The old adage “familiarity breeds contempt” helps explain the “love-hate” relationship most investors have with their home market.
On the one hand, many investors maintain a massive structural overweight to their home country, a phenomenon known as a “home country bias.” At the same time, when I travel, I’ve generally found that investors seem the most pessimistic about their own economy and market. The Europeans fret about the lack of local reforms. In Australia, investors usually bemoan the economy’s dependence on commodities. And in Japan, the case was similar, at least until this year.
Some Lessons—and Surprises—About the Japanese Economy
I normally travel to Tokyo at the end of each year to meet with Japanese institutional clients. In the past, the tone of these discussions was quite bearish, at least in regards to the local equity market. This year was different.
Investors, many of whom I’ve been meeting with consistently for the past five years, were unusually optimistic about the Japanese economy and the outlook for Japanese stocks. But while Japanese investors have turned positive on their domestic market, most voiced caution toward the United States.
With regards to their local market, whether it was the El Nino-induced warm weather or the fact that other markets simply seem to be in worse shape, Japanese investors were positively sanguine on the local state of affairs. Perhaps another year of relatively strong performance has shifted their view. Another potential explanation: Investors have recently been treated to several market friendly government initiatives in the run-up to the upcoming elections.
But regardless of what sparked their optimism, many local investors shared my positive view of the Japanese market, one of the developed markets I particularly like given Japanese stocks’ relatively compelling valuations and the country’s market-friendly monetary easing.
In addition to a generally bullish stance on domestic equities, local investors seemed relatively unconcerned about Japan’s massive government-debt market. Despite Japanese bonds’ barely positive nominal yields-Japanese 10-year bonds recently yielded less than 30 basis points (bps), according to Bloomberg data-and the fact that Japan has the largest debt burden of any developed country, nobody I spoke with seemed worried about Japanese debt.
Investors were more divided as to whether or not the Bank of Japan (BOJ) is likely to expand its quantitative easing (QE) program. That said, there was a strong consensus that the BOJ would be content to see the yen drift a bit lower, perhaps down to 130 yen per dollar.
What Japanese Investors Do Fear: High Yield and Donald Trump
To be sure, Japanese investors weren’t fearless, though their worries seemed focused across the Pacific. In particular, two concerns about the United States dominated our discussions. Given recent volatility and headlines, institutional investors said they were concerned about their U.S. high yield exposure. While Japanese investors didn’t seem particularly eager to sell this asset class, many were eager to understand the impact of lower oil prices on high yield energy issuers.
The second concern was less immediate: the upcoming U.S. Presidential election. Most U.S. investors are still a long way from focusing on the potential implications of the 2016 election, at least judging by media headlines. In Japan, in contrast, the U.S. election was a major topic in every discussion I had.
In particular, investors were both fascinated and worried over the possibility of a Trump Presidency. Interestingly, this topic came up as well during my recent meeting with large family offices in Mexico. Although in fairness to the Mexican investors, one can hardly blame them for being a bit concerned, given that Donald Trump wants Mexico to pay to build a wall along the U.S. border. That wall won’t come cheap.
Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog.
