Investors like drama. When there is an extreme, there is a desire to push it to even more extremes before going in the exact opposite direction. For example, in 2008, we saw the USD turn into the biggest-ever bull market of a reserve currency after having been regarded as ‘not worth the paper it is printed on’. In 2022, we also saw the Nasdaq mega caps transition from rulers of the world to a bursting bubble in the blink of an eye, just to experience a rebirth ever since. As for the first ten weeks of 2024, the swings have been about rate expectations by large central banks.

And while the Nikkei index in Japan has reached an all time high with ingredients for a positive long term story, we continue to watch for volatility.

Japan strategy: What now?

The Nikkei index reached all-time highs last week before retreating slightly on a stronger yen. With Japan’s Nikkei and Topix indices rising in the near term, the positive narrative continues to grab headlines.

First, corporate reform initiatives keep gaining traction, with the most recent monthly report by the Tokyo Stock Exchange showing that 54% (previously 49%) of corporates listed in the Prime section have disclosed some form of initiative to address suppressed valuations and cash hoarding, and to make investments aimed at earning more than their cost of capital.

Second, the earnings story of Japanese corporates has been positive overall, both relative to its own history and to other regions. The chart below shows a strong correlation between earnings revisions and the overall index.

Finally, the keenly watched spring wage negotiations currently under way are pointing to a robust increase in wages. While that could lead to higher costs for companies, we believe that the latter will be more than offset by the positive corporate earnings picture.

However, we are cognizant that Japanese stocks still respond to yen strength, and, with more market commentary focusing on the central bank tightening in March vs April, this could create some volatility.

Currencies: What does this mean for the Japanese yen?

The Japanese yen has recently strengthened as markets’ confidence that the Bank of Japan (BoJ) will soon shift its policy away from negative interest rates has risen. This was backed by indications that the upcoming wage negotiations could bring wages up by 5% and by an upward revision to the Q4 GDP growth data, which called off the technical recession.

We remain somewhat skeptical that the BoJ will already bring its policy rate out of negative territory in one of the next meetings, as domestic demand remains weak, suggesting rather limited inflation pressure. We believe it more likely that the BoJ will first tweak or formally end its yield-curve control already in the first half of this year and that the outright monetary policy tightening will occur instead in the second half of 2024. 

Swiss equities: A defensively tilted market

The recent performance of Swiss equities has been disappointing, as the defensively oriented market index has not benefited from the current euphoria fuelled by the artificial intelligence (AI) theme. Nevertheless, earnings growth expectations remain high, and the index has a solid track record in times of economic slowdown.

Swiss equities have underperformed US and European equities in 2023, and are still lagging year to date. Nonetheless, performance can be quite sensitive to currency adjustments. In 2023, the total return for the Swiss Market Index was 7.1% in CHF terms, while it was 17.6% in USD terms due to the strong appreciation of the CHF.

Year to date, however, the opposite is true: as expectations of a rate cut by the Swiss National Bank are pushing the CHF lower. A further consideration is the defensive tilt of the market, as sectors such as healthcare and consumer defensives make up more than 50% of the weight in Swiss equities. This also helps to explain why the investor euphoria surrounding the AI theme has not had a strong impact on the Swiss market, as the latter has lower exposure to the information technology sector.

What does this mean for investors?

Going forward, we still expect the global slowdown in economic growth to be positive for the Swiss market, as there is a negative correlation between global leading indicators and local equity performance. Furthermore, we see earnings growth expectations remain solid for 2024 and 2025, reaffirming our constructive view on Swiss stocks.

For Japan, the ingredients for a positive long-term story remain and provide opportunities for investors. However, we are cognizant that Japanese stocks still respond to yen strength, and with their tie to the S&P 500 and the market commentary focused on the central bank tightening, this could create some volatility.