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Equity Risk Monitors — May 23, 2023

Equity Risk Monitor Highlights | Week Ended May 19, 2023

Land of the rising equity market

We don’t often talk about the Japanese market in this update, although we did mention it on April 14th in the context of “exceptionalism”, in that it was the only developed market that had shown an increasing trend in risk forecasts.  While there was a jump in the forecast across all four variants of the JP4 risk model in the 2nd half of March, the forecast risk levels have now settled into a range between 13.25% (Medium-Horizon Statistical) and 14.5% (Short-Horizon Statistical):

See chart from the Japan Equity Risk Monitor, week ended May 19, 2023:

These risk levels are lower than the US, but higher than Europe:

What the risk levels don’t show is how well the Japanese market has performed YTD, and especially over the last month or so.

The two following charts are not available in the Equity Risk Monitors but will be furnished upon request:

While the German index (DAX®) has the best performance YTD among the indices we track closely, since the end of April, the Japan 600 is far and away the best performer.  There has been a good deal of press coverage on Japan’s equity market of late, as the index levels have reached 33-year highs, Berkshire Hathaway has taken significant stakes in many Japanese firms along with many other foreign investors, and reforms in market structure have started to take hold.  These reforms include the unwinding of decades-old cross holdings (thereby freeing up liquidity) and return of cash to shareholders in the form of dividend payouts and stock buybacks.  Japanese firms have traditionally held very high cash balances compared with companies domiciled in other countries.  In addition, the Bank of Japan has the most supportive monetary policy of any developed market central bank- as they try to bring about the end of a long deflationary regime.

Looking at factor returns in Japan along with some index metrics appears to align with the news analysis:

There is a lot to point out here- first of all, as we discussed a few weeks ago, the “risk on” factors of Market Sensitivity and Volatility in Japan have strong positive returns in every trailing period. This has not been the case in the US or Europe, where Volatility has been quite negative and Market Sensitivity has been flat or slightly up.  Second, the Large Size effect, which we highlighted back on 28 April for the US, has been extremely strong in Japan, even more so than in the US over the last 3-6 months. Japan’s  Midcap factor (only US and Japan have this factor) has also been strong and been a major contributor to the index return.

The relatively low valuations and high book values of many Japanese firms are attracting traditional value investors (Buffet?) seeking to buy the expected cash flows stored up in all those retained earnings. Hence, we see strong returns to the “Value” trio of factors, namely, Value, Earnings Yield, and Dividend Yield.  It is notable that while Earnings Yield has been strong in other developed markets YTD, Value (based on old-fashioned Book Value) has not.  Japan’s most dominant sector is Industrials (unlike most other Developed Markets) which are capital intensive industries where book value has still has significant economic meaning, and the performance of Value is concurrent with the Industrials sector leading the index: