Schroder Investment: Optimistic about the overall profitability of Japanese companies

According to the Wisdom Financial APP, on August 8th, Schroders Investment published an article stating that recently, the Japanese stock market has been hit hard by selling pressure, but the policy adjustments by the Bank of Japan are not entirely bad news for the local stock market. With the reversal of the yen's trend and wage growth, it is expected to be beneficial for future consumption. Based on these economic trends, the bank holds an optimistic view on the overall profitability of Japanese companies.

In recent days, there has been severe volatility in the global stock markets, with major indices plummeting. In the three days ending on August 5, 2024, the MSCI All Country World Index (ACWI) fell by 6.4%. By August 6th, there were signs of a market recovery, with the Japanese stock market rebounding.

Simon Webber, Global Investment Portfolio Manager at Schroders Investment, stated that in recent days, there has been intense selling in the stock market, affecting market forecasts and leading to crowded trades. However, considering the exceptionally strong performance of the global stock market from October 2023 to the present (rising by about 32% as of mid-July 2024 from the low point in October 2023), this adjustment is completely healthy and normal.

Several factors have contributed to the decline in global stock markets. These include weak US economic data, which has raised concerns about an economic recession, as well as expectations of rapid interest rate cuts by central banks. Additionally, the unexpected rate hike by the Bank of Japan and concerns about corporate profit prospects have also weighed on the market.

Despite some signs of slowing inflation in the US, the Federal Reserve kept interest rates at their highest level in 23 years during the interest rate meeting on July 30-31, 2024. Subsequently, weak US employment data in early August further confirmed the Fed's decision. The US added only 114,000 non-farm payroll jobs in July, well below the market's earlier expectation of 175,000, while the unemployment rate rose to 4.3%.

George Brown, Senior US Economist at Schroders Investment, stated that the rise in the unemployment rate triggered the Sam rule, which occurs when the three-month moving average of the unemployment rate rises by 0.5 percentage points or more relative to the low of the past 12 months. This rule has historically been a reliable indicator of economic recession, but there have also been cases of misjudgment.

Investors are concerned whether the Fed has missed the best time to cut interest rates, and whether maintaining a wait-and-see attitude will lead to an economic downturn.

George Brown pointed out that the issue lies in the Fed's indication in June 2024 that it would only cut interest rates once within the year. This hawkish stance prevented it from swiftly changing policy direction in July. The Fed may need to cut rates by 50 basis points in September to make up for it. However, the current market expectation of five rate cuts by the Fed in 2024 is an overreaction.

From various perspectives, the recent weak US employment market data shows that higher rates are working as expected; if rates are in a tightening mode, the labor market will tend to weaken. In addition, the main reason for the rise in the unemployment rate is the new labor force provided by immigrants at the southern border of the US Schroder Investment believes that the employment data for a certain month should not be overinterpreted, and it is necessary to wait for several months at least to determine whether there is a clear trend. The economic growth data for the second quarter in the United States is robust, with a year-on-year GDP growth rate of 2.8%. Recently, the weak US economic data is not enough to trigger the large-scale selling behavior seen in the near term.

On July 31, 2024, the Bank of Japan raised its interest rate from the previous range of 0% to 0.1% to 0.25%. Taku Arai, Deputy Head of Schroder Investment's Japanese Stock Team, explained that the Bank of Japan's rate hike reflects its confidence in Japan's macroeconomic growth, including wage growth. This also reduces the risk of further weakening of the yen, thereby avoiding a potential increase in Japanese inflation.

The simultaneous occurrence of the Bank of Japan's rate hike and weak US economic data (implying the need for a rate cut by the Federal Reserve) led to a sharp rise in the yen, but also triggered further financial market volatility.

Simon Webber pointed out that yen carry trades (where investors borrow yen and invest in higher-yielding overseas assets) are rapidly unwinding, leading to significant volatility and rapid appreciation of the yen. The yen has long been severely undervalued, but it is still premature to judge whether the financial markets are overreacting or whether all positions have been unwound.

The significant volatility of the yen has caused turmoil in the financial markets, but as always, any change in trends has winners and losers. Taku Arai believes that these financial market trends will support a bullish stance on Japanese small-cap stocks, as they are more focused on the local domestic market, with the financial sector being one of the beneficiaries. However, Japanese exporters may be negatively affected.

The recent sell-off coincided with the second-quarter 2024 earnings season, but this did not cause concern. Simon Webber pointed out that the second-quarter earnings performance in major global stock markets was quite strong, despite clear signs of consumer weakness. The recent trends in the financial markets largely reflect investors' concerns about the outlook for the US economy, leading to a valuation correction in US stocks from the elevated levels we have long warned about.

In fact, with about 75% of the earnings season for the S&P 500 index completed, the number of companies reporting earnings that exceed expectations is significantly higher than those falling below expectations. Tina Fong, Schroder Investment's strategist, stated that the earnings growth rate for this earnings season reached 14%, higher than market expectations. However, the extent of the outperformance is lower than in previous quarters, leading to market disappointment.

Earnings per share growth rate - Expected EPS for the second quarter of 2024 is expected to outperform the first quarter.

Currently, the financial markets are mainly selling off some previously popular industry sectors, such as the technology sector. Several large US technology companies emphasized their investments in artificial intelligence (AI) during their earnings conference calls Tina Fong added that for investors, whether these tech companies can successfully translate their investments in artificial intelligence into profits will be a major focus in the coming quarters.

Overall, Schroder Investment pointed out that while there is indeed adjustment risk in the stock market, the fundamentals of companies are good, and the increased volatility in the financial markets has created opportunities for us to utilize misalignment adjustments in investment portfolios. The bank still forecasts an economic soft landing as the main scenario, and continues to expect moderate earnings growth from companies in the medium term to continue supporting the stock market