place financially to increase spending and add weight to the improved outlook for GDP growth.
We also note that Japan is one of the few equity markets that has seen consistent analysts’ upgrades to corporate profit forecasts over the past 12 months. Indeed, 60% of Japanese companies have reported second-quarter results that have led to these upgrades. After the sell off, the market index appreciation over the past 12 months is below the appreciation in consensus earnings forecasts over the same period.
Chart 5: Japanese Equity Market Appreciation Below the Change in Earnings Forecasts
Source: Bloomberg
Bond markets have settled after the sharp drop in yields. In the absence of a near-term recession, the US 10-year government bond yield, on a number of long-term metrics, is, in our opinion, fairly valued at around the 3.90/4.0% level. Recent bond auctions have not had the blind support of markets as they had much higher yields.
Chart 6: Japanese Equity Market Appreciation Below the Change in Earnings Forecasts
Source: Bloomberg
