2015 Q1 House Views Update
by Nikko Asset Management's Global Investment Committee

Equity Markets

Our forecasted macro-backdrop is positive for global equities. Indeed, aggregating our national forecasts from our base date of March 20th, we forecast that the MSCI World Total Return Index will increase 1.3% (unannualized) through June in USD terms (+2.8% in Yen terms) and 4.8% by September-end (7.2% in Yen terms). These are very attractive gains in today’s low interest environment, especially for Yen-based investors. We have been overweight global equities (except for one neutral quarter) since September 2011 and will remain so for now.

The SPX is now trading at 17.0 times NTM (next twelve month) earnings, which seems a bit high in a historical context, but due to interest rates remaining structurally lower than any time since the 1950s, we believe this is a fair valuation. However, we do not believe further re-rating is possible now that bond yields are likely to rise, but we think stocks can rise along with earnings. USD earnings are decelerating, but this is greatly due to the negative translation effect of USD strength on overseas earnings, and due to lower energy prices, but we expect earnings to grow 5% in 2015, while M&A and share buybacks should also support the market.

Eurozone equity valuations have surged to rather high levels, as equity prices increased with the lower EUR and a rebound in economic confidence from very low levels. We think the market needs to pause (we estimate virtually no gains in USD terms through September) for earnings to catch up, so we will eliminate our six month-old overweight stance on the region.

Japan is finally outperforming, but it remains under-owned and under-appreciated by both local and international investors. It has proved our conviction that it does not need a weak Yen in order to perform and that micro factors (especially corporate earnings) were much more important than macro data like GDP or third arrow concerns.

Abenomics has disappointed some investors and skepticism remains fairly high, but such is fading as more good news comes out, especially on corporate taxes and GPIF’s asset re-allocation. Indeed, we believe that Abenomics is working well, especially for corporations, with pretax profit margins soaring to historical highs for both manufacturing and non-manufacturing sectors. It is, thus, also working very well for equity investors, and should continue to do so., in our view. Indeed, the market PER of 16.3 times our forward earnings estimate is attractive and consensus earnings estimates will likely continue to improve, partly due to a continually slightly weaker Yen but also due to the improving global economy and reduced skepticism by investors. Thus, we expect 8% unannualized returns in USD terms through September and 10.4% in Yen terms.

Regarding TPP, PM Abe has made it clear that he will do everything necessary for it to be successful and we estimate that “Fast Track” legislation will pass the US Congress fairly soon, followed not too long after by a full TPP agreement. This is perhaps the most important part of the “third arrow” set of reforms, so it is very important for investment sentiment. Lastly, we forecast that an equity culture is bound to develop in Japan, as remaining risk-free will likely mean poverty in retirement, as both inflation and VAT rates are likely to rise over the intermediate and long term.

In sum, we forecast that Europe will underperform in the next six months, with the US, Japan and Asia Pac ex Japan performing the best and, thus, deserving an overweight stance.

Main Risks

Greece, global geopolitics and a more aggressive Fed are the highest risk factors to our view and we will continue to be ready to react to any major changes. Similarly, events relating to China’s economy (and/or Europe’s) must be watched very carefully because the tail risk of a major downturn is far from negligible. Lastly, the chance that the global bond markets might sell off more than we expect due to fears about central bank policies is not an impossible risk either.

Investment Strategy Concluding View

We calculate that equity valuations are at fair levels (albeit with some over-valuation in Europe) and that stocks can grow along with earnings due to:

  1. a sturdy, and slightly above consensus G-3 macroeconomic backdrop;
  2. dovish central banks;
  3. tamed geopolitical risks and
  4. other supporting factors such as Abenomics in Japan, high global M&A activity and improved corporate governance in Europe and Japan.

Coupled with our expectation for global bond yields to rise moderately, we maintain our overweight view on global equities vs. bonds. Notably, while we do not make official forecasts on emerging markets, their prospects have reversed our long-held negative view on them to a much more positive stance on their currencies and equity markets.